##### Table of Contents

---



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, 2004



| ̈ | 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 ofincorporation or organization) |  | (I.R.S. EmployerIdentification 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 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 an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes ̈No x



There were no Common Shares of Beneficial Interest held by non-affiliates of the registrant as of December 17, 2004.



The number of Common Shares of Beneficial Interest, $1 Par Value, outstanding as of December 17, 2004 was 4,807,510.



---



---

##### Table of Contents

TABLE OF CONTENTS

PART I



|                                                                                                                    |  |    
|------------------------------------------------------------------------------------------------------------------- |  | ---
|                                                                                                                    | 
|ITEM 1. BUSINESS                                                                                                    |  |    
|Overview                                                                                                            |  | 3  
|Real Estate                                                                                                         |  | 3  
|Banking                                                                                                             |  | 3  
|Federal Taxation                                                                                                    |  | 34 
|                                                                                                                    | 
|ITEM 2.
PROPERTIES                                                                                                  |  | 35 
|Real Estate                                                                                                         |  | 35 
|Banking                                                                                                             |  | 35 
|                                                                                                                    | 
|ITEM 3.
LEGAL PROCEEDINGS                                                                                           |  | 35 
|                                                                                                                    | 
|ITEM 4.
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                                         |  | 35 
|                                                                                                                    | 
|PART II                                                                                                             |  |    
|                                                                                                                    | 
|ITEM 5.
MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASE OF EQUITY SECURITIES |  | 36 
|                                                                                                                    | 
|ITEM 6.
SELECTED FINANCIAL DATA                                                                                     |  | 36 
|                                                                                                                    | 
|ITEM 7.
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS                       |  | 39 
|                                                                                                                    | 
|Financial Condition                                                                                                 |  | 40 
|Real Estate                                                                                                         |  | 40 
|Banking                                                                                                             |  | 41 
|                                                                                                                    | 
|Liquidity and Capital Resources                                                                                     |  | 53 
|Real Estate                                                                                                         |  | 53 
|Banking                                                                                                             |  | 55 
|                                                                                                                    | 
|Results of Operations                                                                                               |  | 57 
|Fiscal 2004 Compared to Fiscal 2003                                                                                 |  | 58 
|Real Estate                                                                                                         |  | 58 
|Banking                                                                                                             |  | 59 
|                                                                                                                    | 
|Fiscal 2003 Compared to Fiscal 2002                                                                                 |  | 64 
|Real Estate                                                                                                         |  | 64 
|Banking                                                                                                             |  | 65 
|                                                                                                                    | 
|ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                                 |  | 67 
|                                                                                                                    | 
|ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA                                                                 |  | 67 
|                                                                                                                    | 
|ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE                        |  | 120
|                                                                                                                    | 
|ITEM 9A.
CONTROLS AND PROCEDURES                                                                                    |  | 120
|                                                                                                                    | 
|PART III                                                                                                            |  |    
|                                                                                                                    | 
|ITEM 10.
TRUSTEES AND EXECUTIVES OFFICERS OF THE TRUST                                                              |  | 120
|                                                                                                                    | 
|Executive Officers of the Trust Who Are Not Directors                                                               |  | 121
|Committees of the Board of Trustees                                                                                 |  | 121
|                                                                                                                    | 
|ITEM 11.
EXECUTIVE COMPENSATION                                                                                     |  | 122
|                                                                                                                    | 
|ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS             |  | 125
|                                                                                                                    | 
|ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS                                                             |  | 125
|                                                                                                                    | 
|ITEM 14.
PRINCIPAL ACCOUNTANT FEES AND SERVICES                                                                     |  | 127
|                                                                                                                    | 
|PART IV                                                                                                             |  |    
|                                                                                                                    | 
|ITEM 15.
EXHIBITS AND FINANCIAL STATEMENT SCHEDULES                                                                 |  | 128



2



---

##### Table of Contents



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 97% of the Trusts
consolidated assets at September 30, 2004, 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 $76.7 million in the fiscal year ended September 30, 2004, compared to a net income of $45.9 million in the fiscal year
ended September 30, 2003.



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 two of its wholly owned subsidiaries, B.F. Saul
Advisory Company L.L.C., referred to in this report as the Advisor, and 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, the Advisor 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.



The Advisor acts as the Real Estate Trusts investment advisor and
manages the financial, accounting, legal and 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.



BANKING



Chevy Chase Bank, F.S.B.
is a federally chartered and federally insured stock savings bank which at September 30, 2004 was conducting business from 228 full-service branch offices, including 54 grocery store banking centers, and 859 automated teller machines in Maryland,
Delaware, Virginia and the District of Columbia. The Bank has its home office in McLean, Virginia and its executive offices in Bethesda, Maryland, both suburban communities of Washington, DC. The Bank either directly or through a wholly owned
subsidiary also maintains a commercial loan production office located in Baltimore, Maryland and six mortgage loan production offices in the mid-Atlantic region. In addition, the Bank utilizes third party originators in order to supplement its
direct origination of loans. At September 30, 2004, the Bank had total assets of $13.3 billion, total deposits of $8.9 billion and total stockholders equity of $711.9 million. Based on total assets at September 30, 2004, Chevy Chase is the
largest full-service bank headquartered in the Washington, DC metropolitan area.



3



---

##### Table of Contents

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. 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 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, Inc., 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 expand its commercial banking program, with an emphasis 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 $231.2 million for
the year ended September 30, 2004, compared to operating income of $146.2 million for the year ended September 30, 2003. At September 30, 2004, the Banks tangible, core, tier 1 risk-based and total risk-based regulatory capital ratios were
6.09%, 6.09%, 8.61% and 10.91%, respectively. The Banks regulatory capital ratios exceeded the requirements under the Financial Institutions Reform, Recovery, and Enforcement Act of 1989, also known as FIRREA, as well as 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.



In October 2003, the Bank issued $125.0 million of its 8%
Noncumulative Perpetual Preferred Stock, Series C (the 8% Preferred Stock) and used the proceeds to redeem all of its 13% Noncumulative Perpetual Preferred Stock, Series A (the 13% Preferred Stock) on October 31, 2003. On
December 2, 2003, the Bank issued $175.0 million of its 6 7/8% subordinated debentures due 2013 (the 2003 Debentures). The net proceeds of that offering, along with short-term borrowings, were used to redeem all of the Banks
subordinated debentures due 2005 and 2008.



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 fully insured up to $100,000 per insured depositor by the FDIC.



4



---

##### Table of Contents

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, 2004.



Hotels



|               |  |                                  |  |           |  |                          |   |  |                          |   |  |      |   |  |      |        |      |   |        |  |   |       
|-------------- |  | -------------------------------- |  | --------- |  | ------------------------ | - |  | ------------------------ | - |  | ---- | - |  | ---- | ------ | ---- | - | ------ |  | - | ------
|               |  |                                  |  |           |  | Average Occupancy (2)    |   |  | Average Room Rate       
|               |  |                                  |  |           |  | Year Ended September 30, |   |  | Year Ended September 30,
|Location       |  | Name                             |  | Rooms (1) |  | 2004                     |   |  | 2003                     |   |  | 2002 |   |  | 2004 |        | 2003 |   | 2002  
|               |  |                                  |  |           |  |                          |   | 
|COLORADO       |  |                                  |  |           |  |                          |   |  |                          |   |  |      |   |  |      |        |      |   |        |  |   |       
|               |  |                                  |  |           |  |                          |   | 
|Pueblo         |  | Pueblo Holiday Inn(3)            |  | 191       |  | 50                       | % |  | 46                       | % |  | 51   | % |  | $    | 58.12  |      | $ | 56.61  |  | $ | 57.39 
|               |  |                                  |  |           |  |                          |   | 
|FLORIDA        |  |                                  |  |           |  |                          |   |  |                          |   |  |      |   |  |      |        |      |   |        |  |   |       
|               |  |                                  |  |           |  |                          |   | 
|Boca Raton     |  | Boca Raton SpringHill Suites     |  | 146       |  | 64                       | % |  | 55                       | % |  | 59   | % |  | $    | 79.78  |      | $ | 73.84  |  | $ | 71.72 
|               |  |                                  |  |           |  |                          |   | 
|Boca Raton     |  | Boca Raton TownePlace Suites     |  | 91        |  | 73                       | % |  | 67                       | % |  | 74   | % |  | $    | 68.70  |      | $ | 64.61  |  | $ | 69.43 
|               |  |                                  |  |           |  |                          |   | 
|Ft. Lauderdale |  | Ft. Lauderdale TownePlace Suites |  | 95        |  | 83                       | % |  | 71                       | % |  | 75   | % |  | $    | 65.20  |      | $ | 64.69  |  | $ | 64.23 
|               |  |                                  |  |           |  |                          |   | 
|MARYLAND       |  |                                  |  |           |  |                          |   |  |                          |   |  |      |   |  |      |        |      |   |        |  |   |       
|               |  |                                  |  |           |  |                          |   | 
|Gaithersburg   |  | Gaithersburg Holiday Inn         |  | 300       |  | 63                       | % |  | 58                       | % |  | 57   | % |  | $    | 82.91  |      | $ | 84.39  |  | $ | 88.94 
|               |  |                                  |  |           |  |                          |   | 
|Gaithersburg   |  | Gaithersburg TownePlace Suites   |  | 91        |  | 78                       | % |  | 71                       | % |  | 76   | % |  | $    | 77.63  |      | $ | 71.82  |  | $ | 69.44 
|               |  |                                  |  |           |  |                          |   | 
|MICHIGAN       |  |                                  |  |           |  |                          |   |  |                          |   |  |      |   |  |      |        |      |   |        |  |   |       
|               |  |                                  |  |           |  |                          |   | 
|Auburn Hills   |  | Auburn Hills Holiday Inn Select  |  | 190       |  | 63                       | % |  | 64                       | % |  | 65   | % |  | $    | 99.54  |      | $ | 98.70  |  | $ | 101.24
|               |  |                                  |  |           |  |                          |   | 
|NEW YORK       |  |                                  |  |           |  |                          |   |  |                          |   |  |      |   |  |      |        |      |   |        |  |   |       
|               |  |                                  |  |           |  |                          |   | 
|Rochester      |  | Rochester Airport Holiday Inn    |  | 279       |  | 62                       | % |  | 66                       | % |  | 59   | % |  | $    | 71.66  |      | $ | 70.46  |  | $ | 67.80 
|               |  |                                  |  |           |  |                          |   | 
|OHIO           |  |                                  |  |           |  |                          |   |  |                          |   |  |      |   |  |      |        |      |   |        |  |   |       
|               |  |                                  |  |           |  |                          |   | 
|Cincinnati     |  | Cincinnati Holiday Inn           |  | 275       |  | 51                       | % |  | 54                       | % |  | 55   | % |  | $    | 71.05  |      | $ | 68.66  |  | $ | 67.66 
|               |  |                                  |  |           |  |                          |   | 
|VIRGINIA       |  |                                  |  |           |  |                          |   |  |                          |   |  |      |   |  |      |        |      |   |        |  |   |       
|               |  |                                  |  |           |  |                          |   | 
|Arlington      |  | National Airport Crowne Plaza    |  | 308       |  | 65                       | % |  | 63                       | % |  | 62   | % |  | $    | 129.50 |      | $ | 124.04 |  | $ | 116.20
|               |  |                                  |  |           |  |                          |   | 
|Arlington      |  | National Airport Holiday Inn     |  | 280       |  | 70                       | % |  | 60                       | % |  | 57   | % |  | $    | 95.25  |      | $ | 90.50  |  | $ | 91.78 
|               |  |                                  |  |           |  |                          |   | 
|Herndon        |  | Herndon Holiday Inn Express      |  | 115       |  | 71                       | % |  | 61                       | % |  | 55   | % |  | $    | 89.69  |      | $ | 81.08  |  | $ | 84.70 
|               |  |                                  |  |           |  |                          |   | 
|McLean         |  | Tysons Corner Courtyard          |  | 229       |  | 74                       | % |  | 67                       | % |  | 64   | % |  | $    | 135.36 |      | $ | 127.57 |  | $ | 132.69
|               |  |                                  |  |           |  |                          |   | 
|McLean         |  | Tysons Corner Holiday Inn(4)     |  | 316       |  | 60                       | % |  | 54                       | % |  | 63   | % |  | $    | 106.07 |      | $ | 91.53  |  | $ | 95.66 
|               |  |                                  |  |           |  |                          |   | 
|Sterling       |  | Dulles Airport Hampton Inn       |  | 123       |  | 71                       | % |  | 62                       | % |  | 54   | % |  | $    | 87.90  |      | $ | 76.26  |  | $ | 81.71 
|               |  |                                  |  |           |  |                          |   | 
|Sterling       |  | Dulles Airport Holiday Inn       |  | 297       |  | 70                       | % |  | 63                       | % |  | 60   | % |  | $    | 89.27  |      | $ | 79.36  |  | $ | 82.60 
|               |  |                                  |  |           |  |                          |   | 
|Sterling       |  | Dulles Airport TownePlace Suites |  | 95        |  | 87                       | % |  | 80                       | % |  | 74   | % |  | $    | 74.42  |      | $ | 70.06  |  | $ | 71.36 
|               |  |                                  |  |           |  |                          |   | 
|Sterling       |  | Dulles Town Center Hampton Inn   |  | 152       |  | 78                       | % |  | 69                       | % |  | 62   | % |  | $    | 90.48  |      | $ | 80.06  |  | $ | 80.36 
|               |  |                                  |  |           |  |                          |   |  |                          |   |  |      |   |  |      |        |      |   |        |  |   |       
|               |  |                                  |  |           |  |                          |   | 
|               |  |                                  |  | 3,573     |  | 66                       | % |  | 61                       | % |  | 61   | % |  | $    | 91.67  |      | $ | 85.93  |  | $ | 86.82 

---

|(1) | Available rooms as of September 30, 2004.
|--- | -----------------------------------------



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



|(3) | Asset held for sale as of September 30, 2004.
|--- | ---------------------------------------------



|(4) | Under renovation during fiscal 2003/2004, completed July 1, 2004.
|--- | -----------------------------------------------------------------



5



---

##### Table of Contents

Office and Industrial



|                |  |                          |  |                        |  |                    |   |  |                           |   |  |      |   |  |         |     |  |         |    
|--------------- |  | ------------------------ |  | ---------------------- |  | ------------------ | - |  | ------------------------- | - |  | ---- | - |  | ------- | --- |  | ------- | ---
|                |  |                          |  |                        |  | LeasingPercentages |   |  | Expiring Leases (1)       |  
|                |  |                          |  |                        |  | September 30,      |   |  | Year Ending September 30, |  
|Location        |  | Name                     |  | Gross Leasable Area(1) |  | 2004               |   |  | 2003                      |   |  | 2002 |   |  | 2005    |     |  | 2006    |    
|                |  |                          |  |                        |  |                    |  
|FLORIDA         |  |                          |  |                        |  |                    |   |  |                           |   |  |      |   |  |         |     |  |         |    
|                |  |                          |  |                        |  |                    |  
|Fort Lauderdale |  | Commerce CenterPhase II |  | 61,149                 |  | 82                 | % |  | 85                        | % |  | 92   | % |  | 11,488  |     |  | 9,408   |    
|                |  |                          |  |                        |  |                    |  
|GEORGIA         |  |                          |  |                        |  |                    |   |  |                           |   |  |      |   |  |         |     |  |         |    
|                |  |                          |  |                        |  |                    |  
|Atlanta         |  | 900 Circle 75 Parkway    |  | 345,502                |  | 82                 | % |  | 78                        | % |  | 82   | % |  | 68,236  |     |  | 56,726  |    
|                |  |                          |  |                        |  |                    |  
|Atlanta         |  | 1000 Circle 75 Parkway   |  | 89,412                 |  | 84                 | % |  | 88                        | % |  | 97   | % |  | 22,087  |     |  | 3,765   |    
|                |  |                          |  |                        |  |                    |  
|Atlanta         |  | 1100 Circle 75 Parkway   |  | 269,049                |  | 91                 | % |  | 90                        | % |  | 95   | % |  | 68,927  |     |  | 56,379  |    
|                |  |                          |  |                        |  |                    |  
|MARYLAND        |  |                          |  |                        |  |                    |   |  |                           |   |  |      |   |  |         |     |  |         |    
|                |  |                          |  |                        |  |                    |  
|Laurel          |  | Sweitzer Lane            |  | 150,020                |  | 100                | % |  | 100                       | % |  | 100  | % |  | NONE    |     |  | NONE    |    
|                |  |                          |  |                        |  |                    |  
|VIRGINIA        |  |                          |  |                        |  |                    |   |  |                           |   |  |      |   |  |         |     |  |         |    
|                |  |                          |  |                        |  |                    |  
|McLean          |  | 8201 Greensboro Drive    |  | 360,854                |  | 93                 | % |  | 75                        | % |  | 81   | % |  | 47,098  |     |  | 20,066  |    
|                |  |                          |  |                        |  |                    |  
|McLean          |  | Tysons Park Place        |  | 247,581                |  | 91                 | % |  | 97                        | % |  | 86   | % |  | 9,253   |     |  | 24,803  |    
|                |  |                          |  |                        |  |                    |  
|Sterling        |  | Dulles North             |  | 59,886                 |  | 100                | % |  | 100                       | % |  | 100  | % |  | NONE    |     |  | NONE    |    
|                |  |                          |  |                        |  |                    |  
|Sterling        |  | Dulles North Two         |  | 79,210                 |  | 100                | % |  | 100                       | % |  | 100  | % |  | NONE    |     |  | 9,991   |    
|                |  |                          |  |                        |  |                    |  
|Sterling        |  | Dulles North Four(2)     |  | 100,207                |  | 100                | % |  | 100                       | % |  | 100  | % |  | NONE    |     |  | NONE    |    
|                |  |                          |  |                        |  |                    |  
|Sterling        |  | Dulles North Five        |  | 80,391                 |  | 100                | % |  | 100                       | % |  | 100  | % |  | NONE    |     |  | NONE    |    
|                |  |                          |  |                        |  |                    |  
|Sterling        |  | Dulles North Six         |  | 53,517                 |  | 100                | % |  | 100                       | % |  | 100  | % |  | NONE    |     |  | NONE    |    
|                |  |                          |  |                        |  |                    |  
|Sterling        |  | Loudoun Tech I(3)        |  | 81,238                 |  | 47                 | % |  | 0                         | % |  | 0    | % |  | NONE    |     |  | NONE    |    
|                |  |                          |  |                        |  |                    |   |  |                           |   |  |      |   |  |         |     |  |         |    
|                |  |                          |  |                        |  |                    |  
|                |  | Totals                   |  | 1,978,016              |  | 90                 | % |  | 85                        | % |  | 86   | % |  | 227,089 | (4) |  | 181,138 | (4)

---

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



|(2) | Operational April 1, 2002.
|--- | --------------------------



|(3) | Operational December 14, 2001.
|--- | ------------------------------



|(4) | Represents 11.5% and 9.2%, respectively, of the Real Estate Trusts office and
industrial portfolio in terms of square footage as of September 30, 2004.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------



Land Parcels



|                                           |  |                                                          |  |                 |  |                                                                  
|------------------------------------------ |  | -------------------------------------------------------- |  | --------------- |  | -----------------------------------------------------------------
|Location                                   |  | Name                                                     |  | Acres           |  | Zoning                                                           
|FLORIDA Boca Raton Fort Lauderdale         |  | Arvida Park of Commerce Commerce
Center                  |  | 6.51.6          |  | Mixed Use Office and Warehouse                                   
|GEORGIA Atlanta                            |  | Circle 75                                                |  | 124.9           |  | Office and Industrial                                            
|KANSAS Overland Park                       |  | Overland Park                                            |  | 161.9           |  | Residential, Office and Retail                                   
|MICHIGAN Auburn Hills                      |  | Auburn Hills Holiday Inn                                 |  | 0.5             |  | Commercial                                                       
|NEW YORK Rochester                         |  | Rochester Airport Holiday Inn                            |  | 2.9             |  | Commercial                                                       
|VIRGINIA McLean Sterling Sterling Sterling |  | Park Place II Cedar Green Church Road Sterling Boulevard |  | 8.110.732.031.9 |  | Office and Industrial Commercial Office and Industrial Industrial
|                                           |  |                                                          |  |                 |  |                                                                  
|                                           |  | Total                                                    |  | 381.0           |  |                                                                  



6



---

##### Table of Contents

Other Real Estate Investments



PURCHASE-LEASEBACK PROPERTIES(1)



|           |  |               |  |                
|---------- |  | ------------- |  | ---------------
|APARTMENTS
|           |  |              
|Location   |  | Name          |  | Number of Units
|LOUISIANA  |  |               |  |                
|Metairie   |  | Chateau Dijon |  | 336            
|TENNESSEE  |  |               |  |                
|Knoxville  |  | Country Club  |  | 232            
|           |  |               |  |                
|           |  | Total         |  | 568            



|                 |  |              |  |                       
|---------------- |  | ------------ |  | ----------------------
|SHOPPING CENTERS
|                 |  |             
|Location         |  | Name         |  | Gross Leasable Area(2)
|GEORGIA          |  |              |  |                       
|Warner Robbins   |  | Houston Mall |  | 264,000               



Other Real Estate



|         |  |              |  |                       
|-------- |  | ------------ |  | ----------------------
|Location |  | Name         |  | Gross Leasable Area(2)
|GEORGIA  |  |              |  |                       
|Atlanta  |  | Old National |  | 160,000               

---

|(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



On August 26, 1993, the Real Estate Trust consummated a series of transactions in which it transferred 22 shopping center
properties and one of its office properties together with the debt associated with such properties, to a newly organized limited partnership, Saul Holdings Limited Partnership (Saul Holdings Partnership), and one of two newly organized
subsidiary limited partnerships of Saul Holdings Partnership. In exchange for the transferred properties, the Real Estate Trust received securities representing a 21.5% limited partnership interest in Saul Holdings Partnership. Entities under common
control with the Trust received limited partnership interests collectively representing a 5.5% partnership interest in Saul Holdings Partnership in exchange for the transfer of property management functions and certain other properties to Saul
Holdings Partnership and its subsidiaries. Saul Centers, Inc., a newly organized, publicly held real estate investment trust (Saul Centers), received a 73.0% general partnership interest in Saul Holdings Partnership in exchange for the
contribution of approximately $220.7 million to Saul Holdings Partnership. Affiliates of the Trust received certain cash distributions from Saul Holdings Partnership 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, 2004 the Real
Estate Trust owns, directly and through one of its wholly owned subsidiaries, 4,184,000 units of limited partnership interests in Saul Holdings Partnership, representing a 19.5% limited partnership interest. The Real Estate Trust owns rights
enabling it to convert its limited partnership interests in Saul Holdings Partnership 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 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 29.9% 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



7



---

##### Table of Contents

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 Partnership. The net income or net loss of Saul Holdings Partnership 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 Partnership and after reimbursement of specified expenses will be distributed quarterly
to the partners in proportion to their respective partnership interests.



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.



Recent revisions to the OTSs Regulatory Handbook for Holding Companies suggest a more active role for the OTS in the direct regulation of thrift holding companies such as the Holding Companies. The current handbook places a greater
emphasis on reviewing the adequacy of the Holding Companies capital, their level of debt, and their ability to fund outstanding debt obligations, and 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.



8



---

##### Table of Contents

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
| | - | ------------------------------------------------------------------------------------------------------



| |  | 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. From time to time, the Bank obtains advances from the FHLB of Atlanta. At September 30, 2004, the Bank had outstanding advances of $2.7 billion.
See Note 14 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 $139.3 million in the capital stock of the FHLB of Atlanta at September 30, 2004. The Bank earned dividends on that stock of
$4.9 million and $4.3 million during the years ended September 30, 2004 and 2003, respectively. Since 1999, membership in the FHLB has been voluntary rather than mandatory 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 meet this requirement 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 4.60% at September 30, 2004 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 to the Savings Association Insurance Fund
(SAIF) 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 supervisory evaluation and on the institutions
capital category under the OTSs prompt corrective action regulations. See Prompt Corrective Action.



Although the FDIC insures commercial banks as well as thrifts, the insurance funds for commercial banks and thrifts have been segregated into the Bank
Insurance Fund (the BIF) and the SAIF. The FDIC is required to maintain the reserve levels of both the BIF and SAIF at 1.25% of insured deposits. If the reserve level of an insurance fund falls below 1.25% the FDIC is required by law to
impose a premium of at least 23 basis points on all institutions whose accounts are insured by that fund until its ratio is restored above the 1.25% minimum. The BIFs reserve ratio was 1.32% and the SAIFs reserve ratio was 1.37% as of
September 30, 2004.



As a result of the Banks assumption
of deposits from a small commercial bank in August, 2003, a small amount of the Banks deposits (less than 1%) are insured by the BIF.



Commercial banks and thrifts are 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 equaled 1.54 basis points for the first semi-annual period of 2004 and 1.47 basis points for the second semi-annual period of 2004.



9



---

##### Table of Contents

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.



Congress has
recently been considering legislation that would reform the deposit insurance system by, among other things, (i) increasing FDIC insurance coverage from $100,000 to $130,000 per account (with certain retirement accounts generally receiving increased
coverage) and indexing future coverage to accommodate inflation, (ii) merging the BIF and the SAIF into a single new Deposit Insurance Fund, (iii) permitting the Funds required reserve ratio to float in a designated range, (iv) eliminating the
current prohibition against assessing risk-based premiums on well-capitalized institutions with high supervisory ratings, thus permitting the FDIC to assess ongoing premiums for all institutions based on their risk profile, and allowing gradual
increases in those premiums if the new Funds ratio falls below the lower end of the designated range, (v) providing dividends to institutions if the ratio exceeds the upper end of the range, and (vi) providing refunds or credits towards future
assessments based on an institutions earlier contributions to the BIF or the SAIF. The Bank expects that these proposals will be considered again during the next session of Congress. Because it remains unclear at this time whether, or in what
form, any such legislation ultimately may be enacted, the Bank is unable to assess the potential effects on the Bank.



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, 2004, the Banks
tangible capital ratio was 6.09%, its core (or leverage) capital ratio was 6.09%, and its total risk-based capital ratio was 10.91%, 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, 2004, the Bank had qualifying servicing assets with a carrying value of $140.7 million, which constituted 17.5% of core capital at that date.



The risk-based capital requirements imposed by the OTS vary the amount of capital required for an asset based on the degree
of credit risk associated with that asset and include, in the asset base, off-balance sheet items used to compute the Banks risk-based capital ratio.



There are currently four categories of risk-weightings:



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



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



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



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



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



Under OTS regulations, residential mortgage loans with negative amortization features that are initially assigned to the 50% risk-weighting may have to be
reassigned to the 100% risk-weighting if, as a result of negative amortization, the loan-to-value ratios are



10



---

##### Table of Contents

no longer commensurate with the risk associated with the loans. The OTS has indicated its intent to conduct a more comprehensive assessment of
negatively amortizing loans and may issue supervisory guidance on their capital treatment.



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.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------



For transactions entered into prior to January 1, 2002, previous capital
rules regarding the treatment of residual interests applied until December 31, 2002; thereafter, the current rules apply.



At September 30, 2004, the Bank had credit enhancing interest-only strips receivable of $1.0 million, which constituted 0.1% 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, non-withdrawable accounts and
pledged deposits, and allowances for loan losses up to a maximum of 1.25% of risk-weighted assets. At September 30, 2004, the Bank had $37.8 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, 2004, the Bank had $175.0 million in
maturing subordinated capital instruments, all of which was includable as supplementary capital. On December 2, 2003, the Bank issued $175.0 million of 2003 Debentures. The net proceeds of the offering, along with short-term borrowings, were used to
redeem all of the 1993 Debentures and the 1996 Debentures. See Deposits and Other Sources of Funds  Borrowings.



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, 2004, the Banks investments in, and loans to, these non-includable subsidiaries totaled approximately $1.1 million, of which $0.9 million constituted a deduction from tangible capital. The Bank has $0.2 million of
valuation allowances maintained against its non-includable subsidiaries, which, pursuant to OTS guidelines, are available as a credit against the otherwise required deductions from 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, 2004, the Bank had one property with a book value of $2.4 million which was treated as an equity investment for regulatory capital purposes. Another property
formerly treated as an equity investment with a book value of $21.9 million was sold on November 20, 2003.



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 2004, the Bank received from the OTS additional extensions through April 7, 2005, of the holding



11



---

##### Table of Contents

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.



In June 2004, the Basel Committee on Banking Supervision published a revised risk-based capital framework designed to replace its 1988 risk-based capital accord, which forms the basis for the risk-based capital
requirements of the OTS and the other U.S. federal financial institution regulators. Key components of what has become known as the Basel II framework include:



| |  | adding a fifth risk-weighting of 150 percent for loans to low-quality companies;
| | - | --------------------------------------------------------------------------------



| |  | using rating agency assessments to determine risk-weightings for claims on banks, commercial loans and securitization interests;
| | - | --------------------------------------------------------------------------------------------------------------------------------



| |  | liberalizing capital requirements for certain collateralized and guaranteed loans;
| | - | ----------------------------------------------------------------------------------



| |  | authorizing regulators to use the supervisory review process to determine whether to impose increased capital requirements on individual institutions with high levels of
interest-rate risk or to require reduction of that risk;
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | establishing a methodology for requiring that capital be maintained against operational risk; and
| | - | -------------------------------------------------------------------------------------------------



| |  | authorizing regulators to impose explicit capital requirements on managed or securitized assets.
| | - | ------------------------------------------------------------------------------------------------



In August 2003, the OTS, along with the other federal banking regulators, issued an Advance Notice of Proposed Rulemaking
setting forth a framework for adoption of Basel II. Under the notice, only the largest U.S. banks would be subject to the new accord, which could adversely affect the competitive position of smaller institutions like the Bank that are generally
expected to continue to operate under a somewhat revised version of the existing capital requirements. U.S. banking regulators have announced plans to publish proposed rules relating to Basel II in mid-2005, with final rules expected to be adopted
in the second quarter of 2006 and to become fully effective in January 2008. They have also indicated that possible changes to capital requirements for institutions like the Bank that will not be subject to the Basel II framework will be considered
and implemented during the same general timeframe. The Bank is unable to predict whether, or in what form, any final changes will be adopted by the OTS or other U.S. regulators, or their possible 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. However, the OTS has not imposed a higher requirement on the Bank.



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



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



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



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



An institutions classification category can be downgraded if, after
notice and an opportunity for a hearing, the OTS determined 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, 2004, the Banks leverage ratio of 6.09%, its tier 1 risk-based ratio of 8.61%, and its total risk-based capital ratio of 10.91% exceeded the minimum ratios established for
well-capitalized institutions.



12



---

##### Table of Contents

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 percent 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 91.4% of its assets invested in qualified thrift
investments at September 30, 2004, 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 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;
| | - | --------------------------------------------------------------



13



---

##### Table of Contents

| |  | 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.
| | - | -------------------------------------------------------------------------------------------------------------------



In October 2003, the Bank issued $125.0 million of its 8% Preferred Stock and
used the proceeds to redeem all of the Banks then-outstanding 13% Preferred Stock on October 31, 2003. 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 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, preferred 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.



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 $152.9 million at September 30, 2004, and no group relationships exceeded this limit at that date.



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



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



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



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



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



14



---

##### Table of Contents

| |  | 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.



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 $1.9 million for the Bank for the 12 month period ending December 31, 2004.



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



Other Regulations and Legislation. The Bank must obtain prior approval
of the OTS before merging with another institution or before acquiring insured deposits through certain transactions. Also, as a SAIF-insured institution, the Bank is subject to limitations on its ability to buy or sell deposits from or to, or to
combine with, a BIF-insured institution. Despite these restrictions, SAIF-insured thrifts may be acquired by banks or by bank holding companies under certain circumstances.



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.
| | - | -----------------------------------------------------------------------------------



15



---

##### Table of Contents

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 will 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 November 25, 2003, the first $6.0 million of the Banks
transaction accounts were subject to a 0% reserve requirement. The next $36.1 million in net transaction accounts were subject to a 3% reserve requirement and any net transaction accounts over $42.1 million were subject to a 10% reserve requirement.
Effective November 25, 2003, the FRB increased the amount of transaction accounts subject to a 0% reserve requirement from $6.0 million to $6.6 million and increased the low reserve tranche from $36.1 million to $38.8 million, which
brings the net transaction amount that was subject to the 10% reserve requirement to amounts over $45.4 million. For net transaction accounts in 2005, the first $7.0 million will be exempt from reserve requirements. A 3% reserve ratio will be
applied to net transaction accounts over $7.0 million up to and including $47.6 million. A 10% reserve ratio will be applied to net transaction accounts in excess of $47.6 million. The Bank met its reserve requirements for each period during the
year ended September 30, 2004.



The Bank may borrow from the
Federal Reserves discount window. FDICIA imposes limitations on the ability of the Federal Reserve to lend to undercapitalized institutions through the discount window.



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.



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 2000 through December 2002, the Bank received an
outstanding CRA rating. The Bank anticipates that its next CRA examination will take place in the first half of 2005.



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.



16



---

##### Table of Contents

Recent revisions to OTS guidelines for holding company supervision suggest a more active role for the OTS
in the direct regulation of thrift holding companies such as the Holding Companies. The current guidelines place a greater emphasis on reviewing the adequacy of the Holding Companies capital, their level of debt, and their ability to fund
outstanding debt obligations, and suggest 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.



Adoption of New Accounting Standard



In January 2003, the Financial Accounting Standards Board (FASB) issued Interpretation No. 46, Consolidation of Variable Interest
Entities (FIN 46). FIN 46 is an Interpretation of Accounting Research Bulletin No. 51 and addresses consolidation by business enterprises of variable interest entities (VIEs). FIN 46 is based on the theory that an
enterprise controlling another entity through interests other than voting interests should consolidate the controlled entity. Business enterprises are required under the provisions of FIN 46 to identify VIEs, based on specified characteristics, and
then determine whether they should be consolidated. An enterprise that holds a majority of the variable interests in another enterprise is considered the primary beneficiary of that enterprise and, therefore, should consolidate the VIE. The primary
beneficiary of a VIE is also required to include various disclosures in interim and annual financial statements. Additionally, an enterprise that holds a significant variable interest in a VIE, but that is not the primary beneficiary, is also
required to make certain disclosures. The Bank is the primary beneficiary of one VIE, which holds the ground lease under the Banks executive offices. The Bank adopted FIN 46 effective July 1, 2003 and, as a result, recorded a gain of $0.9
million as a cumulative effect of a change in accounting principle, net of tax. In addition, upon adoption, the Bank recorded $31.4 million each in property and equipment and minority interest related to the ground lease. See Note 33.



17



---

##### Table of Contents

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 3.1% in September 2004, compared to the national rate of 5.4%.



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 4.7% of the Banks deposits at September 30, 2004 were
obtained from depositors residing outside of Maryland, Virginia and the District of Columbia. 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 eighth in market share in Fairfax County at June 30, 2004, according to the most recently published industry statistics. The per capita incomes of Montgomery and Fairfax Counties rank among the highest of counties and equivalent jurisdictions
nationally. These two counties are also the Washington, DC areas largest suburban employment centers, with a substantial portion of their labor force consisting of federal, 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 2004 was 2.2%, 4.3% and 1.8%, respectively, each of which was below the national rate of 5.4%. The
individual state rates were 3.9% for Maryland and 3.3% 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. See
Lending 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 U.S. Government securities and mortgage-backed securities as either held-to-maturity,
available-for-sale or trading at the time such securities are acquired. All U.S. Government securities and mortgage-backed securities were classified as held-to-maturity at September 30, 2004 and 2003.



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, 2004 and 2003.



18



---

##### Table of Contents

Lending and Leasing Activities



Loan Portfolio Composition. At September 30, 2004, the Banks loan portfolio totaled $10.5 billion, which
represented 79.2% 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 85.1% of the loan portfolio and 66.9% of total assets at that date. 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, |           
|                                        |  | 2004          |            |   | 2003      |       |   | 2002    |   |           | 2001      |  |       | 2000    | 
|                                        |  | Balance       |            |   | % ofTotal |       |   | Balance |   |           | % ofTotal |  |       | Balance |  |   | % ofTotal |   |  | Balance |   |  | % ofTotal |           |   | Balance |       |   | % ofTotal |  
|Single family residential (1)           |  | $             | 7,166,935  |   |           | 68.6  | % |         | $ | 5,761,993 |           |  | 64.7  | %       |  | $ | 4,545,519 |   |  | 59.0    | % |  | $         | 4,519,269 |   |         | 60.9  | % |           | $ | 4,870,474 |   |  | 62.9  | %
|Home equity (1)(2)                      |  |               | 1,721,999  |   |           | 16.5  |   |         |   | 1,336,776 |           |  | 15.0  |         |  |   | 1,090,325 |   |  | 14.1    |   |  |           | 646,390   |   |         | 8.7   |   |           |   | 427,399   |   |  | 5.5   |  
|Real estate construction and ground (2) |  |               | 223,447    |   |           | 2.1   |   |         |   | 234,356   |           |  | 2.6   |         |  |   | 260,199   |   |  | 3.4     |   |  |           | 267,303   |   |         | 3.6   |   |           |   | 296,705   |   |  | 3.8   |  
|Commercial (2)                          |  |               | 920,178    |   |           | 8.8   |   |         |   | 888,847   |           |  | 10.0  |         |  |   | 803,168   |   |  | 10.4    |   |  |           | 769,443   |   |         | 10.4  |   |           |   | 596,384   |   |  | 7.7   |  
|Automobile loans (1)                    |  |               | 300,516    |   |           | 2.9   |   |         |   | 589,024   |           |  | 6.6   |         |  |   | 855,735   |   |  | 11.0    |   |  |           | 1,021,523 |   |         | 13.9  |   |           |   | 1,393,487 |   |  | 18.0  |  
|Other                                   |  |               | 108,690    |   |           | 1.1   |   |         |   | 104,041   |           |  | 1.1   |         |  |   | 160,800   |   |  | 2.1     |   |  |           | 183,453   |   |         | 2.5   |   |           |   | 161,968   |   |  | 2.1   |  
|                                        |  |               |            |   |           |       |   |         |   |           |           |  |       |         |  |   |           |   |  |         |   |  |           |           |   |         |       |   |           |   |           |   |  |       |  
|                                        |  |               | 10,441,765 |   |           | 100.0 | % |         |   | 8,915,037 |           |  | 100.0 | %       |  |   | 7,715,746 |   |  | 100.0   | % |  |           | 7,407,381 |   |         | 100.0 | % |           |   | 7,746,417 |   |  | 100.0 | %
|                                        |  |               |            |   |           |       |   |         |   |           |           |  |       |         |  |   |           |   |  |         |   |  |           |           |   |         |       |   |           |   |           |   |  |       |  
|Unearned premiums and discounts         |  |               | 894        |   |           |       |   |         |   | 1,428     |           |  |       |         |  |   | 1,690     |   |  |         |   |  |           | 2,445     |   |         |       |   |           |   | 3,814     |   |  |       |  
|Net deferred loan origination costs     |  |               | 116,124    |   |           |       |   |         |   | 80,320    |           |  |       |         |  |   | 57,627    |   |  |         |   |  |           | 40,554    |   |         |       |   |           |   | 34,833    |   |  |       |  
|Allowance for loan losses               |  |               | (37,750    | ) |           |       |   |         |   | (58,397   | )         |  |       |         |  |   | (66,079   | ) |  |         |   |  |           | (57,018   | ) |         |       |   |           |   | (52,518   | ) |  |       |  
|                                        |  |               |            |   |           |       |   |         |   |           |           |  |       |         |  |   |           |   |  |         |   |  |           |           |   |         |       |   |           |   |           |   |  |       |  
|                                        |  |               | 79,268     |   |           |       |   |         |   | 23,351    |           |  |       |         |  |   | (6,762    | ) |  |         |   |  |           | (14,019   | ) |         |       |   |           |   | (13,871   | ) |  |       |  
|                                        |  |               |            |   |           |       |   |         |   |           |           |  |       |         |  |   |           |   |  |         |   |  |           |           |   |         |       |   |           |   |           |   |  |       |  
|Total loans receivable                  |  | $             | 10,521,033 |   |           |       |   |         | $ | 8,938,388 |           |  |       |         |  | $ | 7,708,984 |   |  |         |   |  | $         | 7,393,362 |   |         |       |   |           | $ | 7,732,546 |   |  |       |  
|                                        |  |               |            |   |           |       |   |         |   |           |           |  |       |         |  |   |           |   |  |         |   |  |           |           |   |         |       |   |           |   |           |   |  |       |  

---

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



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



19



---

##### 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, 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, 2004. The entire balance of loans held for
securitization and/or sale is shown in the year ending September 30, 2005, because such loans are expected to be sold in less than one year.



Contractual Principal Repayments



(In thousands)



|                                          |  |                                                      |                                                                    |  |      |           |      |   |           |  |           |         |           |   |                     |  |   |         |  |   |         |  |   |          
|----------------------------------------- |  | ---------------------------------------------------- | ------------------------------------------------------------------ |  | ---- | --------- | ---- | - | --------- |  | --------- | ------- | --------- | - | ------------------- |  | - | ------- |  | - | ------- |  | - | ---------
|                                          |  | Principal BalanceOutstanding atSeptember 30, 2004(1) |                                                                    |  |      |           |      |   |           |  |           |         |           |   |                     | 
|                                          |  |                                                      | Approximate Principal Repayments Due in Years Ending September 30,
|                                          |  |                                                      | 2005                                                               |  | 2006 |           | 2007 |   | 2008-2009 |  | 2010-2014 |         | 2015-2019 |   | 2020 and Thereafter
|Single family residential                 |  | $                                                    | 5,232,551                                                          |  | $    | 38,742    |      | $ | 43,895    |  | $         | 47,811  |           | $ | 125,399             |  | $ | 480,002 |  | $ | 621,786 |  | $ | 3,874,916
|Home equity                               |  |                                                      | 1,721,605                                                          |  |      | 14,431    |      |   | 14,828    |  |           | 15,264  |           |   | 35,461              |  |   | 143,511 |  |   | 128,062 |  |   | 1,370,048
|Real estate construction and ground       |  |                                                      | 223,447                                                            |  |      | 205,274   |      |   | 9,518     |  |           | 8,403   |           |   | 252                 |  |   |        |  |   |        |  |   |         
|Commercial                                |  |                                                      | 920,178                                                            |  |      | 693,599   |      |   | 19,682    |  |           | 12,209  |           |   | 36,981              |  |   | 72,673  |  |   | 85,034  |  |   |         
|Automobile loans                          |  |                                                      | 300,516                                                            |  |      | 128,316   |      |   | 88,632    |  |           | 59,294  |           |   | 24,274              |  |   |        |  |   |        |  |   |         
|Other                                     |  |                                                      | 108,690                                                            |  |      | 11,566    |      |   | 12,288    |  |           | 8,832   |           |   | 33,969              |  |   | 33,241  |  |   | 6,536   |  |   | 2,258    
|Loans held for securitization and/or sale |  |                                                      | 1,934,778                                                          |  |      | 1,934,778 |      |   |          |  |           |        |           |   |                    |  |   |        |  |   |        |  |   |         
|                                          |  |                                                      |                                                                    |  |      |           |      |   |           |  |           |         |           |   |                     |  |   |         |  |   |         |  |   |          
|Total loans receivable(2)                 |  | $                                                    | 10,441,765                                                         |  | $    | 3,026,706 |      | $ | 188,843   |  | $         | 151,813 |           | $ | 256,336             |  | $ | 729,427 |  | $ | 841,418 |  | $ | 5,247,222
|                                          |  |                                                      |                                                                    |  |      |           |      |   |           |  |           |         |           |   |                     |  |   |         |  |   |         |  |   |          
|Fixed-rate loans                          |  | $                                                    | 1,630,150                                                          |  | $    | 564,849   |      | $ | 148,741   |  | $         | 109,781 |           | $ | 139,870             |  | $ | 230,579 |  | $ | 240,199 |  | $ | 196,131  
|Adjustable-rate loans                     |  |                                                      | 6,876,837                                                          |  |      | 527,079   |      |   | 40,102    |  |           | 42,032  |           |   | 116,466             |  |   | 498,848 |  |   | 601,219 |  |   | 5,051,091
|Loans held for securitization and/or sale |  |                                                      | 1,934,778                                                          |  |      | 1,934,778 |      |   |          |  |           |        |           |   |                    |  |   |        |  |   |        |  |   |         
|                                          |  |                                                      |                                                                    |  |      |           |      |   |           |  |           |         |           |   |                     |  |   |         |  |   |         |  |   |          
|Total loans receivable(2)                 |  | $                                                    | 10,441,765                                                         |  | $    | 3,026,706 |      | $ | 188,843   |  | $         | 151,813 |           | $ | 256,336             |  | $ | 729,427 |  | $ | 841,418 |  | $ | 5,247,222
|                                          |  |                                                      |                                                                    |  |      |           |      |   |           |  |           |         |           |   |                     |  |   |         |  |   |         |  |   |          

---

|(1) | Of the total amount of loans outstanding at September 30, 2004, which were due after one year, an aggregate principal balance of approximately $1.1 billion had fixed
interest rates and an aggregate principal balance of approximately $6.3 billion had adjustable interest rates.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



Actual payments may not reflect scheduled contractual principal repayments
due to the effect of loan refinancings, prepayments and enforcement of due-on-sale clauses. Although the Banks single-family residential loans historically have had stated maturities of generally 30 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, 2004, excluding loans held
for securitization and/or sale, aggregate principal repayments of $1.1 billion against all loans are contractually due within the next year. Of this amount, $564.8 million is due on fixed-rate loans and $527.1 million is due on adjustable-rate
loans.



20



---

##### Table of Contents

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.



(In thousands)



|                                                                 |  |                                  |            |   |      |   |            |      |  |   |            |  
|---------------------------------------------------------------- |  | -------------------------------- | ---------- | - | ---- | - | ---------- | ---- |  | - | ---------- | -
|                                                                 |  | For the Year Ended September 30, |           
|                                                                 |  | 2004                             |            |   | 2003 |   |            | 2002 | 
|Real estate loan originations and purchases:                     |  |                                  |            |   |      |   |            |      |  |   |            |  
|Single family residential                                        |  | $                                | 9,137,785  |   |      | $ | 9,009,575  |      |  | $ | 5,036,548  |  
|Home equity(1)                                                   |  |                                  | 1,165,108  |   |      |   | 1,032,924  |      |  |   | 902,845    |  
|Commercial real estate and multifamily                           |  |                                  | 20,400     |   |      |   | 1,231      |      |  |   |           |  
|Real estate construction and ground(1)                           |  |                                  | 253,078    |   |      |   | 274,856    |      |  |   | 259,858    |  
|                                                                 |  |                                  |            |   |      |   |            |      |  |   |            |  
|Total originations and purchases                                 |  |                                  | 10,576,371 |   |      |   | 10,318,586 |      |  |   | 6,199,251  |  
|                                                                 |  |                                  |            |   |      |   |            |      |  |   |            |  
|Principal repayments                                             |  |                                  | (2,211,833 | ) |      |   | (2,767,214 | )    |  |   | (2,512,055 | )
|Sales                                                            |  |                                  | (5,795,564 | ) |      |   | (3,753,682 | )    |  |   | (2,043,630 | )
|Loans transferred to real estate acquired in settlement of loans |  |                                  | (3,377     | ) |      |   | (3,019     | )    |  |   | (4,174     | )
|                                                                 |  |                                  |            |   |      |   |            |      |  |   |            |  
|                                                                 |  |                                  | (8,010,774 | ) |      |   | (6,523,915 | )    |  |   | (4,559,859 | )
|                                                                 |  |                                  |            |   |      |   |            |      |  |   |            |  
|Transfers to mortgage-backed securities(2)                       |  |                                  | (767,226   | ) |      |   | (2,358,732 | )    |  |   | (1,186,436 | )
|                                                                 |  |                                  |            |   |      |   |            |      |  |   |            |  
|Increase in real estate loans                                    |  | $                                | 1,798,371  |   |      | $ | 1,435,939  |      |  | $ | 452,956    |  
|                                                                 |  |                                  |            |   |      |   |            |      |  |   |            |  

---

|(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, 2004, $8.9 billion, or 85.1%, of the Banks loan portfolio consisted of loans secured by first or second mortgages on such properties, as
compared to $7.1 billion, or 79.7%, at September 30, 2003. Of these amounts, $9.4 million and $44.4 million consisted of FHA-insured or VA-guaranteed loans at September 30, 2004 and 2003, respectively. At September 30, 2004 and 2003, the Bank had
$2.0 billion and $1.4 billion, respectively, of single-family residential loans held for securitization and/or sale to investors. Approximately 31.4% of the principal balance of the Banks single-family residential real estate loans at
September 30, 2004 were secured by properties located in California.



The Bank originates VA, FHA and a wide variety of conventional residential mortgage 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 30 years and adjustable-rate residential mortgage loans principally with maturities of 30 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, 2004, approximately $7.4 billion of loans settled under this program.



