<PAGE>
 
<TABLE> 
<CAPTION> 


                     SCOTLAND BANCORP, INC. AND SUBSIDIARY
                     SELECTED CONSOLIDATED FINANCIAL DATA



                                                                        September 30,
                                            -----------------------------------------------------------------------
                                                 1997          1996          1995           1994          1993
                                            -----------------------------------------------------------------------
                                                        (Dollars In Thousands, Except Per Share Data)
<S>                                         <C>          <C>           <C>            <C>           <C> 
 Financial Condition Data:
    Total assets                            $   64,399   $    68,622   $     57,718   $    57,715   $    55,068        
    Investments securities /(1)/                16,110        21,464         14,525        19,273        12,791        
    Loans receivable, net                       46,463        45,079         41,204        36,661        40,626        
    Deposits                                    43,140        42,410         48,203        48,995        47,477        
    Stockholders' equity /(2)/                  14,561        24,791          8,580         7,761         6,875        
    Book value per share /(2)/                    7.61         13.47             --            --            --
</TABLE> 
  
<TABLE> 
<CAPTION> 
                                                                  Years Ended September 30,
                                            -----------------------------------------------------------------------
                                                 1997          1996          1995           1994          1993
                                            -----------------------------------------------------------------------
                                                        (Dollars in Thousands, Except Per Share Data)
<S>                                         <C>          <C>           <C>            <C>           <C> 
Operating Data:                                                                                                      
   Interest and dividend income             $    5,171   $     4,870   $      4,313   $     3,889   $     4,249    
   Interest expense                              1,983         2,209          2,144         1,753         1,979    
                                           -----------------------------------------------------------------------   
   Net interest income                           3,188         2,661          2,169         2,136         2,270    
   Provision for loan losses                        24            25             11            20            25    
   Noninterest income                              306            80             73            71            71    
   Noninterest expense                           1,680         1,549          1,158         1,263         1,114    
                                           -----------------------------------------------------------------------   
   Income before income taxes                    1,790         1,167          1,073           924         1,202    
   Income tax expense                              532           409            352           292           470    
                                           -----------------------------------------------------------------------   
   Net income                                $   1,258   $       758   $        721   $       632   $       732    
                                           =======================================================================   
   Earnings per share /(2)//(3)/             $    0.74   $      0.25   $         --   $        --   $        --
   Dividends per share /(2)/                      6.30          0.15             --            --            --
   Dividend payment ratio /(2)//(6)/           851.35%        60.00%             --            --            --
</TABLE> 

                                   (Continued)

                                       1
<PAGE>
 
<TABLE> 
<CAPTION> 

                                                                    Years Ended September 30,
                                            -----------------------------------------------------------------------
                                                 1997          1996          1995           1994          1993
                                            -----------------------------------------------------------------------
                                                        (Dollars in Thousands, Except Per Share Data)
<S>                                           <C>           <C>            <C>             <C>            <C>    
Selected Other Data:
    Return on average assets                    1.84%         1.18%          1.25%           1.13%         1.33%        
    Return on average equity                    5.14%         4.31%          8.52%           8.49%        11.21%      
    Average equity to average assets           35.80%        27.38%         14.67%          13.31%        11.86%      
    Interest rate spread                        3.05%         2.84%          3.27%           3.50%         3.78%      
    Net interest margin                         4.75%         4.15%          3.87%           3.94%         4.24%      
    Efficiency ratio /(5)/                     48.08%        56.51%         51.65%          57.23%        47.59%      
    Allowance for loan losses to                                                                                      
       nonperforming loans /(4)/              830.00%       714.97%          0.00%           0.00%         0.00%      
    Nonperforming loans to total loans          0.06%         0.07%          0.00%           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 $0.30 and $0.15 for the years ended
      September 30, 1997 and 1996 and a return of capital dividend of $6.00
      during the year ended September 30, 1997.
/(3)/ Earnings per share is based on earnings from March 29, 1996 to September
      30, 1996 divided by the weighted average number of shares outstanding
      during the same period for the year ended September 30, 1996.
/(4)/ Nonperforming loans include mortgage loans and consumer/commercial loans
      90 days or more delinquent.
/(5)/ The efficiency ratio represents non-interest expense as a percentage of
      the sum of net interest income and non-interest income.
/(6)/ The dividend payment ratio represents dividends per share as a percent of
      earnings per share. Dividends per share include a $6.00 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 for 1997 and 1996, and changes in
financial position for the years ended September 30, 1997 and 1996,
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. The Company was organized to acquire all of the common stock of
Scotland Savings upon its conversion to stock form. 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, 1997,
approximately 99% of the Bank's net loan portfolio was composed of real estate
loans.

Scotland Savings's 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, 1997 and 1996

Total consolidated assets decreased by $4.2 million during 1997, from $68.6
million at September 30, 1996 to $64.3 million at September 30, 1997. The
decrease resulted primarily from the Company's utilization of cash and
investments to assist funding of the special return of capital dividend of $6
per share on the Company's 1,913,600 issued and outstanding shares of stock,
totaling $11.5 million.

Investments, including short term interest-earning deposits, federal funds sold,
U.S. Treasury and agency obligations, municipal obligations, and mortgage-backed
securities decreased by $5.4 million, primarily as a result of the return of
capital dividend. Funds generated from operations also provided a source for
cash to purchase additional investments.

Loans receivable increased by approximately $1.4 million during 1997 to $46.5
million at September 30, 1997. The markets in which the Bank operates have
experienced consistent yet limited growth in recent years. 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. Management considers the
loan growth during 1997 and 1996 to be average for its market.

Savings deposits increased by approximately $730,000 during 1997 and totaled
$43.1 million at September 30, 1997. The increase is a recovery from the prior
year decrease which was attributable to the withdrawal of deposits by account
holders to purchase shares of common stock of the Company in the Conversion.

The Company had $5.5 million in borrowings outstanding at September 30, 1997.
The $5.5 million in borrowings was incurred to facilitate disbursement of the
return of capital dividend and was repaid subsequent to year end (See Note 7 to
the consolidated financial statements). During 1997, 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 1.84% and 1.18%, and its return on
average equity was 5.14% and 4.31%, for 1997 and 1996, respectively. The return
on average assets in 1996 would have been 1.50% had the Bank not been required
to expense the cost associated with the special SAIF assessment during 1996. The
passage of the "Deposit Insurance Funds Act of 1996" was undertaken to
recapitalize the SAIF insurance fund of the FDIC and required a one time
assessment to the Bank of 65.7 basis points of its assessable deposit base as of
March 31, 1995. The expense recorded for this special assessment amounted to
$320,750 (See Note 9 to the consolidated financial statements).

The Bank is required to meet certain capital requirements as established by the
FDIC and the North Carolina Savings Institutions Division. At September 30,
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

                      MANAGEMENT'S DISCUSSION AND ANALYSIS

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

                Comparison of Operating Results for 1997 and 1996

Net Income

Net income for the years ended September 30, 1997 and 1996 was $1,258,260 and
$757,519, respectively. Net income in 1996 would have been approximately
$208,000 higher than reported earnings without the income tax effected expense
associated with the special assessment that occurred as a result of the
legislation to recapitalize the SAIF. Earnings on the invested proceeds from the
Company's stock offering had a significant positive impact on net interest
income and net income during 1997 and 1996.

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, 1997 and 1996. 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 increased by $301,711 during 1997, from $4,869,707 in 1996
to $5,171,418 in 1997. The increase in interest income during 1997 was
attributable to a $3.0 million increase in the average balance of
interest-earning assets due primarily to the proceeds received from the stock
offering. The Bank's overall yield on interest-earning assets increased slightly
during 1997, from 7.60% in 1996 to 7.70% in 1997. During 1996, interest income
increased by approximately $556,000 due primarily to an increase in the Bank's
average balance of interest-earning assets totaling approximately $8.1 million.

Interest Expense

Total interest expense decreased to $1,982,955 in 1997 from $2,208,854 in 1996,
a decrease of $225,899 or 10.2%. Scotland Savings's cost of funds was 4.65% in
1997 as compared to 4.76% in 1996. Changes in the Bank's cost of funds during
1997 was similar to changes in overall market rates. The Bank's average balance
of outstanding deposits decreased by approximately $2.3 million during 1997
resulting in a decrease in interest expense for the period. Additionally, the
average balance on borrowings declined $1.5 million to $15,000 for 1997 from
$1.5 million during 1996. Interest on borrowed funds had an immaterial impact on
the increase in interest expense in 1997.

