<PAGE>
 
PATAPSCO BANCORP, INC.









  [LOGO]




                                                          1997 ANNUAL REPORT
<PAGE>
 
PATAPSCO BANCORP, INC.
--------------------------------------------------------------------------------

     Patapsco Bancorp, Inc. (the "Company") was incorporated under the laws of
the State of Maryland in November 1995 at the direction of the Board of
Directors of Patapsco Federal Savings and Loan Association (the "Association")
for the purpose of serving as a savings institution holding company of the
Association upon the acquisition of all of the capital stock issued by the
Association in the Association's conversion from mutual to stock form ("Stock
Conversion"). The Association completed the Stock Conversion in April 1996 and
subsequently converted to a commercial bank on September 30, 1996, at which time
it changed its name to The Patapsco Bank (the "Bank"). The Company has no
significant assets other than its investment in the Bank. The Company's
principal business is overseeing the business of the Bank and investing the
retained net Conversion proceeds.

     The Bank is a Maryland commercial bank operating through a single office
located in Dundalk, Maryland and serving eastern Baltimore County. The principal
business of the Bank consists of attracting deposits from the general public and
investing these deposits in loans secured by residential and commercial real
estate, construction loans, commercial business loans and consumer loans. The
Bank derives its income principally from interest earned on loans and, to a
lesser extent, interest earned on mortgage-backed securities and investment
securities and noninterest income. Funds for these activities are provided
principally by operating revenues, deposits and repayments of outstanding loans
and investment securities and mortgage-backed securities.

MARKET INFORMATION
--------------------------------------------------------------------------------

     The Company's common stock began trading under the symbol "PATD" on the
National Quotation Bureau "Pink Sheets" on April 2, 1996. There are currently
362,553 shares of the common stock outstanding and approximately 441 holders of
record of the common stock. On June 27, 1997, the Company paid a special cash
dividend of $12.50 per share, which was treated as a tax-free return of capital
distribution, reducing each stockholders' basis in the common stock by the
dividends received. No regular dividends have been paid on the common stock.
Following are the high and low closing sale prices, by fiscal quarter, as
reported on the Pink Sheets during the periods indicated.

<TABLE> 
<CAPTION> 
                                                      High            Low
                                                      ----            ---
     <S>                                           <C>            <C> 
     Fiscal 1997:
        First Quarter                              $ 26.375       $  24.50
        Second Quarter                               29.375          26.00
        Third Quarter                                 32.00          29.00
        Fourth Quarter                                42.00          27.50


     Fiscal 1996:
        Fourth Quarter                             $  25.75       $  22.00
</TABLE> 

         The stated prices reflect inter-dealer prices, without retail mark-up,
mark-down or commission, and may not represent actual transactions.

TABLE OF CONTENTS
--------------------------------------------------------------------------------
<TABLE> 
<S>                                                                                               <C> 
Patapsco Bancorp, Inc...........................................................................................(i)
Market Information..............................................................................................(i)
Letter to Stockholders............................................................................................1
Selected Consolidated Financial and Other Data....................................................................3
Management's Discussion and Analysis of Financial Condition and Results of Operations.............................5
Consolidated Financial Statements................................................................................19
Corporate Information............................................................................................51
</TABLE> 

                                      (i)
<PAGE>
 
                                 [LETTERHEAD]




Dear Shareholder:

     The directors, officers and staff of Patapsco Bancorp, Inc. and The
Patapsco Bank proudly present our second Annual Report to our shareholders. This
report reflects a year of firsts in the history of your Company. This was our
first full year as a public company and our first year as a commercial bank. It
was the first year our assets exceeded $80 million, our loans exceeded $60
million and our deposits reached $70 million.

     Most significantly, this was the first year our earnings exceeded $820,000,
which was the best in our 87 year history. A significant portion of this
improvement resulted from pretax core earnings increasing by approximately
$900,000 as well as certain legislative acts at the national level. The
elimination of the bad debt recapture provisions for converting thrifts and the
resolution of the FDIC insurance disparity had a positive net effect on our
bottom line of $345,000. Without the impact of this legislation our earnings
would have been $475,000, which is a substantial improvement over prior years.

     The national legislation allowed us in September 1996 to complete our
planned conversion to a commercial bank. In reality, we did little more than
change our name to The Patapsco Bank since we had already begun our commercial
bank transition. We had completed our stock conversion and started the
reallocation of our assets. Our new, but experienced, commercial bank management
team had begun originating new types of loans.

     During the year ended June 30, 1997, we originated our first Small Business
Administration guaranteed loan and our first commercial construction loan. We
increased our loan portfolio by $14.2 million with approximately 400 new loans.
We also increased the overall yield on our average assets by 46 basis points to
7.55% and this, along with a reduced cost of deposits, allowed us to increase
our spread between average interest-earning assets and average interest-bearing
liabilities to 3.30% in fiscal 1997 from 2.54% in fiscal 1996. This resulted in
net interest income increasing by approximately $700,000. NOW interest income
also increased by approximately $200,000. These achievements are strong
indicators that we are moving in the right direction.

     This past year was also significant in terms of improving shareholder
value. We began the year with our stock trading at $25.25 per share. On June 12,
1997, we announced a special $12.50 per share return of capital distribution
which was tax free to our shareholders. We are very much aware that we must
manage our capital to the benefit of our owners and this action represented a
step in the direction of improving the Company's return on equity. Even after
this substantial payout our stock was trading at $27.50 as our fiscal year ended
and the Company retained sufficient capital to grow and remain competitive. The
Company continues to recognize the desirability of providing
<PAGE>
 
current income for our shareholders through the payment of regular dividends as
well as achieving steady and continuous growth in per share value.

     We still have longer-term goals to accomplish. We must continue to focus on
products and services which will allow us to compete in the highly competitive
banking environment. Specifically, we must expand our new ventures into small
business loans, commercial real estate loans, construction and consumer loans
while we continue to build on the strengths of our residential mortgage
business. We must attract more commercial deposit accounts and continue to build
our loan loss reserves as our portfolio continues to grow and change. In short,
we must continue to implement our strategy to achieve a rate of growth which can
be sustained over time consistent with safe and sound practices.

     Your Company will need to grow while continuing to reallocate its assets.
We will focus more attention on the liability side of the balance sheet. We need
to attract new deposits and we will need to supplement deposit growth with
borrowings. We will continue to focus on improving return on equity.

     The new year also will present other challenges. The banking landscape
continues to change as big banks continue to merger in an attempt to increase
market share. Proposed legislation at the national level creates uncertainty for
financial institutions. The economic environment continues to remain extremely
competitive for deposit dollars and quality loans. Nevertheless, your Company
intends to continue in its quest to become a leading independent provider of
financial services throughout the Baltimore area by delivering exceptional
service to an expanding customer base in our tradition of integrity,
personalized style and community orientation.

     Last but not least, the directors, officers and staff of Patapsco Bancorp,
Inc. and The Patapsco Bank thank all of our shareholders and customers for their
confidence and support during the year. We look forward to a successful new
year.


                                            S. Robert Kinghorn
                                            Chairman of the Board



                                            Joseph J. Bouffard
                                            President and
                                            Chief Executive Officer

                                       2
<PAGE>
 
SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA

--------------------------------------------------------------------------------

Selected Consolidated Financial Condition Data

<TABLE> 
<CAPTION> 
                                                        At June 30,
                                               ----------------------------
                                                  1997               1996
                                                  ----               ----
                                                      (In thousands)
<S>                                            <C>                <C> 
Total assets.................................  $  83,650          $  78,850
Loans receivable, net........................     66,236             52,031
Cash, federal funds sold and other interest
   bearing deposits..........................      5,113              7,424
Investment securities........................      1,989              4,424
Mortgage-backed securities...................      7,678             12,778
Deposits.....................................     70,152             64,157
Borrowings...................................      2,700                 --
Stockholders' equity.........................      8,334             12,301
</TABLE> 

--------------------------------------------------------------------------------

Selected Consolidated Income Data

<TABLE> 
<CAPTION> 
                                                     Year Ended June 30,
                                                ----------------------------
                                                  1997                1996
                                                  ----                ----
                                                       (In thousands)
<S>                                             <C>                <C> 
Interest income..............................   $   5,897          $   5,332
Interest expense.............................       2,706              3,038
                                                ---------          ---------
Net interest income before provision
   for loan losses...........................       3,191              2,294
Provision for loan losses....................         240                 68
                                                ---------          ---------
Net interest income after provision
   for loan losses...........................       2,951              2,226
Noninterest income...........................         219                 30
Noninterest expenses:
   Compensation and employee benefits........       1,467              1,178
   Insurance.................................         515  (1)           193
   Professional fees.........................         148                129
   Equipment expenses........................         116                114
   Net occupancy costs.......................          81                 79
   Advertising...............................          44                 38
   Data processing...........................          96                 92
   Other.....................................         346                265
                                                ---------          ---------
      Total noninterest expenses.............       2,813              2,088
Income before provision (benefit) for 
   income taxes..............................         357                168
Income tax provision (benefit)...............        (463) (2)            67
                                                ---------          ---------
Net income...................................   $     820          $     101
                                                =========          =========
</TABLE> 

(1) Includes $415,000 of expense resulting from a one-time assessment to
    capitalize the Savings Association Insurance Fund ("SAIF").

(2) Includes $600,000 reduction of tax expense related to the partial reversal
    of the $740,000 tax bad debt reserve which was recorded in fiscal 1995 as a
    result of the anticipated bank conversion.

                                        3
<PAGE>
 
Key Operating Ratios:

<TABLE> 
<CAPTION> 
                                                                         At or for the
                                                                      Year Ended June 30,
                                                                    -----------------------
                                                                    1997               1996
                                                                    ----               ----
<S>                                                                 <C>                <C> 
Performance Ratios:
   Return on average assets (net income divided by
      average total assets.......................................    1.03%  (1)         0.13%
   Return on average stockholders' equity (net income
      divided by average stockholders' equity)...................    6.62   (1)         1.35
   Interest rate spread (combined weighted average
      interest rate earned less combined weighted
      average interest rate cost)................................    3.30               2.54
   Net interest margin (net interest income
      divided by average interest-earning assets)................    4.08               3.05
   Ratio of average interest-earning assets to
      average interest-bearing liabilities.......................  122.78             112.63
   Ratio of noninterest expense to average total assets..........    3.52   (2)         2.71

Asset Quality Ratios:
   Nonperforming assets to total assets at
      end of period..............................................    0.18               0.35
   Nonperforming (nonaccrual) loans to loans receivable,
      net at end of period.......................................    0.19               0.46
   Allowance for loan losses to total loans
      at end of period...........................................    0.59               0.42
   Allowance for loan losses to nonperforming
      loans at end of period.....................................  322.77              91.25
   Provision for loan losses to loans receivable,
      net at end of period.......................................    0.36               0.13
   Net charge-offs to average loans outstanding..................    0.11               0.02

Capital Ratios:
   Stockholders' equity to total assets at end of period.........    9.96              15.95
   Average stockholders' equity to average assets................   15.51               9.71
</TABLE> 

------------
(1)      Return on average assets and return on average equity ratios include
         $415,000 of expense resulting from a one-time assessment to capitalize
         SAIF and a $600,000 reduction of tax expense related to the partial
         reversal of the $740,000 tax bad debt reserve which was recorded in
         fiscal 1995 as a result of the anticipated bank conversion. If those
         transactions had not occurred, a current return on average assets and
         return of average equity would have been 0.59% and 3.84%, respectively.
(2)      Noninterest expense includes a $415,000 one-time expense as described
         in Note (1) above. Excluding the one-time expense, noninterest expense
         as a percentage of average total assets would have been 3.00%.

                                       4
<PAGE>
 
                MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
                       CONDITION AND RESULTS OF OPERATIONS

--------------------------------------------------------------------------------

General

     Patapsco Bancorp, Inc. (the "Company") was formed in November 1995 by the
Association to become the holding company of the Association following the Stock
Conversion. The Stock Conversion and the acquisition of the Association by the
Company were consummated on April 1, 1996. The Association converted to a
Maryland commercial bank on September 30, 1996, at which time it changed its
name to The Patapsco Bank. All references to the Company prior to September 30,
1996, except where otherwise indicated, are to the Association.

     The Company's results of operations depend primarily on its level of net
interest income, which is the difference between interest earned on
interest-earning assets, consisting primarily of loans, investment securities,
mortgage-backed securities and other investments, and the interest paid on
interest-bearing liabilities, consisting primarily of deposits. The difference
between yields earned on interest-earning assets and rates paid on
interest-bearing liabilities ("net interest rate spread") and the ratio of
interest-earning assets to interest-bearing liabilities significantly impact net
interest income. The Company's net interest rate spread is affected by
regulatory, economic and competitive factors that influence interest rates, loan
and deposit flows. The Company, like other financial institutions, is subject to
interest rate risk to the degree that its interest-earning assets mature or
reprice at different times, or on a different basis, than its interest-bearing
liabilities. To a lesser extent, the Company's results of operations are also
affected by the amount of its noninterest income, including loan fees and
service charges, and levels of noninterest expense, which consists principally
of compensation and employee benefits, insurance premiums, professional fees,
equipment expense, occupancy, costs, advertising, data processing and other
operating expenses.

     The Company's operating results are significantly affected by general
economic and competitive conditions, in particular, changes in market interest
rates, government policies and actions taken by regulatory authorities. Lending
activities are influenced by the demand for and supply of housing, competition
among lenders, the level of interest rates and the availability of funds.
Deposit flows and costs of funds are influenced by prevailing market rates of
interest, primarily on competing investments, account maturities and the level
of personal income and savings in the Company's market area.

Forward-Looking Statements

     When used in this Annual Report, the words or phrases "will likely result,"
"are expected to," "will continue," "is anticipated," "estimate," "project" or
similar expressions are intended to identify "forward-looking statements" within
the meaning of the Private Securities Litigation Reform Act of 1995. Such
statements are subject to certain risks and uncertainties including changes in
economic conditions in the Company's market area, changes in policies by
regulatory agencies, fluctuations in interest rates, demand for loans in the
Company's market area, and competition that could cause actual results to differ
materially from historical earnings and those presently anticipated or
projected. The Company wishes to caution readers not to place undue reliance on
any such forward-looking statements, which speak only as of the date made. The
Company wishes to advise readers that the factors listed above could affect the
Company's financial performance and could cause the Company's actual results for
future periods to differ materially from any opinions or statements expressed
with respect to future periods in any current statements.

     The Company does not undertake, and specifically disclaims any obligation,
to publicly release the result of any revisions which may be made to any
forward-looking statements to reflect events or circumstances after the date of
such statements or to reflect the occurrence of anticipated or unanticipated
events.

                                        5
<PAGE>
 
Average Balance, Interest and Average Yields and Rates

     The following table sets forth certain information relating to the
Company's average interest-earning assets and interest-bearing liabilities and
reflects the average yield on assets and average cost of liabilities for the
periods and at the date indicated. Such yields and costs are derived by dividing
income or expense by the average monthly balance of assets or liabilities,
respectively, for the periods presented. Average balances are derived from
month-end balances. Management does not believe that the use of month-end
balances instead of daily balances has caused any material difference in the
information presented.

