1997 Annual Report

                                   KSB Bancorp


<PAGE>
March 31, 1998

Dear Shareholder:

I am pleased to report to you on the results of  operations  for KSB Bancorp and
Kingfield Bank this past year. The Bank's earnings in 1997 reached record levels
as the Bank reported net income of $1,549,000 or $1.30 basic earnings per share.
This represents a 24% increase over 1996 earnings. Our earnings growth continues
to reflect the growth in the Bank's  balance  sheet.  Total  assets of Kingfield
Bank grew to $153 Million in 1997 or 14% over last year.

The  continued  growth of Kingfield  Bank is due to our  commitment of providing
high quality, personalized service to our customers. Kingfield Bank views itself
as a financial  partner with its customers and the  communities  it operates in.
This  commitment  to serving our customers  and  communities  was evident in the
$58.5 million in loans made in 1997.

The growth in Bank earnings  combined with the market's reception of KSB Bancorp
stock to propel the price of KSB Bancorp's  stock by 190% in 1997 from $7.67 per
share on December  31, 1996 to $22.50 per share on December  31,  1997.  In June
1997 the Board of KSB Bancorp voted a three-for-one  stock split effected in the
form of a 200% stock  dividend.  This stock split has helped  create more market
activity in the stock  resulting  in a higher  market price giving more value to
our shareholders.

The Bank continued its investments in technology this past year, helping improve
our services to our customers and develop greater efficiencies  internally.  The
Bank  expanded  its ATM  network  by 200% and we now have ATM  service  in every
community we serve. We invested over $90,000 in computer technology, creating an
internal  network,  which improves  communication  and productivity  between our
several locations.

More important than our  technological  investments  are the investments we have
made in our  people.  In 1997 we embarked on a  continuous  training  process in
quality service.  We have also developed an  organizational  structure that will
help assure that we are  proactive in  identifying  and meeting the needs of our
customers.

In 1998 we look forward to expanding our services in Somerset  County.  On March
16, 1998 we closed on our  acquisition  of KeyBank's  branch  office in Madison,
Maine.  We feel  confident  that  Kingfield  Bank's  philosophy of  personalized
community banking will be well received by the greater Madison community.

This is my fifth  "letter to  shareholders"  since we became a stock  company in
1993. During this time the Bank has grown from $65.5 million in assets to $152.8
million. Our earnings have more than doubled, and the value of a $10.00 share of
stock  purchased  on June 23,  1993  was  worth  an  equivalent  (dividend/split
adjusted) of $70.00 per share at the end of 1997.  These  results are due to the
efforts  of  a  very  dedicated,  hard-working  staff  and  a  forward-thinking,
supportive  board of  directors.  All of us at Kingfield  Bank are  dedicated to
achieving our mission of building the value of the Bank to our shareholders, our
customers and our  communities.  Thank you, again, for your support as we pursue
this mission.

Sincerely,

/s/John C. Witherspoon

John C. Witherspoon
President/CEO

                                       1
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS

GENERAL

KSB Bancorp , Inc's  wholly-owned  subsidiary,  "Kingfield Bank", is a community
Bank  providing  quality,  personalized  banking  services  to  individuals  and
businesses.  In 1997 the Bank operated  eight retail branch  offices  located in
Franklin, Somerset and Androscoggin counties, Maine.

The Bank's stated mission is "to continuously improve the Bank's long-term value
to  shareholders,  customers,  employees and the  communities it serves".  Since
converting  to a stock  company in 1993,  the bank has  pursued  its  mission by
utilizing  the capital  raised in the offering to fund growth.  A total of $61.7
million in deposits were acquired in  acquisition  of The First Federal  Savings
Association  in March 1994,  and the purchase of four  branches of Fleet Bank of
Maine in March 1995 (two of which were  subsequently  consolidated into existing
Kingfield Bank  branches).  In March 1998,  the Bank will acquire  approximately
$16.7 million  dollars in deposits with the  acquisition  of the Madison,  Maine
branch of KeyBank. This growth has provided a solid base for earnings and proved
to be an effective use of the Bank's capital. It has also diversified the Bank's
markets,  reducing its dependence on a predominantly  rural geography and forest
products and tourism-based economy.

Since 1994, when our rapid growth in deposits without  corresponding loan growth
put pressure on the Bank's margins,  the Bank has pursued a strategy of building
loan  volumes in order to  increase  the  margins of the Bank.  In 1997 the Bank
originated  $58.5 in new loans which resulted in an increase of $19.7 million in
net loan balances  including  loans available for sale. This helped grow the net
interest margin of the Bank from a low of 3.99% in 1994 to 4.46% in 1997.

In  addition  to the  growth  strategies  implemented,  the Bank has  focused on
reducing  operating expenses and gaining  efficiencies and productivity  through
investments  in equipment,  technology and training.  In 1997 these  investments
totaled  $470,000.  The result of these efforts has been a steady decline in the
Bank's operating expense to average asset ratio over the past 5 years from 4.70%
into 3.11%.  The Bank's  efficiency  ratio  dropped  from 67% in 1996 to 62% for
1997.

MORTGAGE BANKING ACTIVITIES

Mortgage banking  activities involve the origination of mortgage loans for sale,
as whole loans or packaging them into  securities  through the Federal Home Loan
Mortgage  Corporation  (FHLMC) or Federal National Mortgage  association (FNMA).
For the years ended December 31, 1997 and December 31, 1996, the Bank originated
$15.8 and $19.2 million,  respectively, of one to four-family mortgage loans. Of
these amounts $4.0 million in 1997 and $5.2 million in 1996 were sold.

The Bank  recognizes fees related to the origination and sale of mortgage loans.
These fees  totaled  $70,000  for 1996 and  $84,000  for 1997.  The 1997  figure
includes  $11,000  of net  gains  recognized  for the  present  value of  future
servicing  rights  on loans  sold.  The 1996  figure  includes  $29,000  of gain
attributed to mortgage servicing rights.

In addition to income earned upon the  origination  and sale of loans,  the Bank
earns fees for the servicing of loans sold. At December 31, 1997, $75.1 in loans
was serviced for others, which generated $297,000 in fee income. At December 31,
1996, $78.3 million in loans were serviced,  earning  $321,000.  The decrease in
the  servicing  portfolio is due, in part,  to the Bank's past  decision to keep
many saleable residential loans in its portfolio.

Mortgage  banking  activities  expose the Bank to interest rate risk between the
date that loan rates are committed to a borrower and the date the loan is closed
and sold. Attempts are made to mitigate this risk through pricing of loan rates,
managing the volume of loans held for sale and utilizing forward  commitments to
sell loans.

COMMERCIAL LENDING ACTIVITIES

The  Bank's  commercial  loan  portfolio  continued  to grow in  1997.  The Bank
originated  $25.3  million in commercial  loans in the year ending  December 31,
1997 resulting in an increase in commercial loan volumes of $10.7 million or 29%
over the levels at  year-end  1996.  This  growth  was a result of an  increased
awareness  of  the  banks   personalized   commercial   loan   services  in  the
Androscoggin,  Somerset,  and southern Franklin county markets. The expertise of
the Bank's  commercial  lending team was recognized by the Finance  Authority of
Maine when, for the second time in three

                                       2
<PAGE>
years,  Kingfield  Bank was named as  Maine's  Community  Bank of the Year.  The
Bank's commercial loans are a combination of adjustable rate loans (based on the
Wall Street  Journal Prime Rate) and fixed rate loans in keeping with the Bank's
asset/liability management strategies.  Loan guarantees available from the Small
Business  Administration  (SBA) and the Finance  Authority  of Maine  (FAME) are
utilized  when  appropriate  to insure up to 90% of the risk  associated  with a
portion of the small business loans.

ASSET/LIABILITY MANAGEMENT

A number  of  measures  are  used to  monitor  and  manage  interest-rate  risk,
including  income  simulation  and  interest  sensitivity  (gap)  analyses.   An
income-simulation  model is the primary  tool used to assess the  direction  and
magnitude of changes in net interest  income  resulting from changes in interest
rates.   Key   assumptions   in  the   model   include   prepayment   speeds  on
mortgage-related  assets;  cash flows and  maturities  of  derivative  and other
financial  instruments  held for purposes other than trading;  changes in market
conditions  on  loan  and  deposit  pricing;   deposit   sensitivity;   customer
preferences;  and management's  financial  capital plans.  These assumptions are
inherently  uncertain and, as a result,  the model cannot precisely estimate net
interest  income or  precisely  predict  the impact of higher or lower  interest
rates on net interest income.  Actual results will differ from simulated results
due to timing,  magnitude, and frequency of interest rate changes and changes in
market conditions and management strategies, among other factors.

Based on the  results of the  simulation  model as of  December  31,  1997,  the
Company would expect a decrease in net interest income of $112,000 or 1.7% and a
decrease in  net-interest  income of $21,000 or 0.3% if interest rates gradually
increase or decrease,  respectively, from current rates by 200 basis points over
a 12-month period.  These results are both within Board-set  tolerance limits of
7.5%.

RESULTS OF OPERATIONS

Net income for 1997 was $1,549,000 or $1.30 basic earnings per share compared to
$1,244,000 in 1996 or $1.07 basic earnings per share. 1997 income was positively
impacted by  continued  growth in the Bank's loan  portfolio  and  corresponding
growth in the net  interest  margin.  Total  assets of the Company grew by $18.4
million, or 13.7%, from $134.4 million at December 31, 1996 to $152.8 million at
December 31, 1997. Net portfolio loans increased by $19.5million, or 20.0%, over
December 31,  1996.  This loan growth  contributed  to an increase in the Bank's
margin  from 4.38% at  December  31,  1996 to 4.46% at  December  31, 1997 which
resulted  in a 12.8%,  or  $712,000,  increase  in net  interest  income  before
provision for loan losses.

Non-interest  income increased by $47,000 from 1996.  However,  included in 1996
income  was a $47,000  loss on the sale of  securities,  which if netted  out of
1996,  would  result in  non-interest  income in 1997 being even with 1996.  Fee
income from  origination and sale of mortgage loans (included in "other" income)
was up $14,000 from  $70,000 in 1996 to $84,000 in 1997.  The increase is due in
part to the Bank's  decision to sell fixed rate loans with terms  longer than 15
years,  thus  increasing the volume of sales and income derived from such sales.
In addition,  the interest rate climate was more  favorable in 1997 resulting in
higher overall loan sale prices than 1996.

Non-interest  expense increased by $141,000 from 1996.  Included in 1996 expense
is a one-time  deposit  assessment of $175,000 by the Federal Deposit  Insurance
Corporation. If that were removed from the 1996 total, expenses would have shown
an increase of $316,000. Included in 1997's non-interest expense is a salary and
benefit  expense of $176,000 which  represents an accounting  adjustment for the
increase  in market  value of the  Company's  stock held in the  Employee  Stock
Ownership Plan (ESOP).  Due to the appreciation in the stock value in 1997, this
adjustment was $106,000 higher in 1997 than in 1996.  Non-interest  expense also
includes $103,000 in expense associated with the amortization of goodwill.  This
is equal to 1996  amortization.  Neither the ESOP market  value  adjustment  nor
goodwill expense impacts the tangible capital of the Bank.

                                       3
<PAGE>
FINANCIAL CONDITION

Total assets of the Bank grew by $18.4  million or 13.7% from  December 31, 1996
to December 31, 1997. Of the asset growth,  $19.5 million was in portfolio loans
while  investments  in  mortgage-backed  and other  securities  declined by $2.5
million.  Of the  increase  in loan  volume,  $1.8  million  was in  residential
mortgage  loans,  $10.7 million was in commercial  loans and $7.4 million was in
consumer and other loans.  Allowance for loan losses increased $0.4 million. The
decline in investments was due to investment  maturities and principal  payments
on mortgage-backed securities.

Total deposits grew by $1.4 million or 1.3% during 1997. Borrowings increased by
$15.0  million,  more than  doubling the  borrowings  outstanding  in 1996.  The
increase in borrowings  resulted  from slower  deposit  growth  coupled with the
funding needs created by strong loan demand.  The Bank's  borrowings  consist of
advances of various  maturities  from the Federal Home Loan Bank. In March 1998,
the Bank will purchase approximately $16.7 million in deposits from KeyBank with
the  acquisition of Key's Madison,  Maine Branch.  The proceeds of this purchase
will be used to reduce the borrowings of the Bank.

