<PAGE>
 
                               Table of Contents
<TABLE>
<CAPTION>
                                                                                                Page
------------------------------------------------------------------------------------------------------
<S>                                                                                             <C>
Selected Consolidated Financial Data                                                             1 - 2
Management's Discussion and Analysis                                                            4 - 14
Independent Auditor's Report                                                                        15
Consolidated Financial Statements:
 Statements of financial condition at September 30, 1998 and 1997                                   16
 Statements of income for the years ended September 30, 1998 and 1997                               17
 Statements of stockholders' equity for the years ended September 30, 1998 and 1997            18 - 19
 Statements of cash flows for the years ended September 30, 1998 and 1997                      20 - 21
Notes to Consolidated Financial Statements                                                     22 - 45
Corporate Information                                                                          46 - 47
</TABLE> 
 
 
 
 
 
 
 
 
 


This annual report to stockholders contains certain forward-looking statements
consisting of estimates with respect to the financial condition, results of
operations and other business of the Company that are subject to various factors
which could cause actual results to differ materially from those estimates.
Factors which could influence the estimates include changes in the national,
regional and local market conditions, legislative and regulatory conditions, and
an adverse interest rate environment.
<PAGE>
 
                     SCOTLAND BANCORP, INC. AND SUBSIDIARY
                     SELECTED CONSOLIDATED FINANCIAL DATA

<TABLE>
<CAPTION>
                                                                              September 30,
                                     -------------------------------------------------------------------------------------
                                                1998             1997             1996             1995             1994
                                     -------------------------------------------------------------------------------------
                                                          (Dollars In Thousands, Except Per Share Data)
<S>                                    <C>              <C>              <C>              <C>                <C>     
Financial Condition Data:
 Total assets                          $       60,730   $       64,399   $       68,622   $       57,718     $      57,715
 Investments securities (1)                    16,137           16,110           21,464           14,525            19,273
 Loans receivable, net                         42,485           46,463           45,079           41,204            36,661
 Deposits                                      44,271           43,140           42,410           48,203            48,995
 Stockholders' equity (2)                      15,337           14,561           24,791            8,580             7,761
 Book value per share                            8.01             7.61            13.47             -                 -

                                                                    Years Ended September 30,
                                     -------------------------------------------------------------------------------------
                                                 1998             1997             1996             1995              1994
                                     -------------------------------------------------------------------------------------
                                                          (Dollars in Thousands, Except Per Share Data)
Operating Data:
 Interest and dividend income          $        4,564   $        5,171   $        4,870   $        4,313   $         3,889
 Interest expense                               2,122            1,983            2,209            2,144             1,753
                                     -------------------------------------------------------------------------------------
 Net interest income                            2,442            3,188            2,661            2,169             2,136
 Provision for loan losses                          6               24               25               11                20
 Noninterest income                                74              306               80               73                71
 Noninterest expense                            1,676            1,680            1,549            1,158             1,263
                                     -------------------------------------------------------------------------------------
 Income before income taxes                       834            1,790            1,167            1,073               924
 Income tax expense                               305              532              409              352               292
                                     -------------------------------------------------------------------------------------
 Net income                            $          529   $        1,258   $          758   $          721   $           632
                                     =====================================================================================
 Basic earnings per share (2)(3)       $         0.32   $         0.74   $         0.25   $            -    $          - 
 Diluted earnings per share (2)(3)               0.32             0.73             0.25                -               -
 Dividends per share (2)                         0.20             6.30             0.15                -               -   
 Dividend payment ratio (2)(6)                  62.50%          851.35%           60.00%               -               -
</TABLE> 
 
                                  (Continued)

                                       1
<PAGE>
 
<TABLE> 
<CAPTION> 
                                                                        Years Ended September 30,
                                        -----------------------------------------------------------------------------------------  
                                                 1998             1997             1996             1995              1994
                                        -----------------------------------------------------------------------------------------
                                                          (Dollars in Thousands, Except Per Share Data)
<S>                                            <C>              <C>              <C>               <C>               <C> 
Selected Other Data:
 Return on average assets                        0.86%            1.84%            1.18%            1.25%             1.13%
 Return on average equity                        3.52%            5.14%            4.31%            8.52%             8.49%
 Average equity to average assets               24.41%           35.80%           27.38%           14.67%            13.31%
 Interest rate spread                            2.89%            3.05%            2.84%            3.27%             3.50%
 Net interest margin                             4.07%            4.75%            4.15%            3.87%             3.94%
 Efficiency ratio (5)                           66.62%           48.08%           56.51%           51.65%            57.23%
 Allowance for loan losses to
   nonperforming loans (4)                     910.71%          830.00%          714.97%            0.00%             0.00%
 Nonperforming loans to total loans              0.06%            0.06%            0.07%            0.00%             0.00%
</TABLE>

(1)  Includes interest-earning deposits, federal funds sold, investment
     securities and mortgage-backed securities.

(2)  On March 29, 1996, Scotland Savings converted from a state chartered mutual
     savings bank to a state chartered stock savings bank and became a wholly
     owned subsidiary of Scotland Bancorp, Inc. The Bank issued regular cash
     dividends per share totaling $0.20, $0.30, and $0.15 for the years ended
     September 30, 1998, 1997, and 1996, respectively. The Bank also issued a
     return of capital dividend of $6.00 per share during the year ended
     September 30, 1997.

(3)  Earnings per share has been calculated in accordance with the Statement of
     Financial Accounting Standards No. 128, "Earnings Per Share", and is based
     on net income for the year, divided by the weighted average number of
     shares outstanding for the year. In accordance with the AICPA's SOP 93-6,
     unallocated ESOP shares were deducted from outstanding shares used in the
     computation of earnings per share. Diluted earnings per share includes the
     effect of dilutive common stock equivalents in the weighted average number
     of shares outstanding.

(4)  Nonperforming loans include mortgage loans and consumer/commercial loans 90
     days or more delinquent.

(5)  The efficiency ratio represents noninterest expense as a percentage of the
     sum of net interest income and noninterest income.

(6)  The dividend payment ratio represents dividends per share as a percent of
     earnings per share. Dividends per share include a $6.00 per share return of
     capital dividend during the year ended September 30, 1997. 

                                       2
<PAGE>
 
                     SCOTLAND BANCORP, INC. AND SUBSIDIARY

                     MANAGEMENT'S DISCUSSION AND ANALYSIS

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

The following discussion and analysis is intended to assist readers in
understanding the results of operations in 1998 and 1997, and changes in
financial position for the years ended September 30, 1998 and 1997,
respectively. This discussion and analysis is intended to compliment, and should
be read in conjunction with the audited consolidated financial statements and
related notes appearing elsewhere in this annual report to stockholders.

                            DESCRIPTION OF BUSINESS

Scotland Bancorp, Inc. (the "Company") was incorporated under the laws of the
State of North Carolina for the purpose of becoming the bank holding company of
Scotland Savings Bank, Inc., SSB (the "Bank" or "Scotland Savings") in
connection with the Bank's conversion from a state chartered mutual savings bank
to a state chartered stock savings bank (the "Conversion"), pursuant to its Plan
of Conversion.  A subscription and community offering of the Company's shares
closed on March 29, 1996, at which time the Company acquired all of the shares
of the Bank and commenced operations.

In accordance with the Plan of Conversion, the Company issued common stock of
$18,400,000 and received proceeds of $17,419,336, net of conversion costs.  The
Company transferred $7,752,868 of the net proceeds to Scotland Savings for the
purchase of all of the capital stock of the Bank.

The Company has no operations and conducts no business of its own other than
owning Scotland Savings, investing its portion of the net proceeds received in
the Conversion, and lending funds to the Employee Stock Ownership Plan (the
"ESOP") which was formed in connection with the Conversion.  The principal
business of the Bank is accepting deposits from the general public and using
those deposits and other sources of funds to make loans secured by real estate
and other forms of collateral located in the Bank's primary market area of
Scotland and Moore counties in North Carolina.  On September 30, 1998
approximately 99% of the Bank's net loan portfolio was composed of real estate
loans.

Scotland Savings' results of operations depend primarily on its net interest
income, which is the difference between interest income from interest-earning
assets and interest expense on interest-bearing liabilities.  The Bank's
operations are also affected by noninterest income, such as miscellaneous income
from loans, customer deposit account service charges, and other sources of
revenue.  The Bank's principal operating expenses, aside from interest expense,
consist of compensation and associated benefits, federal deposit insurance
premiums, occupancy costs, and other general and administrative expenses.

Because the Company has no operations and conducts no business other than as
described above, the discussion contained in this "Management's Discussion and
Analysis" concerns primarily the business of the Bank.  However, for ease of
reading, and because the financial statements are presented on a consolidated
basis, the Company and the Bank are collectively referred to herein as the
"Company", unless otherwise noted.

                                       4
<PAGE>
 
                     SCOTLAND BANCORP, INC. AND SUBSIDIARY

                     MANAGEMENT'S DISCUSSION AND ANALYSIS

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

       COMPARISON OF FINANCIAL CONDITION AT SEPTEMBER 30, 1998 AND 1997

Total consolidated assets decreased by $3.7 million during 1998, from $64.4
million at September 30, 1997 to $60.7 million at September 30, 1998.  The
decrease resulted primarily due to the drop in fixed long term interest rates,
which caused the loan portfolio to decrease.

Investments, including short term interest-earning deposits, federal funds sold,
U.S. Treasury and agency obligations, municipal obligations, and mortgage-backed
securities increased by $26,000 during 1998 and totaled $16.1 million at
September 30, 1998. During the year ended September 30, 1998, investment
securities totaling $5.6 million were sold in order to pay off the note payable
described below, $1.5 million of securities were called, $5.8 million of
securities were purchased, and the unrealized gain on the securities available
for sale portfolio increased by $385,000.

Loans receivable decreased by approximately $4.0 million during 1998 to $42.5
million at September 30, 1998, primarily as a result of the drop in fixed, long-
term interest rates.  Also, many balloon mortgages were paid off during the year
while few balloons were originated.  The area of Scotland County, where the
majority of the Bank's customers reside, is largely rural though the economy is
diversified and generally stable.

Savings deposits increased by approximately $1.1 million during 1998, equating
to 2.62% growth, and totaled $44.3 million at September 30, 1998.  This increase
is comparable to the increase in 1997 of 1.72%.  The increase is attributed to
our concentration on steady and controlled growth in our deposit base.

The Company repaid the $5.5 million note payable during 1998 which was incurred
in September of 1997, thus eliminating the Company's external debt.  The $5.5
million in borrowings was incurred to facilitate disbursement of the return of
capital dividend (See Note 7 to the consolidated financial statements).  During
1998, the Bank obtained no advances from the Federal Home Loan Bank, however,
the Bank retains borrowing capacity through the Federal Home Loan Bank of
Atlanta.

The Company's return on average assets was 0.86% and 1.84%, and its return on
average equity was 3.52% and 5.14%, for 1998 and 1997, respectively.

The Bank is required to meet certain capital requirements as established by the
FDIC and the North Carolina Savings Institutions Division.  At September 30,
1998 and 1997, the Bank's capital was significantly in excess of regulatory
capital requirements (See Note 10 to the consolidated financial statements).

                                       5
<PAGE>
 
                     SCOTLAND BANCORP, INC AND SUBSIDIARY 

                      MANAGMENT'S DISCUSSION AND ANALYSIS

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

               COMPARISON OF OPERATING RESULTS FOR 1998 AND 1997

NET INCOME

Net income for the years ended September 30, 1998 and 1997 was $528,749 and
$1,258,260, respectively.  As discussed below, the decrease in net income was
primarily attributable to a decrease in net interest income due to a lower level
of loans receivable and moderate deposit growth.

NET INTEREST INCOME

Net interest income represents the difference between income derived from
interest-earning assets and interest expense incurred on interest-bearing
liabilities.  Net interest income is affected by both (i) the difference between
the rates of interest earned on interest-earning assets and the rates paid on
interest-bearing liabilities ("interest rate spread") and (ii) the relative
amounts of interest-earning assets and interest-bearing liabilities ("net
earning balance").  The following table on page 7 sets forth information
relating to average balances of the Company's assets and liabilities for the
years ended September 30, 1998 and 1997.  For the periods indicated, the table
reflects the average yield on interest-earning assets and the average cost of
interest-bearing liabilities (derived by dividing income or expense by the
monthly average balance of interest-earning assets or interest-bearing
liabilities, respectively) as well as the net yield on interest-earning assets
(which reflects the impact of the net earning balance).  Nonaccruing loans were
included in the computation of average balances.

INTEREST INCOME

Total interest income decreased by $607,266 during 1998, from $5,171,418 in
1997 to $4,564,152 in 1998.  The decrease in  interest income during 1998 was
attributable to a lower level of interest-earning assets, primarily loans
receivable as previously discussed.  The Bank's overall yield on interest-
earning assets decreased slightly during 1998, from 7.70% in 1997 to 7.60% in
1998.  Interest-earning assets amounted to $58.6 million at September 30, 1998
as compared to $62.6 million at September 30, 1997.  Approximately 97% of the
Company's assets were interest-earning at September 30, 1998, and approximately
73% of such interest-earning assets were held in the form of loans receivable.

INTEREST EXPENSE

Total interest expense increased to $2,122,320 in 1998 from $1,982,955 in 1997,
an increase of $139,365 or 7.03%.  Scotland Saving's cost of funds was 4.71% in
1998 and 4.65% in 1997.  Stability in the Bank's cost of funds during 1998 was
similar to stability in overall market rates.  The Bank's average balance of
outstanding deposits increased by approximately $2.4 million during 1998
resulting in an increase in interest expense for the period.  Additionally,
interest on borrowed funds had an immaterial impact on the increase in interest
expense in 1998.