     The table also presents information for the periods indicated with respect
to the difference between the average yield earned on interest-earning assets
and average rate paid on interest-bearing liabilities, or "interest rate
spread," which savings institutions have traditionally used as an indicator of
profitability. Another indicator of an institution's net interest income is its
"net yield on interest-earning assets," which is its net interest income divided
by the average balance of interest-earning assets. Net interest income is
affected by the interest rate spread and by the relative amounts of
interest-earning assets and interest-bearing liabilities. When interest-earning
assets exceed interest-bearing liabilities, any positive interest rate spread
will generate net interest income.

<TABLE> 
<CAPTION> 
                                                                                         Year Ended June 30,
                                                               ---------------------------------------------------------------------

                                                                             1997                                1996
                                                               -------------------------------     ---------------------------------

                                                                                       Average                              Average
                                                               Average                 Yield/      Average                   Yield/
                                                               Balance     Interest     Cost       Balance     Interest       Cost
                                                               -------     --------    -------     -------     --------     --------

                                                                                      (Dollars in thousands)
<S>                                                           <C>          <C>         <C>        <C>          <C>          <C> 
Interest-earning assets:
   Loans receivable (1)...................................... $   58,473   $  4,721     8.07%     $  45,548    $ 3,514         7.72%

   Investment securities.....................................      2,988        191     6.40         10,642        612         5.75
   Mortgage-backed securities................................      8,629        534     6.18         15,559      1,003         6.44
   Short-term investments and other interest-earning assets..      8,068        451     5.59          3,432        203         5.91
                                                              ----------   --------   ------      ---------    -------       ------
      Total interest-earning assets..........................     78,158      5,897     7.55         75,181      5,332         7.09
                                                                           --------                            -------
Non-interest-earning assets..................................      1,757                              1,933
                                                              ----------                          ---------
      Total assets........................................... $   79,915                          $  77,114
                                                              ==========                          =========

Interest-bearing liabilities:
   Deposits (2).............................................. $   63,545      2,697     4.25      $  63,469      2,851         4.49
   Borrowings................................................        112          9     7.91          3,282        187         5.68
                                                              ----------   --------   ------      ---------    -------       ------
      Total interest-bearing liabilities.....................     63,657      2,706     4.25         66,751      3,038         4.55
                                                                           --------   ------                   -------       ------
Non-interest-bearing liabilities.............................      3,866                              2,873
                                                              ----------                          ---------
      Total liabilities......................................     67,523                             69,624
Retained earnings............................................     12,392                              7,490
                                                              ----------                          ---------
      Total liabilities and retained earnings................ $   79,915                          $  77,114
                                                              ==========                          =========

Net interest income..........................................              $  3,191                            $ 2,294
                                                                           ========                            =======
Interest rate spread.........................................                           3.30%                                  2.54%
                                                                                      ======                                 ======
Net yield on interest-earning assets.........................                           4.08%                                  3.05%
                                                                                      ======                                 ======
Ratio of average interest-earning assets to average
   interest-bearing liabilities..............................                         122.78%                                112.63%
                                                                                      ======                                 ======
</TABLE> 

------------
(1)      Includes nonaccrual loans.
(2)      Includes interest-bearing escrow accounts.

                                       6
<PAGE>
 
Rate/Volume Analysis

     The following table sets forth certain information regarding changes in
interest income and interest expense of the Company for the periods indicated.
For each category of interest-earning asset and interest-bearing liability,
information is provided on changes attributable to: (i) changes in volume
(changes in volume multiplied by prior year's rate); (ii) changes in rate
(changes in rate multiplied by prior year's volume); and (iii) changes in
rate/volume (changes in rate multiplied by changes in volume).

<TABLE> 
<CAPTION> 
                                                                     Year Ended June 30,
                                                      -------------------------------------------------
                                                         1997                 vs.                1996
                                                      -------------------------------------------------
                                                                 Increase (Decrease) Due to
                                                      -------------------------------------------------
                                                                                 Rate/
                                                       Volume         Rate       Volume         Total
                                                       ------         ----       ------         -----
                                                                        (In thousands)
<S>                                                   <C>          <C>         <C>            <C> 
Interest income:
   Loans receivable.................................  $ 1,002      $   160     $     45       $ 1,207
   Investment securities............................     (440)          69          (50)         (421)
   Mortgage-backed securities.......................     (447)         (40)          18          (469)
   Short-term investments and other
     interest-earning assets........................      274          (11)         (15)          248
                                                      -------      -------     --------       -------
       Total interest-earning assets................      389          178           (2)          565
                                                      -------      -------     --------       -------

Interest expense:
   Deposits (1).....................................        4         (157)          (1)         (154)
   Borrowings.......................................     (180)          73          (71)         (178)
                                                      -------      -------     --------       -------
       Total interest-bearing liabilities...........     (176)         (84)         (72)         (332)
                                                      -------      -------     --------       -------

Change in net interest income.......................  $   565      $   262     $     70       $   897
                                                      =======      =======     ========       =======
</TABLE> 

-----------
(1)      Includes interest-bearing escrow accounts.

Comparison of Financial Condition at June 30, 1997 and 1996

     Total assets increased by $4.8 million, or by 6.1%, to $83.6 million at
June 30, 1997 from $78.8 million at June 30, 1996. The increase was primarily
due to a $14.2 million increase in loans receivable partially offset by
decreases of $5.1 million, $2.4 million and $2.3 million in mortgage-backed
securities, investment securities and cash and cash equivalents.

     Net loans receivable increased by $14.2 million, or by 27.3%, to $66.2
million at June 30, 1997 from $52.0 million at June 30, 1996. The increase is
directly attributable to the Company's increased loan demand in residential,
commercial and construction real estate lending, as well as increases in
consumer and commercial lending. Since the recent conversions of the Company's
primary subsidiary from a mutually owned savings and loan association to a
publicly owned commercial bank, the Company has diversified its lending into
segments of the market more closely identified with commercial banks. As a
result, the Company's residential, commercial and construction real estate loan
portfolios increased by $5.6 million, $1.5 million and $2.0 million,
respectively, and the Company's consumer and commercial loan portfolios each
increased by $2.6 million during the year ended June 30, 1997.

                                        7
<PAGE>
 
     The following table sets forth selected data relating to the composition of
the Company's loan portfolio by type of loan at the dates indicated. At June 30,
1997, the Company had no concentrations of loans exceeding 10% of gross loans
other than as disclosed below.

<TABLE> 
<CAPTION> 
                                                                                 At June 30,
                                                            ------------------------------------------------------
                                                                     1997                            1996
                                                            ---------------------           ----------------------
                                                            Amount            %             Amount            %
                                                            ------         ------           ------          ------
                                                                             (Dollars in thousands)
<S>                                                         <C>            <C>              <C>             <C> 
Real estate loans:
   Residential............................................  $   52,907     79.09%           $  47,279       90.06%
   Commercial.............................................       2,612      3.90                1,074        2.05
   Construction (1).......................................       2,002      2.99                 --           --
Consumer loans:
   Home improvement.......................................       4,605      6.88                2,373        4.52
   Home equity loans......................................         420      0.63                   39        0.07
   Loans secured by deposits..............................         364      0.55                  392        0.75
   Other consumer loans...................................         198      0.30                  143        0.27
Commercial loans:
   Commercial loans.......................................       3,400      5.08                1,020        1.94
   Commercial leases......................................         388      0.58                  179        0.34
                                                            ----------    ------            ---------      ------
                                                                66,896    100.00%              52,499      100.00%
                                                                          ======                           ======
Less:
   Deferred loan origination fees,
     net of costs.........................................  $      263                            249
   Allowance for loan losses..............................         397                            219
                                                            ----------                      ---------
      Total...............................................  $   66,236                      $  52,031
                                                            ==========                      =========
</TABLE> 

------------
(1)  Less loans in process.

     The following table sets forth certain information at June 30, 1997
regarding the dollar amount of loans maturing or repricing in the Company's
portfolio. Demand loans, loans having no stated schedule of repayments and no
stated maturity, and overdrafts are reported as due in one year or less.
Adjustable-rate and floating-rate loans are included in the period in which
interest rates are next scheduled to adjust rather than the periods in which
they mature, and fixed-rate loans are included in the period in which the final
contractual repayment is due. The table does not include any estimate of
prepayments which significantly shorten the average life of all mortgage loans
and may cause the Company's repayment experience to differ from that shown
below.

<TABLE> 
<CAPTION> 
                                                          Due after 
                                        Due during        1 through           Due after
                                     the year ending    5 years after       5 years after
                                      June 30, 1998     June 30, 1997       June 30, 1997         Total
                                     --------------     -------------       -------------        --------
                                                                 (In thousands)
<S>                                  <C>                <C>                 <C>                 <C> 
Real estate loans:
   Residential....................   $    17,936          $    9,557          $   25,414        $   52,907
   Commercial.....................         1,350               1,177                  85             2,612
   Construction...................         2,002                  --                  --             2,002
Consumer loans....................           756               1,474               3,357             5,587
Commercial loans..................         2,562                 843                 383             3,788
                                     -----------          ----------          ----------        ----------
     Total........................   $    24,606          $   13,051          $   29,239        $   66,896
                                     ===========          ==========          ==========        ==========
</TABLE> 

                                       8
<PAGE>
 
     The following table sets forth at June 30, 1997 the dollar amount of all
loans which may reprice or are due one year or more after June 30, 1997 which
have predetermined interest rates and have floating or adjustable interest
rates.

<TABLE> 
<CAPTION> 
                                   Predetermined           Floating or
                                       Rates            Adjustable Rates      Total
                                   -------------        ----------------    ---------
                                                         (In thousands)
<S>                                <C>                  <C>                 <C> 
Real estate loans:
   Residential....................    $ 25,565            $   9,406         $  34,971
   Commercial.....................         265                  997             1,262
Consumer..........................       4,831                   --             4,831
Commercial........................       1,226                   --             1,226
                                      --------            ---------         ---------
   Total..........................    $ 31,887            $  10,403         $  42,290
                                      ========            =========         =========
</TABLE> 

     Scheduled contractual principal repayments of loans do not reflect the
actual life of such assets. The average life of loans is substantially less than
their contractual terms because of prepayments. In addition, due-on-sale clauses
on loans generally give the Company the right to declare a loan immediately due
and payable in the event, among other things, that the borrower sells the real
property subject to the mortgage and the loan is not repaid. The average life of
mortgage loans tends to increase when current mortgage loan market rates are
substantially higher than rates on existing mortgage loans and, conversely,
decrease when current mortgage loan market rates are substantially lower than
rates on existing mortgage loans.

     Investment securities decreased by $2.4 million, or by 55.0%, to $2.0
million at June 30, 1997 from $4.4 million at June 30, 1996, and mortgage-backed
securities decreased by $5.1 million, or by 40.0%, to $7.7 million at June 30,
1997 from $12.8 million at June 30, 1996. During the year ended June 30, 1997,
the Company sold $4.3 million of mortgage-backed securities classified as
available for sale. The proceeds from the sale of mortgage-backed securities,
along with cash obtained through maturing investment securities and
mortgage-backed securities were used to fund higher yielding loans. The
following table summarizes the Company's investment securities and
mortgage-backed securities portfolios as of June 30, 1997 and 1996.

     The following table sets forth the carrying value of the Company's
investments at the dates indicated.

<TABLE> 
<CAPTION> 
                                                                   At June 30,
                                                            ----------------------
                                                              1997          1996
                                                            --------      --------
                                                            (Dollars in thousands)
<S>                                                         <C>           <C> 
Securities available for sale, at fair value:
   U.S. government and agency securities................... $  1,989      $  4,424
   Mortgage-backed securities..............................    7,678        12,778
                                                            --------      --------
     Total securities available for sale...................    9,667        17,202
                                                            --------      --------

Investments required by law, at cost:
  FHLB of Atlanta stock....................................      520           491
  FRB of Richmond stock....................................      102            --
                                                            --------      --------
    Total investments required by law, at cost.............      622           491
                                                            --------      --------

    Total investments...................................... $ 10,289      $ 17,693
                                                            ========      ========
</TABLE> 

                                       9
<PAGE>
 
     The following table sets forth the scheduled maturities, carrying values,
market values and average yields for the Company's investment portfolio at June
30, 1997.

<TABLE> 
<CAPTION> 
                                        One Year or Less          One to Five Years        Five to Ten Years   
                                      ---------------------     ---------------------    --------------------- 
                                      Carrying      Average     Carrying     Average     Carrying      Average  
                                        Value        Yield        Value       Yield       Value         Yield  
                                      ---------     -------     ---------   ---------    ---------    --------  
                                                                (Dollars in thousands)
<S>                                   <C>           <C>         <C>         <C>          <C>          <C> 
Securities available for sale:
   U.S. government and agency
     securities...................    $   --          -- %      $     --       -- %       $ 1,989       7.35%  
   Mortgage-backed securities.....        --          --           3,369     6.46           2,962       6.17   
                                      ------                    --------                  -------     

       Total......................    $   --                    $  3,369                  $ 4,951               
                                      ======                    ========                  =======         
                                   
<CAPTION>                                    
                                        More than Ten Years          Total Investment Portfolio                
                                       ---------------------     ----------------------------------                  
                                       Carrying      Average     Carrying      Market      Average                  
                                         Value        Yield        Value        Value       Yield                  
                                       ---------   ---------     ---------    ---------    --------                    
                                                            (Dollars in thousands)
<S>                                    <C>         <C>           <C>          <C>          <C> 
Securities available for sale:                                                                             
   U.S. government and agency                                                                              
     securities...................     $    --         -- %      $  1,989     $  1,989       7.35%                
   Mortgage-backed securities.....       1,347       6.61           7,678        7,678       6.36                  
                                       -------                   --------     --------

       Total......................     $ 1,347                   $  9,667     $  9,667                           
                                       =======                   ========     ========         
</TABLE> 


                                      10


                                   
<PAGE>
 
     Deposits increased by $6.0 million, or by 9.3%, to $70.2 million at
June 30, 1997 from $64.2 million at June 30, 1996. The increase in deposits was
primarily due to increases in non-interest bearing commercial demand accounts
and certificates of deposits. The following table summarizes deposits as of June
30, 1997 and 1996.

     The following tables set forth the average balances based on month-end
balances and interest rates for various types of deposits as of the dates
indicated.

<TABLE> 
<CAPTION> 
                                                              Year Ended June 30,
                                         ------------------------------------------------------------
                                                   1997                                1996
                                         -------------------------          -------------------------
                                         Average           Average          Average           Average
                                         Balance            Rate            Balance             Rate
                                         -------           -------          -------           ------- 
                                                                 (Dollars in thousands)
<S>                                      <C>               <C>              <C>               <C> 
Passbook, statement savings
   and Christmas Club.................   $ 19,253 (1)       2.97%           $ 18,989 (1)       3.07%
NOW checking..........................      2,699           2.02               2,781           2.41
Money market..........................      4,893           3.25               4,636           3.52
Certificates of deposit...............     36,700           5.24              37,063           5.52
Noninterest-bearing checking                2,017             --               1,223             --
                                         --------                           --------
     Total............................   $ 65,562                           $ 64,692
                                         ========                           ========
</TABLE> 

----------
(1)  Includes interest-bearing escrow accounts.


     The following table indicates the amount of the Company's certificates of
deposit of $100,000 or more by time remaining until maturity as of June 30,
1997. At such date, such deposits represented 3.4% of total deposits and had a
weighted average rate of 5.11%. 