                                       6
<PAGE>

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

                                                                                        1997
                                              At               -------------------------------------------------------
                                           September
                                           30, 1997                           (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                     5.58%          $       4,194        $         237               5.65%
  Investments, at cost (1)                      5.74%                 14,587                  934               6.40%
  Mortgage-backed securities                   11.25%                    466                   52              11.16%
  Loans receivable                              8.10%                 47,890                3,948               8.24%
                                                               -------------        -------------        -------------
Total interest-earning assets                   7.54%                 67,137        $       5,171               7.70%
                                                                                    -------------                        
Non-interest earning assets                                            1,415
                                                               -------------
      Total                                                    $      68,552        
                                                               =============        

Liabilities and retained earnings:
Interest-bearing liabilities:
  Passbook accounts                             2.92%          $       4,094        $         119               2.91%
  Transaction accounts                          3.51%                  8,562                  249               2.91%
  Certificates of deposit                       5.45%                 29,952                1,614               5.39%
  FHLB advances                                    -                       -                    -                  -
  Other                                         6.50%                     15                    1               6.67%
                                                               -------------        -------------        -------------
Total interest-bearing liabilities              5.00%                 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)                               2.54%                                       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> 


<TABLE> 
<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               $     6,059          $         326                5.38%                      
  Investments, at cost (1)                     14,550                    840                5.77%                      
  Mortgage-backed securities                      605                     68               11.24%                      
  Loans receivable                             42,878                  3,635                8.48%                      
                                          -----------          -------------
Total interest-earning assets                  64,092          $       4,869                7.60%                      
                                                               -------------                        
Non-interest earning assets                       345
                                          -----------
      Total                               $    64,437                                           
                                          ============                                           
                                                                                                                       
Liabilities and retained earnings:                                                                                     
Interest-bearing liabilities:                                                                                          
  Passbook accounts                       $     5,541          $         160                2.89%                      
  Transaction accounts                          7,024                    194                2.76%                      
  Certificates of deposit                      32,339                  1,808                5.59%                      
  FHLB advances                                   958                     47                4.91%                      
  Other                                           587                      -                   -                      
                                          -------------        -------------                      
Total interest-bearing liabilities             46,449          $       2,209                4.76%                      
                                                               -------------                       
Non-interest bearing liabilities                  400
Equity                                         17,588                                           
                                          -------------                                           
       Total                              $    64,437                                           
                                          =============                                           
Net interest income and interest                                                                                       
  rate spread (2)                                                      2,660                2.84%                     
                                                               =============
Net yield on interest-earning                                                                                          
  assets (3)                                                                                4.15%                      
Ratio of interest-earning assets to                                                                                    
  interest-bearing liabilities                                                            137.98%                      
</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 following table analyzes the dollar amount of changes in interest income and
interest expense for major components of interest-earning assets and
interest-bearing liabilities. The table on page 9 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 $24,000 and $24,528 for the
years ended September 30, 1997 and 1996, respectively. The provision, which is
charged to operations, and the resulting loan loss allowances are amounts
Scotland Savings's 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, 1997 and 1996. Scotland Savings'
charged-off loans amounted to $492 and $6,648 for the years ended 1997 and 1996,
respectively.

Noninterest Income

Noninterest income amounted to $306,272 and $80,298 in 1997 and 1996,
respectively. Noninterest income consists primarily of service charges and fees
associated with the Bank's loan and savings accounts. The increase in Scotland
Savings's level of noninterest income during 1997 relates mainly to the gain on
sale of investments of $240,726 (See Note 2 of the consolidated financial
statements).

                                       8
<PAGE>
 
<TABLE> 
<CAPTION> 
                                                                     Year Ended September 30,
                                                   1997 vs. 1996                                   1996 vs. 1995
                                      --------------------------------------------   ---------------------------------------------
                                          Increase (Decrease) Attributable to           Increase (Decrease) Attributable to
                                      --------------------------------------------   ---------------------------------------------
                                       Volume       Rate    Rate/Volume     Net       Volume      Rate      Rate/Volume     Net
                                      ---------   --------  -----------  ---------   --------   ---------   -----------   --------
                                                                              (In Thousands)
<S>                                   <C>         <C>       <C>          <C>         <C>        <C>         <C>           <C> 
Interest income on:                                                                
  Interest-bearing deposits           $   (100)   $    16   $       (5)  $    (89)   $   133    $    (36)    $     (19)   $    78
  Investments, at cost                       2         92            -         94        106          20             3        129
  Mortgage-backed securities               (15)        (1)           -        (16)       (13)          3            (1)       (11)
  Loans receivable                         425       (103)          (9)       313        353           6             -        359
                                      ---------   --------  -----------  ---------   --------   ---------   -----------   --------
   Total interest income on
   interest-earning assets                 312          4          (14)       302        579          (7)          (17)       555
                                      ---------   --------  -----------  ---------   --------   ---------   -----------   --------

Interest expense on:
  Passbook accounts                        (42)         1            -        (41)        33           3             -         36
  Transaction accounts                      42         11            2         55        (50)        (20)            4        (66)
  Certificates of deposit                 (133)       (65)           4       (194)      (130)        192           (14)        48
  FHLB advances and other                  (46)         -            -        (46)         -           -            47         47
                                      ---------   --------  -----------  ---------   --------   ---------   -----------   --------
   Total interest expense
   on interest-bearing liabilities        (179)       (53)           6       (226)      (147)        175            37         65
                                      ---------   --------  -----------  ---------   --------   ---------   -----------   --------

Increase (decrease) in net
interest income                       $    491    $    57   $      (20)  $    528    $   726    $   (182)   $      (54)   $   490
                                      =========   ========  ===========  =========   ========   =========   ===========   ========
</TABLE> 

                                       9
<PAGE>
 
                     SCOTLAND BANCORP, INC. AND SUBSIDIARY

                      MANAGEMENT DISCUSSION AND ANALYSIS

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

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 $1,680,265 and $1,549,739 in 1997 and
1996, respectively.

Compensation and employee benefits increased by $433,399 during 1997 primary due
to expenses associated with the ESOP and the Management Recognition Plan which
totaled $408,093 and $33,006 for the years ended September 30, 1997 and 1996
respectively. Deposit insurance, excluding the special SAIF assessment in 1996,
fluctuates with the level of deposits outstanding during the periods and
decreased $96,156 to $31,661 in 1997 compared to $127,817 in 1996. Noninterest
expenses were increased by the one time SAIF assessment of $320,750 in 1996.
None of the other noninterest expense categories changed significantly during
1997 and 1996.

Income Taxes

The Company's effective income tax rate was 29.72% and 35.08% in 1997 and 1996,
respectively. The differences in rates were due to changes in the components of
permanent tax differences (See Note 8 to the consolidated financial statements).

                         Capital Resources and Liquidity

Scotland Bancorp, Inc. paid regular cash dividends of $.30 per share during the
year ended September 30, 1997. 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,
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 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, 1997, cash and cash equivalents, a
significant source of liquidity, increased by approximately $1.7 million. Cash
and cash equivalents increased by $2.0 million during 1996. Cash flow resulting
from internal operating activities provided increases of $1,173,256 and
$1,139,430 in cash during the years ended September 30, 1997 and 1996,
respectively. Also, financing activities have provided sources of funds for
asset growth and liquidity. For the year ended September 30, 1997, deposits
increased by $730,000 and borrowings provided $5.5 million in cash but the
return of capital dividends decreased cash by $11.5 million. Deposits decreased
by approximately $5.8 million while proceeds from the issuance of common stock
provided funds totaling $17.4 million during 1996. 

                                      10
<PAGE>
 
                     SCOTLAND BANCORP, INC. AND SUBSIDIARY

                     MANAGEMENT'S DISCUSSION AND ANALYSIS

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

during 1996. 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 1997 and 1996, loans outstanding increased
by $1.4 million and $3.9 million, respectively. During 1997 and 1996, the
Company purchased investment securities amounting to $11.1 million and $9.7
million, respectively, and received proceeds from sales or maturities of
investment securities amounting to $18.6 million and $4.7 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, 1997,
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.

