ANNUAL
                                     REPORT
                                      1998

<PAGE>
LETTER TO STOCKHOLDERS

Dear Stockholder,

I am pleased to report to you the  results of  operations  of KSB  Bancorp,  Inc
("the  Company")  and Kingfield  Bank ("the Bank") for 1998.  This past year was
another  record  year in terms of  earnings  and  asset  growth.  The  Company's
earnings grew by 16.6% from  $1,549,000,  or $1.30 basic earnings per share,  in
1997 to  $1,806,000,  or $1.47 basic  earnings  per share,  in 1998.  The record
earnings  are a result  of a  continuation  of the  Bank's  strategy  to  pursue
profitable growth.

Total assets of KSB Bancorp, Inc. reached $171 million in 1998 -- a 12% increase
over 1997.

Contributing  to the Bank's  growth in 1998 was the opening of our second branch
in Somerset County in March,  when we completed the purchase of the Madison,  ME
branch of Key Bank.  This  branch has  exceeded  our  expectations  for  deposit
growth, bringing over $16 million in new deposits into the Bank.

Stockholders  were rewarded for the increase in earnings with an increase in the
Company's February, 1999 dividend to an annualized rate of $0.16 per share. This
is the  fifth  consecutive  increase  in the  semiannual  dividend  and  further
represents management's commitment to continually improve the long term value of
the Company for our stockholders.

Unfortunately  for us as  stockholders,  the stock  market has not  rewarded the
earnings  growth the Bank has enjoyed.  At the end of 1997, the Company's  stock
price reached an all-time high of $22.50 per share.  This represented a multiple
of 17 times the $1.30 basic  earnings  per share  reported  in 1997.  During the
summer of 1998 with the threat of a recession and deflation facing the worldwide
financial  markets,  stock prices for small bank stocks in general fell sharply.
At the end of 1998,  the market value of KSB Bancorp,  Inc.  stock was at $15.50
per share,  or a multiple of just over 10 and 1/2 times our reported $1.47 basic
earnings  per share.  In essence,  the earnings per share of the company grew by
13% while the market  value of the stock fell by 30%. In spite of this  apparent
paradoxical market behavior, the management of your Bank will continue to follow
strategies  which we  believe  will lead to  continued  growth in  earnings.  We
believe that  ultimately  this will lead to building long term value to you, our
stockholders.

While the world  continues to focus its  attention on the  potential  challenges
facing it due to possible  limitations  in computer  systems at the start of the
new  millennium,  the Board and management of Kingfield Bank have been attending
to this  issue for well over a year.  We have  identified  and tested all of our
mission critical systems for compliance with Year 2000 requirements.  Along with
the rest of the country's  banking  system,  we have also been under the ongoing
audit of our regulators as to Year 2000 compliance.

As we approach the new millennium, Kingfield Bank is positioned well to continue
to provide  personalized,  profitable  financial  products to our customers.  We
envision a new  century of banking in which we will  continue  to build upon our
customer  relationships by providing a full menu of financial products through a
variety of delivery channels, with the added value of always providing access to
high-quality personalized service.

The long term value of Kingfield  Bank and KSB Bancorp,  Inc.  continues to grow
through the efforts of our extremely dedicated, hardworking staff along with the
support of our customers and you, our stockholders.  All of us at Kingfield Bank
thank you for your continued support.

Sincerely,

/s/John C. Witherspoon

John C. Witherspoon
President/CEO

                                      -1-
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS

GENERAL

This Management's  Discussion and Analysis of Financial Condition and Results of
Operations  presents a review of the material changes in the financial condition
of the Company from  December 31, 1997 to December 31, 1998,  and the results of
operations for the twelve month period ended December 31, 1998.  This discussion
and analysis is intended to assist in understanding the financial  condition and
results of operations of the Company.  Accordingly,  this section should be read
in  conjunction  with the condensed  consolidated  financial  statements and the
related notes contained herein.

Certain  statements  contained  herein are not based on historical facts and are
"forward-looking  statements"  within  the  meaning  of the  Private  Securities
Litigation  Reform  Act of  1995,  such  as  statements  relating  to  financial
condition and future prospects, loan loss reserve adequacy, Year 2000 readiness,
simulation  of changes in interest  rates,  prospective  results of  operations,
capital spending and financing  sources,  and revenue  sources.  Forward-looking
statements, which are based on various assumptions (some of which are beyond the
Company's  control),  may be  identified  by  reference  to a future  period  or
periods, or by the use of forward-looking  terminology;  such as "may",  "will",
"believe", "expect", "estimate",  "anticipate",  "continue", or similar terms or
variations on those terms, or the negative of those terms. Such  forward-looking
statements  reflect the current view of management  and are based on information
currently  available to them,  and upon  current  expectations,  estimates,  and
projections  regarding  the Company and its industry,  management's  belief with
respect   thereto,   and  certain   assumptions   made  by   management.   These
forward-looking  statements  are not  guarantees of future  performance  and are
subject to risks, uncertainties,  and other factors. Accordingly, actual results
could differ materially from those set forth in  forward-looking  statements due
to a variety of factors,  including,  but not limited to,  those  related to the
economic  environment,  particularly  in the market  areas in which the  Company
operates,  competitive products and pricing, fiscal and monetary policies of the
U.S.Government,   changes  in   government   regulations   affecting   financial
institutions,  including  regulatory fees and capital  requirements,  changes in
prevailing  interest  rates,   acquisitions  and  the  integration  of  acquired
businesses,  credit  risk  management,  asset/liability  management,  changes in
technology,  changes in the securities markets,  and the availability of and the
costs associated with sources of liquidity.

KSB Bancorp,  Inc's  wholly-owned  subsidiary,  "Kingfield Bank", is a community
Bank  providing  quality,  personalized  banking  services  to  individuals  and
businesses.  In 1998, 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 using
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 acquired an additional $16.2 million dollars
in  deposits  and  $0.5  million  of  reverse  repurchase  agreements  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 capital of the
Bank. 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 the Bank's  growth in deposits  without a  corresponding  loan
growth put pressure on its margins,  the Bank has pursued a strategy of building
loan  volumes in order to increase  the margins.  In 1998,  the Bank  originated
approximately $62.5 million in new loans, which resulted in an increase of $10.3
million in net loan  balances  including  loans  available for sale. In December
1998,  the Bank made a  decision  as part of it's Asset /  Liability  management
strategies  to convert  $9.0  million  of  mortgage  loans into  mortgage-backed
securities, thus lowering the year end loan balance. The loan growth experienced
in 1998 helped the continued  growth of the net interest margin of the Bank from
a low of 3.99% in 1994 to 4.71% in 1998.

In  addition  to the  growth  strategies  implemented,  the Bank has  focused on
reducing  operating  expenses  and gaining  efficiencies  and  productivity.  An
example of this is the  decision  in the fall of 1998 to  convert  two full time
branches in

                                      -2-
<PAGE>
neighboring towns to half time branches managed by the same staff. The result is
an annual  cost  saving  of  approximately  $100,000  while  continuing  banking
services to both  communities.  The Bank's  operating  expense to average  asset
ratio over the past 5 years has dropped from a high of 4.59% in 1994 to 3.10% in
1998. The Bank's efficiency ratio (ratio of operating  expenses to gross income)
dropped  from 67% in 1996 to 62% for 1997 and  further to 60% in 1998.  In 1999,
the Bank will continue to pursue a strategy of profitable growth by implementing
a stronger sales effort throughout the Bank. Plans for 1999 include the addition
of a senior  level sales  manager to manage this effort,  as well as  additional
loan officers.

MORTGAGE BANKING ACTIVITIES

Mortgage banking  activities involve the origination of mortgage loans for sale,
either for cash as whole loans, or by packaging them into securities through the
Federal Home Loan  Mortgage  Corporation  (FHLMC) or Federal  National  Mortgage
Association (FNMA). For the years ended December 31, 1998 and December 31, 1997,
the Bank originated $29.7 and $15.8 million, respectively, of one to four-family
mortgage  loans. Of these amounts $14.1 million in 1998 and $4.5 million in 1997
were sold.  The 1998 sales  figure  includes  $9.0  million  converted  to FHLMC
securities.

The Bank  recognizes fees related to the origination and sale of mortgage loans.
These fees  totaled  $84,000  for 1997 and  $97,000  for 1998.  The 1998  figure
includes $14,000 of gains  recognized  under Statements of Financial  Accounting
Standard No. 125 (SFAS 125)  representing  the present value of future  mortgage
servicing  rights on loans sold.  The 1997 figure  includes  $11,000 of SFAS 125
gain.

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, 1998,  $76.0 million
in loans were serviced for others,  which generated  $268,000 in fee income.  At
December  31, 1997,  $75.1  million in loans were  serviced for others,  earning
$297,000.  The small change in the  servicing  portfolio is due, in part, to the
Bank's past  decision to keep many saleable  residential  loans in its portfolio
along with customers' prepayments of their serviced loans.