<TABLE> 
<CAPTION> 

                                                            Certificates 
              Maturity Period                               of Deposits 
              ---------------                               -----------
                                                           (In thousands)
              <S>                                           <C> 
              Three months or less.......................     $ 1,161
              Over three through six months..............         684
              Over six through 12 months.................         410
              Over 12 months.............................         112
                                                              -------
                  Total..................................     $ 2,367
                                                              =======

</TABLE> 

Comparison of Operating Results for the Years Ended June 30, 1997 and 1996

     The Company had net income of $820,000 for the year ended June 30, 1997 as
compared to net income of $101,000 for the year ended June 30, 1996. The
$719,000 increase in net income was significantly influenced by two events
during September, 1996. First, the Company recognized $255,000 of expense after
tax resulting from the one-time assessment to recapitalize the Federal Deposit
Insurance Corporation's Savings Associations Insurance Fund. Secondly, as a
result of legislation enacted in August, 1996 the Company was able to reverse
$600,000 of tax expense upon its subsidiary's conversion to a state chartered
commercial bank. Excluding those two items, the Company would have earned
$475,000 during fiscal 1997. The increase in net income was also impacted by
increases of $897,000 and $190,000 in net interest income and noninterest
income, respectively, slightly offset by increases in noninterest expenses and
provision for losses on loans.

     Net Interest Income. The Company's net interest income increased $897,000,
or by 39.1%, to $3.2 million at June 30, 1997 from $2.3 million at June 30,
1996.

     The increase in the Company's net interest income is directly attributable
to the Company's loan growth. During fiscal 1996, the Company began to implement
a strategy to improve the interest rate spread by expanding its lending products
to include commercial real estate, construction, consumer and commercial
business loans. These loan 

                                       11
<PAGE>
 
products generally earn higher yields than conventional single-family
residential mortgage loans. To fund these new loan products, the Company began
to divest itself of lower yielding investment securities and mortgage-backed
securities either by normal principal amortization or through the sale of
securities. In addition to the reallocation of its assets, the Company has
utilized the proceeds from its stock conversion and deposit growth to fund
loans.

     The Company's interest rate spread increased to 3.30% in 1997 from 2.54% in
1996. The increase in the interest rate spread was primarily the result of an
increase in the average yield on interest-earning assets to 7.55% during fiscal
1997 from 7.09% in fiscal 1996. The increase in the interest rate spread was
also due to a decrease in the average rate paid on interest-bearing liabilities
to 4.25% during fiscal 1997 from 4.55% in fiscal 1996. The Company's net yield
on average interest-earning assets increased to 4.08% during fiscal 1997 from
3.05% in fiscal 1996 primarily due to the increase in the interest rate spread
and the increase in the ratio of average interest-earning assets to average
interest-bearing liabilities to 122.78% during fiscal 1997 from 112.63% in
fiscal 1996. The average balance of interest-earning assets increased by $3.0
million to $78.2 million during fiscal 1997 from $75.2 in fiscal 1996. The
average balance of interest-bearing liabilities decreased by $3.1 million to
$63.7 million during fiscal 1997 from $66.8 million in fiscal 1996. The Company
completed its stock conversion in the fourth quarter of fiscal of fiscal 1996
and as a result, the average balance sheet does not reflect the full impact from
the use of the proceeds in fiscal 1996.

     Interest Income. The Company's total interest income increased by $565,000,
or by 10.6%, to $5.9 million for the year ended June 30, 1997 as compared to
$5.3 million for the year ended June 30, 1996. The increase was due to an
increase in the average balance of interest-earning assets of $3.0 million to
$78.1 million during fiscal 1997 from $75.2 million in fiscal 1996 and an
increase in the average yield on average interest-earning assets to 7.55 %
during fiscal 1997 from 7.09% in fiscal 1996.

     Interest income on loans increased $1.2 million, or by 34.3% to $4.7
million during 1997 as compared to $3.5 million in fiscal 1996. The increase was
attributable to the increase of $12.9 million in the average balance of loans
receivable to $58.5 million during fiscal 1997 from $45.6 million in fiscal 1996
and the increase in the average yield to 8.07% during 1997 from 7.72% in fiscal
1996.

     Interest income on investment securities decreased by $421,000, or by
68.8%, to $191,000 during fiscal 1997 as compared to $612,000 in fiscal 1996.
The decrease was primarily due to a decrease in the average balance of $7.6
million to $3.0 million during fiscal 1997 from $10.6 million in fiscal 1996.
The effect on interest income from the decline in the average balance of
investment securities was slightly offset by an increase in the average yield to
6.40% during fiscal 1997 from 5.75% in fiscal 1996.

     Interest income on mortgage-backed securities decreased by $468,000, or by
46.8%, to $534,000 during fiscal 1997 as compared to $1,002,000 in fiscal 1996.
The decrease was the result of a $7.0 decrease in the average balance of
mortgage-backed securities to $8.6 million during fiscal 1997 from $15.6 million
in fiscal 1996 and the decrease of the average yield on mortgage-backed
securities to 6.18% during fiscal 1997 from 6.44% in fiscal 1996.

     Interest income on short-term investments and other interest-earning assets
increased by $248,000 to $451,000 during fiscal 1997 as compared to $203,000 in
fiscal 1996. The increase was primarily due to an increase of $4.6 million in
the average balance resulting from the proceeds from the Company's stock
conversion. The average yield declined to 5.59% during fiscal 1997 from 5.91% in
fiscal 1996. The increase in the average balances was partially due to the
Company's stock conversion during the fourth quarter of fiscal 1996.

     Interest Expense. The Company's interest expense decreased by $332,000, or
by 10.9%, to $2.7 million during fiscal 1997 as compared to $3.0 million in
fiscal 1996. The decrease was primarily attributable to the decrease of $3.1
million in the average balance of interest-bearing liabilities to $63.7 million
during fiscal 1997 from $66.8 million in fiscal 1996 and the decrease in the
average rate to 4.25% during fiscal 1997 from 4.55% in fiscal 1996.

     Interest expense on deposits decreased by $154,000, or by 5.4% to $2.7
million during fiscal 1997 as compared to $2.9 million in fiscal 1996. The
decrease was primarily attributable to decrease in the average rate paid on
deposits 

                                       12
<PAGE>
 
to 4.25% during fiscal 1997 from 4.49% in fiscal 1996. The average
balance of deposits remained virtually unchanged at $63.5 million during fiscal
years 1997 and 1996.

     Interest expense on borrowings decreased by $177,000 to $9,000 during
fiscal 1997 as compared to $186,000 in fiscal 1996. During fiscal 1996, the
Company repaid all of its borrowings with the Federal Home Loan Bank of Atlanta.
In fiscal 1997, the Company relied on the proceeds from the stock conversion and
the growth of its deposit to fund loan growth. However, during June, 1997, the
Company borrowed $2.7 million in connection with the payment of the $4.5 million
return of capital distribution.

     Provision for Loan Losses. Provisions for loan losses are charged to
earnings to maintain the total allowance for loan losses at a level considered
adequate by management to provide for probable loan losses, based on prior loss
experience, volume and type of lending conducted by the Company, industry
standards and past due loans in the Company's loan portfolio. The Company's
management periodically monitors and adjusts its allowance for loan losses based
upon its analysis of the loan portfolio. The Company increased its provision for
loan losses to $240,000 during the year ended June 30, 1997, as compared to
$68,000 for the year ended June 30, 1996. The increased provision for loan
losses was due to the Company's higher levels of commercial real estate,
construction, consumer and commercial loan lending, which generally entail a
greater risk than single-family residential loans. The Company has increased its
allowance for loan losses as a percentage of total loans outstanding to 0.59% at
June 30, 1997 from 0.42% at June 30, 1996. The Company's allowance for loan
losses as a percentage of nonperforming loans was 322.8% at June 30, 1997 as
compared to 91.3% at June 30, 1996.

     Noninterest Income. The Company's noninterest income consists of loan
fees and service charges and net gains and losses on sales of investment
securities, mortgage-backed securities and loans. Noninterest income increased
by $190,000 to $220,000 during fiscal 1997, as compared to $30,000 in fiscal
1996. The increase was due to an increase of $95,000 in fees and service charges
during fiscal 1997 as compared to fiscal 1996 and a $99,000 loss resulting
primarily from the sale of investment securities in fiscal 1996. The increases
in fees and service charges are primarily attributable to higher volumes in
commercial demand deposits and automated teller machine transactions.

     Noninterest Expenses. The Company's total noninterest expenses increased by
$725,000, or by 34.7%, to $2.8 million during fiscal 1997, as compared to $2.1
million in fiscal 1996. The increase included a $415,000 one-time savings
deposit premium expense to recapitalize the FDIC's SAIF. The Bank's FDIC
insurance assessment rate was reduced following payment of the special
assessment. Excluding the one-time savings deposit premium expense, the
Company's total noninterest expense would have increased by $310,000, or by
11.1%. The Company experienced an increase of $288,000 in compensation and other
benefits during fiscal 1997 as compared to fiscal 1996 primarily the result of
normal salary increases and additional expenses relating to the Company
stock-based benefit plans and the incentive compensation plan. The Company's
regular SAIF premiums decreased by $92,000 as a result of the new lower SAIF
assessment. Professional fees increased by $19,000 to $148,000 during fiscal
1997 from $129,000 in fiscal 1996 due to fees associated with the bank
conversion and the return of capital distribution. Other noninterest expenses
increased by $81,000 to $346,000 during fiscal 1997 as compared to $265,000 in
fiscal 1996, as a result of increases in transfer agent costs, expense related
to the return of capital distribution and additional stationery and printing
expenses relating to the bank conversion.

     Provision for Income Taxes. The Bank incurred a $740,000 expense for the
recapture of a portion of its tax bad debt reserve during the year ended June
30, 1995 in connection with the determination of the Association's Board of
Directors to convert the Association to a Maryland commercial bank (the "Bank
Conversion"). After this determination was made, legislation was introduced in
Congress which provided that savings and loan associations that convert to
commercial banks would not be required to recapture the portion of tax bad debt
reserve accumulated prior to 1988. Following the introduction of this
legislation, the Board of Directors determined to delay consummation of the Bank
Conversion pending the outcome of this legislation. The legislation ultimately
was enacted into law on August 20, 1996, and the Association completed the Bank
Conversion on September 30, 1996. As a result, the Company reversed $600,000 of
the $740,000 expense previously incurred, which was reflected as a reduction of
tax expense during fiscal 1997. Excluding the one-time reversal, the Company's
provision for tax would have been approximately 

                                       13
<PAGE>
 
$137,000 for 1997 as compared to $67,000 in fiscal 1996. See Note 8 of Notes to
Financial Statements. The Company and the Bank have not entered into an
agreement to file a consolidated federal income tax return as of June 30, 1997.

Asset/Liability Management

     Net interest income, the primary component of the Company's net income, is
derived from the difference or "spread" between the yield on interest-earning
assets and the cost of interest-bearing liabilities. The Company has sought to
reduce its exposure to changes in interest rates by matching more closely the
effective maturities or repricing characteristics of its interest-earning assets
and interest-bearing liabilities. The matching of the Company's assets and
liabilities may be analyzed by examining the extent to which its assets and
liabilities are interest rate sensitive and by monitoring the expected effects
of interest rate changes on the Company's net interest income.

     An asset or liability is interest rate sensitive within a specific time
period if it will mature or reprice within that time period. If the Company's
assets mature or reprice more quickly or to a greater extent than its
liabilities, the Company's net interest income would tend to increase during
periods of rising interest rates but decrease during periods of falling interest
rates. If the Company's assets mature or reprice more slowly or to a lesser
extent than its liabilities, the Company's net portfolio value and net interest
income would tend to decrease during periods of rising interest rates but
increase during periods of falling interest rates. The Company's policy has been
to mitigate the interest rate risk inherent in the historical savings
institution business of originating long-term loans funded by short-term
deposits by pursuing certain strategies designed to decrease the vulnerability
of its earnings to material and prolonged changes in interest rates.

     The Company has established an Asset/Liability Management Committee which
currently is comprised of three non-employee directors, the President and the
Controller. This Committee meets on a monthly basis and reviews the maturities
of the Company's assets and liabilities and establishes policies and strategies
designed to regulate the Company's flow of funds and to coordinate the sources,
uses and pricing of such funds. The first priority in structuring and pricing
the Company's assets and liabilities is to maintain an acceptable interest rate
spread while reducing the net effects of changes in interest rates.

     Management's principal strategy in managing the Company's interest rate
risk has been to maintain short- and intermediate-term assets in portfolio,
including locally originated adjustable-rate mortgage loans. In addition, the
Company has available for sale investment securities and mortgage-backed
securities, carried at fair value, totaling $9,667,897 million as of June 30,
1997. The Company is holding these investment securities and mortgage-backed
securities as available for sale because it may sell these investment securities
and mortgage-backed securities prior to maturity should it need to do so for
liquidity or asset and liability management purposes.

     Management also has shortened the average repricing period of its assets by
emphasizing the origination of 5, 7, 10 and 15 year fixed-rate or
adjustable-rate residential mortgage loans, all of which are retained by the
Company for its portfolio. Beginning in the first quarter of fiscal 1995, the
Company adopted a policy of selling newly originated fixed-rate residential
mortgage loans with original maturities of 30 years in the secondary market.
There were no loans held for sale at June 30, 1997. At June 30, 1997, the
Company held approximately $32.8 million in loans with adjustable interest
rates, which represented approximately 49.0% of the Company's gross loan
portfolio.

     In addition to shortening the average repricing period of its assets, the
Company has sought to lengthen the average maturity of its liabilities, which
provides higher rates of interest on its longer term certificates.

     The Company's Board of Directors is responsible for reviewing the Company's
asset and liability management policies. The Asset/Liability Management
Committee reports to the Board monthly on interest rate risk and trends, as well
as liquidity and capital ratios and requirements. The Company's management is
responsible for administering the policies of the Board of Directors with
respect to the Company's asset and liability goals and strategies.

                                       14
<PAGE>
 
Interest Rate Sensitivity Analysis

     The matching of assets and liabilities may be analyzed by examining the
extent to which such assets and liabilities are "interest rate sensitive" and by
monitoring an institution's interest rate sensitivity "gap." An asset or
liability is said to be interest rate sensitive within a specific period if it
will mature or reprice within that period. The interest rate sensitivity gap is
defined as the difference between the amount of interest-earning assets maturing
or repricing within a specific time period and the amount of interest-bearing
liabilities maturing or repricing within that time period. A gap is considered
positive when the amount of interest rate sensitive assets exceeds the amount of
interest rate sensitive liabilities, and is considered negative when the amount
of interest rate sensitive liabilities exceeds the amount of interest rate
sensitive assets. At June 30, 1997, the Company had a negative one-year interest
rate sensitivity gap of 0.10%. Generally, for institutions with a negative gap,
net interest income would be expected to be positively affected by falling
interest rates and adversely affected by rising interest rates. Generally,
during a period of rising interest rates, a negative gap would be expected to
adversely affect net interest income while a positive gap would be expected to
result in an increase in net interest income, while conversely during a period
of falling interest rates, a negative gap would be expected to result in an
increase in net interest income and a positive gap would be expected to
adversely affect net interest income.

                                       15
<PAGE>
 
     The following table sets forth the amounts of interest-earning assets and
interest-bearing liabilities outstanding at June 30, 1997 which are expected to
mature or reprice in each of the time periods shown.