                                       6
<PAGE>

<TABLE> 
<CAPTION> 
                                                                                        Year Ended September 30,
                                                                  ------------------------------------------------------------
                                                                                                                              
                                                     At                                      1998                            
                                                                  ------------------------------------------------------------
                                                  September                                                                    
                                                  30, 1998                                       (Dollars in Thousands)        
                                                  Average                                                                     
                                                   Yield/               Average                                   Average      
                                                  Rate (4)              Balance              Interest            Yield/Rate    
                                             ------------------   ------------------    -----------------    -----------------
<S>                                          <C>                <C>                   <C>                    <C>  
Assets:                                                                                                                       
Interest-earning assets:                                                                                                      
    Interest-bearing deposits                            5.50%  $             7,457   $              412                5.53% 
    Investments, at cost (1)                             5.45%                7,232                  399                5.52% 
    Mortgage-backed securities                          11.53%                  361                   41               11.36% 
    Loans receivable                                     7.93%               44,986                3,712                8.25% 
                                                                  ------------------    -----------------    -----------------
Total interest-earning assets                            7.52%               60,036   $            4,564                7.60% 
                                                                                        -----------------                     
Non interest-earning assets                                                   1,514                                           
                                                                  ------------------                                          
            Total                                               $            61,550                                           
                                                                  ==================                                          
                                                                                                                              
Liabilities and retained earnings:                                                                                            
Interest-bearing liabilities:                                                                                                 
    Passbook accounts                                    2.93%  $             4,017   $              118                2.94% 
    Transaction accounts                                 3.65%               10,106                  327                3.24% 
    Certificates of deposit                              5.36%               30,905                1,675                5.42% 
    Other                                                   -                    30                    2                6.67% 
                                                                  ------------------    -----------------    -----------------
Total interest-bearing liabilities                       4.81%               45,058   $            2,122                4.71% 
                                                                                        -----------------                     
Non interest-bearing liabilities                                              1,467                                           
Equity                                                                       15,025                                           
                                                                  ------------------                                          
            Total                                               $            61,550                                           
                                                                  ==================                                          
                                                                                                                              
Net interest income and interest                                                                                              
    rate spread (2)                                      2.71%                                     2,442                2.89% 
                                                                                        =================                     
Net yield on interest-earning                                                                                                 
    assets (3)                                                                                                          4.07% 
Ratio of interest-earning assets to                                                                                           
    interest-bearing liabilities                                                                                      133.24% 


<CAPTION> 
                                                              Year Ended September 30,
                                            --------------------------------------------------------------
                                            
                                                                          1997
                                            --------------------------------------------------------------
                                            
                                                              (Dollars in Thousands)
                                            
                                                   Average                                   Average
                                                   Balance              Interest            Yield/Rate
                                               -----------------    -----------------    -----------------
<S>                                          <C>                  <C>                    <C>       
Assets:                                     
Interest-earning assets:                    
    Interest-bearing deposits                $            4,194   $              237                5.65%
    Investments, at cost (1)                             14,587                  934                6.40%
    Mortgage-backed securities                              466                   52               11.16%
    Loans receivable                                     47,890                3,948                8.24%
                                               -----------------    -----------------    -----------------
Total interest-earning assets                            67,137   $            5,171                7.70%
                                                                    -----------------
Non interest-earning assets                               1,415
                                               -----------------
            Total                            $           68,552
                                               =================
                                            
Liabilities and retained earnings:          
Interest-bearing liabilities:               
    Passbook accounts                        $            4,094   $              119                2.91%
    Transaction accounts                                  8,562                  249                2.91%
    Certificates of deposit                              29,952                1,614                5.39%
    Other                                                    15                    1                6.67%
                                               -----------------    -----------------    -----------------
Total interest-bearing liabilities                       42,623   $            1,983                4.65%
                                                                    -----------------
Non interest-bearing liabilities                          1,448
Equity                                                   24,481
                                               -----------------
            Total                            $           68,552
                                               =================
                                            
Net interest income and interest            
    rate spread (2)                                                            3,188                3.05%
                                                                    =================
Net yield on interest-earning               
    assets (3)                                                                                      4.75%
Ratio of interest-earning assets to         
    interest-bearing liabilities                                                                  157.51%
</TABLE> 

(1) Includes investment securities and FHLB of Atlanta stock.

(2) Interest rate spread represents the difference between the average yield on
interest-earning assets and the average cost of interest-bearing liabilities.

(3) Net yield on interest-earning assets represents net interest income divided
by average interest-earning assets. 

(4) The weighted average rate represents the
coupon associated with each asset and liability, weighted by the principle
balance associated with each asset and liability.

                                       7

<PAGE>
 
                     SCOTLAND BANCORP, INC. AND SUBSIDIARY

                     MANAGEMENT'S DISCUSSION AND ANALYSIS
--------------------------------------------------------------------------------

RATE/VOLUME ANALYSIS

The table on page 9 analyzes the dollar amount of changes in interest income and
interest expense for major components of interest-earning assets and interest-
bearing liabilities. This table distinguishes between (i) changes attributable
to volume (changes in volume multiplied by the prior period's rate), (ii)
changes attributable to rate (changes in rate multiplied by the prior period's
volume), and (iii) net change (the sum of the previous columns). The change
attributable to both rate and volume (changes in rate multiplied by changes in
volume) has been allocated equally to both the changes attributable to volume
and the changes attributable to rate.

PROVISION FOR LOAN LOSSES AND ASSET QUALITY

The Bank's provision for loan losses amounted to $6,000 and $24,000 for the
years ended September 30, 1998 and 1997, respectively. The provision, which is
charged to operations, and the resulting loan loss allowances are amounts
Scotland Savings' management believes will be adequate to absorb losses on
existing loans that may become uncollectible. Loans are charged-off against the
allowance when management believes that collectibility is unlikely. An
evaluation to increase the provision and the resulting allowances is based on
factors, such as changes in the nature and volume of the loan portfolio, overall
portfolio quality, and current economic conditions. Scotland Savings has adopted
policies which it believes provides for prudent and adequate levels of loan loss
allowances.

The Bank's level of nonperforming loans, defined as loans past due 90 days or
more, are relatively insignificant as percentage of total loans outstanding,
both historically and at September 30, 1998 and1997. Scotland Savings' charged-
off loans amounted to $50 and $492 for the years ended September30,1998 and
1997, respectively.

NONINTEREST INCOME

Noninterest income amounted to $74,569 and $306,272 in 1998 and 1997,
respectively. Noninterest income consists primarily of service charges and fees
associated with the Bank's loan and savings accounts. The decrease in Scotland
Savings' level of noninterest income during 1998 relates mainly to the gain on
sale of investments of $240,726 which occurred in 1997 (See Note 2 to the
consolidated financial statements).

NONINTEREST EXPENSE

Noninterest expense consists primarily of operating expenses for compensation
and associated benefits, occupancy, federal insurance premiums and operating
assessments, and data processing charges as well as various administrative
expenses. Noninterest expense amounted to $1,676,409 and $1,680,265 in 1998 and
1997, respectively. None of the noninterest expense categories changed
significantly during 1998 and 1997.

INCOME TAXES

The Company's effective income tax rate was 36.60% and 29.72% in 1998 and 1997,
respectively. The differences in rates were due to changes in the components of
permanent tax differences (See Note 8 to the consolidated financial statements).


                                        

                                       8
<PAGE>

<TABLE> 
<CAPTION> 

                                                                                                           Year Ended September 30,
                                                                              1998 vs. 1997                                     
                                             ---------------------------------------------------------------------------------  
                                                                                                                                
                                                                   Increase (Decrease) Attributable to                          
                                                                                                                                
                                             ---------------------------------------------------------------------------------  
                                                                                                                                
                                                  Volume                Rate              Rate/Volume              Net          
                                             ------------------   ------------------    -----------------    -----------------  
<S>                                          <C>                 <C>                   <C>                  <C>                  
Interest income on:                                                                                                             
    Interest-bearing deposits                $             184   $               (5)   $             (4)    $            175    
    Investments, at cost                                  (471)                (129)                 65                 (535)  
    Mortgage-backed securities                             (12)                   1                   -                  (11)   
    Loans receivable                                      (239)                   4                  (1)                (236)  
                                             -----------------    ------------------    -----------------    -----------------  
     Total interest income on                                                                                                   
      interest-earning assets                             (538)                (129)                 60                 (607)   
                                             -----------------    ------------------    -----------------    -----------------  
                                                                                                                                
                                                                                                                                
                                                                                                                                
Interest expense on:                                                                                                            
    Passbook accounts                                       (2)                   1                    -                  (1)   
    Transaction accounts                                    45                   28                    5                  78   
    Certificates of deposit                                 52                    9                    -                  61   
    FHLB advances and other                                  1                    -                    -                   1   
                                             -----------------    ------------------    -----------------    -----------------  
     Total interest expense                                                                                                     
     on interest-bearing liabilities                        96                   38                    5                 139   
                                             -----------------    ------------------    -----------------    -----------------  
                                                                                                                                
Increase (decrease) in net                                                                                                      
interest income                              $            (634)   $            (167)    $             55     $          (746)   
                                             =================   ==================    =================    =================  

<CAPTION> 
                              
                                                                      
                                                                                      1997 vs. 1996   
                                                  ----------------------------------------------------------------------------------
                                                                                              
                                                                               Increase (Decrease)  Attributable to 
                                   
                                                  ----------------------------------------------------------------------------------
                                                                                                                            
                                                        Volume                Rate              Rate/Volume              Net        
                                                  ------------------   ------------------    -----------------   ------------------ 
                                             (In Thousands)  
<S>                                               <C>                  <C>                  <C>                  <C> 
Interest income on:                                                                                                       
    Interest-bearing deposits                     $             (100)  $                16  $               (5)  $             (89) 
    Investments, at cost                                           2                    92                   -                  94 
    Mortgage-backed securities                                   (15)                   (1)                  -                 (16) 
    Loans receivable                                             425                  (103)                 (9)                313 
                                                  ------------------    ------------------   -----------------    ----------------
     Total interest income on                                                                                    
      interest-earning assets                                    312                     4                 (14)                302 
                                                  ------------------    ------------------   ------------------   ----------------
                                                                                                                  
                                                                                                                  
                                                                                                                  
Interest expense on:                                                                                              
    Passbook accounts                                            (42)                    1                   -                 (41) 
    Transaction accounts                                          42                    11                   2                  55 
    Certificates of deposit                                     (133)                  (65)                  4                (194) 
    FHLB advances and other                                      (46)                    -                   -                 (46) 
                                                  ------------------    ------------------  ------------------    ----------------
     Total interest expense                                                                                       
     on interest-bearing liabilities                            (179)                  (53)                  6                (226) 
                                                  ------------------    ------------------  ------------------    ----------------
                                                                                                                 
Increase (decrease) in net                                       
interest income                                   $              491    $               57  $              (20)   $            528 
                                                  ==================    ==================  ==================    ================ 
</TABLE> 

                                       9
<PAGE>
 
                     SCOTLAND BANCORP, INC. AND SUBSIDIARY

                     MANAGEMENT'S DISCUSSION AND ANALYSIS

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

                        CAPITAL RESOURCES AND LIQUIDITY
                                        
Scotland Bancorp, Inc. paid regular cash dividends of $0.20 and $0.30 per share
during the years ended September 30, 1998 and 1997, respectively.  The Company
also paid a special return of capital dividend of $6 per share during the last
quarter of 1997.  Although the Company anticipates that it will continue to
declare cash dividends on a regular basis up until the time of the Company's
anticipated merger with Centura Banks, Inc. is consummated, the Board of
Directors will continue to review its policy on the payment of dividends on an
ongoing basis, and such payment will be subject to future earnings, cash flows,
capital needs, and regulatory restrictions.

The objective of the Company's liquidity management is to ensure the
availability of sufficient cash flows to meet all financial commitments and to
capitalize on opportunities to enhance stockholders' value.  More specifically,
liquidity ensures that adequate funds are available to meet deposit withdrawals,
fund loan commitments, maintain reserve requirements, pay operating expenses,
distribute dividends to stockholders, and meet other institutional commitments.
Funds are primarily provided through financial resources from operating
activities, expansion of the deposit base, the sale or maturity of investments,
or the ability to raise equity capital.

During the year ended September 30, 1998, cash and cash equivalents, a
significant source of liquidity, increased by approximately $1.2 million.  Cash
and cash equivalents increased by $1.7 million during 1997.  Cash flow resulting
from internal operating activities provided increases of $498,654 and $1,173,256
in cash during the years ended September 30, 1998 and 1997, respectively.  Also,
financing activities have provided sources of funds for asset growth and
liquidity.  For the years ended September30,1998, and 1997, respectively,
deposits increased by $1.1 million and $730,000.

The Bank's ability to generate deposits has historically been sufficient to fund
its loan demand and provide for adequate liquidity without the need to access
other forms of credit availability.  The recent stock offering will also enhance
the Bank's ability to grow, and lessen to some extent its reliance on its
deposit base for financing its operations.   In addition, the Bank has a readily
available source of credit through its borrowing capacity at the Federal Home
Loan Bank of Atlanta.

Cash provided by operating and financing activities is used to originate new
loans to customers, to maintain liquid investment portfolios, and to meet short
term liquidity requirements.  During 1998 and 1997, loans outstanding decreased
by $4.0 million and increased $1.4 million, respectively.  During 1998 and 1997,
the Company purchased investment securities amounting to $5.8 million and $11.1
million, respectively, and received proceeds from sales or maturities of
investment securities amounting to $7.1 million and $18.6 million, respectively.

As a state chartered savings bank, Scotland Savings must meet certain liquidity
requirements which are established by the Administrator of the North Carolina
Savings Institutions Division.  The Bank's liquidity ratio at September 30,
1998, as computed under such regulations, was in excess of such requirements.
Given its excess liquidity and its ability to borrow from the Federal Home Loan
Bank, the Bank believes that it will have sufficient funds available to meet
anticipated future loan commitments, unexpected deposit withdrawals, and other
cash requirements.

                                       10
<PAGE>
 
                     SCOTLAND BANCORP, INC. AND SUBSIDIARY

                     MANAGEMENT'S DISCUSSION AND ANALYSIS

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

                          ASSET/LIABILITY MANAGEMENT

Scotland Savings' asset/liability management, or its management of interest rate
risk, is focused primarily on evaluating and managing the Bank's net interest
income given various  risk criteria.  Factors beyond the Bank's control, such as
market interest rates and competition, may also have an impact on the  Bank's
interest income and interest expense.

In the absence of other factors, the Bank's overall yield on interest-earning
assets will increase as will its cost of funds on its interest-bearing
liabilities when market rates increase over an extended period of time.
Inversely, the Bank's yields and cost of funds will decrease when market rates
decline.  The Bank is able to manage these swings to some extent by attempting
to control the maturity or rate adjustments of its interest-earning assets and
interest-bearing liabilities over given periods of time.

The Bank's "gap" is typically described as the difference between the amounts of
such assets and liabilities which reprice within a period of time.  In a
declining interest rate environment, a negative gap, or a situation where the
Bank's interest-bearing liabilities subject to repricing exceed the level of
interest-earning assets which will mature or reprice, will have a favorable
impact of the Bank's net interest income.  Conversely, an increase in general
market rates over a sustained period of time will tend to adversely affect
Scotland Savings' net interest income.  At September 30, 1998, the Bank had a
negative gap position.