The Bank's  non-accrual loans increased from $ 1,895,000 at December 31, 1996 to
$2,090,000 at December 31, 1997. This represents 1.91% and 1.76% of total loans,
respectively.  The increase can be  attributed  to the overall  increase in loan
volumes  in 1997 and an  increase  in the  number of  bankruptcy  filings  among
mortgage  customers  which  lengthens the time it takes the Bank to foreclose on
properties.  During 1997, the Bank incurred net loan charge-offs of $82,000.  In
response to the increased loan volumes,  the Bank provided $530,000 in loan loss
reserves  during 1997  resulting  in an increase  in the  reserve  balance  from
$893,000 at December 31, 1996 to $1,342,000 at December 31, 1997.

In June 1997 the Board of  Directors  voted a  three-for-one  stock split in the
form of a 200% stock  dividend,  in addition to the semiannual  cash dividend of
$0.04 per  share.  The stock  split had the effect of  increasing  the number of
shares outstanding by 822,110 to a total of 1,233,165.  On January 20, 1998, the
Board of Directors  voted to increase the semiannual  cash dividend to $0.05 per
share.

LIQUIDITY AND CAPITAL RESOURCES

A primary function of  asset/liability  management  includes  assuring  adequate
liquidity  that  reflects  the  ability  of the  Bank  to  meet  the  cash  flow
requirements of its customers without significant loss to the Bank.

Liquidity comes from five sources in the balance sheet -- the Bank's  investment
portfolio, deposits, borrowings, loan repayments and profits.

Liquidity  is needed to fund  increased  loan  demand and to cover the  seasonal
outflows of deposits.  The Bank's investment portfolio,  that consists primarily
of mortgage-backed securities, provides liquidity through repayment of principal
and interest and through its  availability  as  collateral  for  borrowings  and
public sector deposit accounts.

Deposits represent the Bank's primary source of funds.  Deposits in 1997 grew by
$1.4 million. Loans grew by $19.5 million. Some of that growth was funded by the
principal  pay downs on  mortgage-backed  securities  and some  through  deposit
growth, but most was funded through borrowings. Borrowings grew by $15.0 million
in 1997.

The  Bank's  primary  approach  to  measuring  liquidity  is  utilizing  a Basic
Surplus/Deficit model. It is used to calculate liquidity over 30-day horizon, by
examining the  relationship  between liquid assets and  short-term  liabilities,
which are  vulnerable  to  non-replacement  within a 30-day  period.  The Bank's
minimum  policy level of liquidity  under this model is 5% of total  assets.  At
December 31, 1997, the 30-day ratio was 9.74% (14.88% including borrowable funds
available from the Federal Home Loan Bank of Boston).

Regulatory  standards for bank capital adequacy require that capital be at least
8% of  risk-adjusted  assets.  KSB Bancorp,  Inc.'s total capital ratio of 11.4%
exceeds the guideline,  as does the Bank's 11.1% ratio.  In dollars,  this means
that the Company has the ability to pay dividends subject to the minimum capital
requirement.

The Company's  profitable year in 1997 resulted in an increase in  stockholder's
equity of  $1,763,000  for the year ended  December  31,  1997.  Included in the
increase is $176,000, which represents the increased market price on ESOP shares
released during 1997 and which, under generally accepted accounting  principles,
is included in salaries and benefits expense.

                                       4
<PAGE>
IMPACT OF INFLATION AND CHANGING PRICES

The Consolidated  Financial  Statements and related notes,  presented  elsewhere
herein,  have been prepared in accordance  with  generally  accepted  accounting
principles.  These principles  require the measurement of financial position and
operating results in terms of historical dollars without  considering changes in
the relative purchasing power of money over time due to inflation.

Unlike many industrial companies,  substantially all of the assets and virtually
all of the liabilities of KSB Bancorp, Inc. are monetary in nature. As a result,
interest rates have a more  significant  impact on the Company  performance than
the general level of inflation.  Over short periods of time,  interest rates may
not  necessarily  move  in the  same  direction  or in  the  same  magnitude  as
inflation.

RECENT ACCOUNTING DEVELOPMENTS

During 1997, the Company adopted  Statements of Financial  Accounting  Standards
(SFAS) No. 125 and No. 127,  which relate to the  accounting  for  transfers and
servicing of financial assets and  extinguishment  of certain  liabilities.  The
adoption  of these  standards  did not have a material  effect on the  financial
statements.

The Financial  Accounting  Standards  Board issued the  following  Statements of
Financial Accounting Standards during 1997:

         SFAS No. 128      Earnings Per Share

         SFAS No. 129      Disclosure of Information About Capital Structure

         SFAS No. 130      Reporting Comprehensive Income

         SFAS No. 131      Disclosures about Segments of an Enterprise and
                           Related Information

These four statements do not change the measurement or recognition  methods used
in  financial  statements  but  rather  deal with  disclosure  and  presentation
requirements.

The financial  statements for 1997 and all prior periods are restated to include
the  disclosure  requirements  relating to earnings  per share that are required
under SFAS No. 128.  Financial  statement  disclosures also comply with SFAS No.
129, which summarizes but does not change the Company's requirements to disclose
information about capital structure.

SFAS No. 130 and No. 131 are effective for periods  beginning after December 15,
1997.  Management  expects  unrealized  gains and losses on  available  for sale
securities to be the only item reported as other comprehensive income under SFAS
No. 130. The effect,  if any, of SFAS No. 131 on disclosure  requirements on the
Company has not been determined

YEAR 2000 RISK ASSESSMENT AND ACTION PLAN

Management is aware of reports in the media and elsewhere that many business and
personal  computer  applications will not operate as intended past the year 1999
without at least some changes in programs or hardware.  This  potential  problem
results from the fact that many computers store dates in two-digit format (e.g.,
97) instead of four-digit format (1997). On January 1, 2000, it is possible that
some  hardware  systems  and  software  programs  will be unable to  distinguish
between  the years 2000 and 1900,  or 2001 and 1901,  resulting  in  calculation
errors or system failures of some magnitude.

During  1997,  the Bank  established  a committee  to identify  all Bank systems
subject to Year 2000  effects  and require  vendor  and/or  in-house  testing to
assure that systems will operate properly beyond December 31, 1999.

In addition to the Bank's own stringent  identification and testing  procedures,
the Bank's deposit insurer, the Federal Deposit Insurance Corporation, is taking
steps to assure that all its insured  institutions  are in compliance  with very
stringent system identification and testing criteria.

                                       5
<PAGE>
<TABLE>
<CAPTION>
Selected Consolidated Financial and Other Data of the Bank

                                                                                       ($ in 000's)
Selected Financial Data:                                    1997            1996           1995           1994         1993
------------------------------------------------------------------------------------------------------------------------------------
<S>                                                        <C>             <C>            <C>           <C>           <C>
   Total assets                                            152,752         134,357        125,233       113,003       65,514
   Loans receivable, net(1)                                118,857          99,197         85,889        68,634       46,661
   Investment securities available for sale(2)               9,261           7,452          8,377             0            0
   Investment securities to be held to maturity             14,171          18,517         19,102        36,207       14,255
   Goodwill                                                    517             620            723           716          322
   Deposits(3,4)                                           111,723         110,282        104,702        81,040       46,406
   Borrowed funds                                           28,219          13,186         10,952        23,367       11,220
   Total equity, substantially restricted                   11,555           9,792          8,498         7,621        7,365

   AVERAGE INTEREST EARNING ASSETS                         137,814         124,331        116,915        88,884       55,149
   AVERAGE ASSETS                                          144,458         130,742        122,899        92,459       58,526
   AVERAGE INTEREST BEARING LIABILITIES                    122,722         111,580        106,129        79,337       46,468
   AVERAGE EQUITY                                           10,612           9,134          7,961         7,502        5,685

Selected Operating Data:
   Interest and dividend income                             12,003          10,705          9,955         6,942        4,679
   Interest expense                                          5,752           5,166          5,025         3,267        1,720
------------------------------------------------------------------------------------------------------------------------------------
   Net interest income                                       6,251           5,539          4,930         3,675        2,959
   Less provision for loan losses                              530             390            315           140          120
------------------------------------------------------------------------------------------------------------------------------------
   Net interest income after
     provision for loan losses                               5,721           5,149          4,615         3,535        2,839
Non-interest income
   Net security gains (losses)                                   0             (47)            32             0            0
   Mortgage servicing                                          297             321            328           306          307
   Service charges and fees                                    705             700            568           440          337
   Other                                                       184             165            194           211          327
------------------------------------------------------------------------------------------------------------------------------------
      Total non-interest income                              1,186           1,139          1,122           957          971
------------------------------------------------------------------------------------------------------------------------------------
Non-interest expense
   Salaries and benefits                                     2,206           2,051          2,100         2,015        1,312
   Occupancy                                                   281             299            312           270          162
   Equipment                                                   730             629            625           634          367
   BIF premium                                                  28             236            137           151           95
   Other                                                     1,357           1,246          1,404         1,178          881
------------------------------------------------------------------------------------------------------------------------------------
      Total non-interest expense                             4,602           4,461          4,578         4,248        2,817
------------------------------------------------------------------------------------------------------------------------------------
   Income before income taxes                                2,305           1,827          1,159           244          993
   Income tax expense                                          756             583            336            22          270
------------------------------------------------------------------------------------------------------------------------------------
      Net income                                             1,549           1,244            823           222          723
====================================================================================================================================
</TABLE>

                                       6
<PAGE>
<TABLE>
<CAPTION>
Selected Consolidated Financial and Other Data of the Bank

Selected Financial Data:                                     1997             1996           1995           1994         1993
------------------------------------------------------------------------------------------------------------------------------------
<S>                                                          <C>             <C>            <C>           <C>           <C>
   Return on average assets                                   1.07%           0.95%          0.67%         0.24%         1.24%
   Return on average equity                                  14.60           13.62          10.34          2.95         12.72
   Average equity to average assets                           7.35            6.99           6.48          8.11          9.71
   Equity to total assets                                     7.56            7.29           6.79          6.74         11.24
   Tangible equity to tangible assets                         7.25            6.86           6.24          6.15         10.80
   Interest rate spread during period                         3.95            3.91           3.70          3.54          4.52
   Net interest margin(5)                                     4.46            4.38           4.14          3.99          5.10
   Operating expenses to average assets(6)                    3.11            3.33           3.73          4.59          4.70
   Non-accruing loans to total loans(7)                       1.76            1.91           1.92          1.99          1.78
   Non-performing assets to total assets(7,8)                 1.47            1.50           1.35          1.22          1.28
   Allowance for loan losses to
     non-performing loans                                    64.21           47.12          52.69         44.95         60.80
   Allowance for loan losses to total loans                   1.12            0.89           1.00          0.89          1.08
   Average interest-earning assets to
     average interest-bearing liabilities                     1.12x           1.11x          1.10x         1.12x         1.19x
   Basic Earnings per Share(9)                               $1.30           $1.07          $0.72         $0.20         $0.65
   Diluted Earnings per Share(9)                             $1.23           $1.01          $0.69         $0.19         $0.62
</TABLE>

1 Includes loans held for sale.

2 At market.

3 Includes escrows and trustee accounts for sold loans.

4 In March, 1994 the Bank acquired one branch with deposits of $42.3 million. In
  March, 1995, the Bank acquired four branches with deposits of $19.4 million.

5 Calculation is based upon net interest income before provision for loan losses
  and before certain loan fees and net income on interest rate swaps, floors and
  caps divided by interest-earning assets.

6 For purposes of calculating this ratio,  operating expenses equal non-interest
  expense less amortization of goodwill.

7 Includes  restructured  loans that are  performing  in  accordance  with their
  restructured  terms but whose  interest  is  recognized  on a cash basis only.
  Amounts are $486,000, $672,000, $765,000, $501,000 and $50,000 at December 31,
  1993, 1994, 1995, 1996 and 1997, respectively.

8 Non-performing assets consist of non-accruing loans and real estate owned.

9 Earnings per Share, restated to reflect stock dividend and stock split.

                                       7
<PAGE>
INDEPENDENT AUDITORS' REPORT

Board of Directors and Stockholders
KSB Bancorp, Inc. and Subsidiary

We have audited the accompanying  consolidated statements of financial condition
of KSB Bancorp,  Inc. and  Subsidiary as of December 31, 1997 and 1996,  and the
related consolidated  statements of income,  changes in stockholders' equity and
cash flows for each of the three years in the period  ended  December  31, 1997.
These financial  statements are the responsibility of the Company's  management.
Our responsibility is to express an opinion on these financial  statements based
on our audits.