Interest rates on the majority of the Banks ARMs are adjusted based on
changes in either (a) yields on U.S. Treasury securities or (b) the London Interbank Offered Rate (LIBOR) of varying maturities. 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.



The Bank has significantly expanded its origination of residential ARMs with interest rates that adjust monthly,
semi-annually and annually, some of which provide a borrower with a below-market introductory interest rate and a variety of monthly payment options.



21



---

##### Table of Contents

Certain of these loans have a payment option that could result in interest being added to the principal of the loan, or negative amortization.
During fiscal years 2004 and 2003, the Bank originated $6.7 billion and $3.9 billion, respectively, of these ARMs, of which $4.1 billion and $2.4 billion, respectively, contained terms that permit negative amortization. At September 30, 2004, loans
with this negative amortization option totaled $3.5 billion, which includes approximately $0.7 million of outstanding principal in excess of the original principal balance of those loans. Each loan contains terms which limit the amount of negative
amortization to a percentage of the original loan amount. The Bank monitors the risks associated with these ARM 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 on these ARM products is 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 in the event market interest rates continue to rise from their current market levels. At September 30, 2004, 95.8% of the Banks single-family residential loans were comprised of ARMs and
65.0% of the Banks single-family residential loans were comprised of ARMs that have interest rates which adjust annually or more frequently.



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. In fiscal year 2004, sales of mortgage loans originated or purchased for securitization and/or sale totaled $6.5 billion compared to $6.0 billion during
fiscal year 2003. 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 Federal Home Loan Mortgage Corporation, Federal National Mortgage Association or Government National Mortgage Association 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 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 2004
and 2003, the Bank exchanged $108.6 million and $88.5 million, respectively, of single-family residential loans held in its portfolio for mortgage-backed securities, which the Bank retained for its own portfolio. The Bank did not exchange any of the
loans held in its portfolio for mortgage-backed securities during fiscal year 2002.



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, 2004 and 2003, the Bank was servicing residential loans totaling $11.3 billion and $8.0 billion, respectively, for other investors. See
Loan Servicing.



Sales of Mortgage-Backed
Securities. The Bank originates and sells mortgage-backed securities pursuant to its normal mortgage banking operations. The securities are generally sold in the same month as they are issued. The securities are formed from conforming mortgage
loans originated for sale or from conforming mortgage loans resulting from the borrowers election to convert from an adjustable-rate loan to a fixed-rate loan. Mortgage-backed securities held for sale in conjunction with mortgage banking
activities are classified as trading securities. During the years ended September 30, 2004 and 2003, the Bank originated and sold $668.5 million and $2.3 billion, respectively, of mortgage-backed securities and recognized gains of $7.6 million and
$37.8 million, respectively. As a result of the sale of trading securities in the month such securities are formed, the Consolidated Statements of Cash Flows in this report reflect significant proceeds from the sales of trading securities, even
though there are no balances of such securities at September 30, 2004.



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 2004 and 2003, 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. The Bank transferred $3.9 million and $11.5 million of home equity credit line receivables
in existing



22



---

##### Table of Contents

trusts to investors and recognized gains of $0.2 million and $0.5 million during the years ended September 30, 2004 and 2003, respectively.



Commercial Real Estate and Real Estate Construction Lending.
Commercial real estate, real estate construction and ground loans are originated directly by the Bank. Aggregate balances of residential and commercial construction, ground and commercial real estate and multifamily were $262.0 million and $253.8
million at September 30, 2004 and 2003, 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, but generally only when a home is under contract for sale by the builder to a consumer. Loan concentrations among types of real estate are reviewed and approved by the Banks Credit Risk Management
Committee.



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, Inc. and Chevy Chase Trust Company, will continue to enhance the operations of the Commercial Banking
Group. Commercial loans increased $31.3 million (or 3.5%) during fiscal year 2004 to $920.2 million at September 30, 2004 from $888.8 million at September 30, 2003.



At September 30, 2004, the Bank held $168.2 million (18.3% of total commercial loans) of participations or syndications in
commercial loans originated by other financial institutions, a decrease from $186.9 million (21.0% of total commercial loans) at September 30, 2003.



Federal laws and regulations limit the Banks commercial loan portfolio to 20% of assets, with at least 10% consisting of small business loans. At
September 30, 2004, the Bank complied with this limit.



Other Consumer Lending Activities. Effective March 2003, the Bank stopped originating indirect automobile loans. The Bank continues its collection efforts on the existing portfolio, and continues to serve its customers by making
direct prime automobile loans. 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 prime automobile loans, home improvement and related loans and overdraft lines of credit and other consumer loans totaled $271.7 million, $34.2 million and $36.0 million, respectively, at September 30, 2004, which accounted for a
combined 3.3% 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 $28.8 million at September 30, 2004, represents 3.6% 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, 2004, the Bank complied with this limit.



Automobile Leasing. Effective March 2003, the Bank also stopped
originating indirect automobile leases. The Bank continues its collection efforts on the existing portfolio. At September 30, 2004 and 2003, the Banks portfolio of automobiles subject to lease totaled $435.3 million and $855.4 million,
respectively. In addition to credit risk associated with a lessees possible default under the lease, the Bank is exposed to the risk that the value of the vehicle at maturity of the lease may be less than the future residual value as estimated
by the Bank at the inception of the lease. To reduce that risk, the Bank (a) purchased insurance in the full amount of the estimated residual value to protect the Bank against possible future decreases in residual values, and (b) used estimates of
residual value that did not exceed published industry estimates unless that excess was also insured. Although the Bank insured residual values, limitations in the insurance policy, and other factors, have resulted and may continue to result in
losses at lease maturity that may not be fully covered by that insurance.



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



23



---

##### Table of Contents

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



The Bank generally makes residential mortgage loans in amounts up to 95% of the appraised 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 95% of the appraised value of the residential property. The Bank
generally also 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, the Bank plans 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.



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. 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 four carriers.



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



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



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



Other Consumer Loan and Lease Underwriting.Other consumer loans,
which include direct 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.



24



---

##### Table of Contents

The Bank purchased residual value insurance on vehicles subject to lease to reduce the risk that the
vehicles value at maturity of the lease may be less than the estimated future residual value at the inception of the lease. The Bank periodically conducts audits of its vehicle lease files to ensure compliance with the requirements of the
residual value insurance policies.



Loan Originations,
Securitizations and Sales  Retained Interest and Servicing Assets.In connection with its loan origination, securitization and sale activities, the Bank generally retains various interests in the sold loans, including servicing assets,
interest only certificates, and interest-only strips receivable. From time to time, the Bank may also purchase servicing assets related to loans originated by third parties. The Bank records these interests as assets on its financial statements. In
some cases, the Bank determines the carrying value of the asset based on expected future cash flows to be received by the Bank from the underlying asset. Some of these cash flows are payable to the Bank before the claims of others, while other cash
flows are subordinated to the claims of others. The tables below summarize the carrying value of these assets at September 30, 2004 and 2003.



|                                |  |                    |         |              |   |        |  |   |        
|------------------------------- |  | ------------------ | ------- | ------------ | - | ------ |  | - | -------
|                                |  | September 30, 2004
|                                |  | NotSubordinated    |         | Subordinated |   | Total 
|                                |  | (In thousands)    
|Servicing assets                |  | $                  | 147,856 |              | $ |       |  | $ | 147,856
|Interest-only certificates      |  |                    | 184,305 |              |   |       |  |   | 184,305
|Interest-only strips receivable |  |                    | 102,495 |              |   | 1,040  |  |   | 103,535
|Overcollateralization of loans  |  |                    |        |              |   | 1,519  |  |   | 1,519  
|Reserve accounts                |  |                    | 6,726   |              |   | 12,257 |  |   | 18,983 
|                                |  |                    |         |              |   |        |  |   |        
|Total                           |  | $                  | 441,382 |              | $ | 14,816 |  | $ | 456,198
|                                |  |                    |         |              |   |        |  |   |        
|                                | 
|                                |  | September 30, 2003
|                                |  | NotSubordinated    |         | Subordinated |   | Total 
|                                |  | (In thousands)    
|Servicing assets                |  | $                  | 96,268  |              | $ |       |  | $ | 96,268 
|Interest-only certificates      |  |                    | 27,465  |              |   |       |  |   | 27,465 
|Interest-only strips receivable |  |                    | 104,299 |              |   | 8,017  |  |   | 112,316
|Overcollateralization of loans  |  |                    |        |              |   | 4,678  |  |   | 4,678  
|Reserve accounts                |  |                    |        |              |   | 19,034 |  |   | 19,034 
|                                |  |                    |         |              |   |        |  |   |        
|Total                           |  | $                  | 228,032 |              | $ | 31,729 |  | $ | 259,761
|                                |  |                    |         |              |   |        |  |   |        



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 Note 1 and Note 7 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, automobile
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.



25



---

##### Table of Contents

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,
|                                             |  | 2004                                      |            | 2003 |   | 2002     
|                                             |  | (In thousands)                           
|Residential                                  |  | $                                         | 11,319,875 |      | $ | 8,025,206 |  | $ | 6,918,984
|Home equity                                  |  |                                           | 10,815     |      |   | 38,675    |  |   | 86,279   
|Automobile                                   |  |                                           | 150,957    |      |   | 393,333   |  |   | 803,852  
|Home improvement loans                       |  |                                           |           |      |   | 18,363    |  |   | 35,410   
|                                             |  |                                           |            |      |   |           |  |   |          
|Total amount of loans serviced for others(1) |  | $                                         | 11,481,647 |      | $ | 8,475,577 |  | $ | 7,844,525
|                                             |  |                                           |            |      |   |           |  |   |          
|Servicing and securitization income          |  | $                                         | 201,139    |      | $ | 103,422   |  | $ | 84,160   
|                                             |  |                                           |            |      |   |           |  |   |          

---

|(1) | The carrying value of the Banks servicing assets and interest-only strips receivable at September 30, 2004, 2003 and 2002 was $435.7 million, $236.0 million
and $149.7 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. 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 2004, the Bank securitized and sold $4.9
billion of loan receivables through new securitization trusts compared to $2.6 billion during fiscal year 2003.



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 present value is
computed based on managements estimates of loan prepayments, default rates and the discount rate.



If actual prepayments or default rates 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. No assurance can be given that underlying loans will not experience significant increases in
prepayments or default rates or that the Bank may not have to write down the interest-only strips receivable value. See Note 3 and Note 17 to the Consolidated Financial Statements in this report.



Overcollateralization of Loans and Reserve Accounts.Overcollateralization of loans and reserve accounts represent assets of the Bank which have been pledged to certain securitization trusts and which are 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, 2004.



26



---

##### Table of Contents

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 all 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, 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 allowances become necessary, provisions for losses are reported in operations in the periods they are determined to be necessary.



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



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



The Federal Financial Institutions Examination Council (FFIEC), which is composed of the OTS and the other federal banking agencies, has issued guidelines regarding the appropriate levels of general
valuation allowances that should be maintained by insured institutions and guidance on the design and implementation of loan loss allowance methodologies and supporting documentation practices. The Bank believes that its levels of general valuation
allowances at September 30, 2004, 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 greater degree on borrowed funds, particularly FHLB advances, to fund its planned asset growth. This source of funding is generally more
volatile and expensive than traditional core deposits.



27



---

##### Table of Contents

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 859 ATMs, including 206 ATMs located in grocery stores. These ATMs significantly enhance the Banks position as a leading provider of convenient ATM 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, 2004, 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 36.1% of the Banks deposits at September 30, 2004 were obtained from
depositors residing outside of Maryland, with approximately 24.0% from depositors residing in Virginia.



28



---

##### 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, |          
|                                     |  | 2004          |           |           | 2003  |   |         | 2002 |           |  | 2001  |         |  | 2000      |          
|                                     |  | Balance       |           | % ofTotal |       |   | Balance |      | % ofTotal |  |       | Balance |  | % ofTotal |           |  | Balance |   | % ofTotal |   |           | Balance |       | % ofTotal | 
|Demand accounts                      |  | $             | 1,181,722 |           | 13.3  | % |         | $    | 951,844   |  | 11.8  | %       |  | $         | 779,634   |  | 10.5    | % |           | $ | 642,490   |         | 8.5   | %         |  | $ | 559,320   |  | 7.9   | %
|NOW accounts                         |  |               | 2,244,724 |           | 25.4  |   |         |      | 1,951,281 |  | 24.0  |         |  |           | 1,656,522 |  | 22.3    |   |           |   | 1,428,486 |         | 18.9  |           |  |   | 1,289,883 |  | 18.4  |  
|Money market deposit accounts        |  |               | 2,364,768 |           | 26.7  |   |         |      | 2,321,026 |  | 28.7  |         |  |           | 1,953,312 |  | 26.3    |   |           |   | 1,570,297 |         | 20.8  |           |  |   | 1,156,829 |  | 16.4  |  
|Savings accounts                     |  |               | 1,042,777 |           | 11.8  |   |         |      | 997,686   |  | 12.3  |         |  |           | 893,093   |  | 12.0    |   |           |   | 780,655   |         | 10.3  |           |  |   | 779,344   |  | 11.1  |  
|Other deposit accounts               |  |               | 171,530   |           | 1.9   |   |         |      | 152,758   |  | 1.9   |         |  |           | 135,169   |  | 1.8     |   |           |   | 117,207   |         | 1.5   |           |  |   | 113,245   |  | 1.6   |  
|Certificate accounts, less than $100 |  |               | 1,238,733 |           | 14.0  |   |         |      | 1,207,728 |  | 14.9  |         |  |           | 1,416,739 |  | 19.0    |   |           |   | 2,361,174 |         | 31.2  |           |  |   | 2,524,769 |  | 35.9  |  
|Certificate accounts, $100 or more   |  |               | 610,864   |           | 6.9   |   |         |      | 518,182   |  | 6.4   |         |  |           | 603,116   |  | 8.1     |   |           |   | 662,161   |         | 8.8   |           |  |   | 614,399   |  | 8.7   |  
|                                     |  |               |           |           |       |   |         |      |           |  |       |         |  |           |           |  |         |   |           |   |           |         |       |           |  |   |           |  |       |  
|Total deposits                       |  | $             | 8,855,118 |           | 100.0 | % |         | $    | 8,100,505 |  | 100.0 | %       |  | $         | 7,437,585 |  | 100.0   | % |           | $ | 7,562,470 |         | 100.0 | %         |  | $ | 7,037,789 |  | 100.0 | %
|                                     |  |               |           |           |       |   |         |      |           |  |       |         |  |           |           |  |         |   |           |   |           |         |       |           |  |   |           |  |       |  



Average Cost of
Deposits



|                      |  |                          |   |  |      |   |  |      |  
|--------------------- |  | ------------------------ | - |  | ---- | - |  | ---- | -
|                      |  | Year Ended September 30, |  
|                      |  | 2004                     |   |  | 2003 |   |  | 2002 |  
|Demand deposits       |  | 0.21                     | % |  | 0.26 | % |  | 0.31 | %
|Money market deposits |  | 0.74                     | % |  | 1.01 | % |  | 1.74 | %
|Savings deposits      |  | 0.27                     | % |  | 0.45 | % |  | 0.96 | %
|Time deposits         |  | 1.91                     | % |  | 2.55 | % |  | 4.14 | %
|Total deposits        |  | 0.79                     | % |  | 1.15 | % |  | 2.15 | %
|                      |  |                          |   |  |      |   |  |      |  



The range of deposit
account products offered by the Bank through its extensive branch and ATM network allows the Bank to 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 and its pricing
strategy.



29



---

##### Table of Contents

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



|                                            |  |                          |             |   |      |   |             |      |  |   |             |  
|------------------------------------------- |  | ------------------------ | ----------- | - | ---- | - | ----------- | ---- |  | - | ----------- | -
|                                            |  | Year Ended September 30, |            
|                                            |  | 2004                     |             |   | 2003 |   |             | 2002 | 
|                                            |  | (In thousands)           |            
|Deposits to accounts                        |  | $                        | 53,155,374  |   |      | $ | 45,309,516  |      |  | $ | 48,432,739  |  
|Withdrawals from accounts                   |  |                          | (52,459,012 | ) |      |   | (44,726,718 | )    |  |   | (48,701,536 | )
|                                            |  |                          |             |   |      |   |             |      |  |   |             |  
|Net cash to (from) accounts                 |  |                          | 696,362     |   |      |   | 582,798     |      |  |   | (268,797    | )
|Interest credited to accounts               |  |                          | 58,251      |   |      |   | 80,122      |      |  |   | 143,912     |  
|                                            |  |                          |             |   |      |   |             |      |  |   |             |  
|Net increase (decrease) in deposit balances |  | $                        | 754,613     |   |      | $ | 662,920     |      |  | $ | (124,885    | )
|                                            |  |                          |             |   |      |   |             |      |  |   |             |  



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,
2004, which will mature during the fiscal years indicated.



Weighted Average Interest Rates of Deposits



(Dollars in thousands)



|                                          |  |                                               |           |                       |                            |   |        |                     |                       |  |                      |        |  |                       |         |  |        |   |                       |   |           |        |      |                       |  |   |           |  |      |  
|----------------------------------------- |  | --------------------------------------------- | --------- | --------------------- | -------------------------- | - | ------ | ------------------- | --------------------- |  | -------------------- | ------ |  | --------------------- | ------- |  | ------ | - | --------------------- | - | --------- | ------ | ---- | --------------------- |  | - | --------- |  | ---- | -
|                                          |  | Demand, NOW and Money Market Deposit Accounts |           |                       | Statement Savings Accounts |   |        | Other Core Accounts |                       |  | Certificate Accounts |        |  | Total                 |        
|                                          |  |                                               |           |                      
|                                          |  |                                               |           |                      
|Maturing During Year Ending September 30, |  | Amount                                        |           | Weighted Average Rate |                            |   | Amount |                     | Weighted Average Rate |  |                      | Amount |  | Weighted Average Rate |         |  | Amount |   | Weighted Average Rate |   |           | Amount |      | Weighted Average Rate | 
|                                          |  |                                               |           |                       |                            |   |        |                     |                      
|                                          |  |                                               |           |                       |                            |   |        |                     |                      
|2005                                      |  | $                                             | 5,791,269 |                       | 0.45                       | % |        | $                   | 1,042,777             |  | 0.28                 | %      |  | $                     | 171,530 |  | 0.25   | % |                       | $ | 1,296,842 |        | 1.62 | %                     |  | $ | 8,302,418 |  | 0.60 | %
|2006                                      |  |                                               |          |                       |                           |   |        |                     |                      |  |                     |        |  |                       |        |  |       |   |                       |   | 379,172   |        | 3.14 |                       |  |   | 379,172   |  | 3.14 |  
|2007                                      |  |                                               |          |                       |                           |   |        |                     |                      |  |                     |        |  |                       |        |  |       |   |                       |   | 55,188    |        | 3.67 |                       |  |   | 55,188    |  | 3.67 |  
|2008                                      |  |                                               |          |                       |                           |   |        |                     |                      |  |                     |        |  |                       |        |  |       |   |                       |   | 33,023    |        | 3.13 |                       |  |   | 33,023    |  | 3.13 |  
|2009                                      |  |                                               |          |                       |                           |   |        |                     |                      |  |                     |        |  |                       |        |  |       |   |                       |   | 85,317    |        | 3.70 |                       |  |   | 85,317    |  | 3.70 |  
|                                          |  |                                               |           |                       |                            |   |        |                     |                       |  |                      |        |  |                       |         |  |        |   |                       |   |           |        |      |                       |  |   |           |  |      |  
|Total                                     |  | $                                             | 5,791,269 |                       | 0.45                       | % |        | $                   | 1,042,777             |  | 0.28                 | %      |  | $                     | 171,530 |  | 0.25   | % |                       | $ | 1,849,542 |        | 2.12 | %                     |  | $ | 8,855,118 |  | 0.77 | %
|                                          |  |                                               |           |                       |                            |   |        |                     |                       |  |                      |        |  |                       |         |  |        |   |                       |   |           |        |      |                       |  |   |           |  |      |  



30



---

##### Table of Contents

The following table summarizes maturities of certificate accounts in amounts of $100,000 or greater as of
September 30, 2004.



|                          |  |                        |         |                     |      |  
|------------------------- |  | ---------------------- | ------- | ------------------- | ---- | -
|Year Ending September 30, |  | Amount                 |         | WeightedAverageRate |     
|                          |  | (Dollars in thousands) |         |                     |     
|2005                      |  | $                      | 428,722 |                     | 1.60 | %
|2006                      |  |                        | 106,817 |                     | 3.32 | %
|2007                      |  |                        | 11,237  |                     | 3.98 | %
|2008                      |  |                        | 8,427   |                     | 3.11 | %
|2009                      |  |                        | 55,661  |                     | 3.73 | %
|                          |  |                        |         |                     |      |  
|Total                     |  | $                      | 610,864 |                     | 2.16 | %
|                          |  |                        |         |                     |      |  



The following table
represents the amounts of deposits by various interest rate categories as of September 30, 2004 maturing during the fiscal years indicated.



Maturities of Deposits by Interest Rates



(In thousands)



|                     |  |                                                    |           |      |   |         |  |      |        |      |   |        |  |   |        |  |   |          
|-------------------- |  | -------------------------------------------------- | --------- | ---- | - | ------- |  | ---- | ------ | ---- | - | ------ |  | - | ------ |  | - | ---------
|                     |  | Accounts Maturing During Year Ending September 30,
|Interest Rate        |  | 2005                                               |           | 2006 |   | 2007    |  | 2008 |        | 2009 |   | Total 
|Demand deposits (0%) |  | $                                                  | 1,182,161 |      | $ |        |  | $    |       |      | $ |       |  | $ |       |  | $ | 1,182,161
|0.01% to 1.99%       |  |                                                    | 6,924,347 |      |   | 52,764  |  |      | 2,756  |      |   |       |  |   |       |  |   | 6,979,867
|2.00% to 2.99%       |  |                                                    | 143,277   |      |   | 168,284 |  |      | 11,850 |      |   | 6,745  |  |   | 248    |  |   | 330,404  
|3.00% to 3.99%       |  |                                                    | 14,285    |      |   | 52,136  |  |      | 12,642 |      |   | 26,276 |  |   | 68,471 |  |   | 173,810  
|4.00% to 4.99%       |  |                                                    | 7,618     |      |   | 95,198  |  |      | 26,608 |      |   |       |  |   | 16,598 |  |   | 146,022  
|5.00% to 5.99%       |  |                                                    | 6,030     |      |   | 6,316   |  |      | 1,332  |      |   | 2      |  |   |       |  |   | 13,680   
|6.00% to 7.99%       |  |                                                    | 24,700    |      |   | 4,474   |  |      |       |      |   |       |  |   |       |  |   | 29,174   
|                     |  |                                                    |           |      |   |         |  |      |        |      |   |        |  |   |        |  |   |          
|Total                |  | $                                                  | 8,302,418 |      | $ | 379,172 |  | $    | 55,188 |      | $ | 33,023 |  | $ | 85,317 |  | $ | 8,855,118
|                     |  |                                                    |           |      |   |         |  |      |        |      |   |        |  |   |        |  |   |          



Borrowings.The
FHLB system functions as a central reserve bank providing credit for member institutions. As a member of the FHLB of Atlanta, Chevy Chase is required to own capital stock in that FHLB and is authorized to apply for advances on the security of that
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.



Under the credit policies of the FHLB of Atlanta, credit may be extended to
creditworthy institutions based upon their financial condition and the adequacy of collateral pledged to secure the extension of credit. Extensions of credit may be obtained pursuant to several different credit programs, each of which has its own
rate and range of maturities. Advances from the FHLB of Atlanta must be secured by certain types of collateral with a value, as determined by the FHLB of Atlanta, at least equal to 100% of the borrowers outstanding advances. The Bank had
outstanding FHLB advances of $2.7 billion at September 30, 2004.



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



31



---

##### Table of Contents

the securities sold is reflected as a liability and the securities underlying the agreements are included in assets in the Consolidated Balance Sheets in
this report. These arrangements are, in effect, borrowings by the Bank secured by the securities sold. The Bank had outstanding repurchase agreements of $21.9 million at September 30, 2004.



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,          |       
|                                                    |  | 2004                   |        |   | 2003 |  
|                                                    |  | (Dollars in thousands) |       
|Securities sold under repurchase agreements:        |  |                        |        |  
|Balance at year-end                                 |  | $                      | 21,878 |   |      | $ | 5,816   |  
|Average amount outstanding during the year          |  |                        | 23,994 |   |      |   | 268,870 |  
|Maximum amount outstanding at any month-end         |  |                        | 87,871 |   |      |   | 506,065 |  
|Weighted average interest rate during the year      |  |                        | 0.87   | % |      |   | 1.44    | %
|Weighted average interest rate on year-end balances |  |                        | 0.98   | % |      |   | 0.77    | %



On December 2, 2003,
the Bank issued $175.0 million aggregate principal amount of its 2003 Debentures. The net proceeds of the offering, along with short-term borrowings, were used to redeem all of the 91⁄4% Subordinated Debentures due 2005 and 2008. The OTS approved
the inclusion of the 2003 Debentures in the Banks regulatory capital and the redemption of the 91⁄4% Subordinated Debentures due 2005 and 2008.



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-monthperiod 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.



32



---

##### Table of Contents

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, 2004, 2.0% and 3.0% of the Banks assets was equal to $265.7 million and $398.6 million, respectively, and the Bank had $27.9 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 Development Activities.Manor Investment Company, a
subsidiary of the Bank, was engaged in certain real estate development activities commenced prior to the enactment of FIRREA and continues to manage the remaining property it holds. 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 customers and depositors of the Bank.



Insurance Services.Chevy Chase Insurance Agency, Inc. (CCIA), a wholly owned subsidiary of CCFS, is a
licensed insurance broker offering a variety of personal line property and casualty and life insurance programs to the general public, including customers and depositors 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
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 adviser, which serves primarily high net worth individuals, and ASB Capital Management,
Inc., a registered investment adviser, which serves primarily institutional customers.



Special Purpose Subsidiaries.At September 30, 2004, Chevy Chase Real Estate, LLC, (CCRE) a wholly owned subsidiary of Chevy Chase, held 100% of the common stock of 11 subsidiaries, seven 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 $19.9
million at September 30, 2004. 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 3,553 full-time and 493 part-time employees at September 30, 2004. 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 agent. 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.



33



---

##### Table of Contents

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, 2004, Chevy Chase had the largest market share, with approximately 24.3% of deposits, in Montgomery County, Maryland, ranked third in market share, with
approximately 15.2% of deposits, in Prince Georges County, Maryland and ranked fifth in market share, with approximately 8.6% of deposits, in the Washington, DC metropolitan area, 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.



Bad Debt Reserve.In 1996, Congress repealed the thrift bad debt provisions of the Internal Revenue Code effective for taxable years beginning after December 31, 1995. As a result, the Bank can deduct only
those bad debts actually incurred during the respective taxable years and was required to recapture and pay income tax on bad debt reserves accumulated since 1987 over a six year period, beginning with the Banks tax year ended September 30,
1999. Accumulated bad debt reserves since 1987 that were subject to recapture were $101.3 million. As of September 30, 2004, all of the bad debt reserves have been recaptured.



Consolidated Tax Returns; Tax Sharing Payments.Generally, the operations of the Trust have generated significant 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 tax sharing payments of $8.8 million in fiscal year 2004. It is expected that the Bank will have taxable income in future years and additional operating losses of the Trust will be utilized to reduce the overall tax liability
of the group which would otherwise arise from that taxable income of the Bank or from the taxable income of other members of the Trusts affiliated group.



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.



34



---

##### Table of Contents

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



State Taxation



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



|ITEM 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, 2004,
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; its office facilities at 1919 M Street, NW, Washington, DC; and 228 full-service offices located in Maryland, Virginia, Delaware and the District of Columbia. On that date, the Bank owned the building and land for 38 of its
branch offices and leased its remaining 190 branch offices. Chevy Chase leases the office facilities at 7926 Jones Branch Drive, 6200 Chevy Chase Drive, 14601 Sweitzer Lane and 1919 M Street, NW. 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 2005 to 2023 and the ground leases have terms expiring from fiscal years
2029 to 2081. The Bank also owns the building and land at 6151 Chevy Chase Drive, Laurel, Maryland. The Bank also owns the building and leases the land at 7700 Old Georgetown Road, Bethesda, Maryland. The Bank also 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 11 to the Consolidated Financial Statements in this report for lease expense and commitments.



At September 30, 2004, the net book value of the Banks office facilities, including leasehold improvements, was $297.9 million, net of accumulated
depreciation of $121.4 million. The Bank owns additional assets, including furniture and data processing equipment. At September 30, 2004, these other assets had a book value of $192.3 million, net of accumulated depreciation of $156.2 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.



As of September 30, 2004, the Bank had received OTS approval to open 13
additional full-service branch offices. The branches, five in Virginia, six in Maryland and two in Washington, DC, are scheduled to open during fiscal year 2005.



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, 2004, automobiles subject to lease had a book value $435.3 million, net of accumulated depreciation of $238.6 million.



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



In the normal course of business, the Trust is involved in litigation, which may include litigation arising out of the collection of loans, the
enforcement or defense of the priority of its security interests, the continued development and marketing of certain of its real estate properties, disputes with tenants and certain employment claims. 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.



|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, 2004.



35



---

##### Table of Contents



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 17, 2004, 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 paid a dividend on its Common Shares of approximately $0.092 per share, totaling
approximately $440,000, in September 2004. No other Common Share dividends were paid during the past two fiscal years. 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.



36



---

##### Table of Contents

SELECTED FINANCIAL DATA



|                                                                            |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|--------------------------------------------------------------------------- |  | ------------------------ | ------- | - | ---- | - | ------- | ---- |  | - | ------- | - |  | ---- | ------- | - |  | - | ------- | -
|                                                                            |  | Year Ended September 30, |        
|(In thousands, except per share amounts and other data)                     |  | 2004                     |         |   | 2003 |   |         | 2002 |  |   | 2001    |   |  | 2000 |        
|STATEMENT OF OPERATIONS DATA:                                               |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Real Estate:                                                                |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Revenues                                                                    |  | $                        | 136,256 |   |      | $ | 125,528 |      |  | $ | 125,610 |   |  | $    | 140,239 |   |  | $ | 129,667 |  
|Operating expenses                                                          |  |                          | 170,175 |   |      |   | 154,885 |      |  |   | 153,150 |   |  |      | 158,322 |   |  |   | 141,968 |  
|Equity in earnings of unconsolidated entities, net                          |  |                          | 7,788   |   |      |   | 7,248   |      |  |   | 8,811   |   |  |      | 7,169   |   |  |   | 7,291   |  
|Impairment loss on investments                                              |  |                          |        |   |      |   | (998    | )    |  |   | (188    | ) |  |      | (296    | ) |  |   |        |  
|Gain on sales of property                                                   |  |                          | 2,769   |   |      |   | 9,079   |      |  |   |        |   |  |      | 11,077  |   |  |   | 994     |  
|                                                                            |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Real estate operating loss                                                  |  |                          | (23,362 | ) |      |   | (14,028 | )    |  |   | (18,917 | ) |  |      | (133    | ) |  |   | (4,016  | )
|                                                                            |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Banking:                                                                    |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Interest income                                                             |  |                          | 441,271 |   |      |   | 451,551 |      |  |   | 541,399 |   |  |      | 721,324 |   |  |   | 710,353 |  
|Interest expense                                                            |  |                          | 163,022 |   |      |   | 205,479 |      |  |   | 273,186 |   |  |      | 422,744 |   |  |   | 394,400 |  
|                                                                            |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Net interest income                                                         |  |                          | 278,249 |   |      |   | 246,072 |      |  |   | 268,213 |   |  |      | 298,580 |   |  |   | 315,953 |  
|Provision for loan losses                                                   |  |                          | 14,522  |   |      |   | (18,422 | )    |  |   | (51,367 | ) |  |      | (59,496 | ) |  |   | (47,940 | )
|                                                                            |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Net interest income after provision for loan losses                         |  |                          | 292,771 |   |      |   | 227,650 |      |  |   | 216,846 |   |  |      | 239,084 |   |  |   | 268,013 |  
|                                                                            |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Other income:                                                               |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Deposit servicing fees                                                      |  |                          | 129,107 |   |      |   | 122,473 |      |  |   | 113,640 |   |  |      | 101,482 |   |  |   | 88,253  |  
|Servicing and securitization income                                         |  |                          | 211,947 |   |      |   | 138,213 |      |  |   | 96,827  |   |  |      | 61,231  |   |  |   | 31,967  |  
|Automobile rental income                                                    |  |                          | 157,034 |   |      |   | 235,360 |      |  |   | 242,646 |   |  |      | 167,379 |   |  |   | 64,142  |  
|Other                                                                       |  |                          | 41,406  |   |      |   | 43,795  |      |  |   | 35,789  |   |  |      | 45,184  |   |  |   | 25,863  |  
|                                                                            |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Total other income                                                          |  |                          | 539,494 |   |      |   | 539,841 |      |  |   | 488,902 |   |  |      | 375,276 |   |  |   | 210,225 |  
|                                                                            |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Operating expenses                                                          |  |                          | 601,050 |   |      |   | 621,301 |      |  |   | 602,166 |   |  |      | 518,713 |   |  |   | 408,092 |  
|                                                                            |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Banking operating income                                                    |  |                          | 231,215 |   |      |   | 146,190 |      |  |   | 103,582 |   |  |      | 95,647  |   |  |   | 70,146  |  
|                                                                            |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Total Company:                                                              |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Income from continuing operations before income taxes and minority interest |  |                          | 207,853 |   |      |   | 132,162 |      |  |   | 84,665  |   |  |      | 95,514  |   |  |   | 66,130  |  
|Income tax provision                                                        |  |                          | 70,232  |   |      |   | 46,523  |      |  |   | 23,364  |   |  |      | 27,275  |   |  |   | 18,744  |  
|                                                                            |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Income from continuing operations before minority interest                  |  |                          | 137,621 |   |      |   | 85,639  |      |  |   | 61,301  |   |  |      | 68,239  |   |  |   | 47,386  |  
|Minority interest held by affiliates                                        |  |                          | (23,070 | ) |      |   | (13,926 | )    |  |   | (9,671  | ) |  |      | (8,660  | ) |  |   | (4,961  | )
|Minority interest  other                                                   |  |                          | (37,195 | ) |      |   | (26,160 | )    |  |   | (25,313 | ) |  |      | (25,313 | ) |  |   | (25,313 | )
|                                                                            |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Income from continuing operations                                           |  |                          | 77,356  |   |      |   | 45,553  |      |  |   | 26,317  |   |  |      | 34,266  |   |  |   | 17,112  |  
|Discontinued real estate operations, net of income taxes                    |  |                          | (656    | ) |      |   | (563    | )    |  |   | (410    | ) |  |      | (347    | ) |  |   | (211    | )
|Extraordinary item                                                          |  |                          |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   | (166    | )
|Cumulative effect of change in accounting principle, net of income taxes    |  |                          |        |   |      |   | 897     |      |  |   |        |   |  |      |        |   |  |   |        |  
|                                                                            |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Total company net income                                                    |  | $                        | 76,700  |   |      | $ | 45,887  |      |  | $ | 25,907  |   |  | $    | 33,919  |   |  | $ | 16,735  |  
|                                                                            |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Net income available to common shareholders                                 |  | $                        | 71,282  |   |      | $ | 40,469  |      |  | $ | 20,489  |   |  | $    | 28,501  |   |  | $ | 11,317  |  
|                                                                            |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Net income (loss) per common share:                                         |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Income from continuing operations                                           |  | $                        | 14.96   |   |      | $ | 8.33    |      |  | $ | 4.32    |   |  | $    | 5.98    |   |  | $ | 2.41    |  
|Discontinued operations                                                     |  |                          | (0.14   | ) |      |   | (0.12   | )    |  |   | (0.08   | ) |  |      | (0.07   | ) |  |   | (0.04   | )
|Extraordinary item                                                          |  |                          |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   | (0.03   | )
|Cumulative effect of change in accounting principle                         |  |                          |        |   |      |   | 0.19    |      |  |   |        |   |  |      |        |   |  |   |        |  
|                                                                            |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Net income per common share (Basis and Diluted)                             |  | $                        | 14.82   |   |      | $ | 8.40    |      |  | $ | 4.24    |   |  | $    | 5.91    |   |  | $ | 2.34    |  
|                                                                            |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  



Continued on following page.



37



---

##### Table of Contents

SELECTED FINANCIAL DATA

(Continued)



|                                                        |  |                          |            |   |      |   |            |      |  |   |            |   |  |      |            |   |  |   |            |  
|------------------------------------------------------- |  | ------------------------ | ---------- | - | ---- | - | ---------- | ---- |  | - | ---------- | - |  | ---- | ---------- | - |  | - | ---------- | -
|                                                        |  | Year Ended September 30, |           
|(In thousands, except per share amounts and other data) |  | 2004                     |            |   | 2003 |   |            | 2002 |  |   | 2001       |   |  | 2000 |           
|BALANCE SHEET DATA:                                     |  |                          |            |   |      |   |            |      |  |   |            |   |  |      |            |   |  |   |            |  
|Assets:                                                 |  |                          |            |   |      |   |            |      |  |   |            |   |  |      |            |   |  |   |            |  
|Real estate assets                                      |  | $                        | 458,169    |   |      | $ | 429,285    |      |  | $ | 437,514    |   |  | $    | 442,104    |   |  | $ | 433,189    |  
|Income-producing properties, net(1)                     |  |                          | 273,292    |   |      |   | 275,005    |      |  |   | 285,308    |   |  |      | 282,984    |   |  |   | 238,249    |  
|Land parcels                                            |  |                          | 41,722     |   |      |   | 42,425     |      |  |   | 44,020     |   |  |      | 40,835     |   |  |   | 39,716     |  
|Banking assets                                          |  |                          | 13,270,847 |   |      |   | 11,779,440 |      |  |   | 11,273,252 |   |  |      | 11,408,707 |   |  |   | 10,724,725 |  
|Total company assets                                    |  |                          | 13,729,016 |   |      |   | 12,208,725 |      |  |   | 11,710,766 |   |  |      | 11,850,811 |   |  |   | 11,157,914 |  
|Liabilities:                                            |  |                          |            |   |      |   |            |      |  |   |            |   |  |      |            |   |  |   |            |  
|Real estate liabilities                                 |  |                          | 676,301    |   |      |   | 652,856    |      |  |   | 663,376    |   |  |      | 667,176    |   |  |   | 665,838    |  
|Mortgage notes payable(1)                               |  |                          | 311,316    |   |      |   | 322,437    |      |  |   | 326,232    |   |  |      | 331,114    |   |  |   | 313,746    |  
|Notes payable - secured                                 |  |                          | 250,000    |   |      |   | 203,800    |      |  |   | 201,750    |   |  |      | 202,500    |   |  |   | 200,000    |  
|Notes payable - unsecured                               |  |                          | 56,428     |   |      |   | 55,349     |      |  |   | 55,156     |   |  |      | 50,717     |   |  |   | 47,463     |  
|Banking liabilities                                     |  |                          | 12,400,167 |   |      |   | 11,039,425 |      |  |   | 10,614,255 |   |  |      | 10,780,154 |   |  |   | 10,121,386 |  
|Minority interest held by affiliates                    |  |                          | 114,933    |   |      |   | 98,062     |      |  |   | 88,137     |   |  |      | 82,048     |   |  |   | 77,006     |  
|Minority interest - other                               |  |                          | 296,013    |   |      |   | 249,698    |      |  |   | 218,307    |   |  |      | 218,307    |   |  |   | 218,307    |  
|Total company liabilities                               |  |                          | 13,487,414 |   |      |   | 12,040,041 |      |  |   | 11,584,075 |   |  |      | 11,747,685 |   |  |   | 11,082,537 |  
|Shareholders equity                                    |  |                          | 241,602    |   |      |   | 168,684    |      |  |   | 126,691    |   |  |      | 103,126    |   |  |   | 75,377     |  
|                                                        |  |                          |            |   |      |   |            |      |  |   |            |   |  |      |            |   |  |   |            |  
|OTHER DATA:                                             |  |                          |            |   |      |   |            |      |  |   |            |   |  |      |            |   |  |   |            |  
|Hotels:                                                 |  |                          |            |   |      |   |            |      |  |   |            |   |  |      |            |   |  |   |            |  
|Number of hotels                                        |  |                          | 18         |   |      |   | 18         |      |  |   | 18         |   |  |      | 18         |   |  |   | 16         |  
|Number of guest rooms                                   |  |                          | 3,573      |   |      |   | 3,574      |      |  |   | 3,578      |   |  |      | 3,578      |   |  |   | 3,196      |  
|Average occupancy                                       |  |                          | 66         | % |      |   | 61         | %    |  |   | 61         | % |  |      | 66         | % |  |   | 71         | %
|Average room rate                                       |  | $                        | 91.67      |   |      | $ | 85.93      |      |  | $ | 86.92      |   |  | $    | 94.32      |   |  | $ | 89.16      |  
|Office properties:                                      |  |                          |            |   |      |   |            |      |  |   |            |   |  |      |            |   |  |   |            |  
|Number of properties                                    |  |                          | 13         |   |      |   | 13         |      |  |   | 13         |   |  |      | 11         |   |  |   | 10         |  
|Leasable area (square feet)                             |  |                          | 1,978,016  |   |      |   | 1,978,016  |      |  |   | 1,978,016  |   |  |      | 1,796,571  |   |  |   | 1,684,425  |  
|Leasing percentages                                     |  |                          | 90         | % |      |   | 85         | %    |  |   | 86         | % |  |      | 92         | % |  |   | 98         | %
|Land parcels:                                           |  |                          |            |   |      |   |            |      |  |   |            |   |  |      |            |   |  |   |            |  
|Number of parcels                                       |  |                          | 10         |   |      |   | 10         |      |  |   | 10         |   |  |      | 10         |   |  |   | 9          |  
|Total acreage                                           |  |                          | 381        |   |      |   | 381        |      |  |   | 389        |   |  |      | 389        |   |  |   | 399        |  
|                                                        |  |                          |            |   |      |   |            |      |  |   |            |   |  |      |            |   |  |   |            |  

---

|(1) | Includes real estate held for sale.
|--- | -----------------------------------



38



---

##### Table of Contents

|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.



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.



Long-lived assets 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 cashflows (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 that the Trust expects to hold and use is based on the fair value of the asset. Long-lived assets to be disposed
of are generally reported at the lower of carrying amount or fair value less costs to sell.



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.



BANKING



General: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 losses inherent in the loan portfolio at the balance sheet date. Management reviews the adequacy of the allowance for losses using a variety of measures and tools
appropriate for the asset type, including historical loss performance, delinquent status, current economic conditions, internal risk ratings, current underwriting policies and practices and market values for similar assets.



39



---

##### Table of Contents

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 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:From time to
time, the Bank sells loans and retains an interest-only strip receivable related to the sold items. The interest-only strips receivable 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 strips receivable are carried at their fair values, with changes in fair value reflected in income. Fair value of
these interest-only strips receivable is based on discounted expected future cash flows, which are determined using market assumptions such as discount rates and prepayment speeds, and, in certain circumstances, an estimate of credit losses based on
the Banks historical experience. The Bank also engages an independent firm that has 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 strips receivable, 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 at fair value. Fair value of MSR is based on discounted expected future income, net of related expenses, to be generated by servicing the underlying loans. When determining fair value, the Bank
uses several assumptions, the most significant of which are the estimated rate of repayment of the underlying loans and the discount rate. The Bank also engages an independent firm that has 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.



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 our 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 our results of operations and financial condition.



FINANCIAL CONDITION



REAL ESTATE



The Real Estate
Trusts investment portfolio at September 30, 2004 consisted primarily of hotels, office projects, and land parcels. See Item 1. Business  Real Estate  Real Estate Investments.



Overall, the hotel portfolio experienced an average occupancy rate of 66% and
an average room rate of $91.67 during fiscal 2004, compared to an average occupancy of 61% and an average room rate of $85.93 during the prior year. REVPAR (revenue per available room) was $60.52 for fiscal 2004, a 15.2% increase from REVPAR for
fiscal 2003 of $52.52.



The Real Estate Trusts hotel
portfolio, and the hospitality sector in general, have experienced positive growth, both in occupancy and in average room rates, during fiscal year 2004 reflecting a strong increase in general business travel.



Office space in the Real Estate Trusts office property portfolio was
90% leased at September 30, 2004, compared to a leasing rate of 85% at September 30, 2003. Although occupancy has increased in fiscal 2004, the Trust has been experiencing a downward trend in its leasing rates commensurate with the competitive
commercial office markets in Northern Virginia and Atlanta, Georgia. At September 30, 2004, the Real Estate Trusts office property portfolio consisted of 13 properties and had a total gross leasable area of 1,978,000 square feet, of which
227,000 square feet (11.5%) and 181,000 square feet (9.2%) are subject to leases expiring in fiscal 2005 and fiscal 2006.



40



---

##### Table of Contents

BANKING



General.The
Banks assets grew to $13.3 billion during fiscal year 2004, an increase of $1.5 billion from fiscal year 2003. The Bank recorded operating income of $231.2 million during fiscal year 2004, compared to operating income of $146.2 million during
fiscal year 2003. The increase in income for fiscal year 2004 was primarily attributable to a $73.7 million increase in servicing, securitization and mortgage banking income, a $55.5 million decrease in depreciation and amortization expense, a $32.2
million increase in net interest income and a decrease of $32.9 million in the provision for loan losses. Partially offsetting these items were increases in salaries and employee benefits expense of $20.4 million, other (non-interest) expense of
$8.6 million and a decrease in automobile rental income of $78.3 million. See Results of Operations.



Servicing, securitization and mortgage banking income increased $73.7 million, or 53.3%, during fiscal year 2004 primarily as a result of increased
securitization activity. During fiscal year 2004, the Bank securitized and sold $4.9 billion of loan receivables and recognized a gain of $182.8 million compared to securitization and sale of $2.6 billion of loan receivables and a gain of $92.9
million in fiscal year 2003. See Notes 3 and 17 to the Consolidated Financial Statements in this report. See Liquidity. The Bank recognized net losses of $30.3 million and $12.5 million on its interest-only strips receivable during
fiscal years 2004 and 2003, respectively, primarily due to increased estimates of future prepayments of the underlying loans.



Real estate owned, net of valuation allowances, decreased from $21.8 million at September 30, 2003 to $20.4 million at September 30, 2004. This reduction
was primarily due to sales of properties, partially offset by capitalized costs. At September 30, 2003, based on an analysis of the value of REO and the prospect for recoveries of value, the Bank charged off its valuation allowances of REO in the
amount of $71.7 million. See Asset Quality  REO.



At September 30, 2004, the Banks tangible, core, tier 1 risk-based and total risk-based regulatory capital ratios were 6.09%, 6.09%, 8.61% and 10.91%, 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.



In October 2003, the Bank issued $125.0 million of its 8% Preferred Stock and used the proceeds to redeem all of its 13% Preferred Stock on October 31,
2003. On December 2, 2003, the Bank issued $175.0 million of its 2003 Debentures. The net proceeds of the offering, along with short-term borrowings, were used to redeem all of the 1993 Debentures and the 1996 Debentures. The effect of those
transactions increased the Banks Tier 1 Capital and reduced the dividend and interest rates associated with these capital instruments.



During fiscal year 2004, the Bank declared and paid, out of the retained earnings of the Bank, cash dividends on its Common Stock in the aggregate amount
of $3,100 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 March 2004.



Asset Quality.Non-Performing Assets. The Banks overall level of non-performing assets decreased during fiscal year 2004 due primarily
to continued winding down of the Banks automobile loan portfolio. 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.