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  commercial  loan  portfolio of the Bank continued to grow in 1998. The Bank
originated  $21.3  million in commercial  loans in the year ending  December 31,
1998 resulting in an increase in commercial  loan volumes of $6.2 million or 13%
over the levels at year-end  1997.  The Bank  continues to be recognized for its
commitment to the small business market. In 1998, the Finance Authority of Maine
recognized  Gordon Flint,  Regional  Vice  President of Kingfield  Bank,  for an
unprecedented  fourth year as one of Maine's  outstanding  commercial lenders of
the year.  Small business  lending will continue to be a focus of Kingfield Bank
in the future.  The Bank has plans for hiring  additional  loan officers to meet
the demands of the market and increase the Bank's market share in  Androscoggin,
Somerset and southern  Franklin  County.  The commercial loans of the Bank are a
combination  of  adjustable  rate loans (based on the Wall Street  Journal Prime
Rate)  and fixed  rate  loans in  keeping  with the  asset/liability  management
strategies  of the Bank.  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

                                      -3-
<PAGE>
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,
consequently,  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 Bank's  simulation model as of December 31, 1998, the Bank would expect a
decrease in net interest income of $117,000 or 1.6% if rates gradually  decrease
by 200 basis  points  over a 12-month  period,  and a decrease  in net  interest
income of $9,000 or 0.1% if interest rates gradually increase from current rates
by 200 basis  points  over a 12-month  period.  These  results  are both  within
Board-set tolerance limits of 7.5%. Based on the results of the simulation model
as of December 31, 1997, the Bank would have expected a decrease in net interest
income of $21,000 or 0.3% if rates gradually  decreased by 200 basis points over
a 12-month period,  and a decrease in net interest income of $112,000 or 1.7% if
interest rates gradually increased by 200 basis points over the ensuing 12-month
period.  The change in results reflects the Bank's increased exposure to falling
rates in the current interest rate environment  compared to the rate environment
at  December  31, 1997 due to the volume of low-rate  deposits  (NOWand  Savings
Accounts)  whose rates  cannot  reasonably  be lowered by 200 basis  points from
their current  levels.  Management  has under  consideration  actions which will
mitigate the risk of decrease in net interest income, if short-term rates should
fall  while at the same  time not  inordinately  increase  the risk of a loss in
interest income should rates rise.

RESULTS OF OPERATIONS

Net  income  for  1998  was  $1,806,000,  or  $1.47  basic  earnings  per  share
($1.41diluted earnings per share) compared to $1,549,000 in 1997, or $1.30 basic
earnings  per share  ($1.23  diluted  earnings  per  share).  1998's  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 $18.5  million,  or 12.2%,  from $152.8  million at December 31, 1997 to
$171.3  million at December  31, 1998.  Net  portfolio  loans  increased by $4.1
million,  or 3.5%,  over December 31, 1997.  The increase  would have been $13.1
million  or  11.2%,  but $9.0  million  of  mortgages  were  converted  to FHLMC
securities  and placed into the  investment  portfolio.  The loan and investment
portfolio  growth  contributed to an increase in the Bank's margin from 4.46% at
December  31, 1997 to 4.71% at December 31, 1998 which  resulted in a 15.9%,  or
$997,000, increase in net interest income before provision for loan losses.

Noninterest  income  increased  by $142,000,  or 12.0% in 1998.  Fee income from
origination  and sale of  mortgage  loans  (included  in "other"  income) was up
$12,000  from $85,000 in 1997 to $97,000 in 1998.  The small  increase is due in
part to the  Bank's  decision  to keep in it's  investment  portfolio  the  $9.0
million of loans sold to FHLMC and converted to securities,  thus decreasing the
income  derived from cash loan sales but  increasing  interest  income.  Service
charges  increased 19.3% from $705,000 to $841,000 due to the acquisition of the
Madison  branch  and it's  deposit  account  base and  increased  fee  income on
closings of residential  mortgage loans. The increase of $35,000 in Other Income
includes  a  $22,000  increase  in ATM  activity  fees as a  result  of the Bank
expanding  it's ATM network to include ATM's at all of its branch  locations and
two non-branch sites.

Noninterest  expense  increased by $527,000  from the 1997 level.  1998 expenses
include a total of  $279,000  attributed  to the  operation  of the new  Madison
branch since March,  1998,  including $91,000 of goodwill  expense.  Included in
1998's  noninterest  expense is a salary and benefit  expense of $231,000  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
higher annualized  average stock value in 1998 compared to 1997, this adjustment
was  $54,000  higher in 1998 than in 1997.  Expenses  also  include  $194,000 in
expense  associated with the  amortization of goodwill.  This is $91,000 greater
than  1997  due  to  amortization  of  goodwill   associated  with  the  Madison
acquisition.  Neither the ESOP market  value  adjustment  nor  goodwill  expense
impact the net tangible  capital of the Bank.  The  remainder of the increase in
expenses is  primarily  in Salaries  and  Benefits  resulting  from  non-Madison
staffing  increases  and general pay  increases.  The total  salary and benefits
increase  not  attributable  to the  Madison  branch  or the ESOP  market  value
adjustment is $174,000.

                                      -4-
<PAGE>
FINANCIAL CONDITION

Total assets of the Bank grew by $18.5  million or 12.2% from  December 31, 1997
to December 31, 1998. Of the asset growth,  $4.1 million was in portfolio  loans
while  investments grew by $6.8 million,  including the addition of $9.0 million
of residential  mortgages converted to FHLMC securities.  Without the conversion
of the $9.0 million in mortgages, growth in the residential portfolio would have
been $6.5  million or 12.2%.  Commercial  loans grew by $6.2  million  and other
loans grew by $0.7 million.  Allowance for loan losses increased  $238,000,  the
net result of  $680,000 in  provision  for loan  losses and net  charge-offs  of
$442,000.

Total  deposits  grew by $21.1  million or 19.1%  during 1998,  including  $16.2
million in deposits  acquired in the purchase of the Madison branch.  Borrowings
from the Federal  Home Loan Bank of Boston  (FHLB)  decreased by $5.6 million --
the net result of the paydown of $14.2 million of borrowings  from $14.6 million
in cash  received in the Madison  acquisition  and the funding  needs created by
loan  demand.  The  borrowings  of the  Bank  consist  of  advances  of  various
maturities  from the  Federal  Home Loan  Bank and  relatively  small  portfolio
($877,000  at December  31, 1998) of daily  reverse-repurchase  agreements  with
commercial customers.

The Bank's non-accrual loans increased from $ 2,090,000, or 1.76% of total loans
at December  31,  1997 to  $2,369,000,  or 1.83% of total loans at December  31,
1998. The increase can be attributed to the overall  increase in loan volumes in
1998.  During 1998,  the Bank  incurred  net loan  charge-offs  of $442,000.  In
response to the  charge-offs  and  increased  loan  volumes,  the Bank  provided
$680,000  in loan loss  reserves  during  1998  resulting  in an increase in the
reserve  balance from  $1,342,000 at December 31, 1997 to $1,580,000 at December
31, 1998. In determining the Allowance for Loan Losses, management uses internal
evaluations  of loan  characteristics  to  determine  loan  classifications  for
individual loans and calculates  reserves based on risk percentages  assigned to
each loan classification. General reserves are calculated for different types of
loans using  percentages  based on risk factors and loss  experience  associated
with those loan types.  Management  also  employs an outside firm to perform its
loan  review  function,  relying on the firm to provide  objective  criteria  in
evaluating the loan portfolio and adequacy of the Allowance for Loan Losses.

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,  which consists 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 1998 grew by
over  $21.1  million.  As  mentioned  earlier,  loans grew by $4.1  million  and
investments by $6.8 million. While the Bank's past growth has been funded partly
by principal paydowns on loans and mortgage-backed securities and partly through
deposit  growth,  much  of the  growth  has  been  funded  from  time to time by
borrowings  from the Federal  Home Loan Bank of Boston.  While total  borrowings
(including  reverse  repurchase  agreements)  decreased  $4.7 million due to the
$14.2  million  paydown from cash  received in the Madison  branch  acquisition,
borrowings remain an important source of funding for the Bank. The Bank also has
a borrowing  arrangement  available  through the discount  window at the Federal
Reserve Bank of Boston,  which the Bank will use in emergencies  necessitated by
unusual outflows of cash from its branches.

The  Bank's   primary   approach  to  measuring   liquidity  is  using  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, 1998, the 30-day ratio was 11.8% (23.1%  including  funds available
from the Federal Home Loan Bank of Boston).

                                      -5-
<PAGE>
Regulatory standards for Bank capital adequacy requires that capital be at least
8% of  risk-adjusted  assets.  KSB Bancorp,  Inc.'s total capital ratio of 12.0%
exceeds the guidelines.  In dollars, this means that the Company has the ability
to pay  dividends  subject to the minimum  capital  requirement.  On January 19,
1999, the Board of Directors  voted to increase the semiannual  cash dividend to
$0.08 per share.

The Company's  profitable year in 1998 resulted in an increase in  stockholders'
equity of  $2,132,000  for the year ended  December  31,  1998.  Included in the
increase is $231,000, which represents the increased market price on ESOP shares
released during 1998 and which, under generally accepted accounting  principles,
is included in salaries and benefits expense.

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's  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

The Financial  Accounting  Standards  Board issued the  following  Statements of
Financial Accounting Standards (SFAS) during 1997 and 1998:

         SFAS No. 130      Reporting Comprehensive Income

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

         SFAS No. 132      Employer's Disclosure about Pension and Other 
                           Post-Retirement Benefits

         SFAS No. 133      Accounting for Derivative Instruments and Hedging
                           Activities

         SFAS No. 134      Accounting for Mortgage-backed Securities Retained
                           after the Securitization of Mortgage Loans Held for
                           Sale by a Mortgage Banking Enterprise

         SFAS No. 130 is  effective  for periods  beginning  after  December 15,
      1997.  The  Company  implemented  SFAS No. 130 in 1998,  and its  required
      disclosures  are  included in the  consolidated  statements  of changes in
      stockholders' equity.