In order to minimize the potential effects of adverse material and prolonged
increases or decreases in market interest rates on the Bank's operations,
management has implemented an asset/liability program designed to improve the
Bank's interest rate gap.  The program emphasizes the origination of adjustable
rate loans, and to a lesser extent shorter term construction and consumer loans,
all of which are held in the portfolio, the investment of excess cash in short
or intermediate term interest earning assets, and the solicitation of
transaction deposit accounts which are less sensitive to changes in interest
rates and can be repriced rapidly.  In addition to shortening the average
repricing of its assets, the Bank has sought to be price rate competitive in the
marketplace on its maturing certificates of deposit to encourage depositors to
reinvest in certificates with the Bank.  The Bank has approximately $26.5
million in certificates maturing in 1999 and management believes that
substantially all of the maturing certificates will be renewed.

Although the Company's asset/liability management program has generally helped
to decrease the exposure of its earnings to interest rate increases, the Company
continues to have a negative gap position which will be adversely impacted
during prolonged periods of rising interest rates and positively affected during
prolonged periods of interest rate declines.  Modeling used by the Company
indicates that, as of September 30, 1998, its net portfolio value (present value
of cash flows from assets, liabilities and off-balance sheet items) could
decrease by 29.57% in the event of an instantaneous and permanent 200 basis
point increase in market interest rates and could increase by 34.49% in the
event of a 200 basis point decrease in market rates.  Such modeling also
indicates that, as of September 30, 1998, such a 200 basis point increase in
market rates would result in a 9% decrease in net interest income and that a 200
basis point decrease in such rates would result in a 6% increase in net interest
income.

                                        
                    IMPACT OF INFLATION AND CHANGING PRICES

The consolidated financial statements and accompanying footnotes have been
prepared in accordance with generally accepted accounting principles ("GAAP"),
which require the measurement of financial position 

                                       11
<PAGE>
 
                     SCOTLAND BANCORP, INC. AND SUBSIDIARY

                     MANAGEMENT'S DISCUSSION AND ANALYSIS

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


and operating results in terms of historical dollars without consideration for
changes in the relative purchasing power of money over time due to inflation.
The assets and liabilities of the Company are primarily monetary in nature and
changes in interest rates have a greater impact on the Company's performance
than do the effects of inflation.

                         FUTURE REPORTING REQUIREMENTS

The FASB has issued SFAS No. 130, "Reporting Comprehensive Income," which the
Company has not been required to adopt as of September 30, 1998.  The Statement,
which is effective for fiscal years beginning after December 15, 1997,
establishes standards for reporting and display of comprehensive income and its
components (revenues, expenses, gains and losses) in a full set of general-
purpose financial statements.  This statement requires that all items that are
recognized under accounting standards as components of comprehensive income be
reported in a financial statement that is displayed with the same prominence as
other financial statements.

The FASB has issued SFAS No. 131, "Disclosures about Segments of an Enterprise
and Related Information," which the Company has not been required to adopt as of
September 30, 1998.  This Statement, which is effective for fiscal years
beginning after December 15, 1997, requires that a public business enterprise
report financial and descriptive information about its reportable operating
segments.  Operating segments are components of an enterprise about which
separate financial information is available that is evaluated regularly by the
chief operating decision maker in deciding how to allocate resources and in
assessing performance.  Generally, financial information is required to be
reported on the basis that it is used internally for evaluating segment
performance and deciding how to allocate resources to segments.

The FASB has issued SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities," which the Company has not been required to adopt as of
September 30, 1998.  This Statement, which is effective for fiscal years
beginning after June 15, 1998, establishes accounting and reporting standards
for derivative instruments embedded in other contracts, (collectively referred
to as derivatives) and for hedging activities.  It requires that an entity
recognize all derivatives as either assets or liabilities in the statement of
financial position and measure those instruments at fair value.  If certain
conditions are met, a derivative may be specifically designated as (a) a hedge
of the exposure to changes in the fair value of a recognized asset or liability
or an unrecognized firm commitment, (b) a hedge of the exposure to variable cash
flows of a forecasted transaction, or (c) a hedge of the foreign currency
exposure of a net investment in a foreign operation, an unrecognized firm
commitment, an available-for-sale security, or a foreign-currency- denominated
forecasted transaction.  This Statement is not expected to have a significant
impact on the Company.

The FASB has issued SFAS No. 134, "Accounting for Mortgage-Backed Securities
Retained after the Securitization of Mortgage Loans Held for Sale by a Mortgage
Banking Enterprise," an amendment of FASB Statement No. 65, which the Company
has not been required to adopt as of September 30, 1998.  Statement No. 65, as
amended by FASB Statements No. 115, "Accounting for Certain Investments in Debt
and Equity Securities," and No. 125, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities," requires that after the
securitization of a mortgage loan held for sale, an entity engaged in mortgage
banking activities classify the resulting 

                                       12
<PAGE>
 
                     SCOTLAND BANCORP, INC. AND SUBSIDIARY

                     MANAGEMENT'S DISCUSSION AND ANALYSIS

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

mortgage-backed security as a trading security. This Statement further amends
Statement No. 65 to require that after the securitization of mortgage loans held
for sale, an entity engaged in mortgage banking activities classify the
resulting mortgage-backed securities or other retained interests based on its
ability and intent to sell or hold those investments. This Statement conforms
the subsequent accounting for securities retained after the securitization of
mortgage loans by a mortgage banking enterprise with the subsequent accounting
for securities retained after the securitization of other types of assets by a
nonmortgage banking enterprise. This Statement is effective for fiscal years
beginning after December 15, 1998, and is not expected to have a significant
impact on the Company.

                      RECAPTURE OF TAX BAD DEBT RESERVES
                                        
Prior to the enactment of the Small Business Job Protection Act of 1996 (the
"1996 Act") on August20,1996, thrift institutions which met certain definitional
tests, were permitted to establish tax reserves for bad debts and to deduct
annual additions to such reserves in arriving at taxable income.  The Bank was
permitted to compute the annual bad debt deduction based upon an experience
method or a percentage equal to 8.0% of the Bank's taxable income (the "PTI
Method") before such bad debt deduction, subject to certain limitations.  Under
the 1996 Act, the PTI Method was repealed and the Bank will be required to use
the experience method for computing its annual bad debt deduction for taxable
years beginning on or after October 1, 1996.

The Bank will also have to recapture its tax bad debt reserves which have
accumulated since 1987 amounting to approximately $340,000 over a six year
period. The tax associated with the recaptured reserves is approximately
$126,000. The recapture was scheduled to begin with the Bank's 1997 year, but
has been delayed two years as the Bank originated a certain level of residential
mortgage loans.  Deferred income taxes have been previously established for the
taxes associated with the recaptured reserves and the ultimate payment of the
taxes will not result in a charge to earnings.

                            IMPACT OF THE YEAR 2000
                                        
A lot of attention has been given to the impact that the year 2000 date change
will have on businesses, utilities and other organizations that rely on
computerized systems to help run their operations.  The year 2000 date change
can affect any system that uses computer software or computer chips including
automated equipment and machinery. For example, many computer programs and
computer chips store the calendar year portion of the date as two digits rather
than four digits.  These software programs and chips record the year 1999 as
"99". This approach works until the year 2000 when the "00" may be interpreted
as the year 1900 instead of the year 2000.  Banks use computer systems to
perform financial calculations, transfer funds, record deposits and loan
payments, run security systems and vaults and a myriad of other functions.
Because banks rely heavily on their computer systems, the Federal Financial
Institutions Examination Council ("FFIEC") has placed significant emphasis on
the problems surrounding the year 2000 issues and has required financial
institutions to document the assessment, testing and corrections made to ready
their computer systems and programs for the year 2000 date change.  The FFIEC
has strict regulations, guidelines, and milestones in place that each FDIC
insured financial institution must follow in order to remain operational.  The
Company's board of directors has remained informed of the Company's position and
progress in its year 2000 project.

As previously noted, Scotland Bancorp, Inc. has entered into an agreement to
sell the Company to Centura Banks, Inc.  Upon completion of the sale, Centura
will convert the Company's computer systems to their own, which are anticipated
to be year 2000 compliant.  However, since the sale is contingent upon

                                       13
<PAGE>
 
                     SCOTLAND BANCORP, INC. AND SUBSIDIARY

                     MANAGEMENT'S DISCUSSION AND ANALYSIS

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

shareholder and regulatory approval, Scotland Bancorp, Inc. is going forward
with the current year 2000 remediation plan.

The Company's year 2000 project remains on schedule according to the guidelines
set forth by the FFIEC. The Company's most critical external exposure to year
2000 system problems is with its data processing provider, Fiserv. Fiserv
renovated its systems in June 1998 and is currently testing its remediation
efforts.  Fiserv plans to have all of its systems year 2000 compliant by
December 1998.  In addition, the Company has contacted its major customers and
vendors to inquire about their progress in addressing the year 2000 problem and
does not believe that the problems of such customers and vendors will have a
material adverse effect on the Company or its operations.  The Company will
continue to monitor the progress of these parties in addressing the year 2000
problem as the new millennium approaches.  Management estimated the cost to
replace the computer hardware and software with year 2000 compliment equipment
to be approximately $160,000.

The year 2000 problems can affect the Company's operation in a number of ways
but the mission critical issue is maintaining customers' account information
including tracking deposits, interest accruals and loan payments.  The Company
is dependent upon electricity, telephone lines, computer hardware and Fiserv's
data processing capability.

The Company is in contact with its electric utility and phone company, and
assurances have been given that no major problems exist and that both companies
will have all year 2000 problems addressed well before December 31, 1999.  If
the electric utility is unable to certify that its renovation is completed by
June 30, 1999, the Company will acquire portable generators with sufficient
capacity to run the system servers and at least one work station in each branch
office.

To prevent difficulties in the event there is an unforeseen interruption in
either telephone or electrical service when the year changes, the Company will
print hard copies of all account information.  In addition, the Company will
download all account information into programs on the Company's hardware that
will allow bank personnel to extract customer information without regard to
outside sources.

Fiserv has responded to the Company that renovation of its program is virtually
complete.  In the event that Fiserv is unable to make the necessary corrections
to its programs to accommodate the year 2000, the Company will convert its data
to one of the other Fiserv programs that is able to operate in the 2000
environment.

                              SALE OF THE COMPANY
                                        
On August 26, 1998 Scotland Bancorp, Inc. and Centura Banks, Inc. announced that
Centura will acquire Scotland Bancorp, which is the holding company for Scotland
Savings Bank, in a cash transaction.  The parties' agreement provides for each
share of Scotland Bancorp's common stock to be exchanged for $11.75 in cash.

This transaction is contingent upon receiving approvals from regulatory
authorities and from Scotland Bancorp's shareholders.  A special meeting of
Scotland shareholders is planned after required regulatory approvals are
received.  It is anticipated that the transaction will be completed in the
second quarter of fiscal 1999.

                                       14
<PAGE>
 
                         INDEPENDENT AUDITOR'S REPORT



To the Board of Directors
Scotland Bancorp, Inc. and Subsidiary
Laurinburg,  North Carolina

We have audited the accompanying consolidated statements of financial condition
of Scotland Bancorp, Inc. and subsidiary as of September 30, 1998 and 1997, and
the related consolidated statements of income, stockholders' equity, and cash
flows for the years then ended.  These financial statements are the
responsibility of the Company's management.  Our responsibility is to express an
opinion on these financial statements based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards.  Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements.  An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Scotland Bancorp,
Inc. and subsidiary as of September 30, 1998 and 1997, and the results of their
operations and their cash flows for the years then ended in conformity with
generally accepted accounting principles.

/s/ McGLADREY & PULLEN, LLP

Charlotte, North Carolina
October 23, 1998

                                       15
<PAGE>
 
SCOTLAND BANCORP, INC. AND SUBSIDIARY
 
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
SEPTEMBER 30, 1998 AND 1997

<TABLE> 
<CAPTION> 
ASSETS                                                                        1998                1997
-----------------------------------------------------------------------------------------------------------
<S>                                                                   <C>                  <C> 
Cash and cash equivalents:
 Interest-bearing deposits                                            $     2,162,224      $      2,931,343
 Noninterest-bearing deposits                                                 767,594               626,905
Federal funds sold                                                          5,000,000             3,200,000
Securities held to maturity (fair value 1998 $0;
 1997 $494,060) (Note 2)                                                            -               500,000
Securities available for sale (Note 2)                                      8,074,324             8,460,850
Nonmarketable equity securities, at cost                                      599,400               599,400
Loans receivable, net (Note 3)                                             42,484,729            46,463,348
Mortgage-backed securities, held to maturity, (fair value 1998
  $341,980; 1997 $481,325) (Note 4)                                           301,097               418,657
Accrued interest receivable on loans                                          169,281               160,821
Accrued interest receivable on investment securities                           38,128                49,938
Office properties and equipment, net (Note 5)                                 755,981               792,359
Income tax refund receivable                                                  145,658                     -
Prepaid expenses and other assets                                             231,464               195,666
                                                                     --------------------------------------
      TOTAL ASSETS                                                    $    60,729,880      $     64,399,287
                                                                     ======================================
-----------------------------------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
-----------------------------------------------------------------------------------------------------------
Liabilities:
 Savings deposits (Note 6)                                            $    44,270,688      $     43,139,725
 Note payable (Note 7)                                                              -             5,500,000
 Accounts payable and accrued expenses (Note 12)                              276,354               447,422
 Advances from borrowers for taxes and insurance                              129,851               160,229
 Income taxes payable                                                               -                37,383
 Deferred income taxes (Note 8)                                               715,934               553,766
                                                                     --------------------------------------
      TOTAL LIABILITIES                                                    45,392,827            49,838,525
                                                                     --------------------------------------
Commitments and contingencies (Notes 13, 16 and 20)
Stockholders' Equity (Note 10):
 Preferred stock, authorized 5,000,000 shares; none issued                          -                     -
 Common stock, no par value, authorized 20,000,000 shares;
   1,913,600 shares issued                                                          -                     -
 Additional paid-in capital                                                 7,922,762             7,939,945
 Unearned ESOP (Note 15)                                                   (1,602,395)           (1,708,545)
 Unrealized gain on securities available for sale, net of tax                 757,272               518,552
 Deferred management recognition plan  (Note 14)                             (594,167)             (824,167)
 Unearned compensation  (Note 15)                                            (802,458)             (834,558)
 Retained earnings, substantially restricted (Notes 8 and 11)               9,656,039             9,469,535
                                                                     --------------------------------------
      TOTAL STOCKHOLDERS' EQUITY                                           15,337,053            14,560,762
                                                                     --------------------------------------
      TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY                      $    60,729,880      $     64,399,287
                                                                     ======================================
</TABLE>

See Notes to Consolidated Financial Statements.

