<PAGE>
 
                                 UNITED STATES
                       ----------------------------------
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

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

                                   FORM 10-KSB

                 ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE
                         SECURITIES EXCHANGE ACT OF 1934

                         For the fiscal year ended  September 30, 1998
                                                    ----------------------

                         Commission file number        1-14266
                                                    ----------------------

                            SCOTLAND BANCORP, INC.
                (Name of small business issuer in its charter)

         North Carolina                                   56-1955133
-------------------------------            ------------------------------------
(State or other jurisdiction of            (I.R.S. Employer Identification No.)
incorporation or organization)
 
        505 South Main Street,
         Post Office Box 1468                             28353-1468
        Laurinburg, North Carolina                        ----------
------------------------------------------                (Zip Code)
(Address of principal executive offices)

                                (910) 276-2703
                          --------------------------          
                          (Issuer's telephone number)

          SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:


   Common Stock, no par value                  American Stock Exchange
----------------------------------   ------------------------------------------
       (Title of class)              (Name of each exchange on which registered)

Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Securities Exchange Act of 1934 during the past 12 months (or
for such shorter period that the registrant was required to file such reports),
and (2) has been subject to such filing requirements for the past 90 
Yes. X   No
---      ---  

Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained in this form, and no disclosure will be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. [ ]

State issuer's revenues for its most recent fiscal year $4,638,721

State the aggregate market value of the voting stock held by non-affiliates
computed by reference to the price at which the stock was sold, or the average
bid and asked prices of such stock, as of a specified date within the past 60
days. Common Stock, no par value -- $16,657,956 (based on the price at which the
stock was sold on December 11, 1998).

State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date.

       Common Stock, no par value                  1,913,600
       --------------------------       ----------------------------------
              (Class)                   (Outstanding at December 11, 1998)

                      DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Annual Report to Stockholders for the year ended September 30,
1998 (the "1998 Annual Report"), are incorporated by reference into Part I and
Part II. Portions of the Proxy Statement for the Annual Meeting of Stockholders
to be held on January 28, 1999 (the "Proxy Statement"), are incorporated by
reference into Part III.

Transitional Small Business Disclosure Format (Check one):  Yes    No  X
                                                               ---    ---
<PAGE>
 
                                    PART I

ITEM 1.     DESCRIPTION OF BUSINESS

General

         Prior to March 29, 1996, Scotland Savings Bank, Inc., SSB (the "Bank")
operated as a mutual North Carolina-chartered savings bank. On March 29, 1996,
the Bank converted from a North Carolina-chartered mutual savings bank to a
North Carolina-chartered stock savings bank (the "Conversion"). In connection
with the Conversion, all of the issued and outstanding capital stock of the Bank
was acquired by Scotland Bancorp, Inc., a North Carolina corporation (the
"Company") which was organized to become the Bank's holding company. At that
time, the Company had an initial public offering of its common stock, no par
value (the "Common Stock").

         The Company is a bank holding company registered with the Board of
Governors of the Federal Reserve System (the "Federal Reserve") under the Bank
Holding Company Act of 1956, as amended (the "BHCA") and the savings bank
holding company laws of North Carolina. The Company's and the Bank's principal
office is located at 505 South Main Street, Laurinburg, North Carolina. The
Company's activities consist of investing the proceeds of its initial public
offering which were retained at the holding company level, holding the
indebtedness outstanding from the Scotland Savings Bank, Inc., SSB Employee
Stock Ownership Plan (the "ESOP") and owning the Bank. The Company's principal
sources of income are earnings on its investments and interest payments received
from the ESOP with respect to the ESOP loan. In addition, the Company will
receive any dividends which are declared and paid by the Bank on its capital
stock.

         The Bank was originally chartered in 1923 and has been a member of the
Federal Home Loan Bank ("FHLB") system since 1933. The deposits of the Bank are
insured by the Savings Association Insurance Fund (the "SAIF") of the Federal
Deposit Insurance Corporation (the "FDIC") to the maximum amount permitted by
law.

         The Bank conducts business through its full service offices in
Laurinburg and Pinehurst, North Carolina. Its primarily engaged in soliciting
deposit accounts from the general public, making mortgage loans to finance the
acquisition and construction of residential dwellings and making limited types
of consumer loans. The Bank's primary source of revenue is interest income from
its lending activities; other major sources of revenue are interest and dividend
income from investments and mortgage-backed securities, interest income from its
interest-bearing deposit balances in other depository institutions and fee
income from its lending and deposit activities. The major expenses of the Bank
are interest on deposits and noninterest expenses such as compensation and
fringe benefits, data processing expenses and branch occupancy and related
expenses.

         At September 30, 1998, the Company had total assets of $60,730,000, net
loans of $42,485,000, deposits of $44,271,000, investment securities of
$16,137,000 and stockholders' equity of $15,337,000.

         At September 30, 1998, the Company and the Bank had a total of 13
employees, all of whom are full-time.

         On August 26, 1998, the Company entered into an Agreement and Plan of
Reorganization and Merger (the "Merger Agreement") with Centura Banks, Inc., a
North Carolina corporation ("Centura") that is a bank holding company registered
with the Federal Reserve. The Merger Agreement provides for the following
transactions to effect the proposed merger of the Company with and into Centura
(the "Merger"):

      1. Centura will create Scotland Acquisition Corporation, a North Carolina
         business corporation, as a wholly-owned subsidiary;

      2. Scotland Acquisition Corporation will merge with and into the Company,
         making the Company a wholly-owned subsidiary of Centura;

                                       1
<PAGE>
 
         3. The Bank will merge with and into Centura Bank, Centura's wholly-
            owned bank subsidiary, and thereafter the Bank's two offices will
            operate as branches of Centura Bank;

         4. The Company will merge with and into Centura.

         The Merger is subject to certain regulatory approvals. Centura has
applied to (i) the Federal Reserve for approval to acquire the Company and to
merge the Company with and into Centura and to merge the Bank into Centura Bank
and to establish new branch offices at the Bank's current offices and (ii) the
North Carolina Commissioner of Banks and the North Carolina Banking Commission
for the merger of the Bank into Centura Bank and the establishment of new
branches at the Bank's current offices. The Company has applied to the
Administrator of the Savings Institutions Division, North Carolina Department of
Commerce for approval for its merger with Scotland Acquisition Corporation and
Centura and for the merger of the Bank into Centura Bank.

         The Merger also is subject to approval from the Company's stockholders.
The proposal to approve the Merger Agreement and Merger will be considered at
the Company's 1999 annual meeting to be held on January 28, 1999. The Merger
will not occur if the Company and Centura do not receive all the required
regulatory approvals and the Company does not receive stockholder approval at
the annual meeting in January 1999. If stockholder and all regulatory approvals
are received, the Company and Centura anticipate consummating the Merger on
February 5, 1999.

         The Company has no operations and conducts no business of its own other
than owning the Bank, investing its portion of the net proceeds received in the
Conversion and lending funds to the ESOP. Accordingly, the discussion of the
business which follows in the Form 10-KSB concerns the business conducted by the
Bank, unless otherwise indicated.

Primary Market Area

         The Bank's primary market area is Scotland County and portions of Moore
County, North Carolina. The Bank's principal office is in Laurinburg, North
Carolina and it has one full-service branch in Pinehurst, North Carolina.
Scotland County is in southeastern North Carolina along the North Carolina/South
Carolina stateline southwest of Fayetteville, North Carolina. Pinehurst is in
Moore County, immediately north of Scotland County and northwest of
Fayetteville.

         The Bank's loans and deposits are primarily generated from the areas
where its offices are located. It does not solicit deposits and loans outside
its primary market area and does not use brokers to obtain deposits.
Approximately 85% of the Bank's deposits are at the Laurinburg office and the
majority of its customers are residents of Laurinburg and Scotland County.
Scotland County is largely rural with a population of 35,000. Its economy is
diversified among agriculture, manufacturing and services. Major area employers
include Abbott Laboratories, Campbell Soup Company, LOF Glass and
Westpoint-Stevens. Although the economy is diversified and generally stable,
population and household growth, and median and per capita income levels for
Scotland County are generally lower than comparable levels for North Carolina
and the nation, while unemployment levels are generally higher. Management
regards the Scotland County market area as a low growth area in which there is
significant competition among financial services providers for market share.
Management believes that opportunities for future earnings growth in the Bank's
home market area are limited in light of these factors.