We  conducted  our  audits  in  accordance  with  generally   accepted  auditing
standards.  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 financial  statements  referred to above present fairly, in
all material respects,  the consolidated financial position of KSB Bancorp, Inc.
and Subsidiary as of December 31, 1997 and 1996, and the consolidated results of
their operations,  and their consolidated cash flows for each of the three years
in the period ended  December 31, 1997, in conformity  with  generally  accepted
accounting principles.


/s/Bery, Dunn, McNeil and Parker
--------------------------------
Bery, Dunn, McNeil and Parker

Portland, Maine
January 16, 1998

                                       8
<PAGE>
<TABLE>
<CAPTION>
Consolidated Statements of Financial Condition
DECEMBER 31, 1997 AND 1996

ASSETS                                                                               1997               1996
------------------------------------------------------------------------------------------------------------------------------------
<S>                                                                               <C>               <C>
Cash and due from banks                                                            $ 3,233,478       $ 2,479,367
Interest-bearing deposits with banks                                                     5,838             1,556
Securities available for sale, at market value                                       9,260,779         7,452,341
Securities held to maturity (market value $14,425,808
      and $18,587,246 at 1997 and 1996, respectively)                               14,170,856        18,516,750
Loans held for sale                                                                  2,007,110         1,819,209

Loans receivable
   Real estate mortgage                                                             52,710,292        50,873,593
   Home equity                                                                      13,718,409         6,041,705
   Installment                                                                       4,255,099         4,401,126
   Commercial                                                                       47,056,531        36,399,651
   Other                                                                               654,300           763,332
   Deferred loan origination fees                                                     (202,808)         (209,164)
------------------------------------------------------------------------------------------------------------------------------------
                                                                                   118,191,823        98,270,243
   Less allowance for possible loan losses                                          (1,341,828)         (893,456)
------------------------------------------------------------------------------------------------------------------------------------
         Total loans receivable, net                                               116,849,995        97,376,787
------------------------------------------------------------------------------------------------------------------------------------
Accrued interest receivable                                                            826,582           767,602
Other real estate owned                                                                158,554           116,500
Federal Home Loan Bank stock, at cost                                                1,537,650         1,320,550
Premises and equipment, net                                                          2,314,298         2,204,415
Goodwill                                                                               516,778           619,825
Deferred tax asset                                                                     661,099           464,903
Cash surrender value of life insurance                                                 588,217           554,096
Other assets                                                                           620,866           663,036
------------------------------------------------------------------------------------------------------------------------------------
                                                                                  $152,752,100      $134,356,937
====================================================================================================================================
</TABLE>

                                       9
<PAGE>
<TABLE>
<CAPTION>
Consolidated Statements of Financial Condition (continued)
LIABILITIES AND STOCKHOLDERS' EQUITY
                                                                                     1997               1996
------------------------------------------------------------------------------------------------------------------------------------
<S>                                                                               <C>               <C>
Liabilities
   Deposit accounts
      Demand                                                                      $ 12,140,898      $  9,206,066
      Regular savings                                                               20,055,303        21,043,376
      NOW accounts                                                                  13,914,421        14,075,564
      Money market accounts                                                          6,211,324         5,700,866
      Time                                                                          58,386,623        59,336,687
------------------------------------------------------------------------------------------------------------------------------------
         Total deposits                                                            110,708,569       109,362,559

   Advances from Federal Home Loan Bank                                             28,219,000        13,186,000
   Escrows and trustee accounts for sold loans                                       1,013,894           919,254
   Accrued expenses and other liabilities                                            1,255,534         1,096,962
------------------------------------------------------------------------------------------------------------------------------------
         Total liabilities                                                         141,196,997       124,564,775
------------------------------------------------------------------------------------------------------------------------------------

Commitments and contingency (Notes 9, 15 and 18)

Stockholders' equity
   Preferred stock, authorized 200,000 shares                                                --                 --
   Common stock, par value $.01; authorized 2,400,000 shares,
      issued and outstanding 1,246,950 shares in 1997 and
      1,233,165 shares in 1996, restated                                                12,470             4,111
   Additional paid-in capital                                                        4,543,655         4,325,499
   Retained earnings                                                                 7,171,531         5,748,714
   Net unrealized gain (loss) on securities available for sale,
      net of deferred taxes                                                             72,698           (37,760)
------------------------------------------------------------------------------------------------------------------------------------
                                                                                    11,800,354        10,040,564

   Less remaining obligation under:
   Employee Stock Ownership Plan                                                      (117,348)         (168,840)
   Bank Recognition and Retention Plan                                                 (50,918)          (79,562)
   Treasury stock, at cost (7,964 shares in 1997)                                      (76,985)               --
------------------------------------------------------------------------------------------------------------------------------------
         Total stockholders' equity                                                 11,555,103         9,792,162
------------------------------------------------------------------------------------------------------------------------------------
                                                                                  $152,752,100      $134,356,937
====================================================================================================================================
</TABLE>


                                       10
<PAGE>
<TABLE>
<CAPTION>
Consolidated Statements of Income
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995

                                                                     1997              1996              1995
------------------------------------------------------------------------------------------------------------------------------------
<S>                                                               <C>              <C>                <C>
Interest and dividend income
   Interest and fees on loans                                     $10,133,178      $ 8,756,148        $7,656,814
   Interest on securities available for sale                          669,865          466,560         2,146,754
   Interest on securities held to maturity                          1,108,105        1,397,322            60,000
   Dividends                                                           92,682           84,501            91,331
------------------------------------------------------------------------------------------------------------------------------------
         Total interest and dividend income                        12,003,830       10,704,531         9,954,899
------------------------------------------------------------------------------------------------------------------------------------
Interest expense
   Interest on deposits                                             4,378,125        4,483,138         4,025,561
   Interest on borrowed funds                                       1,374,125          682,469           998,852
------------------------------------------------------------------------------------------------------------------------------------
         Total interest expense                                     5,752,250        5,165,607         5,024,413
------------------------------------------------------------------------------------------------------------------------------------
         Net interest income                                        6,251,580        5,538,924         4,930,486
Provision for possible loan losses                                    530,000          390,000           315,000
------------------------------------------------------------------------------------------------------------------------------------
         Net interest income after provision
           for possible loan losses                                 5,721,580        5,148,924         4,615,486
------------------------------------------------------------------------------------------------------------------------------------
Noninterest income
   Gain (loss) on disposition of securities                                --          (46,617)           32,025
   Mortgage servicing fees                                            296,579          320,522           328,038
   Service charges and fees                                           705,160          699,747           567,836
   Other                                                              184,346          165,268           193,928
------------------------------------------------------------------------------------------------------------------------------------
         Total noninterest income                                   1,186,085        1,138,920         1,121,827
------------------------------------------------------------------------------------------------------------------------------------
Noninterest expense
   Salaries and benefits                                          $ 2,205,609      $ 2,050,381        $2,100,216
   Occupancy                                                          280,699          298,835           311,975
   Equipment                                                          729,862          629,391           625,234
   BIF Premium                                                         28,456          236,135           137,100
   Other                                                            1,357,196        1,246,321         1,403,861
------------------------------------------------------------------------------------------------------------------------------------
         Total noninterest expense                                  4,601,822        4,461,063         4,578,386
------------------------------------------------------------------------------------------------------------------------------------
         Income before income taxes                                 2,305,843        1,826,781         1,158,927
Income tax expense                                                    756,438          582,453           335,964
------------------------------------------------------------------------------------------------------------------------------------
         Net income                                               $ 1,549,405      $ 1,244,328        $  822,963
====================================================================================================================================

Per Share Data (Note 1)
   Basic earnings per common share                                    $  1.30          $  1.07           $  0.72
------------------------------------------------------------------------------------------------------------------------------------
   Diluted earnings per common share                                  $  1.23          $  1.01          $  0.69
------------------------------------------------------------------------------------------------------------------------------------
</TABLE>

                                       11
<PAGE>
<TABLE>
<CAPTION>
Consolidated  Statements of Changes in Stockholders' Equity
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995

                                                                                                   Net
                                                                                     Bank      Unrealized
                                                                      Employee    Recognition  (Gain) Loss
                                          Additional                     Stock        and     on Securities
                                Common      Paid-In      Retained      Ownership   Retention    Available    Treasury
                                 Stock      Capital      Earnings        Plan        Plan       for Sale       Stock        Total
------------------------------------------------------------------------------------------------------------------------------------
<S>                             <C>       <C>           <C>           <C>          <C>          <C>          <C>        <C>
Balances,
   December 31, 1994            $ 3,738   $3,435,590    $4,601,767    $(279,661)   $(140,870)         $--          --   $ 7,620,564
   Net income                        --           --       822,963           --           --           --          --       822,963
   Cash dividends declared
      ($.061 per share, net
      of dividends on ESOP
      shares)*                       --           --       (64,473)          --           --           --          --       (64,473)
   Payment of obligation
      under Employee Stock
      Ownership Plan                 --       39,350            --       56,695           --           --          --        96,045
      Bank Recognition and
      Retention Plan                 --           --            --           --       32,664           --          --        32,664
   Change in net unrealized loss
      on securities available for
      sale, net of deferred taxes
      of $5,000                      --           --            --           --           --       (9,532)         --        (9,532)
------------------------------------------------------------------------------------------------------------------------------------
Balances,
   December 31, 1995              3,738    3,474,940     5,360,257     (222,966)    (108,206)      (9,532)         --     8,498,231
   Net income                        --           --     1,244,328           --           --           --          --     1,244,328
   Cash dividends declared
      ($.064 per share, net
      of dividends on ESOP
      shares)*                                    --            --      (72,466)          --           --          --       (72,466)
   10% stock dividend               373      783,032      (783,405)          --           --           --          --            --
   Payment of obligation
      under Employee Stock
      Ownership Plan                 --       67,527            --       54,126           --           --          --       121,653
   Bank Recognition and
      Retention Plan                 --           --            --           --       28,644           --          --        28,644
   Change in net unrealized loss
      on securities available for
      sale, net of deferred taxes

      of $14,400                     --           --            --           --           --      (28,228)         --       (28,228)
------------------------------------------------------------------------------------------------------------------------------------
Balances,
   December 31, 1996            $ 4,111   $4,325,499    $5,748,714    $(168,840)   $ (79,562)   $ (37,760)        $--   $ 9,792,162
</TABLE>

                                       12
<PAGE>
<TABLE>
<CAPTION>
Consolidated Statements of Changes in Stockholders' Equity (Continued)
Years Ended December 31, 1997, 1996 and 1995

                                                                                                   Net
                                                                                     Bank      Unrealized
                                                                      Employee    Recognition  (Gain) Loss
                                          Additional                     Stock        and     on Securities
                                Common      Paid-In      Retained      Ownership   Retention    Available    Treasury
                                 Stock      Capital      Earnings        Plan        Plan       for Sale       Stock        Total
------------------------------------------------------------------------------------------------------------------------------------
Balances,
<S>                             <C>       <C>           <C>           <C>          <C>          <C>          <C>        <C>
   December 31, 1996            $ 4,111   $4,325,499    $5,748,714    $(168,840)   $ (79,562)   $ (37,760)        $--   $ 9,792,162
   Net income                        --           --     1,549,405           --           --           --          --     1,549,405
   Cash dividends declared
      ($.073 per share, net
      of dividends on ESOP
      shares)*                       --           --       (85,721)          --           --           --          --       (85,721)
   Payment of obligation
      under Employee
      Stock Ownership
      Plan                           --      176,428            --       51,492           --           --          --       227,920
   Bank Recognition and
      Retention Plan                 --           --            --           --       28,644           --          --        28,644
   17,820 shares issued under
      Stock Option Plans             59       53,941            --           --           --           --          --        54,000
   Purchase of 12,870
      shares of treasury
      stock                          --           --            --           --           --           --    (124,405)     (124,405)
   Retire 4,035 shares of
      treasury stock                (13)     (12,213)      (26,774)          --           --           --      39,000            --
   Reissuance of 871 shares
      of treasury stock              --           --        (5,780)          --           --           --       8,420         2,640
   Effect of July 10, 1997,
      stock split effect-
      ed in the form of a
      200% dividend               8,313           --        (8,313)          --           --           --          --            --
   Change in net unrealized
      gain (loss) on securities
      available for sale, net
      of deferred taxes of
      $56,850                        --           --            --           --           --      110,458                   110,458
------------------------------------------------------------------------------------------------------------------------------------
Balances,
   December 31, 1997            $12,470   $4,543,655    $7,171,531    $(117,348)    $(50,918)    $ 72,698    $(76,985)  $11,555,103
====================================================================================================================================
</TABLE>
*Restated for a three-for-one  stock split, in the form of a 200% stock dividend
declared in 1997.