<TABLE> 
<CAPTION> 
                                            Three     Over Three      Over One    Over Five     Over Ten        Over
                                           Months   Months Through     Through     Through       Through       Twenty
                                           or Less     One Year      Five Years   Ten Years   Twenty Years      Years       Total
                                           -------     --------      ----------   ---------   ------------     -------      -----
                                                                          (Dollars in thousands)
<S>                                      <C>           <C>           <C>          <C>           <C>           <C>         <C> 
Interest-earning assets:
   Real estate loans and mortgage-
       backed securities................ $   8,329     $ 17,972      $  22,855    $ 10,839      $  4,506      $    699    $ 65,200
   Consumer loans.......................     1,130        1,025          2,766         604            62            --       5,587
   Commercial loans.....................     2,515           47            843         368            --            15       3,788
   Investment securities................     1,989           --             --          --            --            --       1,989
   Federal funds sold, other interest-
       earning assets and investments
       required by law..................     4,951           --             --          --            --           622       5,573
                                         ---------     --------      ---------    --------      --------      --------    --------
        Total...........................    18,914       19,044         26,464      11,811         4,568         1,336      82,137
                                         ---------     --------      ---------    --------      --------      --------    --------

Interest-bearing liabilities:
   Deposits (1).........................    14,742       20,599         22,093       5,316         3,057           636      66,443
   Borrowings...........................     2,700           --             --          --            --            --       2,700
                                         ---------     --------      ---------    --------      --------      --------    --------
       Total............................    17,442       20,599         22,093       5,316         3,057           636      69,143
                                         ---------     --------      ---------    --------      --------      --------    --------

Interest sensitivity gap................ $   1,472     $ (1,555)     $   4,371    $  6,495      $  1,511      $    700    $ 12,994
                                         =========     ========      =========    ========      ========      ========    ========
Cumulative interest sensitivity gap..... $   1,472     $    (83)     $   4,288    $ 10,783      $ 12,294      $ 12,994
                                         =========     ========      =========    ========      ========      ========
Ratio of cumulative gap to total assets.      1.76%       (0.10)%         5.13%      12.89%        14.70%        15.53%
                                         =========     ========      =========    ========      ========      ========
</TABLE> 

--------------
(1)      Includes $228,000 of interest-bearing escrows.

                                       16
<PAGE>
 
     The preceding table was prepared utilizing certain assumptions as of June
30, 1997 regarding prepayment and decay rates provided by the FHLB of Atlanta.
While management believes that these assumptions are reasonable, the actual
interest rate sensitivity of the Company's assets and liabilities could vary
significantly from the information set forth in the table due to market and
other factors. The following assumptions were used: (i) adjustable-rate first
mortgage loans on single-family residences and mortgage-backed and related
securities will prepay at the rate of 18.0% for lagging index adjustable-rate
loans and 18.4% for current index adjustable-rate loans per year; (ii) first
mortgage loans on multi-family and commercial properties will not prepay; (iii)
consumer and commercial business loans will prepay at an annual rate of 18.0%
and (iv) fixed-rate mortgage loans on single-family residential properties will
prepay annually as follows:

<TABLE> 
<CAPTION> 
           Coupon Rate                       Annual Prepayment Rate
           <S>                               <C> 
           Up to 8.0%                                   8.0%
           8.01 to 9.0                                 10.4
           9.01 to 10.0                                12.8
           10.01 to 11.0                               16.9
           11.01 or greater                            24.6
</TABLE> 

     The table further assumes the following annual decay rates or withdrawal
factors for deposit accounts other than certificates of deposit:

<TABLE> 
<CAPTION> 
                                        Through         2 through       After
                                         1 Year          3 Years       3 Years
                                        --------        ---------     --------
   <S>                                  <C>             <C>           <C> 
   NOW...............................       37%            32%            17%
   Money market......................       79             31             31
   Passbook and statement............       17             17             16
</TABLE> 

     The interest rate-sensitivity of the Company's assets and liabilities
illustrated in the table above could vary substantially if different assumptions
were used or actual experience differs from the assumptions used. If passbook
and NOW accounts were assumed to mature in one year or less, the Company's
one-year negative gap would have increased.

     Certain shortcomings are inherent in the method of analysis presented in
the above table. Although certain assets and liabilities may have similar
maturities or periods of repricing, they may react in different degrees to
changes in market interest rates. The interest rates on certain types of assets
and liabilities may fluctuate in advance of changes in market interest rates,
while interest rates on other types of assets and liabilities may lag behind
changes in market interest rates. Certain assets, such as adjustable-rate
mortgages, have features which restrict changes in interest rates on a
short-term basis and over the life of the asset. In the event of a change in
interest rates, prepayment and early withdrawal levels would likely deviate
significantly from those assumed in calculating the table. The ability of many
borrowers to service their adjustable-rate debt may decrease in the event of an
interest rate increase.

                                       17
<PAGE>
 
Liquidity and Capital Resources

     An important component of the Company's asset/liability structure is the
level of liquidity available to meet the needs of customers and creditors.
Patapsco's Asset/Liability Management Committee has established general
guidelines for the maintenance of prudent levels of liquidity. The Committee
continually monitors the amount and source of available liquidity, the time to
acquire it and its cost. Management of the Company seeks to maintain a
relatively high level of liquidity in order to retain flexibility in terms of
investment opportunities and deposit pricing. Because liquid assets generally
provide lower rates of return, the Company's relatively high liquidity will, to
a certain extent, result in lower rates of return on assets.

     The Company's most liquid assets are cash on hand, interest-bearing
deposits and Federal funds sold, which are short-term, highly liquid investments
with original maturities of less than three months that are readily convertible
to known amounts of cash. The levels of these assets are dependent on the
Company's operating, financing and investing activities during any given period.
At June 30, 1997, the Company's cash on hand, interest-bearing deposits and
Federal funds sold totaled $5.1 million.

     The Company anticipates that it will have sufficient funds available to
meet its current loan origination, unused lines-of-credit and undisbursed
construction loans-in-process commitments of approximately $1.1 million,
$600,000 and $1.6 million, respectively. Certificates of deposit which are
scheduled to mature in less than one year at March 31, 1997 totaled $27.0
million. Historically, a high percentage of maturing deposits have remained with
the Company.

     The Company's primary sources of funds are deposits, borrowings and
proceeds from maturing investment securities and mortgage-backed securities and
principal and interest payments on loans. While maturities and scheduled
amortization of mortgage-backed securities and loans are predictable sources of
funds, deposit flows and mortgage prepayments are greatly influenced by general
interest rates, economic conditions, competition and other factors.

     At June 30, 1997, the Bank exceeded all regulatory minimum capital
requirements. The table below presents certain information relating to the
Bank's regulatory compliance at June 30, 1997.

     The Bank's actual capital amounts and ratios are also presented in the
table (in thousands).

<TABLE> 
<CAPTION> 
                                                                                                 To Be Well
                                                                                              Capitalized Under
                                                                         For Capital          Prompt Corrective
                                                   Actual             Adequacy Purposes       Action Provisions
                                          ----------------------      ------------------      -----------------
                                          Amount           Ratio      Amount       Ratio      Amount      Ratio
                                          ------           -----      ------       -----      -------     -----
<S>                                       <C> 
As of June 30, 1997:
 Total Capital (to Risk
     Weighted Assets)..................  $   10,910        23.68%     $3,685        8.00%     $ 4,607     10.00%
 Tier 1 Capital (to Risk
     Weighted Assets)..................      10,513        22.82       1,843        4.00        2,764      6.00
 Tier 1 Capital (to Average
     Assets)...........................      10,513        12.81       3,282        4.00        4,103      5.00

As of June 30, 1996:
 Total Capital (to Risk
    Weighted Assets)...................       9,826        28.67       2,742        8.00        3,427     10.00
 Tier 1 Capital (to Risk
    Weighted Assets)...................       9,607        28.03       1,371        4.00        2,056      6.00
 Tier 1 Capital (to Average Assets)           9,607        12.46       3,085        4.00        3,856      5.00

</TABLE> 

                                       18
<PAGE>
 
Impact of Inflation and Changing Prices

     The Consolidated Financial Statements and Notes thereto presented herein
have been prepared in accordance with generally accepted accounting principles,
which require the measurement of financial position and operating results in
terms of historical dollars without considering the change in the relative
purchasing power of money over time and due to inflation. The impact of
inflation is reflected in the increased cost of the Company's operations. Unlike
most industrial companies, nearly all the assets and liabilities of the Company
are monetary in nature. As a result, interest rates have a greater impact on the
Company's performance than do the effects of general levels of inflation.
Interest rates do not necessarily move in the same direction or to the same
extent as the price of goods and services.

Impact of New Accounting Standards

     Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities. In June 1996 the FASB issued Statement of Financial Accounting
Standards No. 125, "Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities" ("SFAS No. 125"). SFAS No. 125 is effective
for transfers and servicing of financial assets and extinguishments of
liabilities occurring after December 31, 1996 and is to be applied
prospectively. This Statement will require, among other things, the Company to
record at fair value, assets and liabilities resulting from a transfer of
financial assets. In December 1996, SFAS No. 127 was issued which deferred the
effectiveness date of certain provisions of SFAS No. 125 related to repurchase
agreements, securities lending and similar transactions until January 1, 1998.
In December 1996, SFAS No. 127 was issued which deferred the effective date of
certain provisions of SFAS No. 125 related to repurchase agreements, securities
lending and similar transactions until January 1, 1998. The Company adopted the
effective provisions of SFAS No. 125 on January 1, 1997, and the adoption did
not have a material effect on the Company's reported financial condition or
results of operations.

     Earnings per Share. In February 1997, the FASB issued SFAS No. 128,
"Earnings per Share," which is effective for the financial statements issued for
periods ending after December 15, 1997. SFAS No. 128 establishes standards for
computing and presenting earnings per share ("EPS") and replaces the
presentation of primary EPS with a presentation of basic EPS. It requires dual
presentation of basic and diluted EPS on the face of the consolidated statement
of income and the reconciliation of the numerator and denominator of the basic
EPS computation to the numerator and denominator of the diluted EPS computation.
Earlier application is not permitted but disclosure of pro forma EPS amounts
computed using the standards established by SFAS No. 128 is permitted in the
notes to financial statements for periods ending prior to the effective date.
Management believes the adoption of the provisions of this statement will not
have a significant effect on the Company's EPS.

     Reporting Comprehensive Income. In June 1997, the FASB issued SFAS No. 130,
"Reporting Comprehensive Income" (SFAS No. 130). SFAS No. 130 establishes
standards for reporting and display of comprehensive income and its components
in a full set of general purpose financial statements. It does not, however,
specify when to recognize or how to measure items that make up comprehensive
income. SFAS No. 130 is effective for both interim and annual periods beginning
after December 15, 1997. Earlier application is permitted. Comparative financial
statements provided for earlier periods are required to be reclassified to
reflect the provisions of this statement. Management has not determined when it
will adopt the provisions of SFAS No. 130 but believes that it will not have a
material effect on the financial condition or results of operations of the
Company.

     Disclosures about Segments of an Enterprise and Related Information. In
June 1997, the FASB also issued SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information" (SFAS No. 131). SFAS No. 131 establishes
standards for the way public business enterprises are to report information
about operating segments in annual financial statements and requires those
enterprises to report selected information about operating segments in interim
financial reports issued to shareholders. SFAS No. 131 is effective for
financial statements for periods beginning after December 15, 1997. Earlier
application is encouraged. Management has not determined when it will adopt the
provisions of SFAS No. 131 but believes that it will not have a material effect
on the financial condition or results of operations of the Company.

                                       19
<PAGE>
 







                         [Patapsco Bancorp, Inc. Logo]






                                      20
<PAGE>
 
Independent Auditors' Report


The Board of Directors
Patapsco Bancorp, Inc.
Dundalk, Maryland:


We have audited the accompanying consolidated statements of financial condition
of Patapsco Bancorp, Inc. and subsidiary (the Company) as of June 30, 1997 and
1996, and the related consolidated statements of income, stockholders' equity
and cash flows for the years then ended. These consolidated financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these consolidated 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 consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Patapsco Bancorp,
Inc. and subsidiary as of June 30, 1997 and 1996, and the results of their
operations and their cash flows for the years then ended in conformity with
generally accepted accounting principles.

                                                /s/ KPMG Peat Marwick LLP
                                                -------------------------
                                                KPMG Peat Marwick LLP



Baltimore, Maryland
August 1, 1997




                                      21
<PAGE>
 
PATAPSCO BANCORP, INC. AND SUBSIDIARY

Consolidated Statements of Financial Condition

June 30, 1997 and 1996

<TABLE> 
<CAPTION> 
===================================================================================================================
                                                                                    1997                    1996
-------------------------------------------------------------------------------------------------------------------
<S>                                                                             <C>                     <C>
ASSETS

Cash:
   On hand and due from banks                                                   $   161,895                 400,286
   Interest bearing deposits                                                          3,698                 229,290
Federal funds sold                                                                4,947,594               6,794,889
Investment securities at fair value (note 2)                                      1,989,380               4,423,767
Mortgage-backed securities at fair value (note 3)                                 7,678,517              12,777,828
Loans receivable, net (note 4)                                                   66,236,126              52,031,297
Investment required by law, at cost (note 9)                                        622,050                 490,500
Property and equipment, net (note 5)                                              1,117,454               1,028,690
Deferred taxes (note 8)                                                             236,000                       -
Accrued interest, prepaid expenses and other assets                                 656,822                 673,399
-------------------------------------------------------------------------------------------------------------------
                                                                                $83,649,536              78,849,946
===================================================================================================================

LIABILITIES AND STOCKHOLDERS' EQUITY

Liabilities:
   Deposits:
        Interest bearing deposits                                               $66,214,826              62,739,519
        Non-interest bearing deposits                                             3,937,467               1,417,369
   Borrowings (note 7)                                                            2,700,000                       -
   Accrued expenses and other liabilities                                         2,239,240               1,719,915
   Income taxes payable                                                             224,000                  75,000
   Deferred taxes (note 8)                                                                -                 597,000
-------------------------------------------------------------------------------------------------------------------
Total liabilities                                                                75,315,533              66,548,803

Stockholders' equity (notes 9, 10 and 11):
   Common stock $0.01 par value; authorized 4,000,000 shares; issued
        and outstanding 362,553 shares                                                3,626                   3,626
   Additional paid-in capital                                                     2,249,725               6,754,240
   Contra equity - Employee Stock Option Plan (ESOP)                               (464,064)               (522,072)
   Contra equity - Management Recognition Plan (MRP)                               (423,724)                      -
   Retained earnings, substantially restricted                                    6,922,716               6,172,405
   Unrealized net holding losses on available-for-sale portfolios,
        net of taxes                                                                (24,276)               (107,056)
-------------------------------------------------------------------------------------------------------------------
                                                                                  8,334,003              12,301,143
Commitments (notes 4, 10 and 11)
-------------------------------------------------------------------------------------------------------------------
                                                                                $83,649,536             $78,849,946
===================================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.