41



---

##### Table of Contents

Non-Performing Assets



(Dollars in thousands)



|                                                                                                                |  |               |        |      |   |        |  |   |         |   |  |      |         |   |  |   |         |  
|--------------------------------------------------------------------------------------------------------------- |  | ------------- | ------ | ---- | - | ------ |  | - | ------- | - |  | ---- | ------- | - |  | - | ------- | -
|                                                                                                                |  | September 30, |       
|                                                                                                                |  | 2004          |        | 2003 |   | 2002   |  |   | 2001    |   |  | 2000 |        
|Non-performing assets:                                                                                          |  |               |        |      |   |        |  |   |         |   |  |      |         |   |  |   |         |  
|Non-accrual loans:                                                                                              |  |               |        |      |   |        |  |   |         |   |  |      |         |   |  |   |         |  
|Residential mortgage                                                                                            |  | $             | 8,993  |      | $ | 6,567  |  | $ | 12,731  |   |  | $    | 6,011   |   |  | $ | 4,207   |  
|Home equity                                                                                                     |  |               | 1,767  |      |   | 1,480  |  |   | 949     |   |  |      | 1,303   |   |  |   | 964     |  
|Real estate and construction and ground                                                                         |  |               |       |      |   | 1,004  |  |   | 653     |   |  |      |        |   |  |   | 70      |  
|                                                                                                                |  |               |        |      |   |        |  |   |         |   |  |      |         |   |  |   |         |  
|Total non-accrual real estate loans                                                                             |  |               | 10,760 |      |   | 9,051  |  |   | 14,333  |   |  |      | 7,314   |   |  |   | 5,241   |  
|Commercial                                                                                                      |  |               | 242    |      |   | 249    |  |   | 2,329   |   |  |      |        |   |  |   |        |  
|Subprime automobile                                                                                             |  |               | 1,164  |      |   | 4,372  |  |   | 7,755   |   |  |      | 13,379  |   |  |   | 12,026  |  
|Prime automobile                                                                                                |  |               | 1,069  |      |   | 1,484  |  |   | 1,705   |   |  |      | 6,013   |   |  |   | 5,117   |  
|Other consumer                                                                                                  |  |               | 472    |      |   | 444    |  |   | 431     |   |  |      | 593     |   |  |   | 282     |  
|                                                                                                                |  |               |        |      |   |        |  |   |         |   |  |      |         |   |  |   |         |  
|Total non-accrual loans(1)                                                                                      |  |               | 13,707 |      |   | 15,600 |  |   | 26,553  |   |  |      | 27,299  |   |  |   | 22,666  |  
|                                                                                                                |  |               |        |      |   |        |  |   |         |   |  |      |         |   |  |   |         |  
|Real estate acquired in settlement of loans                                                                     |  |               | 20,357 |      |   | 21,820 |  |   | 94,665  |   |  |      | 115,931 |   |  |   | 129,213 |  
|Allowance for losses on real estate acquired in settlement of loans                                             |  |               |       |      |   |       |  |   | (71,293 | ) |  |      | (85,152 | ) |  |   | (80,752 | )
|                                                                                                                |  |               |        |      |   |        |  |   |         |   |  |      |         |   |  |   |         |  
|Real estate acquired in settlement of loans, net                                                                |  |               | 20,357 |      |   | 21,820 |  |   | 23,372  |   |  |      | 30,779  |   |  |   | 48,461  |  
|                                                                                                                |  |               |        |      |   |        |  |   |         |   |  |      |         |   |  |   |         |  
|Total non-performing assets                                                                                     |  | $             | 34,064 |      | $ | 37,420 |  | $ | 49,925  |   |  | $    | 58,078  |   |  | $ | 71,127  |  
|                                                                                                                |  |               |        |      |   |        |  |   |         |   |  |      |         |   |  |   |         |  
|Troubled debt restructurings                                                                                    |  | $             |       |      | $ |       |  | $ |        |   |  | $    |        |   |  | $ |        |  
|                                                                                                                |  |               |        |      |   |        |  |   |         |   |  |      |         |   |  |   |         |  
|Allowance for losses on loans                                                                                   |  | $             | 37,750 |      | $ | 58,397 |  | $ | 66,079  |   |  | $    | 57,018  |   |  | $ | 52,518  |  
|Allowance for losses on real estate held for investment                                                         |  |               | 202    |      |   | 202    |  |   | 202     |   |  |      | 202     |   |  |   | 202     |  
|Allowance for losses on real estate acquired in settlement of loans                                             |  |               |       |      |   |       |  |   | 71,293  |   |  |      | 85,152  |   |  |   | 80,752  |  
|                                                                                                                |  |               |        |      |   |        |  |   |         |   |  |      |         |   |  |   |         |  
|Total allowances for losses                                                                                     |  | $             | 37,952 |      | $ | 58,599 |  | $ | 137,574 |   |  | $    | 142,372 |   |  | $ | 133,472 |  
|                                                                                                                |  |               |        |      |   |        |  |   |         |   |  |      |         |   |  |   |         |  
|Interest income recorded                                                                                        |  |               |        |      |   |        |  |   |         |   |  |      |         |   |  |   |         |  
|Non-accrual assets                                                                                              |  | $             | 180    |      | $ | 39     |  | $ | 279     |   |  | $    | 358     |   |  | $ | 4       |  
|                                                                                                                |  |               |        |      |   |        |  |   |         |   |  |      |         |   |  |   |         |  
|Restructured loans                                                                                              |  | $             |       |      | $ |       |  | $ |        |   |  | $    |        |   |  | $ | 340     |  
|                                                                                                                |  |               |        |      |   |        |  |   |         |   |  |      |         |   |  |   |         |  
|Interest income that would have been recorded had the loans beencurrent in accordance with their original terms |  |               |        |      |   |        |  |   |         |   |  |      |         |   |  |   |         |  
|Non-accrual assets                                                                                              |  | $             | 1,206  |      | $ | 2,098  |  | $ | 3,141   |   |  | $    | 3,321   |   |  | $ | 2,434   |  
|                                                                                                                |  |               |        |      |   |        |  |   |         |   |  |      |         |   |  |   |         |  
|Restructured loans                                                                                              |  | $             |       |      | $ |       |  | $ |        |   |  | $    |        |   |  | $ | 1,323   |  
|                                                                                                                |  |               |        |      |   |        |  |   |         |   |  |      |         |   |  |   |         |  

---

|(1) | Before deduction of allowances for losses.
|--- | ------------------------------------------



42



---

##### Table of Contents

Non-Performing Assets (Continued)



|                                                                              |  |               |   |  |        |   |  |        |   |  |        |   |  |        |  
|----------------------------------------------------------------------------- |  | ------------- | - |  | ------ | - |  | ------ | - |  | ------ | - |  | ------ | -
|                                                                              |  | September 30, |  
|                                                                              |  | 2004          |   |  | 2003   |   |  | 2002   |   |  | 2001   |   |  | 2000   |  
|Ratios:                                                                       |  |               |   |  |        |   |  |        |   |  |        |   |  |        |  
|Non-performing assets to total assets                                         |  | 0.26          | % |  | 0.32   | % |  | 0.44   | % |  | 0.51   | % |  | 0.66   | %
|Allowance for losses on real estate loans to non-accrual real estate loans(1) |  | 91.02         | % |  | 75.65  | % |  | 44.05  | % |  | 70.86  | % |  | 167.60 | %
|Allowance for losses on loans to non-accrual loans(1)                         |  | 275.41        | % |  | 374.34 | % |  | 248.86 | % |  | 208.86 | % |  | 231.70 | %
|Allowance for losses on loans to total loans receivable(2)                    |  | 0.36          | % |  | 0.65   | % |  | 0.85   | % |  | 0.77   | % |  | 0.67   | %

---

|(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, non-accrual real estate held
for investment, 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 $34.1 million at September 30, 2004, compared to $37.4 million, at September 30, 2003. The Bank maintained valuation allowances of $37.8 million and $58.4 million on its loan portfolio at September 30, 2004 and
2003, respectively. The $3.3 million decrease in non-performing assets reflected a net decrease in REO of $1.4 million and a net decrease in non-accrual loans of $1.9 million.



Non-accrual Loans. The Banks non-accrual loans totaled $13.7 million at September 30, 2004, a decrease from
$15.6 million at September 30, 2003. At September 30, 2004, non-accrual loans consisted of $10.8 million of non-accrual real estate loans and $2.9 million of non-accrual prime automobile, subprime automobile, commercial and other consumer loans
compared to non-accrual real estate loans of $9.1 million and non-accrual prime automobile, subprime automobile, commercial and other consumer loans of $6.5 million at September 30, 2003. The decrease in non-accrual prime automobile and subprime
automobile loans reflects the winding down of those portfolios.



REO. At September 30, 2004, the Banks REO totaled $20.4 million compared to $21.8 million at September 30, 2003. The $1.4 million decrease was primarily a result of sales in the communities and other properties, which was
partially offset by additional capitalized costs.



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. At September 30, 2004 and 2003, potential problem assets totaled $0.7 million and $14.8 million, respectively. During fiscal year 2004, several potential
problem loans were repaid in full.



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



43



---

##### Table of Contents

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, 2004,
delinquent loans totaled $32.4 million, or 0.3% of loans, compared to $61.4 million, or 0.7% of loans, at September 30, 2003. The following table sets forth information regarding the Banks delinquent loans at September 30, 2004.



|                                  |  |                                                               |        |   |            |   |       |       |  |   |        |  
|--------------------------------- |  | ------------------------------------------------------------- | ------ | - | ---------- | - | ----- | ----- |  | - | ------ | -
|                                  |  | Principal Balance (Dollars in thousands) Loans Delinquent for |       
|                                  |  | 30-59 days                                                    |        |   | 60-89 days |   |       | Total | 
|Residential Mortgage              |  | $                                                             | 7,621  |   |            | $ | 600   |       |  | $ | 8,221  |  
|Home Equity                       |  |                                                               | 4,422  |   |            |   | 676   |       |  |   | 5,098  |  
|Commercial                        |  |                                                               | 3,046  |   |            |   |      |       |  |   | 3,046  |  
|Subprime Automobile               |  |                                                               | 6,804  |   |            |   | 2,084 |       |  |   | 8,888  |  
|Other Consumer                    |  |                                                               | 5,343  |   |            |   | 1,805 |       |  |   | 7,148  |  
|                                  |  |                                                               |        |   |            |   |       |       |  |   |        |  
|Total                             |  | $                                                             | 27,236 |   |            | $ | 5,165 |       |  | $ | 32,401 |  
|                                  |  |                                                               |        |   |            |   |       |       |  |   |        |  
|Total as a Percentage of Loans(1) |  |                                                               | 0.26   | % |            |   | 0.05  | %     |  |   | 0.31   | %
|                                  |  |                                                               |        |   |            |   |       |       |  |   |        |  

---

|(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 decreased to $8.2 million at September 30, 2004 from $9.7 million at September 30, 2003. Home equity loans delinquent 30-89 days decreased to $5.1 million at September 30, 2004 from $6.1 million at September 30, 2003.



Total delinquent commercial loans decreased to $3.0 million at
September 30, 2004, from $10.8 million at September 30, 2003.



Total delinquent subprime automobile loans decreased to $8.9 million at September 30, 2004, from $23.8 million at September 30, 2003, 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 these loans.



Total delinquent other consumer loans decreased to $7.1 million at September 30, 2004, from $8.6 million at September 30, 2003, primarily because the Banks portfolio of indirect automobile loans continues to decline as a result of the
Banks decision to discontinue origination of these 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, 2004 and 2003.



Real Estate Held for
Investment. At September 30, 2004 and 2003, real estate held for investment consisted of one property with book value of $0.9 million, net of a valuation allowance of $0.2 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.



44



---

##### Table of Contents

Analysis of Allowance for and Charge-offs of Loans

(Dollars in thousands)



|                                                           |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|---------------------------------------------------------- |  | ------------------------ | ------- | - | ---- | - | ------- | ---- |  | - | ------- | - |  | ---- | ------- | - |  | - | ------- | -
|                                                           |  | Year Ended September 30, |        
|                                                           |  | 2004                     |         |   | 2003 |   |         | 2002 |  |   | 2001    |   |  | 2000 |        
|Balance at beginning of year                               |  | $                        | 58,397  |   |      | $ | 66,079  |      |  | $ | 57,018  |   |  | $    | 52,518  |   |  | $ | 57,839  |  
|                                                           |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Provision for loan losses                                  |  |                          | (14,522 | ) |      |   | 18,422  |      |  |   | 51,367  |   |  |      | 59,496  |   |  |   | 47,940  |  
|                                                           |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Charge-offs:                                               |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Single family residential                                  |  |                          | (279    | ) |      |   | (273    | )    |  |   | (300    | ) |  |      | (99     | ) |  |   | (79     | )
|Home equity                                                |  |                          | (786    | ) |      |   | (759    | )    |  |   | (832    | ) |  |      | (687    | ) |  |   | (728    | )
|Commercial real estate and multifamily                     |  |                          |        |   |      |   | (382    | )    |  |   | (27     | ) |  |      |        |   |  |   | (7,120  | )
|Subprime automobile                                        |  |                          | (15,596 | ) |      |   | (30,227 | )    |  |   | (40,695 | ) |  |      | (49,749 | ) |  |   | (40,110 | )
|Other consumer                                             |  |                          | (9,897  | ) |      |   | (13,316 | )    |  |   | (14,163 | ) |  |      | (13,706 | ) |  |   | (10,057 | )
|                                                           |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Total charge-offs                                          |  |                          | (26,558 | ) |      |   | (44,957 | )    |  |   | (56,017 | ) |  |      | (64,241 | ) |  |   | (58,094 | )
|                                                           |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Recoveries:                                                |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Home equity                                                |  |                          | 340     |   |      |   | 248     |      |  |   | 76      |   |  |      | 80      |   |  |   | 78      |  
|Commercial real estate and multifamily                     |  |                          |        |   |      |   | 14      |      |  |   | 18      |   |  |      |        |   |  |   |        |  
|Subprime automobile                                        |  |                          | 14,613  |   |      |   | 13,384  |      |  |   | 11,311  |   |  |      | 7,104   |   |  |   | 3,074   |  
|Other consumer                                             |  |                          | 5,480   |   |      |   | 5,207   |      |  |   | 2,306   |   |  |      | 2,061   |   |  |   | 1,681   |  
|                                                           |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Total recoveries                                           |  |                          | 20,433  |   |      |   | 18,853  |      |  |   | 13,711  |   |  |      | 9,245   |   |  |   | 4,833   |  
|                                                           |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Charge-offs, net of recoveries                             |  |                          | (6,125  | ) |      |   | (26,104 | )    |  |   | (42,306 | ) |  |      | (54,996 | ) |  |   | (53,261 | )
|                                                           |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Balance at end of year                                     |  | $                        | 37,750  |   |      | $ | 58,397  |      |  | $ | 66,079  |   |  | $    | 57,018  |   |  | $ | 52,518  |  
|                                                           |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Provision for loan losses to average loans(1)              |  |                          | -0.14   | % |      |   | 0.22    | %    |  |   | 0.70    | % |  |      | 0.76    | % |  |   | 0.66    | %
|Net loan charge-offs to average loans(1)                   |  |                          | 0.06    | % |      |   | 0.31    | %    |  |   | 0.58    | % |  |      | 0.70    | % |  |   | 0.73    | %
|Ending allowance for losses on loans to total loans(1)
(2) |  |                          | 0.36    | % |      |   | 0.65    | %    |  |   | 0.85    | % |  |      | 0.77    | % |  |   | 0.67    | %

---

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



|(2) | Before deduction of allowance for losses.
|--- | -----------------------------------------



45



---

##### Table of Contents

Components of Allowance for Losses on Loans by Type

(Dollars in thousands)



|                                             |  |               |        |                               |      |   |        |      |                               |  |      |        |  |                               |        |  |        |   |                               |   |        |        |      |                               |  |   |        |  |      |  
|-------------------------------------------- |  | ------------- | ------ | ----------------------------- | ---- | - | ------ | ---- | ----------------------------- |  | ---- | ------ |  | ----------------------------- | ------ |  | ------ | - | ----------------------------- | - | ------ | ------ | ---- | ----------------------------- |  | - | ------ |  | ---- | -
|                                             |  | September 30, |       
|                                             |  | 2004          |        |                               | 2003 |   |        | 2002 |                               |  | 2001 |        |  | 2000                          |       
|                                             |  | 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:         |  |               |        |                               |      |   |        |      |                               |  |      |        |  |                               |        |  |        |   |                               |   |        |        |      |                               |  |   |        |  |      |  
|                                             |  |               |        |                               |      |   |        |      |                               | 
|Single family residential                    |  | $             | 4,275  |                               | 68.6 | % |        | $    | 2,161                         |  | 64.7 | %      |  | $                             | 1,953  |  | 59.0   | % |                               | $ | 2,127  |        | 60.9 | %                             |  | $ | 2,127  |  | 62.9 | %
|                                             |  |               |        |                               |      |   |        |      |                               | 
|Home equity                                  |  |               | 3,350  |                               | 16.5 |   |        |      | 2,426                         |  | 15.0 |        |  |                               | 817    |  | 14.1   |   |                               |   | 1,007  |        | 8.7  |                               |  |   | 1,007  |  | 5.5  |  
|                                             |  |               |        |                               |      |   |        |      |                               | 
|Commercial real estate and multifamily       |  |               | 144    |                               | 0.4  |   |        |      | 162                           |  | 0.2  |        |  |                               | 124    |  | 0.3    |   |                               |   | 197    |        | 0.4  |                               |  |   | 893    |  | 0.5  |  
|                                             |  |               |        |                               |      |   |        |      |                               | 
|Real estate construction and ground          |  |               | 2,025  |                               | 2.1  |   |        |      | 2,098                         |  | 2.6  |        |  |                               | 3,419  |  | 3.4    |   |                               |   | 1,852  |        | 3.6  |                               |  |   | 4,757  |  | 3.8  |  
|                                             |  |               |        |                               |      |   |        |      |                               | 
|Commercial                                   |  |               | 7,361  |                               | 8.8  |   |        |      | 14,400                        |  | 10.0 |        |  |                               | 16,934 |  | 10.4   |   |                               |   | 9,135  |        | 10.4 |                               |  |   | 6,904  |  | 7.7  |  
|                                             |  |               |        |                               |      |   |        |      |                               | 
|Prime automobile                             |  |               | 5,400  |                               | 2.6  |   |        |      | 7,013                         |  | 5.5  |        |  |                               | 4,150  |  | 8.0    |   |                               |   | 7,034  |        | 8.1  |                               |  |   | 6,034  |  | 10.0 |  
|                                             |  |               |        |                               |      |   |        |      |                               | 
|Subprime automobile                          |  |               | 4,920  |                               | 0.3  |   |        |      | 16,000                        |  | 1.1  |        |  |                               | 32,000 |  | 3.0    |   |                               |   | 32,000 |        | 5.8  |                               |  |   | 28,782 |  | 8.0  |  
|                                             |  |               |        |                               |      |   |        |      |                               | 
|Home improvement                             |  |               | 1,795  |                               | 0.3  |   |        |      | 1,049                         |  | 0.5  |        |  |                               | 1,151  |  | 1.3    |   |                               |   | 1,523  |        | 1.6  |                               |  |   | 1,523  |  | 1.2  |  
|                                             |  |               |        |                               |      |   |        |      |                               | 
|Overdraft lines of credit and other consumer |  |               | 1,620  |                               | 0.4  |   |        |      | 2,020                         |  | 0.4  |        |  |                               | 1,635  |  | 0.5    |   |                               |   | 491    |        | 0.5  |                               |  |   | 491    |  | 0.4  |  
|                                             |  |               |        |                               |      |   |        |      |                               | 
|Unallocated                                  |  |               | 6,860  |                               |      |   |        |      | 11,068                        |  |     |        |  |                               | 3,896  |  |       |   |                               |   | 1,652  |        |     |                               |  |   |       |  |     |  
|                                             |  |               |        |                               |      |   |        |      |                               |  |      |        |  |                               |        |  |        |   |                               |   |        |        |      |                               |  |   |        |  |      |  
|                                             |  |               |        |                               |      |   |        |      |                               | 
|Total                                        |  | $             | 37,750 |                               |      |   |        | $    | 58,397                        |  |      |        |  | $                             | 66,079 |  |        |   |                               | $ | 57,018 |        |      |                               |  | $ | 52,518 |  |      |  
|                                             |  |               |        |                               |      |   |        |      |                               |  |      |        |  |                               |        |  |        |   |                               |   |        |        |      |                               |  |   |        |  |      |  



46



---

##### Table of Contents

The Bank maintains allowances for estimated losses on loans and real estate. The Banks total
allowances for losses on loans and real estate held for investment or sale decreased to $38.0 million at September 30, 2004, from $58.6 million at September 30, 2003. The allowance for losses on loans decreased to $37.8 million at September 30,
2004, from $58.4 million at September 30, 2003. Management reviews the adequacy of the delinquent status, current economic conditions, internal risk ratings and current underwriting policies and procedures. Using this analysis, management determines
a range of acceptable valuation allowances. 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. Potential problem assets also declined during the year ended September 30, 2004. The
combination of these factors contributed to the Banks decision to reduce the amount of its allowance for loan losses at September 30, 2004.



The allowance for losses on loans secured by real estate totaled $9.8 million at September 30, 2004, a $3.0 million increase from the September 30, 2003
level of $6.8 million. The increase is consistent with the growth in the portfolio. The allowance represented 91.0% and 75.7% of the amount of non-performing real estate loans at September 30, 2004 and 2003, respectively.



The allowance for losses on other consumer loans, including automobile, home
improvement, overdraft lines of credit and other consumer loans, decreased to $13.7 million at September 30, 2004 from $26.1 million at September 30, 2003. Net charge-offs of subprime automobile loans during fiscal year 2004 were $1.0 million,
compared to $16.8 million during fiscal year 2003. The decrease in the allowance 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 these
loans.



The allowance for losses on commercial loans decreased
to $7.4 million at September 30, 2004 from $14.4 million at September 30, 2003. The Banks interest in one syndicated loan, for which the Bank had established a loss allowance of $4.0 million, was repaid in full during the fiscal year ended
September 30, 2004.



The unallocated allowance for losses
decreased to $6.9 million at September 30, 2004 from $11.1 million at September 30, 2003. 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 allowance. The conditions evaluated in connection with the unallocated allowance include existing general economic and business conditions affecting key lending areas of the Bank, credit quality trends, collateral volumes, loan volumes
and concentrations, seasoning of the loan portfolio, specific industry conditions within portfolio segments, recent loss experience, regulatory examination results and findings of the Banks internal credit evaluations.



The Banks allowance for losses on real estate held for investment or
sale was $0.2 million at September 30, 2004 and 2003.



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



The Banks assets and liabilities are
inherently sensitive to changes in interest rates. These movements can result in variations to the overall level of income and market value of equity. Based on the characteristic of a specific asset or liability (including maturity, repricing
frequency and interest rate caps) a change in interest rates can significantly affect the contribution to net income by, and market value of, the instrument. If, in the aggregate, the Banks assets mature or reprice more quickly or to a greater
extent than its liabilities, the Bank is termed asset sensitive and will tend to experience an increase in interest income and market value during periods of rising interest rates and declining interest income and market value during
periods of falling interest rates. Conversely, if the Banks liabilities mature or reprice more quickly or to a greater extent than its assets, the Bank is 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 2004, 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, 2004, adjustable-rate loans accounted for 80.8% of total loans, compared to 68.8% at September 30, 2003. This increase was primarily
due to increased originations of adjustable-rate mortgage products, which typically reprice monthly and bear interest at rates which are tied to the one-month LIBOR, and an increase in payoffs of fixed-rate mortgage loans due to refinancing activity
resulting from continued low interest rates.



47



---

##### Table of Contents

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.



48



---

##### Table of Contents

The following table presents the Banks interest rate sensitivity gap at September 30, 2004.
Balances of interest-earning assets and interest-bearing liabilities are shown in the earlier of the period where contractual payments are due, interest rates adjust or prepayment is anticipated to occur. Adjustable and floating rate loans are
included in the period in which their interest rates are next scheduled to adjust, and prepayment rates are assumed for all of the Banks loans based on managements estimates. The Banks deposits with no stated maturity, including
savings and transaction accounts, have interest rates that may reprice at any time. However, market experience has proven that these deposits adjust to market prices over a much longer period of time. The Bank considers these deposits to be
relatively insensitive to interest rate changes. The table contains information of the Bank only and does not include consolidation or elimination entries required for the Trusts financial presentation.



Interest Rate Sensitivity Table (Gap)



(Dollars in thousands)



|                                               |  |                   |           |   |                                    |   |           |                                     |  |   |                                       |   |  |                     |           |   |       |   |            |   |  |   |           
|---------------------------------------------- |  | ----------------- | --------- | - | ---------------------------------- | - | --------- | ----------------------------------- |  | - | ------------------------------------- | - |  | ------------------- | --------- | - | ----- | - | ---------- | - |  | - | ----------
|                                               |  | Six Monthsor Less |           |   | More thanSix Monthsthrough OneYear |   |           | More thanOne YearthroughThree Years |  |   | More thanThree Yearsthrough FiveYears |   |  | More thanFive Years |           |   | Total
|As of September 30, 2004                       |  |                   |           |   |                                    |   |           |                                     |  |   |                                       |   |  |                     |           |   |       |   |            |   |  |   |           
|Real estate loans:                             |  |                   |           |   |                                    |   |           |                                     |  |   |                                       |   |  |                     |           |   |       |   |            |   |  |   |           
|Adjustable-rate                                |  | $                 | 3,377,555 |   |                                    | $ | 401,112   |                                     |  | $ | 741,330                               |   |  | $                   | 830,640   |   |       | $ | 292        |   |  | $ | 5,350,929 
|Fixed-rate                                     |  |                   | 35,781    |   |                                    |   | 29,190    |                                     |  |   | 67,520                                |   |  |                     | 28,278    |   |       |   | 7,806      |   |  |   | 168,575   
|Home equity credit lines and second mortgages  |  |                   | 1,511,050 |   |                                    |   | 33,481    |                                     |  |   | 98,498                                |   |  |                     | 59,215    |   |       |   | 80,813     |   |  |   | 1,783,057 
|Commercial                                     |  |                   | 738,502   |   |                                    |   | 14,107    |                                     |  |   | 46,521                                |   |  |                     | 33,894    |   |       |   | 85,762     |   |  |   | 918,786   
|Consumer and other                             |  |                   | 129,816   |   |                                    |   | 83,121    |                                     |  |   | 138,844                               |   |  |                     | 15,885    |   |       |   | 4,294      |   |  |   | 371,960   
|Loans held for securitization and/or sale      |  |                   | 1,965,476 |   |                                    |   |          |                                     |  |   |                                      |   |  |                     |          |   |       |   |           |   |  |   | 1,965,476 
|Mortgage-backed securities                     |  |                   | 66,447    |   |                                    |   | 61,600    |                                     |  |   | 80,925                                |   |  |                     | 119,832   |   |       |   | 80,499     |   |  |   | 409,303   
|Other investments                              |  |                   | 259,816   |   |                                    |   |          |                                     |  |   | 71,192                                |   |  |                     |          |   |       |   |           |   |  |   | 331,008   
|                                               |  |                   |           |   |                                    |   |           |                                     |  |   |                                       |   |  |                     |           |   |       |   |            |   |  |   |           
|Total interest-earning assets                  |  |                   | 8,084,443 |   |                                    |   | 622,611   |                                     |  |   | 1,244,830                             |   |  |                     | 1,087,744 |   |       |   | 259,466    |   |  |   | 11,299,094
|Total non-interest earning assets              |  |                   |          |   |                                    |   |          |                                     |  |   |                                      |   |  |                     |          |   |       |   | 1,971,753  |   |  |   | 1,971,753 
|                                               |  |                   |           |   |                                    |   |           |                                     |  |   |                                       |   |  |                     |           |   |       |   |            |   |  |   |           
|Total assets                                   |  | $                 | 8,084,443 |   |                                    | $ | 622,611   |                                     |  | $ | 1,244,830                             |   |  | $                   | 1,087,744 |   |       | $ | 2,231,219  |   |  | $ | 13,270,847
|                                               |  |                   |           |   |                                    |   |           |                                     |  |   |                                       |   |  |                     |           |   |       |   |            |   |  |   |           
|Deposits:                                      |  |                   |           |   |                                    |   |           |                                     |  |   |                                       |   |  |                     |           |   |       |   |            |   |  |   |           
|Fixed maturity deposits                        |  | $                 | 873,117   |   |                                    | $ | 423,195   |                                     |  | $ | 434,830                               |   |  | $                   | 118,455   |   |       | $ |           |   |  | $ | 1,849,597 
|NOW, statement and passbook accounts           |  |                   |          |   |                                    |   | 56,874    |                                     |  |   | 114,291                               |   |  |                     | 115,268   |   |       |   | 3,193,979  |   |  |   | 3,480,412 
|Money market deposit accounts                  |  |                   | 2,364,768 |   |                                    |   |          |                                     |  |   |                                      |   |  |                     |          |   |       |   |           |   |  |   | 2,364,768 
|Borrowings:                                    |  |                   |           |   |                                    |   |           |                                     |  |   |                                       |   |  |                     |           |   |       |   |            |   |  |   |           
|Capital notes - subordinated                   |  |                   |          |   |                                    |   |          |                                     |  |   |                                      |   |  |                     |          |   |       |   | 175,000    |   |  |   | 175,000   
|Other                                          |  |                   | 2,229,765 |   |                                    |   | 1,851     |                                     |  |   | 430,947                               |   |  |                     | 242,394   |   |       |   | 38,560     |   |  |   | 2,943,517 
|                                               |  |                   |           |   |                                    |   |           |                                     |  |   |                                       |   |  |                     |           |   |       |   |            |   |  |   |           
|Total interest-bearing liabilities             |  |                   | 5,467,650 |   |                                    |   | 481,920   |                                     |  |   | 980,068                               |   |  |                     | 476,117   |   |       |   | 3,407,539  |   |  |   | 10,813,294
|Minority interest                              |  |                   |          |   |                                    |   |          |                                     |  |   |                                      |   |  |                     |          |   |       |   | 175,391    |   |  |   | 175,391   
|Total non-interest bearing liabilities         |  |                   |          |   |                                    |   |          |                                     |  |   |                                      |   |  |                     |          |   |       |   | 1,570,301  |   |  |   | 1,570,301 
|Stockholders equity                           |  |                   |          |   |                                    |   |          |                                     |  |   |                                      |   |  |                     |          |   |       |   | 711,861    |   |  |   | 711,861   
|                                               |  |                   |           |   |                                    |   |           |                                     |  |   |                                       |   |  |                     |           |   |       |   |            |   |  |   |           
|Total liabilities & stockholders equity       |  |                   | 5,467,650 |   |                                    | $ | 481,920   |                                     |  | $ | 980,068                               |   |  | $                   | 476,117   |   |       | $ | 5,865,092  |   |  | $ | 13,270,847
|                                               |  |                   |           |   |                                    |   |           |                                     |  |   |                                       |   |  |                     |           |   |       |   |            |   |  |   |           
|Gap                                            |  |                   | 2,616,793 |   |                                    | $ | 140,691   |                                     |  | $ | 264,762                               |   |  | $                   | 611,627   |   |       | $ | (3,148,073 | ) |  |   |           
|Cumulative gap                                 |  |                   | 2,616,793 |   |                                    | $ | 2,757,484 |                                     |  | $ | 3,022,246                             |   |  | $                   | 3,633,873 |   |       | $ | 485,800    |   |  |   |           
|Cumulative gap as a percentage of total assets |  |                   | 19.7      | % |                                    |   | 20.8      | %                                   |  |   | 22.8                                  | % |  |                     | 27.4      | % |       |   | 3.7        | % |  |   |           



49



---

##### Table of Contents

The Banks one-year gap, as a percentage of total assets, was 20.8% at September 30, 2004, compared
to 18.6% at September 30, 2003. The change in the Banks one-year gap during the year results from various initiatives undertaken by management in light of the current low interest rate environment, including increased origination of short-term
adjustable rate loans which were mostly funded through the use of short-term borrowings.



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, 2004.



|                                        |         |                                   |   |        |                                  |   |         |           |   |        |   |          |   |  |     |  
|--------------------------------------- | ------- | --------------------------------- | - | ------ | -------------------------------- | - | ------- | --------- | - | ------ | - | -------- | - |  | --- | -
|                                        |         | (Dollars in thousands)            |  
|(Basis Points) Change in Interest Rates |         | Changes in NetInterest Income (1) |   |        | Change in Net PortfolioValue (2) |   |         | NPV Ratio |  
|                                        | Percent |                                   |   | Amount |                                  |   | Percent |           |   | Amount |   |         
|+200                                    |         | 10.4                              | % |        | $40,029                          |   |         | -8.0      | % |        | $ | (111,506 | ) |  | 8.8 | %
|+100                                    |         | 7.0                               | % |        | 26,863                           |   |         | -2.9      | % |        |   | (40,305  | ) |  | 9.2 | %
|-100                                    |         | -6.7                              | % |        | (25,720                          | ) |         | -5.8      | % |        |   | (80,744  | ) |  | 8.9 | %

---

|(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, 2004, the Bank
recorded a net deferred tax liability of $85.0 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 34 to the Consolidated
Financial Statements in this report.



Capital.At
September 30, 2004, 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.



50



---

##### Table of Contents

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



Regulatory Capital



(Dollars in thousands)



|                                              |  |        |           |   |                             |       |   |                |   |                 |  |      |        |  |                 |         |  |      |  
|--------------------------------------------- |  | ------ | --------- | - | --------------------------- | ----- | - | -------------- | - | --------------- |  | ---- | ------ |  | --------------- | ------- |  | ---- | -
|                                              |  | Actual |           |   | Minimum Capital Requirement |       |   | Excess Capital |  
|                                              |  | Amount |           |   | As a %of Assets             |       |   | Amount         |   | As a %of Assets |  |      | Amount |  | As a %of Assets |        
|Stockholders equity per financial statements |  | $      | 711,861   |   |                             |       |   |                |   |                 |  |      |        |  |                 |         |  |      |  
|Minority interest in REIT Subsidiary(1)       |  |        | 144,000   |   |                             |       |   |                |   |                 |  |      |        |  |                 |         |  |      |  
|                                              |  |        |           |   |                             |       |   |                |   |                 |  |      |        |  |                 |         |  |      |  
|                                              |  |        | 855,861   |   |                             |       |   |                |   |                 |  |      |        |  |                 |         |  |      |  
|Adjustments for tangible and core capital:    |  |        |           |   |                             |       |   |                |   |                 |  |      |        |  |                 |         |  |      |  
|Intangible assets                             |  |        | (42,372   | ) |                             |       |   |                |   |                 |  |      |        |  |                 |         |  |      |  
|Non-includable subsidiaries(2)                |  |        | (929      | ) |                             |       |   |                |   |                 |  |      |        |  |                 |         |  |      |  
|Non-qualifying purchased/originated           |  |        |           |   |                             |       |   |                |   |                 |  |      |        |  |                 |         |  |      |  
|loan servicing rights                         |  |        | (7,048    | ) |                             |       |   |                |   |                 |  |      |        |  |                 |         |  |      |  
|                                              |  |        |           |   |                             |       |   |                |   |                 |  |      |        |  |                 |         |  |      |  
|Total tangible capital                        |  |        | 805,512   |   |                             | 6.09  | % |                | $ | 198,556         |  | 1.50 | %      |  | $               | 606,956 |  | 4.59 | %
|                                              |  |        |           |   |                             |       |   |                |   |                 |  |      |        |  |                 |         |  |      |  
|Total core capital(3)                         |  |        | 805,512   |   |                             | 6.09  | % |                | $ | 529,482         |  | 4.00 | %      |  | $               | 276,030 |  | 2.09 | %
|                                              |  |        |           |   |                             |       |   |                |   |                 |  |      |        |  |                 |         |  |      |  
|Tier 1 risk-based capital(3)                  |  |        | 805,512   |   |                             | 8.61  | % |                | $ | 374,882         |  | 4.00 | %      |  | $               | 430,630 |  | 4.61 | %
|                                              |  |        |           |   |                             |       |   |                |   |                 |  |      |        |  |                 |         |  |      |  
|Adjustments for total risk-based capital:     |  |        |           |   |                             |       |   |                |   |                 |  |      |        |  |                 |         |  |      |  
|Subordinated capital debentures               |  |        | 175,000   |   |                             |       |   |                |   |                 |  |      |        |  |                 |         |  |      |  
|Allowance for general loan losses             |  |        | 37,750    |   |                             |       |   |                |   |                 |  |      |        |  |                 |         |  |      |  
|                                              |  |        |           |   |                             |       |   |                |   |                 |  |      |        |  |                 |         |  |      |  
|Total supplementary capital                   |  |        | 212,750   |   |                             |       |   |                |   |                 |  |      |        |  |                 |         |  |      |  
|                                              |  |        |           |   |                             |       |   |                |   |                 |  |      |        |  |                 |         |  |      |  
|Total available capital                       |  |        | 1,018,262 |   |                             |       |   |                |   |                 |  |      |        |  |                 |         |  |      |  
|Equity investments(2)(4)                      |  |        | (2,360    | ) |                             |       |   |                |   |                 |  |      |        |  |                 |         |  |      |  
|                                              |  |        |           |   |                             |       |   |                |   |                 |  |      |        |  |                 |         |  |      |  
|Total risk-based capital(3)                   |  | $      | 1,015,902 |   |                             | 10.91 | % |                | $ | 749,764         |  | 8.00 | %      |  | $               | 266,138 |  | 2.91 | %
|                                              |  |        |           |   |                             |       |   |                |   |                 |  |      |        |  |                 |         |  |      |  

---

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



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



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



|(4) | Includes one property classified as real estate held for sale which is treated as an equity
investment for regulatory capital purposes.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------



51



---

##### Table of Contents

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, 2004, the Banks leverage, tier 1 risk-based and total risk-based capital ratios were 6.09%, 8.61% and 10.91%, 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 April 2004, the Bank received from the OTS an extension of the holding periods for
certain of its REO properties through April 7, 2005. The following table sets forth the Banks REO at September 30, 2004, by the fiscal year in which the property was acquired through foreclosure.



|            |  |                |        |    
|----------- |  | -------------- | ------ | ---
|Fiscal Year |  | (In thousands) |       
|1990        |  | $              | 2,360  | (1)
|1991        |  |                | 11,380 | (2)
|1995        |  |                | 4,948  | (2)
|2003        |  |                | 57     |    
|2004        |  |                | 1,612  |    
|            |  |                |        |    
|Total REO   |  | $              | 20,357 |    
|            |  |                |        |    

---

|(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 April 7, 2005.
|--- | -------------------------------------------------------------------------------------------------



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.



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.



In October 2003, the Bank issued
$125 million of its 8% Preferred Stock. The net proceeds from the issuance of the 8% Preferred Stock were used to redeem all of the 13% Preferred Stock on October 31, 2003.



On December 2, 2003, the Bank issued $175 million aggregate principal amount of its 2003 Debentures. The net proceeds of the
offering, along with short-term borrowings, were used to redeem all of the 1993 Debentures and the 1996 Debentures.



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.



52



---

##### Table of Contents

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. 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.



During fiscal 2004, the Bank made tax sharing payments totaling $8.8 million and dividend payments totaling $24.8 million to the Real Estate Trust.



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 2004,
the Real Estate Trust purchased, through dividend reinvestment and on the open market, approximately 345,000 shares of common stock of Saul Centers, and as of September 30, 2004, owns approximately 4,090,000 shares representing 25.1% of such
companys outstanding common stock. As of September 30, 2004, the market value of these shares was approximately $134.5 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 Partnership, the Real Estate Trust shares in cash distributions from operations and from capital transactions involving the sale of properties. The partnership agreement
of Saul Holdings Partnership provides for quarterly cash distributions to the partners out of net cash flow. See Item 1. Business  Real Estate  Investment in Saul Holdings Limited Partnership. In fiscal 2004, the Real Estate
Trust received total cash distributions of $6.5 million from Saul Holdings Partnership. Substantially all of the Real Estate Trusts ownership interest in Saul Holdings Partnership has been pledged as collateral with the Real Estate
Trusts two revolving credit lenders.



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



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



During fiscal 2004, the Real Estate Trust sold unsecured notes, with a
maturity ranging from one to ten years, primarily to provide funds to repay maturing unsecured notes. During fiscal 2004, the Real Estate Trust sold notes amounting to $13.3 million, consisting of $6.9 million of new sales and $6.4 million of
rollovers, at a weighted average interest rate of 6.7%. In addition, $5.8 million of unsecured notes were repaid during fiscal 2004. To the degree that the Real Estate Trust does not sell new unsecured notes in an amount sufficient to finance
completely the scheduled repayment of outstanding unsecured notes as they mature, it will finance such repayments from other sources of funds.



The Real Estate Trust has an established $55.0 million secured revolving credit line with an unrelated bank that matures on December 12, 2006, with
provisions for extending the term annually. This facility is secured by a portion of the Real Estate Trusts



53



---

##### Table of Contents

ownership in Saul Holdings Partnership and Saul Centers. Interest is computed by reference to a floating rate index. At September 30, 2004, the Real Estate
Trust had no outstanding borrowings and unrestricted availability of $55.0 million.



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



The maturity schedule for the Real Estate
Trusts outstanding debt, including mortgage notes payable for real estate held for sale, at September 30, 2004 for fiscal years commencing October 1, 2004 is set forth in the following table:



Debt Maturity Schedule



|            |  |                |         |                        |   |                          |  |       |        |  |   |        
|----------- |  | -------------- | ------- | ---------------------- | - | ------------------------ |  | ----- | ------ |  | - | -------
|Fiscal Year |  | MortgageNotes  |         | Notes PayableSecured |   | Notes PayableUnsecured |  | Total
|            |  | (In thousands)
|2005        |  | $              | 16,455  |                        | $ |                         |  | $     | 11,579 |  | $ | 28,034 
|2006        |  |                | 94,982  |                        |   |                         |  |       | 7,874  |  |   | 102,856
|2007        |  |                | 5,521   |                        |   |                         |  |       | 6,499  |  |   | 12,020 
|2008        |  |                | 5,927   |                        |   |                         |  |       | 3,991  |  |   | 9,918  
|2009        |  |                | 15,768  |                        |   |                         |  |       | 4,981  |  |   | 20,749 
|Thereafter  |  |                | 172,663 |                        |   | 250,000                  |  |       | 21,504 |  |   | 444,167
|            |  |                |         |                        |   |                          |  |       |        |  |   |        
|Total       |  | $              | 311,316 |                        | $ | 250,000                  |  | $     | 56,428 |  | $ | 617,744
|            |  |                |         |                        |   |                          |  |       |        |  |   |        



Of the $311.3 million
of mortgage notes outstanding at September 30, 2004, $303.5 million was non-recourse to the Real Estate Trust.



In June 2003 the Real Estate Trust refinanced three hotels with a new fixed rate non-recourse financing. The financing consisted of three separate loans
totaling $46 million, each with a term of 10 years and a 5.9% interest rate. The financing replaced $38.3 million in existing financing on the three hotels.



Real Estate Development and Capital Expenditures



On September 25, 2003, the Real Estate Trust sold 7.7 acres located in Rockville, Maryland, for $11.3 million, and recognized a gain of $9.1 million on
the transaction.



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.



During the quarter ended June 30, 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 the fiscal year ended September 30 2003. This refund has been recorded as an additional gain
on sale of this land parcel in the year ended September 30, 2004.



The Real Estate Trust has placed one of its hotel properties on the market for sale and has written down its investment in this asset by $310,000 to arrive at its estimated fair value, less cost to sell, of $2.1 million. The sale of this
asset closed on December 9, 2004.



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



The Real Estate Trust believes that the capital improvement costs for its income-producing properties will be in the range of $12.0 to $19.0 million per
year for the next several years.



54



---

##### Table of Contents

Liquidity Requirements  Real Estate Trust



As of September 30, 2004 the Real Estate Trust had unfunded contractual payment obligations, excluding recurring operating
obligations, of approximately $38.0 million due within the next twelve months. The table below specifies the total contractual payment obligations as of September 30, 2004.



|                                   |  |            |         |                |   |           |  |          |         |              |   |        |  |   |        
|---------------------------------- |  | ---------- | ------- | -------------- | - | --------- |  | -------- | ------- | ------------ | - | ------ |  | - | -------
|(In thousands)                     |  | Total Cost |         | Lessthan 1Year |   | 1-3 Years |  | 4-5Years |         | After 5Years
|Contractual Obligations            |  |            |         |                |   |           |  |          |         |              |   |        |  |   |        
|Mortgage Notes Payable             |  | $          | 311,316 |                | $ | 16,455    |  | $        | 100,503 |              | $ | 21,695 |  | $ | 172,663
|Notes Payable  Secured            |  |            | 250,000 |                |   |          |  |          |        |              |   |       |  |   | 250,000
|Notes Payable  Unsecured          |  |            | 56,428  |                |   | 11,579    |  |          | 14,373  |              |   | 8,972  |  |   | 21,504 
|Advisory Fee                       |  |            | 5,844   |                |   | 5,844     |  |          |        |              |   |       |  |   |       
|Capital Leases                     |  |            | 1,374   |                |   | 659       |  |          | 715     |              |   |       |  |   |       
|Development Obligations            |  |            | 3,421   |                |   | 3,421     |  |          |        |              |   |       |  |   |       
|                                   |  |            |         |                |   |           |  |          |         |              |   |        |  |   |        
|Total Contractual Cash Obligations |  | $          | 628,383 |                | $ | 37,958    |  | $        | 115,591 |              | $ | 30,667 |  | $ | 444,167
|                                   |  |            |         |                |   |           |  |          |         |              |   |        |  |   |        



As of September 30,
2004, the Real Estate Trusts current contractual obligations, excluding recurring operating obligations, due within one year total approximately $38.0 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 2005 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, new financings, refinancing of maturing debt, proceeds from
asset sales and dividends and tax sharing payments from the Bank.



BANKING



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



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



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



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



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



| |  | 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 $670.8
million of these assets are pledged to the Federal Reserve Bank of Richmond, although there were no outstanding borrowings during fiscal year 2004. As of September 30, 2004, 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 $3.4 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 source of financing at competitive rates and
assist the Bank in 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.



55



---

##### Table of Contents

Since 1988, the Bank has securitized approximately $23.5 billion of loan receivables. At September 30,
2004, the Bank continues to service $7.1 billion and $151.0 million of securitized residential mortgages and automobile loan receivables, respectively. Chevy Chase derives fee-based income from servicing these securitized portfolios. However, that
fee-based income has been adversely affected in prior periods by increases in prepayments, delinquencies and charge-offs related to the receivables in these securitized pools.



The Bank securitized and sold $4.9 billion and $2.6 billion of loan receivables during fiscal year 2004 and 2003,
respectively. At September 30, 2004 and 2003, the Bank had $2.0 billion and $1.4 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 existing and continuing loan commitments, repay borrowings and meet operating expenses. During fiscal year
2004, the Bank used the cash provided by operating, investing and financing activities primarily to (i) fund maturing savings certificates and deposit withdrawals of $52.4 billion, (ii) fund existing and continuing loan commitments, including real
estate held for investment or sale, of $3.5 billion, (iii) purchase investments and loans of $7.8 billion and (iv) meet operating expenses, before depreciation and amortization, of $440.5 million. These commitments were funded primarily through (i)
proceeds from customer deposits and sales of certificates of deposit of $53.2 billion, (ii) proceeds from sales of loans, trading securities and real estate of $6.5 billion, (iii) principal and interest collected on investments, loans, and
securities of $3.6 billion and (iv) proceeds from borrowings of $706.9 million, net of repayment of borrowings.



At September 30, 2004, repayments of borrowed money scheduled to occur during the next 12 months were $2.2 billion. Certificates of deposit maturing
during the next 12 months amounted to $1.3 billion. The Bank expects that a significant portion of these maturing certificates of deposit will remain with the Bank. In the event that deposit withdrawals are greater than anticipated, the Bank may
have to increase deposit interest rates or rely on alternative and potentially higher cost sources of funds in order to meet its liquidity needs.



The Banks liquidity requirements in years subsequent to fiscal year 2004 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 $23.5 billion of loan receivables.



The Bank transfers receivables from time to time to a special purpose entity commonly referred to as a depositor. The depositor then establishes a trust
for each particular securitization, and transfers the related loans to that particular trust. The trust uses proceeds from the sale of the securities to pay the depositor for the loans sold to the trust, and the depositor in turn pays the proceeds
over to the Bank. These securitization vehicles are not consolidated within the Banks consolidated financial statements since 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. 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, the Bank generally retains the right to service the loans. At September 30, 2004, the Bank continues to service
$7.1 billion and $151.0 million of securitized residential mortgages and automotive loan receivables, respectively. 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, 2004 and 2003, total recourse to the Bank related to loan securitization transactions was $14.8 million and
$31.7 million, respectively. See Note 8 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, 2004 and
2003, the recourse to the Bank under these arrangements totaled $4.0 million and $3.4 million, respectively.



56



---

##### Table of Contents

The Banks commitments to extend credit at September 30, 2004 are set forth in the following table.



|                                         |  |                |          
|---------------------------------------- |  | -------------- | ---------
|                                         |  | (In thousands)
|Commitments to originate loans           |  | $              | 807,347  
|                                         |  |                |          
|Loans in process (collateralized loans): |  |                |          
|Home equity                              |  |                | 1,155,364
|Real estate construction and ground      |  |                | 220,728  
|Commercial                               |  |                | 457,253  
|                                         |  |                |          
|Subtotal                                 |  |                | 1,833,345
|                                         |  |                |          
|Loans in process (unsecured loans):      |  |                |          
|Overdraft lines                          |  |                | 139,335  
|Commercial                               |  |                | 330,541  
|                                         |  |                |          
|Subtotal                                 |  |                | 469,876  
|                                         |  |                |          
|Total commitments to extend credit       |  | $              | 3,110,568
|                                         |  |                |          



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 41.6% of commitments to extend credit at September 30, 2004.