                                       13
<PAGE>
<TABLE>
<CAPTION>
Consolidated Statements of Cash Flows
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995

                                                                     1997              1996              1995
------------------------------------------------------------------------------------------------------------------------------------
<S>                                                               <C>              <C>                <C>
Cash flows from operating activities
   Net income                                                     $ 1,549,405      $ 1,244,328        $  822,963
   Adjustments to reconcile net income to net cash
      provided by operating activities
         Depreciation and amortization                                748,677          745,293           675,561
         Decrease in obligation under ESOP and BRP                    256,564          150,298           128,708
         Provision for loan losses                                    530,000          390,000           315,000
         Deferred income taxes                                       (260,405)         (21,857)          (91,045)
         Net gain on sale of loans held for sale                      (63,226)         (49,738)          (35,807)
         Net gain on sale of securities available for sale                 --               --           (32,025)
         Net loss on default of security held to maturity                  --           46,617                --
         Net loss on disposal of equipment                              5,973               --            33,250
         Loss on sale of other real estate owned                           --           14,204             5,653
         Originations of loans held for sale                       (6,625,287)      (5,842,269)       (4,626,130)
         Proceeds from loans held for sale                          4,083,405        5,199,250         7,281,107
         Decrease (increase) in
            Interest receivable                                       (62,914)          48,726           (81,228)
            Other receivables and prepaid expense                     (57,018)           9,119           116,071
            Cash surrender value of life insurance                    (34,121)         (60,337)          (21,504)
         Increase (decrease) in

            Accrued income taxes payable                               (1,175)         (15,690)            5,189
            Deferred origination fees                                  (6,356)          22,846           (39,211)
            Accrued expenses and other liabilities                    167,109           37,745             9,923
------------------------------------------------------------------------------------------------------------------------------------
         Net cash provided by operating activities                    230,631        1,918,535         4,466,475
------------------------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities
   Net decrease (increase) in interest-bearing deposits
      with banks                                                       (4,282)       2,458,977        (2,440,068)
   Proceeds from maturities and principal payments on
      securities held to maturity                                   4,195,590        5,730,367         4,343,000
   Purchase of securities held to maturity                                 --       (5,364,445)               --
   Proceeds from maturities and principal payments on
      securities available for sale                                 5,355,874          860,627           227,549
   Purchase of securities available for sale                       (7,018,176)              --                --
   Proceeds from sale of securities available for sale                     --               --         4,030,625
   Net increase in loans                                          (17,738,199)     (13,142,669)      (13,745,541)
   Capital expenditures                                              (548,528)        (318,563)         (321,512)
   Purchase of FHLB stock                                            (217,100)              --          (167,200)
   Net decrease in other assets                                        61,638           68,330            18,236
   Proceeds from sale of other real estate owned                      116,500           26,973            37,783
------------------------------------------------------------------------------------------------------------------------------------
      Net cash used by investing activities                       (15,796,683)      (9,680,403)       (8,017,128)
------------------------------------------------------------------------------------------------------------------------------------
</TABLE>

                                       14
<PAGE>
<TABLE>
<CAPTION>
Consolidated Statements of Cash Flows (Continued)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995

                                                                     1997              1996              1995
------------------------------------------------------------------------------------------------------------------------------------
<S>                                                               <C>              <C>               <C>
Cash flows from financing activities
   Cash received through branch acquisition                               $--              $--       $12,314,461
   Net increase (decrease) in time deposit accounts                  (950,065)       3,820,457         5,348,492
   Net increase (decrease) in other deposit accounts                2,296,074        1,856,448        (1,364,578)
   Net increase (decrease) in FHLB advances                        15,033,000        2,234,000       (12,415,000)
   Net increase (decrease) in escrow accounts                          94,640          (97,000)          245,366
   Proceeds from stock issuance under option plan                      54,000               --                --
   Purchase of treasury stock issued                                 (124,405)              --                --
   Proceeds from reissuance of treasury stock under
      option plan                                                          --            2,640                --
   Cash dividends paid                                                (85,721)         (72,466)          (64,473)
------------------------------------------------------------------------------------------------------------------------------------
         Net cash provided by financing activities                 16,320,163        7,741,439         4,064,268
------------------------------------------------------------------------------------------------------------------------------------
         Net increase (decrease) in cash and
            cash equivalents                                          754,111          (20,429)          513,615
Cash and cash equivalents, beginning of year                        2,479,367        2,499,796         1,986,181
------------------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents, end of year                            $ 3,233,478      $ 2,479,367       $ 2,499,796
====================================================================================================================================

Supplemental disclosures of cash flow information
   Cash paid during the year for
      Interest                                                    $ 5,703,515      $ 5,200,515       $ 5,058,469
====================================================================================================================================
      Income taxes, net of refunds                                $ 1,018,019       $  620,000        $  333,610
====================================================================================================================================

The Company had the following noncash transactions
   Cost of securities held to maturity transferred to
      securities available for sale                                      $ --              $--       $12,529,371
   Net increase (decrease) required by Statement of
      Financial Accounting Standards No. 115
         Unrealized loss on securities available for sale            (167,309)          42,629            14,532
         Deferred income tax assets                                   (56,851)          14,400             5,000
         Net unrealized loss on securities available for sale        (110,458)          28,229             9,532
   Net transfer from loans to other real estate owned                 158,554          116,500            72,913
</TABLE>

                                       15
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 1997, 1996 and 1995

Nature of Business

      KSB Bancorp,  Inc. (the Company) provides a full range of banking services
      to individual and corporate  customers through its subsidiary and branches
      located in Franklin,  Somerset,  and Androscoggin counties. The Company is
      subject to the  regulations  of certain  state and  federal  agencies  and
      undergoes periodic examination by those regulatory authorities.

1.    Summary of Significant Accounting Policies

      Use of Estimates

      The  preparation  of financial  statements  in conformity  with  generally
      accepted  accounting  principles requires management to make estimates and
      assumptions that affect the reported amounts of assets and liabilities and
      disclosure  of  contingent  assets  and  liabilities  at the  date  of the
      financial  statements  and the  reported  amounts of revenues and expenses
      during the  reporting  period.  Actual  results  could  differ  from those
      estimates.

      Material estimates that are particularly susceptible to significant change
      in the near term relate to the  determination  of the  allowance  for loan
      losses and the  valuation  of real  estate  acquired  in  connection  with
      foreclosures   or  in  satisfaction  of  loans.  In  connection  with  the
      determination  of the allowance for loan losses and the carrying  value of
      real  estate  owned,   management  obtains   independent   appraisals  for
      significant properties.

      Principles of Consolidation

      The accompanying consolidated financial statements include the accounts of
      KSB Bancorp, Inc. and its wholly-owned subsidiary,  Kingfield Savings Bank
      (the Bank). All significant  intercompany  balances and transactions  have
      been eliminated in the accompanying consolidated financial statements.

      Cash and Cash Equivalents

      For the purpose of  presentation  in the  consolidated  statements of cash
      flows, cash and cash equivalents include cash on hand and amounts due from
      banks.

      In the normal  course of business,  the Bank has funds on deposit at other
      financial institutions in amounts in excess of the $100,000 insured by the
      FDIC.

      The Federal Reserve Board requires the Bank to maintain a reserve balance.
      The amount of this reserve balance as of December 31, 1997 is $690,000.

      Securities

      The Bank's investment accounting policies are as follows:

      Securities  Available for Sale:  Securities  available for sale consist of
      securities that the Bank  anticipates  could be made available for sale in
      response to changes in market interest rates,  liquidity needs, changes in
      funding sources and other similar  factors.  These assets are specifically
      identified  and are carried at fair value.  Amortization  of premiums  and
      accretion  of  discounts  are  recognized  in  interest  income  using the
      interest method over the period to maturity.  Unrealized holding gains and
      losses for these assets,  net of related  income taxes,  are excluded from
      earnings  and are  reported  as a net  amount in a separate  component  of
      stockholders'  equity.  Realized  gains and losses on securities  sold are
      computed on the identified cost basis on the trade date.

                                       16
<PAGE>
1.    Summary of Significant Accounting Policies (Continued)

      Securities  Held to  Maturity:  Securities  held to  maturity  consist  of
      securities  purchased  for  which  the Bank has the  positive  intent  and
      ability to hold such securities until maturity.  Securities  classified as
      held to  maturity  are  carried  at cost,  adjusted  for  amortization  of
      premiums  and  accretion  of  discounts.  When  decline in market value is
      considered   other  than   temporary,   the  loss  is  recognized  in  the
      consolidated statements of income, resulting in the establishment of a new
      cost basis for the security. Market values of securities are determined by
      prices obtained from independent market sources.

      Loans Held for Sale

      Mortgage loans  originated  and intended for sale in the secondary  market
      are  carried  at the  lower  of  cost or  estimated  market  value  in the
      aggregate.  Net unrealized losses are recognized in a valuation  allowance
      by  charges  to income.  Gains and  losses  are  computed  on the basis of
      specific identification.

      Loan Servicing

      The Bank  recognizes a loan servicing fee for the  difference  between the
      principal and interest payment  collected on the sold loan and the payment
      remitted to the investor.

      Statement of Financial  Accounting  Standards (SFAS) No. 122,  "Accounting
      for  Mortgage  Servicing  Rights,"  requires  the Company to  recognize as
      separate assets the rights to service  mortgage loans for others for loans
      originated after December 31, 1995.

      SFAS No. 125,  Accounting for Transfers and Servicing of Financial  Assets
      and  Extinguishments  of Liabilities," was adopted at January 1, 1997. The
      Company  capitalizes  mortgage  servicing  rights at their  allocated cost
      based on the relative fair values upon the sale of the related loans.  The
      cost of mortgage  servicing rights is amortized in proportion to, and over
      the period of,  estimated net servicing  revenues.  Impairment of mortgage
      servicing rights is assessed based on the fair value of those rights. Fair
      values are estimated using discounted cash flows based on a current market
      interest  rate.  For  purposes  of  measuring  impairment,  the rights are
      stratified based on the following  predominant risk characteristics of the
      underlying  loans:  interest  rate,  fixed or variable  rate and period of
      origination.  The amount of  impairment  recognized is the amount by which
      the capitalized  mortgage servicing rights for a stratum exceed their fair
      value.  The  adoption  of SFAS No.  122 and  SFAS  No.  125 did not have a
      material  effect  on the  Company's  financial  condition  or  results  of
      operations.

      Loans Receivable

      Loans  receivable  that  management has the intent and ability to hold for
      the foreseeable  future or until maturity or pay-off are reported at their
      outstanding principal balance adjusted for any charge-offs,  the allowance
      for loan losses,  and any deferred fees or costs on originated  loans.

      The  allowance  for loan  losses is  increased  by  charges  to income and
      decreased  by  charge-offs,  net  of  recoveries.   Management's  periodic
      evaluation  of the  adequacy of the  allowance is based on the Bank's past
      loan loss experience,  known and inherent risks in the portfolio,  adverse
      situations that may affect the borrower's  ability to repay, the estimated
      value of any underlying collateral, and current economic conditions.

      Management believes that the allowance for loan losses is adequate.  While
      management  uses  available  information  to  recognize  losses  on loans,
      changing economic  conditions and the economic  prospects of the borrowers
      may necessitate future additions to the allowance.

      Loans  considered  to be  impaired  are  reduced to the  present  value of
      expected  future  cash  flows  or to the  fair  value  of  collateral,  by
      allocating a portion of the  allowance  for loan losses to such loans.  If
      these  allocations  cause the  allowance  for loan  losses to  require  an
      increase, such increase is reported as loan loss provision.

                                       17
<PAGE>

1.    Summary of Significant Accounting Policies (Continued)

      The carrying values of impaired loans are periodically adjusted to reflect
      cash payments,  revised  estimates of future cash flows,  and increases in
      the present value of expected cash flows due to the passage of time.  Cash
      payments  representing  interest  income are reported as such.  Other cash
      payments are reported as  reductions in carrying  value.  Increases due to
      changes  in  estimates  of  future  payments  are  reported  as loan  loss
      provision and decreases are reported as reductions in loan loss provision.