                                      22

<PAGE>
 
PATAPSCO BANCORP, INC. AND SUBSIDIARY

Consolidated Statements of Income

Years ended June 30, 1997 and 1996

<TABLE>
<CAPTION>

===============================================================================================

                                                                           1997           1996
-----------------------------------------------------------------------------------------------

<S>                                                              <C>                 <C>      
Interest income:
     Loans receivable                                            $    4,721,514      3,514,298
     Mortgage-backed securities                                         533,537      1,002,469
     Investment securities                                              191,228        612,390
     Federal funds sold and other investments                           450,964        202,821
-----------------------------------------------------------------------------------------------

Total interest income                                                 5,897,243      5,331,978
-----------------------------------------------------------------------------------------------

Interest expense:
     Deposits                                                         2,697,609      2,851,327
     Borrowings                                                           8,898        186,495
-----------------------------------------------------------------------------------------------

Total interest expense                                                2,706,507      3,037,822
-----------------------------------------------------------------------------------------------

Net interest income                                                   3,190,736      2,294,156

Provision for losses on loans (note 4)                                  240,000         68,000
-----------------------------------------------------------------------------------------------

Net interest income after provision for losses on loans               2,950,736      2,226,156
-----------------------------------------------------------------------------------------------

Noninterest income:
     Fees and service charges                                           203,952        108,997
     Net gain (loss) on sales of securities                               1,844        (99,446)
     Other                                                               13,915         20,153
-----------------------------------------------------------------------------------------------

Total noninterest income                                                219,711         29,704
-----------------------------------------------------------------------------------------------

Noninterest expenses:
     Compensation and employee benefits                               1,467,143      1,178,829
     Insurance                                                          515,260        192,654
     Professional fees                                                  147,757        128,725
     Equipment expenses                                                 115,573        113,697
     Net occupancy costs                                                 81,403         79,377
     Advertising                                                         44,371         38,090
     Data  processing                                                    96,012         91,861
     Other                                                              345,617        264,543
-----------------------------------------------------------------------------------------------

Total noninterest expenses                                            2,813,136      2,087,776
-----------------------------------------------------------------------------------------------

Income before income taxes                                              357,311        168,084

Income tax provision (benefit) (note 8)                                (463,000)        67,000
-----------------------------------------------------------------------------------------------

Net income                                                       $      820,311        101,084
===============================================================================================
</TABLE>

                                                                     (Continued)

                                      23
<PAGE>
 
PATAPSCO BANCORP, INC. AND SUBSIDIARY

Consolidated Statements of Income, Continued

Years ended June 30, 1997 and 1996

<TABLE> 
<CAPTION> 
===============================================================================================

                                                                            1997          1996
-----------------------------------------------------------------------------------------------

<S>                                                              <C>                     <C> 
Net income per share of common stock (note 1):
     Primary                                                     $         2.44             -
     From date of conversion                                                 -            0.26
     Proforma                                                                -            0.74
===============================================================================================
</TABLE> 

See accompanying notes to consolidated financial statements.


                                      24
<PAGE>
 
PATAPSCO BANCORP, INC. AND SUBSIDIARY

Consolidated Statements of Stockholders' Equity

Years ended June 30, 1997 and 1996

<TABLE>
<CAPTION>
                                                                                                                                  
==================================================================================================================================
                                                                      Common            Additional  Contra-equity   Contra-equity   
                                                                       stock       paid-in capital           ESOP             MRP
----------------------------------------------------------------------------------------------------------------------------------
<S>                                                                 <C>            <C>              <C>             <C> 
Balance at June 30, 1995                                            $      -                    -              -                - 
Proceeds from stock offering, net of conversion costs                  3,626            6,742,184              -                - 
Borrowings for Employee Stock Ownership Plan (ESOP)                        -                    -       (580,080)               - 
Compensation under stock-based benefit plans                               -               12,056         58,008                -
Adjustment to unrealized net holding losses on available-for-sale                                                            
     portfolios, net (note 1)                                              -                    -              -                -
Net income                                                                 -                    -              -                -
----------------------------------------------------------------------------------------------------------------------------------
Balance at June 30, 1996                                               3,626            6,754,240       (522,072)               -
Purchase of 14,502 shares of common stock for Management Recognition                                                         
     Plan (MRP) Trust                                                      -                    -              -         (423,724)
Compensation under stock-based benefit plans                               -               27,398         58,008                - 
Adjustment to unrealized net holding losses on available-for-sale                                                            
     portfolios, net (note 1)                                              -                    -              -                - 
Return of capital distribution ($12.50 per share) (note 10)                            (4,531,913)             -                - 
Net income                                                                 -                    -              -                - 
----------------------------------------------------------------------------------------------------------------------------------
Balance at June 30, 1997                                            $  3,626            2,249,725       (464,064)        (423,724)
==================================================================================================================================

<CAPTION>
=======================================================================================================================
                                                                                        Unrealized net
                                                                                     holding losses on           Total
                                                                        Retained    available-for-sale    stockholders'
                                                                        earnings            portfolios          equity
-----------------------------------------------------------------------------------------------------------------------
<S>                                                                   <C>           <C>                   <C> 
Balance at June 30, 1995                                               6,071,321               (31,233)      6,040,088
Proceeds from stock offering, net of conversion costs                          -                     -       6,745,810
Borrowings for Employee Stock Ownership Plan (ESOP)                            -                     -        (580,080)
Compensation under stock-based benefit plans                                   -                     -          70,064
Adjustment to unrealized net holding losses on available-for-sale
     portfolios, net (note 1)                                                  -               (75,823)        (75,823)
Net income                                                               101,084                     -         101,084
-----------------------------------------------------------------------------------------------------------------------
Balance at June 30, 1996                                               6,172,405              (107,056)     12,301,143
Purchase of 14,502 shares of common stock for Management Recognition
     Plan (MRP) Trust                                                          -                     -        (423,724)
Compensation under stock-based benefit plans                                   -                     -          85,406
Adjustment to unrealized net holding losses on available-for-sale
     portfolios, net (note 1)                                                  -                82,780          82,780
Return of capital distribution ($12.50 per share) (note 10)                    -                     -      (4,531,913)
Net income                                                               820,311                     -         820,311
-----------------------------------------------------------------------------------------------------------------------
Balance at June 30, 1997                                               6,992,716               (24,276)      8,334,003
=======================================================================================================================
</TABLE>

See accompanying notes to consolidated financial statements.



                                      25
<PAGE>
 
PATAPSCO BANCORP, INC. AND SUBSIDIARY

Consolidated Statements of Cash Flows

Years ended June 30, 1997 and 1996

<TABLE> 
<CAPTION> 
===============================================================================================

                                                                           1997           1996
-----------------------------------------------------------------------------------------------

<S>                                                              <C>                <C> 
Cash flows from operating activities:
     Net income                                                  $      820,311        101,084
     Adjustments to reconcile net income to net
        cash provided by operating activities:
            Depreciation                                                122,497        109,664
            Provision for losses on loans                               240,000         68,000
            Non-cash compensation under stock-based
                benefit plans                                            85,406         70,064
            Amortization of premiums and discounts, net                  18,098        (48,782)
            Deferred loan origination fees, net of costs                 14,685         95,465
            (Gain) loss on sales of investment securities and
                mortgage-backed securities                               (1,844)        97,102
            Loss on sales of loans                                            -          2,344
            Proceeds from sale of mortgage loans originated
                for sale                                                      -        270,500
            Increase in income taxes payable                            149,000         75,000
            Change in deferred taxes                                   (886,000)      (102,000)
            Decrease in taxes recoverable                                     -         41,000
            Increase in accrued interest on investments, prepaid
                expenses and other assets                               (55,704)       (15,466)
            Increase in accrued expenses and other liabilities          519,325        292,889
-----------------------------------------------------------------------------------------------

Net cash provided by operating activities                             1,025,774      1,056,864
-----------------------------------------------------------------------------------------------

Cash flows from investing activities:
     Loan principal disbursements, net of repayments                 (9,870,978)    (9,578,882)
     Purchases of loans                                              (4,516,255)    (1,120,086)
     Proceeds from sales and operations of real estate acquired
        through foreclosure                                                   -         18,919
     Purchases of property and equipment                               (211,261)       (35,664)
     Purchase of stock in Federal Home Loan Bank of Atlanta             (30,000)             -
     Purchase of stock in Federal Reserve Bank of Richmond             (101,550)             -
     Principal repayments on:
        Mortgage-backed securities available-for-sale                   817,440      2,001,361
        Mortgage-backed securities held-to-maturity                           -      1,268,790
     Maturities of:
        Investment securities available-for-sale                      2,500,000      5,500,000
        Investment securities held-to-maturity                                -      2,000,000
     Sales of:
        Mortgage-backed securities available-for-sale                 4,335,784      2,620,522
        Investment securities available-for-sale                              -      2,857,317
</TABLE> 

                                                                     (Continued)



                                      26
<PAGE>
 
PATAPSCO BANCORP, INC. AND SUBSIDIARY

Consolidated Statements of Cash Flows, Continued

Years ended June 30, 1997 and 1996

<TABLE> 
<CAPTION> 
===============================================================================================
                                                                           1997           1996
-----------------------------------------------------------------------------------------------
<S>                                                              <C>               <C> 
Cash flows from investing activities, continued:
     Purchases of:
        Mortgage-backed securities available-for-sale            $            -     (3,039,875)
-----------------------------------------------------------------------------------------------
Net cash (used in) provided by investing activities                  (7,076,820)     2,492,402
-----------------------------------------------------------------------------------------------
Cash flows from financing activities:
     Net increase in deposits                                         5,995,405        227,315
     Increase in note payable                                         2,700,000              -
     Return of capital distribution                                  (4,531,913)             -
     Purchase of common stock for stock-based benefit plans            (423,724)             -
     Decrease in advances from Federal Home Loan Bank of Atlanta              -     (5,000,000)
     Proceeds from stock offering                                             -      6,165,730
-----------------------------------------------------------------------------------------------
Net cash provided by financing activities                             3,739,768      1,393,045
-----------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents                 (2,311,278)     4,942,311

Cash and cash equivalents at beginning of year                        7,424,465      2,482,154
-----------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year                         $    5,113,187      7,424,465
===============================================================================================

Supplemental information:
     Interest paid on savings deposits and borrowed funds        $    2,705,637      3,036,930
     Income taxes paid                                                  199,000         53,000
===============================================================================================
</TABLE> 
See accompanying notes to consolidated financial statements.


                                      27
<PAGE>
 
PATAPSCO BANCORP, INC. AND SUBSIDIARY

Notes to Consolidated Financial Statements

June 30, 1997 and 1996

--------------------------------------------------------------------------------

 
   (1)   Basis of Presentation and Summary of Significant Accounting Policies

         Description of Business

         Patapsco Bancorp, Inc. (the Company) is the holding company of The
         Patapsco Bank (Patapsco). The primary business of Patapsco is to
         attract deposits from individual and corporate customers and to
         originate residential and commercial mortgage loans, commercial loans
         and consumer loans. Patapsco is subject to competition from other
         financial and mortgage institutions in attracting and retaining
         deposits and in making loans. Patapsco is subject to the regulations of
         certain agencies of the federal government and undergoes periodic
         examination by those agencies.

         Basis of Presentation

         The consolidated financial statements include the accounts of the
         Company and its wholly-owned subsidiary, Patapsco. All significant
         intercompany accounts and transactions have been eliminated in
         consolidation.

         In preparing the consolidated financial statements, management is
         required to make estimates and assumptions that affect the reported
         amounts of assets and liabilities as of the date of the statements of
         financial condition and income and expenses for the periods then ended.
         Actual results could differ significantly 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. In connection with this determination, management
         obtains independent appraisals for significant properties and prepares
         fair value analyses as appropriate.

         Management believes that the allowance for loan losses is adequate.
         While management uses and considers available information in making the
         required estimates, additional provisions for possible losses may be
         necessary based on changes in economic conditions, particularly in
         Baltimore and the State of Maryland. In addition, various regulatory
         agencies, as an integral part of their examination process,
         periodically review Patapsco's allowance for loan losses. Such agencies
         may require Patapsco to recognize additions to the allowance based on
         their judgments about information available to them at the time of
         their examination.

         Cash and Cash Equivalents

         Cash equivalents include short-term investments which consists of
         Federal funds sold. Cash equivalents and other liquidity and short-term
         investments are carried at cost, which approximates market value.

                                                                     (Continued)


                                      28
<PAGE>
 
PATAPSCO BANCORP, INC. AND SUBSIDIARY

Notes to Consolidated Financial Statements



--------------------------------------------------------------------------------

   (1)   Continued

         Investment and Mortgage-Backed Securities

         Debt securities that the Company has the positive intent and ability to
         hold to maturity are classified as held-to-maturity and recorded at
         amortized cost. Debt and equity securities not classified as
         held-to-maturity and equity securities with readily determinable fair
         values are classified as trading securities if bought and held
         principally for the purpose of selling them in the near term. Trading
         securities are reported at fair value, with unrealized gains and losses
         included in earnings. Investments not classified as held-to-maturity or
         trading are considered available-for-sale and are reported at fair
         value, with unrealized holding gains and losses excluded from earnings
         and reported as a separate component of stockholders' equity, net of
         tax effects.

         If a decline in value of an individual security classified as
         held-to-maturity or available-for-sale is judged to be other than
         temporary, the cost basis of that security is reduced to its fair value
         and the amount of the write-down is included in earnings. Fair value is
         determined based on bid prices published in financial newspapers or bid
         quotations received from securities dealers. For purposes of computing
         realized gains or losses on the sales of investments, cost is
         determined using the specific identification method. Premiums and
         discounts on investment and mortgage-backed securities are amortized
         over the term of the security using methods that approximate the
         interest method.

         In November 1995, the Financial Accounting Standards Board announced
         its intention to allow a one-time change in the classification of
         securities, providing such change was effected by December 31, 1995.
         Management utilized this opportunity and on December 15, 1995
         designated its held-to-maturity investment and mortgage-backed
         securities, with an amortized cost of $21,299,156 and an unrealized net
         loss of $73,099, as available-for-sale.

         Property and Equipment

         Property and equipment are stated at cost less accumulated depreciation
         computed by use of straight-line and accelerated methods over the
         estimated useful lives of the related assets. Additions and betterments
         are capitalized and costs of repairs and maintenance are expensed when
         incurred. The related costs and accumulated depreciation are eliminated
         from the accounts when an asset is sold or retired and the resultant
         gain or loss is credited or charged to income.

         Loan Fees

         Loan origination fees are deferred and amortized to income over the
         contractual lives of the related loans using the interest method.
         Certain incremental direct loan origination costs are deferred and
         recognized over the contractual lives of the related loans using the
         interest method as a reduction of the loan yield. Deferred fees and
         costs are combined where applicable and the net amount is amortized.

                                                                     (Continued)


                                      29
<PAGE>
 
PATAPSCO BANCORP, INC. AND SUBSIDIARY

Notes to Consolidated Financial Statements



--------------------------------------------------------------------------------

   (1)   Continued

         Provision for Losses on Loans

         Provisions for losses on loans receivable are charged to income, based
         on management's judgment with respect to the risks inherent in the
         portfolio. Such judgment considers a number of factors including
         historical loss experience, the present and prospective financial
         condition of borrowers, the estimated value of underlying collateral,
         geographic concentrations, current and prospective economic conditions,
         delinquency experience and status of nonperforming assets.
         Additionally, accrual of interest on potential problem loans is
         excluded from income when, in the opinion of management, the full
         collection of principal or interest is in doubt, or payment of
         principal or interest has become 90 days past due, unless the
         obligation is well secured and in the process of collection. Interest
         collected on nonaccrual loans is generally recorded in income in the
         period received.