                           Asset/Liability Management

Scotland Savings's 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's net interest income. At September 30, 1997, 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 

                                      11
<PAGE>
 
                     SCOTLAND BANCORP, INC. AND SUBSIDIARY

                     MANAGEMENT'S DISCUSSION AND ANALYSIS

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

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 $25.3 million in
certificates maturing in 1998 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, 1997, 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, 1997, 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 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. 128, Earnings Per Share, which the Company has not
been required to adopt as of September 30, 1997. The Statement, which will be
effective for the Company's interim period ending after December 15, 1997,
specifies the computation, presentation and disclosure requirements for earnings
per share. The Company does not anticipate the effect of adoption of SFAS No.
128 to significantly impact earnings per share presentation.

The FASB has issued SFAS No. 130, Reporting Comprehensive Income, which the
Company has not been required to adopt as of September 30, 1997. 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.

                                      12
<PAGE>
 
                     SCOTLAND BANCORP, INC. AND SUBSIDIARY

                     MANAGEMENT'S DISCUSSION AND ANALYSIS

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

                            Impact of New Legislation

Deposit Insurance/SAIF Recapitalization

For 1996, SAIF-insured institutions paid deposit insurance assessment rates of
$0.23 to $0.31 per $100 of deposits. In contrast, institutions insured by the
FDIC's Bank Insurance Fund (the "BIF") that were well capitalized and without
any significant supervisory concerns paid the minimum annual assessment of
$2,000, and all other BIF-insured institutions paid deposit insurance assessment
rates of $0.03 to $0.27 per $100 of deposits. In response to the SAIF/BIF
assessment disparity, the Deposit Funds Insurance Act of 1996 (the "Funds Act")
was enacted into law on September 30, 1996.

The Funds Act authorized the FDIC to impose a special assessment on all
institutions with SAIF-assessable deposits in the amount necessary to
recapitalize the SAIF. As implemented by the FDIC, institutions with
SAIF-assessable deposits will pay a special assessment, subject to adjustment,
of 65.7 basis points per $100 of the SAIF-assessable deposits held at March 31,
1995. Based on the foregoing, the Bank charged $320,750 against pretax earnings
for the quarter ended September 30, 1996. The assessment is deductible in the
taxable year paid.

Due to the recapitalization of the SAIF, the FDIC proposed on October 8, 1996 to
reduce the assessment rate for SAIF-assessable deposits for periods beginning on
October 1, 1996. The proposed assessment rates would range from 18 to 27 basis
points per $100 of deposits for the last calendar quarter of 1996 and would
range from -0- to 27 basis points per $100 of deposits for subsequent assessment
periods. However, the Funds Act also provides that the FDIC cannot assess
regular insurance assessments for an insurance fund unless required to maintain
or achieve the designated reserve ratio of 1.25% per $100 of deposits, except
for institutions that are not classified as "well capitalized" or that have
moderately severe or unsatisfactory financial, operational, or compliance
weaknesses as determined by the FDIC. The Bank has not been so classified.

Accordingly, assuming the designated reserve ratio is maintained by the SAIF
after collection of the special assessment, the Bank will pay substantially
lower regular SAIF assessments compared to those paid by the Bank in recent
years, as long as it maintains its current regulatory status.

In addition, the Funds Act expanded the assessment base for the payment of
interest on FICO bonds, which were issued in the late 1980's by the Financing
Corporation to recapitalize the now defunct Federal Savings and Loan Insurance
Corporation, to include the deposits of both BIF and SAIF insured institutions
beginning January 1, 1997. Until December 31, 1999, or until such earlier date
on which the last savings association ceases to exist, the rate of assessment
for BIF insured deposits will be one-fifth of the rate imposed on
SAIF-assessable deposits. The current estimate of the assessment rate for the
payment of the FICO interest is approximately 1.3 basis points for
BIF-assessable deposits and 6.4 basis points for SAIF-assessable deposits.

The Funds Act also provides for the merger of the BIF and SAIF on January 1,
1999, assuming the prior elimination of the thrift charter. The Secretary of the
Treasury is required to conduct a study of the relevant factors for the
development of a common charter for banks and thrifts and report conclusions and
findings to Congress on or before March 31, 1997.

                                      13
<PAGE>
 
                     SCOTLAND BANCORP, INC. AND SUBSIDIARY

                     MANAGEMENT'S DISCUSSION AND ANALYSIS

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

Recapture of Tax Bad Debt Reserves

Prior to the enactment of the Small Business Job Protection Act of 1996 (the
"1996 Act") on August 20, 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
$130,000. The recapture is scheduled to begin with the Bank's 1997 year, but can
be delayed up to two years if the Bank originates a certain level of residential
mortgage loans over the next two years. The Bank was able to delay the recapture
of its bad debt reserves for the 1997 year. 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.

                                      14
<PAGE>
 
                [LOGO OF MCGLADREY & PULLEN, LLP APPEARS HERE]

                            McGLADREY & PULLEN, LLP
                            -----------------------
                 Certified Public Accountants and Consultants


                          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, 1997 and 1996, 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 financial statements referred to above present fairly, in
all material respects, the financial position of Scotland Bancorp, Inc. and
subsidiary as of September 30, 1997 and 1996, and the results of their
operations and their cash flows for the years then ended in conformity with
generally accepted accounting principles.


                                            McGladrey & Pullen, LLP

Charlotte, North Carolina
October 23, 1997

                                      15
<PAGE>
 
 SCOTLAND BANCORP, INC. AND SUBSIDIARY

 CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
 September 30, 1997 and 1996

<TABLE> 
<CAPTION> 

 ASSETS                                                                                1997               1996
 -----------------------------------------------------------------------------------------------------------------
 <S>                                                                             <C>               <C> 
 Cash and cash equivalents:
    Interest-bearing deposits                                                    $   2,931,343     $    4,251,813
    Noninterest-bearing deposits                                                       626,905            754,110
 Federal funds sold                                                                  3,200,000            100,000
 Securities held to maturity (fair value 1997 $494,060;
    1996 $2,493,515) (Note 2)                                                          500,000          2,502,326
 Securities available for sale (Note 2)                                              8,460,850         13,465,261
 Nonmarketable equity securities, at cost (Note 2)                                     599,400            599,400
 Loans receivable, net (Note 3)                                                     46,463,348         45,078,860
 Mortgage-backed securities, held to maturity, (fair value 1997
     $481,325; 1996 $616,580) (Note 4)                                                 418,657            545,290
 Accrued interest receivable on loans                                                  160,821            129,094
 Accrued interest receivable on investment securities                                   49,938            223,190
 Office properties and equipment, net (Note 5)                                         792,359            819,474
 Prepaid expenses and other assets                                                     195,666            152,747
                                                                                 ---------------------------------
            Total assets                                                         $  64,399,287     $   68,621,565
                                                                                 =================================

<CAPTION> 

 LIABILITIES AND STOCKHOLDERS' EQUITY
 -----------------------------------------------------------------------------------------------------------------
 Liabilities:
    Savings deposits (Note 6)                                                    $  43,139,725     $   42,409,568
    Note payable (Note 7)                                                            5,500,000                  -
    Accounts payable and accrued expenses (Note 12)                                    447,422            404,558
    Advances from borrowers for taxes and insurance                                    160,229            156,525
    Special SAIF assessment (Note 9)                                                         -            320,750
    Income taxes payable                                                                37,383            136,090
    Deferred income taxes (Note 8)                                                     553,766            402,802
                                                                                 ---------------------------------
            Total liabilities                                                       49,838,525         43,830,293
                                                                                 ---------------------------------
 Commitments and contingencies (Notes 13 and 16) 
 Stockholder's Equity (Note 10):
    Preferred stock, authorized 5,000,000 shares; none issued                                -                  -
    Common stock, no par value, authorized 20,000,000 shares;
       1997 1,913,600 shares issued; 1996 1,840,000 shares issued                            -                  -
    Additional paid-in capital                                                       7,939,945         17,420,468
    Note receivable from ESOP (Note 15)                                            (1,708,545)        (1,772,292)
    Unrealized gain on securities available for sale, net of tax (Note 2)              518,552            411,135
    Deferred management recognition plan  (Note 14)                                  (824,167)                  -
    Unearned compensation  (Note 15)                                                 (834,558)                  -
    Retained earnings, substantially restricted (Notes 8 and 10)                     9,469,535          8,731,961
                                                                                 ---------------------------------
            Total stockholder's equity                                              14,560,762         24,791,272
                                                                                 ---------------------------------
            Total liabilities and stockholders' equity                           $  64,399,287     $   68,621,565
                                                                                 =================================

</TABLE> 

See Notes to Consolidated Financial Statements.