         SFAS No. 131 is  effective  for periods  beginning  after  December 15,
      1997. The Company's operations include only banking activities. Therefore,
      SFAS No. 131 imposed no additional disclosure requirements.  SFAS No. 132,
      which   revised   employers'   disclosures   about   pension   and   other
      post-retirement  benefits, is effective for years beginning after December
      31, 1997.  The Company is not affected by SFAS No. 132 as it does not have
      pension and post-retirement plans.

         SFAS No. 133, which establishes  accounting and reporting standards for
      derivative  instruments and for hedging activity,  is effective for fiscal
      years  beginning  after June 15,  1999.  The Company has not  measured the
      impact  of  SFAS  No.  133 on  its  financial  condition  and  results  of
      operations.

         SFAS No. 134 is effective for the first fiscal quarter  beginning after
      December  15,  1998,  with  earlier  application  encouraged.  The Company
      applied SFAS No. 134 in 1998 with the  securitization  of  mortgage-backed
      securities. Those securities are classified as available for sale.

                                      -6-
<PAGE>
YEAR 2000 READINESS

The Year 2000 (`Y2K') issue is the result of computer programs using a two-digit
format,  as opposed to four digits,  to indicate the year. Such computer systems
may be unable to  properly  interpret  dates  beyond the year 1999,  which could
cause a system  failure or other  computer  errors,  leading to  disruptions  in
operations.  In 1997, Kingfield Bank developed a five-phase  methodology for Y2K
systems compliance.

Phase I, or  Awareness,  consisted of defining the Y2K issue at Kingfield  Bank;
informing the Board of Directors, management and key customers of the issue; and
developing a strategy of addressing the issue in all areas of the Company.  This
phase has been completed.

Phase II, or  Assessment,  consists of  identifying  all software,  hardware and
customer/vendor  interdependencies  affected  by the Y2K  issue.  This  phase is
essentially complete, but management realizes that additional issues might arise
that may require additional assessment.

Phase III, or Renovation,  includes various upgrades to hardware and software to
ensure Y2K compliance. This phase is expected to be completed by March 31, 1999.
In September 1998, the Bank installed new mainframe hardware.  The Y2K issue was
not the overall  reason for the addition.  The new hardware is Y2K compliant and
facilitates software testing (the software is also certified compliant, but will
be  tested  as part of Phase  IV  Validation).  The  overriding  motivation  for
purchase of the  hardware  was to provide  better,  faster  customer  service by
speeding up processing and backup time for the Bank's application processes. The
hardware  and  software  are  certified  by the  vendors as Y2K  compliant.  The
purchased  hardware and associated  software are being capitalized in accordance
with normal policy.  The costs associated with new software or upgraded hardware
would have been incurred in the normal  course of  operations  regardless of the
Y2K issue.

Phase IV, or Validation, consists of testing all hardware and software in use by
the  Company as well as testing the  interfaces  between  Company  and  external
systems.  Systems in use by critical suppliers of services will be monitored for
testing  progress by management.  The Company plans having the Validation  phase
completed by March 31, 1999. The Bank uses a nationally  recognized  third party
service provider who provides  software to over 3,500 financial  institutions to
provide  application  software  to  process  its  most   mission-critical   data
processing  related to its loans,  deposits,  general ledger and other financial
applications.  The service  provider  has informed the Bank that its software is
Y2K compliant (and has been since 1988).  Testing of the third party  provider's
programs has commenced and is expected to be completed by March 31, 1999.

Phase V, or  Implementation,  will be completed by June 30, 1999 and will result
in the certification of all hardware and software as Y2K compliant.  Contingency
plans have been developed for all mission  critical systems and will be executed
if any  systems  fail to meet  certification  criteria.  The  Company  is in the
process of assessing these plans in light of the possible impact of Y2K failures
and will modify  plans as more  becomes  known  about  evolving  scenarios.  The
Company's  reasonably  most  likely  worst-case  Y2K  scenarios  may include the
failure  of a vendor or third  party  provider,  which is beyond  the  Company's
control.  In the event a  failure  occurs,  the  Company  expects  to be able to
implement  contingency  systems.  The  Bank  has  in  place  stand-by  liquidity
available  to it in the event  unusual  levels of  deposit  outflows  occur as a
result of customers' fear of system failures.

Management believes the Company is adequately  addressing the Y2K issue and that
the current  preparations  and testing being  conducted all seek to minimize any
potential  adverse  effect  on the Bank or its  customers.  The  commercial  and
residential  loan  portfolios,  as well as the  significant  depositor list, are
currently being analyzed by our Y2K team for material exposure to the Y2K issue.
No  material  exposure is  expected  due to the  diverse  nature of our loan and
deposit  portfolios.  It is estimated  that the  Company's  cost of  remediation
during 1998 was under  $5,000  direct  expenses and fewer than 1,500 total hours
spent by management  and staff.  1999 expenses are expected to be under $20,000,
including $10,000 for computer  software,  $5,000 for customer awareness efforts
and $5,000 miscellaneous.

The Company's  regulatory  agency,  the Federal  Deposit  Insurance  Corporation
(`FDIC'), has been monitoring,  and plans to continue monitoring,  the Company's
progress in addressing the Y2K issue. The FDIC has provided substantial guidance
to the Bank concerning the Y2K issue.

                                      -7-
<PAGE>
<TABLE>
<CAPTION>
Selected Consolidated Financial and Other Data of the Bank
                                                                                       ($ in 000's)
Selected Financial Data:                                    1998            1997           1996           1995         1994
-----------------------------------------------------------------------------------------------------------------------------
<S>                                                        <C>             <C>            <C>           <C>          <C>    
   Total assets                                            171,329         152,752        134,357       125,233      113,003
   Loans receivable, net (1)                               129,178         118,857         99,197        85,889       68,634
   Investment securities available for sale (2)             20,967           9,261          7,452         8,377            0
   Investment securities to be held to maturity              9,271          14,171         18,517        19,102       36,207
   Goodwill                                                  1,411             517            620           723          716
   Deposits (3)(4)                                         132,980         111,723        110,282       104,702       81,040
   Borrowed funds                                           23,524          28,219         13,186        10,952       23,367
   Total equity, substantially restricted                   13,687          11,555          9,792         8,498        7,621

   AVERAGE INTEREST EARNING ASSETS                         151,185         137,814        124,331       116,915       88,884
   AVERAGE ASSETS                                          159,328         144,458        130,742       122,899       92,459
   AVERAGE INTEREST BEARING LIABILITIES                    133,194         122,722        111,580       106,129       79,337
   AVERAGE EQUITY                                           12,571          10,612          9,134         7,961        7,502

Selected Operating Data:
   Interest and dividend income                             13,218          12,003         10,705         9,955        6,942
   Interest expense                                          5,970           5,752          5,166         5,025        3,267
-----------------------------------------------------------------------------------------------------------------------------
   Net interest income                                       7,248           6,251          5,539         4,930        3,675
   Less provision for loan losses                              680             530            390           315          140
-----------------------------------------------------------------------------------------------------------------------------
   Net interest income after
     provision for loan losses                               6,568           5,721          5,149         4,615        3,535
Noninterest income
   Net security gains (losses)                                   0               0            (47)           32            0
   Mortgage servicing                                          268             297            321           328          306
   Service charges and fees                                    841             705            700           568          440
   Other                                                       219             184            165           194          211
-----------------------------------------------------------------------------------------------------------------------------
      Total non-interest income                              1,328           1,186          1,139         1,122          957
-----------------------------------------------------------------------------------------------------------------------------
Noninterest expense
   Salaries and benefits                                     2,540           2,206          2,051         2,100        2,015
   Occupancy                                                   316             281            299           312          270
   Equipment                                                   775             730            629           625          634
   BIF premium                                                  29              28            236           137          151
   Other                                                     1,469           1,357          1,246         1,404        1,178
-----------------------------------------------------------------------------------------------------------------------------
      Total non-interest expense                             5,129           4,602          4,461         4,578        4,248
-----------------------------------------------------------------------------------------------------------------------------
   Income before income taxes                                2,767           2,305          1,827         1,159          244
   Income tax expense                                          961             756            583           336           22
-----------------------------------------------------------------------------------------------------------------------------
              Net income                                     1,806           1,549          1,244           823          222
=============================================================================================================================
</TABLE>
                                      -8-
<PAGE>
<TABLE>
<CAPTION>
Selected Consolidated Financial and Other Data of the Bank

Selected Financial Data:                                     1998             1997           1996          1995          1994
------------------------------------------------------------------------------------------------------------------------------
<S>                                                          <C>             <C>            <C>           <C>            <C> 
   Return on average assets %                                 1.13%           1.07%          0.95%         0.67%         0.24%
   Return on average equity                                  14.37           14.60          13.62         10.34          2.95
   Average equity to average assets                           7.89            7.35           6.99          6.48          8.11
   Equity to total assets                                     7.99            7.56           7.29          6.79          6.74
   Tangible equity to tangible assets                         7.22            7.25           6.86          6.24          6.15
   Interest rate spread during period                         4.18            3.95           3.91          3.70          3.54
   Net interest margin (5)                                    4.71            4.46           4.38          4.14          3.99
   Operating expenses to average assets (6)                   3.10            3.11           3.33          3.73          4.59
   Non-accruing loans to total loans (1) (7)                  1.83            1.76           1.91          1.92          1.99
   Non-performing assets to total assets (8) (7)              1.47            1.47           1.50          1.35          1.22
   Allowance for loan losses to
     non-performing loans                                    66.69           64.21          47.12         52.69         44.95
   Allowance for loan losses to total loans (1)               1.21            1.12           0.89          1.00          0.89
   Average interest-earning assets to
     average interest-bearing liabilities                     1.14            1.12           1.11          1.10          1.12
   Basic Earnings per Share (9)                              $1.47           $1.30          $1.07         $0.72         $0.20
   Diluted Earnings per Share (9)                            $1.41           $1.23          $1.01         $0.69         $0.19
</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. In March, 1998 the Bank acquired one branch with deposits of $16.2
     million.