         By comparison, in Pinehurst and Moore County, where the Bank has fewer
deposits and customers, growth and income levels exceed North Carolina and
national figures, reflecting the development of Pinehurst and Moore County as
golfing, resort and retirement centers. The major employers in Moore County
include Moore Regional Hospital, Resorts of Pinehurst and Ithaca Industries.
There is significant competition among providers of financial services in these
markets and the Bank's market share is not large.

                                       2
<PAGE>
 
Asset/Liability Management

         The Bank'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 management monitors interest rate sensitivity through the
use of a model which estimates the change in net portfolio value ("NPV") and net
interest income in response to a range of assumed changes in market interest
rates. NPV is the difference between incoming and outgoing discounted cash flows
from assets, liabilities, and off-balance sheet contracts. The table below
presents the Bank's NPV at September 30, 1998, as calculated by the FHLB, based
on quarterly information voluntarily provided to the FHLB by the Bank. Certain
assumptions were employed by the FHLB in preparing the table. These assumptions
relate to interest rates, loan prepayment rates, deposit decay rates, and the
market values of certain assets under the various interest rate scenarios. It
was also assumed that delinquency rates will not change as a result of changes
in interest rates, although there can be no assurance that this will be the
case. Even if interest rates change in the designated amounts, there can be no
assurance that the Bank's assets and liabilities would perform as set forth
below.

         As a result, certain shortcomings are inherent in the following NPV
table because the data reflects hypothetical changes in NPV based upon
assumptions used by the FHLB in the computation. However, based on the data
below, net interest income should decline with instantaneous increases in
interest rates while net interest income should increase with instantaneous
declines in interest rates. Generally, during periods of increasing interest
rates, the Bank's interest rate sensitive liabilities would reprice faster than
its interest rate sensitive assets, causing a decline in the Bank's interest
rate spread and margin. This would result from an increase in the Bank's cost of
funds that would not be immediately offset by an increase in its yield on
earning assets. An increase in the cost of funds without an equivalent increase
in the yield on earning assets would tend to reduce net interest income. In
times of decreasing interest rates, fixed rate assets would increase in value
and the lag in repricing of interest rate sensitive assets could be expected to
have a positive effect on the Bank's net interest income.

<TABLE>
<CAPTION>

                                     Estimated Change in                          NPV as a % of PV of Assets
                                     Net Portfolio Value                       ----------------------------------
                       -------------------------------------------------           
Change in Rates        $ Amount        $Change(1)               % Change(2)     NPV Ratio(3)            Change(4)
---------------      ------------------------------------------------------     ----------------------------------
                                  (Dollars in Thousands)
<S>                  <C>               <C>                       <C>            <C>                    <C>   
+400 bp                 $10,317           $(5,143)                  -33%           17.33%                -864 bp

+300 bp                 $11,641           $(3,819)                  -25%           19.55%                -642 bp

+200 bp                 $12,965           $(2,495)                  -16%           21.78%                -419 bp

+100 bp                 $14,213           $(1,247)                  - 8%           23.87%                -210 bp

   0 bp                 $15,460               ---                    ---           25.97%                    ---

-100 bp                 $16,537           $ 1,077                     7%           27.77%                +180 bp

-200 bp                 $17,614           $ 2,154                    14%           29.58%                +361 bp

-300 bp                 $18,909           $ 3,449                    22%           31.76%                +579 bp

-400 bp                 $20,204           $ 4,744                    31%           33.93%                +796 bp
</TABLE>

                                       3
<PAGE>
 
(1)      Represents the excess (deficiency) of the estimated NPV assuming the
         indicated change in interest rates minus the estimated NPV assuming no
         change in interest rates.
(2)      Calculated as the amount of change in the estimated NPV divided by the
         estimated NPV assuming no change in interest rates.
(3)      Calculated as the estimated NPV divided by present value of total
         assets.
(4)      Calculated as the excess (deficiency) of the NPV ratio assuming the
         indicated change in interest rates over the estimated NPV ratio
         assuming no change in interest rates.

         At September 30, 1998, a change in interest rates of a positive 200
basis points would have resulted in a 419 basis point decrease in NPV as a
percentage of the present value of the Bank's total assets while a change in
interest rates of a negative 200 basis points would have resulted in a 361 basis
point increase in NPV as a percentage of the present value of the Bank's total
assets.

         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 sensitivity. The program emphasizes the
origination of adjustable rate loans, which are held in the portfolio, the
investment of excess cash in short or intermediate term interest-earning assets,
and the solicitation of passbook or transaction deposit accounts which are less
sensitive to changes in interest rates and can be repriced rapidly.

Lending Activities

         General. The Bank's primary source of revenue is interest and fee
income from its lending activities, consisting primarily of mortgage loans for
the purchase or refinancing of one-to-four family residential real property
located in its primary market area. The Bank also makes loans secured by
improved nonresidential real estate (including loans secured by undeveloped real
estate), construction loans, unsecured loans, loans secured by motor vehicles
and other personal property, mobile home loans, savings account loans and other
loans. The Bank's net loan portfolio totaled approximately $42.5 million on
September 30, 1998, or 70.0% of its total assets. On that date, approximately
$36.4 million or 85.7% of loans outstanding consisted of loans secured by
mortgages on one-to-four family residential properties; $2.5 million or 5.9%
were loans secured by multifamily residential properties; approximately $775,000
or 1.8% of loans were secured by non-residential real estate; approximately
$400,000 net of loans in process or 0.9% were loans secured by residential
construction loans; approximately $2.4 million or 5.7% were line of credit
loans; and approximately $437,000 or 1.0% were loans secured by savings
accounts, automobiles or other collateral. As of September 30, 1998, 99% of the
loans in the Bank's real estate loan portfolio were secured by properties in
North Carolina. In addition to interest earned on loans, the Bank receives fees
in connection with loan originations, loan servicing, loan modifications, late
payments, loan assumptions and other miscellaneous services.

         Generally, adjustable rate loans are originated with the intention that
they will be held in the Bank's loan portfolio. The Bank currently originates a
small number of loans which do not satisfy the purchase requirements of the
Federal Home Loan Mortgage Corporation ("FHLMC") or the Federal National
Mortgage Association ("FNMA"), including loan to value ratios, income
requirements and credit history standards. The Bank originates such
nonconforming loans if they satisfy its underwriting requirements which are
tailored for the local community. While these loans generally produce a higher
yield than would be produced by loans which conform to the purchase requirements
of FHLMC and FNMA, such loans are not readily saleable in the secondary market
and could be sold only after the Bank incurred certain costs or discounted the
purchase price. The Bank plans to continue to originate a small number of
nonconforming loans because such loans meet the needs of its local community and
because such loans have historically had high rates of return and have performed
within acceptable levels.

                                       4
<PAGE>
 
         Analysis of Loan Portfolio. Set forth below is selected data relating
to the composition of the Bank's loan portfolio by type of loan on the dates
indicated.


<TABLE>
<CAPTION>
                                                                         At September 30,
                                                                         ----------------
                                                           1998                                    1997
                                                           ----                                    ----
                                                                     % of                                   % of
                                                    Amount           Total                 Amount          Total
                                                    ------           -----                 ------          -----
                                                                        (Dollars in Thousands)

<S>                                                <C>            <C>                   <C>             <C> 
Real estate loans:
  Residential 1-4 family                            $36,424         85.73%                $41,018         88.28%
  Residential multi-family                            2,514          5.92%                  2,052          4.42%
  Nonresidential real estate                            755          1.78%                    907          1.95%
  Residential construction                            1,593          3.75%                    634          1.36%
  Line of credit                                      2,406          5.66%                  2,540          5.47%
                                                    -------        -------                -------        -------
     Total real estate loans                         43,692        102.84%                 47,151        101.48%
                                                    -------        -------                -------        -------
                                                                                 
 Consumer loans:                                                                 
 Passbook or certificate                                 50          0.12%                     71          0.15%
 Automobile                                             209          0.49%                    119          0.26%
 Other                                                  178          0.42%                    201          0.43%
                                                    -------        -------                -------        -------   
   Total consumer loans                                 437          1.03%                    391          0.84%
                                                    -------        -------                -------        ------- 
                                                                                 
Less:                                                                            
 Deferred loan fees                                     197          0.46%                    216          0.46%
 Loans in process                                     1,192          2.81%                    614          1.32%
 Allowance for loan losses                              255          0.60%                    249          0.54%
                                                    -------        -------                -------        -------
     Total reductions                                 1,644          3.87%                  1,079          2.32%
                                                    -------        -------                -------        -------
                                                                                 
Total loans receivable, net                         $42,485        100.00%                $46,463        100.00%
                                                    =======        =======                =======        =======
</TABLE>

         Loan Maturity Schedule. The following table sets forth the time to
contractual maturity of the Bank's loan portfolio at September 30, 1998. Loans
which have adjustable rates and fixed rates and other loans all are shown as due
in the period of contractual maturity. Demand loans, loans having no stated
maturity and overdrafts are reported as due in one year or less. The table does
not include prepayments. Prepayments and scheduled repayments in the loan
portfolio totaled $12.7 million and $7.1 million in the fiscal years ended
September 30, 1998, and 1997, respectively. Amounts in the table are net of
loans in process and are net of unamortized loan fees.