                                      16
<PAGE>
 
 SCOTLAND BANCORP, INC. AND SUBSIDIARY

 CONSOLIDATED STATEMENTS OF INCOME
 Years Ended September 30, 1997 and 1996

<TABLE> 
<CAPTION> 

                                                                                    1997                 1996
 -----------------------------------------------------------------------------------------------------------------
 Interest and dividend income:
 <S>                                                                          <C>                 <C> 
    Loans                                                                     $     3,948,280     $     3,635,301
    Investment securities                                                             934,000             840,176
    Mortgage-backed securities                                                         51,846              68,193
    Other interest-bearing deposits                                                   237,292             326,037
                                                                              ------------------------------------
                                                                                    5,171,418           4,869,707
                                                                              ------------------------------------
 Interest expense:
    Deposits (Note 6)                                                               1,982,058           2,162,223
    Federal Home Loan Bank advances and other                                             897              46,631
                                                                              ------------------------------------
                                                                                    1,982,955           2,208,854
                                                                              ------------------------------------
               Net interest income                                                  3,188,463           2,660,853
 Provision for loan losses (Note 3)                                                    24,000              24,528
                                                                              ------------------------------------
               Net interest income after provision for loan losses                  3,164,463           2,636,325
                                                                              ------------------------------------
 Noninterest income:
    Gain (loss) on sale of investments (Note 2)                                       240,726             (2,462)
    Service charges and other fees                                                     44,183              54,059
    Other                                                                              21,363              28,701
                                                                              ------------------------------------
                                                                                      306,272              80,298
                                                                              ------------------------------------
 Noninterest expenses:
    Compensation and employee benefits                                              1,103,882             670,483
    Occupancy                                                                          86,990              88,859
    Insurance                                                                          31,661             127,817
    Special SAIF assessment (Note 9)                                                       --             320,750
    Data processing                                                                    94,871              97,490
    Furniture and fixture expense                                                      29,660              37,039
    Other                                                                             333,201             207,301
                                                                              ------------------------------------
                                                                                    1,680,265           1,549,739
                                                                              ------------------------------------
               Income before income taxes                                           1,790,470           1,166,884
                                                                              ------------------------------------
 Income taxes (Note 8):
    Current                                                                           487,272             512,893
    Deferred                                                                           44,938           (103,528)
                                                                              ------------------------------------
                                                                                      532,210             409,365
                                                                              ------------------------------------
               Net income                                                     $     1,258,260     $       757,519
                                                                              ====================================
 Earnings per share (Note 1)                                                  $          0.74     $          0.25
                                                                              ====================================
 Regular cash dividends per share                                             $          0.30     $          0.15
                                                                              ====================================
 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, 1997 and 1996

<TABLE> 
<CAPTION> 

-------------------------------------------------------------------------------------------------------------------    
                                                                                                                       
                                                                                          Deferred                     
                                             Additional               Note               Management                    
                                              Paid in              Receivable            Recognition                   
                                              Capital                 ESOP                  Plan                       
------------------------------------------------------------------------------------------------------------------     
<S>                                    <C>                 <C>                   <C>   
Balance, September 30, 1995            $       -           $          -          $            -                       
                                                                                                                       
  Net proceeds from issuance of                                                                                        
    common stock                           17,419,336                 -                       -                       
                                                                                                                       
  Purchase of common                                                                                                   
    stock by the ESOP                          -                  (1,772,292)                 -                       
  ESOP contribution                             1,132                 -                       -                       
  Cash dividends                               -                      -                       -                       
  Change in net unrealized gain on                                                                                     
    securities available for sale              -                      -                       -                       
  Net income                                   -                      -                       -                       
                                       ---------------------------------------------------------------------------     
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)                      
                                       ===========================================================================      
</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>  
$       -                 $        351,300               $    8,228,805               $    8,580,105     
                                                                                                                       
        -                          -                           -                          17,419,336     
                                                                                                                       
        -                          -                           -                          (1,772,292)     
        -                          -                           -                               1,132     
        -                          -                           (254,363)                    (254,363)     
                                                                                                                       
        -                           59,835                     -                              59,835     
        -                          -                            757,519                      757,519     
----------------------------------------------------------------------------------------------------
        -                          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     
====================================================================================================
</TABLE> 


                                      19
<PAGE>
 
                     (This page intentionally left blank)

                                      20
<PAGE>

SCOTLAND BANCORP, INC. AND SUBSIDIARY   
                                        
CONSOLIDATED STATEMENTS OF CASH FLOWS   
Years Ended September 30, 1997 and 1996  

<TABLE> 
<CAPTION> 

                                                                              1997                       1996
-------------------------------------------------------------------------------------------------------------------    
<S>                                                                  <C>                          <C> 
Cash Flows From Operating Activities                                                                                   
   Net income                                                        $        1,258,260           $        757,519     
   Adjustments to reconcile net income to net                                                                          
     cash provided by operating activities:                                                                            
     Depreciation                                                                36,017                     45,463     
     Provision for loan losses                                                   24,000                     24,528     
     Net amortization/(accretion) on securities                                  (7,729)                     3,179     
     Net (gain) loss on sale of securities available for sale                  (240,726)                     2,462     
     ESOP contribution expense                                                   16,519                      1,132     
     Vesting of deferred management recognition plan                            325,833                       -      
     Deferred income taxes                                                       44,938                   (103,528)    
     Changes in assets and liabilities:                                                                                
      (Increase) decrease in:                                                                                          
        Accrued interest receivable,                                                                                   
          prepaid expenses and other assets                                      98,606                    (65,661)    
      Increase (decrease) in:                                                                                          
        Income taxes payable                                                    (98,707)                   124,741     
        Accounts payable and accrued expenses                                    36,995                     28,845     
        Special SAIF assessment                                                (320,750)                   320,750     
                                                                     ----------------------------------------------    
          Net cash provided by operating activities                           1,173,256                  1,139,430     
                                                                     ----------------------------------------------    
Cash Flows From Investing Activities                                                                                   
   Proceeds from maturities of securities held to maturity                    2,000,000                    500,000     
   Purchases of securities held to maturity                                        -                      (500,000)    
   Proceeds from maturities of securities available for sale                    600,000                  1,000,000     
   Proceeds from sales of securities available for sale                      15,968,635                  3,228,099     
   Purchases of securities available for sale                               (11,100,000)                (9,202,247)    
   Principal collected on mortgage-backed securities                            126,633                    107,155     
   Net increase in loans receivable                                          (1,408,488)                (3,899,070)    
   Purchases of property and equipment                                           (8,902)                   (29,271)    
                                                                      ----------------------------------------------   
          Net cash provided by (used in) investing activities                 6,177,878                 (8,795,334)    
                                                                      ----------------------------------------------    
</TABLE> 

                               (Continued)

                                      21

<PAGE>
 SCOTLAND BANCORP, INC. AND SUBSIDIARY

 CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
 Years Ended September 30, 1997 and 1996

<TABLE> 
<CAPTION> 
                                                                                           1997                           1996
------------------------------------------------------------------------------------------------------------------------------------
<S>                                                                               <C>                              <C> 
 Cash Flows From Financing Activities
    Net increase (decrease) in savings accounts                                             730,157                    (5,793,875)
    Increase (decrease) in escrow deposits                                                    3,704                       (52,893)
    Proceeds from FHLB advances                                                                -                        3,000,000
    Repayments of FHLB advances                                                                -                       (3,000,000)
    Proceeds from borrowings on note payable                                              5,500,000                          -
    Loan to ESOP for purchase of common stock                                                  -                       (1,772,292)
    Principal payment received on note receivable from ESOP                                  63,747                          - 
    Cash dividends paid                                                                    (514,817)                     (127,144)
    Return of capital dividends                                                         (11,481,600)                         -
    Proceeds from issuance of common stock                                                     -                       17,419,336
                                                                               ----------------------------------------------------
             Net cash provided by (used in) financing activities                         (5,698,809)                    9,673,132
                                                                               -----------------------------------------------------
             Net increase in cash and cash equivalents                                    1,652,325                     2,017,228
                                                                                                   