The following table summarizes certain of our material
contractual cash obligations associated with operating, investing and financing activities as of September 30, 2004:



|                            |  |                                       |           |                 |   |           |  |           |         |                  |   |         |  |   |        
|--------------------------- |  | ------------------------------------- | --------- | --------------- | - | --------- |  | --------- | ------- | ---------------- | - | ------- |  | - | -------
|                            |  | Payments due by period (In thousands)
|                            |  | Total                                 |           | Less than1 year |   | 1-3 years |  | 3-5 years |         | More than5 years
|Long term debt obligations  |  | $                                     | 2,003,987 |                 | $ | 621,109   |  | $         | 829,221 |                  | $ | 348,532 |  | $ | 205,125
|Operating lease obligations |  |                                       | 198,726   |                 |   | 24,538    |  |           | 46,885  |                  |   | 33,634  |  |   | 93,669 
|                            |  |                                       |           |                 |   |           |  |           |         |                  |   |         |  |   |        
|Total                       |  | $                                     | 2,202,713 |                 | $ | 645,647   |  | $         | 876,106 |                  | $ | 382,166 |  | $ | 298,794
|                            |  |                                       |           |                 |   |           |  |           |         |                  |   |         |  |   |        



Additionally, the
Banks 8% Preferred Stock pays quarterly dividends in arrears at a yearly rate of $2.00 per share, totaling approximately $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, 2004.



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, governmental
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
are not decreased 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 properties 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.



57



---

##### Table of Contents

The banks operating results historically have depended primarily on its net interest
spread, which is the difference between the 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 2004 COMPARED TO FISCAL 2003



REAL ESTATE



The Real Estate
Trust recorded a loss from continuing operations before depreciation of $4.6 million and an operating loss from continuing operations of $23.4 million for fiscal 2004, compared to income from continuing operations before depreciation of $4.9 million
and an operating loss from continuing operations of $14.0 million for fiscal 2003. The changes reflect improved operating results in the hotel portfolio and lower write-downs of the Real Estate Trusts non-public investments which were offset
by declining results in the office and industrial portfolio, increased interest expense, the write-off of unamortized debt costs of $2.4 million, the early redemption premium of $6.5 million, included in interest and amortization of debt expense,
associated with the payoff of the Real Estate Trusts $200 million Senior Secured Notes and differences in the respective gains recognized on property sales, $9.1 million in fiscal 2003 compared to $2.8 million in fiscal 2004.



Income after direct operating expenses from hotels increased $6.3 million, or
22.9%, in fiscal 2004 from the level achieved in fiscal 2003. Total revenue increased $11.3 million, or 13.3%, as the overall occupancy percentage for the hotel properties increased from 61.1% in fiscal 2003 to 66.0% in fiscal 2004 while the average
room rate increased $5.74, or 6.7% from $85.93 in fiscal 2003 to $91.67 in fiscal 2004, reflecting improved demand at the Real Estate Trusts hotel properties, particularly the Northern Virginia and Florida properties. Room sales for fiscal
2004 increased $10.3 million, or 15.5%, from fiscal year 2003, while food, beverage and other sales increased $956,000, or 5.2%. Direct operating expenses increased $5.0 million, or 8.7%, reflecting increased operating costs, such as payroll,
advertising and other operating costs associated with the increased hotel occupancy.



Income after direct operating expenses from office and industrial properties decreased $1.2 million, or 4.4%, in fiscal 2004 compared to fiscal 2003. Total revenue decreased $896,000, or 2.3%, in fiscal 2004 as
increased vacancy during the first and second fiscal quarters of 2004, specifically at two of the Trusts office properties, offset contractual rent increases. In addition, leased space is turning over at lower rental rates in the current
fiscal period. Direct operating expenses increased $321,000, or 2.8% in fiscal 2004 as increased bad debt, repair and maintenance and utility costs were slightly offset by lower property taxes.



Other income, which includes interest income, income from other real estate
properties and other miscellaneous income, increased $329,000, or 25.3%, in fiscal 2004 principally due to increased revenue from the Real Estate Trusts other real estate investments and higher interest income in the 2004 period reflecting the
increased invested cash balance resulting from the net proceeds received from the $250 million Senior Secured Debt offering.



Land parcels and other expense increased $158,000, or 13.4%, in fiscal 2004 when compared to fiscal 2003 as a result of increased operating expenses at
the Real Estate Trusts other real estate investments.



Interest and amortization of debt expense increased $9.6 million, or 19.0%, from $50.5 million in the fiscal 2003 period to $60.1 million in the fiscal 2004 period. The fiscal 2004 period includes the $6.5 million redemption premium paid as
a result of the early redemption of the $200 million Senior Secured Notes. Other interest expense, which increased $884,000 in the fiscal 2004 period, includes interest on the new $250 million Senior Secured Notes which were issued on February 25,
2004 and interest is payable from that date, therefore interest expense includes interest on both the $200 million and the $250 million Senior Secured Debt from February 25, 2004 through March 31, 2004. This overlap in interest resulted in
additional interest charges of approximately $1.9 million in the fiscal 2004 period. This increase in interest expense was slightly offset by lower interest expense on other debt due to lower mortgage and line of credit balances and lower interest
rates on those borrowings. The average balance of outstanding borrowings increased to $638.1 million in the fiscal 2004 period from $585.1 million in the fiscal 2003 period, reflecting the overlap period of the Senior Secured Debt which offset lower
mortgage and line of credit balances. The average cost of borrowings was 9.06% in the fiscal 2004 period and 8.68% in the fiscal 2003 period, reflecting the $6.5 million redemption premium paid in fiscal 2004 which offset the 225 basis point
reduction in the outstanding Senior Secured Note debt. Amortization of debt expense increased $2.2 million, reflecting the write-off of unamortized debt costs of $2.4 million relating to the $200 million Senior Secured Notes. This increase was
slightly offset by lower other debt cost amortization reflecting debt refinancing and extensions which settled during the 2003 fiscal year.



Depreciation expense decreased $153,000, or 0.8%, as a result of the retirement of certain office and hotel improvements in fiscal 2003 which offset the
additional depreciation expense of new income-producing assets and tenant improvements placed into service in fiscal 2004.



Advisory, management and leasing fees paid to related parties increased $747,000, or 6.1%, in the fiscal 2004 period when compared to the fiscal 2003
period. The advisory fee in fiscal 2004 was $472,000 per month compared to $458,000 per month for fiscal 2003, an aggregate increase of $168,000. The remainder of the cost increase, totaling $579,000, was due to higher hotel management fees
reflecting the 13.3% increase in hotel revenue and increased office leasing costs paid.



58



---

##### Table of Contents

General and administrative expense decreased $380,000, or 13.5%, from $2.8 million in the fiscal 2003
period to $2.4 million in the fiscal 2004 period. Lower legal and licensing costs were slightly offset by other increases, such as the write-off of certain acquisition and development costs for projects that the Real Estate Trust has determined not
to pursue.



Equity in earnings of unconsolidated entities
reflected net earnings of $7.8 million in the fiscal 2004 period as compared to $7.2 million in the fiscal 2003 period, an increase of approximately $600,000. Earnings from Saul Holdings Partnership and Saul Centers were lower by $239,000 in fiscal
2004 primarily due to the dilution caused by the November 2003 Saul Centers preferred stock offering. Losses from other investments totaled $616,000 in fiscal 2004 as compared to losses of $1.4 million in fiscal 2003. These losses are a result of
write-downs of a certain non-public investment accounted for under the equity method.



The Real Estate Trust recorded an impairment charge of $998,000 in the fiscal 2003 period due to write-downs of certain non-public investments accounted for under the cost method. No impairment charges were recorded
in the fiscal 2004 period.



In February 2004 the Commonwealth
of Virginia acquired 7.93 acres of land owned by the Real Estate Trust for use in a highway project. The Commonwealth of Virginia has paid $3.6 million which has resulted in an initial gain of approximately $2.7 million. In addition, during the
quarter ended June 30, 2004 the Real Estate Trust received a refund of approximately $117,000 for an expenditure relating to a September 2003 land sale. The original gain on the sale of this parcel was recorded in the fiscal year ended September 30
2003. This refund has been recorded as an additional gain on sale of this land parcel in the fiscal year ended September 30, 2004.



On September 25, 2003 the Real Estate Trust sold a land parcel in Rockville, Maryland for $11.3 million resulting in a gain of $9.1 million.



The Real Estate Trust has placed one of its hotel properties on the market
for sale and has written down its investment in this asset by $310,000 to arrive at its estimated fair value, less cost to sell, of $2.1 million. Included in the fiscal 2004 period Loss from Operations of Discontinued Real Estate Asset of $1.0
million is the $310,000 write-down. The sale of this asset closed on December 9, 2004.



BANKING



Overview.The
Bank recorded operating income of $231.2 million for the year ended September 30, 2004, compared to operating income of $146.2 million for the year ended September 30, 2003. The improvement in income in fiscal year 2004 was primarily due to
increases in servicing, securitization and mortgage banking income, as well as net interest income and decreases in the provision for loan losses and depreciation and amortization expense. A decrease in automobile rental income and increases in
salaries and employee benefits and other (non-interest) expenses partially offset the increased income. The Banks net income in future periods will continue to be affected by increased operating expenses associated with expansion of the
Banks branch network and other areas of business and potential use of relatively higher cost sources of funding to support continued growth.



Net Interest Income.Net interest income, before the provision for loan losses, increased $32.2 million (or 13.1%) in fiscal year 2004 from fiscal
year 2003. Interest income recorded on non-accrual assets and restructured loans totaled $0.2 million during fiscal year 2004. The Bank would have recorded interest income of $1.2 million in fiscal year 2004 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.



59



---

##### 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, |           
|                                                        |  | 2004                     |            |          | 2003 |             |  | 2002   |                 
|                                                        |  | Average Balances         |            | Interest |      | Yield/ Rate |  |        | Average Balances |  | Interest |            | Yield/ Rate |   |         | Average Balances |       | Interest |  | Yield/ Rate |           
|Assets:                                                 |  |                          |            |          |      |             |  |        |                  |  |          |            |             |   |         |                  |       |          |  |             |            |  |   |         |  |       |  
|Interest-earning assets:                                |  |                          |            |          |      |             |  |        |                  |  |          |            |             |   |         |                  |       |          |  |             |            |  |   |         |  |       |  
|Loans receivable, net(1)                                |  | $                        | 10,081,196 |          | $    | 411,640     |  | 4.08   | %                |  | $        | 8,512,601  |             | $ | 402,405 |                  | 4.73  | %        |  | $           | 7,349,188  |  | $ | 454,297 |  | 6.18  | %
|Mortgage-backed securities                              |  |                          | 435,313    |          |      | 20,505      |  | 4.71   |                  |  |          | 682,799    |             |   | 36,625  |                  | 5.36  |          |  |             | 1,233,159  |  |   | 74,358  |  | 6.03  |  
|Federal funds sold and securities                       |  |                          |            |          |      |             |  |        |                  |  |          |            |             |   |         |                  |       |          |  |             |            |  |   |         |  |       |  
|purchased under agreements to resell                    |  |                          | 67,738     |          |      | 748         |  | 1.10   |                  |  |          | 70,282     |             |   | 885     |                  | 1.26  |          |  |             | 48,022     |  |   | 857     |  | 1.78  |  
|Trading securities                                      |  |                          | 27,079     |          |      | 1,355       |  | 5.00   |                  |  |          | 87,247     |             |   | 4,801   |                  | 5.50  |          |  |             | 47,241     |  |   | 2,988   |  | 6.33  |  
|Investment securities                                   |  |                          | 58,488     |          |      | 1,163       |  | 1.99   |                  |  |          | 46,399     |             |   | 1,192   |                  | 2.57  |          |  |             | 46,206     |  |   | 1,527   |  | 3.30  |  
|Other interest-earning assets                           |  |                          | 219,553    |          |      | 5,860       |  | 2.67   |                  |  |          | 191,318    |             |   | 5,643   |                  | 2.95  |          |  |             | 200,286    |  |   | 7,372   |  | 3.68  |  
|                                                        |  |                          |            |          |      |             |  |        |                  |  |          |            |             |   |         |                  |       |          |  |             |            |  |   |         |  |       |  
|Total                                                   |  |                          | 10,889,367 |          |      | 441,271     |  | 4.05   |                  |  |          | 9,590,646  |             |   | 451,551 |                  | 4.71  |          |  |             | 8,924,102  |  |   | 541,399 |  | 6.07  |  
|                                                        |  |                          |            |          |      |             |  |        |                  |  |          |            |             |   |         |                  |       |          |  |             |            |  |   |         |  |       |  
|Non-interest earning assets:                            |  |                          |            |          |      |             |  |        |                  |  |          |            |             |   |         |                  |       |          |  |             |            |  |   |         |  |       |  
|Cash                                                    |  |                          | 287,557    |          |      |             |  |        |                  |  |          | 298,697    |             |   |         |                  |       |          |  |             | 257,790    |  |   |         |  |       |  
|Real estate held for investment or sale                 |  |                          | 20,785     |          |      |             |  |        |                  |  |          | 24,597     |             |   |         |                  |       |          |  |             | 27,693     |  |   |         |  |       |  
|Property and equipment, net                             |  |                          | 482,874    |          |      |             |  |        |                  |  |          | 471,845    |             |   |         |                  |       |          |  |             | 454,282    |  |   |         |  |       |  
|Automobiles subject to lease, net                       |  |                          | 635,526    |          |      |             |  |        |                  |  |          | 1,039,802  |             |   |         |                  |       |          |  |             | 1,110,660  |  |   |         |  |       |  
|Goodwill and other intangible assets, net               |  |                          | 24,181     |          |      |             |  |        |                  |  |          | 24,597     |             |   |         |                  |       |          |  |             | 25,832     |  |   |         |  |       |  
|Other assets                                            |  |                          | 480,141    |          |      |             |  |        |                  |  |          | 355,771    |             |   |         |                  |       |          |  |             | 294,457    |  |   |         |  |       |  
|                                                        |  |                          |            |          |      |             |  |        |                  |  |          |            |             |   |         |                  |       |          |  |             |            |  |   |         |  |       |  
|Total assets                                            |  | $                        | 12,820,431 |          |      |             |  |        |                  |  | $        | 11,805,955 |             |   |         |                  |       |          |  | $           | 11,094,816 |  |   |         |  |       |  
|                                                        |  |                          |            |          |      |             |  |        |                  |  |          |            |             |   |         |                  |       |          |  |             |            |  |   |         |  |       |  
|Liabilities and stockholders equity:                   |  |                          |            |          |      |             |  |        |                  |  |          |            |             |   |         |                  |       |          |  |             |            |  |   |         |  |       |  
|Interest-bearing liabilities:                           |  |                          |            |          |      |             |  |        |                  |  |          |            |             |   |         |                  |       |          |  |             |            |  |   |         |  |       |  
|Deposit accounts:                                       |  |                          |            |          |      |             |  |        |                  |  |          |            |             |   |         |                  |       |          |  |             |            |  |   |         |  |       |  
|Demand deposits                                         |  | $                        | 2,094,878  |          |      | 4,351       |  | 0.21   |                  |  | $        | 1,799,489  |             |   | 4,601   |                  | 0.26  |          |  | $           | 1,537,403  |  |   | 4,792   |  | 0.31  |  
|Savings deposits                                        |  |                          | 1,200,609  |          |      | 3,294       |  | 0.27   |                  |  |          | 1,099,990  |             |   | 4,921   |                  | 0.45  |          |  |             | 974,371    |  |   | 9,346   |  | 0.96  |  
|Time deposits                                           |  |                          | 1,746,956  |          |      | 33,447      |  | 1.91   |                  |  |          | 1,925,830  |             |   | 49,195  |                  | 2.55  |          |  |             | 2,370,643  |  |   | 98,262  |  | 4.14  |  
|Money market deposits                                   |  |                          | 2,322,983  |          |      | 17,159      |  | 0.74   |                  |  |          | 2,114,947  |             |   | 21,405  |                  | 1.01  |          |  |             | 1,813,702  |  |   | 31,512  |  | 1.74  |  
|                                                        |  |                          |            |          |      |             |  |        |                  |  |          |            |             |   |         |                  |       |          |  |             |            |  |   |         |  |       |  
|Total deposits                                          |  |                          | 7,365,426  |          |      | 58,251      |  | 0.79   |                  |  |          | 6,940,256  |             |   | 80,122  |                  | 1.15  |          |  |             | 6,696,119  |  |   | 143,912 |  | 2.15  |  
|Borrowings                                              |  |                          | 3,173,104  |          |      | 104,771     |  | 3.30   |                  |  |          | 2,769,252  |             |   | 125,357 |                  | 4.53  |          |  |             | 2,688,025  |  |   | 129,274 |  | 4.81  |  
|                                                        |  |                          |            |          |      |             |  |        |                  |  |          |            |             |   |         |                  |       |          |  |             |            |  |   |         |  |       |  
|Total liabilities                                       |  |                          | 10,538,530 |          |      | 163,022     |  | 1.55   |                  |  |          | 9,709,508  |             |   | 205,479 |                  | 2.12  |          |  |             | 9,384,144  |  |   | 273,186 |  | 2.91  |  
|                                                        |  |                          |            |          |      |             |  |        |                  |  |          |            |             |   |         |                  |       |          |  |             |            |  |   |         |  |       |  
|Non-interest-bearing items:                             |  |                          |            |          |      |             |  |        |                  |  |          |            |             |   |         |                  |       |          |  |             |            |  |   |         |  |       |  
|Non-interest bearing deposits                           |  |                          | 1,146,484  |          |      |             |  |        |                  |  |          | 1,091,918  |             |   |         |                  |       |          |  |             | 845,455    |  |   |         |  |       |  
|Other liabilities                                       |  |                          | 302,171    |          |      |             |  |        |                  |  |          | 317,225    |             |   |         |                  |       |          |  |             | 221,286    |  |   |         |  |       |  
|Minority interest                                       |  |                          | 175,391    |          |      |             |  |        |                  |  |          | 146,580    |             |   |         |                  |       |          |  |             | 144,000    |  |   |         |  |       |  
|Stockholders equity                                    |  |                          | 657,855    |          |      |             |  |        |                  |  |          | 540,724    |             |   |         |                  |       |          |  |             | 499,931    |  |   |         |  |       |  
|                                                        |  |                          |            |          |      |             |  |        |                  |  |          |            |             |   |         |                  |       |          |  |             |            |  |   |         |  |       |  
|Total liabilities and stockholders equity              |  | $                        | 12,820,431 |          |      |             |  |        |                  |  | $        | 11,805,955 |             |   |         |                  |       |          |  | $           | 11,094,816 |  |   |         |  |       |  
|                                                        |  |                          |            |          |      |             |  |        |                  |  |          |            |             |   |         |                  |       |          |  |             |            |  |   |         |  |       |  
|Net interest income                                     |  |                          |            |          | $    | 278,249     |  |        |                  |  |          |            |             | $ | 246,072 |                  |       |          |  |             |            |  | $ | 268,213 |  |       |  
|                                                        |  |                          |            |          |      |             |  |        |                  |  |          |            |             |   |         |                  |       |          |  |             |            |  |   |         |  |       |  
|Net interest spread(2)                                  |  |                          |            |          |      |             |  | 2.51   | %                |  |          |            |             |   |         |                  | 2.59  | %        |  |             |            |  |   |         |  | 3.16  | %
|                                                        |  |                          |            |          |      |             |  |        |                  |  |          |            |             |   |         |                  |       |          |  |             |            |  |   |         |  |       |  
|Net yield on interest-earning assets(3)                 |  |                          |            |          |      |             |  | 2.56   | %                |  |          |            |             |   |         |                  | 2.57  | %        |  |             |            |  |   |         |  | 3.01  | %
|                                                        |  |                          |            |          |      |             |  |        |                  |  |          |            |             |   |         |                  |       |          |  |             |            |  |   |         |  |       |  
|Interest-earning assets to interest-bearing liabilities |  |                          |            |          |      |             |  | 103.33 | %                |  |          |            |             |   |         |                  | 98.78 | %        |  |             |            |  |   |         |  | 95.10 | %
|                                                        |  |                          |            |          |      |             |  |        |                  |  |          |            |             |   |         |                  |       |          |  |             |            |  |   |         |  |       |  

---

|(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 and Comprehensive Income; 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.
|--- | -------------------------------------------------------------------------------------------------------



60



---

##### 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 in volume (change in volume multiplied by old rate); changes
in rate (change in rate multiplied by old volume); and changes in rate and volume.



Volume and Rate Changes in Net Interest Income



(In thousands)



|                                                                       |  |                                                                                                                  |         |   |                                                                                                                  |   |         |              |  |   |         |   |  |      |         |   |              |   |          |   |  |   |         |  
|---------------------------------------------------------------------- |  | ---------------------------------------------------------------------------------------------------------------- | ------- | - | ---------------------------------------------------------------------------------------------------------------- | - | ------- | ------------ |  | - | ------- | - |  | ---- | ------- | - | ------------ | - | -------- | - |  | - | ------- | -
|                                                                       |  | Year Ended September 30, 2004 Compared to Year Ended September 30, 2003 Increase (Decrease) Due to Change in
(1) |         |   | Year Ended September 30, 2003 Compared to Year Ended September 30, 2002 Increase (Decrease) Due to Change in
(1) |  
|                                                                       |  | Volume                                                                                                           |         |   | Rate                                                                                                             |   |         | Total Change |  |   | Volume  |   |  | Rate |         |   | Total Change |  
|Interest income:                                                       |  |                                                                                                                  |         |   |                                                                                                                  |   |         |              |  |   |         |   |  |      |         |   |              |   |          |   |  |   |         |  
|Loans(2)                                                               |  | $                                                                                                                | 68,343  |   |                                                                                                                  | $ | (59,108 | )            |  | $ | 9,235   |   |  | $    | 65,112  |   |              | $ | (117,004 | ) |  | $ | (51,892 | )
|Mortgage-backed securities                                             |  |                                                                                                                  | (12,065 | ) |                                                                                                                  |   | (4,055  | )            |  |   | (16,120 | ) |  |      | (30,248 | ) |              |   | (7,485   | ) |  |   | (37,733 | )
|Federal funds sold and securities purchased under agreements to resell |  |                                                                                                                  | (31     | ) |                                                                                                                  |   | (106    | )            |  |   | (137    | ) |  |      | 326     |   |              |   | (298     | ) |  |   | 28      |  
|Trading securities                                                     |  |                                                                                                                  | (3,046  | ) |                                                                                                                  |   | (400    | )            |  |   | (3,446  | ) |  |      | 2,245   |   |              |   | (432     | ) |  |   | 1,813   |  
|Investment securities                                                  |  |                                                                                                                  | 273     |   |                                                                                                                  |   | (302    | )            |  |   | (29     | ) |  |      | 6       |   |              |   | (341     | ) |  |   | (335    | )
|Other interest-earning assets                                          |  |                                                                                                                  | 785     |   |                                                                                                                  |   | (568    | )            |  |   | 217     |   |  |      | (318    | ) |              |   | (1,411   | ) |  |   | (1,729  | )
|                                                                       |  |                                                                                                                  |         |   |                                                                                                                  |   |         |              |  |   |         |   |  |      |         |   |              |   |          |   |  |   |         |  
|Total interest income                                                  |  |                                                                                                                  | 54,259  |   |                                                                                                                  |   | (64,539 | )            |  |   | (10,280 | ) |  |      | 37,123  |   |              |   | (126,971 | ) |  |   | (89,848 | )
|                                                                       |  |                                                                                                                  |         |   |                                                                                                                  |   |         |              |  |   |         |   |  |      |         |   |              |   |          |   |  |   |         |  
|Interest expense:                                                      |  |                                                                                                                  |         |   |                                                                                                                  |   |         |              |  |   |         |   |  |      |         |   |              |   |          |   |  |   |         |  
|Deposit accounts                                                       |  |                                                                                                                  | 4,657   |   |                                                                                                                  |   | (26,528 | )            |  |   | (21,871 | ) |  |      | 5,070   |   |              |   | (68,860  | ) |  |   | (63,790 | )
|Borrowings                                                             |  |                                                                                                                  | 16,549  |   |                                                                                                                  |   | (37,135 | )            |  |   | (20,586 | ) |  |      | 3,828   |   |              |   | (7,745   | ) |  |   | (3,917  | )
|                                                                       |  |                                                                                                                  |         |   |                                                                                                                  |   |         |              |  |   |         |   |  |      |         |   |              |   |          |   |  |   |         |  
|Total interest expense                                                 |  |                                                                                                                  | 21,206  |   |                                                                                                                  |   | (63,663 | )            |  |   | (42,457 | ) |  |      | 8,898   |   |              |   | (76,605  | ) |  |   | (67,707 | )
|                                                                       |  |                                                                                                                  |         |   |                                                                                                                  |   |         |              |  |   |         |   |  |      |         |   |              |   |          |   |  |   |         |  
|Increase (decrease) in net interest income                             |  | $                                                                                                                | 33,053  |   |                                                                                                                  | $ | (876    | )            |  | $ | 32,177  |   |  | $    | 28,225  |   |              | $ | (50,366  | ) |  | $ | (22,141 | )
|                                                                       |  |                                                                                                                  |         |   |                                                                                                                  |   |         |              |  |   |         |   |  |      |         |   |              |   |          |   |  |   |         |  

---

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



61



---

##### Table of Contents

Interest Income in fiscal year 2004 decreased $10.3 million (or 2.3%) from fiscal year 2003 primarily as
a result of lower interest income on mortgage-backed securities, which resulted from lower average yields and lower average balances of those securities. Also contributing to the decreased income were lower average yields on loans receivable, which
was offset by a $1.6 billion increase in the average balances of loans receivables.



The Banks net interest spread decreased slightly to 2.51% in fiscal year 2004 from 2.59% in fiscal year 2003. The 8 basis point decrease reflected a greater decrease in interest earning asset average yields than
interest bearing liability average costs. Average interest-earning assets as a percentage of average interest bearing liabilities increased to 103.3% in fiscal year 2004 compared to 98.8% in fiscal year 2003.



Interest income on loans, the largest category of interest-earning assets,
increased $9.2 million from fiscal year 2003 primarily because of higher balances of loans receivable which was partially offset by lower average yields caused by declines in the various indices on which interest rates on adjustable rate loans are
based. The average yield on the loan portfolio decreased 65 basis points (from 4.73% to 4.08%) from fiscal year 2003. Interest income on single-family residential loans increased $33.0 million due to $1.6 billion of higher average balances, which
was partially offset by lower average yields during fiscal year 2004. Lower average yields and lower average balances of automobile loans resulted in a $28.9 million (or 49.6%) decrease in interest income on those loans.



Interest income on mortgage-backed securities decreased $16.1 million (or
44.0%) primarily because of a $247.5 million reduction in average balances and, to a lesser extent, a decrease in the average interest rates on those securities from 5.36% to 4.71%.



Interest expense on deposits decreased $21.9 million (or 27.3%) during fiscal year 2004, due to decreased average rates. The
36 basis point decrease in the average rate on deposits (from 1.15% to 0.79%) resulted from a reduction in the rates paid by the Bank in response to declines in market interest rates.



Interest expense on borrowings decreased $20.6 million (or 16.4%) in fiscal year 2004 compared to fiscal year 2003. The
decrease resulted from lower average rates paid on Federal Home Loan Bank advances (from 4.68% to 3.19%) which resulted in a decrease of $9.3 million in interest expense. Partially offsetting the decrease in interest expense on borrowings was an
increase in the average balance of Federal Home Loan Bank advances of $681.1 million (or 32.8%). In addition, the average rate on subordinated debentures decreased to 7.57% from 9.25% resulting in a decrease of $7.3 million in interest expense. On
December 2, 2003, the Bank issued $175.0 million aggregate principal amount of 6 7/8% subordinated debentures due 2013. On January 2, 2004, the net proceeds of the offering, along with short-term borrowings, were used to redeem all $250.0 million of
the Banks 91⁄4% subordinated debentures due 2005 and 2008.



Provision for Loan Losses.The Bank recorded a negative provision for loan losses of $14.5 million in fiscal year 2004 compared to a provision of $18.4 million in fiscal year 2003. Managements prior decisions to discontinue
subprime automobile lending and indirect consumer lending, and focus more on residential mortgages, have contributed to the improvement in the overall credit quality of the Banks loan portfolio. As balances of automobile loans continue to
decline, charge-offs and delinquencies also have been declining. Potential problem assets also declined during the year ended September 30, 2004. The combination of these factors contributed to the Banks decision to reduce the allowance for
loan losses. See Financial Condition  Asset Quality  Allowances for Losses.



Other Income.Other non-interest income decreased slightly to $539.5 million in fiscal year 2004 from $539.8 million in fiscal year 2003. The $0.3
million decrease resulted from decreases in automobile rental income and was mostly offset by increases in servicing, securitization and mortgage banking income and deposit servicing fees.



Automobile rental income decreased to $157.0 million during fiscal year 2004
from $235.4 million in the prior year. The decrease resulted primarily from a $404.3 million (or 38.9%) decrease in average outstanding leases as a result of the Banks prior decision to discontinue origination of automobile leases.



Servicing, securitization, and mortgage banking income increased to $211.9
million in fiscal year 2004, from $138.2 million in fiscal year 2003, primarily as a result of an increase in the volume of loans securitized and sold. The Bank securitized and sold $4.9 billion of loans receivable during fiscal year 2004 compared
to $2.6 billion in the prior year.



Deposit servicing fees
increased $6.6 million (or 5.4%) during fiscal year 2004 primarily due to fees generated from the continued expansion of the Banks branch and ATM network.



Operating Expenses.Operating expenses for fiscal year 2004 decreased $20.3 million (or 3.3%) from fiscal year 2003. The decrease in operating
expenses is largely due to a decline in depreciation and amortization which was partially offset by increases in salaries and employee benefits and other (non-interest) expenses.



62



---

##### Table of Contents

Depreciation and amortization decreased $55.5 million (or 25.7%) from fiscal year 2003, largely as a
result of decreased depreciation expense of automobiles subject to lease. Depreciation expense related to automobiles subject to lease decreased $50.0 million, to $120.9 million during fiscal year 2004, due to lower levels of outstanding leases. The
reduced levels reflect the Banks prior decision to discontinue origination of automobile leases.



Salaries and employee benefits increased $20.4 million (or 9.6%) during fiscal year 2004 due primarily to increased expenses in the residential mortgage
lending area and retail branch network.



Other (non-interest)
expenses increased $8.7 million (or 14.8%) primarily as a result of costs related to the January 2, 2004 redemption of the Banks $250.0 million of subordinated debentures due 2005 and 2008.



63



---

##### Table of Contents

FISCAL 2003 COMPARED TO FISCAL 2002



REAL ESTATE



The Real Estate
Trust recorded income from continuing operations before depreciation of $4.9 million and an operating loss from continuing operations of $14.0 million for fiscal 2003, compared to a loss from continuing operations before depreciation of $167,000 and
an operating loss from continuing operations of $18.9 million for fiscal 2002. The increase was largely attributable to a $9.1 million gain on the sale of a property which offset higher impairment losses and losses on unconsolidated entities.



Income after direct operating expenses from hotels decreased
$1.1 million, or 3.8%, in fiscal 2003 from the level achieved in fiscal 2002. Total revenue remained fairly constant between the periods, decreasing by $128,000, or approximately 0.2%, as increased revenues at many of the hotel properties were
offset by a substantial decrease in revenue at one of the hotel properties as this property was under renovation for much of the fiscal 2003 and occupancy was lower due to rooms being taken out of service for the renovation. Room sales for fiscal
2003 decreased $100,000, or 0.1%, from fiscal year 2002, while food, beverage and other sales decreased $28,000, or 0.2%. Direct operating expenses increased $961,000, or 1.7%, due mainly to increased payroll and utility costs.



Income after direct operating expenses from office and industrial properties
increased $307,000, or 1.1%, in fiscal 2003 compared to fiscal 2002. Total revenue increased $198,000, or 0.5%, in fiscal 2003 as revenue increased at the two new office properties which were placed into service in fiscal year 2002 by $925,000 which
was offset by lower revenue at the eleven office properties owned and operating throughout both periods of $727,000. This lower revenue was a result of leased space turning over at lower rental rates in the current period. Direct operating expenses
remained constant, decreasing $109,000, or 0.9%.



Other income,
which includes interest income, income from other real estate properties and other miscellaneous income, decreased $152,000, or 10.5%, principally due to lower interest income in the fiscal 2003 period.



Land parcels and other expense increased $43,000, or 3.8%, in fiscal 2003
from fiscal 2002 due to higher real estate taxes and other carrying charges.



Interest and amortization of debt expense remained relatively constant, increasing $99,000, or 0.2%, in fiscal 2003. Interest expense decreased $43,000, or less than 0.1% as the average balance of outstanding
borrowings increased to $585.1 million for fiscal 2003 from $583.7 million for the prior fiscal year. The change in borrowings occurred as a result of mortgage loan refinancings and unsecured note sales. The average cost of borrowings was 8.68% in
fiscal 2003 and 8.67% in fiscal 2002. Amortization of debt expense increased $142,000, or 15.0%, reflecting costs incurred in connection with obtaining and refinancing mortgage loans in the current and prior fiscal periods.



Depreciation expense increased $209,000, or approximately 1.1%, as a result
of new income-producing assets and tenant improvements placed into service.



Advisory, management and leasing fees paid to related parties decreased $12,000, or 0.1%, in fiscal 2003. The advisory fee in fiscal 2003 was $458,000 per month compared to $475,000 per month for fiscal 2002, an
aggregate decrease of $204,000. This decrease in advisory fees was partially offset by increased office management and leasing fees of $192,000.



General and administrative expense increased $544,000, or 23.9%, in fiscal 2003 principally due to the write-off of certain acquisition and development
costs for projects that the Real Estate Trust has determined not to pursue.



Equity in earnings of unconsolidated entities reflected net earnings of $7.2 million in fiscal 2003 as compared to $8.8 million in fiscal 2002, a decrease of $1.6 million. Earnings from Saul Holdings Partnership and
Saul Centers were lower by $414,000 in fiscal 2003 primarily due to a gain recognized on the sale of a property in fiscal 2002. Losses from other investments increased approximately $1.2 million in fiscal 2003 as a result of a write-down of a
certain non-public investment accounted for under the equity method.



Impairment losses increased $810,000 in fiscal 2003 due to additional write-downs of certain non-public investments accounted for under the cost method.



On September 25, 2003 the Real Estate Trust sold a land parcel in Rockville, Maryland for $11.3 million resulting in a gain
of $9.1 million. There were no property sales in fiscal 2002.



During the 2004 fiscal period the Real Estate Trust placed one of its hotel properties on the market for sale. Operational results for this property have been included in the Loss from Operations of Discontinued Real Estate Asset for fiscal
2003 and 2002 of $865,000 and $631,000, respectively.



64



---

##### Table of Contents

BANKING



Overview.The
Bank recorded operating income of $146.2 million for the year ended September 30, 2003, compared to operating income of $103.6 million for the year ended September 30, 2002. The improvement in income in fiscal year 2003 was primarily due to
increases in servicing, securitization and mortgage banking income and deposit servicing fees. A decrease in the provision for loan losses also contributed to the increased net income. Partially offsetting the increased income were a decrease in net
interest income and an increase in operating expenses.



Net
Interest Income.Net interest income, before the provision for loan losses, decreased $22.1 million (or 8.3%) in fiscal year 2003 from fiscal year 2002. There was no interest income recorded during fiscal year 2003 on non-accrual assets and
restructured loans. The Bank would have recorded interest income of $2.1 million in fiscal year 2003 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 2003 decreased $89.8 million (16.6%) from fiscal year 2002 primarily as a result of lower
average yields on loans receivable, which was partially offset by increases in the average balances of loans receivable of $1.2 billion. Also contributing to the decreased income were lower average yields and lower average balances of
mortgage-backed securities.



The Banks net interest
spread decreased to 2.59% in fiscal year 2003 from 3.16% in fiscal year 2002. The average yield of interest-earning assets decreased at a rate greater than the rate of decrease in the average cost of interest-bearing liabilities. Average
interest-earning assets as a percentage of average interest bearing liabilities increased to 98.8% in fiscal year 2003 compared to 95.1% in fiscal year 2002.



Interest income on loans, the largest category of interest-earning assets, decreased $51.9 million from fiscal year 2002 primarily because of lower
average yields. The decreased average yield on the loan portfolio was primarily due to declines in the various indices on which interest rates on adjustable rate loans are based. The average yield on the loan portfolio decreased 145 basis points
(from 6.18% to 4.73%) from fiscal year 2002. Lower average yields on single-family residential loans during fiscal year 2003 resulted in a $19.0 million (or 7.8%) decrease in interest income. A $541.9 million increase in the average balance of
single-family residential loans partially offset this decrease. In addition, lower average yields and, to a lesser extent, lower average balances of automobile loans resulted in a $30.2 million (or 34.2%) decrease in interest income.



Interest income on mortgage-backed securities decreased $37.7 million (or
50.7%) primarily because of a $550.4 million reduction in average balances and, to a lesser extent, a decrease in the average interest rates on those securities (from 6.03% to 5.36%).



Interest expense on deposits decreased $63.8 million (or 44.3%) during fiscal year 2003, due to decreased average rates. The
100 basis point decrease in the average rate on deposits (from 2.15% to 1.15%) resulted from a reduction in the rates paid by the Bank in response to declines in market interest rates as well as the maturity of higher cost brokered deposits.



Interest expense on borrowings decreased $3.9 million (or
3.0%) in fiscal year 2003 compared to fiscal year 2002. The decrease resulted from lower average rates paid on securities sold under repurchase agreements and other borrowings, which, combined, resulted in a decrease of $5.1 million in interest
expense. A decrease in the average interest rate on Federal Home Loan Bank advances (from 5.16% to 4.68%) also contributed to the decrease in interest expense on borrowings. Partially offsetting the decrease in interest expense on borrowings was an
increase in the average balance of Federal Home Loan Bank advances of $216.2 million (or 11.6%).



Provision for Loan Losses. The Banks provision for loan losses decreased to $18.4 million in fiscal year 2003 from $51.4 million in fiscal
year 2002. The $33.0 million decrease largely reflects improved credit quality of the loan portfolio following the Banks prior decisions to stop originating indirect automobile loans. See Financial Condition-Asset Quality-Allowances for
Losses.



Other Income. Other non-interest income
increased to $539.8 million in fiscal year 2003 from $488.9 million in fiscal year 2002. The $50.9 million (or 10.4%) increase resulted from an increase in servicing, securitization and mortgage banking income, an increase in deposit servicing fees
and an increase in other (non-interest) income.



Servicing,
securitization and mortgage banking income increased to $138.2 million in fiscal year 2003, from $96.8 million in fiscal year 2002, primarily as a result of an increase in the volume of loans securitized and sold. The Bank securitized and sold $2.6
billion of loans receivable during fiscal year 2003 compared to $1.6 billion in the prior year.



Deposit servicing fees increased $8.8 million (or 7.8%) during fiscal year 2003 primarily due to fees generated from the continued expansion of the
Banks branch and ATM network.



65



---

##### Table of Contents

Other (non-interest) income increased to $43.8 million during fiscal year 2003 from $35.8 million in
fiscal year 2002. Other (non-interest) income includes a gain of $5.5 million from the sale of one REO property during fiscal year 2003.



Operating Expenses. Operating expenses for fiscal year 2003 increased $19.1 million (or 3.2%) from fiscal year 2002. The increase in operating
expenses was primarily the result of a $9.7 million (or 4.8%) increase in salaries and employee benefits due to the addition of staff in the residential mortgage lending area and retail branch network. Also contributing to the increase in operating
expenses was an increase in depreciation and amortization of $13.3 million during the current year due to depreciation expense on automobiles subject to lease and, to a lesser extent, the fair market value adjustment of one office building held for
sale.



66



---

##### Table of Contents

|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 Auditors.                                                                                                             |  | 68    
|    |  |                                                                                                                                            
|(b) |  | Consolidated Balance SheetsAs of September 30, 2004 and 2003.                                                                              |  | 69    
|    |  |                                                                                                                                            
|(c) |  | Consolidated Statements of OperationsFor the years ended September 30, 2004, 2003 and 2002.                                                |  | 70-71 
|    |  |                                                                                                                                            
|(d) |  | Consolidated Statements of Comprehensive Income and Changes in Shareholders Equity For the years ended September 30, 2004, 2003 and 2002. |  | 72    
|    |  |                                                                                                                                            
|(e) |  | Consolidated Statements of Cash FlowsFor the years ended September 30, 2004, 2003 and 2002.                                                |  | 73-74 
|    |  |                                                                                                                                            
|(f) |  | Notes to Consolidated Financial Statements.                                                                                                 |  | 75-119



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



67



---

##### Table of Contents

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, 2004 and 2003, 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, 2004.
Our audits also included the financial statement schedules listed in the Index at Item 15(a). These consolidated financial statements and schedules are the responsibility of the Trusts management. Our responsibility is to express an opinion on
these consolidated financial statements and schedules based on our audits.



We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance
about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as 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, 2004 and 2003, and the consolidated results of its operations and its cash flows for each of the three years
in the period ended September 30, 2004 in conformity with U. S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a
whole, present fairly in all material respects the information set forth therein.



As discussed in the notes to the consolidated financial statements, the Trust adopted Financial Accounting Standards Board Interpretation No. (FIN) 46, Consolidation of Variable Interest
Entities, effective July 1, 2003.



/s/
Ernst & Young LLP



|                                                                                                                
|----------------------------------------------------------------------------------------------------------------
|McLean, Virginia December 6, 2004, except for paragraph two of Note 38, as to which the date is December 9, 2004



68



---

##### Table of Contents

Consolidated Balance Sheets

B. F. SAUL REAL ESTATE INVESTMENT TRUST



|                                                                                                                                                                               |  |               |            |   |      |   |            |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | ------------- | ---------- | - | ---- | - | ---------- | -
|                                                                                                                                                                               |  | September 30, |           
|(In thousands)                                                                                                                                                                 |  | 2004          |            |   | 2003 |  
|ASSETS                                                                                                                                                                         |  |               |            |   |      |   |            |  
|Real Estate                                                                                                                                                                    |  |               |            |   |      |   |            |  
|Income-producing properties                                                                                                                                                    |  |               |            |   |      |   |            |  
|Hotel                                                                                                                                                                          |  | $             | 264,020    |   |      | $ | 251,966    |  
|Office and industrial                                                                                                                                                          |  |               | 184,454    |   |      |   | 180,385    |  
|Other                                                                                                                                                                          |  |               | 2,803      |   |      |   | 2,803      |  
|                                                                                                                                                                               |  |               |            |   |      |   |            |  
|                                                                                                                                                                               |  |               | 451,277    |   |      |   | 435,154    |  
|Accumulated depreciation                                                                                                                                                       |  |               | (180,075   | ) |      |   | (162,685   | )
|                                                                                                                                                                               |  |               |            |   |      |   |            |  
|                                                                                                                                                                               |  |               | 271,202    |   |      |   | 272,469    |  
|Land parcels                                                                                                                                                                   |  |               | 41,722     |   |      |   | 42,425     |  
|Real estate held for sale                                                                                                                                                      |  |               | 2,090      |   |      |   | 2,536      |  
|Investment in Saul Holdings and Saul Centers                                                                                                                                   |  |               | 61,767     |   |      |   | 53,383     |  
|Cash and cash equivalents                                                                                                                                                      |  |               | 31,842     |   |      |   | 18,979     |  
|Note receivable and accrued interest  related party                                                                                                                           |  |               | 7,677      |   |      |   | 2,987      |  
|Other assets                                                                                                                                                                   |  |               | 41,869     |   |      |   | 36,506     |  
|                                                                                                                                                                               |  |               |            |   |      |   |            |  
|Total real estate assets                                                                                                                                                       |  |               | 458,169    |   |      |   | 429,285    |  
|                                                                                                                                                                               |  |               |            |   |      |   |            |  
|Banking                                                                                                                                                                        |  |               |            |   |      |   |            |  
|Cash and due from banks                                                                                                                                                        |  |               | 444,603    |   |      |   | 339,960    |  
|Interest-bearing deposits                                                                                                                                                      |  |               | 97,945     |   |      |   | 74,667     |  
|Loans held for securitization and/or sale                                                                                                                                      |  |               | 1,965,476  |   |      |   | 1,378,831  |  
|Investment securities (market value of $70,905 and $46,531, respectively)                                                                                                      |  |               | 71,192     |   |      |   | 46,345     |  
|Mortgage-backed securities (market value of $415,503 and $490,764, respectively)                                                                                               |  |               | 409,303    |   |      |   | 478,392    |  
|Loans receivable (net of allowance for losses of $37,750 and $58,397, respectively)                                                                                            |  |               | 8,555,557  |   |      |   | 7,559,557  |  
|Federal Home Loan Bank stock                                                                                                                                                   |  |               | 139,347    |   |      |   | 107,374    |  
|Real estate held for investment or sale (net of allowance for losses of $202 for both periods)                                                                                 |  |               | 21,282     |   |      |   | 22,745     |  
|Property and equipment, net                                                                                                                                                    |  |               | 492,907    |   |      |   | 490,731    |  
|Automobiles subject to lease, net                                                                                                                                              |  |               | 435,307    |   |      |   | 855,410    |  
|Goodwill and other intangible assets, net                                                                                                                                      |  |               | 24,035     |   |      |   | 24,329     |  
|Interest only strips receivable                                                                                                                                                |  |               | 287,840    |   |      |   | 139,781    |  
|Servicing assets, net                                                                                                                                                          |  |               | 147,856    |   |      |   | 96,268     |  
|Other assets                                                                                                                                                                   |  |               | 178,197    |   |      |   | 165,050    |  
|                                                                                                                                                                               |  |               |            |   |      |   |            |  
|Total banking assets                                                                                                                                                           |  |               | 13,270,847 |   |      |   | 11,779,440 |  
|                                                                                                                                                                               |  |               |            |   |      |   |            |  
|TOTAL ASSETS                                                                                                                                                                   |  | $             | 13,729,016 |   |      | $ | 12,208,725 |  
|                                                                                                                                                                               |  |               |            |   |      |   |            |  
|LIABILITIES                                                                                                                                                                    |  |               |            |   |      |   |            |  
|Real Estate                                                                                                                                                                    |  |               |            |   |      |   |            |  
|Mortgage notes payable                                                                                                                                                         |  | $             | 307,245    |   |      | $ | 318,265    |  
|Mortgage note payable real estate held for sale                                                                                                                                |  |               | 4,071      |   |      |   | 4,172      |  
|Notes payable - secured                                                                                                                                                        |  |               | 250,000    |   |      |   | 203,800    |  
|Notes payable - unsecured                                                                                                                                                      |  |               | 56,428     |   |      |   | 55,349     |  
|Accrued dividends payable - preferred shares of beneficial interest                                                                                                            |  |               |           |   |      |   | 6,139      |  
|Other liabilities and accrued expenses                                                                                                                                         |  |               | 22,109     |   |      |   | 28,680     |  
|Deferred tax liability, net                                                                                                                                                    |  |               | 36,448     |   |      |   | 36,451     |  
|                                                                                                                                                                               |  |               |            |   |      |   |            |  
|Total real estate liabilities                                                                                                                                                  |  |               | 676,301    |   |      |   | 652,856    |  
|                                                                                                                                                                               |  |               |            |   |      |   |            |  
|Banking                                                                                                                                                                        |  |               |            |   |      |   |            |  
|Deposit accounts                                                                                                                                                               |  |               | 8,855,118  |   |      |   | 8,100,505  |  
|Securities sold under repurchase agreements and other short-term borrowings                                                                                                    |  |               | 206,579    |   |      |   | 168,314    |  
|Federal Home Loan Bank advances                                                                                                                                                |  |               | 2,736,938  |   |      |   | 1,987,469  |  
|Custodial accounts                                                                                                                                                             |  |               | 117,714    |   |      |   | 173,842    |  
|Amounts due to banks                                                                                                                                                           |  |               | 65,177     |   |      |   | 69,081     |  
|Other liabilities                                                                                                                                                              |  |               | 243,641    |   |      |   | 290,214    |  
|Capital notes - subordinated                                                                                                                                                   |  |               | 175,000    |   |      |   | 250,000    |  
|                                                                                                                                                                               |  |               |            |   |      |   |            |  
|Total banking liabilities                                                                                                                                                      |  |               | 12,400,167 |   |      |   | 11,039,425 |  
|                                                                                                                                                                               |  |               |            |   |      |   |            |  
|Commitments and contingencies                                                                                                                                                  |  |               |            |   |      |   |            |  
|Minority interest held by affiliates                                                                                                                                           |  |               | 114,933    |   |      |   | 98,062     |  
|Minority interest  other                                                                                                                                                      |  |               | 296,013    |   |      |   | 249,698    |  
|                                                                                                                                                                               |  |               |            |   |      |   |            |  
|TOTAL LIABILITIES                                                                                                                                                              |  |               | 13,487,414 |   |      |   | 12,040,041 |  
|                                                                                                                                                                               |  |               |            |   |      |   |            |  
|SHAREHOLDERS EQUITY                                                                                                                                                           |  |               |            |   |      |   |            |  
|Preferred shares of beneficial interest, $10.50 cumulative, $1 par value, 90 million shares authorized, 516,000 shares issued and outstanding,
liquidation value $51.6 million |  |               | 516        |   |      |   | 516        |  
|Common shares of beneficial interest, $1 par value, 10 million shares authorized, 6,641,598 shares issued                                                                      |  |               | 6,642      |   |      |   | 6,642      |  
|Paid-in surplus                                                                                                                                                                |  |               | 92,943     |   |      |   | 92,943     |  
|Retained earnings                                                                                                                                                              |  |               | 185,342    |   |      |   | 112,424    |  
|                                                                                                                                                                               |  |               |            |   |      |   |            |  
|                                                                                                                                                                               |  |               | 285,443    |   |      |   | 212,525    |  
|Less cost of 1,834,088 common shares of beneficial interest in treasury                                                                                                        |  |               | (43,841    | ) |      |   | (43,841    | )
|                                                                                                                                                                               |  |               |            |   |      |   |            |  
|TOTAL SHAREHOLDERS EQUITY                                                                                                                                                     |  |               | 241,602    |   |      |   | 168,684    |  
|                                                                                                                                                                               |  |               |            |   |      |   |            |  
|TOTAL LIABILITIES AND SHAREHOLDERS EQUITY                                                                                                                                     |  | $             | 13,729,016 |   |      | $ | 12,208,725 |  
|                                                                                                                                                                               |  |               |            |   |      |   |            |  