                                       5
<PAGE>
 
<TABLE>
<CAPTION> 
                                                                    At September 30, 1998
                                   -------------------------------------------------------------------------------------
                                                      Over 1         Over 3         Over 5
                                     One Year         Year to       Years to       Years to        Over 10
                                      Or Less         3 Years        5 Years       10 Years         Years          Total
                                    ---------        --------       --------       --------        -------         -----
                                                                         (In Thousands)
<S>                                <C>             <C>             <C>           <C>            <C>           <C> 
Mortgage loans:
 Adjustable rate 1-4 family
          residential                $     40        $    214       $    414       $    734       $ 16,866       $ 18,268
  Fixed rate 1-4 family                                                                                      
         residential                       72             296            327          4,155         16,488         21,338
  Other adjustable rate real                                                                                 
          estate loans                  1,932              51             56            115             98          2,252
  Other fixed rate real estate                                                                               
          loans                            66              19             --             74            286            445
Other loans                               207             102            123              5             --            437
Less:                                                                                                        
  Allowance for loan losses              (255)             --             --             --             --           (255)
                                     --------        --------       --------       --------       --------       --------
                                     $  2,062        $    682       $    920       $  5,083       $ 33,738       $ 42,485
                                     ========        ========       ========       ========       ========       ========
</TABLE>

         The following table sets forth the dollar amount at September 30, 1998
of all loans maturing or repricing on or after September 30, 1999 which have
fixed or adjustable interest rates.

<TABLE> 
<CAPTION> 
                                                                                                   Fixed       Adjustable
                                                                                                   Rates         Rates
                                                                                                   -----       ----------
                                                                                                      (In Thousands)
<S>                                                                                             <C>             <C> 
Mortgage loans                                                                                     $21,645        $18,548
Other loans                                                                                            230               
                                                                                                   -------        -------
                                                                                                   $21,875        $18,548
                                                                                                   =======        =======
</TABLE> 

         Residential Real Estate Lending. The Bank's primary lending activity,
which it intends to continue to emphasize, is the origination of fixed and
adjustable rate first mortgage loans to enable borrowers to purchase or
refinance one-to-four family residential real property. Consistent with the
Bank's emphasis on being a community- oriented financial institution, it is and
has been the Bank's strategy to focus its lending efforts in Scotland and Moore
Counties, North Carolina and in contiguous counties. On September 30, 1998,
approximately 85.7% of the Bank's total net real estate loan portfolio consisted
of one-to-four family residential real estate loans. These include both loans
secured by detached single-family residences and condominiums and loans secured
by housing containing not more than four separate dwelling units. Of such loans,
50.0% had adjustable interest rates.

         The Bank originates adjustable rate mortgage loans secured by owner
occupied property generally having terms of 30 years in amounts of up to 95% of
the value of the property. Private mortgage insurance is always required if the
loan amount exceeds 80% of the value of the property. In addition, the Bank
makes adjustable rate

                                       6
<PAGE>
 
loans secured by non-owner occupied residential real estate generally having
terms of 20 years in amounts of up to 75% of the value of the property.
                                                    

         Interest rates on adjustable rate residential mortgage loans are tied
to the weekly average yield on United States Treasury securities adjusted to a
constant maturity of one year. Rates are subject to change annually, although in
some programs the period to the initial rate adjustment is as long as three
years. The loans have rate adjustment caps which limit the amount of rate
adjustments at any one time and over the lives of the loans.

         Adjustable rate loans are generally considered to involve a greater
degree of risk than fixed rate loans because borrowers may have difficulty
meeting their payment obligations if interest rates and required payment amounts
increase substantially.

         The Bank also originates fixed-rate mortgage loans secured by owner
occupied property having terms generally ranging from 15 to 30 years in amounts
of up to 95% of the value of the property. Private mortgage insurance is always
required if the loan amount exceeds 80% of the value of the property. In
addition, the Bank makes fixed-rate loans secured by non-owner occupied
residential real estate generally having terms of 20 years in amounts of up to
75% of the value of the property. Substantially all of the fixed-rate loans in
the Bank's mortgage loan portfolio have due on sale provisions allowing the Bank
to declare the unpaid balance due and payable in full upon the sale or transfer
of an interest in the property securing the loan.

         While one-to-four family residential loans are normally originated for
15 to 30 year terms, such loans customarily remain outstanding for substantially
shorter periods because borrowers often prepay their loans in full upon sale of
the property pledged as security or upon refinancing the original loan. Thus,
average loan maturity is a function of, among other factors, the level of
purchase and sale activity in the real estate market, prevailing interest rates,
and the interest rates payable on outstanding loans. The thrift and mortgage
banking industries have generally used 12-year and 7-year average loan lives in
calculations calling for prepayment assumptions for 30-year residential loans
and 15-year residential loans, respectively. Management believes that the Bank's
recent loan prepayment experience has been shorter than these assumed average
loan lives due to recent periods of low interest rates.

         The Bank requires title insurance for its one-to-four family
residential loans. The Bank also requires that fire and extended coverage
casualty insurance (and, if appropriate, flood insurance) be maintained in an
amount at least equal to the loan amount or replacement cost of the improvements
on the property securing the loans, whichever is greater.

         Residential Multifamily. At September 30, 1998, the Bank had
approximately $2.5 million in outstanding loans secured by multifamily
residential real estate, comprising approximately 5.9% of its loan portfolio as
of that date. Substantially all of the Bank's loans secured by multifamily
residential real estate have adjustable rates. Such loans are typically made to
a maximum of 75% of the lesser of the purchase price or appraised value of the
property for a maximum term of 20 years. All such loans are personally
guaranteed by individuals.

         Nonresidential Real Estate Lending. On September 30, 1998, the Bank had
$755,000 in outstanding loans secured by nonresidential real estate, comprising
approximately 1.8% of its net loan portfolio as of that date. Most of these
loans are secured by office, retail, other commercial real estate, as well as
church properties, and have adjustable interest rates. These loans generally do
not exceed 80% of the appraised value of the real estate securing the loans.
Loans secured by commercial real estate and undeveloped land generally are
larger than one-to-four family residential loans and involve a greater degree of
risk. Payments on these loans depend to a large degree on results of operations
and management of the properties and may be affected to a greater extent by
adverse conditions in the real estate market or the economy in general. As of
September 30, 1998, the largest nonresidential real estate loan in the Bank's
loan portfolio totaled $92,000. This loan was performing in accordance with the
original loan contract.

                                       7
<PAGE>
 
         Lines of Credit. At September 30, 1998, the Bank had approximately $2.4
million in line of credit loans, representing approximately 5.7% of its net loan
portfolio. These loans are often originated at the time of the closing of a
one-to-four family residential real estate loan secured by the same property.
The Bank's home equity lines of credit have adjustable interest rates tied to
prime interest rates plus a margin. The home equity lines of credit require
monthly payments until the loan is paid in full. Home equity lines of credit are
generally secured by subordinate liens against residential real property. The
Bank requires that fire and extended coverage casualty insurance (and, if
appropriate, flood insurance) be maintained in an amount at least sufficient to
cover its loan. Home equity loans are generally limited so that the amount of
such loans, along with any senior indebtedness, does not exceed 90% of the value
of the real estate security. Because home equity loans involve revolving lines
of credit which can be drawn over a period of time, the Bank faces risks
associated with changes in the borrower's financial condition. Because home
equity loans have adjustable interest rates with no rate caps (other than usury
limitations), increased delinquencies could occur if interest rate increases
occur and borrowers are unable to satisfy higher payment requirements. The Bank
intends to continue to emphasize its home equity program. The presence of home
equity loans in the Bank's portfolio allows the institution to manage the
interest sensitivity of its assets and liabilities because home equity lines of
credit have adjustable rates which are subject to change monthly and without any
significant rate caps.