 Cash and cash equivalents:                                                                        
    Beginning                                                                             5,105,923                     3,088,695
                                                                               ----------------------------------------------------
    Ending                                                                            $   6,758,248                 $   5,105,923
                                                                               =====================================================
 Cash and cash equivalents:                                                                        
    Cash and short-term investments                                                   $   3,558,248                 $   5,005,923
    Federal funds sold                                                                    3,200,000                       100,000
                                                                               -----------------------------------------------------
                                                                                      $   6,758,248                 $   5,105,923
                                                                               =====================================================
 Supplemental Disclosure of Cash Flow Information                                                  
    Cash payments for:                                                                             
       Interest                                                                       $   1,991,907                $    2,184,189
       Income taxes                                                                         585,979                       388,153
                                                                                                   
 Supplemental Disclosure of Noncash Investing Activities                                           
    Transfer of investments from held to maturity to                                               
       available for sale                                                                      -                        5,432,551
    Change in unrealized gain on securities available for sale                              213,443                        90,659
                                                                                                   
 Supplemental Disclosure of Noncash Financing Activities                                           
    Dividends accrued                                                                       133,088                       127,219
    Adoption of deferred management recognition plan                                      1,150,000                          -

</TABLE> 

See Notes to Consolidated Financial Statements

                                      22


<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,
income derived from 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. Scotland Bancorp, Inc. was capitalized on March 29, 1996,
therefore, the consolidated financial statements for the year ended September
30, 1996 include the operations of the Company for the periods subsequent to
March 29, 1996, and the Bank for the entire fiscal year. 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.

                                      23
<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. Unrealized gains or losses are
reported as increases or decreases in 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.

                                      24
<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, 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 life 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
life 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, 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.

                                      25
<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 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 all 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 all officers, directors and employees at the time of adoption.

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

Earnings per share: The earnings per share computation is based on net income
------------------
earned divided by the weighted average number of shares outstanding from the
beginning of the fiscal year to the end of the fiscal year. The computation for
1996 is based on net income earned from the date of Conversion, March 29, 1996,
to the end of the 1996 fiscal year. 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.

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 financial instruments are not necessarily indicative of
the amounts the Company could realize in a current 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, 1997 and 1996. 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.

                                      26
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

--------------------------------------------------------------------------------
Note 2.    Investment  Securities

Investment 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, 1997 and 1996 are as follows:

<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
    CSC stock                                            4,000                 -                  -               4,000
                                              --------------------------------------------------------------------------
                                                       599,400                 -                  -             599,400
                                              --------------------------------------------------------------------------
                                              $      8,723,875  $        856,845   $        (26,410)   $      9,554,310
                                              ==========================================================================

<CAPTION> 
                                                                                 1996         
                                              --------------------------------------------------------------------------
                                                                     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                      $      2,502,326  $          5,484   $        (14,295)   $      2,493,515
                                              --------------------------------------------------------------------------
 Available for sale:                                                                               
    U. S. Government and federal                                                                   
       agency securities                            12,497,063            17,648           (140,859)         12,373,852
    Municipal securities                               314,152             3,273             (1,549)            315,876
    FHLMC stock                                         31,114           744,419                  -             775,553
                                              --------------------------------------------------------------------------
                                                    12,842,329           765,340           (142,408)         13,465,261
                                              --------------------------------------------------------------------------
 Nonmarketable equity securities:                                                                  
    FHLB stock                                         595,400                 -                  -             595,400
    CSC stock                                            4,000                 -                  -               4,000
                                              --------------------------------------------------------------------------
                                              $        599,400  $              -   $              -    $        599,400
                                              --------------------------------------------------------------------------
                                              $     15,944,055  $        770,824   $       (156,703)   $     16,558,176
                                              ==========================================================================
</TABLE> 

                                      27
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
Note 2.    Investment Securities (Continued)

The amortized cost and fair value of debt securities held to maturity and
available for sale at September 30, 1997 by contractual maturity are shown
below. Equity securities are not included in the maturity categories because
they do not have contractual maturities.

<TABLE> 
<CAPTION> 
                                                      Held to maturity                  Available for Sale
                                              ---------------------------------------------------------------------
                                                 Amortized           Fair           Amortized           Fair
                                                    Cost            Value             Cost             Value
                                              ---------------------------------------------------------------------
<S>                                         <C>                <C>               <C>              <C> 
Due in one year through five years            $        500,000 $        494,060 $       2,500,000 $      2,479,530
Due in five years or more                                 -                -            5,100,000        5,100,000
                                              ---------------------------------------------------------------------
                                              $        500,000 $        494,060 $       7,600,000 $      7,579,530
                                              =====================================================================
</TABLE> 

Summarized below is the sales activity in investment securities:

<TABLE> 
<CAPTION> 
                                                                                   Years Ended September 30,
                                                                             --------------------------------------
                                                                                    1997               1996
                                                                             --------------------------------------
<S>                                                                        <C>                 <C>   
Proceeds from the sale of available for sale securities                      $       15,968,635 $        3,228,099
Realized gains                                                                         (240,726)            (2,397)
Realized losses                                                                            -                 4,859
                                                                             --------------------------------------
Cost of investment securities sold                                           $       15,727,909 $        3,230,561
                                                                             ======================================
</TABLE> 

Subsequent to year end, the Bank sold investments with an amortized cost of
$5,000,000 to fund the payoff of the Company's note payable discussed in Note 7.

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.

                                      28
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
Note 2.     Investment Securities (Continued)

The change in net unrealized gains and losses shown as a separate component of
equity for the years ended September 30, 1997 and 1996 is as shown below:

<TABLE> 
<CAPTION> 
                                                                                     1997              1996
                                                                             --------------------------------------
<S>                                                                         <C>                 <C> 
Balance in equity component, beginning                                       $          411,135 $          351,300
   Change in net unrealized gains                                                       213,443             90,659
   Less change in deferred income taxes                                                (106,026)           (30,824)
                                                                             --------------------------------------
Balance in equity component, ending                                          $          518,552 $          411,135
                                                                             ======================================
</TABLE> 
Investment securities with aggregate cost of $700,000 and estimated fair value
of $693,000 are pledged at September 30, 1997 to collateralize certain public
deposits.

Note 3.    Loans Receivable

Loans receivable at September 30, 1997 and 1996 consist of the following:

<TABLE> 
<CAPTION> 
                                                                                    1997               1996
                                                                             --------------------------------------
<S>                                                                        <C>                <C>   
Real estate loans:
    Residential, one-to-four units                                          $       41,018,267 $       38,694,588
    Residential, multifamily                                                         2,052,097          2,152,855
    Nonresidential real estate                                                         907,451            939,058
    Residential construction                                                           634,100          2,608,500
    Line of credit                                                                   2,539,817          2,331,895
                                                                             --------------------------------------
                                                                                    47,151,732         46,726,896
Share loans                                                                             71,058             22,660
Automobile                                                                             119,019            136,853
Other                                                                                  201,381            186,530
                                                                             --------------------------------------
                                                                                    47,543,190         47,072,939
                                                                             --------------------------------------
    Less:
       Undisbursed portion of loans in process                                         614,230          1,533,995
       Allowance for loan losses                                                       248,860            225,352
       Deferred loan fees                                                              216,752            234,732
                                                                             --------------------------------------
                                                                                     1,079,842          1,994,079
                                                                             --------------------------------------
                                                                            $       46,463,348 $       45,078,860
                                                                             ======================================
</TABLE> 

29
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

--------------------------------------------------------------------------------
Note 3.          Loans Receivable (Continued)

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

<TABLE> 
<CAPTION> 

                                               1997               1996
                                        --------------------------------------
 <S>                                    <C>                 <C>   
 Balance at the beginning of year       $    225,352        $    207,472
    Provisions charged to operations          24,000              24,528
    Charge-offs                                 (492)             (6,648)
                                        --------------------------------------
 Balance at the end of the year         $    248,860         $   225,352
                                        ======================================
</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 $30,000 at
September 30, 1997. This loan is collateral dependent and management has
determined that the underlying collateral is in excess of the carrying amounts.
As a result, the Bank has determined that a specific allowance on this loan is
not required.