                                       16
<PAGE>
 
See Notes to Consolidated Financial Statements.


SCOTLAND BANCORP, INC. AND SUBSIDIARY
 
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED SEPTEMBER 30, 1998 AND 1997

<TABLE> 
<CAPTION> 
                                                                             1998                1997
---------------------------------------------------------------------------------------------------------
<S>                                                                  <C>                 <C> 
Interest and dividend income:
 Loans                                                               $     3,712,042     $      3,948,280
 Investment securities                                                       399,173              934,000
 Mortgage-backed securities                                                   41,293               51,846
 Other interest-bearing deposits                                             411,644              237,292
                                                                    -------------------------------------
                                                                           4,564,152            5,171,418
                                                                    ------------------------------------- 
Interest expense:
 Deposits (Note 6)                                                         2,120,334            1,982,058
 Other borrowings                                                              1,986                  897
                                                                    ------------------------------------- 
                                                                           2,122,320            1,982,955
                                                                    -------------------------------------
     NET INTEREST INCOME                                                   2,441,832            3,188,463
Provision for loan losses (Note 3)                                             6,000               24,000
                                                                    -------------------------------------
     NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES                   2,435,832            3,164,463
                                                                    -------------------------------------
Noninterest income:
 Gain of sale of investments (Note 2)                                              -              240,726
 Service charges and other fees                                               51,208               44,183
 Other                                                                        23,361               21,363
                                                                    -------------------------------------
                                                                              74,569              306,272
                                                                    -------------------------------------
Noninterest expenses:
 Compensation and employee benefits                                        1,079,689            1,103,882
 Occupancy                                                                    86,455               86,990
 Insurance                                                                    38,091               31,661
 Data processing                                                              97,813               94,871
 Furniture and fixture expense                                                31,554               29,660
 Other                                                                       342,807              333,201
                                                                    -------------------------------------
                                                                           1,676,409            1,680,265
                                                                    -------------------------------------
     INCOME BEFORE INCOME TAXES                                              833,992            1,790,470
                                                                    -------------------------------------
Income taxes (Note 8):                                              
 Current                                                                     289,386              487,272
 Deferred                                                                     15,857               44,938
                                                                    -------------------------------------
                                                                             305,243              532,210
                                                                    -------------------------------------
     NET INCOME                                                      $       528,749     $      1,258,260
                                                                    =====================================
Basic earnings per share (Note 9)                                    $          0.32     $           0.74
                                                                    =====================================
Diluted earnings per share (Note 9)                                  $          0.32     $           0.73
                                                                    =====================================
Regular cash dividends per share                                     $          0.20     $           0.30
                                                                    =====================================
Return of capital dividend per share                                 $             -     $           6.00
                                                                    =====================================
</TABLE>

See Notes to Consolidated Financial Statements.

                                       17
<PAGE>
 
SCOTLAND BANCORP, INC. AND SUBSIDIARY
 
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED SEPTEMBER 30, 1998 AND 1997

<TABLE>
<CAPTION> 
-----------------------------------------------------------------------------------------------------------------

                                                                                                    Deferred 
                                                          Additional                                Management 
                                                           Paid-in              Unearned            Recognition
                                                           Capital                ESOP                 Plan     
-----------------------------------------------------------------------------------------------------------------
<S>                                                  <C>                   <C>                    <C>
Balance, September 30, 1996                          $   17,420,468        $   (1,772,292)          $        -   
 Cash dividends                                                -                     - 
 Return of capital dividend                             (10,647,042)                 -                       -  
 Change in net unrealized gain on
   securities available for sale                               -                     -                       - 
 Adoption of deferred management
   recognition plan                                       1,150,000                  -                 (1,150,000)
 Vesting of deferred management
   recognition plan                                            -                     -                    325,833
    ESOP contribution                                        16,519                  -                       - 
 Principal payment on note
   receivable from ESOP                                        -                   63,747                    -   
 Net income                                                    -                     -                       - 
                                                     ------------------------------------------------------------     
Balance, September 30, 1997                               7,939,945            (1,708,545)               (824,167)
 Cash dividends                                                -                     -                       - 
 Change in net unrealized gain on                              
   securities available for sale                               -                     -                       -  
    Amortization of unearned                                   
   compensation                                                -                     -                       -  
    Vesting deferred management                                
   recognition plan                                            -                     -                    230,000
    ESOP contribution                                       (17,183)                 -                       -  
 Principal payment on note              
   receivable from ESOP                                        -                  106,150                    - 
 Net income                                                    -                     -                       - 
                                                     ------------------------------------------------------------
Balance, September 30, 1998                          $    7,922,762        $   (1,602,395)          $    (594,167)
                                                     ============================================================
</TABLE>

See Notes to Consolidated Financial Statements.

                                       18
<PAGE>
 
<TABLE>
<CAPTION>
--------------------------------------------------------------------------
                         Unrealized                                       
                          Gain on                                         
                        Securities                                Total      
       Unearned          Available          Retained          Stockholders'  
     Compensation        for Sale           Earnings             Equity      
-------------------------------------------------------------------------- 
<S>                  <C>               <C>                <C>             
$        -           $    411,135      $    8,731,961     $    24,791,272 
         -                   -               (520,686)           (520,686)
     (834,558)               -                   -            (11,481,600)
                                                                          
         -                107,417                -                107,417 
                                                                          
         -                   -                   -                   -    
                                                                          
         -                   -                   -                325,833 
         -                   -                   -                 16,519 
                                                                          
         -                   -                   -                 63,747 
         -                   -              1,258,260           1,258,260 
-------------------------------------------------------------------------- 
     (834,558)            518,552           9,469,535          14,560,762 
         -                   -               (342,245)           (342,245)
                                                                          
         -                238,720                -                238,720 
                                                                          
       32,100                -                   -                 32,100 
                                                                          
         -                   -                   -                230,000 
         -                   -                   -                (17,183)
                                                                          
         -                   -                   -                106,150 
         -                   -                528,749             528,749 
-------------------------------------------------------------------------- 
$    (802,458)       $    757,272      $    9,656,039     $    15,337,053 
==========================================================================
</TABLE>

                                       19
<PAGE>
 
SCOTLAND BANCORP, INC. AND SUBSIDIARY
 
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED SEPTEMBER 30, 1998 AND 1997

<TABLE>
<CAPTION>
                                                                         1998                  1997
-----------------------------------------------------------------------------------------------------------
<S>                                                               <C>                     <C>
Cash Flows From Operating Activities
 Net income                                                       $          528,749      $       1,258,260
 Adjustments to reconcile net income to net
   cash provided by operating activities:
   Depreciation                                                               44,944                 36,017
   Provision for loan losses                                                   6,000                 24,000
   Net accretion on securities                                                (3,443)                (7,729)
   Amortization of unearned compensation                                      32,100                      -
   Net (gain) loss on sale of securities available for sale                        -               (240,726)
   ESOP contribution                                                         (17,183)                16,519
   Vesting of deferred management recognition plan                           230,000                325,833
   Deferred income taxes                                                      15,857                 44,938
    (Increase) decrease in:
      Accrued interest receivable,
       prepaid expenses and other assets                                     (32,448)                98,606
      Income tax refund receivable                                          (145,658)                     -
    Increase (decrease) in:
      Income taxes payable                                                   (37,383)               (98,707)
      Accounts payable and accrued expenses                                 (122,881)                36,995
      Special SAIF assessment                                                      -               (320,750)
                                                                -------------------------------------------
        NET CASH PROVIDED BY OPERATING ACTIVITIES                            498,654              1,173,256
                                                                -------------------------------------------
Cash Flows From Investing Activities
 Proceeds from maturities of securities held to maturity                     500,000              2,000,000
 Proceeds from maturities of securities available for sale                 1,000,000                600,000
 Proceeds from sales of securities available for sale                      5,600,000             15,968,635
 Purchases of securities available for sale                               (5,825,000)           (11,100,000)
 Principal collected on mortgage-backed securities                           117,560                126,633
 Net (increase) decrease in loans receivable                               3,972,619             (1,408,488)
 Purchases of property and equipment                                          (8,566)                (8,902)
                                                                -------------------------------------------
        NET CASH PROVIDED BY INVESTING ACTIVITIES                          5,356,613              6,177,878
                                                                -------------------------------------------
Cash Flows From Financing Activities
 Net increase in savings accounts                                          1,130,963                730,157
 Increase (decrease) in escrow deposits                                      (30,378)                 3,704
 Proceeds from borrowings on note payable                                          -              5,500,000
 Payment of note payable                                                  (5,500,000)                     -
 Principal payment on note receivable from ESOP                              106,150                 63,747
 Payment of dividends                                                       (390,432)              (514,817)
 Return of capital dividends                                                       -            (11,481,600)
                                                                -------------------------------------------
        NET CASH USED IN FINANCING ACTIVITIES                             (4,683,697)            (5,698,809)
                                                                -------------------------------------------
        NET INCREASE IN CASH AND CASH EQUIVALENTS                          1,171,570              1,652,325
Cash and cash equivalents:
 Beginning                                                                 6,758,248              5,105,923
                                                                -------------------------------------------
 Ending                                                           $        7,929,818      $       6,758,248
                                                                ===========================================
</TABLE> 

                      (Continued)

                                       20
<PAGE>
 
SCOTLAND BANCORP, INC. AND SUBSIDIARY
 
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
YEARS ENDED SEPTEMBER 30, 1998 AND 1997
 
<TABLE>
<CAPTION> 
                                                                                1998                   1997
<S>                                                               <C>                        <C> 
-----------------------------------------------------------------------------------------------------------
Cash and cash equivalents:
 Cash and short-term investments                                  $        2,929,818         $    3,558,248
 Federal funds sold                                                        5,000,000              3,200,000
                                                                  -----------------------------------------
                                                                  $        7,929,818         $    6,758,248
                                                                  =========================================
Supplemental Disclosure of Cash Flow Information
 Cash payments for:
   Interest                                                                2,136,409              1,991,907
   Income taxes                                                              472,427                585,979
 
Supplemental Disclosure of Noncash Investing Activities
 Change in unrealized gain on securities available for sale                  238,720                107,417
 
Supplemental Disclosure of Noncash Financing Activities
 Dividends accrued                                                            84,901                133,088
 Adoption of deferred management recognition plan                                  -              1,150,000
</TABLE>

See Notes to Consolidated Financial Statements. 

                                       21
<PAGE>
 
SCOTLAND BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

NOTE 1.  NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES

Nature of business:  Scotland Bancorp, Inc. (the "Company") is a bank holding
------------------                                                           
company registered with the Board of Governors of the Federal Reserve System
under the Bank Holding Company Act of 1956, as amended, and the savings bank
holding company laws of North Carolina.  The Company owns 100% of the common
stock of Scotland Savings Bank ("Scotland Savings" or the "Bank"), which
converted to stock form (the "Conversion") on March 29, 1996.  The Company has
no operations and conducts no business of its own other than owning the Bank,
investing its portion of the net proceeds received in the Conversion, and
lending funds to the Employee Stock Ownership Plan (the "ESOP") which was formed
in connection with the Conversion.

Scotland Savings Bank operates as a stock savings bank and its principal
activities consist of obtaining deposits and providing credit in the form of
loans to customers in its primary markets, Scotland and Moore counties of North
Carolina.  The Bank's primary regulators are the Federal Deposit Insurance
Company ("FDIC") and the Administrator of the North Carolina Savings
Institutions Division (the "NC Administrator").  The Bank's deposits are insured
by the Savings Association Insurance Fund ("SAIF") of the FDIC.

The following is a description of the significant accounting policies used in
the preparation of the accompanying financial statements.

Principles of consolidation:  The consolidated financial statements include the
---------------------------                                                    
accounts of Scotland Bancorp, Inc. and its wholly-owned subsidiary, Scotland
Savings Bank.  All significant intercompany transactions and balances have been
eliminated in consolidation.

Basis of financial statement presentation:  The accounting and reporting
-----------------------------------------                               
policies of the Company conform to generally accepted accounting principles and
general practices within the financial services industry.  In preparing the
financial statements, management is required to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities as of the date of the financial statements and
the reported revenues and expenses for the period.  Actual results could differ
from those estimates.

Cash and cash equivalents:  For purposes of reporting the statements of cash
-------------------------                                                   
flows, the Company considers all interest-bearing deposits with maturities of
less than three months at acquisition, noninterest-bearing deposits, federal
funds sold, and cash on hand to be cash equivalents.  The Company maintains
amounts due from banks which, at times, may exceed federally insured limits.
The Company has not experienced any losses in such accounts.

Investment securities:   The Bank has investments in debt and equity securities.
----------------------
Debt securities consist primarily of U. S. Treasury Notes, Federal Farm Credit
Notes, Federal Home Loan Bank bonds and state revenue bonds.   Equity securities
consist of Federal Home Loan Mortgage Corporation ("FHLMC") stock.

                                       22
<PAGE>
 
SCOTLAND BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

NOTE 1.   NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

Management classifies all debt securities and certain equity securities as
trading, available for sale, or held to maturity as individual investment
securities are acquired, and thereafter the appropriateness of such
classification is reassessed at each statement of financial condition date.
Because the Bank does not buy investment securities in anticipation of short-
term fluctuations in market prices, none of the investment securities are
classified as trading in accordance with SFAS No. 115.  All securities have been
classified as either available for sale or held to maturity.

Securities available for sale:   Securities classified as available for sale are
------------------------------                                                  
those securities that the Bank intends to hold for an indefinite period of time
but, as in the case of debt securities, not necessarily to maturity.  Any
decision to sell a security classified as available for sale would be based on
various factors, including significant movements in interest rates, changes in
the maturity mix of the Bank's assets and liabilities, liquidity needs,
regulatory capital considerations, and other similar factors.  Securities
available for sale are carried at fair value.  Premiums and discounts are
amortized using the interest method over the contractual lives.  Unrealized
gains or losses are reported as increases or decreases in stockholders' equity,
net of the related deferred tax effect.  Realized gains or losses, determined on
the basis of the cost of specific securities sold, are included in income.

Securities held to maturity:   Securities classified as held to maturity are
----------------------------                                                
those securities for which the Bank has both the intent and ability to hold to
maturity regardless of changes in market conditions, liquidity needs or changes
in general economic conditions.  These securities are carried at cost adjusted
for amortization of premium and accretion of discount, computed by the interest
method over their contractual lives.  Based on the Bank's financial position and
liquidity, management believes the Bank has the ability to hold these securities
to maturity.