      The accrual of interest on loans is  discontinued  when,  in  management's
      opinion,  the borrower may be unable to meet  payments as they become due.
      Uncollectible  interest  on  loans  that  are  contractually  past  due is
      reversed.  The loan is returned to accrual  status when,  in  management's
      judgment,  the borrower's  ability to make periodic interest and principal
      payments is back to normal.  Until the loan is returned to accrual status,
      all payments are applied to principal and interest income.

      Loan Origination Fees and Related Costs

      Loan fees and certain direct loan origination costs are deferred,  and the
      net fee or cost is recognized  as an  adjustment to interest  income using
      the interest method over the contractual  life of the loans,  adjusted for
      estimated   prepayments   based  on  the  Bank's   historical   prepayment
      experience.

      Real Estate Owned

      Real estate properties  acquired through,  or in lieu of, loan foreclosure
      are  initially  recorded at the lower of cost or fair value at the date of
      foreclosure.  Costs relating to  improvement of property are  capitalized,
      whereas costs relating to the holding of property are expensed. Valuations
      are periodically  performed by management,  and an allowance for losses is
      established  by a charge to operations if the carrying value of a property
      exceeds its fair market value less estimated costs to sell.

      Premises and Equipment

      Premises and equipment and related  improvements  are stated at cost, less
      accumulated depreciation and amortization.

      Premises  and  equipment  are   depreciated  by  the   straight-line   and
      accelerated  methods over the assets'  estimated  useful lives.  Leasehold
      improvements  are  amortized  by the  straight-line  method over the lease
      terms.

      Goodwill

      The  excess of cost  over  fair  value of net  assets  acquired  in branch
      acquisitions is amortized to expense using the  straight-line  method over
      ten years.  On an ongoing  basis,  management  reviews the  valuation  and
      amortization of goodwill to determine possible impairment.

      Income Taxes

      Deferred  tax  assets  and  liabilities   are  determined   based  on  the
      differences  between the  financial  statement and tax bases of assets and
      liabilities  using  enacted  tax rates in effect for the year in which the
      differences  are  expected to  reverse.  Principal  temporary  differences
      include  depreciation,  the provision for loan losses, and the deferral of
      loan origination fees.

      Financial Instruments with Off-Balance Sheet Risk

      The Company uses  off-balance  sheet financial  instruments as part of its
      asset/liability management activities. The Company does not intend to sell
      any of these instruments.

                                       18
<PAGE>
1.    Summary of Significant Accounting Policies (Concluded)

      Interest rate swap  agreements are accounted for using the accrual method.
      Net interest  income  (expense)  resulting from the  differential  between
      exchanging  floating  and  fixed-rate  interest  payments is recorded on a
      current  basis.

      Interest  rate floors are contracts in which a floor is  established  at a
      specified  rate and period of time.  The premium  paid for the contract is
      amortized  over its life.  Any cash  payments  received are recorded as an
      adjustment to net interest income.

      In  the  ordinary  course  of  business,  the  Company  has  entered  into
      off-balance  sheet  financial  instruments  consisting of  commitments  to
      extend credit and commercial letters of credit. Such financial instruments
      are recorded in the financial  statements  when they are funded or related
      fees are incurred or received.

      Stockholders' Equity

      At December 31, 1997,  the Company  adopted  SFAS No. 128,  "Earnings  Per
      Share." SFAS 128 specifies the computation and disclosure requirements for
      earnings  per  share for  entities  with  publicly  held  common  stock or
      potential  common  stock.  The  effect  of SFAS No.  128 on the  Company's
      financial  statements is to  retroactively  present  diluted  earnings per
      share,  in addition to basic  earnings per share  already  presented.

      The   basic   earnings   per   share   computation   is  based   upon  the
      weighted-average  number of shares of stock outstanding during the period.
      Only ESOP shares that have been  committed to be released  are  considered
      outstanding.  Potential  common stock is considered in the  calculation of
      weighted-average shares outstanding for diluted earnings per share.

      In 1997, the Company declared a three-for-one  stock split effected in the
      form of a 200% stock  dividend.  Earnings and cash dividends per share and
      weighted-average  shares outstanding have been  retroactively  restated to
      reflect the stock dividend.

      At December 31, 1997,  the Company  adopted SFAS No. 129,  "Disclosure  of
      Information about Capital  Structure." This statement has no effect on the
      Company's  financial  statements  as  the  capital  disclosures  meet  the
      requirements of SFAS No. 129.

2.    Securities

      Debt and  equity  securities  have  been  classified  in the  consolidated
      statements of financial  condition  according to management's  intent. The
      carrying  amounts  of  securities  and their  approximate  fair  values at
      December 31 follow:
<TABLE>
<CAPTION>
                                                Gross                   Gross
                                              Amortized              Unrealized             Unrealized                Fair
                                                Cost                    Gains                 Losses                  Value
------------------------------------------------------------------------------------------------------------------------------------
<S>                                        <C>                         <C>                    <C>                <C>
      Available for Sale:
      1997
      Mortgage-backed securities             $ 9,150,630                $113,570                $ 3,421            $ 9,260,779
====================================================================================================================================
      1996
      U.S. Government agency securities
        and obligations                      $ 3,999,921                 $ 1,594                $ 2,452           $  3,999,063
      Mortgage-backed securities               3,509,581                      --                 56,303              3,453,278
------------------------------------------------------------------------------------------------------------------------------------
                                             $ 7,509,502                 $ 1,594               $ 58,755           $  7,452,341
====================================================================================================================================
      Held to Maturity:
      1997
      Mortgage-backed securities             $12,769,001                $231,052               $ 17,512            $12,982,541
      REMIC                                    1,401,855                  41,412                     --              1,443,267
------------------------------------------------------------------------------------------------------------------------------------
                                             $14,170,856                $272,464               $ 17,512            $14,425,808
====================================================================================================================================
      1996
      Corporate bonds                           $ 21,611                   $  54                   $ --               $ 21,665
      Mortgage-backed securities              16,728,785                 160,288                108,438             16,780,635
      REMIC                                    1,766,354                  18,592                     --              1,784,946
------------------------------------------------------------------------------------------------------------------------------------
                                           $  18,516,750               $ 178,934              $ 108,438          $  18,587,246
====================================================================================================================================
</TABLE>

                                       19
<PAGE>
      2. Securities (Concluded)

      Mortgage-backed  securities  are subject to risk of  prepayment  which can
      affect the yields  realized on the  securities by increasing or decreasing
      the period over which  premiums and discounts  are  recognized in interest
      income.

      The  amortized  cost and fair value of securities at December 31, 1997, by
      contractual maturity, are as follows:
<TABLE>
<CAPTION>
                                                        Held to Maturity                            Available for Sale
------------------------------------------------------------------------------------------------------------------------------------
                                               Amortized                 Fair                  Amortized                Fair
                                                 Cost                    Value                   Cost                   Value
------------------------------------------------------------------------------------------------------------------------------------
<S>                                          <C>                     <C>                     <C>                    <C>
      Due in one year or less                 $  238,845              $  237,175                    $--                    $--
      Due from one to five years               5,271,281               5,337,255                     --                     --
      Due from five to ten years               4,143,773               4,213,674              2,731,811              2,731,021
      Due after ten years                      4,516,957               4,637,704              6,418,819              6,529,758
------------------------------------------------------------------------------------------------------------------------------------
                                             $14,170,856             $14,425,808             $9,150,630             $9,260,779
====================================================================================================================================
</TABLE>

      For purposes of the maturity table,  mortgage-backed securities, which are
      not due at a single  maturity  date,  have been  allocated  over  maturity
      groupings  based on the  weighted-average  contractual  maturities  of the
      underlying collateral.  The mortgage-backed  securities may mature earlier
      than their  weighted-average  contractual  maturities because of principal
      prepayments.

      Gross realized gains on sale of securities available for sale were $32,025
      for 1995. No securities  available for sale were sold in 1996 or 1997. The
      Bank  realized  a loss of $46,617  on the  default  of a security  held to
      maturity  in  1996.   The  Bank  has  pledged   $4,250,000  of  its  FHLMC
      mortgage-backed securities against public unit deposits.

3.    Loans Receivable

      Activity in the allowance for loan losses is summarized as follows for the
      years ended December 31:
<TABLE>
<CAPTION>
                                                                     1997              1996              1995
------------------------------------------------------------------------------------------------------------------------------------
<S>                                                                <C>                <C>               <C>
      Balance at beginning of year                                 $  893,456         $866,770          $613,600
      Provision charged to income                                     530,000          390,000           315,000
      Loans charged off                                              (141,098)        (400,684)          (95,742)
      Recoveries on loans previously charged off                       59,470           37,370            33,912
------------------------------------------------------------------------------------------------------------------------------------
      Balance at end of year                                       $1,341,828         $893,456          $866,770
====================================================================================================================================
</TABLE>

      Information regarding impaired loans is as follows:
<TABLE>
<CAPTION>
                                                                                       1997              1996
------------------------------------------------------------------------------------------------------------------------------------
<S>                                                                                 <C>               <C>
      Average investment in impaired loans                                          $1,790,147        $1,126,828
      Interest income recognized on impaired loans including
        interest income recognized on cash basis                                       186,119           105,397
      Interest income recognized on impaired loans on cash basis                       204,328            99,637


      Information regarding allowance for loan losses allocated to impaired
      loans at December 31, is as follows:
      Balance of impaired loans                                                     $1,573,216        $  945,107
      Less portion for which no allowance for loan losses
        is allocated                                                                 1,545,234           779,036
------------------------------------------------------------------------------------------------------------------------------------
      Portion of impaired loan balance for which an allowance
        for loan losses is allocated                                                $   27,982        $  166,071
====================================================================================================================================
      Portion of allowance for loan losses allocated to the
        impaired loan balances                                                      $   10,982         $  92,542
====================================================================================================================================
</TABLE>
                                       20
<PAGE>
      3. Loans Receivable (Concluded)

      Loans placed on nonaccrual status amounted to $2,090,266,  $1,894,503, and
      $1,645,262,  at December  31,  1997,  1996 and 1995,  respectively.  Gross
      interest  income that would have been recorded under the original terms of
      such loans and the interest income actually recognized for the years ended
      December 31 are summarized below:
<TABLE>
<CAPTION>
                                                                     1997              1996              1995
------------------------------------------------------------------------------------------------------------------------------------
<S>                                                                  <C>              <C>               <C>
      Interest income that would have been recorded                  $205,906         $203,800          $198,247
      Interest income recognized                                       89,041          135,178           129,730
------------------------------------------------------------------------------------------------------------------------------------
      Interest income foregone                                       $116,865         $ 68,622          $ 68,517
====================================================================================================================================
</TABLE>

4.    Loan Servicing

      Mortgage  loans  serviced for others are not included in the  accompanying
      statement of financial  condition.  The unpaid principal  balance of these
      loans is  $75,111,086  and  $78,287,014  at  December  31,  1997 and 1996,
      respectively.

      Custodial escrow balances maintained in connection with the foregoing loan
      servicing  were  $303,482  and  $460,166  at  December  31, 1997 and 1996,
      respectively.

      Mortgage  servicing  rights of $38,456  and  $27,712  are  capitalized  at
      December  31,  1997 and  1996,  respectively,  and are  included  in other
      assets.  The amortized cost  approximates  fair value at December 31, 1997
      and 1996.

5.    Premises and Equipment

      Premises and equipment at December 31 consist of the following:
<TABLE>
<CAPTION>
                                                                                       1997              1996
------------------------------------------------------------------------------------------------------------------------------------
<S>                                                                                 <C>               <C>
      Land and improvements                                                         $  310,889        $  310,889
      Bank buildings and leasehold improvements                                      1,643,639         1,552,031
      Furniture and fixtures                                                         2,592,222         2,187,846
------------------------------------------------------------------------------------------------------------------------------------
                                                                                     4,546,750         4,050,766
      Less accumulated depreciation                                                  2,232,452         1,846,351
------------------------------------------------------------------------------------------------------------------------------------
                                                                                    $2,314,298        $2,204,415
====================================================================================================================================
</TABLE>
      Depreciation expense was $432,674,  $368,556, and $375,994, in 1997, 1996,
      and 1995, respectively.

      The Bank is committed under a  noncancellable  operating lease with a term
      greater  than one year.  Future  minimum  rental  commitments  under  this
      operating lease through the year 2000 are  approximately  $4,000 per year.