         In accordance with the provisions of Statement of Financial Accounting
         Standards No. 114, Accounting for Creditors for Impairment of a Loan,
         as amended by Statement 118, Accounting by Creditors for Impairment of
         a Loan - Income Recognition and Disclosures (collectively referred to
         as "Statement 114"), Patapsco determines and recognizes impairment of
         certain loans. A loan is determined to be impaired when, based on
         current information and events, it is probable that Patapsco will be
         unable to collect all amounts due according to the contractual terms of
         the loan agreement. A loan is not considered impaired during a period
         of delay in payment if Patapsco expects to collect all amounts due,
         including past-due interest. Patapsco generally considers a period of
         delay in payment to include delinquency up to and including 90 days.
         Statement 114 requires that impaired loans be measured at the present
         value of its expected future cash flows discounted at the loan's
         effective interest rate, or at the loan's observable market price or
         the fair value of the collateral if the loan is collateral dependent.

         Statement 114 is generally applicable for all loans except large groups
         or smaller-balance homogeneous loans that are evaluated collectively
         for impairment, including residential first and second mortgage loans
         and consumer installment loans. Impaired loans are therefore generally
         comprised of commercial mortgage, real estate development, and certain
         restructured residential loans. In addition, impaired loans are
         generally loans which management has placed in nonaccrual status since
         loans are placed in nonaccrual status on the earlier of the date that
         management determines that the collection of principal and/or interest
         is in doubt or the date that principal or interest is 90 days or more
         past-due.


                                                                     (Continued)


                                      30
<PAGE>
 
PATAPSCO BANCORP, INC. AND SUBSIDIARY

Notes to Consolidated Financial Statements



--------------------------------------------------------------------------------

   (1)   Continued

         Patapsco recognizes interest income for impaired loans consistent with
         its method for non-accrual loans. Specifically, interest payments
         received are recognized as interest income or, if the ultimate
         collectibility of principal is in doubt, are applied to principal.

         Real Estate Acquired Through Foreclosure

         Real estate acquired through foreclosure is initially recorded at the
         lower of cost or estimated fair value and subsequently at the lower of
         book value or fair value less estimated costs to sell. Costs relating
         to holding such real estate are charged against income in the current
         period, while costs relating to improving such real estate are
         capitalized until a salable condition is reached.

         Sales of Mortgage Loans

         Loans originated for sale are carried at the lower of aggregate cost or
         market value. Market value is determined based on outstanding investor
         commitments or, in the absence of such commitments, based on current
         investor yield requirements. Gains and losses on loan sales are
         determined using the specific identification method.

         Income Taxes

         Deferred income taxes are recognized, with certain exceptions, for
         temporary differences between the financial reporting basis and income
         tax basis of assets and liabilities based on enacted tax rates expected
         to be in effect when such amounts are realized or settled. Deferred tax
         assets (including tax loss carryforwards) are recognized only to the
         extent that it is more likely than not that such amounts will be
         realized based on consideration of available evidence, including tax
         planning strategies and other factors.

         The effects of changes in tax laws or rates on deferred tax assets and
         liabilities are recognized in the period that includes the enactment
         date.

         Net Income per Share of Common Stock

         Net income per share for 1997 and 1996 has been computed based on the
         weighted average shares of common stock equivalents outstanding,
         336,449 and 333,549, respectively.


                                                                     (Continued)


                                      31
<PAGE>
 
PATAPSCO BANCORP, INC. AND SUBSIDIARY

Notes to Consolidated Financial Statements



--------------------------------------------------------------------------------

   (1)   Continued

         Net income per share for the portion of the year ended June 30, 1996
         the Company was a stock corporation, April 1, 1996 through June 30,
         1996, is computed using net income for such period. Pro forma net
         income per share for the year ended June 30, 1996 utilized net income
         for the portion of the year the Company was a stock corporation and
         assumed net proceeds of the sale of common stock in the conversion were
         received and invested beginning for the period July 1, 1995 to March
         31, 1996 at a net effective yield of 3.45% (approximate yield on the
         one-year Treasury bill at June 30, 1995, net of tax).

         Stock-Based Compensation

         In October 1995, the FASB issued Statement of Financial Standards No.
         123 (Statement 123), Accounting for Stock-Based Compensation. Statement
         123, which is effective for fiscal years beginning after December 15,
         1995, establishes financial accounting and reporting standards for
         stock-based employee compensation plans and for transactions in which
         an entity issues its equity instruments to acquire goods and services
         from nonemployees. Statement 123 allows companies to account for
         stock-based compensation either under the new provisions of SFAS 123 or
         under the provisions of Accounting Principles Board Opinion No. 25 (APB
         25), Accounting for Stock Issued to Employees, but requires pro forma
         disclosure in the footnotes to the financial statements as if the
         measurement provisions of Statement 123 had been adopted. The Company
         has continued to account for its stock-based compensation in accordance
         with APB 25. Information required by Statement 123 regarding the
         Company's stock-based compensation plans is provided in note 11.

         Reclassification

         Certain amounts from 1996 have been reclassified to conform to the
         presentation in 1997.


   (2)   Investment Securities

         Investment securities, classified as available-for-sale, are summarized
         as follows as of June 30:

<TABLE> 
<CAPTION> 
 
                                                      1997
                             ---------------------------------------------------
                              Amortized Unrealized Unrealized     Fair  Carrying
                                   cost      gains     losses    value     value
         -----------------------------------------------------------------------
         <S>                <C>         <C>        <C>       <C>       <C>    
         U.S. Government                                            
            and Agency                                          
            obligations                                             
            due 5 through   
            10 years        $ 1,988,310      1,070     -     1,989,380 1,989,380
         -----------------------------------------------------------------------
</TABLE> 



                                                                     (Continued)


                                      32
<PAGE>

PATAPSCO BANCORP, INC. AND SUBSIDIARY

Notes to Consolidated Financial Statements


--------------------------------------------------------------------------------

   (2)  Continued
<TABLE> 
<CAPTION> 
                                                                        1996
                                       -----------------------------------------------------------------------
                                          Amortized    Unrealized    Unrealized           Fair       Carrying
                                               cost         gains        losses          value          value
          ----------------------------------------------------------------------------------------------------   
          <S>                          <C>             <C>           <C>             <C>            <C> 
          U.S. Government and
               Agency obligations
               due:
                   1 through 5 years   $  2,500,000        -             32,800      2,467,200      2,467,200
                   5 through 10 years     1,987,067        -             30,500      1,956,567      1,956,567
          ----------------------------------------------------------------------------------------------------
                                       $  4,487,067        -             63,300      4,423,767      4,423,767
          ====================================================================================================
</TABLE> 

        Accrued interest receivable at June 30, 1997 and 1996 was $1,611 and
        $32,126, respectively.

        There were no sales of investment securities in 1997. In 1996, the
        Company sold investment securities classified available-for-sale with
        an amortized cost of $2,928,753 and realized a net loss of $71,436.


   (3)  Mortgage-Backed Securities

        Mortgage-backed securities, classified as available-for-sale, are
        summarized as follows as of June 30:

<TABLE> 
<CAPTION> 
                                                                        1997
                                       ---------------------------------------------------------------------
                                          Amortized    Unrealized    Unrealized          Fair      Carrying
                                               cost         gains        losses         value         value
          --------------------------------------------------------------------------------------------------   
          <S>                          <C>             <C>           <C>            <C>           <C> 
          Federal National Mortgage                                                              
              Association (FNMA)       $  1,482,295         6,549         4,949     1,483,895     1,483,895
          Federal Home Loan                                                                      
              Mortgage Corporation                                                               
              (FHLMC)                       747,221             -         8,520       738,701       738,701
          FNMA Collateralized                                                                    
              Mortgage Obligations        5,489,622             -        33,701     5,455,921     5,455,921
          --------------------------------------------------------------------------------------------------
                                       $  7,719,138         6,549        47,170     7,678,517     7,678,517
         ===================================================================================================

                                                                                                 (Continued)
</TABLE> 




                                      33
<PAGE>
 
PATAPSCO BANCORP, INC. AND SUBSIDIARY

Notes to Consolidated Financial Statements

--------------------------------------------------------------------------------
(3)   Continued

<TABLE> 
<CAPTION>          

                                                                      1996
                                     --------------------------------------------------------------------
                                      Amortized     Unrealized     Unrealized         Fair       Carrying
                                           cost          gains         losses        value          value
        -------------------------------------------------------------------------------------------------
        <S>                           <C>           <C>            <C>             <C>          <C>  
        FNMA                          $ 1,767,779           --         29,564      1,738,215    1,738,215
        FHLMC                             855,044           --         25,068        829,976      829,976
        FNMA Collateralized
           Mortgage Obligations         6,597,595        8,177         59,902      6,545,870    6,545,870 
        FHLMC Collateralized
           Mortgage Obligations         3,668,525        7,975         12,733      3,663,767    3,663,767
        -------------------------------------------------------------------------------------------------
                                      $12,888,943       16,152        127,267     12,777,828   12,777,828
        =================================================================================================
</TABLE> 

      Accrued interest receivable at June 30, 1997 and 1996 was $41,110 and
      $75,530, respectively.

      In 1997, the Company sold mortgage-backed securities classified available-
      for-sale with an amortized cost of $4,333,940 and realized a net gain of
      $1,844. In 1996, the Company sold mortgage-backed securities classified
      available-for-sale with an amortized cost of $2,646,188 and realized a net
      loss of $25,666.

      Contractual maturities of mortgage-backed securities as of June 30 are
      as follows:

<TABLE> 
<CAPTION> 

                                                            1997                            1996
                                                 --------------------------     -------------------------- 
                                                  Amortized            Fair      Amortized            Fair
                                                       cost           value           cost           value
        --------------------------------------------------------------------------------------------------
        <S>                                     <C>             <C>              <C>            <C>  
        Due one through five years              $ 3,370,321       3,369,288             --              --
        Due after five through ten years          2,988,890       2,962,771      8,670,917       8,644,226 
        Due after ten years                       1,359,927       1,346,458      4,218,026       4,133,602
        --------------------------------------------------------------------------------------------------
                                                $ 7,719,138       7,678,517     12,888,943      12,777,828
        ==================================================================================================
</TABLE> 

      Contractual maturities do not consider anticipated prepayments of
      mortgage-backed securities.

                                                                     (Continued)

                                      34
<PAGE>
 
PATAPSCO BANCORP, INC. AND SUBSIDIARY

Notes to Consolidated Financial Statements

--------------------------------------------------------------------------------

   (4)   Loans Receivable

         Loans receivable and accrued interest receivable thereon are summarized
         as follows as of June 30:

<TABLE> 
<CAPTION> 

------------------------------------------------------------------------------------------------
<S>                                                    <C>                          <C> 
Real estate secured by first mortgage:
     Residential                                       $        52,906,474           47,278,681
     Commercial                                                  2,611,818            1,074,454
     Construction, net of loans in process                       2,001,892                    -
------------------------------------------------------------------------------------------------

                                                                57,520,184           48,353,135

Home improvement loans                                           4,604,954            2,372,648
Commercial loans                                                 3,399,694            1,020,000
Home equity loans                                                  420,392               39,340
Commercial leases                                                  388,618              179,386
Loans secured                                                      364,334              391,428
Consumer loans                                                     198,285              142,999
------------------------------------------------------------------------------------------------

                                                                66,896,461           52,498,936

Less:
     Deferred loan origination fees, net of costs                  263,323              248,638
     Allowance for loan losses                                     397,012              219,001
------------------------------------------------------------------------------------------------
Loans receivable, net                                  $        66,236,126           52,031,297
================================================================================================
</TABLE> 


         Accrued interest receivable on loans was $363,448 and $306,883 at June
         30, 1997 and 1996, respectively.

         Substantially all of the Company's loans receivable are mortgage loans
         secured by residential real estate properties. Loans are extended only
         after evaluation by management of customers' creditworthiness and other
         relevant factors on a case-by-case basis. On first mortgage loans, the
         Company does not lend more than 95% of the appraised value of an owner
         occupied residential property and in instances where the Company lends
         more than 80% of the appraised value, private mortgage insurance is
         required. For investor loans on residential property (not owner
         occupied) the Company does not lend more than 70% of the appraised
         value.

         The Company's residential lending operations are focused in the State
         of Maryland, primarily the Baltimore Metropolitan area. While
         residential lending is generally considered to involve less risk than
         other forms of lending, payment experience on these loans is dependent
         to some extent on economic and market conditions in the Company's
         primary lending area.

                                                                     (Continued)

                                      35
<PAGE>
 
PATAPSCO BANCORP, INC. AND SUBSIDIARY

Notes to Consolidated Financial Statements

--------------------------------------------------------------------------------

   (4)   Continued

         Nonaccrual loans amounted to approximately $123,000 and $240,000 at
         June 30, 1997 and 1996, respectively. The amount of interest income
         that would have been recorded on loans in nonaccrual status at June 30,
         1997 and 1996 had such loans performed in accordance with their terms,
         was approximately $5,500 and $19,000, respectively. The actual interest
         income recorded on these loans during 1997 and 1996 was approximately
         $7,000 and $8,000, respectively. No loans were impaired, as defined,
         during 1997 and 1996.

         The Company, through its normal asset review process, classifies
         certain loans which management believes involve a degree of risk
         warranting additional attention. These classifications are special
         mention, substandard, doubtful and loss. At June 30, 1997, loans
         classified special mention and substandard totaled approximately
         $655,000 and $140,000, respectively. No loans were classified doubtful
         or loss at June 30, 1997.

         The activity in the allowance for loan losses is summarized as follows
         for the years ended June 30:

<TABLE> 
<CAPTION> 

                                                              1997          1996
--------------------------------------------------------------------------------
<S>                                                     <C>             <C> 
Balance at beginning of year                            $ 219,001       158,768
Provision for losses on loans                             240,000        68,000
Charge-offs, net of recoveries                            (61,989)       (7,767)
--------------------------------------------------------------------------------
Balance at end of year                                  $ 397,012       219,001
================================================================================
</TABLE> 

         Commitments to extend credit are agreements to lend to customers,
         provided that terms and conditions of the commitment are met.
         Commitments are generally funded from loan principal repayments, excess
         liquidity and savings deposits. Since certain of the commitments may
         expire without being drawn upon, the total commitment amounts do not
         necessarily represent future cash requirements.

         Substantially all of the Company's outstanding commitments at June 30,
         1996 are for loans which would be secured by real estate with appraised
         values in excess of the commitment amounts. The Company's exposure to
         credit loss under these contracts in the event of non-performance by
         the other parties, assuming that the collateral proves to be of no
         value, is represented by the commitment amounts.

                                                                     (Continued)

                                      36
<PAGE>
 
PATAPSCO BANCORP, INC. AND SUBSIDIARY

Notes to Consolidated Financial Statements

--------------------------------------------------------------------------------

   (4)   Continued

         Outstanding commitments to extend credit, which generally expire within
         60 days, are as follows at June 30, 1997:

<TABLE> 
<CAPTION> 
                                                                            Floating
                                                        Fixed rate              rate
         ---------------------------------------------------------------------------
         <S>                                            <C>                 <C> 
         Residential mortgage loans                      $ 298,125           626,550
         Commercial business and lease loans               140,875            45,000
         Undisbursed lines of credit                        87,077           502,808
         ===========================================================================
</TABLE> 

         As of June 30, 1997 and 1996, Patapsco was servicing loans for the
         benefit of others approximately $1,470,000 and $409,000, respectively.