Investment in Federal Home Loan Bank stock:   The Bank, as a member of the
-------------------------------------------                               
Federal Home Loan Bank ("FHLB") system, is required to maintain an investment in
capital stock of the Federal Home Loan Bank in an amount equal to the greater of
1% of its outstanding home loans or 5% of advances from the FHLB.  No ready
market exists for the Federal Home Loan Bank stock, and it has no quoted market
value.

Loans receivable:   Loans receivable are stated at unpaid principal balances,
-----------------                                                            
less the allowance for loan losses,  the undisbursed portion of construction
loans, and net deferred loan-origination fees and costs.  The Bank's loan
portfolio consists principally of mortgage loans collateralized by first trust
deeds on single family residences, other residential property, commercial
property and land.

The allowance for loan losses is increased by charges to income and decreased by
charge-offs (net of recoveries) based on the Bank's evaluation of the potential
and inherent risk of losses in its loan portfolio.  Management's periodic
evaluation of the adequacy of the allowance is based on the Bank's past loan
loss experience, known and inherent risks in the portfolio, adverse situations
that may affect the borrower's ability to repay, the estimated value of any
underlying collateral, and current economic conditions.  While management uses
the best information available to make evaluations, future adjustments may be
necessary, if economic or other conditions differ or change substantially from
the assumptions used.

                                       23
<PAGE>
 
SCOTLAND BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

NOTE 1.  NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

Impaired loans:  SFAS No. 114 requires that the Bank establish a specific loan
---------------                                                               
allowance on an impaired loan if the present value of the future cash flows
discounted using the loan's effective interest rate is less than the carrying
value of the loan.  An impaired loan can also be valued based upon its fair
value or the market value of the underlying collateral if the loan is primarily
collateral dependent.  The Bank assesses for impairment all  loans delinquent
more than 90 days.  See Note 3 for a further explanation of the Statement.   No
loans were impaired at September 30, 1998 and 1997, and there is no specific
SFAS No. 114 allowance associated with the portfolio.

Interest income:  The Bank recognizes interest income on loans using the
---------------                                                         
interest method over the contractual lives of the loans.  The Bank does not
record interest on loans delinquent 90 days or more unless in the opinion of
management, collectibility is assured.  If collectibility is not certain, the
Bank establishes a reserve for uncollected interest. Interest collected while
the loan is in such status is credited to income in the period received.  If the
loan is brought to a status in which it is no longer delinquent 90 days, the
reserve for uncollected interest is reversed and interest income is recognized.
The Bank anticipates that it will account for interest on impaired loans in a
similar fashion in the future if and when it has impaired loans.

Loan-origination fees and related costs:   Loan fees and certain direct loan
----------------------------------------                                    
origination costs are deferred, and the net fee or cost is recognized as an
adjustment to interest income using the interest method over the contractual
lives of the loans, adjusted for actual prepayments.

Real estate acquired in settlement of loans:   Real estate acquired in
--------------------------------------------                          
settlement of loans is initially recorded at estimated fair value at the date of
foreclosure establishing a new cost basis.  Subsequent to foreclosure,
valuations of the property are periodically performed by management and the real
estate is carried at the lower of cost or fair value minus estimated costs to
sell.  Costs relating to improvement of the property are capitalized, while
holding costs of the property are charged to expense in the period incurred.
The Bank has no real estate acquired in settlement of loans at September 30,
1998 and 1997.

Advances from borrowers for insurance and taxes:  Certain borrowers make monthly
-----------------------------------------------                                 
payments, in addition to principal and interest, in order to accumulate funds
from which the Bank can pay the borrowers' property taxes and insurance
premiums.

Office properties and equipment: Office properties and equipment are stated at
-------------------------------                                               
cost less accumulated depreciation computed principally by the straight-line
method over estimated useful lives.

Income taxes:  Deferred income taxes are provided on a liability method whereby
------------                                                                   
deferred tax assets are recognized for deductible temporary differences and
operating loss and tax credit carryforwards, and deferred tax liabilities are
recognized for taxable temporary differences. Temporary differences are
differences between the reported amounts of assets and liabilities and their tax
bases. Deferred tax assets are reduced by a valuation allowance when, in the
opinion of management, it is more likely than not that some portion or all of
the deferred tax assets will not be realized.  Deferred tax assets and
liabilities are adjusted for the effects of changes in tax laws and rates on the
date of enactment.

                                       24
<PAGE>
 
SCOTLAND BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

NOTE 1.  NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

Benefit plans:  The Bank has deferred compensation and retirement plan
-------------                                                         
agreements for the benefit of three members of the Board of Directors.  The
plans are unfunded and the liabilities are being accrued over the terms of
active service of the directors.  The Bank has a defined benefit pension plan
covering substantially all of its employees.  The Bank's funding policy is to
make the maximum annual contribution that is allowable for income tax purposes.
The Bank also has an ESOP which covers substantially all of its employees.
Contributions to the plan are based upon the amortization requirements of the
ESOP's debt to the Company, subject to compensation limitations, and are
expensed in accordance with the AICPA's Statement of Position 93-6, Employers'
Accounting for Employee Stock Ownership Plans.

Additionally, the Company has implemented a qualified stock option plan
authorizing the grant of up to 184,000 stock options to certain officers,
directors and employees at the time of the adoption either in the form of
incentive stock options or non-incentive stock options.  The Bank has also
implemented a management recognition plan by reserving 73,600 shares of common
stock for issuance to certain officers, directors and employees at the time of
adoption.

The Bank has a 401(k) retirement plan available to substantially all employees.
The Bank will match certain portions of voluntary contributions by participating
employees.

Off-statement of financial condition risk:  The Bank is a party to financial
-----------------------------------------                                   
instruments with off-statement of financial condition risk such as commitments
to extend credit and home equity lines of credit.  Management assesses the risk
related to these instruments for potential losses on an ongoing basis.

Fair value of financial instruments:   The estimated fair values required under
------------------------------------                                           
SFAS No. 107, Disclosures About Fair Value of Financial Instruments, have been
determined by the Company using available market information and appropriate
valuation methodologies.  However, considerable judgment is required to develop
the estimates of fair value.  Accordingly, the estimates presented for the fair
value of the Company's current financial instruments are not necessarily
indicative of the amounts the Company could realize in market exchange.  The use
of different market assumptions or estimation methodologies may have a material
effect on the estimated fair market value amounts.

The fair value estimates presented are based on pertinent information available
to management as of September 30, 1998 and 1997.  Although management is not
aware of any factors that would significantly affect the estimated fair value
amount, such amounts have not been comprehensively revalued for purposes of
these financial statements since that date and therefore, current estimates of
fair value may differ significantly from the amounts presented herein.

                                       25
<PAGE>
 
SCOTLAND BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

NOTE 2.  DEBT AND EQUITY  SECURITIES

Debt and equity securities have been classified in the statement of financial
condition according to management's intent.  The carrying amount of securities
and approximate fair values at September 30, 1998 and 1997 were as follows:

<TABLE>
<CAPTION>
                                                                          1998
                                       ------------------------------------------------------------------------
                                                                Gross             Gross
                                            Amortized         Unrealized        Unrealized           Fair
                                               Cost             Gains             Losses            Value
                                       ------------------------------------------------------------------------
<S>                                      <C>                  <C>               <C>                <C>
Available for sale:                                                               
 U. S. Government and federal                                                     
   agency securities                     $      1,000,000      $      2,657     $        -         $  1,002,657
 State revenue bonds                            5,828,443             2,500              -            5,830,943
 FHLMC stock                                       24,475         1,216,249              -            1,240,724
                                       ------------------------------------------------------------------------
                                                6,852,918         1,221,406              -            8,074,324
                                       ------------------------------------------------------------------------
Nonmarketable equity securities:
 FHLB stock                                       595,400                 -              -              595,400
 Fiserv stock                                       4,000                 -              -                4,000
                                       ------------------------------------------------------------------------
                                                  599,400                 -              -              599,400
                                       ------------------------------------------------------------------------
                                         $      7,452,318      $  1,221,406     $        -         $  8,673,724
                                       ========================================================================
</TABLE>

<TABLE>
<CAPTION>
                                                                      1997
                                    ---------------------------------------------------------------------
                                                            Gross            Gross
                                         Amortized       Unrealized        Unrealized          Fair
                                           Cost             Gains            Losses            Value
                                    ---------------------------------------------------------------------
<S>                                 <C>                  <C>               <C>               <C>
Held to maturity:
 U. S. Government and federal
   agency securities                  $       500,000     $          -     $     (5,940)     $    494,060
                                    ---------------------------------------------------------------------
Available for sale:
 U. S. Government and federal
   agency securities                        2,500,000                -          (20,470)        2,479,530
 State revenue bonds                        5,100,000                -                -         5,100,000
 FHLMC stock                                   24,475          856,845                -           881,320
                                    ---------------------------------------------------------------------
                                            7,624,475          856,845          (20,470)        8,460,850
                                    ---------------------------------------------------------------------
Nonmarketable equity securities:
 FHLB stock                                   595,400                -                -           595,400
 Fiserv stock                                   4,000                -                -             4,000
                                    ---------------------------------------------------------------------
                                              599,400                -                -           599,400
                                    ---------------------------------------------------------------------
                                      $     8,723,875     $    856,845     $    (26,410)     $  9,554,310
                                    =====================================================================
</TABLE>

                                       26
<PAGE>
 
SCOTLAND BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

NOTE 2.   DEBT AND EQUITY SECURITIES (CONTINUED)

The amortized cost and fair value of debt securities available for sale at
September 30, 1998 by contractual maturity are shown below.  Equity securities
are not included in the maturity categories because they do not have contractual
maturities.

<TABLE>
<CAPTION>
                                                                               Available for Sale
                                                                    ----------------------------------------
                                                                          Amortized              Fair
                                                                             Cost               Value
                                                                    ----------------------------------------
<S>                                                                   <C>                     <C>
Due in one year or less                                               $          225,425      $      225,873
Due in one year through five years                                             1,203,018           1,207,727
Due in five years or more                                                      5,400,000           5,400,000
                                                                    ----------------------------------------
                                                                      $        6,828,443      $    6,833,600
                                                                    ========================================
</TABLE>


Summarized below is the sales activity in investment securities:

<TABLE>
<CAPTION>
                                                                            Years Ended September 30,
                                                                   ----------------------------------------
                                                                            1998                1997
                                                                   ----------------------------------------
<S>                                                                  <C>                     <C>
Proceeds from the sale of available for sale securities              $        5,600,000      $   15,968,635
Realized gains                                                                        -            (240,726)
Realized losses                                                                       -                   -
                                                                   ----------------------------------------
Cost of investment securities sold                                   $        5,600,000      $   15,727,909
                                                                   ========================================
</TABLE>

The Bank, as a member of the Federal Home Loan Bank system, is required to
maintain an investment in capital stock of the Federal Home Loan Bank in an
amount equal to the greater of 1% of its outstanding home loans or one-twentieth
of its outstanding advances.  No ready market exists for the bank stock and it
has no quoted market value.  For disclosure purposes, such stock is assumed to
have a market value which is equal to cost.

The change in net unrealized gains and losses shown as a separate component of
stockholders' equity for the years ended September 30, 1998 and 1997 is as shown
below:

<TABLE>
<CAPTION>
                                                                               1998                1997
                                                                       -------------------------------------
<S>                                                                     <C>                   <C>
Balance in equity component, beginning                                  $       518,552       $      411,135
 Change in net unrealized gains                                                 385,031              213,443
 Less change in deferred income taxes                                          (146,311)            (106,026)
                                                                       -------------------------------------
Balance in equity component, ending                                     $       757,272       $      518,552
                                                                       =====================================
</TABLE>

Investment securities with aggregate cost of $700,000 and estimated fair value
of $702,000 are pledged at September 30, 1998 to collateralize certain public
deposits.

                                       27
<PAGE>
 
SCOTLAND BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

Note 3. LOANS RECEIVABLE

Loans receivable at September, 1998 and 1997 consist of the following:

<TABLE>
<CAPTION>
                                                                            1998                1997
                                                                   ----------------------------------------
Real estate loans:
<S>                                                                  <C>                 <C> 
 Residential, one-to-four units                                      $       36,423,685  $       41,018,267
 Residential, multifamily                                                     2,513,660           2,052,097
 Nonresidential real estate                                                     755,218             907,451
 Residential construction                                                     1,593,400             634,100
 Line of credit                                                               2,406,102           2,539,817
                                                                   ----------------------------------------
                                                                             43,692,065          47,151,732
Share loans                                                                      49,737              71,058
Automobile                                                                      209,397             119,019
Other                                                                           178,059             201,381
                                                                   ----------------------------------------
                                                                             44,129,258          47,543,190
                                                                   ----------------------------------------
Less:
 Undisbursed portion of loans in process                                      1,192,273             614,230
 Allowance for loan losses                                                      254,810             248,860
 Deferred loan fees                                                             197,446             216,752
                                                                   ----------------------------------------
                                                                              1,644,529           1,079,842
                                                                   ----------------------------------------
                                                                     $       42,484,729  $       46,463,348
                                                                   ========================================
</TABLE>

The following summarizes transactions in the Bank's allowance for loan losses:

<TABLE>
<CAPTION>
                                                                            1998                 1997
                                                                   -----------------------------------------
<S>                                                                  <C>                  <C>
Balance at the beginning of year                                     $          248,860   $          225,352
 Provisions charged to operations                                                 6,000               24,000
 Charge-offs                                                                        (50)                (492)
                                                                   -----------------------------------------
Balance at the end of the year                                       $          254,810   $          248,860
                                                                   =========================================
</TABLE>

SFAS No. 114, Accounting by Creditors for Impairment of a Loan, as amended by
SFAS No. 118 Accounting by Creditors for Impairment of a Loan-Income Recognition
and Disclosure, requires that the Bank establish a specific allowance on
impaired loans and disclosure of the Bank's method of accounting for interest
income on impaired loans.  The Bank assesses all loans delinquent more than 90
days for impairment and such loans amounted to approximately $28,000 and $30,000
at September 30, 1998 and 1997, respectively.  These loans are collateral
dependent and management had determined that the underlying collateral value is
in excess of the carrying amount.  As a result, the Bank determined that
specific allowances on these loans is not required.

                                       28
<PAGE>
 
SCOTLAND BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

NOTE 3.  LOANS RECEIVABLE (CONTINUED)


The Bank does not accrue interest on loans past due 90 days or more if in the
opinion of management, collectibility is in doubt.   Such interest is removed
from income through the establishment of a reserve for uncollected interest.  At
September 30, 1998 a reserve for uncollected interest was not established
because management expects that all such interest is fully collectible.