      The related rent expense,  net of sublease income,  was $(1,587),  $1,226,
      and $21,025, in 1997, 1996, and 1995, respectively.

6.    Branch Acquisitions

      On March 10, 1995,  the Bank acquired four western Maine branches of Fleet
      Bank of Maine. The acquisition was accounted for under the purchase method
      of  accounting  for business  combinations.  The Bank received net cash of
      approximately  $12,300,000  for  deposits  assumed,  net of loans and bank
      premises and equipment  acquired.

      Goodwill  for  branches  acquired  in 1995  and in  prior  years  is being
      amortized  using the  straight-line  method  over ten years.  Amortization
      charged to operations was $103,047,  $103,047, and $101,240 in 1997, 1996,
      and 1995, respectively.

                                       21
<PAGE>
      7. Deposits

      At December 31, 1997,  the  scheduled  maturities  of time deposits are as
      follows:

      1998                          $29,875,946
      1999                           10,442,172
      2000                           16,200,087
      2001                              890,664
      2002 and thereafter               977,754
                                    -----------
                                    $58,386,623
                                    ===========

      The aggregate  amount of short-term  jumbo  certificates of deposit,  each
      with a minimum denomination of $100,000,  was $6,742,758 and $6,644,804 at
      December 31, 1997 and 1996, respectively.

8.    Advances from Federal Home Loan Bank

      Advances from Federal Home Loan Bank (FHLB) are summarized as follows:
<TABLE>
<CAPTION>
                                                             Interest Rates
                                                          at December 31, 1997        1997               1996
------------------------------------------------------------------------------------------------------------------------------------
<S>                                                          <C>                   <C>               <C>
      Fixed advances                                         5.63 -- 6.14%         $25,889,000       $10,952,000
      Variable advance                                            7.05%              2,330,000         2,234,000
------------------------------------------------------------------------------------------------------------------------------------
                                                                                   $28,219,000       $13,186,000
====================================================================================================================================
</TABLE>

      Pursuant  to   collateral   agreements   with  the  FHLB,   advances   are
      collateralized  by all  stock in the FHLB and  qualifying  first  mortgage
      loans. Advances at December 31, 1997, mature as follows:

      1998                          $24,767,000
      1999                            2,000,000
      2000                            1,452,000

      The Bank also has $2,276,000 available on a line of credit with the FHLB.

9.    Income Taxes

      Actual tax expense  differs from the expected tax expense  computed at the
      federal statutory tax rate for the following reasons:
<TABLE>
<CAPTION>
                                                                      1997              1996             1995
------------------------------------------------------------------------------------------------------------------------------------
<S>                                                 <C>              <C>              <C>               <C>
      Provision for income taxes at statutory rates (34%)            $784,000         $621,100          $394,000
      Add (deduct)
      Pass-through tax credit from investment                         (82,700)         (82,700)          (82,700)
      State income tax, net of federal taxes                           18,600           15,400            12,120
      Nontaxable income                                               (16,100)         (12,200)          (16,700)
      Nondeductible expenses                                           78,600           41,000            32,500
      Deductible expense                                              (29,000)              --                --
      Other                                                             3,038             (147)           (3,256)
------------------------------------------------------------------------------------------------------------------------------------
                                                                     $756,438         $582,453          $335,964
====================================================================================================================================
</TABLE>

                                       22
<PAGE>
      9. Income Taxes (Concluded)

      The components of income tax expense are:
<TABLE>
<CAPTION>
                                                                     Federal            State           Total
------------------------------------------------------------------------------------------------------------------------------------
<S>                                                                  <C>               <C>            <C>
      1997
        Current                                                      $988,587          $28,256        $1,016,843
        Deferred                                                     (260,405)              -           (260,405)
------------------------------------------------------------------------------------------------------------------------------------
          Total                                                      $728,182          $28,256        $  756,438
====================================================================================================================================
      1996
        Current                                                     $ 580,994         $ 23,316         $ 604,310
        Deferred                                                      (21,857)             -             (21,857)
------------------------------------------------------------------------------------------------------------------------------------
          Total                                                     $ 559,137         $ 23,316         $ 582,453
====================================================================================================================================
      1995
        Current                                                     $ 408,639         $ 18,370         $ 427,009
        Deferred                                                      (91,045)              --           (91,045)
------------------------------------------------------------------------------------------------------------------------------------
          Total                                                     $ 317,594         $ 18,370         $ 335,964
====================================================================================================================================
</TABLE>

      The tax effect of  temporary  differences  which give rise to the deferred
      income tax assets and liabilities are as follows:
<TABLE>
<CAPTION>
                                                              1997                                         1996
------------------------------------------------------------------------------------------------------------------------------------
                                                 Asset                 Liability                 Asset                Liability
------------------------------------------------------------------------------------------------------------------------------------
<S>                                             <C>                     <C>                    <C>                    <C>
      Accrued liabilities and
        unearned income                         $111,894                      $--              $ 97,278                   $ --
      Allowance for possible
        loan losses                              456,222                  39,504                303,775                 65,790
      Interest on nonaccrual loans                20,937                      --                 21,260                     --
      Goodwill, amortization,
        and depreciation                          38,000                      --                 17,600                    815
      Loans held for sale                         10,055                      --                  5,590                     --
      Change in method of
        accounting for tax from
        cash basis to accrual basis                   --                  37,054                     --                 55,580
      Unrealized loss on securities
        available for sale                            --                  37,450                 19,400                     --
      Other assets                                    --                  33,477                     --                 32,659
      Other                                       23,991                      --                     --                     --
------------------------------------------------------------------------------------------------------------------------------------
                                                $661,099                $147,485               $464,903               $154,844
====================================================================================================================================
</TABLE>

      No valuation allowance is deemed necessary for the deferred tax asset.

      Retained  earnings include $222,000  representing an allocation for income
      tax bad  debt  deductions  prior  to 1988,  referred  to as the base  year
      reserve.  No income taxes have been  provided  for the base year  reserve,
      though it  continues  to be subject  to  provisions  of  present  law that
      require  recapture  in  the  case  of  certain  excess   distributions  to
      stockholders.

                                       23
<PAGE>
10.   Related Parties

      The Bank has entered into  transactions  with its  directors and principal
      officers and their affiliates (related parties).  All such loans were made
      under terms that are consistent  with the Bank's normal lending  policies.
      Loans to related parties at December 31, 1997 and 1996 were as follows:
<TABLE>
<CAPTION>
                                                                                       1997              1996
------------------------------------------------------------------------------------------------------------------------------------
<S>                                                                                   <C>               <C>
      Beginning balance                                                               $145,740          $179,889
        New loans                                                                      221,574            19,652
        Less repayments                                                                 17,653            53,801
------------------------------------------------------------------------------------------------------------------------------------
      Ending balance                                                                  $349,661          $145,740
====================================================================================================================================
</TABLE>

11.   Employee Benefit Plans

      Number of shares and per share  conversion  price have been restated for a
      three-for-one  stock split  effected in the form of a 200% stock  dividend
      declared in 1997.

      401(k) Plan

      The Bank has a 401(k)  defined  contribution  plan for  employees  meeting
      certain service requirements.  The Bank makes contributions based on wages
      of the qualified employees. Total 401(k) contribution expense was $54,905,
      $50,494, and $43,693, in 1997, 1996, and 1995, respectively.

      Employee Stock Ownership Plan

      The Bank established an Employee Stock Ownership Plan (ESOP) and trust for
      employees meeting certain service requirements. The ESOP purchased 9.9% or
      122,103  shares of the common stock issued  during 1993 using funds loaned
      by the Company.  Interest earned on the loan amounted to $9,903,  $13,114,
      and $16,246 in 1997, 1996, and 1995, respectively.

      The  shares  purchased  by the  ESOP are held in a  suspense  account  and
      released  annually in an amount  proportionate  to the annual repayment of
      the loan.  Contributions to the ESOP and shares released from the suspense
      account are allocated to eligible  employees on the basis of  compensation
      in the year of allocation.  The Bank's  contributions  to the ESOP are not
      fixed, so benefits payable under the ESOP cannot be estimated.  Commencing
      January 1, 1994,  ESOP expense is recognized  using the average fair value
      of the shares  committed to be released during the period.  The difference
      between the  average  fair value and the cost of the shares is recorded to
      additional paid-in capital. Total ESOP expense was $227,920, $121,653, and
      $96,045 for 1997, 1996, and 1995, respectively.

      As of  December  31,  1997,  83,379  shares  have been  allocated  and the
      remaining  38,724  shares are suspense  shares held by the ESOP.  The fair
      value of unearned ESOP shares at December 31, 1997, is $871,312. Dividends
      paid on allocated shares are recorded against retained earnings.

      Bank Recognition and Retention Plan

      The Bank also established Bank Recognition and Retention Plans as a method
      of providing  officers and other  employees of the Bank with a proprietary
      interest in the Company.  The Bank  contributed  funds to the  recognition
      plans to enable them to acquire,  in aggregate,  approximately 4.0% of the
      shares  of common  stock  (49,335  shares).  The Bank  recognizes  expense
      related  to the plans  based on the  vesting  schedule.  Participants  are
      vested at a rate of 20% per year  commencing one year from the date of the
      award.  Total  expenses  related to these plans was  $28,644,  $28,644 and
      $32,664 for 1997, 1996, and 1995, respectively.

                                       24
<PAGE>
11.   Employee Benefit Plans (Continued)

      A summary of the status of the Bank  Recognition  and  Retention  Plans is
      presented below:
<TABLE>
<CAPTION>
                                                                      1997              1996             1995
                                                                     Number            Number           Number
                                                                    of Shares         of Shares        of Shares
------------------------------------------------------------------------------------------------------------------------------------
<S>                                                                  <C>               <C>                <C>
      Outstanding at beginning of year                               41,135            41,135             29,601
      Granted during the year                                           --                --              11,534
      Forfeited during the year                                       1,973               --                  --
------------------------------------------------------------------------------------------------------------------------------------
                                                                     39,162            41,135             41,135
====================================================================================================================================
</TABLE>

      Stock Option Plan

      The Company has a fixed stock  option  plan for  employees  accounted  for
      under APB  Opinion 25 and  related  interpretations.  The plan  allows the
      Company to grant  options to employees  for up to 83,870  shares of common
      stock.  The  options  are  vested  20% per year from the date of grant and
      expire ten years from the date of grant. The exercise price of each option
      equals  the  market  price of the  Company's  stock on the date of  grant.
      Accordingly, no compensation cost has been recognized for the plan.

      The Company also has a fixed stock option plan for directors accounted for
      under APB  Opinion 25 and  related  interpretations.  The plan  allows the
      Company to grant  options to directors  for up to 39,600  shares of common
      stock. The options are vested  immediately upon grant and expire ten years
      from the date of grant.  The  exercise  price of each  option  equals  the
      market price of the Company's stock on the date of grant. Accordingly,  no
      compensation cost has been recognized for this plan.

      Had  compensation  cost for the plans  been  determined  based on the fair
      value of the options at the grant dates consistent with the method of SFAS
      No. 123,  "Accounting  for Stock Based  Compensation,"  the  Company's net
      income and  earnings  per share  would have been  reduced to the pro forma
      amounts indicated below.
<TABLE>
<CAPTION>
                                                                                          1997                 1996
------------------------------------------------------------------------------------------------------------------------------------
<S>                                   <C>                                               <C>                  <C>
      Net income                      As reported                                       $1,549,405           $1,244,328
                                      Pro forma                                          1,485,496            1,232,032
      Basic earnings per share        As reported                                            $1.30                $1.07
                                      Pro forma                                               1.25                 1.06
      Diluted earnings per share      As reported                                            $1.23                $1.01
                                      Pro forma                                               1.18                 1.00
</TABLE>

      The fair  value of each  option  grant is  estimated  on the date of grant
      using  the   Black-Scholes   options  pricing  model  with  the  following
      weighted-average assumptions used:
<TABLE>
<CAPTION>
                                                                                          1997                 1996
------------------------------------------------------------------------------------------------------------------------------------
<S>                                                                                     <C>                  <C>
      Dividend yield                                                                       0.44%                 0.31%
      Expected volatility                                                                 39.40                 25.30
      Risk-free interest rate                                                              5.75                  6.43
      Expected life                                                                     10 years             10 years
</TABLE>

                                       25
<PAGE>
      11.         Employee Benefit Plans (Concluded)

      A summary of the status of the Company's  fixed stock option plans for the
      years ended December 31, 1997, 1996, and 1995 is presented below:
<TABLE>
<CAPTION>
                                                                   1997                                  1996
------------------------------------------------------------------------------------------------------------------------------------
                                                          Number        Weighted Average          Number       Weighted Average
                                                         of Shares       Exercise Price          of Shares      Exercise Price
------------------------------------------------------------------------------------------------------------------------------------
<S>                                                       <C>                <C>                  <C>               <C>
      Outstanding at beginning of year                    109,688            $ 3.20               105,188           $3.03
      Granted during the year                              12,000              7.67                 4,500            7.08
      Exercised during the year                            18,691              3.03                    --              --
      Forfeited during the year                             5,280              3.03                    --              --
                                                          -------                                 -------
      Outstanding at end of year                           97,717              3.79               109,688            3.20
                                                          =======                                 =======

      Exercisable at end of year                           74,249              3.28                81,473            3.25
      Weighted average grant-date fair value
        of options granted during the year                                   $17.67                                 $4.14
</TABLE>

      No options were granted or exercised during 1995.