(5)  Calculation is based upon net interest  income  excluding  certain fees and
     before provision for loan losses 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 $0,  $50,000,  $501,000,  $765,000 and $672,000 at December 31,
     1998,1997, 1996, 1995, and 1994, 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


                                      -9-
<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, 1998 and 1997,  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, 1998.
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, 1998 and 1997, and the consolidated results of
their operations and their  consolidated  cash flows for each of the three years
in the period ended  December 31, 1998, in conformity  with  generally  accepted
accounting principles.

/s/Berry, Dunn, McNeil & Parker

Portland, Maine
January 21, 1999


                                      -10-
<PAGE>
<TABLE>
<CAPTION>
Consolidated Statements of Financial Condition
DECEMBER 31, 1998 AND 1997

ASSETS                                                            1998               1997
----------------------------------------------------------------------------------------------
<S>                                                           <C>               <C>         
Cash and due from banks                                        $ 3,233,994       $ 3,233,478
Interest-bearing deposits with banks                                 2,833             5,838
Securities available for sale, at market value                  20,967,448         9,260,779
Securities held to maturity (market value $9,444,467
   and $14,425,808 at 1998 and 1997, respectively)               9,271,046        14,170,856

Loans held for sale                                              8,228,153         2,007,110

Loans receivable
   Real estate mortgage                                         50,150,567        52,710,292
   Home equity                                                  13,657,144        13,718,409
   Installment                                                   4,594,097         4,255,099
   Commercial                                                   53,277,542        47,056,531
   Other                                                         1,075,589           654,300
   Deferred loan origination fees                                 (224,447)         (202,808)
----------------------------------------------------------------------------------------------
                                                               122,530,492       118,191,823
   Less allowance for possible loan losses                      (1,580,233)       (1,341,828)
----------------------------------------------------------------------------------------------
         Total loans receivable, net                           120,950,259       116,849,995
----------------------------------------------------------------------------------------------
Accrued interest receivable                                        851,868           826,582
Other real estate owned                                            146,705           158,554
Federal Home Loan Bank stock, at cost                            1,641,350         1,537,650
Premises and equipment, net                                      2,563,083         2,314,298
Goodwill                                                         1,411,119           516,778
Deferred tax asset                                                 781,433           661,099
Cash surrender value of life insurance                             638,567           588,217
Other assets                                                       641,020           620,866
----------------------------------------------------------------------------------------------
                                                              $171,328,878      $152,752,100
==============================================================================================
</TABLE>

                  The accompanying notes are an integral part
                  of these consolidated financial statements.

                                      -11-
<PAGE>
<TABLE>
<CAPTION>
Consolidated Statements of Financial Condition (concluded)
LIABILITIES AND STOCKHOLDERS' EQUITY

                                                                       1998              1997
----------------------------------------------------------------------------------------------------
<S>                                                                <C>               <C>         
Liabilities
   Deposit accounts
      Demand                                                       $ 12,385,129      $ 12,140,898
      Regular savings                                                23,875,002        20,055,303
      NOW accounts                                                   23,807,239        13,914,421
      Money market accounts                                           8,895,048         6,211,324
      Time                                                           62,877,090        58,386,623
----------------------------------------------------------------------------------------------------
         Total deposits                                             131,839,508       110,708,569
   Advances from Federal Home Loan Bank                              22,647,000        28,219,000
   Other borrowed funds                                                 877,387                --
   Escrows and trustee accounts for sold loans                        1,140,712         1,013,894
   Accrued expenses and other liabilities                             1,137,742         1,255,534
----------------------------------------------------------------------------------------------------
         Total liabilities                                          157,642,349       141,196,997
----------------------------------------------------------------------------------------------------

Commitments and contingency (Notes 10, 12, 14, and 16)

Stockholders' equity
   Preferred stock, authorized 200,000 shares                               --                --
   Common stock, par value $.01; authorized 2,400,000
      shares, issued 1,269,411 shares in 1998 and 1,246,950
      shares in 1997                                                     12,695            12,470
   Additional paid-in capital                                         4,842,369         4,543,655
   Retained earnings                                                  8,796,056         7,171,531
   Net unrealized gain on securities available for sale,
      net of deferred taxes                                             210,571            72,698
----------------------------------------------------------------------------------------------------
                                                                     13,861,691        11,800,354
   Less remaining obligation under:
      Employee Stock Ownership Plan                                     (68,453)         (117,348)
      Bank Recognition and Retention Plan                               (29,724)          (50,918)
   Treasury stock, at cost (7,964 shares in 1998 and 1997)              (76,985)          (76,985)
----------------------------------------------------------------------------------------------------
         Total stockholders' equity                                  13,686,529        11,555,103
----------------------------------------------------------------------------------------------------
                                                                   $171,328,878      $152,752,100
====================================================================================================
</TABLE>
                  The accompanying notes are an integral part
                  of these consolidated financial statements.

                                      -12-
<PAGE>
<TABLE>
<CAPTION>
Consolidated Statements of Income
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
                                                                     1998              1997              1996
------------------------------------------------------------------------------------------------------------------------------------
<S>                                                               <C>              <C>               <C>        
Interest and dividend income
   Interest and fees on loans                                     $11,666,663      $10,133,178       $ 8,756,148
   Interest on securities available for sale                          604,522          669,865           466,560
   Interest on securities held to maturity                            841,636        1,108,105         1,397,322
   Dividends                                                          104,762           92,682            84,501
------------------------------------------------------------------------------------------------------------------------------------
         Total interest and dividend income                        13,217,583       12,003,830        10,704,531
------------------------------------------------------------------------------------------------------------------------------------
Interest expense
   Interest on deposits                                             4,797,856        4,378,125         4,483,138
   Interest on borrowed funds                                       1,171,888        1,374,125           682,469
------------------------------------------------------------------------------------------------------------------------------------
         Total interest expense                                     5,969,744        5,752,250         5,165,607
------------------------------------------------------------------------------------------------------------------------------------
         Net interest income                                        7,247,839        6,251,580         5,538,924
Provision for loan losses                                             680,000          530,000           390,000
------------------------------------------------------------------------------------------------------------------------------------
   Net interest income after provision
      for loan losses                                               6,567,839        5,721,580         5,148,924
------------------------------------------------------------------------------------------------------------------------------------
Noninterest income
   Gain (loss) on disposition of securities                                --               --           (46,617)
   Mortgage servicing fees                                            268,462          296,579           320,522
   Service charges and fees                                           840,852          705,160           699,747
   Other                                                              218,848          184,346           165,268
------------------------------------------------------------------------------------------------------------------------------------
         Total noninterest income                                   1,328,162        1,186,085         1,138,920
------------------------------------------------------------------------------------------------------------------------------------
Noninterest expense
   Salaries and benefits                                            2,540,418        2,205,609         2,050,381
   Occupancy                                                          315,963          280,699           298,835
   Equipment                                                          775,143          729,862           629,391
   BIF Premium                                                         28,896           28,456           236,135
   Other                                                            1,468,543        1,357,196         1,246,321
------------------------------------------------------------------------------------------------------------------------------------
         Total noninterest expense                                  5,128,963        4,601,822         4,461,063
------------------------------------------------------------------------------------------------------------------------------------
         Income before income taxes                                 2,767,038        2,305,843         1,826,781
Income tax expense                                                    961,042          756,438           582,453
------------------------------------------------------------------------------------------------------------------------------------
         Net income                                               $ 1,805,996      $ 1,549,405       $ 1,244,328
====================================================================================================================================
Per Share Data
   Basic earnings per common share                                     $ 1.47          $  1.30           $  1.07
====================================================================================================================================
   Diluted earnings per common share                                   $ 1.41          $  1.23           $  1.01
====================================================================================================================================
   Weighted-average shares outstanding                              1,227,009        1,187,651         1,166,371
====================================================================================================================================
</TABLE>
                  The accompanying notes are an integral part
                  of these consolidated financial statements.

                                      -13-
<PAGE>
<TABLE>
<CAPTION>
Consolidated Statements of Changes in Stockholders' Equity
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
                                                                                                   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, 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
   Change in net unrealized loss
      on securities available for
      sale, net of deferred taxes
      of $14,400                     --           --            --           --           --      (28,228)         --       (28,228)
------------------------------------------------------------------------------------------------------------------------------------
   Total comprehensive income        --           --     1,244,328           --           --      (28,228)         --     1,216,100
   Cash dividends declared
      ($.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
------------------------------------------------------------------------------------------------------------------------------------
Balances,
   December 31, 1996             $4,111   $4,325,499    $5,748,714    $(168,840)   $ (79,562)   $ (37,760)     $   --    $9,792,162
====================================================================================================================================
</TABLE>

                  The accompanying notes are an integral part
                  of these consolidated financial statements.

                                      -14-
<PAGE>
<TABLE>
<CAPTION>
Consolidated Statements of Changes in Stockholders' Equity (continued)
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
                                                                                                   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, 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
   Change in net unrealized
      gain (loss) on securities
      available for sale, net
      of deferred taxes of

      $56,850                        --           --            --           --           --      110,458          --       110,458
------------------------------------------------------------------------------------------------------------------------------------
   Total comprehensive
      income                         --           --     1,549,405           --           --      110,458          --     1,659,863
   Cash dividends declared
      ($.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 effected
      in the form of a
      200% dividend               8,313           --        (8,313)          --           --           --          --            --
------------------------------------------------------------------------------------------------------------------------------------
Balances,
   December 31, 1997            $12,470  $ 4,543,655   $ 7,171,531    $(117,348)    $(50,918)    $ 72,698   $ (76,985)  $11,555,103
====================================================================================================================================
</TABLE>

                  The accompanying notes are an integral part
                  of these consolidated financial statements.