         Construction Lending. The Bank makes construction loans primarily for
the construction of single-family dwellings. The aggregate outstanding balance
of such loans on September 30, 1998 was approximately $400,000, net of loans in
process, representing approximately 0.9% of the Bank's net loan portfolio. Most
of these loans were made to persons who are constructing properties for the
purpose of occupying them. Loans made to individual property owners are both
pure construction loans and "construction-permanent" loans which generally
provide for the payment of interest only during a construction period, after
which the loans convert to a permanent loan at fixed or adjustable interest
rates having terms similar to other one-to-four family residential loans.
Construction loans to persons who intend to occupy the finished premises
generally have a maximum loan-to-value ratio of 80%.

         Construction loans are generally considered to involve a higher degree
of risk than long-term financing secured by real estate which is already
occupied. A lender's risk of loss on a construction loan is dependent largely
upon the accuracy of the initial estimate of the property's value at the
completion of construction and the estimated cost (including interest) of
construction. If the estimate of construction costs proves to be inaccurate, the
lender may be required to advance funds beyond the amount originally committed
in order to permit completion of construction. If the estimate of anticipated
value proves to be inaccurate, the lender may have security which has value
insufficient to assure full repayment.

         Consumer Loans. In addition to the loans described above, the Bank also
offers loans which are primarily secured by various items of personal property
or which are unsecured. As of September 30, 1998, the Bank had approximately
$437,000 of such loans outstanding, representing approximately 1.0% of its net
loan portfolio. Many of these loans are secured by deposits, new and used motor
vehicles, mobile homes and other properties. New and used motor vehicle
financing is available for terms of up to four years. Generally, financing of
new and current year models does not exceed 80% of the sticker price. Financing
of used motor vehicles does not exceed the loan value provided in the current
Southeastern Edition of the NADA Used Car Guide.

         The Bank makes unsecured consumer loans in amounts of up to 10% of an
individual borrower's verifiable net worth. Some of these loans are payable at
maturity and have a term of 90 days. Others require monthly payments and have a
term of up to 24 months. In addition, the Bank provides overdraft lines of
credit in amounts of up to $5,000. Payments are required in amounts of 5% of the
outstanding balance or $20, whichever is greater.

         Loan Solicitation, Processing and Underwriting. Loan originations are
derived from a number of sources such as referrals from real estate brokers,
present depositors and borrowers, builders, attorneys, walk-in customers and in
some instances, other lenders.

                                       8
<PAGE>
 
         During its loan approval process, the Bank assesses the applicant's
ability to make principal and interest payments on the loan and the value of the
property securing the loan. The Bank obtains detailed written loan applications
to determine the borrower's ability to repay and verifies responses on the loan
application through the use of credit reports, financial statements, and other
confirmations. Under current practice, the loan officer of the Bank analyzes the
loan application and the property involved, and an appraiser inspects and
appraises the property. The Bank requires independent fee appraisals on all
loans originated primarily on the basis of real estate collateral. The Bank also
obtains information concerning the income, financial condition, employment and
the credit history of the applicant.

         Mortgage loans of up to $150,000 may be approved by certain designated
loan officers and the chief lending officer of the Bank in cases where the loan
meets all of the Bank's underwriting guidelines. Loans of over $150,000 must be
approved by the Bank's loan committee which is composed of its President, Senior
Vice President and three other members of the Board of Directors. The loan
committee also reviews all other mortgage loan approvals.

         Normally, upon approval of a residential mortgage loan application, the
Bank gives a commitment to the applicant that it will make the approved loan at
a stipulated rate any time within a 30-day period. The loan is typically funded
at such rate of interest and on other terms which are based on market conditions
existing as of the date of the commitment. As of September 30, 1998, the Bank
had $134,000 in such unfunded mortgage loan commitments. In addition, on such
date the Bank had $3.1 million in unfunded commitments for unused lines of
credit and letters of credit.

         Origination of Loans. Generally, the Bank has originated its
one-to-four family residential mortgage or other loans with the capability, but
not the intention, that they will be sold in the secondary market. The Bank
originates a small number of loans which satisfy the Bank's underwriting
requirements and are tailored to its local community but do not necessarily
satisfy various requirements imposed by the FHLMC and FNMA, including some loans
which do not satisfy loan-to-value requirements, income requirements and credit
history standards.

         Although the Bank believes that many of its nonconforming loans are
readily saleable in the secondary market, some of such nonconforming loans could
be sold only after the Bank incurred certain costs and/or discounted the
purchase price. As a result, the Bank's loan portfolio is slightly less liquid
than would be the case if it was composed entirely of loans originated in
conformity with secondary market requirements. In addition, certain types of
nonconforming loans are generally thought to have greater risks of default and
nonperformance. However, such loans generally produce a higher yield than would
be produced by conforming loans, and the Bank has historically found that its
origination of such loans has not resulted in a high level of nonperforming
assets. See "-- Nonperforming Assets and Asset Classification". These
nonconforming loans satisfy a need in the Bank's local community, and the Bank
intends to continue to originate a small number of nonconforming loans. Any such
nonconforming loans will satisfy FHLMC and FNMA requirements with respect to
income and credit history. However, if the loan amount is less than $30,000 and
the loan to value ratio is less than 80%, the current tax value may be used to
establish the property value rather than a full appraisal. Any decision to use
the tax value must be approved by the Bank's management.

         For the years ended September 30, 1998 and 1997, the Bank's loan
originations totaled $8.7 million and $8.5 million, respectively.

         In addition to earning interest on loans, the Bank receives fees in
connection with originating loans. Fees for loan servicing, loan modifications,
late payments, loan assumptions and other miscellaneous services in connection
with loans are also charged by the Bank.

         Nonperforming Assets and Asset Classification. When a borrower fails to
make a required payment on a loan and does not cure the delinquency promptly,
the loan is classified as delinquent. Delinquencies on all loans are 

                                       9
<PAGE>
 
reviewed monthly by the Board of Directors. The normal procedure followed by the
Bank once a loan is classified as delinquent is to make contact with the
borrower at prescribed intervals in an effort to bring the loan to a current
status, and late charges are assessed as allowed by law. In most cases,
delinquencies are cured promptly. If a delinquency is not cured, the Bank
normally, subject to any required prior notice to the borrower, commences
foreclosure proceedings. If the loan is not reinstated within the time permitted
for reinstatement, or the property is not redeemed prior to sale, the property
may be sold at a foreclosure sale. In foreclosure sales, the Bank may acquire
title to the property through foreclosure, in which case the property so
acquired is offered for sale and may be financed by a loan involving terms more
favorable to the borrower than those normally offered. Any property acquired as
a result of foreclosure or by deed in lieu of foreclosure is classified as real
estate owned until such time as it is sold or otherwise disposed of by the Bank
to recover its investment. As of September 30, 1998, the Bank did not own any
real estate acquired in settlement of loans. Real estate acquired through, or in
lieu of, loan foreclosure is initially recorded at fair value at the date of
foreclosure, establishing a new cost basis. After foreclosure, valuations are
periodically performed by management, and the real estate is carried at the
lower of cost or fair value minus costs to sell. Revenue and expenses from
holding the properties and additions to the valuation allowance are included in
operations.

         Accrual of interest income on loans is suspended when, in management's
judgment, doubts exist as to the collectibility of additional interest within a
reasonable time. Loans are returned to accrual status when management
determines, based upon an evaluation of the underlying collateral, together with
the borrower's payment record and financial condition, that the borrower has the
capability and intent to meet the contractual obligations of the loan agreement.
Interest on loans placed on nonaccrual status is generally reversed by the
establishment of an allowance for uncollected interest. The allowance is
established by a charge to interest income equal to all interest previously
accrued, and income is subsequently recognized only to the extent cash payments
are received until the loan is returned to accrual status. For the fiscal year
ended September 30, 1998, interest income that would have been recorded on
nonaccrual loans under the original terms of such loans was zero.

         The following table sets forth information with respect to
nonperforming assets identified by the Bank, including nonaccrual loans and real
estate owned at the dates indicated.


<TABLE> 
<CAPTION> 
                                                                   At September 30,
                                                                   -----------------
                                                              1998                   1997
                                                              ----                   ----
                                                                 (Dollars in Thousands)
<S>                                                     <C>                     <C>  
Total nonaccrual loans:
   Mortgage Loans delinquent 90 days or more                $    28                $    30
   Consumer loans delinquent 90 days or more                     --                     --
Real estate owned                                                --                     -- 
                                                            -------                -------
   Total non-performing assets                              $    28                $    30
                                                            =======                =======
Non-performing loans to total loans                            0.06%                 0.06%

Non-performing assets to total assets                          0.05%                 0.05%

Total assets                                                $60,730                $64,399

Total loans                                                 $42,485                $46,463
</TABLE>

         Applicable regulations require the Bank to "classify" its own assets on
a regular basis. In addition, in connection with examinations of savings
institutions, regulatory examiners have authority to identify problem assets

                                       10
<PAGE>
 
and, if appropriate, classify them. Problem assets are classified as
"substandard," "doubtful" or "loss," depending on the presence of certain
characteristics as discussed below.