      The following  information  applies to options outstanding at December 31,
      1997:

      Range of exercise prices                                 $3.03 - $7.67
      Weighted-average remaining contractual life                  6.1 years

12.   Earnings Per Share

      The  following  table  sets  forth the  computation  of basic and  diluted
      earnings per share:
<TABLE>
<CAPTION>
                                                                     1997              1996              1995
------------------------------------------------------------------------------------------------------------------------------------
<S>                                                                <C>              <C>               <C>
      Net income, as reported                                      $1,549,405       $1,244,328        $  822,963
------------------------------------------------------------------------------------------------------------------------------------
      Weighted-average shares outstanding                          $1,187,651       $1,166,371        $1,147,994
      Effect of dilutive potential common shares
        Stock options                                                  69,262           64,055            40,281
------------------------------------------------------------------------------------------------------------------------------------
      Adjusted weighted-average shares outstanding                 $1,256,913       $1,230,426        $1,188,275
====================================================================================================================================
      Basic earnings per share                                         $1.30             $1.07           $.72
      Diluted earnings per share                                       $1.23             $1.01           $.69
</TABLE>

13.   Regulatory Matters

      The  Bank  is   subject  to  various   regulatory   capital   requirements
      administered  by the Federal  banking  agencies.  Failure to meet  minimum
      capital   requirements  can  initiate  certain   mandatory--and   possibly
      additional discretionary--actions by regulators that, if undertaken, could
      have a direct material effect on the Bank's  financial  statements.  Under
      capital  adequacy  guidelines  and the  regulatory  framework  for  prompt
      corrective  action,  the Bank must meet specific  capital  guidelines that
      involve  quantitative  measures  of the Bank's  assets,  liabilities,  and
      certain  off-balance-sheet items as calculated under regulatory accounting
      practices.  The Bank's capital amounts and classification are also subject
      to  qualitative  judgments  by  the  regulators  about  components,   risk
      weightings,  and  other  factors.

      Quantitative measures established by regulation to ensure capital adequacy
      require the Bank to maintain  minimum amounts and ratios (set forth in the
      table  below) of total and Tier I capital (as defined in the  regulations)
      to risk-weighted  assets (as defined),  and of Tier I capital (as defined)
      to average assets (as defined).  Management  believes,  as of December 31,
      1997, that the Bank meets all capital adequacy requirements to which it is
      subject.

                                       26
<PAGE>
13.   Regulatory Matters (Concluded)

      As of December 31,  1997,  the most recent  notification  from the Federal
      Deposit  Insurance  Corporation  categorized the Bank as well  capitalized
      under  the  regulatory  framework  for  prompt  corrective  action.  To be
      categorized  as well  capitalized,  the Bank must  maintain  minimum total
      risk-based,  Tier I risk-based, and Tier I leverage ratios as set forth in
      the table.  There are no conditions or events since that notification that
      management  believes have changed the institution's  category.

      The Bank's  actual  capital  amounts and ratios are also  presented in the
      table.
<TABLE>
<CAPTION>
                                                                                                                To Be Well
                                                                                                              Capitalized Under
                                                                                  For Capital                 Prompt Corrective
                                                           Actual               Adequacy Purposes             Action Provisions
------------------------------------------------------------------------------------------------------------------------------------
                                                    Amount      Ratio        Amount           Ratio         Amount          Ratio
------------------------------------------------------------------------------------------------------------------------------------
<S>                                               <C>          <C>       <C>                 <C>       <C>               <C>
      As of December 31, 1997:
      Total Capital to Risk Weighted Assets
         Consolidated                             $12,308,000  11.4%    <179>$8,664,000     <179>8.0%    N/A
         Bank                                      12,066,000  11.1%    <179> 8,668,480     <179>8.0%  <179>$10,835,600  <179>10.0%
      Tier I to Risk Weighted Assets
         Consolidated                              10,996,000  10.1%    <179> 4,332,000     <179>4.0%    N/A
         Bank                                      10,724,000   9.9%    <179> 4,334,240     <179>4.0%  <179>  6,501,360  <179> 6.0%
      Tier I Capital to Average Assets
         Consolidated                              10,996,000   7.2%    <179> 6,123,360     <179>4.0%    N/A
         Bank                                      10,724,000   7.0%    <179> 6,100,440     <179>4.0%  <179>  7,625,550  <179> 5.0%
      As of December 31, 1996:
      Total Capital to Risk Weighted Assets
         Consolidated                             $10,065,793  11.5%    <179>$6,982,720     <179>8.0%    N/A
         Bank                                       9,851,000  11.3%    <179> 6,982,720     <179>8.0%  <179>$ 8,728,400  <179>10.0%
      Tier I Capital to Risk Weighted Assets
         Consolidated                               9,172,337  10.4%    <179> 3,491,360     <179>4.0%    N/A
         Bank                                       8,958,000  10.2%    <179> 3,491,360     <179>4.0%  <179>  5,237,040  <179> 6.0%
      Tier I Capital to Average Assets
         Consolidated                               9,172,337   6.8%    <179> 5,359,480     <179>4.0%    N/A
         Bank                                       8,958,000   6.7%    <179> 5,359,480     <179>4.0%  <179>  6,699,350  <179> 5.0%
</TABLE>

      The ability of the Bank to pay  dividends to the parent is also subject to
      the minimum  regulatory  capital  requirements.  At December 31, 1997, the
      amount available for dividends by the Bank was  approximately  $2,839,000.

      On  September  30,  1996,  Federal  legislation  was passed  relating to a
      special deposit  insurance  assessment on deposits  insured by the Savings
      Association  Insurance  Fund  (SAIF).  Although  deposits  in the Bank are
      insured by the Bank Insurance  Fund,  the Bank had acquired  deposits in a
      1994 branch  acquisition  which are still  considered SAIF deposits.  As a
      result of the legislation, the Bank was charged approximately $175,000 for
      the special assessment on SAIF deposits in 1996.

                                       27
<PAGE>

14.   Other Noninterest Expense

      Other noninterest  expense amounts are summarized as follows for the years
      ended December 31:
<TABLE>
<CAPTION>
                                                                     1997              1996              1995
------------------------------------------------------------------------------------------------------------------------------------
<S>                                                                <C>              <C>               <C>
      Printing, postage, stationery and supplies                   $  228,806       $  239,749        $  264,209
      Advertising and promotion                                       119,679          117,806           140,931
      Data processing                                                 152,614          145,324           169,682
      Professional fees                                               176,446          136,556           194,597
      Meetings and training                                           104,612           63,172            52,737
      Insurance                                                        21,414           24,872            26,480
      Goodwill amortization                                           103,047          103,047           101,241
      Loss on disposal of equipment                                     5,973               --            33,250
      Other                                                           444,605          415,795           420,734
------------------------------------------------------------------------------------------------------------------------------------
                                                                   $1,357,196       $1,246,321        $1,403,861
====================================================================================================================================
</TABLE>

15.   Financial Instruments With Off-Balance-Sheet Risk

      The Bank is a party to financial instruments with  off-balance-sheet  risk
      in the  normal  course  of  business  to meet the  financing  needs of its
      customers. These financial instruments are commitments to originate loans,
      interest  rate  swaps and  floors.  The  instruments  involve,  to varying
      degrees, elements of credit risk in excess of the amount recognized in the
      consolidated  statement of  financial  condition.  The Bank's  exposure to
      credit  loss  in the  event  of  nonperformance  by the  other  party  for
      commitments to extend credit is represented  by the  contractual  notional
      amount of those  instruments.  The Bank's  exposure  to credit loss in the
      event of  nonperformance  by the other  party to  interest  rate swaps and
      floors is limited to the other party's obligation to pay the Bank interest
      based on the notional amount of the instrument.  The Bank follows the same
      credit policies in making  commitments  and conditional  obligations as it
      does for on-balance-sheet  instruments,  including requiring collateral or
      other security to support financial instruments with credit risk.

      Loan Commitments

      Commitments to extend credit are agreements to lend to a customer provided
      there  is no  violation  of any  condition  established  in the  contract.
      Commitments  generally have fixed  expiration  dates or other  termination
      clauses and may require  payment of a fee.  Since many of the  commitments
      are  expected to expire  without  being drawn upon,  the total  commitment
      amounts do not necessarily  represent future cash  requirements.  The Bank
      evaluates each customer's  creditworthiness  on an individual  basis.  The
      amount of collateral  obtained is based on management's  credit evaluation
      of  the  borrower.   Collateral  held  varies  but  may  include  accounts
      receivable,   inventory,   property  and  equipment  and  income-producing
      commercial  properties.

      Loan  commitments on undisbursed  loans and letters of credit to originate
      loans at December 31, 1997, are as follows:

      Real estate lines of credit                           $10,459,607
      Commercial lines of credit                              3,966,043
      Construction loans                                      1,012,660
      Consumer lines of credit                                  737,395
      Commercial letters of credit                              116,900
--------------------------------------------------------------------------------
                                                            $16,292,605
================================================================================

                                       28
<PAGE>


15.   Financial Instruments With Off-Balance-Sheet Risk (Concluded)

      Commitments to originate loans at December 31, 1997, are as follows:

      First mortgage fixed rate loans                        $  921,500
      Variable rate commercial loans                          1,809,200
--------------------------------------------------------------------------------
                                                            $ 2,730,700
================================================================================

      Interest Rate Swap

      The Bank is party to an interest rate swap agreement with the Federal Home
      Loan Bank in the notional amount of $5,000,000 on which it is obligated to
      pay interest based on the three-month LIBOR rate, adjusted quarterly,  and
      receives a 6.63% fixed-rate  payment.  The contract is dated June 1996 and
      matures June 1999.  The variable rate was 5.91% at December 31, 1997.  The
      Bank has  utilized  interest  rate  swaps  to  partially  protect  its net
      interest income stream against the effects of falling rates on prime-based
      loans.  The  notional  amount  is a figure  used to  calculate  settlement
      payments and does not represent exposure to credit loss.

      Interest is paid to the Bank on the  interest  rate swap and the Bank pays
      interest quarterly. The Bank is exposed to loss of net interest receivable
      should the counter-party  default. Net interest income earned on the swaps
      was  $28,332  and  $9,047 in 1997 and  1996,  respectively.  Net  interest
      expense on the swaps was $24,822 in 1995.

      Interest Rate Floor

      The Company has an interest rate floor contract in the notional  amount of
      $5,000,000  on which it receives the excess of the strike  rate,  6%, over
      the three-month LIBOR rate, adjusted quarterly.  The floor matures in June
      1998. The Company received $15,774 of interest income in 1997.

      Interest Rate Cap

      The Company has an interest rate cap in the notional amount of $10,000,000
      on which it receives the excess of the  three-month  LIBOR rate,  adjusted
      quarterly,  over 6.50%.  The cap matures June 1999. No interest income was
      received in 1997.

      Other

      The Bank  services  approximately  $43.4  million  of  Federal  Home  Loan
      Mortgage  Corporation  (FHLMC) loans.  The Bank is liable to FHLMC for any
      interest which becomes delinquent.

16.   Significant Group Concentrations of Credit Risk

      Most of the Bank's business activity is in rural areas of Maine, where the
      resort  and  logging  industries  predominate.  Accordingly,  the  Bank is
      dependent  on the  health of these  industries  for  continued  profitable
      operations.  However,  the Bank has  diversified  into the  central  Maine
      regions. In addition, the Bank services approximately $75 million of loans
      previously  originated  and  sold  by the  Bank.