                                      -15-
<PAGE>
<TABLE>
<CAPTION>
Consolidated Statements of Changes in Stockholders' Equity (continued)
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
                                                                                                   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, 1997            $12,470   $4,543,655    $7,171,531    $(117,348)    $(50,918)    $72,698    $(76,985)   $11,555,103
------------------------------------------------------------------------------------------------------------------------------------
   Net income                        --           --     1,805,996           --           --          --          --      1,805,996
   Change in net unrealized
      gain on securities
      available for sale, net
      of deferred taxes
      of $71,025                     --           --            --           --           --     137,873          --        137,873
------------------------------------------------------------------------------------------------------------------------------------
   Total comprehensive
      income                         --           --     1,805,996           --           --     137,873          --      1,943,869
   Cash dividends
      declared ($.011 per
      share, net of dividends
      on ESOP shares)                --           --      (113,411)          --           --          --  --(113,411)
   Payment of obligation
      under Employee Stock
      Ownership Plan                 --      230,875            --       48,895           --          --          --        279,770
   Bank Recognition and
      Retention Plan                 --           --            --           --       21,194          --          --         21,194
   26,879 shares issued under
      Stock Option Plans            269       81,183            --           --           --          --          --         81,452
   Purchase of 4,418 shares of
      treasury stock                 --           --            --           --           --          --     (81,448)(81,448)
   Retire 4,418 shares of
      treasury stock                (44)     (13,344)      (68,060)          --           --          --      81,448             --
------------------------------------------------------------------------------------------------------------------------------------
Balances,
   December 31, 1998            $12,695   $4,842,369    $8,796,056     $(68,453)    $(29,724)   $210,571    $(76,985)   $13,686,529
====================================================================================================================================
</TABLE>
                  The accompanying notes are an integral part
                  of these consolidated financial statements.

                                      -16-
<PAGE>
<TABLE>
<CAPTION>
Consolidated Statements of Cash Flows
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
                                                                     1998              1997              1996
------------------------------------------------------------------------------------------------------------------
<S>                                                              <C>              <C>               <C>         
Cash flows from operating activities
   Net income                                                    $  1,805,996     $  1,549,405      $  1,244,328
   Adjustments to reconcile net income to net cash
      provided (used) by operating activities
         Depreciation and amortization                                772,932          748,677           745,294
         Decrease in obligation under ESOP and BRP                    300,964          256,564           150,297
         Provision for loan losses                                    680,000          530,000           390,000
         Deferred income taxes                                       (138,288)        (260,405)          (21,857)
         Net gain on sale of loans held for sale                      (89,892)         (63,226)          (49,738)
         Net loss on default of security held to maturity                  --               --            46,617
         Net loss on disposal of equipment                              3,207            5,973                --
         Loss on sale of other real estate owned                       28,143               --            14,204
         Originations of loans held for sale                      (15,473,626)      (6,625,287)       (5,842,269)
         Proceeds from loans held for sale                          5,054,251        4,083,405         5,199,250
         Decrease (increase) in
            Interest receivable                                       (26,585)         (62,914)           48,726
            Other receivables and prepaid expense                     (92,637)         (57,018)            9,119
            Cash surrender value of life insurance                    (50,350)         (34,121)          (60,337)
         Increase (decrease) in
            Accrued income taxes payable                              (39,853)          (1,175)          (15,690)
            Deferred origination fees                                  21,639           (6,356)           22,846
            Accrued expenses and other liabilities                    (94,243)         167,109            37,745
------------------------------------------------------------------------------------------------------------------
         Net cash provided (used) by operating activities          (7,338,342)         230,631         1,918,535
------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities
   Net decrease (increase) in interest-bearing deposits
      with banks                                                        3,005           (4,282)        2,458,977
   Proceeds from maturities and principal payments on
      securities held to maturity                                   4,807,090        4,195,590         5,730,367
   Purchase of securities held to maturity                                 --               --        (5,364,445)
   Proceeds from maturities and principal payments on
      securities available for sale                                 2,535,797        5,355,874           860,627
   Purchase of securities available for sale                       (5,045,490)      (7,018,176)               --
   Net increase in loans                                           (9,192,461)     (17,738,199)      (13,142,669)
   Capital expenditures                                              (530,614)        (548,528)         (318,563)
   Purchase of FHLB stock                                            (103,700)        (217,100)               --
   Net decrease in other assets                                         9,500           61,638            68,330
   Proceeds from sale of other real estate owned                      446,952          116,500            26,973
------------------------------------------------------------------------------------------------------------------
         Net cash used by investing activities                     (7,069,921)     (15,796,683)       (9,680,403)
------------------------------------------------------------------------------------------------------------------
</TABLE>
                  The accompanying notes are an integral part
                  of these consolidated financial statements.

                                      -17-
<PAGE>
<TABLE>
<CAPTION>
Consolidated Statements of Cash Flows (Continued)
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
                                                                     1998              1997              1996
------------------------------------------------------------------------------------------------------------------------------------
<S>                                                               <C>             <C>                  <C>      
Cash flows from financing activities
   Cash received through branch acquisition                       $14,632,259            $  --               $--
   Net increase (decrease) in time deposit accounts                (1,836,978)        (950,065)        3,820,457
   Net increase (decrease) in other deposit accounts                6,815,858        2,296,074         1,856,448
   Net increase (decrease) in FHLB advances                        (5,215,771)      15,033,000         2,234,000
   Net increase (decrease) in escrow accounts                         126,818           94,640           (97,000)
   Proceeds from stock issuance under option plan                      81,452           54,000                --
   Purchase of treasury stock issued                                  (81,448)        (124,405)               --
   Proceeds from reissuance of treasury stock under
      option plan                                                          --            2,640                --
   Cash dividends paid                                               (113,411)         (85,721)          (72,466)
------------------------------------------------------------------------------------------------------------------------------------
         Net cash provided by financing activities                 14,408,779       16,320,163         7,741,439
------------------------------------------------------------------------------------------------------------------------------------
         Net increase (decrease) in cash and
            cash equivalents                                              516          754,111           (20,429)
Cash and cash equivalents, beginning of year                        3,233,478        2,479,367         2,499,796
------------------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents, end of year                            $ 3,233,994      $ 3,233,478        $2,479,367
====================================================================================================================================
Supplemental disclosures of cash flow information
   Cash paid during the year for
      Interest                                                   $  5,979,379      $ 5,703,515        $5,200,515
====================================================================================================================================
      Income taxes, net of refunds                                $ 1,107,184      $ 1,018,019        $  620,000
====================================================================================================================================
The Company had the following noncash transactions
   Net increase (decrease) required by Statement of
      Financial Accounting Standards No. 115
         Unrealized (gain) loss on securities
            available for sale                                    $  (208,898)    $   (167,309)        $  42,629
         Deferred income tax asset                                    (71,025)         (56,851)           14,400
         Net unrealized (gain) loss on securities
            available for sale                                       (137,873)        (110,458)           28,229
   Net transfer from loans to other real estate owned                 463,246          158,554           116,500
   Securitization of mortgage loans                                 9,014,129               --                --

</TABLE>
                  The accompanying notes are an integral part
                  of these consolidated financial statements.

                                      -18-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998, 1997 and 1996

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

      Operating Segments

      The Financial  Accounting  Standards Board issued  Statements of Financial
      Accounting  Standards  (SFAS) No. 131,  "Disclosures  About Segments of an
      Enterprise  and  Related  Information,"  effective  January 1,  1998.  The
      Company's   operations  are  comprised  of  a  single  operating  segment;
      therefore, SFAS No. 131 imposes no additional disclosure requirements.

      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 Bank has not  experienced any losses in such accounts and
      the Bank believes it is not exposed to any  significant  risk with respect
      to these accounts. The Federal Reserve Board requires the Bank to maintain
      a reserve  balance.  The amount of this reserve balance as of December 31,
      1998 is $940,000.

      Securities

      The Bank's investment accounting policies are as follows:

                                      -19-
<PAGE>
1.    Summary of Significant Accounting Policies (Continued)

      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.

      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

      Mortgage  loans  serviced for others are not included in the  accompanying
      balance sheet. 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.

      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. 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.

                                      -20-
<PAGE>
1.    Summary of Significant Accounting Policies (Continued)

      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.

      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 reductions in loan
      loss provision and decreases are reported as 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.

                                      -21-
<PAGE>
1.    Summary of Significant Accounting Policies (Concluded)

      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.

      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 and caps are  contracts in which a floor or a cap is
      established  at a specified  rate and for a specified  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  basic  and  diluted
      earnings per share.

      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.

      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.