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



69



---

##### 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)                                                                               |  | 2004                             |         |   | 2003 |   |         | 2002 | 
|REAL ESTATE                                                                                                            |  |                                  |         |   |      |   |         |      |  |   |         |  
|Income                                                                                                                 |  |                                  |         |   |      |   |         |      |  |   |         |  
|Hotels                                                                                                                 |  | $                                | 96,402  |   |      | $ | 85,107  |      |  | $ | 85,235  |  
|Office and industrial (including $5,205, $5,290 and $5,100 of rental income earned from banking segment, respectively) |  |                                  | 38,225  |   |      |   | 39,121  |      |  |   | 38,923  |  
|Other                                                                                                                  |  |                                  | 1,629   |   |      |   | 1,300   |      |  |   | 1,452   |  
|                                                                                                                       |  |                                  |         |   |      |   |         |      |  |   |         |  
|Total income                                                                                                           |  |                                  | 136,256 |   |      |   | 125,528 |      |  |   | 125,610 |  
|                                                                                                                       |  |                                  |         |   |      |   |         |      |  |   |         |  
|Expenses                                                                                                               |  |                                  |         |   |      |   |         |      |  |   |         |  
|Direct operating expenses:                                                                                             |  |                                  |         |   |      |   |         |      |  |   |         |  
|Hotels                                                                                                                 |  |                                  | 62,602  |   |      |   | 57,606  |      |  |   | 56,645  |  
|Office and industrial properties                                                                                       |  |                                  | 11,805  |   |      |   | 11,484  |      |  |   | 11,593  |  
|Land parcels and other                                                                                                 |  |                                  | 1,341   |   |      |   | 1,183   |      |  |   | 1,140   |  
|Interest and amortization of debt expense                                                                              |  |                                  | 60,130  |   |      |   | 50,529  |      |  |   | 50,430  |  
|Depreciation                                                                                                           |  |                                  | 18,806  |   |      |   | 18,959  |      |  |   | 18,750  |  
|Advisory, management and leasing fees - related parties                                                                |  |                                  | 13,048  |   |      |   | 12,301  |      |  |   | 12,313  |  
|General and administrative                                                                                             |  |                                  | 2,443   |   |      |   | 2,823   |      |  |   | 2,279   |  
|                                                                                                                       |  |                                  |         |   |      |   |         |      |  |   |         |  
|Total expenses                                                                                                         |  |                                  | 170,175 |   |      |   | 154,885 |      |  |   | 153,150 |  
|                                                                                                                       |  |                                  |         |   |      |   |         |      |  |   |         |  
|Equity in earnings (losses) of unconsolidated entities:                                                                |  |                                  |         |   |      |   |         |      |  |   |         |  
|Saul Holdings and Saul Centers                                                                                         |  |                                  | 8,404   |   |      |   | 8,643   |      |  |   | 9,057   |  
|Other, including impairment                                                                                            |  |                                  | (616    | ) |      |   | (1,395  | )    |  |   | (246    | )
|Impairment loss on investments                                                                                         |  |                                  |        |   |      |   | (998    | )    |  |   | (188    | )
|Gain on sales of property                                                                                              |  |                                  | 2,769   |   |      |   | 9,079   |      |  |   |        |  
|                                                                                                                       |  |                                  |         |   |      |   |         |      |  |   |         |  
|REAL ESTATE OPERATING LOSS                                                                                             |  | $                                | (23,362 | ) |      | $ | (14,028 | )    |  | $ | (18,917 | )
|                                                                                                                       |  |                                  |         |   |      |   |         |      |  |   |         |  
|BANKING                                                                                                                |  |                                  |         |   |      |   |         |      |  |   |         |  
|Interest income                                                                                                        |  |                                  |         |   |      |   |         |      |  |   |         |  
|Loans                                                                                                                  |  | $                                | 411,640 |   |      | $ | 402,405 |      |  | $ | 454,297 |  
|Mortgage-backed securities                                                                                             |  |                                  | 20,505  |   |      |   | 36,625  |      |  |   | 74,358  |  
|Other                                                                                                                  |  |                                  | 9,126   |   |      |   | 12,521  |      |  |   | 12,744  |  
|                                                                                                                       |  |                                  |         |   |      |   |         |      |  |   |         |  
|Total interest income                                                                                                  |  |                                  | 441,271 |   |      |   | 451,551 |      |  |   | 541,399 |  
|                                                                                                                       |  |                                  |         |   |      |   |         |      |  |   |         |  
|Interest expense                                                                                                       |  |                                  |         |   |      |   |         |      |  |   |         |  
|Deposit accounts                                                                                                       |  |                                  | 58,251  |   |      |   | 80,122  |      |  |   | 143,912 |  
|Short-term borrowings                                                                                                  |  |                                  | 20,012  |   |      |   | 10,836  |      |  |   | 15,401  |  
|Long-term borrowings                                                                                                   |  |                                  | 84,759  |   |      |   | 114,521 |      |  |   | 113,873 |  
|                                                                                                                       |  |                                  |         |   |      |   |         |      |  |   |         |  
|Total interest expense                                                                                                 |  |                                  | 163,022 |   |      |   | 205,479 |      |  |   | 273,186 |  
|                                                                                                                       |  |                                  |         |   |      |   |         |      |  |   |         |  
|Net interest income                                                                                                    |  |                                  | 278,249 |   |      |   | 246,072 |      |  |   | 268,213 |  
|Provision for loan losses                                                                                              |  |                                  | 14,522  |   |      |   | (18,422 | )    |  |   | (51,367 | )
|                                                                                                                       |  |                                  |         |   |      |   |         |      |  |   |         |  
|Net interest income after provision for loan losses                                                                    |  |                                  | 292,771 |   |      |   | 227,650 |      |  |   | 216,846 |  
|                                                                                                                       |  |                                  |         |   |      |   |         |      |  |   |         |  
|Other income                                                                                                           |  |                                  |         |   |      |   |         |      |  |   |         |  
|Deposit servicing fees                                                                                                 |  |                                  | 129,107 |   |      |   | 122,473 |      |  |   | 113,640 |  
|Servicing and securitization income                                                                                    |  |                                  | 211,947 |   |      |   | 138,213 |      |  |   | 96,827  |  
|Automobile rental income, net                                                                                          |  |                                  | 157,034 |   |      |   | 235,360 |      |  |   | 242,646 |  
|Other                                                                                                                  |  |                                  | 41,406  |   |      |   | 43,795  |      |  |   | 35,789  |  
|                                                                                                                       |  |                                  |         |   |      |   |         |      |  |   |         |  
|Total other income                                                                                                     |  |                                  | 539,494 |   |      |   | 539,841 |      |  |   | 488,902 |  
|                                                                                                                       |  |                                  |         |   |      |   |         |      |  |   |         |  

Continued on following page.



70



---

##### 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)                                                                                 |  | 2004                             |         |   | 2003 |   |         | 2002 | 
|BANKING (Continued)                                                                                                      |  |                                  |         |   |      |   |         |      |  |   |         |  
|Operating expenses                                                                                                       |  |                                  |         |   |      |   |         |      |  |   |         |  
|Salaries and employee benefits                                                                                           |  | $                                | 233,093 |   |      | $ | 212,697 |      |  | $ | 203,004 |  
|Servicing assets amortization and other loan expenses                                                                    |  |                                  | 53,542  |   |      |   | 50,923  |      |  |   | 54,196  |  
|Property and equipment (including $5,290, $5,100 and $3,983 of rental expense paid to real estate segment, respectively) |  |                                  | 39,032  |   |      |   | 38,309  |      |  |   | 42,256  |  
|Marketing                                                                                                                |  |                                  | 12,171  |   |      |   | 9,516   |      |  |   | 7,497   |  
|Data processing                                                                                                          |  |                                  | 35,452  |   |      |   | 35,301  |      |  |   | 32,498  |  
|Depreciation and amortization                                                                                            |  |                                  | 160,509 |   |      |   | 215,961 |      |  |   | 202,619 |  
|Other                                                                                                                    |  |                                  | 67,251  |   |      |   | 58,594  |      |  |   | 60,096  |  
|                                                                                                                         |  |                                  |         |   |      |   |         |      |  |   |         |  
|Total operating expenses                                                                                                 |  |                                  | 601,050 |   |      |   | 621,301 |      |  |   | 602,166 |  
|                                                                                                                         |  |                                  |         |   |      |   |         |      |  |   |         |  
|BANKING OPERATING INCOME                                                                                                 |  | $                                | 231,215 |   |      | $ | 146,190 |      |  | $ | 103,582 |  
|                                                                                                                         |  |                                  |         |   |      |   |         |      |  |   |         |  
|TOTAL COMPANY                                                                                                            |  |                                  |         |   |      |   |         |      |  |   |         |  
|Income from continuing operations before income taxes and minority interest                                              |  | $                                | 207,853 |   |      | $ | 132,162 |      |  | $ | 84,665  |  
|Income tax provision                                                                                                     |  |                                  | 70,232  |   |      |   | 46,523  |      |  |   | 23,364  |  
|                                                                                                                         |  |                                  |         |   |      |   |         |      |  |   |         |  
|Income from continuing operations before minority interest                                                               |  |                                  | 137,621 |   |      |   | 85,639  |      |  |   | 61,301  |  
|Minority interest held by affiliates                                                                                     |  |                                  | (23,070 | ) |      |   | (13,926 | )    |  |   | (9,671  | )
|Minority interest  other                                                                                                |  |                                  | (37,195 | ) |      |   | (26,160 | )    |  |   | (25,313 | )
|                                                                                                                         |  |                                  |         |   |      |   |         |      |  |   |         |  
|INCOME FROM CONTINUING OPERATIONS                                                                                        |  |                                  | 77,356  |   |      |   | 45,553  |      |  |   | 26,317  |  
|Discontinued real estate operations:                                                                                     |  |                                  |         |   |      |   |         |      |  |   |         |  
|Loss from operations of discontinued real estate asset                                                                   |  |                                  |         |   |      |   |         |      |  |   |         |  
|(including loss on disposal of $310, $, $, respectively)                                                               |  |                                  | (1,009  | ) |      |   | (865    | )    |  |   | (631    | )
|Income tax benefit                                                                                                       |  |                                  | (353    | ) |      |   | (302    | )    |  |   | (221    | )
|                                                                                                                         |  |                                  |         |   |      |   |         |      |  |   |         |  
|LOSS ON DISCONTINUED REAL ESTATE OPERATIONS                                                                              |  |                                  | (656    | ) |      |   | (563    | )    |  |   | (410    | )
|                                                                                                                         |  |                                  |         |   |      |   |         |      |  |   |         |  
|Income before cumulative effect of change in accounting principle                                                        |  |                                  | 76,700  |   |      |   | 44,990  |      |  |   | 25,907  |  
|Cumulative effect of change in accounting principle, net of tax                                                          |  |                                  |        |   |      |   | 897     |      |  |   |        |  
|                                                                                                                         |  |                                  |         |   |      |   |         |      |  |   |         |  
|TOTAL COMPANY NET INCOME                                                                                                 |  | $                                | 76,700  |   |      | $ | 45,887  |      |  | $ | 25,907  |  
|Dividends: Real Estate Trusts preferred shares of beneficial interest                                                   |  |                                  | (5,418  | ) |      |   | (5,418  | )    |  |   | (5,418  | )
|                                                                                                                         |  |                                  |         |   |      |   |         |      |  |   |         |  
|NET INCOME AVAILABLE TO COMMON SHAREHOLDERS                                                                              |  | $                                | 71,282  |   |      | $ | 40,469  |      |  | $ | 20,489  |  
|                                                                                                                         |  |                                  |         |   |      |   |         |      |  |   |         |  
|NET INCOME (LOSS) PER COMMON SHARE                                                                                       |  |                                  |         |   |      |   |         |      |  |   |         |  
|Income from continuing operations                                                                                        |  | $                                | 14.96   |   |      | $ | 8.33    |      |  | $ | 4.32    |  
|Discontinued operations                                                                                                  |  |                                  | (0.14   | ) |      |   | (0.12   | )    |  |   | (0.08   | )
|Cumulative effect of change in accounting principle                                                                      |  |                                  |        |   |      |   | 0.19    |      |  |   |        |  
|                                                                                                                         |  |                                  |         |   |      |   |         |      |  |   |         |  
|NET INCOME PER COMMON SHARE (BASIC AND DILUTED)                                                                          |  | $                                | 14.82   |   |      | $ | 8.40    |      |  | $ | 4.24    |  
|                                                                                                                         |  |                                  |         |   |      |   |         |      |  |   |         |  



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



71



---

##### 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)                                                                        |  | 2004                             |         |   | 2003 |   |         | 2002 | 
|COMPREHENSIVE INCOME                                                                          |  |                                  |         |   |      |   |         |      |  |   |         |  
|Net income                                                                                    |  | $                                | 76,700  |   |      | $ | 45,887  |      |  | $ | 25,907  |  
|Other comprehensive income:                                                                   |  |                                  |         |   |      |   |         |      |  |   |         |  
|Cumulative effect of change in accounting principle                                           |  |                                  |        |   |      |   |        |      |  |   | 1,614   |  
|Net unrealized gain on cash flow hedges                                                       |  |                                  |        |   |      |   |        |      |  |   | 1,147   |  
|Income tax related to other comprehensive income                                              |  |                                  |        |   |      |   |        |      |  |   | (1,091  | )
|                                                                                              |  |                                  |         |   |      |   |         |      |  |   |         |  
|Other comprehensive income, net of tax                                                        |  |                                  |        |   |      |   |        |      |  |   | 1,670   |  
|                                                                                              |  |                                  |         |   |      |   |         |      |  |   |         |  
|TOTAL COMPREHENSIVE INCOME                                                                    |  | $                                | 76,700  |   |      | $ | 45,887  |      |  | $ | 27,577  |  
|                                                                                              |  |                                  |         |   |      |   |         |      |  |   |         |  
|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                                                                             |  |                                  | 112,424 |   |      |   | 68,438  |      |  |   | 46,543  |  
|Net income                                                                                    |  |                                  | 76,700  |   |      |   | 45,887  |      |  |   | 25,907  |  
|Adjustments - Saul Holdings investment, net of taxes of $1,120, $1,894 and $757, respectively |  |                                  | 2,080   |   |      |   | 3,517   |      |  |   | 1,406   |  
|Dividends:                                                                                    |  |                                  |         |   |      |   |         |      |  |   |         |  
|Real Estate Trust preferred shares of beneficial interest                                     |  |                                  | (5,418  | ) |      |   | (5,418  | )    |  |   | (5,418  | )
|Real Estate Trust common shares of beneficial interest                                        |  |                                  | (444    | ) |      |   |        |      |  |   |        |  
|                                                                                              |  |                                  |         |   |      |   |         |      |  |   |         |  
|End of year                                                                                   |  |                                  | 185,342 |   |      |   | 112,424 |      |  |   | 68,438  |  
|                                                                                              |  |                                  |         |   |      |   |         |      |  |   |         |  
|ACCUMULATED OTHER COMPREHENSIVE INCOME                                                        |  |                                  |         |   |      |   |         |      |  |   |         |  
|Beginning of year                                                                             |  |                                  |        |   |      |   |        |      |  |   | (1,670  | )
|Cumulative effect of change in accounting principle                                           |  |                                  |        |   |      |   |        |      |  |   | 977     |  
|Net unrealized gain (loss) on cash flow hedges                                                |  |                                  |        |   |      |   |        |      |  |   | 693     |  
|                                                                                              |  |                                  |         |   |      |   |         |      |  |   |         |  
|End of year                                                                                   |  |                                  |        |   |      |   |        |      |  |   |        |  
|                                                                                              |  |                                  |         |   |      |   |         |      |  |   |         |  
|TREASURY SHARES                                                                               |  |                                  |         |   |      |   |         |      |  |   |         |  
|Beginning of year (1,834,088, 1,814,688 and 1,814,688 shares, respectively)                   |  |                                  | (43,841 | ) |      |   | (41,848 | )    |  |   | (41,848 | )
|Purchases (19,400 shares)                                                                     |  |                                  |        |   |      |   | (1,993  | )    |  |   |        |  
|                                                                                              |  |                                  |         |   |      |   |         |      |  |   |         |  
|End of year (1,834,088, 1,834,088 and 1,814,688 shares, respectively)                         |  |                                  | (43,841 | ) |      |   | (43,841 | )    |  |   | (41,848 | )
|                                                                                              |  |                                  |         |   |      |   |         |      |  |   |         |  
|TOTAL SHAREHOLDERS EQUITY                                                                    |  | $                                | 241,602 |   |      | $ | 168,684 |      |  | $ | 126,691 |  
|                                                                                              |  |                                  |         |   |      |   |         |      |  |   |         |  



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



72



---

##### Table of Contents

Consolidated Statements of Cash Flows



B. F. SAUL REAL ESTATE INVESTMENT TRUST



|                                                                                            |  |                                  |            |   |      |   |            |      |  |   |            |  
|------------------------------------------------------------------------------------------- |  | -------------------------------- | ---------- | - | ---- | - | ---------- | ---- |  | - | ---------- | -
|                                                                                            |  | For the Year Ended September 30, |           
|(In thousands)                                                                              |  | 2004                             |            |   | 2003 |   |            | 2002 | 
|CASH FLOWS FROM OPERATING ACTIVITIES                                                        |  |                                  |            |   |      |   |            |      |  |   |            |  
|Real Estate                                                                                 |  |                                  |            |   |      |   |            |      |  |   |            |  
|Net loss                                                                                    |  | $                                | (15,580    | ) |      | $ | (9,815     | )    |  | $ | (12,777    | )
|Adjustments to reconcile net loss to net cash provided by (used in) operating activities:   |  |                                  |            |   |      |   |            |      |  |   |            |  
|Depreciation                                                                                |  |                                  | 19,053     |   |      |   | 19,330     |      |  |   | 19,147     |  
|Amortization of debt expense                                                                |  |                                  | 4,507      |   |      |   | 2,028      |      |  |   | 1,847      |  
|Equity in earnings of unconsolidated entities, net                                          |  |                                  | (7,788     | ) |      |   | (7,248     | )    |  |   | (8,811     | )
|Impairment losses on investments                                                            |  |                                  |           |   |      |   | 998        |      |  |   | 188        |  
|Gain on sale of property                                                                    |  |                                  | (2,769     | ) |      |   | (9,079     | )    |  |   |           |  
|Loss on disposal of discontinued real estate asset                                          |  |                                  | 310        |   |      |   |           |      |  |   |           |  
|Deferred tax (benefit) provision                                                            |  |                                  | (1,123     | ) |      |   | (657       | )    |  |   | 2,637      |  
|Increase in accounts receivable and accrued income                                          |  |                                  | (10,766    | ) |      |   | (3,346     | )    |  |   | (12,150    | )
|(Decrease) increase in accounts payable and accrued expenses                                |  |                                  | (6,023     | ) |      |   | (3,465     | )    |  |   | 1,425      |  
|Dividends and tax sharing payments                                                          |  |                                  | 33,611     |   |      |   | 27,460     |      |  |   | 21,667     |  
|Other                                                                                       |  |                                  | (1,725     | ) |      |   | (2,435     | )    |  |   | (2,245     | )
|                                                                                            |  |                                  |            |   |      |   |            |      |  |   |            |  
|                                                                                            |  |                                  | 11,707     |   |      |   | 13,771     |      |  |   | 10,928     |  
|                                                                                            |  |                                  |            |   |      |   |            |      |  |   |            |  
|                                                                                            |  |                                  |           
|Banking                                                                                     |  |                                  |            |   |      |   |            |      |  |   |            |  
|Net income                                                                                  |  |                                  | 92,280     |   |      |   | 55,702     |      |  |   | 38,684     |  
|Adjustments to reconcile net income to net cash provided by (used in) operating activities: |  |                                  |            |   |      |   |            |      |  |   |            |  
|Amortization of premiums, discounts and net deferred loan fees                              |  |                                  | 28,502     |   |      |   | 24,393     |      |  |   | 16,220     |  
|Deferred tax (benefit) provision                                                            |  |                                  | (49,481    | ) |      |   | 42,812     |      |  |   | 18,725     |  
|Depreciation and amortization                                                               |  |                                  | 160,509    |   |      |   | 215,961    |      |  |   | 202,627    |  
|Provision for loan losses                                                                   |  |                                  | (14,522    | ) |      |   | 18,422     |      |  |   | 51,367     |  
|Minority interest held by affiliates                                                        |  |                                  | 23,070     |   |      |   | 13,926     |      |  |   | 9,671      |  
|Minority interestother                                                                     |  |                                  | 18,193     |   |      |   | 9,750      |      |  |   | 9,750      |  
|Proceeds from sales of trading securities                                                   |  |                                  | 668,458    |   |      |   | 2,297,793  |      |  |   | 1,196,001  |  
|Purchases and net fundings of loans held for securitization and/or sale                     |  |                                  | (6,686,606 | ) |      |   | (6,438,614 | )    |  |   | (4,556,397 | )
|Proceeds from sales of loans held for securitization and/or sale                            |  |                                  | 5,810,798  |   |      |   | 3,773,127  |      |  |   | 2,286,369  |  
|Increase in interest-only strips receivable                                                 |  |                                  | (148,059   | ) |      |   | (50,475    | )    |  |   | (26,328    | )
|(Increase) decrease in servicing assets                                                     |  |                                  | (51,588    | ) |      |   | (35,838    | )    |  |   | 1,996      |  
|Increase (decrease) in other assets                                                         |  |                                  | (20,938    | ) |      |   | 4,570      |      |  |   | 17,219     |  
|(Decrease) increase in custodial accounts                                                   |  |                                  | (56,128    | ) |      |   | (34,963    | )    |  |   | 95,349     |  
|Increase (decrease) in other liabilities                                                    |  |                                  | 10,267     |   |      |   | (38,936    | )    |  |   | 5,412      |  
|Other                                                                                       |  |                                  | (12,938    | ) |      |   | (40,008    | )    |  |   | (8,049     | )
|                                                                                            |  |                                  |            |   |      |   |            |      |  |   |            |  
|                                                                                            |  |                                  | (228,183   | ) |      |   | (182,378   | )    |  |   | (641,384   | )
|                                                                                            |  |                                  |            |   |      |   |            |      |  |   |            |  
|Net cash used in operating activities                                                       |  |                                  | (216,476   | ) |      |   | (168,607   | )    |  |   | (630,456   | )
|                                                                                            |  |                                  |            |   |      |   |            |      |  |   |            |  
|CASH FLOWS FROM INVESTING ACTIVITIES                                                        |  |                                  |            |   |      |   |            |      |  |   |            |  
|                                                                                            |  |                                  |           
|Real Estate                                                                                 |  |                                  |            |   |      |   |            |      |  |   |            |  
|Capital expenditures - properties                                                           |  |                                  | (17,973    | ) |      |   | (9,855     | )    |  |   | (8,758     | )
|Property sales                                                                              |  |                                  | 3,719      |   |      |   | 11,306     |      |  |   | 9,650      |  
|Note receivable and accrued interest  related party (Advances)/repayments, net             |  |                                  | (4,690     | ) |      |   | 3,500      |      |  |   | 1,300      |  
|Equity investment in unconsolidated entities                                                |  |                                  | 3,220      |   |      |   | 4,213      |      |  |   | 3,508      |  
|Other investments                                                                           |  |                                  | (800       | ) |      |   | (1,864     | )    |  |   | (3,271     | )
|Other                                                                                       |  |                                  |           |   |      |   |           |      |  |   | (239       | )
|                                                                                            |  |                                  |            |   |      |   |            |      |  |   |            |  
|                                                                                            |  |                                  | (16,524    | ) |      |   | 7,300      |      |  |   | 2,190      |  
|                                                                                            |  |                                  |            |   |      |   |            |      |  |   |            |  
|Banking                                                                                     |  |                                  |            |   |      |   |            |      |  |   |            |  
|Proceeds from maturities of investment securities                                           |  |                                  | 10,000     |   |      |   |           |      |  |   | 45,000     |  
|Purchases of investment securities                                                          |  |                                  | (34,917    | ) |      |   |           |      |  |   | (45,717    | )
|Proceeds from redemption of Federal Home Loan Bank stock                                    |  |                                  | 287,599    |   |      |   | 152,625    |      |  |   | 84,559     |  
|Purchases of Federal Home Loan Bank stock                                                   |  |                                  | (319,573   | ) |      |   | (171,350   | )    |  |   | (60,177    | )
|Net principal collected of loans                                                            |  |                                  | 463,338    |   |      |   | 2,348,511  |      |  |   | 1,917,169  |  
|Purchases of loans receivable                                                               |  |                                  | (1,951,074 | ) |      |   | (3,309,953 | )    |  |   | (1,207,628 | )
|Principal collected on mortgage-backed securities                                           |  |                                  | 186,654    |   |      |   | 636,084    |      |  |   | 464,622    |  
|Purchases of mortgage-backed securities                                                     |  |                                  | (9,105     | ) |      |   |           |      |  |   | (21,450    | )
|Net repayments (purchases) of automobiles subject to lease                                  |  |                                  | 299,199    |   |      |   | 84,603     |      |  |   | (162,386   | )
|Net purchases of property and equipment                                                     |  |                                  | (64,197    | ) |      |   | (32,175    | )    |  |   | (55,839    | )
|Net proceeds from sales of property and equipment                                           |  |                                  | 23,320     |   |      |   |           |      |  |   |           |  
|Net proceeds from sales of real estate                                                      |  |                                  | 9,500      |   |      |   | 13,957     |      |  |   | 21,905     |  
|Disbursements for real estate held for investment or sale                                   |  |                                  | (3,272     | ) |      |   | (3,525     | )    |  |   | (10,884    | )
|                                                                                            |  |                                  |            |   |      |   |            |      |  |   |            |  
|                                                                                            |  |                                  | (1,102,528 | ) |      |   | (281,223   | )    |  |   | 969,174    |  
|                                                                                            |  |                                  |            |   |      |   |            |      |  |   |            |  
|Net cash provided by (used in) investing activities                                         |  |                                  | (1,119,052 | ) |      |   | (273,923   | )    |  |   | 971,364    |  
|                                                                                            |  |                                  |            |   |      |   |            |      |  |   |            |  



Continued on following page.



73



---

##### Table of Contents

Consolidated Statements of Cash Flows (Continued)



B. F. SAUL REAL ESTATE INVESTMENT TRUST



|                                                                                                        |  |                                  |             |   |      |   |             |      |  |   |             |  
|------------------------------------------------------------------------------------------------------- |  | -------------------------------- | ----------- | - | ---- | - | ----------- | ---- |  | - | ----------- | -
|                                                                                                        |  | For the Year Ended September 30, |            
|(In thousands)                                                                                          |  | 2004                             |             |   | 2003 |   |             | 2002 | 
|CASH FLOWS FROM FINANCING ACTIVITIES                                                                    |  |                                  |             |   |      |   |             |      |  |   |             |  
|                                                                                                        |  |                                  |            
|Real Estate                                                                                             |  |                                  |             |   |      |   |             |      |  |   |             |  
|Proceeds from mortgage financing                                                                        |  | $                                |            |   |      | $ | 46,000      |      |  | $ | 14,562      |  
|Principal curtailments and repayments of mortgages                                                      |  |                                  | (9,923      | ) |      |   | (48,600     | )    |  |   | (18,261     | )
|Net secured note financings (repayments)                                                                |  |                                  | 46,200      |   |      |   | 2,050       |      |  |   | (750        | )
|Proceeds from sales of unsecured notes                                                                  |  |                                  | 6,877       |   |      |   | 5,539       |      |  |   | 7,601       |  
|Repayments of unsecured notes                                                                           |  |                                  | (5,798      | ) |      |   | (5,346      | )    |  |   | (3,162      | )
|Costs of obtaining financings                                                                           |  |                                  | (7,676      | ) |      |   | (1,705      | )    |  |   | (1,005      | )
|Purchase of treasury stock                                                                              |  |                                  |            |   |      |   | (1,993      | )    |  |   |            |  
|Cash dividends paid on preferred stock                                                                  |  |                                  | (11,556     | ) |      |   | (12,000     | )    |  |   | (12,000     | )
|Cash dividends paid on common stock                                                                     |  |                                  | (444        | ) |      |   |            |      |  |   |            |  
|                                                                                                        |  |                                  |             |   |      |   |             |      |  |   |             |  
|                                                                                                        |  |                                  | 17,680      |   |      |   | (16,055     | )    |  |   | (13,015     | )
|                                                                                                        |  |                                  |             |   |      |   |             |      |  |   |             |  
|                                                                                                        |  |                                  |            
|Banking                                                                                                 |  |                                  |             |   |      |   |             |      |  |   |             |  
|Proceeds from customer deposits and sales of certificates of deposit                                    |  |                                  | 53,155,374  |   |      |   | 45,309,516  |      |  |   | 48,432,739  |  
|Customer withdrawals of deposits and payments for maturing certificates of deposit                      |  |                                  | (52,400,761 | ) |      |   | (44,646,596 | )    |  |   | (48,557,624 | )
|Net increase (decrease) in securities sold under repurchase agreements                                  |  |                                  | 16,062      |   |      |   | (499,324    | )    |  |   | 394,303     |  
|Advances from the Federal Home Loan Bank                                                                |  |                                  | 17,470,676  |   |      |   | 13,445,065  |      |  |   | 7,271,409   |  
|Repayments of advances from the Federal Home Loan Bank                                                  |  |                                  | (16,721,207 | ) |      |   | (13,160,560 | )    |  |   | (7,809,043  | )
|Net increase (decrease) in other borrowings                                                             |  |                                  | 22,203      |   |      |   | 8,154       |      |  |   | (17,169     | )
|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                                                                  |  |                                  | (10,750     | ) |      |   | (9,750      | )    |  |   | (9,750      | )
|Cash dividends paid on common stock                                                                     |  |                                  | (31,000     | ) |      |   | (20,000     | )    |  |   | (20,000     | )
|                                                                                                        |  |                                  |             |   |      |   |             |      |  |   |             |  
|                                                                                                        |  |                                  | 1,458,632   |   |      |   | 426,505     |      |  |   | (315,135    | )
|                                                                                                        |  |                                  |             |   |      |   |             |      |  |   |             |  
|Net cash provided by (used in) financing activities                                                     |  |                                  | 1,476,312   |   |      |   | 410,450     |      |  |   | (328,150    | )
|                                                                                                        |  |                                  |             |   |      |   |             |      |  |   |             |  
|                                                                                                        |  |                                  |            
|Net increase (decrease) in cash and cash equivalents                                                    |  |                                  | 140,784     |   |      |   | (32,080     | )    |  |   | 12,758      |  
|Cash and cash equivalents at beginning of year                                                          |  |                                  | 433,606     |   |      |   | 465,686     |      |  |   | 452,928     |  
|                                                                                                        |  |                                  |             |   |      |   |             |      |  |   |             |  
|Cash and cash equivalents at end of year                                                                |  | $                                | 574,390     |   |      | $ | 433,606     |      |  | $ | 465,686     |  
|                                                                                                        |  |                                  |             |   |      |   |             |      |  |   |             |  
|                                                                                                        |  |                                  |            
|Components of cash and cash equivalents at end of year as presented in the consolidated balance sheets: |  |                                  |             |   |      |   |             |      |  |   |             |  
|Real Estate                                                                                             |  |                                  |             |   |      |   |             |      |  |   |             |  
|Cash and cash equivalents                                                                               |  | $                                | 31,842      |   |      | $ | 18,979      |      |  | $ | 13,963      |  
|Banking                                                                                                 |  |                                  |             |   |      |   |             |      |  |   |             |  
|Cash and due from banks                                                                                 |  |                                  | 444,603     |   |      |   | 339,960     |      |  |   | 329,471     |  
|Interest-bearing deposits                                                                               |  |                                  | 97,945      |   |      |   | 74,667      |      |  |   | 122,252     |  
|                                                                                                        |  |                                  |             |   |      |   |             |      |  |   |             |  
|Cash and cash equivalents at end of year                                                                |  | $                                | 574,390     |   |      | $ | 433,606     |      |  | $ | 465,686     |  
|                                                                                                        |  |                                  |             |   |      |   |             |      |  |   |             |  
|                                                                                                        |  |                                  |            
|Supplemental disclosures of cash flow information:                                                      |  |                                  |             |   |      |   |             |      |  |   |             |  
|Cash paid during the year for:                                                                          |  |                                  |             |   |      |   |             |      |  |   |             |  
|Interest                                                                                                |  | $                                | 227,757     |   |      | $ | 248,372     |      |  | $ | 320,582     |  
|Income taxes paid                                                                                       |  |                                  | 107,689     |   |      |   | 17,415      |      |  |   | 19,226      |  
|Shares of Saul Centers, Inc. common stock                                                               |  |                                  | 9,330       |   |      |   | 7,835       |      |  |   | 7,988       |  
|Cash received during the year from:                                                                     |  |                                  |             |   |      |   |             |      |  |   |             |  
|Dividends on shares of Saul Centers, Inc. common stock                                                  |  |                                  | 6,023       |   |      |   | 5,521       |      |  |   | 4,969       |  
|Distributions from Saul Holdings Limited Partnership                                                    |  |                                  | 6,527       |   |      |   | 6,527       |      |  |   | 6,527       |  
|                                                                                                        |  |                                  |            
|Supplemental disclosures of noncash activities:                                                         |  |                                  |             |   |      |   |             |      |  |   |             |  
|Rollovers of notes payable - unsecured                                                                  |  |                                  | 6,432       |   |      |   | 7,005       |      |  |   | 4,880       |  
|Loans made in connection with the sale of real estate                                                   |  |                                  |            |   |      |   |            |      |  |   | 900         |  
|Loans receivable transferred to real estate acquired in settlement of loans                             |  |                                  | 3,376       |   |      |   | 3,019       |      |  |   | 4,174       |  
|Loans receivable exchanged for mortgage-backed securities held-to-maturity                              |  |                                  | 108,640     |   |      |   | 88,471      |      |  |   |            |  



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



74



---

##### Table of Contents

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 97% of the Trusts consolidated assets as of September 30, 2004, 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 3. 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.



75



---

##### Table of Contents

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 2004, 2003 and 2002 weighted average number of shares used in the calculation was 4,807,510, 4,819,628 and 4,826,910, respectively. The Trust has no common
share equivalents.



RECLASSIFICATIONS



Certain reclassifications have been made to the consolidated financial
statements for the years ended September 30, 2003 and 2002 to conform with the presentation used for the year ended September 30, 2004.



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.



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.



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 estimated useful lives of 28 to 50 years for buildings and up to 20 years for certain other
improvements. Tenant improvements are amortized over the lesser of their estimated useful lives or the lives of the related leases using the straight-line method.



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 of approximately $12.6 million
and $9.6 million at September 30, 2004 and 2003, 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 CENTERS, INC.



The Real Estate Trust accounts for its investments in Saul Holdings Limited Partnership and Saul Centers, Inc. 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 methods and
assumptions were used to estimate the fair value of each class of financial instruments.



76



---

##### Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



Cash and Cash Equivalents and Notes Receivable  Related Party



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



Liabilities



The fair market value of notes payablesecured is approximately $250
million. The fair value of mortgage notes payable is based on managements estimate of current market rates for its debt. At September 30, 2004, and 2003, the fair value of mortgage notes payable was $331.9 and $326.4 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, 2004 and 2003, the fair value of notes payableunsecured was $60.0 and $59.9 million.



ADOPTION OF NEW ACOUNTING STANDARDS



In April 2002, the FASB issued SFAS No. 145, Rescission of FASB No. 4,
44 and 64, Amendment of FASB No. 13 and Technical Corrections. SFAS No. 145, among other things, changes the financial reporting requirements for the gains or losses recognized from the extinguishment of debt. Under SFAS No. 4, all gains and
losses from the extinguishment of debt were required to be aggregated and, if material, classified as an extraordinary item, net of the related income tax effect. SFAS No. 145 eliminates SFAS No. 4 and as a result, the criteria in APB Opinion No. 30
now will be used to classify those gains and losses. The Real Estate Trust has no gains or losses from debt extinguishment that would require restatement. The Real Estate Trust does not expect the adoption of SFAS No. 145 to have a material impact
on its financial condition or results of operations.



In
November 2002, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. (FIN) 45, Guarantors Accounting and Disclosure Requirements for Guarantees, Including Direct Guarantees of Indebtedness
of Others. FIN 45 outlines the disclosures to be made by a guarantor in its financial statements about its obligations under certain guarantees. It states that a guarantor is required to recognize, at the inception of a guarantee, a liability
for the fair value of its obligation. The Real Estate Trust has no liabilities that need to be recognized as a result of the adoption of FIN 45, and the Real Estate Trust does not expect the adoption of FIN 45 to have a material impact on its
financial condition or results of operations.



In January 2003,
the FASB issued FIN 46, Consolidation of Variable Interest Entities. FIN 46 is an Interpretation of Accounting Research Bulletin No. 51 and addresses consolidation by business enterprises of variable interest entities (VIEs).
FIN 46 is based on the theory that an enterprise controlling another entity through interests other than voting interests should consolidate the controlled entity. Business enterprises are required under the provisions of FIN 46 to identify VIEs,
based on specified characteristics, and then determine whether they should be consolidated. An enterprise that holds a majority of the variable interests in another enterprise is considered the primary beneficiary of that enterprise and, therefore,
should consolidate the VIE. The primary beneficiary of a VIE is also required to include various disclosures in interim and annual financial statements. Additionally, an enterprise that holds a significant variable interest in a VIE, but that is not
the primary beneficiary, is also required to make certain disclosures. At September 30, 2004, the Real Estate Trust does not have any unconsolidated entities or VIEs and therefore the adoption of FIN 46 will not have an 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 $70.5, $56.0 and $44.1 million during the years ended September 30, 2004, 2003 and 2002, respectively.



Loans Held for Securitization and/or Sale:



At September 30, 2004, loans held for securitization and sale were composed
of single-family residential and home equity loans of $1,965.1 million and $394,000 respectively. At September 30, 2003, loans held for securitization and sale were composed entirely of single-family residential loans. 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. Single-family residential loans held for sale will either be sold or will be exchanged for mortgage-backed securities and then sold.



77



---

##### Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



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



The Bank periodically securitizes and sells certain
pools of loan receivables in the public and private markets in transactions that are recorded as sales. Loans held for securitization and sale are reported at the lower of aggregate cost or aggregate market value for each asset type.



U.S. Government and Mortgage-Backed Securities:



The Bank classifies its U.S. Government and mortgage-backed securities as
either held-to-maturity, available-for-sale or trading at the time such securities are acquired. U.S. Government and mortgage-backed securities classified as held-to-maturity are reported at amortized
cost. U.S. Government 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. U.S. Government and mortgage-backed securities classified as trading are reported at fair value, with unrealized gains and losses included in earnings. All U.S. Government securities and mortgage-backed securities are classified
as held-to-maturity at September 30, 2004 and 2003. Premiums and discounts on U.S. Government securities and mortgage-backed securities are amortized or accreted using the level-yield method.



Trading Securities:



As part of its mortgage banking activities, the Bank exchanges 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 $668.5, $2,297.8 and
$1,196.0 million during the years ended September 30, 2004, 2003 and 2002, respectively. The Bank realized net gains of $7.6, $37.8 and $13.3 million on the sales of trading securities for the years ended September 30, 2004, 2003 and 2002,
respectively. 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, 2004 and 2003.



The Bank sold its stock held in Concord EFS, Inc. during fiscal year 2003.
The Bank recognized net losses of $47,000 and $2.1 million on this investment during the years ended September 30, 2003 and 2002, respectively.



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, 2004 and 2003, the Bank had one impaired loan with a book value of $242,000 and $249,000, respectively. The Bank did not recognize any
interest income on impaired loans during the years ended September 30, 2004, 2003 and 2002.



78



---

##### Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



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.



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 Investment:



At
September 30, 2004 and 2003, real estate held for investment consists of developed land owned by one of the Banks subsidiaries. Real estate held for investment is carried at the lower of cost or net realizable value. See Note 14.



Real Estate Held for Sale:



Real estate held for sale 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. At September 30, 2003, based on an analysis of the values of REO and the prospects for recoveries of values, the Bank charged off against its valuation allowances, REO in the amount of $71.3 million.



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 9. 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 20 years. Maintenance and repairs are
charged to operating expenses as incurred.



79



---

##### Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



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:



The Bank adopted Statement of Financial Accounting
Standard (SFAS) No. 142, Goodwill and Other Intangible Assets (SFAS 142) on October 1, 2002. SFAS 142 requires that goodwill no longer be amortized, but, instead, be subjected to impairment testing. An impairment
loss on goodwill is recognized if the fair value is less than the carrying amount. At September 30, 2004 and 2003, the fair value of the goodwill recorded on the Banks balance sheet exceeded its carrying value. At September 30, 2004 and 2003,
goodwill totaled $23.7 million. See Note 15.



The premium
attributable to the value of home equity relationships related to certain home equity loans purchased in fiscal 1999, amounting to $320,000 and $614,000 at September 30, 2004 and 2003, respectively, is included in goodwill and other intangible
assets in the Consolidated Balance Sheets. 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 2004, 2003 and 2002.



Accumulated amortization of goodwill and other intangible assets was $54.4
and $54.1 million at September 30, 2004 and 2003, 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.



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 strips receivable) as trading securities and, accordingly, carries them at fair value. The Bank estimates the fair value of the interest-only strips
receivable on a discounted cash flow basis using market based discount and prepayment rates. The fair value adjustments for interest-only strips receivable are included in servicing, securitization and mortgage banking income. Fair value write downs
of $30.3, $12.5 and $7.2 million were recorded in the years ended September 30, 2004, 2003 and 2002, respectively.



Interest income on interest-only strips receivable is recognized using the level yield method over the estimated lives of the underlying loans. The Bank
uses certain assumptions to calculate the carrying values of the interest-only strips receivable, 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.



Interest-only strips receivable capitalized in the years ended September 30, 2004, 2003 and 2002 amounted to $235.9, $108.9 and $68.6 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, 2004 and 2003, all derivatives are recorded on the balance sheet at their fair market value. See Note 29.



80



---

##### Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



Adoption of New Accounting Standard:



In January 2003, the Financial Accounting Standards Board (FASB) issued Interpretation No. 46,
Consolidation of Variable Interest Entities (FIN 46). FIN 46 is an Interpretation of Accounting Research Bulletin No. 51 and addresses consolidation by business enterprises of variable interest entities (VIEs).
FIN 46 is based on the theory that an enterprise controlling another entity through interests other than voting interests should consolidate the controlled entity. Business enterprises are required under the provisions of FIN 46 to identify VIEs,
based on specified characteristics, and then determine whether they should be consolidated. An enterprise that holds a majority of the variable interests in another enterprise is considered the primary beneficiary of that enterprise and, therefore,
should consolidate the VIE. The primary beneficiary of a VIE is also required to include various disclosures in interim and annual financial statements. Additionally, an enterprise that holds a significant variable interest in a VIE, but that is not
the primary beneficiary, is also required to make certain disclosures. The Bank is the primary beneficiary of one VIE, which holds the ground lease under the Banks executive offices. The Bank adopted FIN 46 effective July 1, 2003 and, as a
result, recorded a gain of $897,000 as a cumulative effect of a change in accounting principle, net of tax. In addition, upon adoption, the Bank recorded $31.4 million each in property and equipment and minority interest related to the ground lease.
See Note 33.



4. LIQUIDITY AND CAPITAL RESOURCESREAL ESTATE
TRUST:



The Real Estate Trusts cash flow from
operating activities 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. Tax sharing and dividend payments received by the Real Estate Trust are presented as cash flows from operating
activities in the Consolidated Statements of Cash Flows.



During fiscal 2004, 2003 and 2002, the Bank made tax sharing payments totaling $8.8, $11.5 and $5.7 million to the Real Estate Trust. During fiscal 2004, 2003 and 2002, the Bank made dividend payments totaling $24.8, $16.0 and $16.0 million
to the Real Estate Trust.



In recent years, the operations of
the 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 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 (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, Inc. 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, 2004, the Real Estate Trust owns (directly or through one of its
wholly owned subsidiaries) a 19.5% interest, other entities affiliated with the Real Estate Trust own a 4.7% interest, and Saul Centers owns a 75.8% 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, 2004, 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



81



---

##### Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



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



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



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, 2004, 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, 2004, 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)                                  |  |   |        
|Saul Holdings:                                  |  |   |         |  
|Investment in partnership units                 |  | $ | 12,045  |  
|Distributions in excess of allocated net income |  |   | (21,169 | )
|Saul Centers:                                   |  |   |         |  
|Investment in common shares                     |  |   | 84,291  |  
|Distributions in excess of allocated net income |  |   | (13,400 | )
|                                                |  |   |         |  
|Total                                           |  | $ | 61,767  |  
|                                                |  |   |         |  



The Trusts
investments in Saul Centers exceeded the underlying book value of the investment at the time of the purchases. At September 30, 2004 the cumulative excess totaled $79.0 million. This amount is being amortized over the useful life of the underlying
real estate assets. At September 30, 2004, the unamortized balance was $70.3 million.



As of September 30, 2004, the Real Estate Trust, through its partnership interest in Saul Holdings of 19.5% and its ownership of common shares of Saul Centers of 25.1% (market value of $134.5 million at September 30,
2004), effectively owns 38.5% 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 7.



The unaudited Condensed Consolidated Balance Sheets as of September 30, 2004
and 2003, and the unaudited Condensed Consolidated Statements of Operations for the years ended September 30, 2004, 2003 and 2002 of Saul Centers follow.