      The Bank's policy for requiring collateral is to obtain security in excess
      of the amount  borrowed.  The amount of  collateral  obtained  is based on
      management's  credit  evaluation  of  the  borrower.   The  Bank  requires
      appraisals of real property held as collateral.  For consumer  loans,  the
      Bank will accept security which has a title  certificate.  Collateral held
      for commercial loans may include accounts receivable,  inventory, property
      and equipment and income-producing properties.

      The contractual  amounts of credit-related  financial  instruments such as
      commitments  to extend credit and letters of credit  represent the amounts
      of potential  accounting loss should the contract be fully drawn upon, the
      customer  default,  and  the  value  of  any  existing  collateral  become
      worthless.

                                       29
<PAGE>
17.   Fair Value Disclosures of Financial Instruments

      The following  disclosures  are made in accordance  with the provisions of
      SFAS No. 107  "Disclosures  About Fair  Value of  Financial  Instruments,"
      which requires the disclosure of fair value information about both on- and
      off-balance  sheet  financial  instruments  where  it  is  practicable  to
      estimate  that value.  Fair value is defined in SFAS No. 107 as the amount
      at which an instrument could be exchanged in a current transaction between
      willing parties, other than in a forced or liquidation sale.

      In accordance  with the  provisions  of SFAS No. 107, the  estimated  fair
      values of deposits, credit card loans and residential real estate mortgage
      loans do not take into account the fair values of long-term relationships,
      which  are  integral  parts  of the  related  financial  instruments.  The
      disclosed  estimated  fair  values  of  such  instruments  would  increase
      significantly  if the fair  values  of the  long-term  relationships  were
      considered.  The use of different  assumptions  (e.g.,  discount rates and
      cash flow estimates) and estimation  methods could also have a significant
      effect on fair value amounts.  Accordingly, the estimates presented herein
      are not necessarily indicative of the amounts the Company could realize in
      a current market exchange. Because SFAS No. 107 excludes certain financial
      instruments  and  all   nonfinancial   instruments   from  its  disclosure
      requirements,  any  aggregation of the fair value amounts  presented would
      not represent the underlying value of the Company.

      A summary of the carrying values of the Company's  significant  on-balance
      sheet financial instruments are as follows:
<TABLE>
<CAPTION>
                                                            December 31, 1997                        December 31, 1996
------------------------------------------------------------------------------------------------------------------------------------
                                                     Carrying               Fair                Carrying             Fair
                                                       Value                Value                 Value              Value
------------------------------------------------------------------------------------------------------------------------------------
      Assets
<S>                                                  <C>                   <C>                 <C>                 <C>
         Cash and due from banks(1)                  $ 3,239,316           $ 3,239,316         $ 2,480,923         $ 2,480,923
         Securities available for sale(1)              9,260,779             9,260,779           7,452,341           7,452,341
         Securities to be held to maturity(2)         14,170,856            14,425,808          18,516,750          18,587,246
         Loans receivable, net of allowance
            and discounts(3)                         116,849,995           118,769,000          97,376,787          98,631,000
         Loans held for sale(2)                        2,007,110             2,036,685           1,819,209           1,835,648
         Federal Home Loan Bank stock(1)               1,537,650             1,537,650           1,320,550           1,320,550
         Accrued interest receivable(1)                  826,582               826,582             767,602             767,602
      Liabilities
         Deposits(4)                                 110,708,569           111,276,088         109,362,559         109,879,022
         Advances from Federal Home
            Loan Bank(5)                              28,219,000            28,219,000          13,186,000          13,161,429
         Escrows and trustee accounts for
            sold loans(1)                              1,013,894             1,013,894             919,254             919,254
         Accrued interest payable(1)                     111,253               111,253              62,518              62,518
</TABLE>

Valuation Methods and Assumptions

(1)  Fair value equals or approximates carrying value.

(2)  Based on quoted market prices of similar instruments.

(3)  Fair values of commercial term loans were estimated using a discounted cash
     flow model.  Certain  residential  real estate  loans were valued  based on
     quoted market prices of similar loans,  with adjustments for differences in
     loan characteristics.  For consumer loans, whose current weighted - average
     coupons and  remaining  term to  maturity  approximate  the current  market
     conditions,  carrying values were used as an  approximation  of fair value.
     For loans with  interest  rates which  change  within six months  (such as,
     lines  of  credit  and  time  notes),  carrying  values  were  used  as  an
     approximation of fair values.

(4)  Fair values of  certificates  of deposit were estimated based on discounted
     cash flows  using  current  rates for  certificates  of  similar  remaining
     maturity.  For  all  other  deposits,  carrying  values  were  used  as  an
     approximation of their fair values.

(5)  Fair values of advances were estimated based on discounted cash flows using
     current rates for advances of similar remaining maturity.


                                       30
<PAGE>
      17. Fair Value Disclosures of Financial Instruments (Concluded)

      The Company's off-balance sheet instruments include interest rate swaps, a
      floor and a cap and loan  commitments.  Fair  values for loan  commitments
      have not been presented as the future revenue  derived from such financial
      instruments is not  significant.  Fair values for the interest rate swaps,
      floor and cap are based on quoted market prices as follows:
<TABLE>
<CAPTION>
           Notional                                                         Maturity                     Fair
           Principal                         Contract Date                    Date                       Value
------------------------------------------------------------------------------------------------------------------------------------
<S>                                    <C>                          <C>                          <C>
     Interest Rate Swaps
      December 31, 1997
      -----------------
          $ 5,000,000                        June 21, 1996                 June 21, 1999                $45,705
          ===========                                                                                   =======

      December 31, 1996
      -----------------
          $ 2,000,000                     November 15, 1993             November 15, 1997              $(16,254)
            5,000,000                     June 21, 1996                 June 21, 1999                    55,600
          -----------                                                                                   -------
          $ 7,000,000                                                                                   $39,346
          ===========                                                                                   =======

      December 31, 1995
      -----------------
          $ 2,000,000                     November 15, 1993             November 15, 1997              $(21,623)
          ===========                                                                                   =======

      Interest Rate Floor
      December 31, 1997
      -----------------
          $ 5,000,000                     June 20, 1996                 June 24, 1998                  $  4,310
          ===========                                                                                   =======

      December 31, 1996
      -----------------
          $ 5,000,000                     June 20, 1996                 June 24, 1998                  $ 30,828
          ===========                                                                                   =======

      Interest Rate Cap
      December 31, 1997
      -----------------
          $10,000,000                     July 21, 1997                 July 21, 1999                  $  9,707
          ===========                                                                                   =======
</TABLE>

18.   Subsequent Event

      The Bank has signed a purchase agreement with Key Bank to acquire a branch
      in Madison,  Maine,  in March 1998.  The Bank will  receive  approximately
      $14,500,000 in cash and  $16,700,000 in deposit  accounts,  in addition to
      acquiring some loans, fixed assets and goodwill.

                                       31
<PAGE>
Information

Board of Directors

Winfield F. Robinson, Chairman
Vice President of United Timber Corp.

John C. Witherspoon
President/CEO
Kingfield Bank

William P. Dubord
Attorney

G. Norton Luce
Retired Gas Company Owner

Roger G. Spear
CFO, University of Maine at Farmington

Theodore C. Johanson
President, Falcon Shoe Company

Annual Meeting

The Annual Meeting is scheduled for Wednesday,  May 13, 1998,  5:30 p.m., at the
Winter's Inn, Kingfield, Maine.

Stock Listing

The common stock is traded over-the-counter on the NASDAQ National Market System
under the ticker symbol KSBK.  Stock price  quotations  can be found in The Wall
Street  Journal  and local daily  newspapers  as well as on the  internet  under
NASDAQ.

Officers of the Holding Company and Bank

John C. Witherspoon, President/CEO
John E. Thien, Vice President/CFO/Treasurer

Officers of the Bank

Gordon A. Flint, Vice President
Robert D. Stone, Vice President
Gerard Belanger, Vice President
<PAGE>
Price Range of Stock

Set forth below is the  quarterly  high and low price for the common stock since
the beginning of the year,  restated for a three-for-one stock split effected in
the form of a 200% stock dividend in 1997 and a 10% stock dividend in 1996.

Quarter Ending            1997                       1996
--------------------------------------------------------------------------------
March 31       High:  11.33  Low:   8.67   High:  6.29   Low:   5.49
June 30        High:  16.33  Low:   9.00   High:  5.74   Low:   6.29
September 30   High:  16.50  Low:  12.50   High:  7.33   Low:   6.82
December 31    High:  22.50  Low:  12.63   High:  8.67   Low:   7.08

Dividends  declared  in  1996  and  1997  were  $0.064  and  $0.073  per  share,
respectively,  restated  for a 10% stock  dividend  in 1996 and a  three-for-one
stock split effected in the form of a 200% stock dividend in 1997.

Number of Shares Outstanding and Shareholders

At March 1, 1998, KSB Bancorp, Inc. had 1,258,954 shares

of  $.01  par  value  common  stock  outstanding,  owned  by  approximately  340
shareholders of record, including brokerage firms, banks and registered clearing
agencies acting as nominees for an  indeterminate  number of beneficial  owners.
KSB Bancorp, Inc. pays a semi-annual cash dividend of $.05 per share.

Inquiries

Shareholder Information

Attn: Jennifer L. Piekart
KSB Bancorp, Inc.

P.O. Box 105
Kingfield, ME 04947

207-265-2181

The  Annual  Report on Form  10-KSB,  filed  with the  Securities  and  Exchange
Commission, is available to shareholders without charge upon written request.

Auditors

Berry, Dunn, McNeil & Parker
P.O. Box 1100, Portland, ME 04101

Transfer Agent & Registrar

Registrar and Transfer Company
10 Commerce Drive, Cranford, NJ 07016

Corporate Securities Counsel

John J. Gorman, Esq.
Luse Lehman Gorman Pomerenk & Schick
5335 Wisconsin Avenue, N.W., Suite 400

Washington, DC 20015


                                       32
<PAGE>
                   The Board of Directors would like to thank
                        the employees of Kingfield Bank
       for their commitment to building the long-term value of the Bank.

Kingfield Office                             Operations
      Shelly Abbott                                Katherine Dumont
      Donna Chase                                  Janet Enos
      Jennifer Kruger                              Jacqueline Garey
      Brenda Thompson                              Linda Miller
                                                   Michelle Mason
Stratton Office                                    Jeannine McGraw
      Debora Dudley                                Pauline Nadeau
      Donna Pelletier                              Karen Stewart
      Linda Shane                                  Robert Stone
      Wendy Wyman                                  Timothy Thompson

Rangeley Office                              Administration/Finance
      M. Rachel Lee                                Mark Brooks
      Wendy Marquis                                Linda Manning
      Constance St. Cyr                            Karen Moore
      Sheila Waldeck                               Jennifer Piekart
                                                   Cindy Spencer
Phillips Office                                    John Thien
      Elizabeth Cram                               Gillian Trapp
      Dawn Field                                   John Witherspoon
      Kelly Hader
      Linda Toothaker                        Retail/Commercial Lending
                                                   Carla Allen
Farmington Office                                  Justine Ameraul
      Susan Haines                                 Gerard Belanger
      Laurie Marble                                Michael Bonsey
      Kathleen Mason                               Jenni Brown
      Nancy Richardson                             Susan Crowley
                                                   Sally Dwyer
Lewiston Office                                    Gordon Flint
      Nancy Brown                                  Patricia Haggan
      Katherine Fales                              Wendy Hinkley
      Cynthia Hoyt                                 Cynthia Gilmore
      Elizabeth Lyons                              Shelly Lowell
      Melissa Saucier                              Marcelle Labbe
                                                   Todd Marlowe
Bingham Office                                     Mary Miller
      Kathleen Barrett                             Laurie Nile
      Mary Brown                                   Nancy Richard
      Phebe Durgin
      Tricia LeHay

Strong Office
      Rhonda Bartholomew
      Sandy Cavanagh
      Lynn Vashaw
<PAGE>
                              Kingfield Bank Locations

                    Bingham                         207-672-5541
                    Farmington                      207-778-0302
                    Kingfield                       207-265-2181
                    Lewiston                        207-784-7376
                    Madison                         207-696-3376
                    Phillips                        207-639-2851
                    Rangeley                        207-864-3321
                    Stratton                        207-246-2181
                    Strong                          207-684-5501

                                 1-800-962-0070