The following summarizes transactions during the years ended September 30, 1998
and 1997 for loans made by the Bank to the Company's officers, directors and
their affiliates:


<TABLE>
<CAPTION>
                                                                              1998               1997
                                                                   -----------------------------------------
<S>                                                                  <C>                  <C> 
Principal balances, beginning of year                                $        1,489,027   $        1,459,560
   New loans originated                                                         160,875              224,903
   Principal repayments                                                        (601,284)            (195,436)
                                                                   -----------------------------------------
Principal balances, end of year                                      $        1,048,618   $        1,489,027
                                                                   =========================================
</TABLE>

The Bank has pledged its stock in the Federal Home Loan Bank and entered into a
security agreement with a blanket floating lien pledging mortgage loans to
secure potential borrowings from the Federal Home Loan Bank of Atlanta.  Unused
borrowing capacity from the Federal Home Loan Bank amounts to approximately $10
million at September 30, 1998.  No advances were outstanding at September 30,
1998 or 1997.


NOTE 4.  MORTGAGE-BACKED SECURITIES

Mortgage-backed securities consist of the following at September 30, 1998 and
1997:

<TABLE>
<CAPTION>
                                                                  Gross            Gross
                                                Amortized       Unrealized       Unrealized      Fair
                              September 30        Cost             Gains           Losses        Value
                              ----------------------------------------------------------------------------
<S>                           <C>               <C>             <C>              <C>                 <C>
GNMA mortgage-backed
 securities
                                  1998  $       301,097  $        40,883  $           -    $       341,980
                                  1997          418,657           62,668              -            481,325
</TABLE>

All of the Bank's mortgage-backed securities have been classified as held to
maturity at September 30, 1998 and 1997, and there have been no sales during the
years ended September 30, 1998 and 1997.

                                       29
<PAGE>
 
SCOTLAND BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

NOTE 5.  OFFICE PROPERTIES AND EQUIPMENT


Office properties and equipment consist of the following at September 30, 1998
and 1997:


<TABLE>
<CAPTION>
                                                                            1998                 1997
                                                                   -----------------------------------------
<S>                                                                  <C>                  <C> 
Land                                                                 $          141,406   $          141,406
Office buildings and improvements                                               954,743              954,661
Furniture and fixtures                                                          195,335              306,789
                                                                   -----------------------------------------
                                                                              1,291,484            1,402,856
Accumulated depreciation                                                       (535,503)            (610,497)
                                                                   -----------------------------------------
                                                                     $          755,981   $          792,359
                                                                   =========================================
</TABLE>

NOTE 6. SAVINGS DEPOSITS
 
Savings deposits consist of the following at September 30, 1998 and 1997:

<TABLE>
<CAPTION>
                                                                            1998                 1997
                                                                   -----------------------------------------
<S>                                                                  <C>                  <C> 
Regular savings,  2.93% (2.92% in 1997)                              $        3,866,118   $        4,106,067
MMDA accounts,  4.36% (4.33% in 1997)                                         6,334,998            5,380,543
NOW accounts,  2.03% (2.00% in 1997)                                          2,507,891            2,620,405
Super NOW accounts,  2.25% (2.25% in 1997)                                      313,794              364,073
Noninterest-bearing accounts                                                    678,437              633,056
                                                                   -----------------------------------------
                                                                             13,701,238           13,104,144
                                                                   -----------------------------------------
Certificates of deposit: weighted average rate of 5.36% (5.45% in 1997)
 0.00% to 3.00%                                                                  96,410              139,441
 3.01% to 5.00%                                                               7,951,887            9,277,632
 5.01% to 7.00%                                                              22,487,165           19,958,213
 7.01% to 9.00%                                                                       -              612,218
                                                                   -----------------------------------------   
                                                                             30,535,462           29,987,504
                                                                   -----------------------------------------
Accrued interest payable                                                         33,988               48,077
                                                                   -----------------------------------------
                                                                     $       44,270,688   $       43,139,725
                                                                   =========================================
Weighted average cost of savings deposits                                          4.81%                4.74%
                                                                   =========================================
</TABLE>

                                       30
<PAGE>
 
SCOTLAND BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

NOTE 6.   SAVINGS DEPOSITS (CONTINUED)


At September 30, 1998, the scheduled maturities of certificates of deposit are
as follows:


<TABLE>
<S>                                                          <C> 
1999                                                           $  26,489,774
2000                                                               3,855,885
2001                                                                 164,385
2002                                                                  25,418
                                                             ---------------
                                                               $  30,535,462
                                                             ===============
</TABLE>

The aggregate amount of certificates of deposit with a minimum denomination of
$100,000 at September 30, 1998 is as shown below:

<TABLE>
<CAPTION>
Maturity                                                           Amount
-------------------------------------------------------------------------------
<S>                                                          <C> 
Less than 3 months                                             $   1,334,083
3 to 6 months                                                      1,149,734
6 to 12 months                                                     1,021,887
More than 12 months                                                  301,310
                                                             ---------------
                                                               $   3,807,014
                                                             ===============
</TABLE>

Eligible savings accounts are insured up to $100,000 by the SAIF which is
administered by the FDIC.


Interest expense on savings deposit accounts for the years ended September 30,
1998 and 1997 is summarized as follows:


<TABLE>
<CAPTION>
                                                      1998         1997
                                                    ------------------------
<S>                                                 <C>           <C>  
Regular savings accounts                            $   118,082   $  119,308
MMDA and NOW accounts                                   327,229      248,592
Certificate of deposit accounts                       1,675,023    1,614,158
                                                    ------------------------
                                                    $ 2,120,334  $ 1,982,058
                                                    ========================
</TABLE>


NOTE 7.   NOTE PAYABLE

The Company had an unsecured note payable to another bank for $5,500,000 at
September 30, 1997 which bears interest at 6.5% (prime minus 2%) and was due in
full on October 31, 1997. Maximum borrowings outstanding during the years ended
September 30, 1998 and 1997 were $5,500,000.

                                       31
<PAGE>
 
SCOTLAND BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

NOTE 8.  INCOME TAXES

Under the Internal Revenue Code, the Bank is allowed a special bad debt
deduction related to additions to tax bad debt reserves established for the
purpose of absorbing losses. Through 1996, the provisions of the Code permitted
the Bank to deduct from taxable income an allowance for bad debts based upon a
percentage of taxable income (8%) before such deduction or actual loss
experience. Legislation passed in 1996 eliminated the percentage of taxable
income method as an option for computing bad debt deductions in all future
years. The Bank will still be permitted to take deductions for bad debts, but
will be required to compute such deductions using an experience method.

The Bank will also have to recapture its tax bad debt reserves which have
accumulated since 1987 and amount to approximately $340,000 over a six year
period. The tax associated with the recaptured reserves is approximately
$126,000. The recapture was scheduled to begin with the Bank's 1997 year, but
has been delayed two years since the Bank originated a required minimum level of
residential mortgage loans. Deferred income taxes have been previously
established for the taxes associated with the recaptured reserves and the
ultimate payment of the taxes will not result in a charge to earnings.

Deferred taxes have been provided for certain increases in the Bank's tax bad
debt reserves subsequent to December 31, 1987 in excess of additions to recorded
loan loss allowances. At September 30, 1998, retained earnings contain certain
historical additions to bad debt reserves for income tax purposes of
approximately $1,422,000, the balance at December 31, 1987, for which no
deferred taxes have been provided because the Bank does not intend to use these
reserves for purposes other than to absorb losses. If amounts which qualified as
bad debt deductions are used for purposes other than to absorb bad debt losses
or adjustments arising from the carryback of net operating losses, income taxes
may be imposed at the then existing rates. The approximate amount of
unrecognized tax liability associated with these historical additions is
$540,000. In the future, if the Bank does not meet the income tax requirements
necessary to permit the deduction of an allowance for bad debts, the Bank's
effective tax rate would be increased to the maximum percent under existing law.


Deferred income taxes consist of the following components as of September 30,
1998 and 1997:

<TABLE>
<CAPTION>
                                                       1998        1997
                                                    ---------------------
Deferred tax assets:                              
<S>                                                 <C>        <C>
 Deferred directors retirement expense              $       -  $    2,262
 Excess book pension expense                            4,380      22,673
 Allowance for loan losses                             96,828      94,567
 Deferred management recognition plan                  36,417      36,417
                                                    ---------------------
    Total deferred tax assets                         137,625     155,919
                                                    ---------------------
Deferred tax liabilities:                                         
 Market valuation of investments                      464,134     317,823
 Tax bad debt reserves                                126,375     126,375
 Excess accumulated tax depreciation                  173,425     177,621
 Federal Home Loan Bank stock basis                    83,795      83,795
 Other                                                  5,830       4,071
                                                    ---------------------
    Total deferred tax liabilities                    853,559     709,685
                                                    ---------------------
    Net deferred tax liabilities                    $ 715,934  $  553,766
                                                    =====================
</TABLE>

                                       32
<PAGE>
 
SCOTLAND BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

NOTE 8.   INCOME TAXES (CONTINUED)

The Company's effective income tax rate differs from the federal statutory rate
of 35% as follows:


<TABLE>
<CAPTION>
                                                          1998         1997
                                                      ------------------------
<S>                                                   <C>           <C>  
Statutory federal income tax rate                         35.00 %      35.00 %
  State income taxes, net of federal benefit               4.10         1.80
  Nontaxable municipal interest                           (1.02)       (4.86)
    Other, net                                            (1.48)       (2.22)
                                                      ------------------------
Effective income tax rate                                 36.60 %      29.72 %
                                                      ========================
</TABLE>


NOTE 9.   EARNINGS PER SHARE

Earnings per share has been calculated in accordance with Financial Accounting
Standards Board Statement No. 128, "Earnings Per Share," and Statement of
Position 93-6, "Employers' Accounting for Employee Stock Ownership Plans." For
purposes of this computation, the number of shares of common stock purchased by
the Bank's employee stock ownership plan which have not been allocated to
participant accounts are not assumed to be outstanding. MRP restricted stock
awards and stock options for the year ended September 30, 1998 have not been
included in diluted earnings per share since they are anti-dilutive. The
following are reconciliations of the amounts used in the per share calculations:


<TABLE>
<CAPTION>
                                          For the Year Ended September 30, 1998
                                        ---------------------------------------
                                          Income         Shares      Per Share
                                        (Numerator)   (Denominator)    Amount
                                        ---------------------------------------
<S>                                     <C>           <C>            <C> 
BASIC AND DILUTED EPS                   
Income available to stockholders          $   528,749    1,676,597     $ 0.32
                                        =======================================
                                        
                                          For the Year Ended September 30, 1997
                                        ---------------------------------------
                                          Income         Shares      Per Share
                                        (Numerator)   (Denominator)    Amount
                                        ---------------------------------------
BASIC EPS                               
Income available to stockholders          $ 1,258,260    1,705,453     $ 0.74
                                                                       ========
                                        
EFFECT OF DILUTIVE SECURITIES           
MRP restricted stock awards                         -        2,948
Stock options                                       -        9,893
                                        --------------------------
DILUTED EPS                             
Income available to stockholders          $ 1,258,260    1,718,294     $ 0.73
                                        =======================================
</TABLE> 

                                       33
<PAGE>
 
SCOTLAND BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

NOTE 10.  STOCKHOLDERS' EQUITY

On March 29, 1996, Scotland Bancorp, Inc. completed and closed its stock
offering.  Gross proceeds from the sale of 1,840,000 shares amounted to
$18,400,000 and were reduced by conversion costs of $980,664.  The Company paid
$7,752,868 for all of the common stock of the Bank, and retained the remaining
net proceeds.

Concurrent with the Conversion, the Bank established a liquidation account in an
amount equal to its net worth as reflected in its latest statement of financial
condition used in its final offering circular.  The liquidation account will be
maintained for the benefit of eligible deposit account holders and supplemental
eligible deposit account holders who continue to maintain their deposit accounts
in the Bank after the Conversion.  Only in the event of a complete liquidation
will eligible deposit account holders and supplemental eligible deposit account
holders be entitled to receive a liquidation distribution from the liquidation
account in the amount of the then current adjusted sub-account balance.

Subject to applicable law, the Board of Directors of Scotland Savings and
Scotland Bancorp, Inc. may each provide for the payment of dividends.  Future
declarations of cash dividends, if any, by the Company may depend upon dividend
payments by the Bank to the Company.  Subject to regulations promulgated by the
NC Administrator, the Bank will not be permitted to pay dividends on its common
stock if its stockholders' equity would be reduced below the amount required for
the liquidation account or its capital requirement.

For a period of five years after its conversion from mutual to stock form,
Scotland Savings  must obtain the written approval from the NC Administrator
before declaring or paying a cash dividend to Scotland Bancorp, Inc. on its
capital stock in an amount in excess of one-half of the greater of (i) the
Bank's net income for the most recent fiscal year end or (ii) the average of the
Bank's net income after dividends for the most recent fiscal year-end and not
more than two of the immediately preceding fiscal year ends.  During 1998 and
1997, the Bank paid  $335,000 and $306,000, respectively, in regular dividends
to Scotland Bancorp, Inc.  In 1998, with the permission of the NC Administrator,
the Bank paid $5,481,600 in special dividends to the Company to pay off the note
payable discussed in Note 7.

Scotland Bancorp, Inc. paid regular cash dividends totaling $0.20 per share and
$0.30 per share during the years ended September 30, 1998 and 1997,
respectively, and a return of capital dividend of $6.00 per share during 1997.

                                       34
<PAGE>
 
SCOTLAND BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

NOTE 10.          STOCKHOLDERS' EQUITY (CONTINUED)

The FDIC requires Scotland Savings to have a minimum leverage ratio of Tier I
Capital  to total assets of 3% based on the Bank's latest regulatory
examination.  The FDIC also requires that the Bank maintain a ratio of total
capital to risk-weighted assets of 8%, of which at least 4% must be in the form
of Tier I Capital.  The North Carolina Savings Institutions Division requires a
net worth equal to at least 5% of total assets.