         An asset is considered "substandard" if not adequately protected by the
current net worth and paying capacity of the obligor or the collateral pledged,
if any. "Substandard" assets include those characterized by the "distinct
possibility" that the insured institution will sustain "some loss" if the
deficiencies are not corrected. Assets classified as "doubtful" have all of the
weaknesses inherent in those classified "substandard" with the added
characteristic that the weaknesses present make "collection or liquidation in
full," on the basis of currently existing facts, conditions, and values, "highly
questionable and improbable". Assets classified "loss" are those considered
"uncollectible" and of such little value that their continuance as assets
without the establishment of a loss reserve is not warranted.

         As of September 30, 1998, the Bank had $28,000 in loans internally
classified as "substandard", none as "doubtful" and none as "loss".

         The Bank also identifies assets which possess credit deficiencies or
potential weaknesses deserving close attention by management. These assets may
be considered "special mention" assets and do not yet warrant adverse
classification. At September 30, 1998, the Bank had no loans in the "special
mention" category.

         When an insured institution classifies problem assets as either
substandard or doubtful, it is required to establish general allowances for loan
losses in an amount deemed prudent by management. These allowances represent
loss allowances which have been established to recognize the inherent risk
associated with lending activities and the risks associated with particular
problem assets. When an insured institution classifies problem assets as "loss,"
it charges off the balance of the asset. The Bank's determination as to the
classification of its assets and the amount of its valuation allowances is
subject to review by the FDIC and the Administrator of the Savings Institutions
Division of the North Carolina Department of Commerce (the "Administrator")
which can order the establishment of additional loss allowances.

         Allowance for Loan Losses. In originating loans, the Bank recognizes
that credit losses will be experienced and that the risk of loss will vary with,
among other things, the type of loan being made, the creditworthiness of the
borrower over the term of the loan and, in the case of a secured loan, the
quality of the security for the loan as well as general economic conditions. It
is management's policy to maintain an adequate allowance for loan losses based
on, among other things, the Bank's historical loan loss experience, evaluation
of economic conditions and regular reviews of delinquencies and loan portfolio
quality. Specific allowances are provided for individual loans when ultimate
collection is considered questionable by management after reviewing the current
status of loans which are contractually past due and considering the net
realizable value of the security for the loans. The Bank adopted SFAS No. 114
Accounting by Creditors for Impairment of a Loan which was subsequently amended
by SFAS No. 118 Accounting by Creditors for Impairment of a Loan-Income
Recognition and Disclosures during 1996. SFAS No. 114 requires that the Bank
establish specific loan loss allowances on impaired loans if it is doubtful that
all principal and interest due according to the loan terms will be collected.
The Bank had one loan amounting to $28,000 which was assessed for impairment at
September 30, 1998. This loan is collateral dependent and management has
determined that the underlying collateral value is in excess of the carrying
amount. Therefore, there is no specific SFAS No. 114 allowance for impaired
loans at September 30, 1998. The Bank charged a provision to the allowance for
loan losses of $6,000 and $24,000 during the years ended September 30, 1998 and
1997, respectively. These provisions were charged to make the Bank's allowance
for loan losses reflect the economic environment and to conservatively reserve
for any future loan losses.

         Management continues to actively monitor the Bank's asset quality, to
charge off loans against the allowance for loan losses when appropriate and to
provide specific loss reserves when necessary. Although management believes it
uses the best information available to make determinations with respect to the
allowance for 

                                       11
<PAGE>
 
loan losses, future adjustments may be necessary if economic conditions differ
substantially from the economic conditions in the assumptions used in making the
initial determinations.

         The following table describes the activity related to the Bank's
allowance for loan losses for the periods indicated.




                                                      Year Ended September 30,
                                                      ------------------------

                                                    1998                  1997
                                                    ----                  ----

                                                      (Dollars in Thousands)

Balance, beginning of period                               $ 249      $ 225

Provision for loan losses                                      6         24

Charge-offs                                                   --         --

Recoveries                                                    --         --
                                                           -----      -----
Balance, end of period                                     $ 255      $ 249
                                                           =====      =====
Net charge-offs as a % of average loans outstanding           --         --

Allowance at period end as a % of nonperforming loans     910.71%    830.00%

         The following table sets forth the composition of the allowance for
loan losses by type of loan at the dates indicated. The allowance is allocated
to specific categories of loans for statistical purposes only, and may be
applied to loan losses incurred in any loan category.

<TABLE>
<CAPTION>

                                                                       At September 30,
                                                                       ----------------
                                                         1998                                      1997
                                                         ----                                      ----
                                                                 Amount of                                 Amount of
                                            Amount of            Loans to              Amount of           Loans to
                                            Allowance           Gross Loans            Allowance          Gross Loans
                                            ---------           -----------            ---------          -----------
                                                                    (Dollars in Thousands)
<S>                                     <C>                     <C>                     <C>                 <C>  
Real estate loans:
  Residential 1-4 family                      $ 124                 82.54%                $  123              86.28%
  Residential multi-family                        6                  5.70%                     5               4.32%
  Nonresidential real estate                     48                  1.71%                    57               1.91%
  Residential construction                        4                  3.61%                     1               1.33%
  Line of credit                                 33                  5.45%                    35               5.34%
                                              -----                -------                ------              ------ 
     Total real estate loans                    215                 99.01%                   221              99.18%
                                              -----                -------                ------              ------   
</TABLE> 

                                       12
<PAGE>
 
<TABLE> 
<CAPTION> 

<S>                                             <C>              <C>                    <C>                  <C>  
Consumer loans:
 Passbook or certificate                         --                  0.11%                    --               0.15%
 Automobile                                      32                  0.47%                    18               0.25%
 Other                                            8                  0.41%                    10               0.42%
                                              -----                -------                ------              ------   
   Total consumer loans                          40                  0.99%                    28               0.82%
                                              -----                -------                ------              ------   

Total allowance for loan losses               $ 255                100.00%                 $ 249             100.00%
                                              =====                =======                ======             =======
</TABLE>


Investment Securities

         Interest and dividend income from investment securities generally
provides the second largest source of income to the Company after interest on
loans. In addition, the Company receives interest income from deposits in other
financial institutions. On September 30, 1998, the carrying value of the
Company's investment securities portfolio totaled approximately $16.1 million
and consisted of U.S. government and agency securities, mortgage-backed
securities, FHLMC stock, stock in the FHLB of Atlanta, federal funds sold and
deposits in other financial institutions. The mortgage-backed securities consist
of mortgage-backed securities issued by the GNMA.

         Investments in mortgage-backed securities involve a risk that, because
of changes in the interest rate environment, actual prepayments will be greater
than estimated prepayments over the life of the security, which may require
adjustments to the amortization of any premium or accretion of any discount
relating to such instruments, thereby reducing the net yield on such securities.
There is also reinvestment risk associated with the cash flows from such
securities. In addition, the market value of such securities may be adversely
affected by changes in interest rates.

         Investments may be classified in one of three categories and accounted
for as follows: (1) debt securities that the entity has the positive intent and
ability to hold to maturity are classified as held-to-maturity and reported at
amortized cost; (2) debt and equity securities that are bought and held
principally for the purpose of selling them in the near term are classified as
trading securities and reported at fair value, with net unrealized gains and
losses included in earnings; and (3) debt securities not classified as either
held-to-maturity or trading securities and equity securities not classified as
trading securities are classified as securities available-for-sale and reported
at fair value, with unrealized gains and losses excluded from earnings and
reported as a separate component of equity. The Company has no trading
securities. See Notes 1 and 2 of "Notes to Consolidated Financial Statements".

         The amortized cost of securities classified as held-to-maturity or
available-for-sale is adjusted for amortization of premiums and accretion of
discounts to maturity, or in the case of mortgage-backed securities, over the
estimated life of the security. Such amortization is included in interest income
from investments. Realized gains and losses, and declines in value judged to be
other than temporary are included in net securities gains (losses). The cost of
securities sold is based on the specific identification method.