      Comprehensive Income

      The  Company  adopted  SFAS No.  130,  "Reporting  Comprehensive  Income,"
      effective  January 1,  1998.  The  required  disclosures  for all  periods
      presented  are  included  in the  consolidated  statement  of  changes  in
      stockholders'  equity.  Comprehensive  income includes both net income and
      other  comprehensive  income.  The only  component of other  comprehensive
      income  is  net  unrealized   gains  and  losses  on  available  for  sale
      securities, net of deferred taxes.
<PAGE>
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:

      1998
      Mortgage-backed securities            $ 20,648,402             $ 320,402               $1,356              $  20,967,448
==============================================================================================================================
      1997
      Mortgage-backed securities            $  9,150,630             $ 113,570               $ 3,421             $   9,260,779
==============================================================================================================================
</TABLE>

                                      -22-
<PAGE>
2.    Securities (Concluded)
<TABLE>
<CAPTION>
                                                                        Gross                  Gross
                                             Amortized               Unrealized             Unrealized                Fair
                                               Cost                     Gains                 Losses                  Value
------------------------------------------------------------------------------------------------------------------------------
<S>                                         <C>                      <C>                    <C>                   <C>         
      Held to Maturity:
      1998
      Mortgage-backed securities            $ 8,288,487              $ 151,860              $  9,144              $  8,431,203
      REMIC                                     982,559                 30,705                    --                 1,013,264
------------------------------------------------------------------------------------------------------------------------------
                                            $ 9,271,046              $ 182,565              $  9,144              $  9,444,467
==============================================================================================================================
      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
==============================================================================================================================
</TABLE>

      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, 1998, 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                 $       --              $       --            $       --            $        --
      Due from one to five years               3,532,304               3,576,624              1,355,785              1,371,976
      Due from five to ten years               3,421,588               3,513,373                543,497                548,767
      Due after ten years                      2,317,154               2,354,470             18,749,120             19,046,705
--------------------------------------------------------------------------------------------------------------------------------
                                              $9,271,046              $9,444,467            $20,648,402            $20,967,448
================================================================================================================================
</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.  No securities available for sale were sold in 1996, 1997, or
      1998.  The Bank  realized a loss of  $46,617 on the  default of a security
      held to maturity in 1996.  The Bank has  pledged  $7,501,000  of its FHLMC
      mortgage-backed securities against public unit deposits.
<PAGE>
3.    Loans Receivable

      Activity in the allowance for loan losses is summarized as follows for the
years ended December 31:
<TABLE>
<CAPTION>
                                                                     1998              1997              1996
-----------------------------------------------------------------------------------------------------------------
<S>                                                                <C>              <C>                <C>      
      Balance at beginning of year                                 $1,341,828       $  893,456         $ 866,770
      Provision charged to income                                     680,000          530,000           390,000
      Loans charged off                                              (506,023)        (141,098)         (400,684)
      Recoveries on loans previously charged off                       64,428           59,470            37,370
-----------------------------------------------------------------------------------------------------------------
      Balance at end of year                                       $1,580,233       $1,341,828         $ 893,456
=================================================================================================================
</TABLE>


                                      -23-
<PAGE>
      3. Loans Receivable (Concluded)

         Information regarding impaired loans is as follows:
<TABLE>
<CAPTION>
                                                                                       1998              1997
-----------------------------------------------------------------------------------------------------------------
<S>                                                                                 <C>               <C>       
      Average investment in impaired loans                                          $3,147,210        $1,790,147
      Interest income recognized on impaired loans including
        interest income recognized on cash basis                                       425,649           186,119
      Interest income recognized on impaired loans on cash basis                       437,678           204,328

      Information regarding allowance for loan losses allocated to impaired
        loans at December 31, is as follows:
      Balance of impaired loans                                                     $3,299,288        $1,573,216
      Less portion for which no allowance for loan losses
        is allocated                                                                 2,745,184         1,545,234
-----------------------------------------------------------------------------------------------------------------
      Portion of impaired loan balance for which an allowance
        for loan losses is allocated                                                $  554,104           $27,982
=================================================================================================================
      Portion of allowance for loan losses allocated to the
        impaired loan balances                                                      $  190,719           $10,982
=================================================================================================================
</TABLE>

      Loans placed on nonaccrual status amounted to $2,368,521,  $2,090,266, and
      $1,894,503,  at December 31, 1998,  1997,  and 1996,  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>
                                                                      1998              1997              1996
-----------------------------------------------------------------------------------------------------------------
<S>                                                                  <C>              <C>               <C>     
      Interest income that would have been recorded                  $232,924         $205,906          $203,800
      Interest income recognized                                      115,235           89,041           135,178
-----------------------------------------------------------------------------------------------------------------
      Interest income foregone                                       $117,689         $116,865           $68,622
=================================================================================================================
</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  $75,950,532  and  $75,111,086  at  December  31,  1998 and 1997,
      respectively. 

      Custodial escrow balances maintained in connection with the foregoing loan
      servicing  were  $380,811  and  $303,482  at  December  31, 1998 and 1997,
      respectively.

      Mortgage  servicing  rights of $45,571  and  $38,456  are  capitalized  at
      December  31,  1998 and  1997,  respectively,  and are  included  in other
      assets.  The amortized cost  approximates  fair value at December 31, 1998
      and 1997.
<PAGE>
5.    Premises and Equipment

      Premises and equipment at December 31 consist of the following:
<TABLE>
<CAPTION>
                                                                                       1998              1997
-----------------------------------------------------------------------------------------------------------------
<S>                                                                                 <C>               <C>       
      Land and improvements                                                         $  326,114        $  310,889
      Bank buildings and leasehold improvements                                      1,967,003         1,643,639
      Furniture and fixtures                                                         2,880,911         2,592,222
-----------------------------------------------------------------------------------------------------------------
                                                                                     5,174,028         4,546,750
      Less accumulated depreciation                                                  2,610,945         2,232,452
-----------------------------------------------------------------------------------------------------------------
                                                                                    $2,563,083        $2,314,298
=================================================================================================================
</TABLE>

                                      -24-
<PAGE>
5.    Premises and Equipment (Concluded)

      Depreciation expense was $446,833,  $432,674, and $368,556, in 1998, 1997,
      and 1996, 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  $5,000 per year.

      The related rent expense, net of sublease income, was $688, $(1,587),  and
      $1,226, in 1998, 1997, and 1996, respectively.

6.    Branch Acquisitions

      On March 14, 1998, the Bank acquired the Madison,  Maine branch of KeyBank
      of Maine.  The  acquisition was accounted for under the purchase method of
      accounting  for  business  combinations.  The  Bank  received  net cash of
      approximately  $14,632,000  for  deposits  assumed,  net  of  loans,  bank
      premises and equipment acquired and deposit premium  (goodwill). 

      Goodwill for the Madison  branch and  branches  acquired in prior years is
      being   amortized   using  the   straight-line   method  over  ten  years.
      Amortization charged to operations was $193,770, $103,047, and $103,047 in
      1998, 1997, and 1996, respectively.

7.    Deposits

      At December 31, 1998,  the  scheduled  maturities  of time deposits are as
      follows:

      1999                          $38,600,014
      2000                           19,867,007
      2001                            1,772,235
      2002                              923,328
      2003 and thereafter             1,714,506
                                    -----------
                                    $62,877,090
                                    ===========

      The aggregate amount of jumbo certificates of deposit, each with a minimum
      denomination  of $100,000,  was  $7,227,823 and $6,742,758 at December 31,
      1998 and 1997, respectively.
<PAGE>
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, 1998        1998               1997
------------------------------------------------------------------------------------------
<S>                                    <C>                  <C>               <C>        
      Fixed advances                   4.71 - 6.10%         $14,952,000       $25,889,000
      Variable advances                5.06 - 5.40%           7,695,000         2,330,000
------------------------------------------------------------------------------------------
                                                            $22,647,000       $28,219,000
==========================================================================================
</TABLE>

      Pursuant  to   collateral   agreements   with  the  FHLB,   advances   are
      collateralized  by all  stock in the FHLB and  qualifying  first  mortgage
      loans and investments. Advances at December 31, 1998, mature as follows:

      1999                          $12,195,000
      2000                            5,452,000
      2008                            5,000,000
                                    -----------
                                    $22,647,000
                                    ===========

      The Bank also has $3,108,000 available on a line of credit with the FHLB.

                                      -25-
<PAGE>
9.    Other Borrowed Funds

      Other borrowed funds amounting to $877,387 at December 31, 1998 consist of
      securities sold under  agreements to repurchase,  which  generally  mature
      within one day from the transaction date. At December 31, 1998, securities
      with a fair value of $968,000 were pledged to secure other borrowed funds.

10.   Income Taxes

      Actual tax expense  differs from the expected tax expense  computed at the
      federal statutory tax rate for the following reasons:
<TABLE>
<CAPTION>
                                                                      1998              1997             1996
-----------------------------------------------------------------------------------------------------------------
<S>                                                                  <C>              <C>               <C>     
      Provision for income taxes at statutory rates (34%)            $940,800         $784,000          $621,100
        Add (deduct)
        Pass-through tax credit from investment                       (82,700)         (82,700)          (82,700)
        State income tax, net of federal taxes                         21,000           18,600            15,400
        Nontaxable income                                             (19,000)         (16,100)          (12,200)
        Nondeductible expenses                                         98,400           78,600            41,000
        Deductible expense                                                 --          (29,000)               --
        Other                                                           2,542            3,038              (147)
-----------------------------------------------------------------------------------------------------------------
                                                                     $961,042         $756,438          $582,453
=================================================================================================================
</TABLE>

      The components of income tax expense are:

<TABLE>
<CAPTION>
                                Federal            State           Total
-----------------------------------------------------------------------------
<S>                         <C>                  <C>            <C>        
      1998
        Current               $1,067,486         $ 31,844      $  1,099,330
        Deferred                (138,288)              --          (138,288)
-----------------------------------------------------------------------------
            Total             $  929,198         $ 31,844      $   961,042
=============================================================================

      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
=============================================================================
</TABLE>
                                      -26-
<PAGE>
      10.         Income Taxes (Concluded)

      The tax effect of  temporary  differences  which give rise to the deferred
      income tax assets and liabilities are as follows:
<TABLE>
<CAPTION>
                                                         1998                                         1997
---------------------------------------------------------------------------------------------------------------------------
                                           Asset                 Liability                 Asset                Liability
---------------------------------------------------------------------------------------------------------------------------
<S>                                       <C>                     <C>                    <C>                    <C>     
Accrued liabilities and
  unearned income                         $120,966                $      -               $111,894               $     -
Allowance for possible loan losses         537,280                  35,593                456,222                 39,504
Interest on nonaccrual loans                28,336                      --                 20,937                     -
Goodwill, amortization, and

  depreciation                              60,379                      --                 38,000                     -
Loans held for sale                         34,472                      --                 10,055                     -
Change in method of accounting for
  tax from cash basis to accrual basis          --                  18,527                      -                 37,054
Unrealized gain on securities
  available for sale                            --                 108,476                      -                 37,450
Other assets                                    --                  37,960                      -                 33,477
Other                                           --                      --                 23,991                     -
---------------------------------------------------------------------------------------------------------------------------
                                          $781,433                $200,556               $661,099               $147,485
===========================================================================================================================
</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.