82



---

##### Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



SAUL CENTERS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)



|                                                     |  |               |          |   |      |   |          |  
|---------------------------------------------------- |  | ------------- | -------- | - | ---- | - | -------- | -
|                                                     |  | September 30, |         
|(In thousands)                                       |  | 2004          |          |   | 2003 |  
|Assets                                               |  |               |          |   |      |   |          |  
|Real estate investments                              |  | $             | 666,834  |   |      | $ | 537,172  |  
|Accumulated depreciation                             |  |               | (176,848 | ) |      |   | (161,153 | )
|Other assets                                         |  |               | 70,143   |   |      |   | 41,515   |  
|                                                     |  |               |          |   |      |   |          |  
|Total assets                                         |  | $             | 560,129  |   |      | $ | 417,534  |  
|                                                     |  |               |          |   |      |   |          |  
|                                                     |  |              
|Liabilities and stockholders equity (deficit)       |  |               |          |   |      |   |          |  
|Notes payable                                        |  | $             | 429,498  |   |      | $ | 400,668  |  
|Other liabilities                                    |  |               | 31,754   |   |      |   | 22,470   |  
|                                                     |  |               |          |   |      |   |          |  
|Total liabilities                                    |  |               | 461,252  |   |      |   | 423,138  |  
|Total stockholders equity (deficit)                 |  |               | 98,877   |   |      |   | (5,604   | )
|                                                     |  |               |          |   |      |   |          |  
|Total liabilities and stockholders equity (deficit) |  | $             | 560,129  |   |      | $ | 417,534  |  
|                                                     |  |               |          |   |      |   |          |  



SAUL CENTERS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

|                                                  |  |                                           |         |   |      |   |        |      |  |   |        |  
|------------------------------------------------- |  | ----------------------------------------- | ------- | - | ---- | - | ------ | ---- |  | - | ------ | -
|                                                  |  | For the Twelve Months Ended September 30, |        
|(In thousands)                                    |  | 2004                                      |         |   | 2003 |   |        | 2002 | 
|Revenue                                           |  |                                           |         |   |      |   |        |      |  |   |        |  
|Base rent                                         |  | $                                         | 87,785  |   |      | $ | 76,900 |      |  | $ | 73,893 |  
|Other revenue                                     |  |                                           | 21,617  |   |      |   | 19,363 |      |  |   | 18,182 |  
|                                                  |  |                                           |         |   |      |   |        |      |  |   |        |  
|Total revenue                                     |  |                                           | 109,402 |   |      |   | 96,263 |      |  |   | 92,075 |  
|                                                  |  |                                           |         |   |      |   |        |      |  |   |        |  
|Expenses                                          |  |                                           |         |   |      |   |        |      |  |   |        |  
|Operating expenses                                |  |                                           | 21,795  |   |      |   | 19,843 |      |  |   | 17,752 |  
|Interest expense and amortization of debt expense |  |                                           | 26,357  |   |      |   | 26,701 |      |  |   | 25,582 |  
|Depreciation and amortization                     |  |                                           | 20,458  |   |      |   | 16,815 |      |  |   | 17,468 |  
|General and administrative                        |  |                                           | 7,785   |   |      |   | 6,032  |      |  |   | 5,226  |  
|                                                  |  |                                           |         |   |      |   |        |      |  |   |        |  
|Total expenses                                    |  |                                           | 76,395  |   |      |   | 69,391 |      |  |   | 66,028 |  
|                                                  |  |                                           |         |   |      |   |        |      |  |   |        |  
|Operating income                                  |  |                                           | 33,007  |   |      |   | 26,872 |      |  |   | 26,047 |  
|Non-operating item                                |  |                                           |         |   |      |   |        |      |  |   |        |  
|Gain on sale of property                          |  |                                           | 754     |   |      |   |       |      |  |   | 1,426  |  
|                                                  |  |                                           |         |   |      |   |        |      |  |   |        |  
|Net income before minority interest               |  |                                           | 33,761  |   |      |   | 26,872 |      |  |   | 27,473 |  
|Minority interest                                 |  |                                           | (8,100  | ) |      |   | (8,082 | )    |  |   | (8,069 | )
|                                                  |  |                                           |         |   |      |   |        |      |  |   |        |  
|Net income                                        |  |                                           | 25,661  |   |      |   | 18,790 |      |  |   | 19,404 |  
|Preferred dividends                               |  |                                           | (7,244  | ) |      |   |       |      |  |   |       |  
|                                                  |  |                                           |         |   |      |   |        |      |  |   |        |  
|Net income available to common shareholders       |  | $                                         | 18,417  |   |      | $ | 18,790 |      |  | $ | 19,404 |  
|                                                  |  |                                           |         |   |      |   |        |      |  |   |        |  



83



---

##### Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



6. 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   |  | RelatedDebt |        
|September 30, 2004             |  |     |  |      |        |                           |   |         |  |             |         |  |   |         |    
|Income-producing properties(1) |  |     |  |      |        |                           |   |         |  |             |         |  |   |         |    
|Hotels                         |  | 17  |  | $    | 18,141 |                           | $ | 245,879 |  | $           | 264,020 |  | $ | 159,026 |    
|Office and industrial          |  | 13  |  |      | 14,786 |                           |   | 169,668 |  |             | 184,454 |  |   | 149,593 |    
|Other                          |  | 4   |  |      | 2,803  |                           |   |        |  |             | 2,803   |  |   |        |    
|                               |  |     |  |      |        |                           |   |         |  |             |         |  |   |         |    
|                               |  | 34  |  | $    | 35,730 |                           | $ | 415,547 |  | $           | 451,277 |  | $ | 308,619 | (2)
|                               |  |     |  |      |        |                           |   |         |  |             |         |  |   |         |    
|Land Parcels                   |  | 10  |  | $    | 41,722 |                           | $ |        |  | $           | 41,722  |  | $ |        |    
|                               |  |     |  |      |        |                           |   |         |  |             |         |  |   |         |    

---

|(1) | Excludes real estate held for sale.
|--- | -----------------------------------



|(2) | Amount includes $307.2 million of mortgage notes payable and approximately $1.4 million of
capital leases.
|--- | ----------------------------------------------------------------------------------------------------------



|                               |  |     |  |      |        |                           |   |         |  |             |         |  |   |         |    
|------------------------------ |  | --- |  | ---- | ------ | ------------------------- | - | ------- |  | ----------- | ------- |  | - | ------- | ---
|(Dollars in thousands)         |  | No. |  | Land |        | Buildings andImprovements |   | Total   |  | RelatedDebt |        
|September 30, 2003:            |  |     |  |      |        |                           |   |         |  |             |         |  |   |         |    
|Income-producing properties(3) |  |     |  |      |        |                           |   |         |  |             |         |  |   |         |    
|Hotels                         |  | 17  |  | $    | 18,141 |                           | $ | 233,825 |  | $           | 251,966 |  | $ | 163,743 |    
|Office and industrial          |  | 13  |  |      | 14,786 |                           |   | 165,599 |  |             | 180,385 |  |   | 155,228 |    
|Other                          |  | 4   |  |      | 2,803  |                           |   |        |  |             | 2,803   |  |   |        |    
|                               |  |     |  |      |        |                           |   |         |  |             |         |  |   |         |    
|                               |  | 34  |  | $    | 35,730 |                           | $ | 399,424 |  | $           | 435,154 |  | $ | 318,971 | (4)
|                               |  |     |  |      |        |                           |   |         |  |             |         |  |   |         |    
|Land Parcels                   |  | 9   |  | $    | 42,425 |                           | $ |        |  | $           | 42,425  |  | $ |        |    
|                               |  |     |  |      |        |                           |   |         |  |             |         |  |   |         |    

---

|(3) | Excludes real estate held for sale.
|--- | -----------------------------------



|(4) | Amount includes $318.3 million of mortgage notes payable and $700,000 of capital leases.
|--- | ----------------------------------------------------------------------------------------



On September 25, 2003, the Real Estate Trust sold 7.7 acres located in Rockville, Maryland, for $11.3 million, and
recognized a gain of $9.1 million on the transaction.



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.



During the quarter ended June 30, 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 the fiscal year ended September 30 2003. This refund has been recorded
as an additional gain on sale of this land parcel in the year ended September 30, 2004.



The Real Estate Trust has placed one of its hotel properties on the market for sale and has written down its investment in this asset by $310,000 to arrive at its estimated fair value, less cost to sell, of $2.1
million. The sale of this asset closed on December 9, 2004 (see Note 38).



7. DISCONTINUED OPERATIONS  REAL ESTATE TRUST:



On June 22, 2004 the Real Estate Trust determined it would sell one of its hotel properties because the property no longer meets the Real Estate Trusts investment criteria and is located outside of the Real Estate Trusts core
markets. Therefore, on June 22, 2004, the Real Estate Trust determined that the held for sale criteria in accordance with FASB No. 144, Accounting for the Impairment or Disposal of Long-Lived



84



---

##### Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



Assets has been met. Accordingly, the Real Estate Trust has written down its investment in the property to its fair value, less cost to sell. The
asset, classified as Real estate held for sale on the Consolidated Balance Sheets, is subject to a mortgage note of $4.1 million, classified as Mortgage note payable  real estate held for sale on the Consolidated Balance Sheets. The Real
Estate Trust has recognized a loss of $310,000 as a result of this write-down, which is included in Loss from operations of discontinued real estate asset on the Consolidated Statements of Operations. The sale of this asset closed on December 9,
2004 (see Note 38).



8. DEBTREAL ESTATE TRUST:



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 3.1% to 9.1%. Certain mortgages contain a number of
restrictions, including cross default provisions. At September 30, 2004, the Real Estate Trust is in compliance with the debt covenants.



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. The weighted average interest rates were
8.5% and 9.2% at September 30, 2004 and 2003, respectively. During fiscal 2004 and 2003, the Real Estate Trust sold notes amounting to approximately $13.3 and $12.5 million, respectively. At September 30, 2004, the Real Estate Trust is in compliance
with the debt covenants.



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



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



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



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



The maturity schedule for the Real Estate Trusts outstanding debt, including mortgage notes payable for real estate held for sale, at September 30, 2004 for the fiscal years commencing October 1, 2004 is set
forth in the following table:



Debt Maturity Schedule

(In thousands)



|            |  |                |  |                       |  |                         |  |         
|----------- |  | -------------- |  | --------------------- |  | ----------------------- |  | --------
|Fiscal Year |  | Mortgage Notes |  | Notes PayableSecured |  | Notes PayableUnsecured |  | Total   
|2005        |  | $16,455        |  | $                    |  | $11,579                 |  | $28,034 
|2006        |  | 94,982         |  |                      |  | 7,874                   |  | 102,856 
|2007        |  | 5,521          |  |                      |  | 6,499                   |  | 12,020  
|2008        |  | 5,927          |  |                      |  | 3,991                   |  | 9,918   
|2009        |  | 15,768         |  |                      |  | 4,981                   |  | 20,749  
|Thereafter  |  | 172,663        |  | 250,000               |  | 21,504                  |  | 444,167 
|            |  |                |  |                       |  |                         |  |         
|Total       |  | $311,316       |  | $250,000              |  | $56,428                 |  | $617,744
|            |  |                |  |                       |  |                         |  |         



Of the $311.3 million
of mortgage notes outstanding at September 30, 2004, $303.5 million was non-recourse to the Real Estate Trust.



85



---

##### Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



9. 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 2004, 2003, and 2002 amounted to $33.9, $34.5 and $33.7 million, respectively. Future minimum rentals as of September 30, 2004 under non-cancelable leases are as follows:



|            |  |                |        
|----------- |  | -------------- | -------
|Fiscal Year |  | (In thousands)
|2005        |  | $              | 33,045 
|2006        |  |                | 29,032 
|2007        |  |                | 24,045 
|2008        |  |                | 20,354 
|2009        |  |                | 16,224 
|Thereafter  |  |                | 46,477 
|            |  |                |        
|Total       |  | $              | 169,177
|            |  |                |        



10. TRANSACTIONS WITH RELATED
PARTIESREAL ESTATE TRUST:



TRANSACTIONS WITH B. F. SAUL COMPANY
AND ITS SUBSIDIARIES



The Real Estate Trust is 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 monthly fee was $472,000 during fiscal 2004, $458,000 during fiscal 2003, and $475,000 during fiscal 2002. The advisory contract has been extended
until September 30, 2005, and will continue thereafter unless canceled by either party at the end of any contract year. Certain loan agreements prohibit termination of this contract.



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. Fees paid to Saul Co. and Saul Property Co.
amounted to $8.6, $7.7 and $7.7 million in fiscal 2004, 2003 and 2002, respectively.



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 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. These payments amounted to $266,000, $251,000 and $183,000 in fiscal 2004, 2003 and 2002,
respectively.



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 $288,000, $302,000 and $196,000 in fiscal 2004, 2003 and 2002,
respectively.



At October 1, 2001, the Real Estate Trust had an
unsecured note receivable from the Saul Co. with an outstanding balance of $7.8 million. During fiscal 2004, the Saul Co. borrowed an additional $4.7 million. During fiscal 2003 and 2002, curtails of $3.5 and $1.3 million, respectively, were paid by
the Saul Co. Interest on the loan is computed by reference to a floating rate index. At September 30, 2004 and 2003, the total due the Real Estate Trust was $7.7 million and $3.0 million, respectively, which included accrued interest of $1.8 million
in both periods. Interest earned on these loans amounted to $108,000, $151,000 and $275,000 during fiscal 2004, 2003 and 2002, respectively.



REMUNERATION OF TRUSTEES AND OFFICERS



For fiscal years 2004, 2003, and 2002, the Real Estate Trust paid the Trustees approximately $109,000, $105,000 and $95,000, 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 and Chief Executive Officer of the Bank, and four 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.



86



---

##### Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



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 2004, 2003 and 2002 was $8.4, $8.6 and $9.1 million, respectively. See Note 2.



OTHER TRANSACTIONS



The Real Estate Trust leases space to the Bank and Saul Property Co. at two of its income-producing properties. Minimum rents and expense recoveries paid
by these affiliates amounted to approximately $5.2, $5.3 and $5.1 million in fiscal 2004, 2003 and 2002, respectively.



11. INVESTMENT AND MORTGAGE-BACKED SECURITIES  THE BANK:



At September 30, 2004 and 2003, investment securities are comprised of U.S. Government securities and are classified as held-to-maturity. At September 30,
2004 and 2003, 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:



|                                                        |  |               |         |                              |   |                               |  |                     |       |  |   |        
|------------------------------------------------------- |  | ------------- | ------- | ---------------------------- | - | ----------------------------- |  | ------------------- | ----- |  | - | -------
|                                                        |  | AmortizedCost |         | GrossUnrealizedHolding Gains |   | GrossUnrealizedHolding Losses |  | Aggregate FairValue
|(In thousands)                                          |  |               |         |                              |   |                               |  |                    
|September 30, 2004                                      |  |               |         |                              |   |                               |  |                     |       |  |   |        
|Investment securities:                                  |  |               |         |                              |   |                               |  |                     |       |  |   |        
|Original maturity after one year, but within five years |  | $             | 71,192  |                              | $ |                              |  | $                   | 287   |  | $ | 70,905 
|Mortgage-backed securities:                             |  |               |         |                              |   |                               |  |                     |       |  |   |        
|FNMA                                                    |  |               | 222,953 |                              |   | 2,291                         |  |                     | 681   |  |   | 224,563
|FHLMC                                                   |  |               | 130,926 |                              |   | 4,794                         |  |                     | 4     |  |   | 135,716
|Private label, AAA-rated                                |  |               | 55,424  |                              |   |                              |  |                     | 200   |  |   | 55,224 
|                                                        |  |               |         |                              |   |                               |  |                     |       |  |   |        
|Total                                                   |  | $             | 480,495 |                              | $ | 7,085                         |  | $                   | 1,172 |  | $ | 486,408
|                                                        |  |               |         |                              |   |                               |  |                     |       |  |   |        
|(In thousands)                                          |  |               |         |                              |   |                               |  |                    
|September 30, 2003                                      |  |               |         |                              |   |                               |  |                     |       |  |   |        
|Investment securities:                                  |  |               |         |                              |   |                               |  |                     |       |  |   |        
|Original maturity after one year, but within five years |  | $             | 46,345  |                              | $ | 186                           |  | $                   |      |  | $ | 46,531 
|Mortgage-backed securities:                             |  |               |         |                              |   |                               |  |                     |       |  |   |        
|FNMA                                                    |  |               | 170,849 |                              |   | 4,741                         |  |                     | 1     |  |   | 175,589
|FHLMC                                                   |  |               | 222,777 |                              |   | 7,494                         |  |                     |      |  |   | 230,271
|Private label, AAA-rated                                |  |               | 84,766  |                              |   | 219                           |  |                     | 81    |  |   | 84,904 
|                                                        |  |               |         |                              |   |                               |  |                     |       |  |   |        
|Total                                                   |  | $             | 524,737 |                              | $ | 12,640                        |  | $                   | 82    |  | $ | 537,295
|                                                        |  |               |         |                              |   |                               |  |                     |       |  |   |        



There
were no sales of investment securities during the years ended September 30, 2004, 2003 and 2002.



87



---

##### Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



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, 2004 and 2003. 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 and mortgage-backed securities are not considered to be other than temporary because they relate to
changes in interest rates and do not affect the expected cash flows of the securities. Securities which were temporarily impaired at September 30, 2004 are shown below, along with the length of the impairment period.



|                                      |  |                     |         |                     |   |           |  |                  |        |            |   |                   |  |   |         |  |   |      
|------------------------------------- |  | ------------------- | ------- | ------------------- | - | --------- |  | ---------------- | ------ | ---------- | - | ----------------- |  | - | ------- |  | - | -----
|                                      |  | Less than 12 months |         | 12 months or longer |   | Total    
|(In thousands)                        |  | Fair Value          |         | UnrealizedLosses    |   | FairValue |  | UnrealizedLosses |        | Fair Value |   | Unrealized Losses
|U.S. government securities            |  | $                   | 70,905  |                     | $ | 287       |  | $                |       |            | $ |                  |  | $ | 70,905  |  | $ | 287  
|Mortgage-backed securities            |  |                     | 385,454 |                     |   | 794       |  |                  | 23,848 |            |   | 91                |  |   | 409,302 |  |   | 885  
|                                      |  |                     |         |                     |   |           |  |                  |        |            |   |                   |  |   |         |  |   |      
|Total temporarily impaired Securities |  | $                   | 456,359 |                     | $ | 1,081     |  | $                | 23,848 |            | $ | 91                |  | $ | 480,207 |  | $ | 1,172
|                                      |  |                     |         |                     |   |           |  |                  |        |            |   |                   |  |   |         |  |   |      



Contractual maturities of the
Banks mortgage-backed securities at September 30, 2004 are as follows:



|                                           |  |                |        
|------------------------------------------ |  | -------------- | -------
|                                           |  | (In thousands)
|Due within one year                        |  | $              | 9,567  
|Due after one year, but within five years  |  |                | 41,065 
|Due after five years, but within ten years |  |                | 69,345 
|Due after ten years                        |  |                | 289,326
|                                           |  |                |        
|Total                                      |  | $              | 409,303
|                                           |  |                |        



Accrued interest
receivable on mortgage-backed securities totaled $1.7 and $2.2 million at September 30, 2004 and 2003, respectively, and is included in other assets in the Consolidated Balance Sheets.



12. LOANS RECEIVABLE  THE BANK:



Loans receivable is composed of the following:



|                                                           |  |               |           |   |      |   |           |  
|---------------------------------------------------------- |  | ------------- | --------- | - | ---- | - | --------- | -
|                                                           |  | September 30, |          
|(In thousands)                                             |  | 2004          |           |   | 2003 |  
|Single-family residential                                  |  | $             | 5,232,551 |   |      | $ | 4,397,394 |  
|Home equity                                                |  |               | 1,721,605 |   |      |   | 1,336,776 |  
|Real estate construction and ground                        |  |               | 223,447   |   |      |   | 234,356   |  
|Commercial                                                 |  |               | 920,178   |   |      |   | 888,847   |  
|Prime automobile                                           |  |               | 271,731   |   |      |   | 492,896   |  
|Other                                                      |  |               | 137,475   |   |      |   | 200,169   |  
|                                                           |  |               |           |   |      |   |           |  
|                                                           |  |               | 8,506,987 |   |      |   | 7,550,438 |  
|                                                           |  |               |           |   |      |   |           |  
|                                                           |  |              
|Unearned discounts and net deferred loan origination costs |  |               | 86,320    |   |      |   | 67,516    |  
|Allowance for losses on loans                              |  |               | (37,750   | ) |      |   | (58,397   | )
|                                                           |  |               |           |   |      |   |           |  
|                                                           |  |               | 48,570    |   |      |   | 9,119     |  
|                                                           |  |               |           |   |      |   |           |  
|Total                                                      |  | $             | 8,555,557 |   |      | $ | 7,559,557 |  
|                                                           |  |               |           |   |      |   |           |  



The Bank serviced
loans owned by others amounting to $11,481.6 and $8,475.6 million at September 30, 2004 and 2003, respectively.



Accrued interest receivable on loans totaled $30.0 and $25.4 million at September 30, 2004 and 2003, respectively, and is included in other assets in the
Consolidated Balance Sheets.



88



---

##### Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



13. ALLOWANCE FOR LOSSES  THE BANK:



Activity in the allowance for losses on loans receivable is summarized as follows:



|                     |  |               |         |   |      |   |         |      |  |   |         |  
|-------------------- |  | ------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                     |  | September 30, |        
|(In thousands)       |  | 2004          |         |   | 2003 |   |         | 2002 | 
|Beginning Balance    |  | $             | 58,397  |   |      | $ | 66,079  |      |  | $ | 57,018  |  
|Provision for losses |  |               | (14,522 | ) |      |   | 18,422  |      |  |   | 51,367  |  
|Charge-offs          |  |               | (26,558 | ) |      |   | (44,957 | )    |  |   | (56,017 | )
|Recoveries           |  |               | 20,433  |   |      |   | 18,853  |      |  |   | 13,711  |  
|                     |  |               |         |   |      |   |         |      |  |   |         |  
|Ending Balance       |  | $             | 37,750  |   |      | $ | 58,397  |      |  | $ | 66,079  |  
|                     |  |               |         |   |      |   |         |      |  |   |         |  



14. REAL ESTATE HELD FOR INVESTMENT
OR SALE  THE BANK:



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



|                                                                                       |  |               |        |      |   |       
|-------------------------------------------------------------------------------------- |  | ------------- | ------ | ---- | - | ------
|                                                                                       |  | September 30,
|(In thousands)                                                                         |  | 2004          |        | 2003
|Real estate held for investment (net of allowance for losses of $202 for both periods) |  | $             | 925    |      | $ | 925   
|Real estate held for sale                                                              |  |               | 20,357 |      |   | 21,820
|                                                                                       |  |               |        |      |   |       
|Total real estate held for investment or sale                                          |  | $             | 21,282 |      | $ | 22,745
|                                                                                       |  |               |        |      |   |       



89



---

##### Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



Income (loss) on real estate held for investment or sale is composed of the following:



|                                 |  |                          |       |      |   |       |  |   |       |  
|-------------------------------- |  | ------------------------ | ----- | ---- | - | ----- |  | - | ----- | -
|                                 |  | Year Ended September 30, |      
|(In thousands)                   |  | 2004                     |       | 2003 |   | 2002  | 
|Provision for losses             |  | $                        |      |      | $ |      |  | $ | (700  | )
|Income from operating properties |  |                          | 842   |      |   | 957   |  |   | 652   |  
|Net gain on sales                |  |                          | 1,400 |      |   | 5,823 |  |   | 1,040 |  
|                                 |  |                          |       |      |   |       |  |   |       |  
|Total                            |  | $                        | 2,242 |      | $ | 6,780 |  | $ | 992   |  
|                                 |  |                          |       |      |   |       |  |   |       |  



15. GOODWILL AMORTIZATION 
THE BANK



As a result of adopting SFAS No. 142,
Goodwill and other Intangible Assets, on October 1, 2002, the Bank did not record goodwill amortization expense during the fiscal years ended September 30, 2004 and 2003. The following table sets forth net income for the fiscal year
ended September 30, 2002, on a pro forma basis, excluding goodwill amortization. The table contains information of the Bank only and does not include consolidation or elimination entries required for the Trusts financial position.



|                                          |  |                    |        
|----------------------------------------- |  | ------------------ | -------
|(In thousands)                            |  | September 30, 2002
|                                          | 
|Operating income:                         |  |                    |        
|As reported                               |  | $                  | 103,582
|Add back:                                 |  |                    |        
|Goodwill amortization, net of related tax |  |                    | 1,531  
|                                          |  |                    |        
|Pro forma operating income                |  | $                  | 105,113
|                                          |  |                    |        



90



---

##### Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



16. LOAN SERVICING RIGHTS  THE BANK:



Servicing assets are recorded when purchased and in conjunction with loan sales and securitization transactions when
servicing rights are retained by the Bank. Activity in servicing assets is summarized as follows:



|                    |  |                          |         |   |      |   |         |      |  |   |         |  
|------------------- |  | ------------------------ | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                    |  | Year ended September 30, |        
|(In thousands)      |  | 2004                     |         |   | 2003 |   |         | 2002 | 
|Beginning Balance   |  | $                        | 119,386 |   |      | $ | 105,963 |      |  | $ | 81,777  |  
|Additions           |  |                          | 97,640  |   |      |   | 75,277  |      |  |   | 51,794  |  
|Charge-offs         |  |                          | (3,856  | ) |      |   | (30,656 | )    |  |   |        |  
|Sales               |  |                          | (5,228  | ) |      |   |        |      |  |   |        |  
|Amortization        |  |                          | (43,177 | ) |      |   | (31,198 | )    |  |   | (27,608 | )
|                    |  |                          |         |   |      |   |         |      |  |   |         |  
|Ending Balance      |  |                          | 164,765 |   |      |   | 119,386 |      |  |   | 105,963 |  
|Valuation Allowance |  |                          | (16,909 | ) |      |   | (23,118 | )    |  |   | (45,533 | )
|                    |  |                          |         |   |      |   |         |      |  |   |         |  
|Carrying Value      |  | $                        | 147,856 |   |      | $ | 96,268  |      |  | $ | 60,430  |  
|                    |  |                          |         |   |      |   |         |      |  |   |         |  



Accumulated
amortization was $208.2 and $165.0 million at September 30, 2004 and 2003, respectively. The aggregate fair value of servicing assets at September 30, 2004 and 2003 was $149.4 and $96.9 million, respectively.



Activity in the valuation allowance for servicing assets is summarized as
follows:



|                                                |  |                          |        |   |      |   |         |      |  |   |       
|----------------------------------------------- |  | ------------------------ | ------ | - | ---- | - | ------- | ---- |  | - | ------
|                                                |  | Year Ended September 30,
|(In thousands)                                  |  | 2004                     |        |   | 2003 |   |         | 2002
|Balance at beginning of year                    |  | $                        | 23,118 |   |      | $ | 45,533  |      |  | $ | 19,343
|Additions (reductions) charged to loan expenses |  |                          | (17    | ) |      |   | 8,241   |      |  |   | 26,190
|Charge-offs                                     |  |                          | (3,856 | ) |      |   | (30,656 | )    |  |   |      
|Sales                                           |  |                          | (2,336 | ) |      |   |        |      |  |   |      
|                                                |  |                          |        |   |      |   |         |      |  |   |       
|Balance at end of year                          |  | $                        | 16,909 |   |      | $ | 23,118  |      |  | $ | 45,533
|                                                |  |                          |        |   |      |   |         |      |  |   |       



During fiscal year
2004, the Bank sold $2.9 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. There were no
sales of rights to service mortgage loans during fiscal years 2003 and 2002. Servicing fees are included in servicing, securitization and mortgage banking income in the Consolidated Statements of Operations and Comprehensive Income.



91



---

##### Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



At September 30, 2004 and 2003, 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, 2004       |        
|                                             |  | Single-FamilyResidential |         |   | Home Equity/Home Improvement |  
|(Dollars in thousands)                       |  |                          |         |   |                              |  
|Carrying value                               |  | $                        | 143,041 |   |                              | $ | 113   |  
|Weighted average life (in years)             |  |                          | 4.0     |   |                              |   | 2.1   |  
|Prepayment speed assumption (annual rate)(1) |  |                          | 19.37   | % |                              |   | 47.07 | %
|Impact on fair value at 10% adverse change   |  | $                        | (4,872  | ) |                              | $ | (8    | )
|Impact on fair value at 20% adverse change   |  | $                        | (9,370  | ) |                              | $ | (14   | )
|Discount rate (annual)                       |  |                          | 8.50    | % |                              |   | 8.42  | %
|Impact on fair value at 10% adverse change   |  | $                        | (2,716  | ) |                              | $ | (2    | )
|Impact on fair value at 20% adverse change   |  | $                        | (5,652  | ) |                              | $ | (3    | )



|                                             |  |                          |        |   |                              |   |       |  
|-------------------------------------------- |  | ------------------------ | ------ | - | ---------------------------- | - | ----- | -
|                                             |  | September 30, 2003       |       
|                                             |  | Single-FamilyResidential |        |   | Home Equity/Home Improvement |  
|(Dollars in thousands)                       |  |                          |        |   |                              |  
|Carrying value                               |  | $                        | 90,209 |   |                              | $ | 234   |  
|Weighted average life (in years)             |  |                          | 4.1    |   |                              |   | 1.6   |  
|Prepayment speed assumption (annual rate)(1) |  |                          | 22.03  | % |                              |   | 48.00 | %
|Impact on fair value at 10% adverse change   |  | $                        | (4,338 | ) |                              | $ | (15   | )
|Impact on fair value at 20% adverse change   |  | $                        | (8,220 | ) |                              | $ | (30   | )
|Discount rate (annual)                       |  |                          | 8.38   | % |                              |   | 7.21  | %
|Impact on fair value at 10% adverse change   |  | $                        | (1,976 | ) |                              | $ | (3    | )
|Impact on fair value at 20% adverse change   |  | $                        | (4,130 | ) |                              | $ | (6    | )

---

|(1) | Represents Constant Prepayment Rate.
|--- | ------------------------------------



92



---

##### Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



17. LOAN SECURITIZATION TRANSACTIONS  THE BANK:



The Bank periodically sells various receivables through asset-backed
securitizations, in which receivables are transferred to trusts, and certificates are sold to investors. The following chart summarizes the Banks securitization activities:



|                                      |  |                                           |           |      |   |           |  |   |          
|------------------------------------- |  | ----------------------------------------- | --------- | ---- | - | --------- |  | - | ---------
|                                      |  | As of or for the year ended September 30,
|(In thousands)                        |  | 2004                                      |           | 2003 |   | 2002     
|Single-Family Residential             |  |                                           |           |      |   |           |  |   |          
|Loans sold into new trusts            |  | $                                         | 4,853,624 |      | $ | 2,551,634 |  | $ | 1,400,685
|Outstanding trust certificate balance |  |                                           | 7,246,410 |      |   | 3,509,029 |  |   | 1,341,712
|Gains recognized                      |  |                                           | 182,821   |      |   | 92,901    |  |   | 52,452   
|                                      |  |                                           |          
|Automobile                            |  |                                           |           |      |   |           |  |   |          
|Loans sold into new trusts            |  | $                                         |          |      | $ |          |  | $ | 236,085  
|Outstanding trust certificate balance |  |                                           | 149,345   |      |   | 389,678   |  |   | 792,949  
|Gains recognized                      |  |                                           |          |      |   |          |  |   | 3,098    
|                                      |  |                                           |          
|Home Equity                           |  |                                           |           |      |   |           |  |   |          
|Loans sold into existing trusts       |  | $                                         | 3,929     |      | $ | 11,457    |  | $ | 32,802   
|Outstanding trust certificate balance |  |                                           |          |      |   | 20,097    |  |   | 42,904   
|Gains recognized                      |  |                                           | 195       |      |   | 540       |  |   | 1,275    
|                                      |  |                                           |          
|Home Improvement                      |  |                                           |           |      |   |           |  |   |          
|Loans sold into existing trusts       |  | $                                         |          |      | $ |          |  | $ | 1,547    
|Outstanding trust certificate balance |  |                                           |          |      |   | 19,205    |  |   | 35,927   
|Gains recognized                      |  |                                           |          |      |   |          |  |   |         



93



---

##### Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



The Bank continues to service, and receives servicing fees on, the outstanding balance of securitized
receivables. The Bank also retains rights, which may be subordinated, to future cash flows arising from the receivables. The Bank generally estimates the fair value of these retained interests based on the estimated present value of expected future
cash flows from securitized and sold receivables, using managements best estimates of the key assumptions  credit losses, prepayment speeds and discount rates commensurate with the risks involved.



The following table summarizes certain cash flows received from
securitization trusts:



|                                                |  |                          |           |      |   |          
|----------------------------------------------- |  | ------------------------ | --------- | ---- | - | ---------
|                                                |  | Year Ended September 30,
|(In thousands)                                  |  | 2004                     |           | 2003
|Proceeds from new securitizations               |  | $                        | 4,774,686 |      | $ | 2,510,584
|Servicing fees received                         |  |                          | 20,290    |      |   | 14,585   
|Other cash flows received on retained interests |  |                          | 73,891    |      |   | 42,087   



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.



94



---

##### Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



At September 30, 2004 and 2003, 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:



|                                                  |  |                           |         |      |            |   |        |                               |  |   |       |     
|------------------------------------------------- |  | ------------------------- | ------- | ---- | ---------- | - | ------ | ----------------------------- |  | - | ----- | ----
|                                                  |  | September 30, 2004        |         |      |            |  
|(Dollars in thousands)                            |  | Single-FamilyResidential  |         |      | Automobile |   |        |                               | 
|Carrying value (fair value)                       |  | $                         | 295,805 |      |            | $ | 12,537 |                               |  |   |       |     
|Weighted average life (in years)                  |  |                           | 3.8     |      |            |   | 0.5    |                               |  |   |       |     
|Prepayment speed assumption (average annual rate) |  |                           | 19.91   | %(1) |            |   | 1.50   | %(2)                          |  |   |       |     
|Impact on fair value at 10% adverse change        |  | $                         | (21,328 | )    |            | $ | (22    | )                             |  |   |       |     
|Impact on fair value at 20% adverse change        |  | $                         | (39,206 | )    |            | $ | (37    | )                             |  |   |       |     
|Expected credit losses (annual rate)              |  |                           | 0.01    | %    |            |   | 4.53   | %                             |  |   |       |     
|Impact on fair value at 10% adverse change        |  | $                         | (22     | )    |            | $ | (338   | )                             |  |   |       |     
|Impact on fair value at 20% adverse change        |  | $                         | (43     | )    |            | $ | (677   | )                             |  |   |       |     
|Discount rate (annual rate)                       |  |                           | 8.50    | %    |            |   | 8.00   | %                             |  |   |       |     
|Impact on fair value at 10% adverse change        |  | $                         | (7,593  | )    |            | $ | (3     | )                             |  |   |       |     
|Impact on fair value at 20% adverse change        |  | $                         | (13,586 | )    |            | $ | (5     | )                             |  |   |       |     
|                                                  | 
|                                                  |  | September 30, 2003        |        
|(Dollars in thousands)                            |  | Single-Family Residential |         |      | Automobile |   |        | Home Equity/ Home Improvement | 
|Carrying value (fair value)                       |  | $                         | 135,985 |      |            | $ | 23,805 |                               |  | $ | 3,703 |     
|Weighted average life (in years)                  |  |                           | 4.0     |      |            |   | 0.9    |                               |  |   | 0.8   |     
|Prepayment speed assumption (average annual rate) |  |                           | 22.59   | %(1) |            |   | 1.50   | %(2)                          |  |   | 55.88 | %(1)
|Impact on fair value at 10% adverse change        |  | $                         | (8,361  | )    |            | $ | (699   | )                             |  | $ | (53   | )   
|Impact on fair value at 20% adverse change        |  | $                         | (15,697 | )    |            | $ | (1,093 | )                             |  | $ | (96   | )   
|Expected credit losses (annual rate)              |  |                           | 0.01    | %    |            |   | 2.06   | %                             |  |   | 1.50  | %   
|Impact on fair value at 10% adverse change        |  | $                         | (33     | )    |            | $ | (672   | )                             |  | $ | (21   | )   
|Impact on fair value at 20% adverse change        |  | $                         | (66     | )    |            | $ | (1,343 | )                             |  | $ | (43   | )   
|Discount rate (annual rate)                       |  |                           | 8.50    | %    |            |   | 8.00   | %                             |  |   | 8.52  | %   
|Impact on fair value at 10% adverse change        |  | $                         | (3,106  | )    |            | $ | (175   | )                             |  | $ | (2    | )   
|Impact on fair value at 20% adverse change        |  | $                         | (5,989  | )    |            | $ | (349   | )                             |  | $ | (4    | )   



95



---

##### Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



Key assumptions used in measuring retained interest at the date of securitizations completed during
fiscal year 2004 and 2003 are as follows:



|                                                  |  |                          |     
|------------------------------------------------- |  | ------------------------ | ----
|                                                  |  | Single-FamilyResidential |     
|Year Ended September 30, 2004                     |  |                          |     
|                                                  | 
|Prepayment speed assumption (average annual rate) |  | 19.91                    | %(1)
|Expected credit losses (annual rate)              |  | 0.01                     | %   
|Discount rate (annual rate)                       |  | 8.50                     | %   
|                                                  | 
|Year Ended September 30, 2003                     |  |                          |     
|                                                  | 
|Prepayment speed assumption (average annual rate) |  | 20.49                    | %(1)
|Expected credit losses (annual rate)              |  | 0.01                     | %   
|Discount rate (annual rate)                       |  | 8.50                     | %   

---

|(1) | Represents Constant Prepayment Rate. Certain loans may require the payment of a fee if the borrower prepays the loan during the period up to three years after
origination. The Bank uses a lower prepayment assumption during these periods.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(2) | Represents absolute prepayment model (ABS)  an assumed rate of prepayment
each month relative to the original number of automobile loans in a pool.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------



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.



96



---

##### Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



Principal balances, delinquent amounts and net credit losses for securitized loans were as follows:



|                                                |  |                                                |           |                                                                   |   |                               |  |   |       |  
|----------------------------------------------- |  | ---------------------------------------------- | --------- | ----------------------------------------------------------------- | - | ----------------------------- |  | - | ----- | -
|                                                |  | As of or for the year ended September 30, 2004 |          
|(In thousands)                                  |  | Total PrincipalAmount of Loans                 |           | Principal Amountof Loans Past Due90 Days or More orNon-Performing |   | Net Credit Losses(Recoveries) | 
|Single-family residential                       |  | $                                              | 7,140,749 |                                                                   | $ | 12,104                        |  | $ | (239  | )
|Automobile                                      |  |                                                | 150,957   |                                                                   |   | 2,300                         |  |   | 8,612 |  
|Home equity, home improvement and related loans |  |                                                |          |                                                                   |   |                              |  |   | (342  | )
|                                                |  |                                                |           |                                                                   |   |                               |  |   |       |  
|Total                                           |  | $                                              | 7,291,706 |                                                                   | $ | 14,404                        |  | $ | 8,031 |  
|                                                |  |                                                |           |                                                                   |   |                               |  |   |       |  



|                                                |  |                                                |           |                                                                   |   |                               |  |   |        |  
|----------------------------------------------- |  | ---------------------------------------------- | --------- | ----------------------------------------------------------------- | - | ----------------------------- |  | - | ------ | -
|                                                |  | As of or for the year ended September 30, 2003 |          
|(In thousands)                                  |  | Total PrincipalAmount of Loans                 |           | Principal Amountof Loans Past Due90 Days or More orNon-Performing |   | Net Credit Losses(Recoveries) | 
|Single-family residential                       |  | $                                              | 3,427,013 |                                                                   | $ | 4,535                         |  | $ |       |  
|Automobile                                      |  |                                                | 393,333   |                                                                   |   | 5,697                         |  |   | 20,371 |  
|Home equity, home improvement and related loans |  |                                                | 37,606    |                                                                   |   | 649                           |  |   | (197   | )
|                                                |  |                                                |           |                                                                   |   |                               |  |   |        |  
|Total                                           |  | $                                              | 3,857,952 |                                                                   | $ | 10,881                        |  | $ | 20,174 |  
|                                                |  |                                                |           |                                                                   |   |                               |  |   |        |  



18. PROPERTY AND EQUIPMENT 
THE BANK:



Property and equipment is composed of the
following:



|                                          |  |                       |      |               |         |  |   |        
|----------------------------------------- |  | --------------------- | ---- | ------------- | ------- |  | - | -------
|                                          |  | EstimatedUseful Lives |      | September 30,
|(Dollars in thousands)                    |  |                       | 2004 |               | 2003   
|Land                                      |  |                      |      | $             | 87,175  |  | $ | 87,647 
|Projects in progress                      |  |                      |      |               | 13,144  |  |   | 3,950  
|Buildings and improvements                |  | 10-65 years           |      |               | 281,488 |  |   | 298,371
|Leasehold and tenant improvements         |  | 5-20 years            |      |               | 147,762 |  |   | 134,356
|Furniture and equipment                   |  | 5-10 years            |      |               | 241,341 |  |   | 229,041
|Automobiles                               |  | 3-5 years             |      |               | 6,813   |  |   | 4,048  
|                                          |  |                       |      |               |         |  |   |        
|                                          |  |                       |      |               | 777,723 |  |   | 757,413
|Less:                                     |  |                       |      |               |         |  |   |        
|Accumulated depreciation and amortization |  |                       |      |               | 284,816 |  |   | 266,682
|                                          |  |                       |      |               |         |  |   |        
|Total                                     |  |                       |      | $             | 492,907 |  | $ | 490,731
|                                          |  |                       |      |               |         |  |   |        



97



---

##### Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



Depreciation and amortization expense related to property and equipment amounted to $39.3, $44.5 and
$38.7 million for the years ended September 30, 2004, 2003 and 2002, respectively.



19. AUTOMOBILES SUBJECT TO LEASE  THE BANK:



Automobiles subject to lease is composed of the following:



|                         |  |                       |      |               |         |  |   |          
|------------------------ |  | --------------------- | ---- | ------------- | ------- |  | - | ---------
|                         |  | EstimatedUseful Lives |      | September 30,
|(Dollars in thousands)   |  |                       | 2004 |               | 2003   
|Automobiles              |  | 3-5 years             |      | $             | 673,891 |  | $ | 1,178,161
|Less:                    |  |                       |      |               |         |  |   |          
|Accumulated depreciation |  |                       |      |               | 238,584 |  |   | 322,751  
|                         |  |                       |      |               |         |  |   |          
|Total                    |  |                       |      | $             | 435,307 |  | $ | 855,410  
|                         |  |                       |      |               |         |  |   |          



Depreciation expense
related to automobile leases amounted to $120.9, $170.9 and $161.9 million for the years ended September 30, 2004, 2003, and 2002, respectively. Automobile rental income amounted to $157.0, $235.4 and $242.6 million for the years ended September 30,
2004, 2003 and 2002, respectively.



The following is a schedule
by years of future minimum automobile rental income at September 30, 2004:



|                          |  |                |        
|------------------------- |  | -------------- | -------
|Year Ending September 30, |  | (In thousands)
|2005                      |  | $              | 90,983 
|2006                      |  |                | 48,994 
|2007                      |  |                | 14,471 
|2008                      |  |                | 1,542  
|                          |  |                |        
|Total                     |  | $              | 155,990
|                          |  |                |        



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 2005 to fiscal year 2023 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, 2004:



|                          |  |                |        
|------------------------- |  | -------------- | -------
|Year Ending September 30, |  | (In thousands)
|2005                      |  | $              | 24,538 
|2006                      |  |                | 23,875 
|2007                      |  |                | 23,010 
|2008                      |  |                | 17,819 
|2009                      |  |                | 15,815 
|Thereafter                |  |                | 93,669 
|                          |  |                |        
|Total                     |  | $              | 198,726
|                          |  |                |        



98



---

##### Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



Rent expense totaled $24.0, $31.5 and $29.9 million for the years ended September 30, 2004, 2003 and
2002, 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:



An analysis of deposit accounts and the related weighted average effective interest rates at year end are as follows:



|                                     |  |               |           |                     |      |   |        |   |                     |  |      |  
|------------------------------------ |  | ------------- | --------- | ------------------- | ---- | - | ------ | - | ------------------- |  | ---- | -
|                                     |  | September 30, |          
|                                     |  | 2004          |           |                     | 2003 |  
|(Dollars in thousands)               |  | Amount        |           | WeightedAverageRate |      |   | Amount |   | WeightedAverageRate | 
|Demand accounts                      |  | $             | 1,181,722 |                     |     |   |        | $ | 951,844             |  |     |  
|NOW accounts                         |  |               | 2,244,724 |                     | 0.21 | % |        |   | 1,951,281           |  | 0.20 | %
|Money market deposit accounts        |  |               | 2,364,768 |                     | 0.90 | % |        |   | 2,321,026           |  | 0.70 | %
|Statement savings accounts           |  |               | 1,042,777 |                     | 0.28 | % |        |   | 997,686             |  | 0.28 | %
|Other deposit accounts               |  |               | 171,530   |                     | 0.25 | % |        |   | 152,758             |  | 0.25 | %
|Certificate accounts, less than $100 |  |               | 1,238,733 |                     | 2.09 | % |        |   | 1,207,728           |  | 2.05 | %
|Certificate accounts, $100 or more   |  |               | 610,864   |                     | 2.16 | % |        |   | 518,182             |  | 1.87 | %
|                                     |  |               |           |                     |      |   |        |   |                     |  |      |  
|Total                                |  | $             | 8,855,118 |                     | 0.77 | % |        | $ | 8,100,505           |  | 0.71 | %
|                                     |  |               |           |                     |      |   |        |   |                     |  |      |  



The Banks
deposits are insured by the FDIC up to $100,000 for each insured depositor.



Interest expense on deposit accounts is composed of the following:



|                              |  |                          |        |      |   |        |  |   |        
|----------------------------- |  | ------------------------ | ------ | ---- | - | ------ |  | - | -------
|                              |  | Year Ended September 30,
|(In thousands)                |  | 2004                     |        | 2003 |   | 2002  
|NOW accounts                  |  | $                        | 4,320  |      | $ | 4,562  |  | $ | 4,752  
|Money market deposit accounts |  |                          | 17,159 |      |   | 21,405 |  |   | 31,512 
|Statement savings accounts    |  |                          | 2,885  |      |   | 4,387  |  |   | 8,447  
|Certificate accounts          |  |                          | 33,446 |      |   | 49,195 |  |   | 98,262 
|Other deposit accounts        |  |                          | 441    |      |   | 573    |  |   | 939    
|                              |  |                          |        |      |   |        |  |   |        
|Total                         |  | $                        | 58,251 |      | $ | 80,122 |  | $ | 143,912
|                              |  |                          |        |      |   |        |  |   |        



99



---

##### Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



Outstanding certificate accounts at September 30, 2004 mature in the years indicated as follows:



|                          |  |                |          
|------------------------- |  | -------------- | ---------
|Year Ending September 30, |  | (In thousands)
|2005                      |  | $              | 1,296,843
|2006                      |  |                | 379,181  
|2007                      |  |                | 55,188   
|2008                      |  |                | 33,035   
|2009                      |  |                | 85,350   
|                          |  |                |          
|Total                     |  | $              | 1,849,597
|                          |  |                |          



At September 30, 2004,
certificate accounts of $100,000 or more have contractual maturities as indicated below:



|                                     |  |                |        
|------------------------------------ |  | -------------- | -------
|                                     |  | (In thousands)
|Three months or less                 |  | $              | 270,461
|Over three months through six months |  |                | 61,105 
|Over six months through 12 months    |  |                | 97,156 
|Over 12 months                       |  |                | 182,142
|                                     |  |                |        
|Total                                |  | $              | 610,864
|                                     |  |                |        



22. SECURITIES SOLD UNDER
REPURCHASE AGREEMENTS AND OTHER SHORT-TERM BORROWINGS  THE BANK:



Short-term borrowings are summarized as follows:



|                                                    |  |               |         |   |      |   |         |      |  |   |         |  
|--------------------------------------------------- |  | ------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                    |  | September 30, |        
|(Dollars in thousands)                              |  | 2004          |         |   | 2003 |   |         | 2002 | 
|Securities sold under repurchase agreements:        |  |               |         |   |      |   |         |      |  |   |         |  
|Balance at year end                                 |  | $             | 21,878  |   |      | $ | 5,816   |      |  | $ | 505,140 |  
|Average amount outstanding during the year          |  |               | 23,994  |   |      |   | 268,870 |      |  |   | 405,844 |  
|Maximum amount outstanding at any month end         |  |               | 87,871  |   |      |   | 506,065 |      |  |   | 559,957 |  
|Amount maturing within 30 days                      |  |               | 18,878  |   |      |   | 2,816   |      |  |   | 505,140 |  
|Weighted average interest rate during the year      |  |               | 0.87    | % |      |   | 1.44    | %    |  |   | 1.95    | %
|Weighted average interest rate on year end balances |  |               | 0.98    | % |      |   | 0.77    | %    |  |   | 1.82    | %
|Other short-term borrowings:                        |  |               |         |   |      |   |         |      |  |   |         |  
|Balance at year end                                 |  | $             | 184,701 |   |      | $ | 162,498 |      |  | $ | 154,344 |  
|Average amount outstanding during the year          |  |               | 178,748 |   |      |   | 170,385 |      |  |   | 169,037 |  
|Maximum amount outstanding at any month end         |  |               | 227,365 |   |      |   | 209,805 |      |  |   | 179,069 |  
|Amount maturing within 30 days                      |  |               | 184,701 |   |      |   | 162,498 |      |  |   | 154,344 |  
|Weighted average interest rate during the year      |  |               | 0.34    | % |      |   | 0.55    | %    |  |   | 1.17    | %
|Weighted average interest rate on year end balances |  |               | 0.52    | % |      |   | 0.32    | %    |  |   | 1.07    | %



100



---

##### Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



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, 2004, the Bank had pledged
mortgage-backed securities and U.S. Government securities with a combined book value of $231.8 million to secure certain other short-term borrowings. Also at September 30, 2004, the Bank had pledged, but did not borrow against, other loans with a
total principal balance of $855.3 million.



23. FEDERAL HOME LOAN BANK
ADVANCES  THE BANK:



At September 30, 2004, advances
from the Federal Home Loan Bank of Atlanta (FHLB) totaled $2,736.9 million. The interest rate on each FHLB advance is fixed for the term of the advance and the weighted average interest rate for all advances is 2.79%. The advances mature
over varying periods as follows:



|                                         |  |                |          
|---------------------------------------- |  | -------------- | ---------
|                                         |  | (In thousands)
|Six months or less                       |  | $              | 2,023,186
|More than six months through one year    |  |                | 1,851    
|More than one year through three years   |  |                | 430,947  
|More than three years through five years |  |                | 242,393  
|More than five years                     |  |                | 38,561   
|                                         |  |                |          
|Total                                    |  | $              | 2,736,938
|                                         |  |                |          



Under a Specific
Collateral Agreement with the FHLB, advances are secured by the FHLB stock owned by the Bank and qualifying first mortgage loans with a total principal balance of $5,234.9 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 September 30, 2004 advances is available to secure additional advances from the FHLB, subject to its collateralization
guidelines.