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, 1997 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, 1997
and 1996 for loans made by the Bank to the Company's officers, directors and
their affiliates:

<TABLE> 
<CAPTION> 
                                                 1997            1996
                                          --------------------------------------
 <S>                                      <C>              <C>  
 Principal balances, beginning of year    $   1,459,560    $   1,436,552
       New loans originated                     224,903          224,696
       Principal repayments                    (195,436)        (201,688)
                                          --------------------------------------
 Principal balances, end of year          $   1,489,027    $   1,459,560
                                          ======================================

</TABLE> 
The Bank has pledged all of 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 $10 million
at September 30, 1997. No advances were outstanding at September 30, 1997 or
1996.




                                      30
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

--------------------------------------------------------------------------------
Note 4.    Mortgage-Backed Securities

Mortgage-backed securities consist of the following at September 30, 1997 and
1996:

<TABLE> 
<CAPTION> 

                                                                     Gross            Gross
                                                  Amortized        Unrealized       Unrealized          Fair
                              September 30           Cost            Gains            Losses           Value
                              -------------------------------------------------------------------------------------
<S>                           <C>              <C>             <C>                <C>            <C> 
GNMA mortgage-backed
   securities 
                                    1997       $    418,657    $     62,668       $     --       $    481,325
                                    1996            545,290          71,920             --            616,580
</TABLE> 

All of the Bank's mortgage-backed securities have been classified as "held to
maturity" at September 30, 1997 and 1996 and the Bank has had no sales during
the years ended September 30, 1997 and 1996.

Note 5.    Office Properties and Equipment


Office properties and equipment consist of the following at September 30, 1997
and 1996:

<TABLE> 
<CAPTION> 

                                                                                   1997               1996
                                                                            ---------------------------------
<S>                                                                         <C>               <C> 
Land                                                                        $    141,406      $      141,406   
Office buildings and improvements                                                954,661             954,661   
Furniture and fixtures                                                           306,789             297,887   
                                                                            ---------------------------------  
                                                                               1,402,856           1,393,954   
Accumulated depreciation                                                        (610,497)           (574,480)  
                                                                            ---------------------------------  
                                                                            $    792,359      $      819,474   
                                                                            =================================   
</TABLE> 

                                      31
<PAGE>

SCOTLAND BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

--------------------------------------------------------------------------------
Note 6.       Savings Deposits


Savings deposits consist of the following at September 30, 1997 and 1996:

<TABLE> 
<CAPTION> 
                                                                                         1997             1996
                                                                                 -------------------------------------
<S>                                                                              <C>                <C> 
 Regular savings, 2.92% (2.88% in 1996)                                          $      4,106,067   $    4,310,396
 MMDA accounts, 4.33% (2.87% in 1996)                                                   5,380,543        4,205,597
 NOW accounts, 2.00% (2.00% in 1996)                                                    2,620,405        2,321,234
 Super NOW accounts, 2.25% (2.25% in 1996)                                                364,073          309,628
 Noninterest-bearing accounts                                                             633,056          511,470
                                                                                 -------------------------------------
                                                                                       13,104,144       11,658,325
                                                                                 -------------------------------------
 Certificates of deposit: weighted average rate of 5.45% (5.32% in 1996)
    0.00% to 3.00%                                                                        139,441           34,342
    3.01% to 5.00%                                                                      9,277,632        8,770,704
    5.01% to 7.00%                                                                     19,958,213       21,292,981
    7.01% to 9.00%                                                                        612,218          596,187
                                                                                 -------------------------------------
                                                                                       29,987,504       30,694,214
                                                                                 -------------------------------------
 Accrued interest payable                                                                  48,077           57,029
                                                                                 -------------------------------------
                                                                                 $     43,139,725   $   42,409,568
                                                                                 =====================================
 Weighted average cost of savings deposits                                                  4.74%            4.63%
                                                                                 =====================================
</TABLE> 

Certificates of deposit by range of rate and maturity at September 30, 1997 are
summarized as follows:
<TABLE> 
<CAPTION> 

                                                            Amounts Maturing During
                             --------------------------------------------------------------------------------------
         Rate Range                  1998             1999              2000           Thereafter         Total
 ------------------------------------------------------------------------------------------------------------------
 <S>                         <C>                <C>              <C>                <C>              <C>  
 0.00% to 3.00%              $         25,051   $      114,390     $           -    $           -    $     139,441
 3.01% to 5.00%                     8,052,423        1,054,519           154,449           16,241        9,277,632
 5.01% to 7.00%                    16,603,124        3,065,996           269,446           19,647       19,958,213
 7.01% to 9.00%                       612,218                -                 -                -          612,218
                             --------------------------------------------------------------------------------------
                             $     25,292,816   $    4,234,905     $     423,895    $      35,888    $  29,987,504
                             ======================================================================================
</TABLE> 


                                      32
<PAGE>

SCOTLAND BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

--------------------------------------------------------------------------------
Note 6.     Savings Deposits (Continued)

The aggregate amount of certificates of deposit with a minimum denomination of
$100,000 at September 30, 1997 is as shown below:
<TABLE> 
<CAPTION> 
 Maturity                                                                                             Amount
 ------------------------------------------------------------------------------------------------------------------
 <S>                                                                                            <C> 
 Less than 3 months                                                                             $        1,149,516
 3 to 6 months                                                                                             922,618
 6 to 12 months                                                                                            434,376
 More than 12 months                                                                                       200,354
                                                                                                -------------------
                                                                                                $        2,706,864
                                                                                                ===================
</TABLE> 
Interest expense on savings deposit accounts for the years ended September 30,
1997 and 1996 is summarized as follows:

<TABLE> 
<CAPTION> 
                                                                                     1997               1996
                                                                             --------------------------------------
 <S>                                                                         <C>                <C>  
 Regular savings accounts                                                    $        119,308   $          160,204
 MMDA and NOW accounts                                                                248,592              193,701
 Certificate of deposit accounts                                                    1,614,158            1,808,318
                                                                             --------------------------------------
                                                                             $      1,982,058   $        2,162,223
                                                                             ======================================
</TABLE> 
Note 7.     Note Payable

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

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. The Bank was unable to take a bad debt deduction in its 1996 income
tax returns due to limitations imposed by the IRS Code. In addition, 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.


                                      33
<PAGE>

SCOTLAND BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

--------------------------------------------------------------------------------
Note 8.    Income Taxes (Continued)

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
$130,000. The recapture began with the Bank's 1997 year. 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 1987 which are in excess of additions to recorded
loan loss allowances. At September 30, 1997, 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
approximately $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,
1997 and 1996:

<TABLE> 
<CAPTION> 
                                                                                     1997               1996
                                                                               ------------------------------------
 <S>                                                                           <C>                <C> 
 Deferred tax assets:
    Deferred directors retirement expense                                      $           2,262  $          6,862
    Excess book pension expense                                                           22,673             7,625
    Allowance for loan losses                                                             94,567            85,634
    Special SAIF assessment                                                                    -           121,885
    Deferred management recognition plan                                                  36,417                 -
                                                                               ------------------------------------
         Total deferred tax assets                                                       155,919           222,006
                                                                               ------------------------------------
 Deferred tax liabilities:
    Market valuation of investments                                                      317,823           211,797
    Tax bad debt reserves                                                                126,375           126,375
    Excess accumulated tax depreciation                                                  177,621           183,838
    Federal Home Loan Bank stock basis                                                    83,795            83,795
    Other                                                                                  4,071            19,003
                                                                               ------------------------------------
         Total deferred tax liabilities                                                  709,685           624,808
                                                                               ------------------------------------
         Net deferred tax liabilities                                          $         553,766  $        402,802
                                                                               ====================================
</TABLE> 

                                      34
<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:

                                                         1997           1996
                                                       -----------------------
 Statutory federal income tax rate                        35.00 %     35.00 %
    State income taxes, net of federal benefit             1.80        1.60
    Non-taxable municipal interest                        (4.86)        - 
    Other, net                                            (2.22)      (1.52)
                                                       -----------------------
 Effective income tax rate                                29.72 %     35.08 %
                                                       =======================

Note 9.  Special SAIF Assessment

On September 30, 1996, the "Deposit Insurance Funds Act of 1996" was signed into
law. The legislation included a special assessment to recapitalize the SAIF
insurance fund up to it statutory goal of 1.25% of insured deposits. The
assessment is equal to approximately 65.7 basis points of the SAIF assessable
deposit base as of March 31, 1995. Although the assessment was paid during the
three month period ended December 31, 1996, the Bank was required to accrue and
expense such cost as of September 30, 1996. In addition, this assessment was not
deducted for tax purposes until paid. The expense recorded for the special
assessment for the year ending September 30, 1996 was $320,750.