11.   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, 1998 and 1997 were as follows:
<TABLE>
<CAPTION>
                                                1998              1997
---------------------------------------------------------------------------
<S>                                            <C>               <C>     
      Beginning balance                        $349,661          $145,740
        New loans                               181,313           221,574
        Less repayments                         201,147            17,653
---------------------------------------------------------------------------
      Ending balance                           $329,827          $349,661
===========================================================================
</TABLE>

12.   Employee Benefit Plans

      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 $64,172,
      $54,905, and $50,494, in 1998, 1997, and 1996, respectively.

                                      -27-
<PAGE>
12.   Employee Benefit Plans (Continued)

      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 $6,193,  $9,903,
      and $13,114 in 1998, 1997, and 1996, 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 $279,770, $227,920, and $121,653 for 1998,
      1997, and 1996, respectively.  As of December 31, 1998, 99,512 shares have
      been allocated and the remaining 22,591 shares are suspense shares held by
      the ESOP.  The fair value of unearned ESOP shares at December 31, 1998, is
      $316,275. 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 $21,194,  $28,644,  and
      $28,644 for 1998, 1997, and 1996, respectively.
<PAGE>
      A summary of the status of the Bank  Recognition  and  Retention  Plans is
      presented below:
<TABLE>
<CAPTION>
                                                    1998              1997             1996
                                                   Number            Number           Number
                                                  of Shares         of Shares        of Shares
-------------------------------------------------------------------------------------------------
<S>                                                <C>               <C>                <C>   
      Outstanding at beginning of year             39,162            41,135             41,135
      Granted during the year                      10,173                 -                  -
      Forfeited during the year                         --             1,973                 -
-------------------------------------------------------------------------------------------------
                                                   49,335            39,162             41,135
=================================================================================================
</TABLE>

      Stock Option Plan

      The Company has two fixed stock option plans for  employees  accounted for
      under  APB  Opinion  25  and  related  interpretations.  The  first  plan,
      established  in 1993 ("1993  Plan") allows the Company to grant options to
      employees for up to 83,738 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 second plan was established in 1998
      ("1998  Plan") and allows the Company to grant options to employees for up
      to 58,000  shares.  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.

                                      -28-
<PAGE>
12.   Employee Benefit Plans (Continued)

      The Company also has two fixed stock option plans for directors  accounted
      for under APB  Opinion 25 and  related  interpretations.  The first  plan,
      established in 1993,  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.  The second  plan  established  in 1998  allows the Company to grant
      options to directors for up to 12,000 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>
                                                                     1998                 1997                 1996
------------------------------------------------------------------------------------------------------------------------
<S>                                   <C>                        <C>                    <C>                  <C>       
      Net income                      As reported                $1,805,996             $1,549,405           $1,244,328
                                      Pro forma                   1,570,945              1,485,496            1,230,803
      Basic earnings per share        As reported                     $1.47                  $1.30                $1.07
                                      Pro forma                        1.28                   1.25                 1.06
      Diluted earnings per share      As reported                     $1.41                  $1.23                $1.01
                                      Pro forma                        1.23                   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>
                                                                     1998                 1997                 1996
------------------------------------------------------------------------------------------------------------------------
<S>                                                                <C>                    <C>                  <C>     
      Dividend yield                                                   0.63%                  0.44%                0.31%
      Expected volatility                                             41.50                  39.40                25.30
      Risk-free interest rate                                          4.75%                  5.75%                6.43%
      Expected life                                                10 years               10 years             10 years
</TABLE>
<PAGE>
      A summary of the status of the Company's  fixed stock option plans for the
years ended December 31, 1998, 1997, and 1996 is presented below:
<TABLE>
<CAPTION>
                                                        1998                          1997                           1996
------------------------------------------------------------------------------------------------------------------------------------
                                                              Weighted                       Weighted                       Weighted
                                                               Average                        Average                        Average
                                               Number         Exercise         Number        Exercise         Number        Exercise
                                              of Shares         Price         of Shares        Price         of Shares        Price
------------------------------------------------------------------------------------------------------------------------------------
<S>                                            <C>           <C>              <C>           <C>              <C>            <C>  
      Outstanding at beginning of year          98,167       $  3.80          110,138        $ 3.21           105,188        $3.03
      Granted during the year                   64,500         18.29           12,000          7.67             4,950         7.08
      Exercised during the year                 26,879          3.03           18,691          3.03                --           --
      Reload options granted                     4,418         18.44               --            --                --           --
      Forfeited during the year                  3,000         18.50            5,280          3.03                --           --
------------------------------------------------------------------------------------------------------------------------------------
      Outstanding at end of year               137,206        $10.91           98,167        $ 3.80           110,138        $3.21
====================================================================================================================================
      Exercisable at end of year                78,106       $  6.42           74,699        $ 3.30            81,923        $3.28
====================================================================================================================================
      Weighted average grant-date
      fair value of options granted
      during the year                                         $ 8.03                         $17.67                          $4.14
</TABLE>

                                      -29-
<PAGE>
      12.         Employee Benefit Plans (Concluded)

      The following table summarizes information about stock options outstanding
      at December 31, 1998:
<TABLE>
<CAPTION>
                                        Number                   Weighted Average
          Range of                  Outstanding at                   Remaining                Weighted Average
       Exercise Prices             December 31, 1998             Contractual Life              Exercise Price
---------------------------------------------------------------------------------------------------------------
<S>                                    <C>                         <C>                          <C>    
       $3.03  -   7.67                  71,288                      5.3 years                    $  4.09
      $15.50  -  18.50                  65,918                      9.6 years                      18.29
       $3.03  -  18.50                 137,206                      7.4 years                      10.91
</TABLE>

13.   Earnings Per Share

      The  following  table  sets  forth the  computation  of basic and  diluted
earnings per share:
<TABLE>
<CAPTION>
                                                                      1998              1997             1996
-----------------------------------------------------------------------------------------------------------------
<S>                                                                <C>              <C>               <C>       
      Net income, as reported                                      $1,805,996       $1,549,405        $1,244,328
=================================================================================================================
      Weighted-average shares outstanding                           1,227,009        1,187,651         1,166,371
      Effect of dilutive potential common shares
        Stock options                                                  54,693           69,262            64,055
-----------------------------------------------------------------------------------------------------------------
      Adjusted weighted-average shares outstanding                  1,281,702        1,256,913         1,230,426
=================================================================================================================
      Basic earnings per share                                          $1.47            $1.30             $1.07
      Diluted earnings per share                                        $1.41            $1.23             $1.01
</TABLE>

      Options to purchase  65,918 shares of common stock at an average  exercise
      price of $18.29  per share  were  outstanding  during  1998,  but were not
      included in the  computation  of diluted  earnings  per share  because the
      options'  exercise  price was greater than the average market price of the
      common stock.

14.   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,
      1998, that the Bank meets all capital adequacy requirements to which it is
      subject.

      As of December 31,  1998,  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.

                                      -30-
<PAGE>
      14.         Regulatory Matters (Concluded)

      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, 1998:

Total Capital to Risk Weighted Assets
     Consolidated                       $13,466,000    12.0%   <179>$8,988,000   <179>8.0%        N/A
     Bank                                13,183,000    11.7%   <179> 8,971,920   <179>8.0%        <179>$11,214,900      <179>10.0%
Tier I to Risk Weighted Assets                                                
     Consolidated                        12,060,000    10.7%   <179> 4,494,000   <179>4.0%        N/A
     Bank                                11,779,000    10.5%   <179> 4,485,960   <179>4.0%        <179> 6,728,940       <179> 6.0%
Tier I Capital to Average Assets                                              
     Consolidated                        12,060,000     7.3%   <179> 6,615,560   <179>4.0%        N/A
     Bank                                11,779,000     7.1%   <179> 6,615,560   <179>4.0%        <179> 8,269,450       <179> 5.0%
                                                                              
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 Capital 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%
</TABLE>                                                       

      The ability of the Bank to pay  dividends to the parent is also subject to
      the minimum  regulatory  capital  requirements.  At December 31, 1998, the
      amount available for dividends by the Bank was  approximately  $2,583,000.

      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.