         As a member of the FHLB of Atlanta, the Bank is required to maintain an
investment in stock of the FHLB of Atlanta equal to the greater of 1% of the
Bank's outstanding home loans or 5% of its outstanding advances from the FHLB of
Atlanta. No ready market exists for such stock, which is carried at cost. As of
September 30, 1998, the Bank's investment in stock of the FHLB of Atlanta was
$595,400.

         North Carolina regulations require the Bank to maintain a minimum
amount of liquid assets which may be invested in specified short-term
securities. The Bank is also permitted to make certain other securities
investments.

                                       13
<PAGE>
 
         The Company's current investment policy states that the Company's
investments will be limited to U.S. Treasury obligations, federal agency
securities, municipal obligations of the State of North Carolina or its
political subdivisions rated A and above, pass-through and planned amortization
class collateralized mortgage obligations, stock of the FHLB of Atlanta and
certificates of deposits of $100,000 or less in federally insured financial
institutions.

         Investment decisions are made by authorized officers of the Bank or the
Company under policies established by the Boards of Directors. Such investments
are managed in an effort to produce the highest yield consistent with
maintaining safety of principal and compliance with regulations governing the
financial services industry.


         The following tables set forth certain information regarding the
Company's interest bearing deposits and the amortized cost and market values of
the Company's investment and mortgage-backed securities portfolio at the dates
indicated.

<TABLE>
<CAPTION>

                                                                             At September 30,
                                                                             ----------------
                                                                    1998                               1997
                                                                    ----                               ----
                                                       Amortized                            Amortized
                                                         Cost            Fair Value           Cost          Fair Value
                                                         ----            ----------           ----          ----------
                                                                                    (In Thousands)
<S>                                                    <C>              <C>                <C>            <C> 
Interest-bearing deposits                               $ 7,162           $ 7,162            $ 6,131         $ 6,131
                                                          -----             -----              -----          ------ 
Mortgage-backed securities, held to maturity                301               342                419             481
                                                          -----             -----              -----          ------  
Investment securities:
 Held to maturity:
    U.S. Treasury and agency securities                      --                --                500             494
 Available for sale:
    U.S. Treasury and agency securities                   1,000             1,003              2,500           2,480
    State revenue bonds                                   5,828             5,831              5,100           5,100
    Federal Home Loan Mortgage
           Corporation stock                                 25             1,241                 25             881
 Non-marketable equity securities:
    Federal Home Loan Bank stock                            595               595                595             595
Certificate of Participation Interest                         4                 4                  4               4
                                                          -----             -----              -----          ------  
                                                          7,452             8,674              8,724           9,554

Available for sale market adjustment                      1,222                                  836
                                                        -------                              -------         
Total                                                   $16,137           $16,178            $16,110         $16,166
                                                        =======           =======            =======         =======
</TABLE>

         The following table sets forth certain information regarding the
carrying value, weighted average yields and contractual maturities of the
Company's interest bearing deposits, investment and mortgage-backed securities
as of September 30, 1998.

                                       14
<PAGE>
 
<TABLE>
<CAPTION>

                                                                      After One Year           After Five Years      
                                         One Year or Less           Through Five Years         Through Ten Years     
                                         ----------------           ------------------         -----------------     

                                                    Weighted                    Weighted                  Weighted   
                                      Carrying       Average      Carrying      Average     Carrying      Average    
                                        Value         Yield        Value          Yield       Value        Yield     
                                        -----         -----        -----         ------       -----        -----     
                                                                                             Dollars in Thousands)  
<S>                                 <C>            <C>           <C>            <C>         <C>          <C> 
Interest-bearing deposits              $7,162         5.50%         $ --             --         $ --           --      

Mortgage-backed securities                 --            --           --             --           --           --      

U.S. Treasury and agency                                             
   securities and state revenue bonds     226         4.20%        1,208           5.62%          --           --     
Federal Home Loan Mortgage                                                           --           --           --     
   Corporation stock (1)                1,241         4.89%           --             --           --           --     
Federal Home Loan Bank stock(2)            --            --           --             --           --           --     
Certificate of Participation                                          --             --           --           --      
   Interest(2)                             --            --           --             --           --           --     
                                       ------         -----       ------          ------        ----          ---- 
Total                                  $8,629         5.38%       $1,208           5.62%        $ --           --      
                                       ======         =====       ======          ======        ====          ====

<CAPTION> 
 

                                    
                                         After Ten Years                 Total
                                         ---------------                 -----

                                                    Weighted                     Weighted
                                        Carrying     Average       Carrying       Average
                                         Value        Yield         Value          Yield
                                         -----       ------         -----          -----
                                                  
Interest-bearing deposits                $   --           --         $ 7,162         5.50%
                                                  
Mortgage-backed securities                  301        11.53%            301        11.53% 
                                                  
U.S. Treasury and agency                          
   securities and state revenue bonds     5,400         
Federal Home Loan Mortgage                   --         5.46%          6,834         5.45% 
   Corporation stock (1)                     --           --           1,241         4.89% 
Federal Home Loan Bank stock(2)             595         7.24%            595         7.24%
Certificate of Participation                      
   Interest(2)                                4           --               4           -- 
                                        -------        ------        -------        ------
Total                                   $ 6,300         5.91%        $16,137         5.61%
                                        =======        ======        =======        =======
</TABLE> 


(1) Equity security with no stated maturities; readily available and assumed to
    mature in the period one year or less.

(2) Nonmarketable equity security; substantially all required to be maintained
    and assumed to mature in periods greater than 10 years.

                                       15
<PAGE>
 
Deposits and Borrowings

         General. Deposits are the primary source of the Bank's funds for
lending and other investment purposes. In addition to deposits, the Bank derives
funds from loan principal repayments, interest payments, investment income,
interest from its own interest-bearing deposits, interest income from
mortgage-backed securities and otherwise from its operations. Loan repayments
are a relatively stable source of funds while deposit inflows and outflows may
be significantly influenced by general interest rates and money market
conditions. Borrowings may be used on a short-term basis to compensate for
reductions in the availability of funds from other sources. They may also be
used on a longer term basis for general business purposes. The Bank has no
borrowings outstanding at September 30, 1998; however, it does maintain
borrowing capabilities through the FHLB of Atlanta.

         Deposits. On September 30, 1998 and September 30, 1997, the Bank's
deposits totaled $44.3 million and $43.1 million, respectively.

         The following table sets forth information relating to the Bank's
deposit flows during the periods shown and total deposits at the end of the
periods shown.

<TABLE>
<CAPTION>

                                                                At or For the Year Ended September 30,
                                                                --------------------------------------
                                                                  1998                        1997
                                                                  ----                        ----
                                                                            (In Thousands)
<S>                                                            <C>                       <C> 
Total deposits at beginning of period                           $43,140                    $42,410
Net decrease before interest credited                              (989)                    (1,252)
Interest credited                                                 2,120                      1,982
                                                                -------                    -------
Total deposits at end of period                                 $44,271                    $43,140
                                                                =======                    =======
</TABLE>

         The Bank attracts both short-term and long-term deposits from the
general public by offering a variety of accounts and rates. The Bank offers
statement savings accounts, negotiable order of withdrawal accounts, money
market accounts, and fixed interest rate certificates with varying maturities.
The Bank also offers an adjustable rate certificate in its individual retirement
account program. All deposit flows are greatly influenced by economic
conditions, the general level of interest rates, competition, and other factors,
including the restructuring of the thrift industry. The Bank's savings deposits
traditionally have been obtained primarily from its primary market area. The
Bank utilizes traditional marketing methods to attract new customers and savings
deposits, including print media advertising and direct mailings. The Bank does
not advertise for deposits outside of its local market area or utilize the
services of deposit brokers. The vast majority of the Bank's depositors are
residents of North Carolina. In the unlikely event the Bank is liquidated
following the Conversion, depositors will be entitled to full payment of their
deposit accounts prior to any payment being made to stockholders.

         The following table sets forth certain information regarding the Bank's
savings deposits at the dates indicated.