At September 30, 1998 and 1997, Scotland Savings complied with all capital
requirements described above as shown below:


<TABLE>
<CAPTION>
                                                             September 30, 1998 (Bank only)
                                     ---------------------------------------------------------------------------
                                           Leverage            Tier I                                  NC
                                           Ratio of             Risk-              Risk-             Savings
                                            Tier I            Adjusted             Based              Bank
                                            Capital            Capital            Capital            Capital
                                     ---------------------------------------------------------------------------
<S>                                  <C>                  <C>                <C>                <C>            
GAAP capital                           $     12,977,896   $     12,977,896   $     12,977,896   $     12,977,896
Unrealized gain on securities                  (757,272)          (757,272)          (757,272)          (757,272)
Allowance for loan losses                             -                  -            254,810            254,810
                                     ---------------------------------------------------------------------------
Regulatory capital                           12,220,624         12,220,624         12,475,434         12,475,434
Minimum capital requirement                   1,809,630          1,442,720          2,885,440          2,952,420
                                     ---------------------------------------------------------------------------
Excess regulatory capital              $     10,410,994   $     10,777,904   $      9,589,994   $      9,523,014
                                     ===========================================================================
 
Total Bank-only assets at
 September 30, 1998                                                                             $     59,048,393
Average Bank-only assets for the
 quarter ended September 30, 1998      $     60,321,000
Risk-weighted Bank-only assets at
 September 30, 1998                                       $     36,068,000   $     36,068,000
Capital as a percentage of assets:
 Actual                                           20.26%             33.88%             34.59%             21.13%
 Required                                          3.00%              4.00%              8.00%              5.00%
                                     ---------------------------------------------------------------------------
 Excess                                           17.26%             29.88%             26.59%             16.13%
                                     ===========================================================================
</TABLE>

                                       35
<PAGE>
 
SCOTLAND BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

NOTE 10.     STOCKHOLDERS' EQUITY (CONTINUED)

<TABLE>
<CAPTION>
                                                             September 30, 1997 (Bank only)
                                     ---------------------------------------------------------------------------
                                           Leverage            Tier I                                  NC
                                           Ratio of             Risk-              Risk-             Savings
                                            Tier I            Adjusted             Based              Bank
                                            Capital            Capital            Capital            Capital
                                     ---------------------------------------------------------------------------
<S>                                  <C>                  <C>                      <C>          <C>            
GAAP capital                           $     17,880,843   $     17,880,843         17,880,843   $     17,880,843
Unrealized gain on securities                  (518,552)          (518,552)          (518,552)          (518,552)
Allowance for loan losses                             -                  -            248,860            248,860
                                     ---------------------------------------------------------------------------
Regulatory capital                           17,362,291         17,362,291         17,611,151         17,611,151
Minimum capital requirement                   1,904,130          1,232,836          2,465,673          3,177,593
                                     ---------------------------------------------------------------------------
Excess regulatory capital              $     15,458,161   $     16,129,455   $     15,145,478   $     14,433,558
                                     ===========================================================================
 
Total Bank-only assets at
 September 30, 1997                                                                             $     63,551,855
Average Bank-only assets for the
 quarter ended September 30, 1997      $     63,471,000
Risk-weighted Bank-only assets at
 September 30, 1997                                       $     30,820,911   $     30,820,911
Capital as a percentage of assets:
 Actual                                           27.35%             56.33%             57.14%             27.71%
 Required                                          3.00%              4.00%              8.00%              5.00%
                                     ---------------------------------------------------------------------------
 Excess                                           24.35%             52.33%             49.14%             22.71%
                                     ===========================================================================
</TABLE>

Under the FDIC prompt corrective action regulations, a savings institution is
considered to be well capitalized if its ratio of total capital to risk-weighted
assets is at least 10%,  its ratio of Tier 1 capital to risk-weighted assets is
at least 6.0%, and its ratio of Tier 1 capital to total average assets is at
least 5.0%.  The Bank meets all of the above requirements and is considered to
be well capitalized under the prompt corrective action regulations.

                                       36
<PAGE>
 
SCOTLAND BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

NOTE 11.  EMPLOYEE RETIREMENT PLANS

The Bank's pension plan was transferred into The Financial Institutions
Retirement Fund during 1997. The Financial Institutions Retirement Fund is a
tax-qualified pension trust covering multiple-employers and is administered by
the Pentegra Group. Multiple-employer plans do not provide or segregate the
actuarial valuations with respect to each employer.  Therefore the components of
pension cost charged to expense for 1998 and 1997 are unavailable.

Pension expense under the Bank's defined benefit plan amounted to $97,100 and
$39,600 in 1998 and 1997, respectively.

In addition, Scotland Savings has a 401(k) retirement plan which contains
provisions for specified matching contributions by the Bank.  The Bank funds
contributions as they accrue and 401(k) plan expense amounted to $0 and $2,024
for the years ended September 30, 1998 and 1997, respectively.

NOTE 12.  DEFERRED DIRECTOR'S COMPENSATION


The Bank has a deferred compensation plan for certain of its directors under
which the directors, or their designated beneficiaries, would be paid specified
amounts over a ten-year period in return for the deferral of certain amounts of
directors fees over a seven-year period. Three directors participate in the
plan. The Bank has purchased life insurance policies with the Bank named as the
beneficiary to fund the benefits.  Total expense related to the plan amounted to
$10,004 and $11,271 for the years ended September 30, 1998 and 1997,
respectively.  The Bank's accrued liability for plan obligations amounted to
$92,685 and $106,057 at September 30, 1998 and 1997, respectively.

NOTE 13.  COMMITMENTS AND CONTINGENCIES


The Bank has entered into an employment agreement with a key executive officer
to ensure a stable and competent management base.  The agreement provides for a
three-year term, but upon each anniversary, the agreement may be extended for an
additional year so that the remaining term shall always be three years.  The
agreement provides for benefits as defined in the contract and cannot be
terminated by the Board of Directors, except for cause, without prejudicing the
officer's right to receive vested rights, including compensation, for the
remaining term of the agreement.  In the event of a change in control of the
Bank, as defined in the agreement, the agreement will automatically be extended
for three years from the date of such change in control and the acquirer will be
bound to the terms of the contract for that period.

In addition, the Bank has entered into a special termination agreement with
another key employee which provides for severance pay benefits in the event of a
change in control of the Bank which results in the termination of such employee
or diminished compensation, duties or benefits within two years of a change in
control.  The employee covered under this agreement is entitled to a cash
payment equal to two times his average base amount of compensation, as defined
by Internal Revenue Service Code Section 280G(b)(3), for the most recent five
tax years prior to the change in control.  The agreement is effective for a
three year period and may be extended annually for an additional year.

                                       37
<PAGE>
 
SCOTLAND BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

NOTE 13.     COMMITMENT AND CONTINGENCIES (CONTINUED)

The Bank has also adopted a severance plan for the benefit of its employees in
the event of a change in control of the Bank which provides for varying
severance benefits for employees based on their salaries and length of service
with the Bank.

NOTE 14.  MANAGEMENT RECOGNITION PLAN AND STOCK OPTION PLAN

The Company's stockholders approved the Bank's Management Recognition Plan (the
"MRP") and the Company's stock option plan on April 17, 1997.  The stock option
plan provides for issuance of up to 184,000 stock options to certain officers,
directors, and employees either in the form of incentive stock options or non-
incentive stock options.  The exercise price of the stock options may not be
less than the fair value of the Company's common stock at date of grant. Under
the Plan, 177,000 of the options, which vest at the rate of 25% annually
beginning at the date of grant, were all granted on May 13, 1997 and expire on
May 13, 2007. The MRP stock awards and the stock options become fully vested if
the employee is terminated after a greater than 50% change in control of the
Company. As permitted under the generally accepted accounting principles, grants
under the stock option plan are accounted for following the provisions of APB
Opinion No. 25 and its related interpretations. Accordingly, no compensation
cost has been recognized for stock option grants made to date. Had compensation
cost been determined based on the fair value method prescribed in FASB Statement
No. 123, the pro forma effect on reported net income and earnings per share for
the years ended September 30, 1998 and 1997 would be as follows:

<TABLE>
<CAPTION>
                                                                                1998              1997
                                                                      -----------------------------------------
<S>                                                                     <C>                 <C> 
Net income                                                                              
     As reported                                                        $        528,748    $      1,258,260
     Pro forma                                                                   296,866             926,256
Basic earnings per share                                                                
     As reported                                                                    0.32                0.74
     Pro forma                                                                      0.18                0.54
Diluted earnings per share                                                              
     As reported                                                                    0.32                0.73
     Pro forma                                                                      0.18                0.54
</TABLE>

In determining the fair value of the option grant as prescribed in Statement No.
123, the Black-Scholes option pricing model was used with the following
assumptions:  a risk-free interest rate of 6.86%, expected lives of  10 years,
expected volatility of 18.88% and expected dividends of $.30 per year.

                                       38
<PAGE>
 
SCOTLAND BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
 
NOTE 14.     MANAGEMENT RECOGNITION PLAN AND STOCK OPTION PLAN (CONTINUED)
 
At September 30, 1998, 177,000 options have been granted at an exercise price of
$10.50, as adjusted for the return of capital dividend, of which 88,500 options
are currently exercisable. No options have been exercised to date and all
options granted are outstanding at September 30, 1998.
 
The MRP reserved for issuance 73,600 shares of common stock to certain officers,
directors, and employees at the time of the adoption. The Bank issued shares to
fund the MRP in May of 1997. The restricted common stock under the MRP vests at
the rate of 20% annually beginning at the date of grant. The expense relating to
the vesting of the MRP totaled $230,000 and $325,833 for the years ended
September 30, 1998 and 1997, respectively.

NOTE 15.  EMPLOYEE STOCK OWNERSHIP PLAN

The Bank has established an employee stock ownership plan ("ESOP") to benefit
all qualified employees.  The ESOP purchased 233,492 shares of common stock in
the open market subsequent to the Conversion with proceeds received from a loan
from the Company and from dividends paid to the ESOP.

The Company's note receivable is to be repaid based upon 15 annual installments
of principal and interest on March 31 of each year through  March 31, 2011.
Interest is based upon prime, which will be adjusted and paid annually.  The
note may be prepaid without penalty.  The unallocated shares of stock held by
the ESOP are pledged as collateral for the debt.  The ESOP is funded by
contributions made by the Bank in amounts sufficient to retire the debt.  At
September 30, 1998 and 1997, the outstanding balance of the note receivable is
$1,602,395 and $1,708,545 and is presented as a reduction of stockholders'
equity.

Shares released as the debt is repaid and earnings from the common stock held by
the ESOP are allocated among participants on the basis of compensation in the
year of allocation.  Benefits become 100% vested after five years of credited
service.  Forfeitures of nonvested benefits will be reallocated among remaining
participating employees in the same proportion as contributions.  All ESOP
shares would also become fully vested to the participants upon a greater than
50% change in ownership of the Company.

Dividends on unallocated shares may be used by the ESOP to repay the debt to the
Company and are not reported as dividends in the financial statements.
Dividends on allocated or committed to be allocated shares are credited to the
accounts of the participants and reported as dividends in the financial
statements.  Special return of capital dividends paid on 139,093 unallocated
ESOP shares totaled $834,558 on September 30, 1997 and are being amortized as
compensation expense in subsequent periods as ESOP shares are released to the
participants.

                                       39
<PAGE>
 
SCOTLAND BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

NOTE 15.     EMPLOYEE STOCK OWNERSHIP PLAN (CONTINUED)

Expense of $96,059 and $82,260 during 1998 and 1997 has been incurred in
connection with the ESOP.  The expense includes, in addition to the cash
contribution necessary to fund the ESOP, ($17,183) in 1998 and $16,519 in 1997,
which represents the difference between the fair value of the shares which have
been released or committed to be released to participants, and the cost of these
shares to the ESOP.  The Bank has credited (debited) this amount to paid-in
capital in accordance with the provisions of AICPA Statement of Position 93-6.

At September 30, 1998, 17,884 shares held by the ESOP have been released or
committed to be released to the plan's participants for purposes of computing
earnings per share.  The fair value of the unallocated shares amounted to
approximately $2.4 million at September 30, 1998.

NOTE 16.  CONCENTRATION OF CREDIT RISK AND OFF-STATEMENT OF FINANCIAL CONDITION

The Bank originates residential and commercial real estate loans and consumer
and commercial  loans within its primary lending area of  Scotland and  Moore
counties.

The Bank is a party to financial instruments with off-statement of financial
condition risk in the normal courseof business to meet the financing needs of
its customers.  These financial instruments include commitments to extend
credit, the undisbursed portion of construction loans, and unused portions of
equity lines of credit.  Those instruments involve, to varying degrees, elements
of credit risk and interest rate risk in excess of the amounts recognized in the
balance sheet.  Commitments to extend credit (which were principally variable
rate commitments) amounted to approximately $134,000 and $214,000 at September
30, 1998 and 1997, respectively.  The undisbursed portion of construction loans
amounted to $1,192,273 and $614,230 and the unused portion of equity lines of
credit totaled approximately $3,062,000 and $2,989,000 at September 30, 1998 and
1997, respectively.

Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract.  Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee.  Since commitments may expire without being drawn
upon, the total commitment amounts above do not necessarily represent future
cash requirements.  The Bank evaluates each customer's creditworthiness on a
case by case basis.  The amount of collateral obtained depends upon management's
credit evaluation of the customer.  Collateral held varies, but may include
residential real estate, equipment, autos, and income-producing commercial real
estate.

The Bank's exposure to credit loss in the event of nonperformance by the other
party to the financial instrument for commitments to extend credit is
represented by the contractual notional amount of those instruments.  The Bank
uses the same credit policies in making commitments and conditional obligations
as it does for on-statement of financial condition instruments.

                                       40
<PAGE>
 
SCOTLAND BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

NOTE 17.   FAIR VALUE OF FINANCIAL INSTRUMENTS

The following table reflects a comparison of carrying amounts and the fair
values of the financial instruments as of September 30, 1998 and 1997:

<TABLE>
<CAPTION>
                                                     1998                               1997
                                         Carrying              Fair         Carrying            Fair
                                          Amount              Value          Amount            Value
                                  --------------------------------------------------------------------
<S>                                 <C>              <C>              <C>              <C>   
Financial assets:                                                                         
 Cash and cash equivalents          $     2,929,818  $     2,929,818  $     3,558,248  $     3,558,248
 Federal funds sold                       5,000,000        5,000,000        3,200,000        3,200,000
 Securities held to maturity                      -                -          500,000          494,060
 Securities available for sale            8,074,324        8,074,324        8,460,850        8,460,850
 Nonmarketable equity securities            599,400          599,400          599,400          599,400
 Loans receivable                        42,484,729       43,316,387       46,463,348       46,531,442
 Mortgage-backed securities                 301,097          341,980          418,657          481,325
 Accrued interest receivable                207,409          207,409          210,759          210,759
Financial liabilities:                                                                    
 Savings deposits                        44,270,688       43,912,820       43,139,724       43,373,536
 Note payable                                     -                -        5,500,000        5,500,000
</TABLE>


The fair values utilized in the table were derived using the information
described below for the group of instruments listed.  It should be noted that
the fair values disclosed in this table do not represent market values of all
assets and liabilities of the Company and, thus, should not be interpreted to
represent the market or liquidation value of the Company.