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 for
deposit accounts then held before any liquidation distribution may be made with
respect to common stockholders.

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 stockholder's equity would be reduced below the amount required for
the liquidation account or its capital requirement.



                                      35
<PAGE>

SCOTLAND BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

--------------------------------------------------------------------------------
Note 10.          Stockholders' Equity (Continued)

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 1997, the
Bank paid $306,000 in dividends to Scotland Bancorp, Inc. Subsequent to
year-end, with the permission of the NC Administrator, the Bank paid $5,481,600
in dividends to the Company to pay off the note payable discussed in Note 7.

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




                                      36
<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, 1997, Scotland Savings complied with all capital requirements
described above as shown below:
<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                                 $  18,705,009     $  18,705,009    $  18,705,009    $  18,705,009
 Unrealized gain on securities                     (518,552)         (518,552)        (518,552)        (518,552)
 Allowances for loan losses                               -                 -          248,860          248,860
                                              ---------------------------------------------------------------------
 Regulatory capital                              18,186,457        18,186,457       18,435,317       18,435,317
 Minimum capital requirement                      1,904,130         1,232,836        2,465,673        3,177,593
                                              ---------------------------------------------------------------------
 Excess regulatory capital                    $  16,282,327     $  16,953,621    $  15,969,644    $  15,257,724
                                              =====================================================================

 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                                           28.65%            59.01%           59.81%           29.01%
    Required                                          3.00%             4.00%            8.00%            5.00%
                                              ---------------------------------------------------------------------
    Excess                                           25.65%            55.01%           51.81%           24.01%
                                              =====================================================================
</TABLE> 




                                      37
<PAGE>
SCOTLAND BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


Note 10.     Stockholders' Equity (Continued)
------------------------------------------------------------------------
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.

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
acturarial valuations with respect to each employer. Therefore, the components
of pension cost charged to expense for 1997 are unavailable.

Pension expense under the Bank's defined benefit plan amounted to $39,600 and
$62,720 in 1997 and 1996, respectively. The components of pension cost charged
to expense for 1996 consisted of the following:

<TABLE> 
<CAPTION>                                                                                              1996
                                                                                                -------------------   
<S>                                                                                            <C> 
 Service cost-benefits earned during the period                                                 $           45,594
 Interest cost on projected benefit obligation                                                              40,993
 Actual return on plan assets                                                                             (39,202)
 Amortizations and deferrals                                                                                15,335
                                                                                                -------------------
            Net periodic pension expense                                                        $           62,720
                                                                                                ===================
</TABLE> 

                                      38
<PAGE>
 
SCOTLAND BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

Note 11.   Employee Retirement Plans (Continued)

The following table sets forth the plan's funded status as of September 30, 1996
and the amounts recognized in the statement of financial position at September
30, 1996:

<TABLE>
<CAPTION>

                                                                     1996
                                                                 ------------ 
<S>                                                              <C>         
Actuarial present value of benefit obligations:
  Vested benefits                                                $    466,889
                                                                 ============ 
  Accumulated benefits                                           $    503,664
                                                                 ============ 
  Projected benefits                                             $    672,199
Plan assets at fair value, held in savings deposits                  
  of the Bank and outside insurance products                          487,951
                                                                 ------------ 
Projected benefit obligation in excess of plan assets                (184,248)
Transition obligation                                                  20,616
Unrecognized prior service cost                                       100,689
Unrecognized net loss, past experience different                     
  from that assumed                                                    47,230
                                                                 ------------ 
Accrued pension cost included in other liabilities               $    (15,713)
                                                                 ------------ 
</TABLE>

The weighted average discount rate and rate of increase in future compensation
used in determining the actuarial present value of the projected benefit
obligation are 7% and 5%, respectively. The expected long-term rate of return on
plan assets at September 30, 1996 was 7%.

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 $2,024 and
$7,001 for the years ended September 30, 1997 and 1996, 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
$11,271 and $12,419 for the years ended September 30, 1997 and 1996,
respectively. The Bank's accrued liability for plan obligations amounted to
$106,057 and $118,161 at September 30, 1997 and 1996, respectively.

                                      39
<PAGE>
 
SCOTLAND BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

--------------------------------------------------------------------------------
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 indicated 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 acquiror 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 annual compensation for income tax purposes 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.

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 the issuance of up to 184,000 stock options to all officers,
directors, and employees 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 market value of the Company's common stock at the date of grant. Under the
Plan 177,000 of 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. As
permitted under the generally accepted accounting principles, grants under the
plan are accounted for following the provisions of APB Opinion No. 25 and its
related interpretations. Accordingly, no compensation cost has been recognized
for 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 for the year ended September 30, 1997 would be as follows:

<TABLE>

    <S>                                           <C>   
    Net income                    
      As reported                                 $   1,258,260
      Pro forma                                         926,256
    Earnings per share
      As reported                                          0.74
      Pro forma                                            0.54
</TABLE>

                                      40
<PAGE>
 
SCOTLAND BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

--------------------------------------------------------------------------------
Note 14.     Management Recognition Plan and Stock Option Plan (Continued)

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 9.33 years,
expected volatility of 18.88% and expected dividends of $0.30 per year.

At September 30, 1997, 177,000 options have been granted at an exercise price of
$15.625, of which 44,250 options are currently exerciseable. No options have
been exercised to date and all options granted are outstanding at September 30,
1997. The MRP reserved for issuance 73,600 shares of common stock to all
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
related to the vesting of the MRP totaled $325,833 for the year ended September
30, 1997.

Note 15.   Employee Stock Ownership Plan

The Bank has established an employee stock ownership plan (ESOP) to benefit all
qualified employees. The ESOP purchased 147,200 shares of common stock in the
open market subsequent to the Conversion with proceeds received from a loan from
the Company.

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, 1997 and
1996, the outstanding balance of the note receivable is $1,708,545 and
$1,772,292 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.

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 on unallocated ESOP shares totaling $834,558 are
recorded as unearned compensation, and reported as a separate component of
stockholders' equity.

Expense of $82,260 and $33,006 during 1997 and 1996 has been incurred in
connection with the ESOP. The expense includes, in addition to the cash
contribution necessary to fund the ESOP, $16,519 in 1997 and $1,132 and 1996,
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 this amount to paid-in capital in
accordance with the provisions of AICPA Statement of Position 93-6.

                                      41
<PAGE>
 
SCOTLAND BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

--------------------------------------------------------------------------------
Note 15.   Employee Stock Ownership Plan (Continued)

At September 30, 1997, 8,108 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 $1.7 million at September 30, 1997.

Note 16.   Concentration of Credit Risk and Off-Statement of Financial 
           Condition Risk

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 course of 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
statement of financial condition. Commitments to extend credit (which were
principally variable rate commitments) amounted to approximately $214,000 and
$621,000 at September 30, 1997 and 1996, respectively. The undisbursed portion
of construction loans amounted to $614,230 and $1,533,995 and the unused portion
of equity lines of credit totaled approximately $2,989,000 and $2,815,000 at
September 30, 1997 and 1996, 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.

                                      42
<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, 1997 and 1996:

<TABLE>
<CAPTION>

                                                    1997                            1996
                                         Carrying          Fair           Carrying           Fair
                                          Amount          Value            Amount           Value
                                      --------------------------------------------------------------
Financial assets:
<S>                                   <C>             <C>             <C>              <C>          
  Cash and cash equivalents           $   3,558,248   $   3,558,248   $    5,005,923   $   5,005,923
  Federal funds sold                      3,200,000       3,200,000          100,000         100,000
  Securities held to maturity               500,000         494,060        2,502,326       2,493,515
  Securities available for sale           8,460,850       8,460,850       13,465,261      13,465,261
  Nonmarketable equity securities           599,400         599,400          599,400         599,400
  Loans receivable                       46,463,348      46,531,442       45,078,860      45,051,588
  Mortgage-backed securities                418,657         481,325          545,290         616,580
  Accrued interest receivable               210,759         210,759          352,284         352,284
Financial liabilities:
  Savings deposits                       43,139,724      43,373,536       42,409,568      42,531,568
  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 approximate their fair values.