                                       16
<PAGE>
 
<TABLE>
<CAPTION>



                                                                              At September 30,
                                                              1998                                              1997
                                                 ----------------------------                        -----------------------------

                                                     Weighted                                       Weighted
                                                      Average        % of                            Average         % of
                                        Amount         Rate        Deposits             Amount         Rate        Deposits
                                        -----          ----        --------             ------       ------        --------
                                                                      (Dollars in Thousands)
<S>                                   <C>             <C>         <C>                 <C>          <C>          <C>   
Demand accounts:                                                                                                      
   Passbook accounts                   $ 3,866         2.93%         8.73%              $ 4,106       2.92%         9.52%
   NOW accounts                          2,822         2.06%         6.37%               2,984        2.03%         6.92% 
   Money market deposit                                                                                               
   accounts                              6,335         4.36%        14.31%               5,381        4.33%        12.47% 
   Noninterest bearing accounts            678            --         1.54%                633           --          1.47% 
                                        ------         ------       ------              ------      ------         ------         
           Total demand deposits        13,701         3.29%        30.95%              13,104       3.16%         30.38% 
                                                                                                                         
Time deposits                           30,536         5.36%        68.98%              29,988        5.45%         69.51%

Accrued interest                            34                       0.07%                  48                       0.11%
                                        ------                     -------               ------                    -------
           Total deposits              $44,271         4.81%       100.00%              $43,140       4.74%        100.00%
                                        ======         =====       =======               ======       =====        =======
</TABLE>

         As of September 30, 1998, the aggregate amount of time certificates of
deposit in amounts greater than or equal to $100,000 was $3.8 million. (Some of
these deposits were deposits of state and local governments which are subject to
rebidding from time to time and to securitization requirements.) The following
table presents the maturity of these time certificates of deposit at the dates
indicated.


                                                                  At
                                                          September 30, 1998
                                                          ------------------
                                                            (In Thousands)
3 Months or less                                                $1,334
Over 3 months through 6 months                                   1,150
Over 6 months through 12 months                                  1,022
Over 12 months                                                    301
                                                                ------ 
         Total                                                  $3,807
                                                                ====== 

         Borrowings. The FHLB system functions in a reserve credit capacity for
savings institutions. As a member, the Bank is required to own capital stock in
the FHLB of Atlanta and is authorized to apply for advances from the FHLB of
Atlanta on the security of that stock and a floating lien on certain of its real
estate secured loans and other assets. Each credit program has its own interest
rate and range of maturities. Depending on the program, limitations on the
amount of advances are based either on a fixed percentage of an institution's
net worth or on the FHLB of Atlanta's assessment of the institution's
creditworthiness. The Company and the Bank had no outstanding borrowings with
the FHLB at September 30, 1998 or 1997. During 1998 the Bank did not obtain any
Federal Home Loan Bank advances, however the Bank retains borrowing capacity
through the Federal Home Loan Bank of Atlanta.

         The Company had outstanding borrowings of $5.5 million in the form of a
bank note payable at September 30, 1997. The note, which had an interest rate of
prime minus 2%, was paid in full on October 27, 1997.

                                       17
<PAGE>
 
Subsidiaries

         The Company has no subsidiaries other than the Bank. The Bank has no
subsidiaries.

Competition

         The Bank faces strong competition both in attracting deposits and
making real estate and other loans. Its most direct competition for deposits has
historically come from other savings institutions, credit unions and commercial
banks located in its primary market area, including large financial institutions
which have greater financial and marketing resources available to them. The Bank
has also faced additional significant competition for investors' funds from
short-term money market securities and other corporate and government
securities. At September 30, 1998, there were at least 6 other commercial banks,
credit unions and mortgage companies as well as numerous other financial
services providers located in the Bank's primary market area. At September 30,
1998, the Bank had a deposit market share of approximately 20% in Scotland
County. In Moore County where the Pinehurst branch is located, the Bank had less
than 1% of the deposit market share as of that same date. The ability of the
Bank to attract and retain savings deposits depends on its ability to generally
provide a rate of return, liquidity and risk comparable to that offered by
competing investment opportunities.

         The Bank experiences strong competition for real estate loans from
other savings institutions, commercial banks, and mortgage banking companies.
The Bank competes for loans primarily through the interest rates and loan fees
it charges, the efficiency and quality of services it provides borrowers, and
its more flexible underwriting standards. Competition may increase as a result
of the continuing reduction of restrictions on the interstate operations of
financial institutions.

Supervision and Regulation

         Bank holding companies and state savings banks are extensively
regulated under both federal and state law. The following is a brief summary of
certain statutes and rules and regulations that affect or will affect the
Company and the Bank. This summary is qualified in its entirety by reference to
the particular statute and regulatory provisions referred to below and is not
intended to be an exhaustive description of the statutes or regulations
applicable to the business of the Company and the Bank. Supervision, regulation
and examination of the Company and the Bank by the regulatory agencies are
intended primarily for the protection of depositors rather than shareholders of
the Company.

Regulation of the Company

         General. The Company was organized for the purpose of acquiring and
holding all of the capital stock of the Bank to be issued in the Conversion. As
a savings bank holding company subject to the BHCA, the Company is subject to
certain regulations of the Federal Reserve. Under the BHCA, the Company's
activities and those of its subsidiary are limited to banking, managing or
controlling banks, furnishing services to or performing services for its
subsidiary or engaging in any other activity which the Federal Reserve
determines to be so closely related to banking or managing or controlling banks
as to be a proper incident thereto. The BHCA prohibits the Company from
acquiring direct or indirect control of more than 5% of the outstanding voting
stock or substantially all of the assets of any bank or savings bank or merging
or consolidating with another bank holding company or savings bank holding
company without prior approval of the Federal Reserve.

         Additionally, the BHCA prohibits the Company from engaging in, or
acquiring ownership or control of, more than 5% of the outstanding voting stock
of any company engaged in a nonbanking business unless such business is
determined by the Federal Reserve to be so closely related to banking as to be
properly incident thereto.

                                       18
<PAGE>
 
         Similarly, Federal Reserve approval (or, in certain cases,
non-disapproval) must be obtained prior to any person acquiring control of the
Company. Control is conclusively presumed to exist if, among other things, a
person acquires more than 25% of any class of voting stock of the holding
company or controls in any manner the election of a majority of the directors of
the holding company. Control is presumed to exist if a person acquires more than
10% of any class of voting stock and the stock is registered under Section 12 of
the Exchange Act or the acquiror will be the largest shareholder after the
acquisition.

         There are a number of obligations and restrictions imposed on bank
holding companies and their depository institution subsidiaries by law and
regulatory policy that are designed to minimize potential loss to the depositors
of such depository institutions and the FDIC insurance funds in the event the
depository institution becomes in danger of default or in default. For example,
to avoid receivership of an insured depository institution subsidiary, a bank
holding company is required to guarantee the compliance of any insured
depository institution subsidiary that may become "undercapitalized" with the
terms of any capital restoration plan filed by such subsidiary with its
appropriate federal banking agency up to the lesser of (i) an amount equal to 5%
of the institution's total assets at the time the institution became
undercapitalized or (ii) the amount which is necessary (or would have been
necessary) to bring the institution into compliance with all acceptable capital
standards as of the time the institution fails to comply with such capital
restoration plan. Under a policy of the Federal Reserve with respect to bank
holding company operations, a bank holding company is required to serve as a
source of financial strength to its subsidiary depository institutions and to
commit resources to support such institutions in circumstances where it might
not do so absent such policy. The Federal Reserve under the BHCA also has the
authority to require a bank holding company to terminate any activity or to
relinquish control of a nonbank subsidiary (other than a nonbank subsidiary of a
bank) upon the Federal Reserve's determination that such activity or control
constitutes a serious risk to the financial soundness and stability of any bank
subsidiary of the bank holding company.

         In addition, insured depository institutions under common control are
required to reimburse the FDIC for any loss suffered by either the SAIF or the
Bank Insurance Fund (the "BIF") as a result of the default of a commonly
controlled insured depository institution or for any assistance provided by the
FDIC to a commonly controlled insured depository institution in danger of
default. The FDIC may decline to enforce the cross-guarantee provisions if it
determines that a waiver is in the best interest of the SAIF or the BIF or both.
The FDIC's claim for damages is superior to claims of stockholders of the
insured depository institution or its holding company but is subordinate to
claims of depositors, secured creditors and holders of subordinated debt (other
than affiliates) of the commonly controlled insured depository institutions.

         Federal regulations require that the Company must notify the Federal
Reserve Bank of Richmond prior to repurchasing Common Stock in excess of ten
percent of its net worth during a rolling twelve month period. As a result of
the Company's ownership of the Bank, the Company is registered under the savings
bank holding company laws of North Carolina. Accordingly, the Company is also
subject to regulation and supervision by the Administrator.

         Capital Adequacy Guidelines for Holding Companies. The Federal Reserve
has adopted capital adequacy guidelines for bank holding companies and banks
that are members of the Federal Reserve system and have consolidated assets of
$150 million or more. For bank holding companies with less than $150 million in
consolidated assets, the guidelines are applied on a bank-only basis unless the
parent bank holding company (i) is engaged in nonbank activity involving
significant leverage or (ii) has a significant amount of outstanding debt that
is held by the general public.