The following methods and assumptions were used by the Company in estimating the
fair value of its financial instruments:

Cash, cash equivalents and federal funds sold:   The carrying amounts for cash,
----------------------------------------------                                 
cash equivalents and federal funds sold approximate their fair values.

Nonmarketable equity securities:  The fair value of nonmarketable equity
--------------------------------                                        
securities is the stated value by the FHLB and the cost of Fiserv stock.

Investment and mortgage-backed securities:   Fair values for securities are
------------------------------------------                                 
based on quoted market prices, where available.  If quoted market prices are not
available, fair values are based on quoted market prices of similar securities.

Loans receivable:   The fair value of fixed rate loans is estimated by
-----------------                                                     
discounting the future cash flows using the current rates at which similar loans
would be made to borrowers with similar credit ratings and for the same
remaining maturities.  The fair value of variable rate loans approximates their
carrying value as these loans reprice frequently.

Accrued interest receivable:   The fair value of accrued interest is the amount
----------------------------                                                   
receivable on demand at the statement of financial condition date.

                                       41
<PAGE>
 
SCOTLAND BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

NOTE 17.     FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)

Savings deposits:   The fair value of demand deposits, savings accounts and
-----------------                                                          
certain money market deposits is the amount payable on demand at the statement
of financial condition date.  The fair value of fixed maturity certificates of
deposit are estimated based upon the discounted value of contractual cash flows
using rates currently offered for deposits with similar remaining maturities.

Note payable:  The fair value of the note payable approximates its carrying
-------------                                                              
amount due to its short-term nature.

Off-statement of financial condition instruments:   Fair values for the Bank's
-------------------------------------------------                             
off-statement of financial condition instruments (loan commitments) are based on
fees currently charged for similar agreements, taking into account the remaining
terms of the agreements and the counterparties' credit standings.  The fair
value for such commitments is nominal.

NOTE 18.     PARENT COMPANY FINANCIAL DATA

The following is a summary of the condensed financial statements of Scotland
Bancorp, Inc. as of and for the years ended September 30, 1998 and 1997:

                           CONDENSED BALANCE SHEETS
                          SEPTEMBER 30, 1998 AND 1997

<TABLE> 
<CAPTION> 
                                                                            1998               1997
                                                                     ----------------------------------
<S>                                                                  <C>               <C> 
Assets:                                                                                    
 Cash                                                                $     2,168,725   $      2,110,284
 Investment in Scotland Savings Bank                                      12,977,896         17,880,843
 Accrued interest receivable                                                  66,112             73,204
 Prepaids and other assets                                                   225,191            146,584
                                                                   ------------------------------------
                                                                     $    15,437,924   $     20,210,915
                                                                   ====================================
Liabilities and Stockholders' Equity:                                                      
 Liabilities:                                                                              
   Note payable                                                      $             -   $      5,500,000
   Accrued dividends payable                                                  95,680            143,520
   Other accrued expenses                                                      5,191              5,469
   Deferred income taxes                                                           -              1,164
                                                                   ------------------------------------
                                                                             100,871          5,650,153
                                                                   ------------------------------------
 Stockholders' equity:                                                                     
   Additional paid-in capital                                             16,489,259         16,506,442
   Note receivable ESOP                                                   (1,602,395)        (1,708,545)
   Deferred management recognition plan                                     (594,167)          (824,167)
   Unearned compensation                                                    (802,458)          (834,558)
   Unrealized gain on securities available for sale, net of tax              757,272            518,552
   Retained earnings                                                       1,089,542            903,038
                                                                   ------------------------------------
                                                                          15,337,053         14,560,762
                                                                   ------------------------------------
                                                                     $    15,437,924   $     20,210,915
                                                                   ====================================
</TABLE> 

                                       42
<PAGE>
 
SCOTLAND BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

NOTE 18.   PARENT COMPANY FINANCIAL DATA (CONTINUED)

                        CONDENSED STATEMENTS OF INCOME
                    YEARS ENDED SEPTEMBER 30, 1998 AND 1997

<TABLE> 
<CAPTION> 
                                                                               1998              1997
                                                                   ----------------------------------
<S>                                                                  <C>              <C> 
Interest income                                                      $      237,979   $       587,304
Equity in earnings of Scotland Savings Bank                                 462,117           888,500
Miscellaneous expense                                                      (140,307)         (114,043)
Income taxes                                                                (31,040)         (103,501)
                                                                   ----------------------------------
    Net income                                                       $      528,749   $     1,258,260
                                                                   ==================================
</TABLE>

                      CONDENSED STATEMENTS OF CASH FLOWS
                    YEARS ENDED SEPTEMBER 30, 1998 AND 1997

<TABLE>
<CAPTION>
                                                                        1998              1997
                                                                  -----------------------------------
<S>                                                                 <C>               <C> 
Cash Flows from Operating Activities:                                                     
 Net income                                                         $       528,749   $     1,258,260
 Equity in earnings of Scotland Savings Bank                               (462,117)         (888,500)
 Amortization of unearned compensation                                       32,100              -  
 Other                                                                       (1,164)            1,164
 Gain on sale of securities available for sale                                 -               (6,779)
 Change in assets and liabilities:                                                        
   (Increase) decrease in other assets                                      (71,167)            2,813
   Decrease in accrued income taxes                                            -              (10,446)
   Increase (decrease) in other accrued expenses                               (278)            2,902
                                                                  -----------------------------------
    Net cash provided by operating activities                                26,123           359,414
                                                                  -----------------------------------
Cash Flows from Investing Activities:                                                     
 Purchase of investment securities available for sale                          -           (6,000,000)
 Proceeds from sale of investment securities available for sale                -            9,720,120
 Upstream dividend from Scotland Savings Bank                             5,816,600           306,000
 Principal payment received on note receivable from ESOP                    106,150            63,747
                                                                  -----------------------------------
    Net cash provided by investing activities                             5,922,750         4,089,867
                                                                  -----------------------------------
Cash Flows from Financing Activities:                                                    
 Proceeds from borrowing on note payable                                       -            5,500,000
 Payment of note payable                                                 (5,500,000)             -
 Payment of dividends                                                      (390,432)         (514,817)
 Return of capital dividends                                                   -          (11,481,600)
                                                                  -----------------------------------
    Net cash used in financing activities                                (5,890,432)       (6,496,417)
                                                                  -----------------------------------
Net increase (decrease) in cash                                              58,441        (2,047,136)
Cash, beginning                                                           2,110,284         4,157,420
                                                                  -----------------------------------
Cash, ending                                                        $     2,168,725   $     2,110,284
                                                                  ===================================
                                                                                          
Supplemental Disclosure of Noncash Financing Activities:                                  
 Dividends accrued                                                  $        84,901   $       133,088
Supplemental Disclosure of Noncash Investing Activities:                                  
 Change in unrealized gain on securities available for sale                    -                4,689
</TABLE>

                                       43
<PAGE>
 
SCOTLAND BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

NOTE 19.  FUTURE REPORTING REQUIREMENTS

The FASB has issued SFAS No. 130, "Reporting Comprehensive Income," which the
Company has not been required to adopt as of September 30, 1998.  The Statement,
which is effective for fiscal years beginning after December 15, 1997,
establishes standards for reporting and display of comprehensive income and its
components (revenues, expenses, gains and losses) in a full set of general-
purpose financial statements.  This statement requires that all items that are
recognized under accounting standards as components of comprehensive income be
reported in a financial statement that is displayed with the same prominence as
other financial statements.

The FASB has issued SFAS No. 131, "Disclosures about Segments of an Enterprise
and Related Information," which the Company has not been required to adopt as of
September 30, 1998.  This Statement, which is effective for fiscal years
beginning after December 15, 1997, requires that a public business enterprise
report financial and descriptive information about its reportable operating
segments.  Operating segments are components of an enterprise about which
separate financial information is available that is evaluated regularly by the
chief operating decision maker in deciding how to allocate resources and in
assessing performance.  Generally, financial information is required to be
reported on the basis that it is used internally for evaluating segment
performance and deciding how to allocate resources to segments.

The FASB has issued SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities," which the Company has not been required to adopt as of
September 30, 1998.  This Statement, which is effective for fiscal years
beginning after June 15, 1998, establishes accounting and reporting standards
for derivative instruments embedded in other contracts, (collectively referred
to as derivatives) and for hedging activities.  It requires that an entity
recognize all derivatives as either assets or liabilities in the statement of
financial position and measure those instruments at fair value.  If certain
conditions are met, a derivative may be specifically designated as (a) a hedge
of the exposure to changes in the fair value of a recognized asset or liability
or an unrecognized firm commitment, (b) a hedge of the exposure to variable cash
flows of a forecasted transaction, or (c) a hedge of the foreign currency
exposure of a net investment in a foreign operation, an unrecognized firm
commitment, an available-for-sale security, or a foreign-currency- denominated
forecasted transaction.  This Statement is not expected to have a significant
impact on the Company.

                                       44
<PAGE>
 
SCOTLAND BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

NOTE 19.  FUTURE REPORTING REQUIREMENTS (CONTINUED)

The FASB has issued SFAS No. 134, "Accounting for Mortgage-Backed Securities
Retained after the Securitization of Mortgage Loans Held for Sale by a Mortgage
Banking Enterprise," an amendment of FASB Statement No. 65, which the Company
has not been required to adopt as of September 30, 1998.  Statement No. 65, as
amended by FASB Statements No. 115, "Accounting for Certain Investments in Debt
and Equity Securities," and No. 125, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities," requires that after the
securitization of a mortgage loan held for sale, an entity engaged in mortgage
banking activities classify the resulting mortgage-backed security as a trading
security.  This Statement further amends Statement No. 65 to require that after
the securitization of mortgage loans held for sale, an entity engaged in
mortgage banking activities classify the resulting mortgage-backed securities or
other retained interests based on its ability and intent to sell or hold those
investments.  This Statement conforms the subsequent accounting for securities
retained after the securitization of mortgage loans by a mortgage banking
enterprise with the subsequent accounting for securities retained after the
securitization of other types of assets by a nonmortgage banking enterprise.
This Statement is effective for fiscal years beginning after December 15, 1998,
and is not expected to have a significant impact on the Company.

NOTE 20.  SALE OF THE COMPANY

In August of 1998, Scotland Bancorp, Inc. entered into an agreement to sell the
Company to Centura Banks, Inc. in a cash transaction for $11.75 per share of
Scotland Bancorp, Inc. stock.  The sale is contingent upon regulatory and
shareholder approval and is anticipated to be completed during the second
quarter of fiscal year 1999.

                                       45
<PAGE>
 
                             CORPORATE INFORMATION
 
                              EXECUTIVE OFFICERS:

<TABLE> 
<S>                                    <C>                          <C> 
WILLIAM C. FITZGERALD, III                                                 JOHN B. CLARK
      President and CEO                                             Vice President/Secretary
                                           DIRECTORS:
 
                                        S.T. SNOWDON, JR.
                                   Chairman; Retired Architect
 
JAMES E. MILLIGAN                   WILLIAM C. FITZGERALD, III              JOHN B. CLARK
  Vice Chairman;                        President and CEO             Vice President/Secretary     
Retired Newspaper Publisher          of Scotland Bancorp, Inc.         of Scotland Bancorp, Inc.
                                   
 
  JAMES W. MASON                        CLIFTON P. BUIE                JAMES S. MITCHENER, JR.
 Retired Attorney                     VP of Manufacturing,                 Retired Surgeon
                                       Charles Craft, Inc.
 
 E. S. HILL, JR.                       JOHN W. HUDSON                    JAMES T. WILLIS
 General Manager,                   Retired Plant Manager,          VP of Adams & Willis, Inc.
   Eaton Corp.                          LOF Glass                     GM of Firestone Store

    STOCK TRANSFER AGENT                                            ANNUAL MEETING
Registrar and Transfer Company                   The  1999 annual meeting  of  stockholders of
     10 Commerce Drive                           Scotland Bancorp, Inc. will be held at 4:00 p.m.  
    Cranford, NJ 07016                           on January 28, 1999 at the Company's corporate  
                                                 office at 505 South Main Street, Laurinburg, NC.

 SPECIAL LEGAL COUNSEL
Brooks, Pierce, McLendon,                                           FORM 10-KSB
Humphrey & Leonard, LLP                          A copy of Form 10-KSB as filed with the Securities and
2000 Renaissance Plaza                           Exchange Commission will be  furnished without charge 
230 North Elm Street                             to the Company's stockholders upon written request to  
Greensboro, NC 27420                             Scotland Bancorp, Inc., P. O. Box 1468, Laurinburg, NC 28353.  

INDEPENDENT AUDITORS
McGladrey & Pullen, LLP                                           CORPORATE OFFICE
6805 Morrison Boulevard                                         505 South Main Street
Charlotte, NC 28211                                             Laurinburg, NC 28301
</TABLE>

                                       46
<PAGE>
 
                           COMMON STOCK INFORMATION

There are 1,913,600 shares of common stock outstanding which were held by
approximately 470 stockholders of record (excluding shares held in street name)
on September 30, 1998.   The Company's common stock is quoted on the American
Stock Exchange under the symbol "SSB."  The following table reflects the stock
trading and dividend payment frequency of the Company for the years ended
September 30, 1998 and 1997.

<TABLE>
<CAPTION>
                                                            Dividends                       Stock Price
                                                -----------------------------------------------------------------
                                                     Regular         Special           High             Low
                                                -----------------------------------------------------------------
<S>                                               <C>            <C>              <C>            <C> 
1998:
First Quarter                                     $       0.050  $      -         $  12.875      $    9.875
Second Quarter                                            0.050         -            11.375           9.750
Third  Quarter                                            0.050         -             9.750           8.125
Fourth Quarter                                            0.050         -            11.250          10.750
</TABLE>

<TABLE>
<CAPTION>
                                                            Dividends                       Stock Price
                                                -----------------------------------------------------------------
                                                     Regular         Special           High             Low
                                                -----------------------------------------------------------------
<S>                                                  <C>         <C>              <C>            <C> 
1997:
First Quarter                                         $   0.075  $      -         $  14.375      $   12.750
Second Quarter                                            0.075         -            16.750          14.250
Third  Quarter                                            0.075         -            16.375          14.750
Fourth Quarter                                            0.075         6.00         19.250          12.500
</TABLE>

                                       47