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.

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

                                      43
<PAGE>
 
SCOTLAND BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

--------------------------------------------------------------------------------
Note 17.   Fair Value of Financial Instruments (Continued)

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 receivable is
---------------------------
the amount receivable on demand at the statement of financial condition date.

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.

                                      44
<PAGE>
 
SCOTLAND BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

--------------------------------------------------------------------------------
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 periods ended September 30, 1997 and 1996:

                            Condensed Balance Sheets

                           September 30, 1997 and 1996 

<TABLE>
<CAPTION>

                                                                            1997               1996
                                                                       --------------------------------
Assets:
<S>                                                                    <C>                 <C>         
  Cash                                                                 $  2,110,284        $  4,157,420
  Securities available for sale                                                  -            3,708,652
  Investment in Scotland Savings Bank                                    17,880,843          16,851,668
  Accrued interest receivable                                                73,204             140,414
  Prepaids and other assets                                                 146,584              82,537
  Deferred income taxes                                                          -                1,594
                                                                       --------------------------------
                                                                       $ 20,210,915        $ 24,942,285
                                                                       ================================
Liabilities and Stockholders' Equity:
  Liabilities:
    Note payable                                                       $  5,500,000        $         -
    Accrued dividends payable                                               143,520             138,000
    Other accrued expenses                                                    5,469               2,566
    Income taxes payable                                                         -               10,446
    Deferred income taxes                                                     1,164                  -
                                                                       --------------------------------
                                                                          5,650,153             151,012
                                                                       --------------------------------
Stockholders' Equity:
    Additional paid-in capital                                           16,506,442          25,986,966
    Note receivable ESOP                                                 (1,708,545)         (1,772,292)
    Deferred management recognition  plan                                  (824,167)                 -
    Unearned compensation                                                  (834,558)                 -
    Unrealized gain on available for sale securities, net of tax            518,552             411,135
    Retained earnings                                                       903,038             165,464
                                                                       --------------------------------
                                                                         14,560,762          24,791,273
                                                                       --------------------------------
                                                                       $ 20,210,915        $ 24,942,285
                                                                       ================================
</TABLE>

                                      45
<PAGE>
 
SCOTLAND BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

--------------------------------------------------------------------------------
Note 18.   Parent Company Financial Data (Continued)


                         Condensed Statements of Income
      Year Ended September 30, 1997 and the period from March 29, 1996 to
                               September 30, 1996

<TABLE>
<CAPTION>

                                                    1997              1996
                                                ------------------------------
<S>                                             <C>                <C>        
Interest income                                 $   587,304        $   281,982
Equity in earnings of Scotland Savings Bank         888,500            251,941
Miscellaneous expense                              (114,043)           (22,150)
Income taxes                                       (103,501)           (91,946)
                                                ------------------------------
                                                $ 1,258,260        $   419,827
                                                ==============================
</TABLE>

                                      46
<PAGE>
 
SCOTLAND BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

--------------------------------------------------------------------------------
Note 18.   Parent Company Financial Data (Continued)

                      Condensed Statements of Cash Flows
     Year Ended September 30, 1997 and the period from March 29, 1996 to 
                              September 30, 1996

<TABLE>
<CAPTION>

                                                                            1997               1996
                                                                       --------------------------------
Cash Flows from Operating Activities:
<S>                                                                    <C>                 <C>         
  Net income                                                           $  1,258,260        $    419,827
  Equity in earnings of Scotland Savings Bank                              (888,500)           (251,941)
  Other                                                                       1,164               2,186
  Gain on the sale of securities available for sale                          (6,779)                 -
  Change in assets and liabilities:
    (Increase) decrease in other assets                                       2,813            (212,168)
    Increase (decrease) in accrued income taxes                             (10,446)             10,446
    Increase in other accrued expenses                                        2,902               2,566
                                                                       --------------------------------
      Net cash provided by (used in) operating activities                   359,414             (29,084)
                                                                       --------------------------------
Cash Flows from Investing Activities:
  Purchase of investment securities available for sale                   (6,000,000)         (3,715,528)
  Proceeds from sale of investment securities available for sale          9,720,120                  -
  Upstream dividend from Scotland Savings Bank                              306,000             135,000
  Initial investment in Scotland Savings Bank                                    -           (7,752,868)
  Loan to ESOP for purchase of common stock                                      -           (1,772,292)
  Principal payment received on note receivable from ESOP                    63,747                  -
                                                                       --------------------------------
      Net cash provided by (used in) investing activities                 4,089,867         (13,105,688)
                                                                       --------------------------------
Cash Flows from Financing  Activities:
  Proceeds from borrowings on note payable                                5,500,000                  - 
  Common stock proceeds received from the Conversion                             -           17,419,336
  Payment of dividends                                                     (514,817)           (127,144)
  Return of capital dividends                                           (11,481,600)                 -
                                                                       --------------------------------
      Net cash provided by (used in) financing activities                (6,496,417)         17,292,192
                                                                       --------------------------------
Net increase (decrease) in cash                                          (2,047,136)          4,157,420
Cash, beginning                                                           4,157,420                  -
                                                                       --------------------------------
Cash, ending                                                           $  2,110,284        $  4,157,420
                                                                       ================================
Supplemental Disclosure of Noncash Financing Activities:
  Dividends accrued                                                    $    133,088        $    127,219
Supplemental Disclosure of Noncash Investing Activities:
  Change in unrealized gain on securities available for sale                  4,689               4,689
</TABLE>

                                      47
<PAGE>
 
SCOTLAND BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

--------------------------------------------------------------------------------
Note 19.   Future Reporting Requirements


The FASB has issued SFAS No. 128, Earnings Per Share, which the Company has not
been required to adopt as of September 30, 1997. The Statement, which will be
effective for the Company's interim period ending after December 15, 1997,
specifies the computation, presentation and disclosure requirements for earnings
per share. The Bank does not anticipate the effect of adoption of SFAS No. 128
to significantly impact earnings per share presentation.

The FASB has issued SFAS No. 130, Reporting Comprehensive Income, which the
Company has not been required to adopt as of September 30, 1997. 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.

                                      48
<PAGE>
 
                              CORPORATE INFORMATION

                               EXECUTIVE OFFICERS:
 William C. Fitzgerald, III                                John B. Clark
     President and CEO                                Vice President/Secretary
                                   DIRECTORS:

                                James W. Mason
                              Chairman; Attorney


S. T. Snowdon, Jr.        William C. Fitzgerald, III         John B. Clark  
Vice Chairman;                 President and CEO       Vice President/Secretary
Retired Architect          of Scotland Bancorp, Inc.   of Scotland Bancorp, Inc.
                                        

James E. Milligan              Clifton P. Buie          James S. Mitchener, Jr. 
Retired Newspaper            VP of Manufacturing,           Retired Surgeon   
   Publisher                  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 1998 annual meeting of stockholders
    10 Commerce Drive                   Scotland Bancorp, Inc. will be held at 
   Cranford, NJ  07016                  4:00 p.m. on January 15, 1998 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 
 2000 Renaissance Plaza                 Securities and Exchange Commission will 
  230 North Elm Street                  be furnished without charge to the      
 Greensboro, NC  27420                  Company's stockholders upon written     
                                        request to Scotland Bancorp, Inc., P.O. 
                                        Box 1468, Laurinburg, NC 28301. 
                                       

  Independent Auditors                          
McGladrey & Pullen, LLP                            Corporate Office   
6805 Morrison Boulevard                         505 South Main Street  
  Charlotte, NC 28211                            Laurinburg, NC 28301 
                                       
        
                           Common Stock Information

There are 1,913,600 shares of common stock outstanding which were held by
approximately 488 stockholders of record (excluding shares held in street name)
on September 30, 1997. 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, 1997 and 1996.

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<PAGE>
 
<TABLE>
<CAPTION>


                            Dividends                Stock Price
                       Regular     Special        High          Low
                     --------------------------------------------------
1997:
<S>                  <C>          <C>         <C>           <C>        
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


1996:
First Quarter        $      -     $   -       $       -     $       -
Second Quarter              -         -               -             -
Third  Quarter            0.075       -            12.375        11.625
Fourth Quarter            0.075       -            13.875        11.875
</TABLE>

                                      50