24. CAPITAL NOTES  SUBORDINATED  THE BANK:



Capital notes, which are subordinated to the interest of
deposit account holders and other senior debt, are composed of the following:



|                                 |  |                   |      |               |         |              |   |         |  |      |  
|-------------------------------- |  | ----------------- | ---- | ------------- | ------- | ------------ | - | ------- |  | ---- | -
|                                 |  | Issue Date        |      | September 30, |         | InterestRate |  
|(In thousands)                   |  |                   | 2004 |               | 2003    |             
|Subordinated debentures due 2013 |  | December 2, 2003  |      | $             | 175,000 |              | $ |        |  | 67/8 | %
|Subordinated debentures due 2005 |  | November 23, 1993 |      |               |        |              |   | 150,000 |  | 91⁄4   | %
|Subordinated debentures due 2008 |  | December 3, 1996  |      |               |        |              |   | 100,000 |  | 91⁄4   | %
|                                 |  |                   |      |               |         |              |   |         |  |      |  
|Total                            |  |                   |      | $             | 175,000 |              | $ | 250,000 |  |      |  
|                                 |  |                   |      |               |         |              |   |         |  |      |  



101



---

##### Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



On December 2, 2003, the Bank issued $175.0 million aggregate principal amount of 67/8% subordinated debentures due 2013 (the 2003 Debentures). The net proceeds of the offering, along with
short-term borrowings, were used to redeem all of the 91⁄4% Subordinated Debentures due 2005 and the 91⁄4% Subordinated Debentures due 2008. 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 8% Preferred Stock (as defined below).



Deferred debt issuance costs, net of accumulated amortization, amounted to $3.5 and $4.2 million at September 30, 2004 and 2003, respectively, and are
included in other assets in the Consolidated Balance Sheets.



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 net proceeds from the issuance of the Series C Preferred Stock were used to redeem all of the Banks 13% Noncumulative
Perpetual Preferred Stock, Series A, on October 31, 2003, at a price of $27.25 per share. The Series C Preferred Stock trades on the New York Stock Exchange under the symbol CCX PrC. 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 covers those full-time employees who meet the requirements as specified in the Plan. Prior to January 1, 2002, the Plan, which can be modified or discontinued at any time, required participating employees to
contribute 2.0% of their compensation. Beginning January 1, 2002, only corporate contributions are made to the Plan.



Corporate contributions, at the discretionary amount of up to six percent of the employees cash compensation, subject to certain limits, were $9.2,
$8.8 and $8.2 million for the years ended September 30, 2004, 2003 and 2002, respectively. There are no past



102



---

##### Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



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 $1.2 million, $1.1 million and $861,000 for the years
ended September 30, 2004, 2003 and 2002, 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 $13.3 and $11.2 million at September 30, 2004 and 2003, respectively.



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, 2004, the Bank had recorded a liability totaling $23.2 million. The Banks expense under the deferred compensation plan totaled $7.5, $5.3 and $3.8 million
during the years ended September 30, 2004, 2003 and 2002, respectively.



27.
REGULATORY MATTERS  THE BANK:



The Banks
regulatory capital requirements at September 30, 2004 and 2003 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,
2004 and 2003, the Bank was in compliance with its tangible, core and total risk-based 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.



103



---

##### Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



|                                                     |  |                    |           |   |                            |       |   |                |   |                |  |      |        |  |                |         |  |      |  
|---------------------------------------------------- |  | ------------------ | --------- | - | -------------------------- | ----- | - | -------------- | - | -------------- |  | ---- | ------ |  | -------------- | ------- |  | ---- | -
|                                                     |  | September 30, 2004 |          
|(Dollars in thousands)                               |  | Actual             |           |   | Minimum CapitalRequirement |       |   | Excess Capital |  
|                                                     |  | Amount             |           |   | As a %ofAssets             |       |   | Amount         |   | As a %ofAssets |  |      | Amount |  | As a %ofAssets |        
|Capital per financial statements                     |  | $                  | 711,861   |   |                            |       |   |                |   |                |  |      |        |  |                |         |  |      |  
|Minority interest in REIT                            |  |                    |           |   |                            |       |   |                |   |                |  |      |        |  |                |         |  |      |  
|Subsidiary(1)                                        |  |                    | 144,000   |   |                            |       |   |                |   |                |  |      |        |  |                |         |  |      |  
|                                                     |  |                    |           |   |                            |       |   |                |   |                |  |      |        |  |                |         |  |      |  
|Adjusted capital                                     |  |                    | 855,861   |   |                            |       |   |                |   |                |  |      |        |  |                |         |  |      |  
|Adjustments for tangible and core capital:           |  |                    |           |   |                            |       |   |                |   |                |  |      |        |  |                |         |  |      |  
|Intangible assets                                    |  |                    | (42,372   | ) |                            |       |   |                |   |                |  |      |        |  |                |         |  |      |  
|Non-includable subsidiaries(2)                       |  |                    | (929      | ) |                            |       |   |                |   |                |  |      |        |  |                |         |  |      |  
|Non-qualifying purchased / originated loan servicing |  |                    | (7,048    | ) |                            |       |   |                |   |                |  |      |        |  |                |         |  |      |  
|                                                     |  |                    |           |   |                            |       |   |                |   |                |  |      |        |  |                |         |  |      |  
|Total tangible capital                               |  |                    | 805,512   |   |                            | 6.09  | % |                | $ | 198,556        |  | 1.50 | %      |  | $              | 606,956 |  | 4.59 | %
|                                                     |  |                    |           |   |                            |       |   |                |   |                |  |      |        |  |                |         |  |      |  
|Total core capital(3)                                |  |                    | 805,512   |   |                            | 6.09  | % |                | $ | 529,482        |  | 4.00 | %      |  | $              | 276,030 |  | 2.09 | %
|                                                     |  |                    |           |   |                            |       |   |                |   |                |  |      |        |  |                |         |  |      |  
|Tier 1 risk-based capital(3)                         |  |                    | 805,512   |   |                            | 8.61  | % |                | $ | 374,882        |  | 4.00 | %      |  | $              | 430,630 |  | 4.61 | %
|                                                     |  |                    |           |   |                            |       |   |                |   |                |  |      |        |  |                |         |  |      |  
|Adjustments for total risk-based capital:            |  |                    |           |   |                            |       |   |                |   |                |  |      |        |  |                |         |  |      |  
|Subordinated capital debentures                      |  |                    | 175,000   |   |                            |       |   |                |   |                |  |      |        |  |                |         |  |      |  
|Allowance for general loan losses                    |  |                    | 37,750    |   |                            |       |   |                |   |                |  |      |        |  |                |         |  |      |  
|                                                     |  |                    |           |   |                            |       |   |                |   |                |  |      |        |  |                |         |  |      |  
|Total supplementary capital                          |  |                    | 212,750   |   |                            |       |   |                |   |                |  |      |        |  |                |         |  |      |  
|                                                     |  |                    |           |   |                            |       |   |                |   |                |  |      |        |  |                |         |  |      |  
|Total available capital                              |  |                    | 1,018,262 |   |                            |       |   |                |   |                |  |      |        |  |                |         |  |      |  
|Equity investments(2)(4)                             |  |                    | (2,360    | ) |                            |       |   |                |   |                |  |      |        |  |                |         |  |      |  
|                                                     |  |                    |           |   |                            |       |   |                |   |                |  |      |        |  |                |         |  |      |  
|Total risk-based capital(3)                          |  | $                  | 1,015,902 |   |                            | 10.91 | % |                | $ | 749,764        |  | 8.00 | %      |  | $              | 266,138 |  | 2.91 | %
|                                                     |  |                    |           |   |                            |       |   |                |   |                |  |      |        |  |                |         |  |      |  

---

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



|(2) | Reflects an aggregate offset of $202 representing the allowance for losses maintained against the Banks equity investments and non-includable subsidiaries
which, pursuant to OTS guidelines, is available as a credit against the deductions from capital otherwise required for such investments.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



|(4) | Includes one property classified as real estate held for sale which is treated as an equity investment for regulatory capital purposes.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------



104



---

##### Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



|                                                     |  |                    |         |   |                            |       |   |                |   |                |  |      |        |  |                |         |  |      |  
|---------------------------------------------------- |  | ------------------ | ------- | - | -------------------------- | ----- | - | -------------- | - | -------------- |  | ---- | ------ |  | -------------- | ------- |  | ---- | -
|                                                     |  | September 30, 2003 |        
|(Dollars in thousands)                               |  | Actual             |         |   | Minimum CapitalRequirement |       |   | Excess Capital |  
|                                                     |  | Amount             |         |   | As a %ofAssets             |       |   | Amount         |   | As a %ofAssets |  |      | Amount |  | As a %ofAssets |        
|Capital per financial statements                     |  | $                  | 580,997 |   |                            |       |   |                |   |                |  |      |        |  |                |         |  |      |  
|Minority interest in REIT                            |  |                    |         |   |                            |       |   |                |   |                |  |      |        |  |                |         |  |      |  
|Subsidiary(1)                                        |  |                    | 144,000 |   |                            |       |   |                |   |                |  |      |        |  |                |         |  |      |  
|                                                     |  |                    |         |   |                            |       |   |                |   |                |  |      |        |  |                |         |  |      |  
|Adjusted capital                                     |  |                    | 724,997 |   |                            |       |   |                |   |                |  |      |        |  |                |         |  |      |  
|Adjustments for tangible and core capital:           |  |                    |         |   |                            |       |   |                |   |                |  |      |        |  |                |         |  |      |  
|Intangible assets                                    |  |                    | (42,666 | ) |                            |       |   |                |   |                |  |      |        |  |                |         |  |      |  
|Non-includable subsidiaries(2)                       |  |                    | (939    | ) |                            |       |   |                |   |                |  |      |        |  |                |         |  |      |  
|Non-qualifying purchased / originated loan servicing |  |                    | (5,427  | ) |                            |       |   |                |   |                |  |      |        |  |                |         |  |      |  
|                                                     |  |                    |         |   |                            |       |   |                |   |                |  |      |        |  |                |         |  |      |  
|Total tangible capital                               |  |                    | 675,965 |   |                            | 5.75  | % |                | $ | 176,202        |  | 1.50 | %      |  | $              | 499,763 |  | 4.25 | %
|                                                     |  |                    |         |   |                            |       |   |                |   |                |  |      |        |  |                |         |  |      |  
|Total core capital(3)                                |  |                    | 675,965 |   |                            | 5.75  | % |                | $ | 469,872        |  | 4.00 | %      |  | $              | 206,093 |  | 1.75 | %
|                                                     |  |                    |         |   |                            |       |   |                |   |                |  |      |        |  |                |         |  |      |  
|Tier 1 risk-based capital(3)                         |  |                    | 675,965 |   |                            | 7.67  | % |                | $ | 351,879        |  | 4.00 | %      |  | $              | 324,086 |  | 3.67 | %
|                                                     |  |                    |         |   |                            |       |   |                |   |                |  |      |        |  |                |         |  |      |  
|Adjustments for total risk-based capital:            |  |                    |         |   |                            |       |   |                |   |                |  |      |        |  |                |         |  |      |  
|Subordinated capital debentures                      |  |                    | 250,000 |   |                            |       |   |                |   |                |  |      |        |  |                |         |  |      |  
|Allowance for general loan losses                    |  |                    | 58,397  |   |                            |       |   |                |   |                |  |      |        |  |                |         |  |      |  
|                                                     |  |                    |         |   |                            |       |   |                |   |                |  |      |        |  |                |         |  |      |  
|Total supplementary capital                          |  |                    | 308,397 |   |                            |       |   |                |   |                |  |      |        |  |                |         |  |      |  
|                                                     |  |                    |         |   |                            |       |   |                |   |                |  |      |        |  |                |         |  |      |  
|Total available capital                              |  |                    | 984,362 |   |                            |       |   |                |   |                |  |      |        |  |                |         |  |      |  
|Equity investments(2)(4)                             |  |                    | (24,009 | ) |                            |       |   |                |   |                |  |      |        |  |                |         |  |      |  
|                                                     |  |                    |         |   |                            |       |   |                |   |                |  |      |        |  |                |         |  |      |  
|Total risk-based capital(3)                          |  | $                  | 960,353 |   |                            | 11.05 | % |                | $ | 703,758        |  | 8.00 | %      |  | $              | 256,595 |  | 3.05 | %
|                                                     |  |                    |         |   |                            |       |   |                |   |                |  |      |        |  |                |         |  |      |  

---

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



|(2) | Reflects an aggregate offset of $202 representing the allowance for losses maintained against the Banks equity investments and non-includable subsidiaries
which, pursuant to OTS guidelines, is available as a credit against the deductions from capital otherwise required for such investments.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



|(4) | Includes two properties treated as equity investments for regulatory capital purposes. One property has a book value of $2,053 and is classified as real estate held
for sale. The other property has a book value of $21,956 and is classified as property and equipment.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



105



---

##### Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



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 April 2004, the Bank received from the OTS an extension of the holding periods for certain of its REO properties through April 7, 2005.



The following table sets forth the Banks REO at September 30, 2004, by
the fiscal year in which the property was acquired through foreclosure.



|            |  |                |        |    
|----------- |  | -------------- | ------ | ---
|Fiscal Year |  | (In thousands) |       
|1990        |  | $              | 2,360  | (1)
|1991        |  |                | 11,380 | (2)
|1995        |  |                | 4,948  | (2)
|2003        |  |                | 57     |    
|2004        |  |                | 1,612  |    
|            |  |                |        |    
|Total REO   |  | $              | 20,357 |    
|            |  |                |        |    

---

|(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 April 7, 2005.
|--- | -------------------------------------------------------------------------------------------------



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 for the year ended September 30, 2004 is as follows:



|                            |  |                |        |  
|--------------------------- |  | -------------- | ------ | -
|                            |  | (In thousands) |       
|Balance September 30, 2003  |  | $              | 16,990 |  
|Additions                   |  |                | 3,847  |  
|Reductions                  |  |                | (1,666 | )
|                            |  |                |        |  
|Balance, September 30, 2004 |  | $              | 19,171 |  
|                            |  |                |        |  



Services:



B.F. Saul Company, which is a shareholder of the Trust, and its subsidiaries
provide certain services to the Bank. These services include property management, insurance brokerage and leasing. Fees for these services were $2.4 million, $4.7 million and $775,000 for the years ended September 30, 2004, 2003 and 2002,
respectively.



For each of the years ended September 30, 2004,
2003 and 2002, 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. A fourth director of the Bank was paid $50,000 for consulting services rendered to the Bank for the year ended September 30, 2002.



106



---

##### Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



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 paid $8.8, $11.5 and $5.7 million to the Trust during fiscal 2004, 2003 and 2002, respectively, under the Tax Sharing Agreement.



Other:



The Bank paid $9.0, $9.3 and $9.2 million for office space leased from or managed by companies affiliated with the Bank or its directors during the years
ended September 30, 2004, 2003 and 2002, 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 totaled $65.8 and $40.6 million at
September 30, 2004 and 2003, respectively. The Bank paid interest on the accounts amounting to $436,000, $342,000 and $504,000 during fiscal years ended 2004, 2003 and 2002, respectively.



29. FINANCIAL INSTRUMENTS  THE BANK:



The Bank, in the normal course of business, is a party to financial instruments with off-balance-sheet risk and other derivative financial instruments
to meet the financing needs of its customers and to reduce its own exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit at both fixed and variable rates, letters of credit, interest-rate cap
agreements 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 Balance
Sheets.



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 cap agreements, assets sold with limited recourse and forward purchase and sale commitments, the contract 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 approximately $3.1 billion of commitments to extend credit at
September 30, 2004. 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, 2004, the Bank had issued standby letters of credit in the amount of $105.4 million to guarantee the
performance of and irrevocably assure payment by customers under construction projects. Of the total, $54.3 million will expire in fiscal 2005 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. At September 30, 2004, the Bank holds mortgage-backed securities with a book value of $74.3 million that have been pledged as collateral for
certain of these letters of credit.



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 recourse provisions, the Bank maintained restricted cash accounts and overcollateralization of receivables amounting to $19.0
and $1.5 million, respectively, at September 30, 2004, and $19.0 and $4.7 million, respectively, at September 30, 2003, both of which are included in other assets in the Consolidated Balance Sheets.



107



---

##### Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



The Bank is also obligated under various recourse provisions related to the swap of single-family
residential loans for mortgage-backed securities issued by the Bank. At September 30, 2004, recourse to the Bank under these arrangements was $3.8 million, consisting of restricted cash accounts of $2.0 million and overcollateralization of
receivables of $1.8 million. At September 30, 2003, recourse to the Bank under these arrangements was $4.7 million, consisting of restricted cash accounts of $2.7 million and overcollateralization of receivables of $1.9 million.



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 $4.0 and $3.4 million at September 30, 2004 and 2003, 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 Balance Sheets.



During fiscal 2004, the Bank discontinued hedging the change in fair value of its mortgage servicing rights.



During fiscal 2003, the Bank hedged the change in fair value of its mortgage
servicing rights related to changes in the benchmark Treasury rate using treasury futures and options. At September 30, 2003, mortgage servicing rights with a fair value of $2.1 million were hedged.



At September 30, 2003, the Bank owned treasury futures contracts representing
a notional amount of $9.2 million and fair value of $550,000, call options on the treasury futures contracts representing a notional amount of $7.5 million and fair value of $240,000 and put options on treasury futures contracts representing a
notional amount of $9.5 million and fair value of $170,000 related to its mortgage servicing rights fair value hedges. The net gain on derivative instruments and related hedged items for the year ended September 30, 2003 was $3.2 million and is
reflected as a reduction of servicing assets amortization and other loan expenses in the Consolidated Statements of Operations and Comprehensive Income.



At September 30, 2004, the Bank had certain 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 $1.1 million at September 30, 2004. The net unrealized gain in the value of the related hedged item was $1.2 million. The net unrealized gains and losses are included in other income in the
Consolidated Statement of Operations and Comprehensive Income. Hedge ineffectiveness during the year ended September 30, 2004 was $75,000.



At September 30, 2003, the Bank had certain 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 $12.7 million at September 30, 2003. The net unrealized loss in the value of the related hedged item was $1.4 million. The net unrealized losses are included in other income in the Consolidated
Statement of Operations and Comprehensive Income. Hedge ineffectiveness during the year ended September 30, 2003 was $544,000.



Cash Flow Hedges For derivatives designated as cash flow hedges, mark to market adjustments are recorded as a component of equity. At
September 30, 2004 and 2003, 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 and Comprehensive Income. The derivatives fair values are included in other assets in the Consolidated Balance Sheets.



At September 30, 2004, the Bank had $61.0 million in forward sale
commitments. The net unrealized loss in the value of these commitments was $30,000 at September 30, 2004. At September 30, 2004, the Bank had interest rate locks (IRLs) with a notional amount of $101.4 million. The net unrealized gain in
the value of the IRLs was $27,000.



At September 30, 2003, the
Bank had $66.8 million in forward sale commitments. The net unrealized loss in the value of these commitments was $887,000 at September 30, 2003. At September 30, 2003, the Bank had IRLs with a notional amount of $147.0 million. The net unrealized
gain in the value of the IRLs was $830,000.



108



---

##### Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



Concentrations of Credit:



The Banks principal market is the metropolitan Washington, DC area. In addition, a significant portion of the
Banks residential mortgage loans are secured by properties in California. Service industries and federal, state and local governments employ a significant portion of the Washington, DC area labor force. Adverse changes in economic conditions
in these areas could have a direct impact on the timing and amount of payments by borrowers.



30. ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS  THE BANK:



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



The estimated fair values of the Banks financial instruments are as follows:



|                                                                                                                        |  |                |           |      |           |   |                |  |   |            |     |  |   |          
|----------------------------------------------------------------------------------------------------------------------- |  | -------------- | --------- | ---- | --------- | - | -------------- |  | - | ---------- | --- |  | - | ---------
|                                                                                                                        |  | September 30, 
|                                                                                                                        |  | 2004           |           | 2003
|(In thousands)                                                                                                          |  | CarryingAmount |           |      | FairValue |   | CarryingAmount |  |   | Fair Value
|Financial assets:                                                                                                       |  |                |           |      |           |   |                |  |   |            |     |  |   |          
|Cash, due from banks, interest-bearing deposits, federal funds sold and securities purchased under agreements to resell |  | $              | 542,548   |      |           | $ | 542,548        |  | $ | 414,627    |     |  | $ | 414,627  
|                                                                                                                        |  |                |           |     
|Loans held for securitization and/or sale                                                                               |  |                | 1,965,476 |      |           |   | 2,036,520      |  |   | 1,378,831  |     |  |   | 1,393,191
|U.S. Government securities                                                                                              |  |                | 71,192    |      |           |   | 70,905         |  |   | 46,345     |     |  |   | 46,531   
|Mortgage-backed securities                                                                                              |  |                | 409,303   |      |           |   | 415,503        |  |   | 478,392    |     |  |   | 490,764  
|Loans receivable, net                                                                                                   |  |                | 8,555,557 |      |           |   | 8,723,302      |  |   | 7,559,557  |     |  |   | 7,683,109
|Other financial assets                                                                                                  |  |                | 456,884   |      |           |   | 456,884        |  |   | 278,903    |     |  |   | 278,903  
|                                                                                                                        |  |                |           |     
|Financial liabilities:                                                                                                  |  |                |           |      |           |   |                |  |   |            |     |  |   |          
|Deposit accounts with no stated maturities                                                                              |  |                | 7,005,521 |      |           |   | 7,005,521      |  |   | 6,374,739  |     |  |   | 6,374,739
|Deposit accounts with stated maturities                                                                                 |  |                | 1,849,597 |      |           |   | 1,866,692      |  |   | 1,725,766  |     |  |   | 1,749,968
|Securities sold under repurchase agreements and other short-term borrowings and Federal Home Loan Bank advances         |  |                | 2,943,517 |      |           |   | 2,954,544      |  |   | 2,155,783  |     |  |   | 2,214,470
|Capital notes-subordinated                                                                                              |  |                | 171,489   | (1)  |           |   | 171,500        |  |   | 245,831    | (1) |  |   | 248,125  
|Other financial liabilities                                                                                             |  |                | 182,891   |      |           |   | 182,891        |  |   | 242,976    |     |  |   | 242,976  

---

|(1) | Net of deferred debt issuance costs which are included in other assets in the Consolidated Balance Sheets.
|--- | ----------------------------------------------------------------------------------------------------------



109



---

##### Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



The following methods and assumptions were used to estimate the fair value amounts at September 30,
2004 and 2003:



Cash, due from banks, interest-bearing
deposits, federal funds sold and securities purchased under agreements to resell: 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.



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.



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 approximates fair value. Interest-only strips receivable and 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, notes payable and other short-term payables approximates fair value.



110



---

##### Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



31. BUSINESS SEGMENTS  THE BANK:



The Bank has three operating segments: retail banking, commercial banking, and non-banking 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.



Selected segment information is as follows:



|                              |  |               |            |   |          |   |           |       |  |   |            |  
|----------------------------- |  | ------------- | ---------- | - | -------- | - | --------- | ----- |  | - | ---------- | -
|(in thousands)                |  | RetailBanking |            |   | Other(1) |   |           | Total | 
|Year ended September 30, 2004 |  |               |            |   |          |   |           |       |  |   |            |  
|Operating income              |  | $             | 762,495    |   |          | $ | 51,585    |       |  | $ | 814,080    |  
|Operating expense             |  |               | 557,650    |   |          |   | 44,028    |       |  |   | 601,678    |  
|                              |  |               |            |   |          |   |           |       |  |   |            |  
|Core earnings                 |  |               | 204,845    |   |          |   | 7,557     |       |  |   | 212,402    |  
|Non-core items                |  |               | 11,680     |   |          |   | 7,133     |       |  |   | 18,813     |  
|                              |  |               |            |   |          |   |           |       |  |   |            |  
|Operating income              |  | $             | 216,525    |   |          | $ | 14,690    |       |  | $ | 231,215    |  
|                              |  |               |            |   |          |   |           |       |  |   |            |  
|Average assets                |  | $             | 11,625,320 |   |          | $ | 1,195,111 |       |  | $ | 12,820,431 |  
|                              |  |               |            |   |          |   |           |       |  |   |            |  
|                              |  |               |           
|Year ended September 30, 2003 |  |               |            |   |          |   |           |       |  |   |            |  
|Operating income              |  | $             | 718,471    |   |          | $ | 48,152    |       |  | $ | 766,623    |  
|Operating expense             |  |               | 581,487    |   |          |   | 41,884    |       |  |   | 623,371    |  
|                              |  |               |            |   |          |   |           |       |  |   |            |  
|Core earnings                 |  |               | 136,984    |   |          |   | 6,268     |       |  |   | 143,252    |  
|Non-core items                |  |               | (456       | ) |          |   | 3,394     |       |  |   | 2,938      |  
|                              |  |               |            |   |          |   |           |       |  |   |            |  
|Operating income              |  | $             | 136,528    |   |          | $ | 9,662     |       |  | $ | 146,190    |  
|                              |  |               |            |   |          |   |           |       |  |   |            |  
|Average assets                |  | $             | 10,658,508 |   |          | $ | 1,147,447 |       |  | $ | 11,805,955 |  
|                              |  |               |            |   |          |   |           |       |  |   |            |  
|                              |  |               |           
|Year ended September 30, 2002 |  |               |            |   |          |   |           |       |  |   |            |  
|Operating income              |  | $             | 690,170    |   |          | $ | 44,584    |       |  | $ | 734,754    |  
|Operating expense             |  |               | 564,986    |   |          |   | 40,515    |       |  |   | 605,501    |  
|                              |  |               |            |   |          |   |           |       |  |   |            |  
|Core earnings                 |  |               | 125,184    |   |          |   | 4,069     |       |  |   | 129,253    |  
|Non-core items                |  |               | (15,259    | ) |          |   | (10,412   | )     |  |   | (25,671    | )
|                              |  |               |            |   |          |   |           |       |  |   |            |  
|Net income (loss)             |  | $             | 109,925    |   |          | $ | (6,343    | )     |  | $ | 103,582    |  
|                              |  |               |            |   |          |   |           |       |  |   |            |  
|Average assets                |  | $             | 10,019,353 |   |          | $ | 1,075,463 |       |  | $ | 11,094,816 |  
|                              |  |               |            |   |          |   |           |       |  |   |            |  

---

|(1) | Includes commercial banking and non-banking services.
|--- | -----------------------------------------------------



111



---

##### Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



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



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 these suits 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.



33. MINORITY INTERESTTHE TRUST:



At September 30, 2004 and 2003, minority interest held by affiliates of
$114.9 and $98.1 million represent the 20% minority interest in the banks common shares.



Minority interest  other consists of the following:



|                                                 |  |               |         |      |   |        
|------------------------------------------------ |  | ------------- | ------- | ---- | - | -------
|                                                 |  | September 30,
|(In thousands)                                   |  | 2004          |         | 2003
|Preferred Stock of Chevy Chases REIT subsidiary |  | $             | 144,000 |      | $ | 144,000
|Chevy Chases Preferred Stock (See Note 25)      |  |               | 120,622 |      |   | 74,307 
|Chevy Chases ground lease (See below)           |  |               | 31,391  |      |   | 31,391 
|                                                 |  |               |         |      |   |        
|Total minority interestother                    |  | $             | 296,013 |      | $ | 249,698
|                                                 |  |               |         |      |   |        



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, 2004:



|                          |  |                |        
|------------------------- |  | -------------- | -------
|Year Ending September 30, |  | (In thousands)
|2005                      |  | $              | 3,509  
|2006                      |  |                | 3,579  
|2007                      |  |                | 3,650  
|2008                      |  |                | 3,723  
|2009                      |  |                | 3,798  
|Thereafter                |  |                | 272,854
|                          |  |                |        
|Total                     |  | $              | 291,113
|                          |  |                |        



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.



Effective
July 1, 2003, the Bank adopted FIN 46. FIN 46 requires companies to identify variable interest entities and consolidate them if it is determined that the company is the primary beneficiary of the variable interest entity. Pursuant to FIN 46, 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, 2004 and 2003 related to the Banks involvement
with the LLC. See Note 3.



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 $5,000 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 $50,000 plus accrued and unpaid dividends. Except under certain limited circumstances, the



112



---

##### Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



holders of the REIT Preferred Stock 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:



|                                                             |  |                 |       
|------------------------------------------------------------ |  | --------------- | ------
|                                                             |  | (In Thousands) 
|If redeemed during the 12-month
period beginning January 15, |  | RedemptionPrice
|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.



34. 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, 2004, 2003 and 2002, consist of the following:



|                                                                                     |  |                          |         |   |      |   |        |  |   |       
|------------------------------------------------------------------------------------ |  | ------------------------ | ------- | - | ---- | - | ------ |  | - | ------
|                                                                                     |  | Year Ended September 30,
|(In thousands)                                                                       |  | 2004                     |         |   | 2003 |   | 2002  
|Current provision (benefit):                                                         |  |                          |         |   |      |   |        |  |   |       
|Federal                                                                              |  | $                        | 114,214 |   |      | $ | 1,257  |  | $ | 100   
|State                                                                                |  |                          | 6,389   |   |      |   | 2,809  |  |   | 1,563 
|                                                                                     |  |                          |         |   |      |   |        |  |   |       
|                                                                                     |  |                          | 120,603 |   |      |   | 4,066  |  |   | 1,663 
|                                                                                     |  |                          |         |   |      |   |        |  |   |       
|Deferred provision (benefit):                                                        |  |                          |         |   |      |   |        |  |   |       
|Federal                                                                              |  |                          | (55,982 | ) |      |   | 35,936 |  |   | 19,385
|State                                                                                |  |                          | 5,258   |   |      |   | 6,219  |  |   | 2,095 
|                                                                                     |  |                          |         |   |      |   |        |  |   |       
|                                                                                     |  |                          | (50,724 | ) |      |   | 42,155 |  |   | 21,480
|                                                                                     |  |                          |         |   |      |   |        |  |   |       
|Total                                                                                |  | $                        | 69,879  |   |      | $ | 46,221 |  | $ | 23,143
|                                                                                     |  |                          |         |   |      |   |        |  |   |       
|Tax effect of other items:                                                           |  |                          |         |   |      |   |        |  |   |       
|Tax effect of other equity transactions                                              |  | $                        | 1,120   |   |      | $ | 1,894  |  | $ | 757   
|Tax effect of net unrealized holding gains (losses) reported in stockholders equity |  |                          |        |   |      |   |       |  |   | 1,365 
|                                                                                     |  |                          |         |   |      |   |        |  |   |       
|Total                                                                                |  | $                        | 1,120   |   |      | $ | 1,894  |  | $ | 2,122 
|                                                                                     |  |                          |         |   |      |   |        |  |   |       



113



---

##### Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



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)                                                                       |  | 2004                     |        |   | 2003 |   |        | 2002 | 
|Computed tax at statutory Federal income tax rate                                    |  | $                        | 72,396 |   |      | $ | 45,657 |      |  | $ | 29,412 |  
|Increase (reduction) in taxes resulting from:                                        |  |                          |        |   |      |   |        |      |  |   |        |  
|Minority interest                                                                    |  |                          | (6,651 | ) |      |   | (5,447 | )    |  |   | (5,447 | )
|Goodwill and other purchase accounting adjustments                                   |  |                          |       |   |      |   |       |      |  |   | 70     |  
|Change in valuation allowance for deferred tax asset allocated to income tax expense |  |                          | (707   | ) |      |   | 169    |      |  |   | (923   | )
|State income taxes                                                                   |  |                          | 7,573  |   |      |   | 5,863  |      |  |   | 3,314  |  
|Tax credits                                                                          |  |                          | (1,316 | ) |      |   | (977   | )    |  |   | (1,583 | )
|Other                                                                                |  |                          | (1,416 | ) |      |   | 956    |      |  |   | (1,700 | )
|                                                                                     |  |                          |        |   |      |   |        |      |  |   |        |  
|                                                                                     |  | $                        | 69,879 |   |      | $ | 46,221 |      |  | $ | 23,143 |  
|                                                                                     |  |                          |        |   |      |   |        |      |  |   |        |  



114



---

##### Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



The components of the net deferred tax asset (liability) were as follows:



|                                               |  |               |          |   |      |   |          |  
|---------------------------------------------- |  | ------------- | -------- | - | ---- | - | -------- | -
|                                               |  | September 30, |         
|(In thousands)                                 |  | 2004          |          |   | 2003 |  
|Deferred tax assets:                           |  |               |          |   |      |   |          |  
|Unrealized gains on loans and investments, net |  | $             | 30,061   |   |      | $ | 21,606   |  
|State net operating loss carry forwards        |  |               | 27,267   |   |      |   | 38,974   |  
|Allowance for loan and real estate losses      |  |               | 22,285   |   |      |   | 24,519   |  
|Deferred compensation                          |  |               | 15,740   |   |      |   | 13,942   |  
|Other                                          |  |               | 12,189   |   |      |   | 9,618    |  
|                                               |  |               |          |   |      |   |          |  
|Gross deferred tax assets                      |  |               | 107,542  |   |      |   | 108,659  |  
|                                               |  |               |          |   |      |   |          |  
|Deferred tax liabilities:                      |  |               |          |   |      |   |          |  
|Automobile leasing                             |  |               | 94,750   |   |      |   | 161,806  |  
|Saul Holdings and Saul Centers                 |  |               | 46,771   |   |      |   | 46,145   |  
|Originated servicing rights                    |  |               | 38,094   |   |      |   | 20,097   |  
|Property and depreciation                      |  |               | 16,611   |   |      |   | 23,582   |  
|Deferred expenses and other                    |  |               | 23,518   |   |      |   | 19,893   |  
|                                               |  |               |          |   |      |   |          |  
|Gross deferred tax liabilities                 |  |               | 219,744  |   |      |   | 271,523  |  
|                                               |  |               |          |   |      |   |          |  
|                                               |  |               | (112,202 | ) |      |   | (162,864 | )
|Valuation allowance                            |  |               | (10,300  | ) |      |   | (9,240   | )
|                                               |  |               |          |   |      |   |          |  
|Net deferred tax liability                     |  | $             | (122,502 | ) |      | $ | (172,104 | )
|                                               |  |               |          |   |      |   |          |  



At September 30, 2004,
the Real Estate Trust and the Bank had state net operating loss carryovers totaling approximately $304.8 million and 247.2 million, respectively. The state net operating loss carryovers will expire in the years 2005 through 2024.



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 year 2004, the Bank determined it will be
able to fully utilize its state net operating loss carryforwards and, as a result, the valuation allowance of $707,000 was eliminated. 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.



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 $8.8, $11.5 and $5.7 million, to the Trust during fiscal 2004, 2003 and 2002.



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 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 income tax return of the group.



115



---

##### Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



35. 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 $11.6, $12.0 and $12.0 million per year in fiscal 2004, 2003 and 2002, respectively. At September 30, 2004 there were no dividends in arrears on the preferred shares. At September 30, 2003, and 2002,
the amount of dividends in arrears on the preferred shares was $6.1 million ($11.90 per share) and $12.7 million ($24.65 per share), respectively.



36. 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)                                                              |  | 2004                    |         |   | 2003 |   |         | 2002 | 
|INCOME (from continuing operations)                                         |  |                         |         |   |      |   |         |      |  |   |         |  
|Hotels                                                                      |  | $                       | 96,402  |   |      | $ | 85,107  |      |  | $ | 85,235  |  
|Office and industrial properties                                            |  |                         | 38,225  |   |      |   | 39,121  |      |  |   | 38,923  |  
|Other                                                                       |  |                         | 1,629   |   |      |   | 1,300   |      |  |   | 1,452   |  
|                                                                            |  |                         |         |   |      |   |         |      |  |   |         |  
|                                                                            |  | $                       | 136,256 |   |      | $ | 125,528 |      |  | $ | 125,610 |  
|                                                                            |  |                         |         |   |      |   |         |      |  |   |         |  
|OPERATING PROFIT (LOSS) (from continuing operations)(1)                     |  |                         |         |   |      |   |         |      |  |   |         |  
|Hotels                                                                      |  | $                       | 21,879  |   |      | $ | 15,514  |      |  | $ | 16,182  |  
|Office and industrial properties                                            |  |                         | 19,558  |   |      |   | 20,688  |      |  |   | 21,011  |  
|Other                                                                       |  |                         | 265     |   |      |   | 94      |      |  |   | 289     |  
|                                                                            |  |                         |         |   |      |   |         |      |  |   |         |  
|                                                                            |  |                         | 41,702  |   |      |   | 36,296  |      |  |   | 37,482  |  
|Equity earnings of unconsolidated entities                                  |  |                         | 7,788   |   |      |   | 7,248   |      |  |   | 8,811   |  
|Impairment loss on investments                                              |  |                         |        |   |      |   | (998    | )    |  |   | (188    | )
|Gain on sales of property                                                   |  |                         | 2,769   |   |      |   | 9,079   |      |  |   |        |  
|Interest and amortization of debt expense                                   |  |                         | (60,130 | ) |      |   | (50,529 | )    |  |   | (50,430 | )
|Advisory fee, management and leasing fees  related parties                 |  |                         | (13,048 | ) |      |   | (12,301 | )    |  |   | (12,313 | )
|General and administrative                                                  |  |                         | (2,443  | ) |      |   | (2,823  | )    |  |   | (2,279  | )
|                                                                            |  |                         |         |   |      |   |         |      |  |   |         |  
|Operating loss from continuing operations                                   |  | $                       | (23,362 | ) |      | $ | (14,028 | )    |  | $ | (18,917 | )
|                                                                            |  |                         |         |   |      |   |         |      |  |   |         |  
|IDENTIFIABLE ASSETS (AT YEAR END)                                           |  |                         |         |   |      |   |         |      |  |   |         |  
|Hotels                                                                      |  | $                       | 175,699 |   |      | $ | 172,662 |      |  | $ | 177,294 |  
|Office and industrial properties                                            |  |                         | 124,966 |   |      |   | 126,102 |      |  |   | 128,917 |  
|Other                                                                       |  |                         | 157,504 |   |      |   | 130,521 |      |  |   | 131,303 |  
|                                                                            |  |                         |         |   |      |   |         |      |  |   |         |  
|                                                                            |  | $                       | 458,169 |   |      | $ | 429,285 |      |  | $ | 437,514 |  
|                                                                            |  |                         |         |   |      |   |         |      |  |   |         |  
|INTEREST AND AMORTIZATION OF DEBT EXPENSE (from continuing operations)      |  |                         |         |   |      |   |         |      |  |   |         |  
|Hotels                                                                      |  | $                       | 12,485  |   |      | $ | 12,317  |      |  | $ | 12,725  |  
|Office and industrial properties                                            |  |                         | 12,512  |   |      |   | 12,906  |      |  |   | 12,904  |  
|Other                                                                       |  |                         | 35,133  |   |      |   | 25,306  |      |  |   | 24,801  |  
|                                                                            |  |                         |         |   |      |   |         |      |  |   |         |  
|                                                                            |  | $                       | 60,130  |   |      | $ | 50,529  |      |  | $ | 50,430  |  
|                                                                            |  |                         |         |   |      |   |         |      |  |   |         |  
|DEPRECIATION (from continuing operations)                                   |  |                         |         |   |      |   |         |      |  |   |         |  
|Hotels                                                                      |  | $                       | 11,921  |   |      | $ | 11,987  |      |  | $ | 12,408  |  
|Office and industrial properties                                            |  |                         | 6,862   |   |      |   | 6,949   |      |  |   | 6,319   |  
|Other                                                                       |  |                         | 23      |   |      |   | 23      |      |  |   | 23      |  
|                                                                            |  |                         |         |   |      |   |         |      |  |   |         |  
|                                                                            |  | $                       | 18,806  |   |      | $ | 18,959  |      |  | $ | 18,750  |  
|                                                                            |  |                         |         |   |      |   |         |      |  |   |         |  
|CAPITAL EXPENDITURES AND PROPERTY ACQUISITIONS (from continuing operations) |  |                         |         |   |      |   |         |      |  |   |         |  
|Hotels                                                                      |  | $                       | 12,833  |   |      | $ | 5,368   |      |  | $ | 1,891   |  
|Office and industrial properties                                            |  |                         | 4,782   |   |      |   | 3,956   |      |  |   | 6,284   |  
|Other                                                                       |  |                         | 247     |   |      |   | 414     |      |  |   | 487     |  
|                                                                            |  |                         |         |   |      |   |         |      |  |   |         |  
|                                                                            |  | $                       | 17,862  |   |      | $ | 9,738   |      |  | $ | 8,662   |  
|                                                                            |  |                         |         |   |      |   |         |      |  |   |         |  



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



116



---

##### Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



37. 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)                                                      |  | 2004         |          |   | 2003 |  
|ASSETS                                                              |  |              |          |   |      |   |          |  
|Income-producing properties                                         |  | $            | 451,277  |   |      | $ | 435,154  |  
|Accumulated depreciation                                            |  |              | (180,075 | ) |      |   | (162,685 | )
|                                                                    |  |              |          |   |      |   |          |  
|                                                                    |  |              | 271,202  |   |      |   | 272,469  |  
|Land parcels                                                        |  |              | 41,722   |   |      |   | 42,425   |  
|Real estate held for sale - net of depreciation                     |  |              | 2,090    |   |      |   | 2,536    |  
|Equity investment in bank                                           |  |              | 459,897  |   |      |   | 392,418  |  
|Cash and cash equivalents                                           |  |              | 31,842   |   |      |   | 18,979   |  
|Note receivable and accrued interest - related party                |  |              | 7,677    |   |      |   | 2,987    |  
|Other assets                                                        |  |              | 103,473  |   |      |   | 89,726   |  
|                                                                    |  |              |          |   |      |   |          |  
|TOTAL ASSETS                                                        |  | $            | 917,903  |   |      | $ | 821,540  |  
|                                                                    |  |              |          |   |      |   |          |  
|LIABILITIES                                                         |  |              |          |   |      |   |          |  
|Mortgage notes payable                                              |  | $            | 307,245  |   |      | $ | 318,265  |  
|Mortgage notes payable - real estate held for sale                  |  |              | 4,071    |   |      |   | 4,172    |  
|Notes payable  secured                                             |  |              | 250,000  |   |      |   | 203,800  |  
|Notes payable  unsecured                                           |  |              | 56,428   |   |      |   | 55,349   |  
|Accrued dividends payable - preferred shares of beneficial interest |  |              |         |   |      |   | 6,139    |  
|Other liabilities and accrued expenses                              |  |              | 58,557   |   |      |   | 65,131   |  
|                                                                    |  |              |          |   |      |   |          |  
|Total liabilities                                                   |  |              | 676,301  |   |      |   | 652,856  |  
|                                                                    |  |              |          |   |      |   |          |  
|TOTAL SHAREHOLDERS EQUITY                                          |  |              | 241,602  |   |      |   | 168,684  |  
|                                                                    |  |              |          |   |      |   |          |  
|TOTAL LIABILITIES AND SHAREHOLDERS EQUITY                          |  | $            | 917,903  |   |      | $ | 821,540  |  
|                                                                    |  |              |          |   |      |   |          |  

---

|* | See Consolidated Statements of Shareholders Equity
|- | ---------------------------------------------------



CONDENSED STATEMENTS OF OPERATIONS



|                                                               |  |                                 |          |   |      |   |          |      |  |   |          |  
|-------------------------------------------------------------- |  | ------------------------------- | -------- | - | ---- | - | -------- | ---- |  | - | -------- | -
|                                                               |  | For the Year Ended September 30 |         
|(In thousands)                                                 |  | 2004                            |          |   | 2003 |   |          | 2002 | 
|Total income                                                   |  | $                               | 136,256  |   |      | $ | 125,528  |      |  | $ | 125,610  |  
|Total expenses                                                 |  |                                 | (170,175 | ) |      |   | (154,885 | )    |  |   | (153,150 | )
|Equity in earnings of unconsolidated entities, net             |  |                                 | 7,788    |   |      |   | 7,248    |      |  |   | 8,811    |  
|Gain on sales of property                                      |  |                                 | 2,769    |   |      |   | 9,079    |      |  |   |         |  
|Impairment loss on investments                                 |  |                                 |         |   |      |   | (998     | )    |  |   | (188     | )
|                                                               |  |                                 |          |   |      |   |          |      |  |   |          |  
|Real estate operating income (loss) from continuing operations |  |                                 | (23,362  | ) |      |   | (14,028  | )    |  |   | (18,917  | )
|Equity in earnings of bank                                     |  |                                 | 92,280   |   |      |   | 55,702   |      |  |   | 38,684   |  
|                                                               |  |                                 |          |   |      |   |          |      |  |   |          |  
|Total company operating income                                 |  |                                 | 68,918   |   |      |   | 41,674   |      |  |   | 19,767   |  
|Income tax benefit (provision)                                 |  |                                 | 8,438    |   |      |   | 4,776    |      |  |   | 6,550    |  
|Discontinued operations-net of income tax benefit              |  |                                 | (656     | ) |      |   | (563     | )    |  |   | (410     | )
|                                                               |  |                                 |          |   |      |   |          |      |  |   |          |  
|TOTAL COMPANY NET INCOME                                       |  | $                               | 76,700   |   |      | $ | 45,887   |      |  | $ | 25,907   |  
|                                                               |  |                                 |          |   |      |   |          |      |  |   |          |  



117



---

##### Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



CONDENSED STATEMENTS OF CASH FLOWS



|                                                                                  |  |                                 |          |   |      |   |         |      |  |   |         |  
|--------------------------------------------------------------------------------- |  | ------------------------------- | -------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                                                  |  | For the Year Ended September 30 |         
|(In thousands)                                                                    |  | 2004                            |          |   | 2003 |   |         | 2002 | 
|CASH FLOWS FROM OPERATING ACTIVITIES                                              |  |                                 |          |   |      |   |         |      |  |   |         |  
|Net income                                                                        |  | $                               | 76,700   |   |      | $ | 45,887  |      |  | $ | 25,907  |  
|Adjustments to reconcile net income to net cash provided by operating activities: |  |                                 |          |   |      |   |         |      |  |   |         |  
|Depreciation                                                                      |  |                                 | 19,053   |   |      |   | 19,330  |      |  |   | 19,147  |  
|Amortization of debt expense                                                      |  |                                 | 4,507    |   |      |   | 2,028   |      |  |   | 1,847   |  
|Equity in earnings of bank                                                        |  |                                 | (92,280  | ) |      |   | (55,702 | )    |  |   | (38,684 | )
|Equity in earnings of unconsolidated entities, net                                |  |                                 | (7,788   | ) |      |   | (7,248  | )    |  |   | (8,811  | )
|Impairment loss on investments                                                    |  |                                 |         |   |      |   | 998     |      |  |   | 188     |  
|Gain on sale of property                                                          |  |                                 | (2,769   | ) |      |   | (9,079  | )    |  |   |        |  
|Loss on disposal of discontinued real estate asset                                |  |                                 | 310      |   |      |   |        |      |  |   |        |  
|Deferred taxes                                                                    |  |                                 | (1,123   | ) |      |   | (657    | )    |  |   | 2,637   |  
|Increase in accounts receivable and accrued income                                |  |                                 | (10,766  | ) |      |   | (3,346  | )    |  |   | (12,150 | )
|Increase (decrease) in accounts payable and accrued expenses                      |  |                                 | (6,023   | ) |      |   | (3,465  | )    |  |   | 1,425   |  
|Dividends and tax sharing payments                                                |  |                                 | 33,611   |   |      |   | 27,460  |      |  |   | 21,667  |  
|Other                                                                             |  |                                 | (1,725   | ) |      |   | (2,435  | )    |  |   | (2,245  | )
|                                                                                  |  |                                 |          |   |      |   |         |      |  |   |         |  
|Net cash provided by operating activities                                         |  |                                 | 11,707   |   |      |   | 13,771  |      |  |   | 10,928  |  
|                                                                                  |  |                                 |          |   |      |   |         |      |  |   |         |  
|CASH FLOWS FROM INVESTING ACTIVITIES                                              |  |                                 |          |   |      |   |         |      |  |   |         |  
|Capital expendituresproperties                                                   |  |                                 | (17,973  | ) |      |   | (9,855  | )    |  |   | (8,758  | )
|Property sales                                                                    |  |                                 | 3,719    |   |      |   | 11,306  |      |  |   | 9,650   |  
|Note receivable and accrued interest - Related party repayments                   |  |                                 | 750      |   |      |   | 3,500   |      |  |   | 1,300   |  
|Note receivable and accrued interest - Related party advances                     |  |                                 | (5,440   | ) |      |   |        |      |  |   |        |  
|Equity investment in unconsolidated entities                                      |  |                                 | 3,220    |   |      |   | 4,213   |      |  |   | 3,508   |  
|Other investments                                                                 |  |                                 | (800     | ) |      |   | (1,864  | )    |  |   | (3,271  | )
|Other                                                                             |  |                                 |         |   |      |   |        |      |  |   | (239    | )
|                                                                                  |  |                                 |          |   |      |   |         |      |  |   |         |  
|Net cash provided by (used in) investing activities                               |  |                                 | (16,524  | ) |      |   | 7,300   |      |  |   | 2,190   |  
|                                                                                  |  |                                 |          |   |      |   |         |      |  |   |         |  
|CASH FLOWS FROM FINANCING ACTIVITIES                                              |  |                                 |          |   |      |   |         |      |  |   |         |  
|Proceeds from mortgage financing                                                  |  |                                 |         |   |      |   | 46,000  |      |  |   | 14,562  |  
|Principal curtailments and repayments of mortgages                                |  |                                 | (9,923   | ) |      |   | (48,600 | )    |  |   | (18,261 | )
|Proceeds from secured note financings                                             |  |                                 | 9,000    |   |      |   | 25,050  |      |  |   | 1,750   |  
|Repayments of secured note financings                                             |  |                                 | (12,800  | ) |      |   | (23,000 | )    |  |   | (2,500  | )
|Proceeds from sales of unsecured notes                                            |  |                                 | 6,877    |   |      |   | 5,539   |      |  |   | 7,601   |  
|Repayments of unsecured notes                                                     |  |                                 | (5,798   | ) |      |   | (5,346  | )    |  |   | (3,162  | )
|Senior secured notes  proceeds                                                   |  |                                 | 250,000  |   |      |   |        |      |  |   |        |  
|Senior secured notes  repayments                                                 |  |                                 | (200,000 | ) |      |   |        |      |  |   |        |  
|Costs of obtaining financings                                                     |  |                                 | (7,676   | ) |      |   | (1,705  | )    |  |   | (1,005  | )
|Purchase of treasury stock                                                        |  |                                 |         |   |      |   | (1,993  | )    |  |   |        |  
|Dividends paidpreferred shares of beneficial interest                            |  |                                 | (12,000  | ) |      |   | (12,000 | )    |  |   | (12,000 | )
|                                                                                  |  |                                 |          |   |      |   |         |      |  |   |         |  
|Net cash provided by (used in) financing activities                               |  |                                 | 17,680   |   |      |   | (16,055 | )    |  |   | (13,015 | )
|                                                                                  |  |                                 |          |   |      |   |         |      |  |   |         |  
|Net increase (decrease) in cash and cash equivalents                              |  |                                 | 12,863   |   |      |   | 5,016   |      |  |   | 103     |  
|Cash and cash equivalents at beginning of year                                    |  |                                 | 18,979   |   |      |   | 13,963  |      |  |   | 13,860  |  
|                                                                                  |  |                                 |          |   |      |   |         |      |  |   |         |  
|Cash and cash equivalents at end of year                                          |  | $                               | 31,842   |   |      | $ | 18,979  |      |  | $ | 13,963  |  
|                                                                                  |  |                                 |          |   |      |   |         |      |  |   |         |  



118



---

##### Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (Continued)





38. SUBSEQUENT EVENTS  THE REAL
ESTATE TRUST:



Beginning on November 15, 2004 and through
December 2, 2004, the Real Estate Trust purchased an additional 94,175 common shares of Saul Centers, Inc. for approximately $3.3 million. These purchases increased the Real Estate Trusts total ownership to 4,184,000 shares representing
approximately 25.4% of Saul Centers, Inc. outstanding common stock.