   (5)   Property and Equipment

         Property and equipment are summarized as follows at June 30:

<TABLE> 
<CAPTION> 

                                                                                              Estimated
                                                             1997                1996      useful lives
         ----------------------------------------------------------------------------------------------
         <S>                                          <C>                    <C>           <C> 
         Land                                         $    92,684              92,684                --
         Building and improvements                        981,015             908,528          40 years
         Furniture, fixtures and equipment              1,047,272             908,498        5-10 years
         ----------------------------------------------------------------------------      ============

         Total, at cost                                 2,120,971           1,909,710

         Less accumulated depreciation                  1,003,517             881,020
         ----------------------------------------------------------------------------

         Property and equipment, net                  $ 1,117,454           1,028,690
         ============================================================================
</TABLE> 

       The Company has no obligations under long-term operating leases.

                                                                     (Continued)

                                      37
<PAGE>
 
PATAPSCO BANCORP, INC. AND SUBSIDIARY

Notes to Consolidated Financial Statements

--------------------------------------------------------------------------------

   (6)   Deposits

         The aggregate amount of short-term jumbo certificates, each with a
         minimum denomination of $100,000, was approximately $2,367,000 and
         $1,251,000 in 1997 and 1996, respectively.

         At June 30, 1997, the scheduled maturities of certificates are as
         follows:

<TABLE> 
         <S>                                             <C>   
         Under 12 months                                 $     25,568,008
         12 months to 24 months                                 6,800,016
         24 months to 36 months                                 4,274,149
         36 months to 48 months                                   653,235
         48 months to 60 months                                   955,786
         -----------------------------------------------------------------
                                                         $     38,251,194
         =================================================================
</TABLE> 

   (7)   Borrowings

         At June 30, 1997, the Company had a credit agreement with a commercial
         bank, due July 15, 1997. The note bears interest at the LIBOR rate plus
         2% (7.6875% at June 30, 1997). The note was secured by assets of the
         Company and was repaid in July 1997.

         At June 30, 1997 the Company had an agreement under a blanket floating
         lien with the Federal Home Loan Bank of Atlanta providing the Company a
         line of credit of $20 million. There were no advances outstanding
         during 1997.


   (8)   Income Taxes

         The provision (benefit) for income taxes is composed of the following
         for the years ended June 30:

<TABLE> 
<CAPTION> 

                                                                      1997         1996
         -------------------------------------------------------------------------------
         <S>                                                   <C>            <C> 
         Current:                  
            Federal                                            $   347,000      221,000
            State                                                   76,000       44,000
         -------------------------------------------------------------------------------
                                                                   423,000      265,000
         -------------------------------------------------------------------------------
         Deferred:                 
            Federal                                               (726,000)    (160,000)
            State                                                 (160,000)     (38,000)
         -------------------------------------------------------------------------------
                                                                  (886,000)    (198,000)
         -------------------------------------------------------------------------------
                                                               $  (463,000)      67,000
         ===============================================================================
</TABLE> 

                                                                     (Continued)

                                      38
<PAGE>
 
PATAPSCO BANCORP, INC. AND SUBSIDIARY

Notes to Consolidated Financial Statements


--------------------------------------------------------------------------------

   (8)   Continued

         The net deferred tax asset (liability) consists of the following at
June 30:

<TABLE> 
<CAPTION> 

                                                            1997         1996  
         ----------------------------------------------------------------------
         <S>                                           <C>            <C>    
           Total deferred tax liabilities              $ (191,000)    (934,000)
           Total deferred tax assets                      427,000      337,000 
         ----------------------------------------------------------------------
                                                                               
                                                       $  236,000     (597,000)
         ====================================================================== 
</TABLE>
   
         The tax effects of temporary differences between the financial
         reporting and income tax basis of assets and liabilities relate to the
         following at June 30:

<TABLE> 
<CAPTION> 
                                                                      1997        1996
---------------------------------------------------------------------------------------
<S>                                                              <C>          <C>      
Tax bad debt reserves                                            $ (65,000)   (758,000)
Allowance for losses on loans                                      153,000      85,000
Federal Home Loan Bank stock dividends                             (71,000)    (71,000)
Unrealized holding losses                                           15,000      68,000
Accumulated depreciation                                           (25,000)    (69,000)
Deferred compensation                                              206,000     133,000
Deferred loan fees                                                  37,000      37,000
Assets and liabilities recognized on the accrual basis
     for financial statement purposes and on the cash basis
     for tax purposes                                                    -     (36,000)
Other, net                                                         (14,000)     14,000
---------------------------------------------------------------------------------------

                                                                 $ 236,000    (597,000)
=======================================================================================
</TABLE> 

         A reconciliation of the income tax provision (benefit) and the amount
         computed by multiplying income before income taxes by the statutory
         Federal income tax rate of 34% is as follows for the years ended June
         30:

<TABLE> 
<CAPTION> 
                                                                     1997       1996
-------------------------------------------------------------------------------------
<S>                                                             <C>           <C> 
Tax at statutory rate                                           $ 121,000     59,000
State income taxes, net of Federal income tax benefit             (55,000)     4,000
Reinstatements of Federal bad debt deductions                    (548,000)         -
Other                                                              19,000      4,000
-------------------------------------------------------------------------------------

Income tax provision (benefit)                                 $ (463,000)    67,000
=====================================================================================

                                                                          (Continued)
</TABLE> 


                                      39
<PAGE>
 
PATAPSCO BANCORP, INC. AND SUBSIDIARY

Notes to Consolidated Financial Statements

--------------------------------------------------------------------------------

   (8)  Continued

        The Company has qualified under provisions of the Federal Internal
        Revenue Code which permit it to deduct from taxable income a provision
        for bad debts based on either actual bad debt experience or a percentage
        of taxable income before such deduction. The deduction percentage,
        subject to certain minimum tax provisions and other limitations, is 8%.
        The provision for bad debts deducted from taxable income for Federal
        income tax purposes was based on the experience method in 1997 and the
        percentage method in 1996.

        The Company's Federal income tax returns have been audited through 
        June 30, 1995.

        In 1995, the Company recorded a $740,000 charge in connection with the
        decision to convert the Association to a commercial bank. Legislation
        enacted by Congress and signed by the President on August 20, 1996
        allowed for recovery of a portion of this charge and in 1997 the Company
        recorded the recovery totaling $600,000.


   (9)  Regulatory Matters

        The Federal Deposit Insurance Corporation (FDIC), through the Savings
        Association Insurance Fund, insures deposits of accountholders up to
        $100,000. Patapsco pays an annual premium to provide for this insurance.
        Patapsco is also a member of the Federal Home Loan Bank System and is
        required to maintain an investment in the stock of the Federal Home Loan
        Bank of Atlanta equal to at least 1% of the unpaid principal balances of
        its residential mortgage loans, .3% of its total assets or 5% of its
        outstanding advances from Patapsco, whichever is greater. Purchases and
        sales of stock are made directly with Patapsco at par value.

        Pursuant to regulations of the Federal Reserve Board, all FDIC-insured
        depository institutions must maintain average daily reserves against
        their transaction accounts. No reserves are required to be maintained on
        the first $4.3 million of transaction accounts, reserves equal to 3%
        must be maintained on the next $49.3 million of transaction accounts,
        and a reserve of 10% must be maintained against all remaining
        transaction accounts. These reserve requirements are subject to
        adjustments by the Federal Reserve Board. Because required reserves must
        be maintained in the form of vault cash or in a noninterest bearing
        account at a Federal Reserve Bank, the effect of the reserve requirement
        is to reduce the amount of the institution's interest-earning assets. At
        June 30, 1997, the Bank met its reserve requirements.

                                                                     (Continued)

                                      40
<PAGE>
 
PATAPSCO BANCORP, INC. AND SUBSIDIARY

Notes to Consolidated Financial Statements

--------------------------------------------------------------------------------

   (9)  Continued

        Patapsco 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 Patapsco's financial statements.
        Under capital adequacy guidelines and the regulatory framework for
        prompt corrective action, Patapsco must meet specific capital guidelines
        that involve quantitative measures of Patapsco's assets, liabilities,
        and certain off-balance-sheet items as calculated under regulatory
        accounting practices. Patapsco'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 Patapsco to maintain minimum amounts and ratios (as
        defined in the regulations and as set forth in the table below, as
        defined) of total and Tier I capital (as defined) to risk-weighted
        assets (as defined), and of Tier I capital to average assets (as
        defined). Management believes, as of June 30, 1996, that Patapsco meets
        all capital adequacy requirements to which it is subject.

        As of June 30, 1997, the most recent notification from banking
        regulators categorized Patapsco as well capitalized under the regulatory
        framework for prompt corrective action. To be categorized as adequately
        capitalized Patapsco must maintain minimum total risk-based, Tier I 
        risk-based, and Tier I leverage ratios as set forth in table. There are
        no conditions or events since that notification that management believes
        have changed the institution's category.

                                                                     (Continued)

                                      41
<PAGE>
 
PATAPSCO BANCORP, INC. AND SUBSIDIARY

Notes to Consolidated Financial Statements

--------------------------------------------------------------------------------

   (9)  Continued

        Patapsco's actual capital amounts and ratios are also presented in the
        table (in thousands).

<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 June 30, 1997:
           Total Capital (to Risk
             Weighted Assets)             $  10,910        23.68%  $   3,685       8.00%  $   4,607         10.0%     
           Tier 1 Capital (to Risk
             Weighted Assets)                10,513        22.82%      1,843       4.00%      2,764          6.0%
           Tier 1 Capital (to Average
             Assets)                         10,513        12.81%      3,282       4.00%      4,103          5.0%

        As of June 30, 1996:
           Total Capital (to Risk 
             Weighted Assets)                 9,826        28.67%      2,742       8.00%      3,427         10.0%
           Tier 1 Capital (to Risk
             Weighted Assets)                 9,607        28.03%      1,371       4.00%      2,056          6.0%
           Tier 1 Capital (to Average
             Assets                           9,607        12.46%      3,085       4.00%      3,856          5.0%
        ==========================================================================================================
</TABLE> 

  (10)  Stockholders' Equity and Related Matters

        On September 14, 1995, the Board of Directors approved a plan of
        reorganization from a mutual savings association to a capital stock
        savings bank and the concurrent formation of a holding company. The
        conversion was accomplished through amendment of Patapsco's charter and
        the sale of the Company's common stock in an amount equal to the
        consolidated pro forma market value of the Company and Patapsco after
        giving effect to the conversion. A subscription offering of the shares
        of common stock was offered initially to employee benefit plans of the
        Company, depositors, borrowers, directors, officers and employees of the
        Company and to certain other eligible subscribers. In connection with
        the Conversion, the Company publicly issued 362,553 shares of its common
        stock, par value $.01 per share (the "Common Stock"), for gross proceeds
        of $7,251,060 and net proceeds of $6,745,810, of which $3,372,905 was
        contributed to Patapsco in exchange for all of its outstanding common
        stock.

                                                                     (Continued)

                                      42
<PAGE>
 
PATAPSCO BANCORP, INC. AND SUBSIDIARY

Notes to Consolidated Financial Statements


--------------------------------------------------------------------------------


  (10)   Continued

         Federal regulations require that, upon conversion from mutual to stock
         form of ownership, a "liquidation account" be established by
         restricting a portion of net worth for the benefit of eligible savings
         account holders who maintain their savings accounts with Patapsco after
         conversion. In the event of complete liquidation (and only in such
         event), each savings account holder who continues to maintain his
         savings account shall be entitled to receive a distribution from the
         liquidation account after payment to all creditors, but before any
         liquidation distribution with respect to capital stock. This account
         will be proportionately reduced for any subsequent reduction in the
         eligible holders' savings accounts. At conversion the liquidation
         account totaled approximately $6,088,000.

         In addition to the foregoing, certain bad debt reserves deducted from
         income for federal income tax purposes and included in retained income
         of Patapsco, are not available for the payment of cash dividends or
         other distributions to stockholders without payment of taxes at the
         then-current tax rate by Patapsco, on the amount removed from the
         reserves for such distributions.

         During fiscal 1997, the Company declared a special distribution of
         $12.50 per common share from funds retained by the Company in the
         conversion and was deemed by management to constitute a return of
         capital. Accordingly, the Company charged the return of capital
         distribution to additional paid-in-capital. Management has obtained a
         Private Letter Ruling from the Internal Revenue Service which states
         that the Company's dividend payments in excess of accumulated earnings
         and profits are considered a tax-free return of capital for federal
         income tax purposes. As a result, management believes the entire
         distribution constitutes a tax-free return of capital.


  (11)   Benefit Plans

         Employee Stock Ownership Plan

         Patapsco has established an Employee Stock Ownership Plan (ESOP) for
         its employees. On April 1, 1996 the ESOP acquired 29,004 shares of the
         Company's common stock in connection with Patapsco's conversion to a
         capital stock form of organization. The ESOP holds the common stock in
         a trust for allocation among participating employees. in trust or
         allocated to the participants' accounts, and an annual contribution
         from Patapsco to the ESOP and earnings thereon.

         All employees of Patapsco who attain the age of 21 and complete six
         months of service with Patapsco will be eligible to participate in the
         ESOP. Participants will become 100% vested in their accounts after
         three years of service with Patapsco or, if earlier, upon death,
         disability or attainment of normal retirement age. Participants receive
         credit for service with Patapsco prior to the establishment of the
         ESOP.

                                                                     (Continued)

                                      43
<PAGE>
 
PATAPSCO BANCORP, INC. AND SUBSIDIARY

Notes to Consolidated Financial Statements


--------------------------------------------------------------------------------



  (11)   Continued

         Patapsco recognizes the cost of the ESOP in accordance with AICPA
         Statement of Position 93-6 Employers' Accounting for Employee Stock
         Ownership Plans. As shares are released from collateral, Patapsco
         reports compensation expense equal to the current market price of the
         shares and the shares become outstanding for earnings-per-share
         computations. Dividends on allocated shares are recorded as a reduction
         of retained earnings; dividends on unallocated shares are recorded as a
         reduction of debt. For the years ended June 30, 1997 and 1996
         compensation expense recognized related to the ESOP and Patapsco's
         contribution to the ESOP was $85,405 and $70,046, respectively.

         The ESOP shares were as follows as of June 30:

<TABLE> 
<CAPTION> 
                                                          1997         1996
----------------------------------------------------------------------------
<S>                                                  <C>            <C> 
Shares released and allocated                            5,800        2,900
Unearned shares                                         23,204       26,104
----------------------------------------------------------------------------

                                                        29,004       29,004
============================================================================

Fair value of unearned shares                      $   638,110      659,126
============================================================================
</TABLE> 

         Directors Retirement Plan

         Effective September 28, 1995, Patapsco adopted a deferred compensation
         plan covering all non-employee directors. The plan provides benefits
         based upon certain vesting requirements. Compensation expense
         recognized in connection with the Plan during the year ended June 30,
         1997 and 1996 was $75,659 and $131,257, respectively.