                                      -31-
<PAGE>
15.   Other Noninterest Expense

      Other noninterest  expense amounts are summarized as follows for the years
ended December 31:
<TABLE>
<CAPTION>
                                                                1998              1997             1996
------------------------------------------------------------------------------------------------------------
<S>                                                          <C>              <C>               <C>       
Printing, postage, stationery and supplies                   $  259,162       $  228,806        $  239,749
Advertising and promotion                                       144,808          119,679           117,806
Data processing                                                 176,816          152,614           145,324
Professional fees                                               150,931          176,446           136,556
Meetings and training                                            92,401          104,612            63,172
Bond and directors' and officers' insurance                      18,998           21,414            24,872
Goodwill amortization                                           193,770          103,047           103,047
Loss on sale/disposal of equipment                                5,230            5,973                --
Other                                                           426,427          444,605           415,795
------------------------------------------------------------------------------------------------------------
                                                             $1,468,543       $1,357,196        $1,246,321
============================================================================================================
</TABLE>

16.   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 and to mitigate interest rate risk. These financial  instruments
      are  commitments  to  originate  loans and interest  rate swaps,  caps 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,  caps 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, 1998, are as follows:

      Real estate lines of credit                           $11,104,665
      Commercial lines of credit                              4,743,268
      Construction loans                                      1,343,012
      Consumer lines of credit                                  919,992
      Commercial letters of credit                              323,568

      Commitments to originate loans at December 31, 1998, are as follows:

      First mortgage fixed rate loans                        $  759,940
      Variable rate commercial loans                          1,307,700

                                      -32-
<PAGE>
16.   Financial Instruments With Off-Balance-Sheet Risk (Concluded)

      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 5.2209% at December 31, 1998. 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
      $44,522 and $28,332 in 1998 and 1997, respectively.

      Interest Rate Floor

      The Company had an interest rate floor contract in the notional  amount of
      $5,000,000  on which it received the excess of the strike  rate,  6%, over
      the three-month LIBOR rate, adjusted quarterly.  The floor matured in June
      1998. The Company received $4,725 of interest income in 1998.

      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 1998.

      Other

      The Bank services  approximately $47 million of Federal Home Loan Mortgage
      Corporation  (FHLMC)  loans.  The Bank is liable to FHLMC for any interest
      which becomes delinquent.

17.   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 $76 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.

                                      -33-
<PAGE>
18.   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, 1998                        December 31, 1997
--------------------------------------------------------------------------------------------------------------------------
                                                Carrying                Fair              Carrying              Fair
                                                  Value                 Value               Value               Value
--------------------------------------------------------------------------------------------------------------------------
Assets
<S>                                           <C>                   <C>                 <C>                 <C>        
   Cash and due from banks(1)                 $  3,236,827          $  3,236,827        $  3,239,316        $  3,339,316
   Securities available for sale(1)             20,967,448            20,967,448           9,260,779           9,260,779
   Securities to be held to maturity(2)          9,271,046             9,444,467          14,170,856          14,425,808
   Loans receivable, net of allowance
     and discounts(3)                          120,950,259           123,405,000         116,849,995         118,769,000
   Loans held for sale(2)                        8,228,153             8,329,541           2,007,110           2,036,685
   Federal Home Loan Bank stock(1)               1,641,350             1,641,350           1,537,650           1,537,650
   Accrued interest receivable(1)                  851,868               851,868             826,582             826,582

Liabilities

   Deposits(4)                                 131,839,508           132,481,386         110,708,569         111,276,088
   Advances from Federal Home
      Loan Bank(5)                              22,647,000            22,678,829          28,219,000          28,219,000
   Other borrowed funds(1)                         877,387               877,387                  --                  --
   Escrows and trustee accounts for
     sold loans1                                 1,140,712             1,140,712           1,013,894           1,013,894
   Accrued interest payable(1)                     101,618               101,618             111,253             111,253
</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 are estimated using a discounted cash
     flow  model.  Certain  residential  real estate  loans are 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 are 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 are used as an  approximation  of
     fair values.

                                      -34-
<PAGE>
      18.         Fair Value Disclosures of Financial Instruments (Concluded)

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

(5)  Fair values of fixed rate advances are estimated  based on discounted  cash
     flows using current rates for advances of similar remaining  maturity.  For
     variable  rate  advances  and advances  with  short-term  call  provisions,
     carrying values were used as an approximation of their fair values.


      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, 1998
-----------------
     $5,000,000                     June 21, 1996                 June 21, 1999                  $ 34,282
     ==========                                                                                  ========

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
     ==========                                                                                 =========
<PAGE>
<CAPTION>
     Notional                                                       Maturity                      Fair
     Principal                        Contract Date                   Date                        Value
------------------------------------------------------------------------------------------------------------
<S>                                 <C>                           <C>                          <C>
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, 1998
-----------------
    $10,000,000                     July 21, 1997                 July 21, 1999                 $   --
    ===========                                                                                 ==========

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


                                      -35-
<PAGE>
Information

Board of Directors

Winfield F. Robinson, Chairman
President
Timber Resource Group LLC

John C. Witherspoon
President/CEO
Kingfield Bank

William P. Dubord
Attorney, Marden,DuBord, Bernier &Stevens

G. Norton Luce
Retired Gas Company Owner

Roger G. Spear
CFO, University of Maine at Farmington

Theodore C. Johanson
President of Falcon Shoe Company

Annual Meeting

The Annual Meeting is scheduled for Wednesday,  May 12, 1999,  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 R. Belanger, Vice President
Cindy A. Spencer, Assistant Vice President
<PAGE>
Price Range of Stock

Set forth below are the  quarterly  high and low prices for the common stock for
1998 and 1997.

Quarter Ending          1998                       1997
-----------------------------------------------------------------------
March 31       High: $22.00  Low: $18.00     High:$11.33   Low: $ 8.67
June 30        High:  19.38  Low:  17.00     High: 16.33   Low:   9.00
September 30   High:  18.38  Low:  15.50     High: 16.50   Low:  12.50
December 31    High:  18.38  Low:  12.00     High: 22.50   Low:  12.63

Dividends   declared  in  1997  and  1998  were  $0.073  and  $0.11  per  share,
respectively.

Number of Shares Outstanding and Shareholders

At March 1, 1999,  KSB  Bancorp,  Inc.  had  1,269,668  shares of $.01 par value
common stock  outstanding,  owned by  approximately  332 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 $.08 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 or
on the Internet at www.edgar-online.com

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

Luse, Lehman, Gorman, Pomerenk & Schick
Attn: John J. Gorman, Esq.
5335 Wisconsin Avenue, NW, Suite 400

Washington, DC 20015
<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
      Barbara Chadbourne
      Donna Chase
      Susan Froehlich
      Cynthia Gilmore
      Angela Stone
      Brenda Thompson

Stratton Office
      Debbie Dudley
      Melissa Perry
      Linda Shane
      Wendy Wyman

Phillips/Strong Offices
      Shelly Abbott
      Elizabeth Cram
      Dawn Field

Rangeley Office
      Leslie Ferguson
      Stacy Jordan
      Wendy Marquis
      Dora Sargent
      Sheila Waldeck

Farmington Office
      Lynn Brennick
      Jack Ellrich
      Tracy Goldsmith
      Michelle Guillaume
      Susan Haines
      Laurie Marble
      Nancy Richard
      Amy Lynn Smith
      Nancy Richardson
      Elvira Weidmann
      Dassie Withee

Lewiston Office
      Gerard Belanger
      Nancy Brown
      Christine Dutil
      Katherine Fales
      John Farrell
      Cynthia Hoyt
      Melissa Saucier
      Rebecca Sirois

Bingham Office
      Kathleen Barrett
      Phebe Durgin
      Tricia LeHay
      Brenda Washburn
<PAGE>
Madison Office
      Gary Allain
      Mary Knight
      Bernadette LeBlanc
      Patricia Magoon
      Robin Melancon-Quimby
      Cheryl Philpot

Administration and Finance
      Elizabeth Lyons
      Linda Manning
      Donna Pelletier
      Jennifer Piekart
      John Thien
      Gillian Trapp
      John Witherspoon

Operations
      Mark Brooks
      Jacqueline Garey
      Stacey Gilks
      Michelle Mason
      Jeannine McGraw
      Pauline Nadeau
      Robert Stone
      Timothy Thompson

Retail/Commercial Lending
      Carla Allen
      Justine Amerault
      Kim Blais
      Jenni Brown
      Sandy Cavanagh
      Gordon Flint
      Patty Haggan
      Wendy Hinkley
      Marcelle Labbe
      Rachel Lee
      Shelly Lowell
      Todd Marlowe
      Laurie Nile
      Gary Poulin 
      Cindy Spencer 
      Lynn Vashaw
<PAGE>
                                 Kingfield Bank
                                Branch Locations

                                 Bingham Branch
                            Main Street o PO Box 625
                        Bingham, ME 04920 o 207-672-5541

                                Farmington Branch
                            Routes 2 & 4 o PO Box 947
                       Farmington, ME 04938 o 207-778-0302

                                Kingfield Branch
                            Depot Street o POBox 105
                       Kingfield, ME 04947 o 207-265-2181

                                 Lewiston Branch
                          110 Canal Street o POBox 1378
                        Lewiston, ME 04240 o 207-784-7376

                                 Madison Branch
                                 53 Main Street
                        Madison, ME 04950 o 207-696-3376

                                 Phillips Branch
                             Main Street o PO Box E
                        Phillips, ME 04966 o 207-639-2851

                                 Rangeley Branch
                            Main Street o PO Box 548
                        Rangeley, ME 04970 o 207-864-3321

                                 Stratton Branch
                            Main Street o PO Box 157
                        Stratton, ME 04982 o 207-246-2181

                                  Strong Branch
                             Main Street o PO Box 51
                         Strong, ME 04983 o 207-684-5501

                                 1-800-962-0070
                                www.kingfield.com