On December 9 2004 the sale of the 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.



119



---

##### Table of Contents

|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 designated 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, 2004.
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, 2004.



During the three months ended September 30, 2004 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.



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 2006 Annual Meeting



Philip D. Caraci, age 66, was elected a Trustee in 2003 after his retirement. For the previous five 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.



Gilbert M. Grosvenor, age 73, has served as a Trustee since 1971. Mr. Grosvenor also serves as Chairman of the Board of Trustees of the National
Geographic Society and as a Director of Chevy Chase, Saul Centers, Marriott International Corp., and Ethyl Corporation.



B. Francis Saul II, age 72, has served as a Chairman and Chief Executive Officer of the Trust since 1969 and as a Trustee since 1964. Mr. Saul also
serves as President and Chairman of the Board of Directors of Saul Company, the Advisor, Chevy Chase Property Company, Westminster Investing Corporation, and Chevy Chase Lake Corporation, as Chairman of the Board and Chief Executive Officer of Chevy
Chase and Saul Centers, and as a Trustee of the National Geographic Society, the Brookings Institute, the Johns Hopkins Medicine Board and Washington College.



Mr. Saul is the father of B. Francis Saul III.



Class Two TrusteesTerms End at the 2007 Annual Meeting



George M. Rogers, Jr., age 71, has served as a Trustee since 1969. Mr. Rogers is a Senior Counsel in the law firm of 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 42, has served as a Trustee and Vice
President of the Trust 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, the Advisor, Saul Property Co., Chevy Chase Property



120



---

##### Table of Contents

Company, Westminster Investing Corporation, and Saul Centers. He is also a Chairman of the Board of Childrens Hospital, and the Boys and Girls Club of
Greater Washington. Mr. Saul is the son of B. Francis Saul II.



Class Three
TrusteesTerms End at the 2005 Annual Meeting



Garland J. Bloom, Jr., age 73, has served as a Trustee since 1964. He is currently a real estate consultant. Mr. Bloom was formerly Executive Vice President and Principal of GMB Associates, Inc. (a real estate finance and management
firm) from 1988 to 1990 and Vice Chairman and Chief Operating Officer of Smithy-Braedon Company (a real estate finance and management firm) from 1985 to 1987.



John R. Whitmore, age 71, has served as a Trustee since 1984. He also has served as Senior Advisor to The Bessemer Group, Incorporated (a
financial management and banking firm) and its Bessemer Trust Company subsidiaries since 1998. 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 49, 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.



Timothy Hanlon, age 67, serves as General Counsel of the Trust and Executive Vice President and General Counsel of Chevy Chase.



Patrick T. Connors, age 42, 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 Shaw Pittman LLP, Washington, DC.



Kenneth D. Shoop,age 45, 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.



Ross E.
Heasley, age 65, serves as Vice President of the Trust, Saul Company, the Advisor, Saul Property Co. and Saul Centers.



Henry Ravenel, Jr., age 70, serves as Vice President of the Trust, Saul Company, the Advisor and Saul Centers.



John A. Spain, age 41, has served as Vice President of the Trust and
Saul Company since August 2001.



Committees of the Board of Trustees



The Board of Trustees met four times during fiscal 2004. 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. Bloom and Grosvenor. The Board of Trustees has determined that Mr. Bloom is an audit committee financial expert and is independent as such terms are defined in the Exchange Act and the rules and regulations
thereunder. The Audit Committees duties include nominating the Trusts independent auditors, 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 2004.



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. This committee did not meet during fiscal 2004.



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, 2004, the Real Estate Trust paid total fees of $109,000 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.



121



---

##### Table of Contents

|ITEM 11. | EXECUTIVE COMPENSATION
|-------- | ----------------------



The Real Estate Trust pays no compensation to its executive officers for their services in such capacity. Mr. Saul II receives compensation from Chevy
Chase for his services as the banks Chairman of the Board of Directors and Chief Executive Officer, Mr. Halpin receives compensation from Chevy Chase for his services as Executive Vice President and Chief Financial Officer, and since 2000, Mr.
Saul III receives compensation from Chevy Chase for his services as Vice Chairman of the Board of Directors. 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, 2004, 2003 and 2002.



The following table sets forth the cash compensation paid by Chevy Chase to Mr. Saul II, Mr. Halpin, and Mr. Saul III for or with respect to the fiscal years ended September 30, 2004, 2003 and 2002 for all capacities in which they served
during such fiscal years.



SUMMARY COMPENSATION TABLE



Annual Compensation



|                                           |  |      |  |        |           |       |   |                              |  |                       |         |  |   |           |    
|------------------------------------------ |  | ---- |  | ------ | --------- | ----- | - | ---------------------------- |  | --------------------- | ------- |  | - | --------- | ---
|Name and Principal Position                |  | Year |  | Salary |           | Bonus |   | Long-TermCompensationPayouts |  | All OtherCompensation |        
|B. Francis Saul II,                        |  | 2004 |  | $      | 1,678,078 |       | $ | 2,000,000                    |  | $                     | 655,206 |  | $ | 1,399,311 | (1)
|Chairman and Chief                         |  | 2003 |  |        | 1,607,311 |       |   | 1,550,000                    |  |                       | 440,496 |  |   | 753,545   | (2)
|Executive Officer of Chevy Chase           |  | 2002 |  |        | 1,590,004 |       |   | 1,240,000                    |  |                       | 440,496 |  |   | 431,260   | (3)
|Stephen R. Halpin, Jr.,                    |  | 2004 |  | $      | 517,311   |       | $ | 75,000                       |  | $                     | 163,801 |  | $ | 291,869   | (1)
|Executive Vice President                   |  | 2003 |  |        | 490,197   |       |   | 72,750                       |  |                       | 88,099  |  |   | 156,673   | (2)
|and Chief Financial Officer of Chevy Chase |  | 2002 |  |        | 485,004   |       |   | 58,200                       |  |                       | 88,099  |  |   | 89,731    | (3)
|B. Francis Saul III                        |  | 2004 |  | $      | 240,199   |       | $ | 35,250                       |  | $                     |        |  | $ | 42,676    | (1)
|Vice Chairman of Chevy Chase               |  | 2003 |  |        | 228,469   |       |   | 33,750                       |  |                       |        |  |   | 25,633    | (2)
|                                           |  | 2002 |  |        | 225,004   |       |   | 23,000                       |  |                       |        |  |   | 20,024    | (3)

---

|(1) | 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); and (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).
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(2) | The total amounts shown in the All Other Compensation column for fiscal year 2003 consist of the following: (i) contributions made by Chevy Chase to its
Supplemental Executive Retirement Plan on behalf of Mr. Saul II ($215,868), Mr. Halpin ($27,063) and Mr. Saul III ($15,733); (ii) the taxable benefit of premiums paid for group term insurance on behalf of Mr. Saul II ($14,466), Mr. Halpin ($1,698)
and Mr. Saul III ($784); (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 ($12,000); and (iv) accrued earnings on awards previously made
under Chevy Chases Deferred Compensation Plan on behalf of Mr. Saul II ($523,211), Mr. Halpin ($115,912), and Mr. Saul III ($9,116).
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(3) | The total amounts shown in the All Other Compensation column for fiscal year 2002
consist of the following: (i) contributions made by Chevy Chase to its Supplemental Executive Retirement Plan on behalf of Mr. Saul II ($193,230), Mr. Halpin ($25,878) and Mr. Saul III ($15,120); (ii) the taxable benefit of premiums paid for group
term insurance on behalf of Mr. Saul II ($14,466), Mr. Halpin ($1,698) and Mr. Saul III ($744); (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 ($12,000); and (iv) accrued earnings on awards previously made under Chevy Chases Deferred Compensation Plan on behalf of Mr. Saul II ($223,564), Mr. Halpin ($50,155) and Mr. Saul III ($4,160).
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



122



---

##### Table of Contents

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 2004 under the Banks Deferred Compensation Plan (the
Plan).



LONG-TERM INCENTIVE PROGRAMAWARDS
IN LAST FISCAL YEAR



|                       |  |                                                    |  |                                                                |         |         |   |           |  |   |          
|---------------------- |  | -------------------------------------------------- |  | -------------------------------------------------------------- | ------- | ------- | - | --------- |  | - | ---------
|Name                   |  | Performanceor OtherPeriod UntilMaturationor Payout |  | Estimated Future Payouts (1) Under Non-Stock Price-Based Plans
|                       |  | Threshold                                          |  | Target(2)                                                      |         | Maximum
|B. Francis Saul II(3)  |  | 2004                                               |  | $                                                              | 800,000 |         | $ | 4,187,068 |  | $ | 4,953,389
|Stephen R. Halpin, Jr. |  | 2013                                               |  | $                                                              | 170,000 |         | $ | 889,752   |  | $ | 1,052,595

---

|(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, 2013.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(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, 2004.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(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, 2004, the vested account balance
maintained for Mr. Sauls benefit under the Plan was $8,345,667. 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 2013.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



As of September 30, 2004, the following
individuals have vested amounts that are payable within 120 days after September 30, 2004: Mr. Saul ($836,521); Mr. Halpin ($191,205).



The Plan provides that, as of the end of each fiscal year in the ten-year period ending September 30, 2013 (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, 2013;
| | - | -------------------



| |  | 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, 2008.



Payouts are made under the Plan within 120 days after September 30, 2013, 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



123



---

##### Table of Contents

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.



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 and Halpin. 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 CommitteeGarland P. Moore, Jr., Chair George M. Rogers, Jr. B. Francis Saul II




124



---

##### Table of Contents

|ITEM 12. | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
|-------- | ----------------------------------------------------------------------------------------------



The following table sets forth certain information, as of December 17, 2004, concerning beneficial ownership of Common
Shares and preferred shares of beneficial interest, referred to in this report as the Preferred Shares, by (a) each person known by the Trust to be the beneficial owner of more than 5% of the Common Shares and the Preferred Shares, (b)
each member of the Board of Trustees, (c) each executive officer of the Trust named in the Summary Compensation Table under Item 11. Executive Compensation and (d) all trustees and executive officers of the Trust as a group.



|                                                           |  |                                                 |     |  |                    |  
|---------------------------------------------------------- |  | ----------------------------------------------- | --- |  | ------------------ | -
|Name of Beneficial Owner                                   |  | Aggregate Number ofShares BeneficiallyOwned (1) |     |  | PercentofClass (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, 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 is managed by the Advisor, a wholly owned subsidiary of Saul Company. The Advisor is paid a fixed monthly fee subject to annual review by the trustees. The monthly fee was $472,000 for fiscal 2004. The advisory contract has been extended until
September 30, 2005, and will continue thereafter unless cancelled by either party at the end of any contract year. The monthly fee for fiscal 2005 will be $487,000. 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 $8.6 million in fiscal 2004.



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.



125



---

##### Table of Contents

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. The Advisor received $266,000 in such fees in fiscal 2004.



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 $288,000 in fiscal 2004.



At October 1, 2001, the Real Estate Trust had an unsecured note receivable from the Saul Company with an outstanding balance
of $7.8 million. During fiscal 2004, the Saul Company borrowed an additional $4.7 million. During fiscal 2003 and 2002, curtails of $3.5 and $1.3 million, respectively, were paid by the Saul Company. Interest on the loan is computed by reference to
a floating rate index. At September 30, 2004, the total due the Real Estate Trust was $7.7 million. Interest earned on these loans amounted to $108,000 during fiscal 2004.



The Trust has retained the law firm of Shaw Pittman LLP, at which Mr. Rogers is senior counsel, to perform legal services
for the Trust in fiscal 2003 and 2004



The Board of Trustees of
the Trust, including the two 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 ancillary functions at cost, such as computer and payroll services, benefits administration, certain other direct and indirect administrative payroll and in-house legal services. In addition,
the Trust shares insurance expense with Saul Centers on a pro rata basis. The allocation is based upon managements estimate of usage or time incurred in Trust matters. The Trust believes that the amounts allocated to it for such shared
services represent a fair allocation between the Trust and Saul Centers.



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 Partnership.
The purpose of these agreements is to minimize potential conflicts of interest between the Real Estate Trust, Saul Centers and Saul Holdings Partnership.



Holdings 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 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 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 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, 2004, 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 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 Partnership and its subsidiaries by the Real Estate
Trust and its subsidiaries in connection with the formation of Saul Centers and Saul Holdings 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 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.



Remuneration of Trustees and Officers. For fiscal 2004, the Trust paid the trustees $109,000 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, Mr. Saul II was paid by Chevy Chase for his services as the banks Chairman and Chief Executive Officer, Mr.
Halpin was paid by Chevy Chase for his services as Executive Vice President and Chief Financial Officer, and Mr. Saul III was paid by Chevy Chase for his services as Vice Chairman. 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 $5.2
million in fiscal 2004. 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



126



---

##### Table of Contents

2004 was $1.7 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 2004 were $2.0 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 ACCOUNTANT FEES AND SERVICES
|-------- | --------------------------------------



Fees Paid to Independent
Auditor



During fiscal years 2004 and 2003, The Trust
retained Ernst & Young LLP to provide services in the following categories and amounts:



|                      |  |                 |         |                 |   |        
|--------------------- |  | --------------- | ------- | --------------- | - | -------
|                      |  | FiscalYear 2004 |         | FiscalYear 2003
|Audit Fees(1)         |  | $               | 403,004 |                 | $ | 211,049
|Audit Related Fees(2) |  |                 | 3,300   |                 |   | 3,000  
|                      |  |                 |         |                 |   |        
|Subtotaled            |  |                 | 406,304 |                 |   | 214,049
|Tax Fees(3)           |  |                 | 24,910  |                 |   | 24,900 
|All Other Fees        |  |                 |        |                 |   |       
|                      |  |                 |         |                 |   |        
|Total Fees            |  | $               | 431,214 |                 | $ | 238,949
|                      |  |                 |         |                 |   |        



|(1) | Audit fees include the audit fee and fees for comfort letters, attest services and consents.
|--- | --------------------------------------------------------------------------------------------



|(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 Auditor.



The Audit Committee has responsibility for appointing, setting compensation and overseeing the work of the independent auditor. 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 auditor.



Prior to engagement of the independent auditor 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 auditor 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 auditor for additional services not contemplated in the original pre-approval. In those instances, the Audit Committee requires specific pre-approval before engaging the
independent accountant.



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.



127



---

##### 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, 2004 and 2003.
| | --- | --------------------------------------------------------------



| | (c) | Consolidated Statements of OperationsFor the years ended September 30, 2004, 2003 and 2002.
| | --- | --------------------------------------------------------------------------------------------



| | (d) | Consolidated Statements of Comprehensive Income and Changes in Shareholders EquityFor the years ended September 30, 2004, 2003 and 2002.
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------



| | (e) | Consolidated Statements of Cash FlowsFor the years ended September 30, 2004, 2003 and 2002.
| | --- | --------------------------------------------------------------------------------------------



| | (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, 2004, 2003 and 2002.



Schedule IIIConsolidated Schedule of
Investment Properties As of September 30, 2004.



(b) Exhibits



|                                                                             |  |                                                                                                                                                                                                                                                                                                                                                                       
|---------------------------------------------------------------------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|EXHIBITS                                                                     |  | DESCRIPTION                                                                                                                                                                                                                                                                                                                                                           
|3. ORGANIZATIONAL DOCUMENTS                                                 
|                                                                             | 
|(a)                                                                          |  | Second Amended and Restated Declaration of Trust filed with the Maryland State Department of Assessments and Taxation on May 23, 2002 as Exhibit 3(a) to Registration Statement 333-70753 is
hereby incorporated by reference.                                                                                                                                        
|                                                                             | 
|(b)                                                                          |  | Second Amended and Restated By-Laws of the Trust dated as of May 23, 2002 as Exhibit 3(b) to Registration Statement 333-70753 is hereby incorporated by reference.                                                                                                                                                                                                    
|                                                                            
|4. INSTRUMENTS DEFINING THE RIGHTS OF SECURITY HOLDERS, INCLUDING INDENTURES
|                                                                             | 
|(a)                                                                          |  | Indenture, dated as of February 25, 2004, by and between the Trust and Wells Fargo Bank, National Association, as Trustee, with respect to the Trusts 7 1⁄2% Senior Secured Notes due
2014 and 7 1⁄2% Series B Senior Secured Notes due 2014, including Form of Note, as filed as Exhibit 4 (a) to Registration Statement 333-113640 is hereby incorporated by reference.
|                                                                             | 
|(b)                                                                          |  | Indenture, dated as of April 14, 2003, between the Trust and U.S. Bank National Association, as Trustee, with respect to the Trusts Unsecured Notes Due for One Year to Ten Years from
Date of Issue, as filed as Exhibit 4 (a) to Registration Statement 333-104068 is hereby incorporated by reference.                                                            
|                                                                             | 
|(c)                                                                          |  | Indenture dated as of September 1, 1992 with respect to the Trusts Notes due from One to Ten Years form Date of Issue filed as Exhibit 4(a) to Registration Statement No. 33-34930 is
hereby incorporated by reference.                                                                                                                                              
|                                                                             | 
|(d)                                                                          |  | First Supplemental Indenture dated as of January 16, 1997 with respect to the Trusts Notes due from One to Ten years from Date of Issue filed as Exhibit 4(b) to Registration Statement
No. 33-34930 is hereby incorporated by reference.                                                                                                                            
|                                                                             | 
|(e)                                                                          |  | Second Supplemental Indenture dated as of January 13, 1999 with respect to the Trusts Notes due from One to Ten Years from Date of Issuance as filed as Exhibit 4(l) to Registration
Statement No. 333-70753 is hereby incorporated by reference.                                                                                                                    



128



---

##### Table of Contents

|                       |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|---------------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|EXHIBITS               |  | DESCRIPTION                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|10. MATERIAL CONTRACTS
|                       | 
|(a)                    |  | Amended and Restated Advisory Contract by and among the Trust, B.F. Saul Company and B.F. Saul Advisory Company effective October 1, 1992, as amended (filed herewith).                                                                                                                                                                                                                                                                                                                                                                                                                         
|                       | 
|(b)                    |  | Assignment and Guaranty Agreement effective May 1, 1972 by and among the Trust, B.F. Saul Company and B.F. Saul Advisory Company, 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.                                                                                                                                                                                                                                                                                       
|                       | 
|(c)                    |  | Commercial Property Leasing and Management Agreement effective October 1, 1982 between the Trust and B.F. Saul Property Company filed as Exhibit 10(b) to Registration Statement No. 2-80831 is
hereby incorporated by reference.                                                                                                                                                                                                                                                                                                                                                               
|                       | 
|(d)                    |  | Amendments to Commercial Property Leasing and Management Agreement between the Trust and B.F. Saul Property Company dated as of December 31, 1992 (Amendment No. 5), July 1, 1989 (Amendment
No. 4), October 1, 1986 (Amendment No. 3), January 1, 1985 (Amendment No. 2) and July 1, 1984 (Amendment No. 1) filed as Exhibit 10(o) to Registration Statement No. 33-34930 is hereby incorporated by reference.                                                                                                                                                                                 
|                       | 
|(e)                    |  | 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.                                                                                                                                                                                                                                                                                                                                                                         
|                       | 
|(f)                    |  | 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.                                                                                                                                                                                                                                                                             
|                       | 
|(g)                    |  | 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.                                                                                                                                                                  
|                       | 
|(h)                    |  | 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.                                                                                                                                                                                                                                                             
|                       | 
|(i)                    |  | 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.                                                                                                                                                                                                                       
|                       | 
|(j)                    |  | 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.                                                                                                                             
|                       | 
|(k)                    |  | 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.                                                                                                                                                                                                                               
|                       | 
|(l)                    |  | 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.
|                       | 
|(m)                    |  | 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.                                                                                                                                                                                                                                                                                                                                       
|                       | 
|(n)                    |  | Note Administration Fee Agreement dated as of February 8, 2002, between the Trust and B.F. Saul Advisory Company L.L.C., as filed as Exhibit 10(n) to the Trusts Quarterly Report on Form
10-Q (File No. 1-7184) for the fiscal quarter ended December 31, 2001 is hereby incorporated by reference.                                                                                                                                                                                                                                                                                           
|                       | 
|12.                    |  | Ratio of 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).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            



129



---

##### Table of Contents

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
|2004                    |  | 2003        |  | 2002       
|$24,800,000             |  | $16,000,000 |  | $16,000,000



130



---

##### Table of Contents

SCHEDULE III



CONSOLIDATED SCHEDULE OF INVESTMENT PROPERTIESREAL ESTATE TRUST



September 30, 2004



(Dollars in Thousands)



|                                              |  |                      |         |                                           |   |                           |                          |       |   |        |  |   |         |  |   |        
|--------------------------------------------- |  | -------------------- | ------- | ----------------------------------------- | - | ------------------------- | ------------------------ | ----- | - | ------ |  | - | ------- |  | - | -------
|                                              |  | InitialBasis toTrust |         | Costs CapitalizedSubsequent toAcquisition |   |                           | Basis at Close of Period
|Hotels (1)                                    |  |                      |         | Land                                      |   | Buildings andImprovements |                          | Total
|CourtyardTysons Corner, McLean VA            |  | $                    | 31,077  |                                           | $ | (324                      | )                        |       | $ | 843    |  | $ | 29,910  |  | $ | 30,753 
|Crown PlazaNational Airport, Arlington VA    |  |                      | 26,979  |                                           |   | 6,069                     |                          |       |   | 4,229  |  |   | 28,819  |  |   | 33,048 
|Hampton InnDulles Airport, Sterling VA       |  |                      |        |                                           |   | 7,224                     |                          |       |   | 290    |  |   | 6,934   |  |   | 7,224  
|Hampton InnDulles Town Center, Sterling VA   |  |                      | 11,379  |                                           |   | 24                        |                          |       |   | 795    |  |   | 10,608  |  |   | 11,403 
|Holiday Inn, Cincinnati OH                    |  |                      | 6,859   |                                           |   | 4,499                     |                          |       |   | 245    |  |   | 11,113  |  |   | 11,358 
|Holiday InnDulles Airport, Sterling VA       |  |                      | 6,950   |                                           |   | 23,637                    |                          |       |   | 862    |  |   | 29,725  |  |   | 30,587 
|Holiday Inn, Gaithersburg MD                  |  |                      | 3,849   |                                           |   | 17,684                    |                          |       |   | 1,781  |  |   | 19,752  |  |   | 21,533 
|Holiday InnNational Airport, Arlington VA    |  |                      | 10,187  |                                           |   | 9,888                     |                          |       |   | 1,183  |  |   | 18,892  |  |   | 20,075 
|Holiday Inn, Pueblo CO                        |  |                      | 3,458   |                                           |   | 2,416                     |                          |       |   | 542    |  |   | 5,332   |  |   | 5,874  
|Holiday InnRochester Airport, Rochester NY   |  |                      | 3,340   |                                           |   | 11,353                    |                          |       |   | 605    |  |   | 14,088  |  |   | 14,693 
|Holiday InnTysons Corner, McLean VA          |  |                      | 6,976   |                                           |   | 18,949                    |                          |       |   | 2,265  |  |   | 23,660  |  |   | 25,925 
|Holiday Inn Express, Herndon VA               |  |                      | 5,259   |                                           |   | 554                       |                          |       |   | 1,178  |  |   | 4,635   |  |   | 5,813  
|Holiday Inn Select, Auburn Hills MI           |  |                      | 10,450  |                                           |   | 2,655                     |                          |       |   | 1,031  |  |   | 12,074  |  |   | 13,105 
|SpringHill Suites, Boca Raton FL              |  |                      | 10,942  |                                           |   | 439                       |                          |       |   | 1,220  |  |   | 10,161  |  |   | 11,381 
|TownePlace Suites, Boca Raton FL              |  |                      | 7,527   |                                           |   | 31                        |                          |       |   | 869    |  |   | 6,689   |  |   | 7,558  
|TownePlace SuitesDulles Airport, Sterling VA |  |                      | 5,849   |                                           |   | 202                       |                          |       |   | 219    |  |   | 5,832   |  |   | 6,051  
|TownePlace SuitesFt. Lauderdale FL           |  |                      | 7,059   |                                           |   | 25                        |                          |       |   | 420    |  |   | 6,664   |  |   | 7,084  
|TownePlace Suites, Gaithersburg MD            |  |                      | 6,382   |                                           |   | 47                        |                          |       |   | 107    |  |   | 6,322   |  |   | 6,429  
|                                              |  |                      |         |                                           |   |                           |                          |       |   |        |  |   |         |  |   |        
|SubtotalHotels(1)                            |  | $                    | 164,522 |                                           | $ | 105,372                   |                          |       | $ | 18,684 |  | $ | 251,210 |  | $ | 269,894
|                                              |  |                      |         |                                           |   |                           |                          |       |   |        |  |   |         |  |   |        
|Commercial                                    |  |                     
|900 Circle 75 Pkway, Atlanta GA               |  | $                    | 33,434  |                                           | $ | 4,614                     |                          |       | $ | 563    |  | $ | 37,485  |  | $ | 38,048 
|1000 Circle 75 Pkway, Atlanta GA              |  |                      | 2,820   |                                           |   | 1,601                     |                          |       |   | 248    |  |   | 4,173   |  |   | 4,421  
|1100 Circle 75 Pkway, Atlanta GA              |  |                      | 22,746  |                                           |   | 3,451                     |                          |       |   | 419    |  |   | 25,778  |  |   | 26,197 
|8201 Greensboro, Tysons Corner VA             |  |                      | 28,890  |                                           |   | 5,848                     |                          |       |   | 1,633  |  |   | 33,105  |  |   | 34,738 
|Commerce Ctr-Ph II, Ft Lauderdale FL          |  |                      | 4,266   |                                           |   | 896                       |                          |       |   | 782    |  |   | 4,380   |  |   | 5,162  
|Dulles North, Loudoun County VA               |  |                      | 5,882   |                                           |   | 54                        |                          |       |   | 507    |  |   | 5,429   |  |   | 5,936  
|Dulles North Two, Loudoun County VA           |  |                      | 7,729   |                                           |   | 91                        |                          |       |   | 404    |  |   | 7,417   |  |   | 7,820  
|Dulles North Four, Loudoun County VA          |  |                      | 11,093  |                                           |   | 192                       |                          |       |   | 2,208  |  |   | 9,077   |  |   | 11,285 



131



---

##### Table of Contents

|                                          |  |                      |         |                                          |   |                           |                          |       |   |        |  |   |         |  |   |        
|----------------------------------------- |  | -------------------- | ------- | ---------------------------------------- | - | ------------------------- | ------------------------ | ----- | - | ------ |  | - | ------- |  | - | -------
|Dulles North Five, Loudoun County VA      |  |                      | 5,078   |                                          |   | (76                       | )                        |       |   | 535    |  |   | 4,467   |  |   | 5,002  
|Dulles North Six, Loudoun County VA       |  |                      | 2,667   |                                          |   | 179                       |                          |       |   | 257    |  |   | 2,589   |  |   | 2,846  
|Loudoun Tech Center I, Loudoun County VA  |  |                      | 5,334   |                                          |   | 558                       |                          |       |   | 1,075  |  |   | 4,817   |  |   | 5,892  
|Sweitzer Lane, Laurel MD                  |  |                      | 13,703  |                                          |   |                          |                          |       |   | 3,701  |  |   | 10,002  |  |   | 13,703 
|Tysons Park Place, Tysons Corner VA       |  |                      | 21,811  |                                          |   | 1,593                     |                          |       |   | 2,453  |  |   | 20,951  |  |   | 23,404 
|                                          |  |                      |         |                                          |   |                           |                          |       |   |        |  |   |         |  |   |        
|SubtotalCommercial                       |  | $                    | 165,453 |                                          | $ | 19,001                    |                          |       | $ | 14,785 |  | $ | 169,669 |  | $ | 184,454
|                                          |  |                      |         |                                          |   |                           |                          |       |   |        |  |   |         |  |   |        
|                                          |  |                      |        
|                                          |  | InitialBasis toTrust |         | CostsCapitalizedSubsequent toAcquisition |   |                           | Basis at Close of Period
|PurchaseLeasebacks and other             |  |                      |         | Land                                     |   | Buildings andImprovements |                          | Total
|Chateau di Jon, Metairie, LA              |  | $                    | 1,125   |                                          | $ |                          |                          |       | $ | 1,125  |  | $ |        |  | $ | 1,125  
|Country Club, Knoxville, TN               |  |                      | 500     |                                          |   | (22                       | )                        |       |   | 478    |  |   |        |  |   | 478    
|Houston Mall, Warner Robbins, GA          |  |                      | 650     |                                          |   |                          |                          |       |   | 650    |  |   |        |  |   | 650    
|Old National, Atlanta, GA (Other)         |  |                      | 550     |                                          |   |                          |                          |       |   | 550    |  |   |        |  |   | 550    
|                                          |  |                      |         |                                          |   |                           |                          |       |   |        |  |   |         |  |   |        
|SubtotalPurchase-Leasebacks and other    |  | $                    | 2,825   |                                          | $ | (22                       | )                        |       | $ | 2,803  |  | $ |        |  | $ | 2,803  
|                                          |  |                      |         |                                          |   |                           |                          |       |   |        |  |   |         |  |   |        
|Total Income-Producing Properties         |  | $                    | 332,800 |                                          | $ | 124,351                   |                          |       | $ | 36,272 |  | $ | 420,879 |  | $ | 457,151
|                                          |  |                      |         |                                          |   |                           |                          |       |   |        |  |   |         |  |   |        
|Land Parcels                              |  |                      |         |                                          |   |                           |                          |       |   |        | 
|Arvida Park of Commerce, Boca Raton, FL   |  | $                    | 7,378   |                                          |   | (1,945                    | )                        |       | $ | 5,433  |  | $ |        |  | $ | 5,433  
|Cedar Green, Loudoun Co., VA              |  |                      | 3,314   |                                          |   | 83                        |                          |       |   | 2,831  |  |   | 566     |  |   | 3,397  
|Church Road, Loudoun Co., VA              |  |                      | 2,586   |                                          |   | 1,248                     |                          |       |   | 3,834  |  |   |        |  |   | 3,834  
|Circle 75, Atlanta, GA                    |  |                      | 12,927  |                                          |   | 3,801                     |                          |       |   | 16,049 |  |   | 679     |  |   | 16,728 
|Holiday InnAuburn Hills, Auburn Hills MI |  |                      | 218     |                                          |   |                          |                          |       |   | 218    |  |   |        |  |   | 218    
|Holiday InnRochester, Roch., NY          |  |                      | 68      |                                          |   |                          |                          |       |   | 68     |  |   |        |  |   | 68     
|Overland Park, Overland Park, KA          |  |                      | 3,771   |                                          |   | 726                       |                          |       |   | 4,497  |  |   |        |  |   | 4,497  
|Prospect Indust. Pk, Ft. Laud., FL        |  |                      | 2,203   |                                          |   | (1,943                    | )                        |       |   | 260    |  |   |        |  |   | 260    
|Sterling Blvd., Loudoun Co., VA           |  |                      | 505     |                                          |   | 4,082                     |                          |       |   | 2,620  |  |   | 1,967   |  |   | 4,587  
|Tysons Park Place II, Fairfax, VA         |  |                      |        |                                          |   | 2,700                     |                          |       |   |       |  |   | 2,700   |  |   | 2,700  
|                                          |  |                      |         |                                          |   |                           |                          |       |   |        |  |   |         |  |   |        
|Subtotal                                  |  | $                    | 32,970  |                                          | $ | 8,752                     |                          |       | $ | 35,810 |  | $ | 5,912   |  | $ | 41,722 
|                                          |  |                      |         |                                          |   |                           |                          |       |   |        |  |   |         |  |   |        
|Total Investment Properties(1)            |  | $                    | 365,770 |                                          | $ | 133,103                   |                          |       | $ | 72,082 |  | $ | 426,791 |  | $ | 498,873
|                                          |  |                      |         |                                          |   |                           |                          |       |   |        |  |   |         |  |   |        



132



---

##### Table of Contents

|                                              |  |                         |         |                 |   |                     |  |                          |  |                                                      |  |     
|--------------------------------------------- |  | ----------------------- | ------- | --------------- | - | ------------------- |  | ------------------------ |  | ---------------------------------------------------- |  | ----
|Hotels (1)                                    |  | AccumulatedDepreciation |         | (2) RelatedDebt |   | Date ofConstruction |  | DateAcquired/Transferred |  | Buildings and Improvements Depreciable Lives (Years)
|CourtyardTysons Corner, McLean VA            |  | $                       | 7,064   |                 | $ | 25,949              |  | 2000                     |  | 12/00                                                |  | 40  
|Crown PlazaNational Airport, Arlington VA    |  |                         | 8,594   |                 |   | 15,752              |  | 1959                     |  | 12/97                                                |  | 39  
|Hampton InnDulles Airport, Sterling VA       |  |                         | 3,477   |                 |   | 6,070               |  | 1987                     |  | 4/87                                                 |  | 31.5
|Hampton InnDulles Town Center, Sterling VA   |  |                         | 3,490   |                 |   | 7,883               |  | 2000                     |  | 11/00                                                |  | 40  
|Holiday Inn, Cincinnati OH                    |  |                         | 7,200   |                 |   | 5,501               |  | 1975                     |  | 2/76                                                 |  | 40  
|Holiday InnDulles Airport, Sterling VA       |  |                         | 19,570  |                 |   | 11,523              |  | 1971                     |  | 11/84                                                |  | 28  
|Holiday Inn, Gaithersburg MD                  |  |                         | 10,751  |                 |   | 6,449               |  | 1972                     |  | 6/75                                                 |  | 45  
|Holiday InnNational Airport, Arlington VA    |  |                         | 10,710  |                 |   | 11,506              |  | 1973                     |  | 11/83                                                |  | 30  
|Holiday Inn, Pueblo CO                        |  |                         | 3,784   |                 |   | 4,089               |  | 1973                     |  | 3/76                                                 |  | 40  
|Holiday InnRochester Airport, Rochester NY   |  |                         | 8,618   |                 |   | 12,044              |  | 1975                     |  | 3/76                                                 |  | 40  
|Holiday InnTysons Corner, McLean VA          |  |                         | 11,230  |                 |   | 14,113              |  | 1971                     |  | 6/75                                                 |  | 47  
|Holiday Inn Express, Herndon VA               |  |                         | 1,350   |                 |   | 4,523               |  | 1987                     |  | 10/96                                                |  | 40  
|Holiday Inn Select, Auburn Hills MI           |  |                         | 4,544   |                 |   | 11,192              |  | 1989                     |  | 11/94                                                |  | 31.5
|SpringHill Suites, Boca Raton FL              |  |                         | 1,874   |                 |   | 5,900               |  | 1999                     |  | 9/99                                                 |  | 40  
|TownePlace Suites, Boca Raton FL              |  |                         | 1,141   |                 |   | 5,354               |  | 1999                     |  | 6/99                                                 |  | 40  
|TownePlace SuitesDulles Airport, Sterling VA |  |                         | 1,157   |                 |   | 6,154               |  | 1998                     |  | 8/98                                                 |  | 40  
|TownePlace SuitesFt. Lauderdale FL           |  |                         | 1,165   |                 |   | 4,401               |  | 1999                     |  | 10/99                                                |  | 40  
|TownePlace Suites, Gaithersburg MD            |  |                         | 1,146   |                 |   | 4,693               |  | 1999                     |  | 6/99                                                 |  | 40  
|                                              |  |                         |         |                 |   |                     |  |                          |  |                                                      |  |     
|SubtotalHotels(1)                            |  | $                       | 106,865 |                 | $ | 163,096             |  |                          |  |                                                      |  |     
|                                              |  |                         |         |                 |   |                     |  |                          |  |                                                      |  |     
|                                              |  |                         |         |                 |  
|Commercial                                    |  |                         |         |                 |   |                     |  |                          |  |                                                     
|900 Circle 75 Pkway, Atlanta GA               |  | $                       | 20,817  |                 | $ | 20,689              |  | 1985                     |  | 12/85                                                |  | 35  
|1000 Circle 75 Pkway, Atlanta GA              |  |                         | 2,983   |                 |   | 4,723               |  | 1974                     |  | 4/76                                                 |  | 40  
|1100 Circle 75 Pkway, Atlanta GA              |  |                         | 15,947  |                 |   | 12,016              |  | 1982                     |  | 9/82                                                 |  | 40  
|8201 Greensboro, Tysons Corner VA             |  |                         | 16,090  |                 |   | 33,473              |  | 1985                     |  | 4/86                                                 |  | 35  
|Commerce Ctr-Ph II, Ft Lauderdale FL          |  |                         | 2,204   |                 |   | 3,589               |  | 1986                     |  | 1/87                                                 |  | 35  
|Dulles North, Loudoun County VA               |  |                         | 2,464   |                 |   | 4,752               |  | 1990                     |  | 10/90                                                |  | 31.5
|Dulles North Two, Loudoun County VA           |  |                         | 2,132   |                 |   | 8,196               |  | 1999                     |  | 10/99                                                |  | 40  
|Dulles North Four, Loudoun County VA          |  |                         | 1,860   |                 |   | 8,565               |  | 2002                     |  | 4/02                                                 |  | 40  
|Dulles North Five, Loudoun County VA          |  |                         | 799     |                 |   | 6,441               |  | 2000                     |  | 3/00                                                 |  | 40  
|Dulles North Six, Loudoun County VA           |  |                         | 326     |                 |   | 4,618               |  | 2000                     |  | 10/00                                                |  | 40  
|Loudoun Tech Center I, Loudoun County VA      |  |                         | 305     |                 |   | 3,774               |  | 2001                     |  | 12/01                                                |  | 40  



133



---

##### Table of Contents

|                                          |  |                          |         |             |   |                      |  |                          |  |                   |  |   
|----------------------------------------- |  | ------------------------ | ------- | ----------- | - | -------------------- |  | ------------------------ |  | ----------------- |  | --
|Sweitzer Lane, Laurel MD                  |  |                          | 979     |             |   | 10,354               |  | 1995                     |  | 11/00             |  | 40
|Tysons Park Place, Tysons Corner VA       |  |                          | 10,015  |             |   | 28,404               |  | 1976                     |  | 12/99             |  | 30
|                                          |  |                          |         |             |   |                      |  |                          |  |                   |  |   
|SubtotalCommercial                       |  | $                        | 76,921  |             | $ | 149,594              |  |                          |  |                   |  |   
|                                          |  |                          |         |             |   |                      |  |                          |  |                   |  |   
|PurchaseLeasebacks                       |  | Accumulated Depreciation |         | RelatedDebt |   | Date of Construction |  | DateAcquired/Transferred |  |                  
|Chateau di Jon, Metairie, LA              |  | $                        |         |             | $ |                      |  |                          |  | 11/73             |  |   
|Country Club, Knoxville, TN               |  |                          |         |             |   |                      |  |                          |  | 5/76              |  |   
|Houston Mall, Warner Robbins, GA          |  |                          |         |             |   |                      |  |                          |  | 2/72              |  |   
|Old National, Atlanta, GA                 |  |                          |         |             |   |                      |  |                          |  | 8/71              |  |   
|                                          |  |                          |         |             |   |                      |  |                          |  |                   |  |   
|SubtotalPurchaseLeasebacks              |  | $                        |         |             | $ |                      |  |                          |  |                   |  |   
|                                          |  |                          |         |             |   |                      |  |                          |  |                   |  |   
|Total Income-Producing Properties         |  | $                        | 183,786 |             | $ | 312,690              |  |                          |  |                   |  |   
|                                          |  |                          |         |             |   |                      |  |                          |  |                   |  |   
|                                          |  |                          |         |             |  
|Land Parcels                              |  |                          |         |             |   |                      |  |                          |  |                  
|Arvida Park of Commerce, Boca Raton, FL   |  | $                        |        |             | $ |                     |  |                          |  | 12/84 & 5/85      |  |   
|Cedar Green, Loudoun Co., VA              |  |                          |        |             |   |                     |  |                          |  | 10/00             |  |   
|Church Road, Loudoun Co., VA              |  |                          |        |             |   |                     |  |                          |  | 9/84 &4/85        |  |   
|Circle 75, Atlanta, GA                    |  |                          | 73      |             |   |                     |  |                          |  | 2/77 &1/84        |  |   
|Flagship Centre, Rockville, MD            |  |                          |        |             |   |                     |  |                          |  | 8/85              |  |   
|Holiday InnAuburn Hills, Auburn Hills MI |  |                          |        |             |   |                     |  |                          |  | 7/97              |  |   
|Holiday InnRochester, Roch., NY          |  |                          |        |             |   |                     |  |                          |  | 9/86              |  |   
|Overland Park, Overland Park, KA          |  |                          |        |             |   |                     |  |                          |  | 1/77 &2/85        |  |   
|Prospect Indust. Pk, Ft. Laud., FL        |  |                          |        |             |   |                     |  |                          |  | 10/83 &8/84       |  |   
|Sterling Blvd., Loudoun Co., VA           |  |                          |        |             |   |                     |  |                          |  | 4/84, 2/00 & 3/00 |  |   
|                                          |  |                          |         |             |   |                      |  |                          |  |                   |  |   
|Subtotal                                  |  | $                        | 73      |             | $ |                     |  |                          |  |                   |  |   
|                                          |  |                          |         |             |   |                      |  |                          |  |                   |  |   
|Total Investment Properties(1)            |  | $                        | 183,859 |             | $ | 312,690              |  |                          |  |                   |  |   
|                                          |  |                          |         |             |   |                      |  |                          |  |                   |  |   



NOTES:



|(1) | Includes real estate held for sale.
|--- | -----------------------------------



|(2) | Includes hotel capital lease obligations of approximately $1.4 million.
|--- | -----------------------------------------------------------------------



|(3) | 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.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(4) | A reconciliation of the basis of investment properties and accumulated depreciation follows.
|--- | --------------------------------------------------------------------------------------------



134



---

##### Table of Contents

BASIS OF INVESTMENT PROPERTIES AND ACCUMULATED DEPRECIATION

(In thousands)



|                                                                  |  |                                 |         |   |      |   |         |      |  |   |         |  
|----------------------------------------------------------------- |  | ------------------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                                  |  | For The Year Ended September 30 |        
|Basis of investment properties (1)                                |  | 2004                            |         |   | 2003 |   |         | 2002 | 
|Balance at beginning of period                                    |  | $                               | 483,673 |   |      | $ | 479,309 |      |  | $ | 455,478 |  
|                                                                  |  |                                 |        
|Additions (reductions) during the period:                         |  |                                 |         |   |      |   |         |      |  |   |         |  
|Capital expenditures and property acquisitions from nonaffiliates |  |                                 | 17,973  |   |      |   | 9,855   |      |  |   | 8,758   |  
|Sales to nonaffiliates                                            |  |                                 |        |   |      |   | (1,873  | )    |  |   | (22     | )
|Transferred from construction in progress, net                    |  |                                 |        |   |      |   |        |      |  |   | 18,407  |  
|Other                                                             |  |                                 | (2,773  | ) |      |   | (3,618  | )    |  |   | (3,312  | )
|                                                                  |  |                                 |         |   |      |   |         |      |  |   |         |  
|                                                                  |  |                                 |        
|Balance at end of period                                          |  | $                               | 498,873 |   |      | $ | 483,673 |      |  | $ | 479,309 |  
|                                                                  |  |                                 |         |   |      |   |         |      |  |   |         |  
|                                                                  |  |                                 |        
|Accumulated depreciation                                          |  |                                 |         |   |      |   |         |      |  |   |         |  
|                                                                  |  |                                 |        
|Balance at beginning of period                                    |  | $                               | 166,243 |   |      | $ | 149,981 |      |  | $ | 131,659 |  
|                                                                  |  |                                 |        
|Additions (reductions) during the period:                         |  |                                 |         |   |      |   |         |      |  |   |         |  
|Depreciation expense                                              |  |                                 | 19,053  |   |      |   | 19,330  |      |  |   | 19,147  |  
|Sales to nonaffiliates                                            |  |                                 |        |   |      |   |        |      |  |   |        |  
|Other                                                             |  |                                 | (1,437  | ) |      |   | (3,068  | )    |  |   | (825    | )
|                                                                  |  |                                 |         |   |      |   |         |      |  |   |         |  
|                                                                  |  |                                 |        
|Balance at end of period                                          |  | $                               | 183,859 |   |      | $ | 166,243 |      |  | $ | 149,981 |  
|                                                                  |  |                                 |         |   |      |   |         |      |  |   |         |  



|(1) | Includes real estate held for sale.
|--- | -----------------------------------



135



---

##### Table of Contents

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 17, 2004 |  |  |  | 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
IIB. Francis Saul II         |  | Trustee, Chairman of the Board (Principal Executive Officer)                          |  | December 17, 2004
|                                                    |  |                                                                                      
|/s/    STEPHEN R. HALPIN,
JR.Stephen R. Halpin,
Jr. |  | Vice President and Chief Financial Officer (Principal Financial Officer)              |  | December 17, 2004
|                                                    |  |                                                                                      
|/s/    KENNETH D.
SHOOPKenneth D.
Shoop             |  | Vice President, Treasurer and Chief Accounting Officer (Principal Accounting Officer) |  | December 17, 2004
|                                                    |  |                                                                                      
|/s/    PHILIP D. CARACIPhilip D. Caraci             |  | Trustee                                                                               |  | December 17, 2004
|                                                    |  |                                                                                      
|/S/    GARLAND J. BLOOM,
JR.Garland J. Bloom,
Jr.   |  | Trustee                                                                               |  | December 17, 2004
|                                                    |  |                                                                                      
|/S/    GILBERT M.
GROSVENORGilbert M.
Grosvenor     |  | Trustee                                                                               |  | December 17, 2004
|                                                    |  |                                                                                      
|/S/    GEORGE M. ROGERS,
JR.George M. Rogers,
Jr.   |  | Trustee                                                                               |  | December 17, 2004
|                                                    |  |                                                                                      
|/S/    B. FRANCIS SAUL
IIIB. Francis Saul III       |  | Trustee                                                                               |  | December 17, 2004
|                                                    |  |                                                                                      
|/S/    JOHN R.
WHITMOREJohn R.
Whitmore             |  | Trustee                                                                               |  | December 17, 2004



136