         Stock Options

         The Company's 1996 Stock Options and Incentive Plan (Plan) was approved
         by the stockholders at the 1996 annual meeting. The Plan provides for
         the granting of options to acquire common stock to directors and key
         employees. Option prices are equal or greater than the estimated fair
         market value of the common stock at the date of the grant. In October
         1996 the Company granted options to purchase 34,474 shares at $27.50
         per share. Such fair value has been adjusted to $18.91 per share for
         the effect of the return of capital distribution paid by the Company in
         June 1997. The Plan provides for one-fifth of the options granted to be
         exercisable on each of the first five anniversaries of the date of
         grant.

         The weighted average remaining life of options outstanding at June 30,
         1997 was 9.25 years.

                                                                     (Continued)

                                      44
<PAGE>
 
PATAPSCO BANCORP, INC. AND SUBSIDIARY

Notes to Consolidated Financial Statements


--------------------------------------------------------------------------------

  (11)   Continued

         The Company applies the intrinsic value method in accounting for its
         stock options and, accordingly, no compensation cost has been
         recognized for its options in the financial statements. Had the Company
         determined compensation cost based on the fair value at the grant date
         for its stock options under Statement No. 123, the Company's net income
         for 1997 would have been decreased to the pro forma amounts indicated
         below:

         Net loss:
              As reported                               $    820,311
              Pro forma                                      774,311
         Primary loss per share:
              As reported                                       2.44
              Pro forma                                         2.30
================================================================================

         The weighted average fair values of options granted during 1997 were
         $27.50 on the dates of grant. The fair value of option grant was
         calculated using the Black-Scholes option-pricing model with the
         following assumptions: risk-free interest rate of 6%; expected
         volatility of 30%; and expected lives of 9.25 years.

         Management Recognition Plan

         Effective October 11, 1996, the Company established a Management
         Recognition Plan (MRP) to retain personnel of experience and ability in
         key positions of responsibility. Members of the Board of Directors and
         certain executive officers were awarded a total of 14,502 shares of
         stock which are held in a separate trust that manages the MRP. The
         Company funded the MRP in 1997 by purchasing 14,502 shares of common
         stock in the open market. Shares awarded to participants in the MRP
         vest at a rate of 20% per year on each anniversary of the effective
         date of the MRP. If a participant terminates employment for reasons
         other than death or disability, he or she forfeits all rights to
         unvested shares. For the years ended June 30, 1997, compensation
         expense related to the MRP was $145,136.
                                                                     (Continued)

                                      45
<PAGE>
 
PATAPSCO BANCORP, INC. AND SUBSIDIARY

Notes to Consolidated Financial Statements


--------------------------------------------------------------------------------

 (12)    Fair Value of Financial Instruments

         Statement of Financial Accounting Standards No. 107, Disclosures about
         Fair Value of Financial Instruments (SFAS 107) requires the Company to
         disclose estimated fair values for certain on- and off-balance sheet
         financial instruments. Fair value estimates, methods, and assumptions
         are set forth below for the Company's financial instruments as of June
         30, 1997 and 1996.

         The carrying value and estimated fair value of financial instruments is
         summarized as follows at June 30:
<TABLE> 
<CAPTION> 
                                                1997                        1996
                                   ---------------------------  ---------------------------
                                      Carrying           Fair      Carrying           Fair
                                         value          value         value          value
-------------------------------------------------------------------------------------------
<S>                              <C>               <C>           <C>            <C>     
Assets:
     Cash and interest-bearing   
       deposits                    $   165,593        164,000       629,576        630,000 
     Federal funds sold              4,947,594      4,948,000     6,794,889      6,794,000
     Investment securities           1,989,380      1,989,000     4,423,767      4,424,000
     Mortgage-backed securities      7,678,517      7,679,000    12,777,828     12,778,000
     Loans receivable, net          66,236,126     65,294,000    52,031,297     52,047,000

Liabilities:
     Deposits                       70,152,293     70,495,000    64,156,888     64,457,000
     Advance payments by
        borrowers for taxes,
        insurance and ground rents   1,323,193      1,323,000     1,189,735      1,190,000
     Borrowings                      2,700,000      2,700,000             -              -

Off balance sheet instruments:
     Commitments to extend credit            -              -             -              -
-------------------------------------------------------------------------------------------
</TABLE> 

         Cash on Hand and in Banks

         The carrying amount for cash on hand and in banks approximates fair
         value due to the short maturity of these instruments.
                                                                     (Continued)

                                      46
<PAGE>
 
PATAPSCO BANCORP, INC. AND SUBSIDIARY

Notes to Consolidated Financial Statements


--------------------------------------------------------------------------------



 (12)    Continued

         Short-Term Investments

         The carrying amount for short-term investments which consists of
         Federal funds sold, approximates fair value due to the overnight
         maturity of these instruments.

         Investment Securities and Mortgage-Backed Securities

         The fair value of investment securities and mortgage-backed securities
         is based on bid prices received from an external pricing service or bid
         quotations received from securities dealers.

         Loans

         Loans were segmented into portfolios with similar financial
         characteristics. Loans were also segmented by type such as residential,
         multifamily and nonresidential, construction and land, second mortgage
         loans, commercial, and consumer. Each loan category was further
         segmented by fixed and adjustable rate interest terms and performing
         and nonperforming categories.

         The fair value of residential loans was calculated by discounting
         anticipated cash flows based on weighted-average contractual maturity,
         weighted-average coupon, prepayment assumptions and discount rate.
         Prepayment speed estimates were derived from published historical
         prepayment experience in the mortgage pass-through market and recent
         issuance activity in the primary and secondary mortgage markets. The
         discount rate for residential loans was calculated by adding to the
         Treasury yield for the corresponding weighted average maturity
         associated with each prepayment assumption a market spread as observed
         for mortgage-backed securities with similar characteristics. The fair
         values of multifamily and nonresidential loans were calculated by
         discounting the contractual cash flows at Patapsco's current
         nonresidential loan origination rate. Construction, land and commercial
         loans, loans secured by savings accounts and mortgage lines of credit
         were determined to be at fair value due to their adjustable rate
         nature. The fair value of second mortgage loans was calculated by
         discounting scheduled cash flows through the estimated maturity using
         estimated market discount rates that reflected the credit and interest
         rate risk inherent in the portfolio. The fair value of consumer loans
         was calculated by discounting the contractual cash flows at the
         Company's current consumer loan origination rate.

         The fair value for nonperforming loans was determined by reducing the
         carrying value of nonperforming loans by the Company's historical loss
         percentage for each specific loan category.

                                                                     (Continued)

                                      47
<PAGE>
 
PATAPSCO BANCORP, INC. AND SUBSIDIARY

Notes to Consolidated Financial Statements


--------------------------------------------------------------------------------



 (12)    Continued

         Accrued Interest Receivable

         The carrying amount of accrued interest receivable approximates its
         fair value.

         Savings Accounts

         Under SFAS 107, the fair value of deposits with no stated maturity,
         such as noninterest bearing deposits, interest bearing NOW accounts,
         money market and statement savings accounts, is equal to the carrying
         amounts. The fair value of certificates of deposit was based on the
         discounted value of contractual cash flows. The discount rate for
         certificates of deposit was estimated using the rate currently offered
         for deposits of similar remaining maturities.

         Borrowed Funds

         Securities sold under agreements to repurchase are considered to be at
         fair value.

         Accrued Interest Payable

         The carrying amount of accrued interest payable approximates its fair
         value.

         Advance Payments by Borrowers for Taxes, Insurance and Ground Rents

         The carrying amount of advance payments by borrowers for taxes,
         insurance and ground rents approximates its fair value.

         Off-Balance Sheet Financial Instruments

         The Company is a party to financial instruments with off-balance sheet
         risk in the normal course of business, including mortgage loan
         commitments and undisbursed lines of credit on commercial business
         loans. These instruments involve, to various degrees, elements of
         credit and interest rate risk in excess of the amount recognized in the
         consolidated statements of financial condition.

         The Company's exposure to credit loss in the event of nonperformance by
         the other party to the financial instrument is represented by the
         contract amount of the financial instrument.

         The company uses the same credit policies in making commitments for
         off-balance-sheet financial instruments as it does for on-balance-sheet
         financial instruments. The fair values of such commitments are
         immaterial.


                                                                     (Continued)

                                      48
<PAGE>
 
PATAPSCO BANCORP, INC. AND SUBSIDIARY

Notes to Consolidated Financial Statements


--------------------------------------------------------------------------------



 (12)    Continued

         The disclosure of fair value amounts does not include the fair values
         of any intangibles, including core deposit intangibles. Core deposit
         intangibles represent the value attributable to total deposits based on
         an expected duration of customer relationships.

         Limitations

         Fair value estimates are made at a specific point in time, based on
         relevant market information and information about financial
         instruments. These estimates do not reflect any premium or discount
         that could result from offering for sale at one time the Company's
         entire holdings of a particular financial instrument. Because no market
         exists for a significant portion of the Company's financial
         instruments, fair value estimates are based on judgments regarding
         future expected loss experience, current economic conditions, risk
         characteristics of various financial instruments and other factors.
         These estimates are subjective in nature and involve uncertainties and
         matters of significant judgment and therefore cannot be determined with
         precision. Changes in assumptions could significantly affect estimates.


  (13)   Condensed Financial Information (Parent Company Only)

         Summarized financial information for the Company are as follows as of
         and for the years ended June 30:

<TABLE> 
<CAPTION> 
Statements of Financial Condition                          1997           1996
-------------------------------------------------------------------------------
<S>                                               <C>               <C> 
Cash                                              $      80,659          8,196
Federal funds sold                                            -      2,299,859
Equity in net assets of the bank                     10,497,661      9,499,999
Note receivable - bank                                  464,064        522,072
Other assets                                              8,400         26,993
-------------------------------------------------------------------------------

                                                  $  11,050,784     12,357,119
===============================================================================

Accrued expenses and other liabilities            $      16,781         55,976
Note payable                                          2,700,000              -
Stockholders' equity                                  8,334,003     12,301,143
-------------------------------------------------------------------------------

                                                  $  11,050,784     12,357,119
===============================================================================
</TABLE> 
The note payable was repaid in July 1997.

                                                                     (Continued)

                                      49
<PAGE>
 
PATAPSCO BANCORP, INC. AND SUBSIDIARY

Notes to Consolidated Financial Statements


--------------------------------------------------------------------------------

(13)   Continued
<TABLE> 
<CAPTION> 

     Statements of Income                                                     1997         1996
     -------------------------------------------------------------------------------------------
     <S>                                                               <C>           <C>     
     Income:                                               
          Loans receivable                                             $    43,071       11,931
          Federal funds sold                                                 6,701        1,621
          Expenses                                                         (64,694)          --
     -------------------------------------------------------------------------------------------
                                                           
     Net income (loss) before equity in net income of      
          subsidiary and income taxes                                      (14,922)      13,552
                                                           
     Equity in net income of subsidiary                                    829,477       92,766
     -------------------------------------------------------------------------------------------
                                                           
     Income before income tax provision (benefit)                          814,555      106,318
                                                           
     Income tax provision (benefit)                                         (5,756)       5,234
     -------------------------------------------------------------------------------------------
                                                           
     Net income                                                        $   820,311      101,084
     ===========================================================================================

<CAPTION>                                                            
     Statements of Cash Flows                                                 1997         1996
     -------------------------------------------------------------------------------------------
     <S>                                                               <C>           <C>     
     Operating activities:                                 
          Net income                                                   $   820,311      101,084
          Adjustments to reconcile net income to net cash provided 
             by operating activities:                       
                 Equity in net income of subsidiary                       (829,477)     (92,766)
                 Other, net                                                (20,601)      28,983
     -------------------------------------------------------------------------------------------
                                                           
     Net cash provided by (used in) operating activities                   (29,767)      37,301
     -------------------------------------------------------------------------------------------
                                                           
     Investing activities:                                 
          Purchase of stock of subsidiary                                       --   (3,372,904)
          Loan to fund ESOP                                                     --     (580,080)
          Loan repayment                                                    58,008       58,008
     -------------------------------------------------------------------------------------------
                                                           
     Net cash provided by (used in) investing activities                    58,008   (3,894,976)
     -------------------------------------------------------------------------------------------
                                                           
     Financing activities:                                 
          Increase in note payable                                       2,700,000           --
          Purchase of common stock for stock-based              
             benefits plan                                                (423,724)          --
          Return of capital distribution                                (4,531,913)          --
          Net proceeds of stock conversion                                      --    6,165,730
     -------------------------------------------------------------------------------------------
                                                           
     Net cash provided by (used in) financing activities                (2,255,637)   6,165,730
     -------------------------------------------------------------------------------------------
                                                           
     Increase (decrease) in cash and equivalents                        (2,227,396)   2,308,055
                                                           
     Cash and equivalents, beginning of year                             2,308,055           --
     -------------------------------------------------------------------------------------------
                                                           
     Cash and equivalents, end of year                                 $    80,659    2,308,055
     ===========================================================================================
</TABLE> 
--------------------------------------------------------------------------------

                                      50
<PAGE>
 
                              BOARD OF DIRECTORS

S. Robert Kinghorn
Chairman of the Board
Retired Controller of Bethlehem Steel Corporation, Sparrows Point Plant

Joseph N. McGowan
Vice Chairman of the Board
Director, Training Division, Baltimore County 
Police Department

Thomas P. O'Neill
Managing Partner of Wolpoff & Company, LLP

Joseph J. Bouffard
President and Chief Executive Officer of the Company and the Bank

Nicole N. Kantorski
Budget Director for Baltimore County Police Department

Robert M. Lating
President and Manager of Model Realty; Partner in C&L Associates

Douglas H. Ludwig
Retired Principal of the Baltimore County Public School System

Dr. Theodore C. Patterson
Retired Physician
Secretary of the Company


EXECUTIVE OFFICERS

Joseph J. Bouffard
President and Chief Executive Officer

Timothy C. King
Vice President, Controller and Treasurer

Debra L. Brockschmidt
Vice President - Operations; Assistant Secretary

John W. McClean
Vice President - Real Estate Lending

Frank J. Duchacek, Jr.
Vice President - Commercial Lending

Joseph R. Sallese
Vice President - Consumer Lending


OFFICE LOCATION

1301 Merritt Boulevard
Dundalk, Maryland 21222-2194
Website: \www.patapscobank.com
Telephone: (410) 285-1010


CORPORATE INFORMATION

Independent Certified Accountants
KPMG Peat Marwick LLP
111 South Calvert Street
Baltimore, Maryland 21202

General Counsel
Nolan Plumhoff & Williams
Suite 700, Nottingham Centre
502 Washington Avenue
Towson, MD  21204-4528

Transfer Agent and Registrar
Registrar and Transfer Co.
10 Commerce Drive
Cranford, New Jersey 07016-3572
1 (800) 368-5948

Special Counsel
Housley Kantarian & Bronstein, P.C.
1220 19th Street, N.W., Suite 700
Washington, D.C.  20036

Annual Meeting
The 1997 Annual Meeting of Stockholders
will be held on October 23, 1997 at 10:00 a.m. at 1301 Merritt Boulevard, 
Dundalk, Maryland 21222-2194


Annual Report on Form 10-KSB

A copy of the Company's Annual Report on Form 10-KSB for the fiscal year ended
June 30, 1997 as filed with the Securities and Exchange Commission, will be
furnished without charge to stockholders as of the record date for the 1997
Annual Meeting upon written request to: Corporate Secretary, Patapsco Bancorp,
Inc., 1301 Merritt Boulevard, Dundalk, Maryland 21222-2194