         Bank holding companies are required to comply with the Federal
Reserve's risk-based capital guidelines. Under these regulations, the minimum
ratio of total capital to risk-weighted assets (including certain off-balance
sheet activities, such as standby letters of credit) is 8%. At least half of the
total capital is required to be "Tier I capital," principally consisting of
common stockholders' equity, noncumulative perpetual preferred stock, and a

                                       19
<PAGE>
 
limited amount of cumulative perpetual preferred stock, less certain goodwill
items. The remainder ("Tier II capital") may consist of a limited amount of
subordinated debt, certain hybrid capital instruments and other debt securities,
perpetual preferred stock, and a limited amount of the general loan loss
allowance. In addition to the risk-based capital guidelines, the Federal Reserve
has adopted a minimum Tier I capital (leverage) ratio, under which a bank
holding company must maintain a minimum level of Tier I capital to average total
consolidated assets of at least 3% in the case of a bank holding company which
has the highest regulatory examination rating and is not contemplating
significant growth or expansion. All other bank holding companies are expected
to maintain a Tier I capital (leverage) ratio of at least 1% to 2% above the
stated minimum.

Federal Securities Law

         The Company has registered its Common Stock with the SEC pursuant to
Section 12(g) of the Securities Exchange Act of 1934 (the "Exchange Act") and
will not deregister the Common Stock for a period of three years following the
completion of the Conversion. As a result of such registration, the proxy and
tender offer rules, insider trading reporting requirements, annual and periodic
reporting and other requirements of the Exchange Act are applicable to the
Company.

Regulation of the Bank

         General. Federal and state legislation and regulation significantly
affect the operations of federally insured savings institutions and other
federally regulated financial institutions. The operation of regulated
depository institutions, including the Bank, is subject to changes in applicable
statutes and regulations from time to time. Such changes may or may not be
favorable to the Bank.

         The Bank is a North Carolina-chartered savings bank, is a member of the
FHLB system, and its deposits are insured by the FDIC through the SAIF. It is
subject to examination and regulation by the FDIC and the Administrator and to
regulations governing such matters as capital standards, mergers, establishment
of branch offices, subsidiary investments and activities, and general investment
authority. Generally, North Carolina state chartered savings banks whose
deposits are issued by the SAIF are subject to restrictions with respect to
activities and investments, transactions with affiliates and loans-to-one
borrower similar to those applicable to SAIF insured savings associations. Such
examination and regulation is intended primarily for the protection of
depositors and the federal deposit insurance funds.

         The Bank is subject to various regulations promulgated by the Federal
Reserve including, without limitation, Regulation B (Equal Credit Opportunity),
Regulation D (Reserves), Regulation E (Electronic Fund Transfers), Regulation O
(Loans to Executive Officers, Directors and Principal Shareholders), Regulation
Z (Truth in Lending), Regulation CC (Availability of Funds) and Regulation DD
(Truth in Savings). As creditors of loans secured by real property and as owners
of real property, financial institutions, including the Bank, may be subject to
potential liability under various statutes and regulations applicable to
property owners generally, including statutes and regulations relating to the
environmental condition of real property.

         The FDIC has extensive enforcement authority over North
Carolina-chartered savings banks, including the Bank. This enforcement authority
includes, among other things, the ability to assess civil money penalties, to
issue cease and desist or removal orders and to initiate injunctive actions. In
general, these enforcement actions may be initiated in response to violations of
laws and regulations and unsafe or unsound practices.

         The grounds for appointment of a conservator or receiver for a North
Carolina savings bank on the basis of an institution's financial condition
include: (i) insolvency, in that the assets of the savings bank are less than
its liabilities to depositors and others; (ii) substantial dissipation of assets
or earnings through violations of law or unsafe or unsound practices; (iii)
existence of an unsafe or unsound condition to transact business; (iv)
likelihood that the savings bank will be unable to meet the demands of its
depositors or to pay its obligations in the normal 

                                       20
<PAGE>
 
course of business; and (v) insufficient capital or the incurring or likely
incurring of losses that will deplete substantially all of the institution's
capital with no reasonable prospect of replenishment of capital without federal
assistance.

         Transactions with Affiliates. Under current federal law, transactions
between the Bank and any affiliate are governed by Sections 23A and 23B of the
Federal Reserve Act. An affiliate of the Bank is any company or entity that
controls, is controlled by or is under common control with the savings bank.
Generally, subsidiaries of a bank, other than a bank subsidiary, and certain
other types of companies are not considered to be affiliates. Generally,
Sections 23A and 23B (i) limit the extent to which the Bank or its subsidiaries
may engage in "covered transactions" with any one affiliate to an amount equal
to 10% of such the Bank's capital stock and surplus, and contain an aggregate
limit on all such transactions with all affiliates to an amount equal to 20% of
such capital stock and surplus and (ii) require that all such transactions be on
terms substantially the same, or at least as favorable, to the Bank or the
subsidiary as those provided to a nonaffiliate. The term "covered transaction"
includes the making of loans or other extensions of credit to an affiliate, the
purchase of assets from an affiliate, the purchase of, or an investment in, the
securities of an affiliate, the acceptance of securities of an affiliate as
collateral for a loan or extension of credit to any person, or issuance of a
guarantee, acceptance or letter of credit on behalf of an affiliate.

         Further, current federal law has extended to savings banks the
restrictions contained in Section 22(h) of the Federal Reserve Act and its
implementing regulations with respect to loans to directors, executive officers
and principal stockholders. Under Section 22(h), loans to directors, executive
officers and stockholders who own more than 10% of a savings bank, and certain
affiliated entities of any of the foregoing, may not exceed, together with all
other outstanding loans to such person and affiliated entities, the savings
bank's loans-to-one borrower limit as established by federal law and all loans
to such persons may not exceed the institution's unimpaired capital and
unimpaired surplus. Section 22(h) also prohibits loans above amounts prescribed
by the appropriate federal banking agency to directors, executive officers and
stockholders who own more than 10% of a savings bank, and their respective
affiliates, unless such loan is approved in advance by a majority of the
disinterested directors of the board of directors of the savings bank and the
Company. Any "interested" director may not participate in the voting. The
Federal Reserve has prescribed the loan amount (which includes all other
outstanding loans to such person), as to which such prior board of director
approval is required, as being the greater of $25,000 or 5% of unimpaired
capital and unimpaired surplus (up to $500,000). Further, pursuant to Section
22(h) the Federal Reserve requires that loans to directors, executive officers,
and principal stockholders be made on terms substantially the same as offered in
comparable transactions to other persons and not involve more than the normal
risk of repayment or present other unfavorable features. Section 22(h) also
generally prohibits a depository institution from paying the overdrafts of any
of its executive officers or directors.

         Deposit Insurance. The Bank is required to pay assessments based on a
percentage of its insured deposits to the FDIC for insurance of its deposits by
the SAIF. Under the FDIC's risk-based deposit insurance assessment system, the
assessment rate for an insured depository institution depends on the assessment
risk classification assigned to the institution by the FDIC, which is determined
by the institution's capital level and supervisory evaluations. Based on the
data reported to regulators for the date closest to the last day of the seventh
month preceding the semi-annual assessment period, institutions are assigned to
one of three capital groups -- well capitalized, adequately capitalized or
undercapitalized -- using the same percentage criteria as in the prompt
corrective action regulations. See "-- Regulation of the Bank - Prompt
Corrective Regulatory Action." Within each capital group, institutions are
assigned to one of three subgroups on the basis of supervisory evaluations by
the institution's primary supervisory authority and such other information as
the FDIC determines to be relevant to the institution's financial condition and
the risk posed to the deposit insurance fund. Subgroup A consists of financially
sound institutions with only a few minor weaknesses. Subgroup B consists of
institutions that demonstrate weaknesses which, if not corrected, could result
in significant deterioration of the institution and increased risk of loss to
the deposit insurance fund. Subgroup C consists of institutions that pose a
substantial probability of loss to the deposit insurance fund unless effective
corrective action is taken. The assessment rate for SAIF members had ranged from
0.23% of deposits for well capitalized institutions in Subgroup A to 0.31% of
deposits for 

                                       21
<PAGE>
 
undercapitalized institutions in Subgroup C while assessments for over 90% of
the BIF members had been the statutory minimum of $2,000. Recently enacted
legislation provided for a one-time assessment of 65.7 basis points of insured
deposits as of March 31, 1995, that fully capitalized the SAIF and had the
effect of reducing future SAIF assessments. Accordingly, although the special
assessment resulted in a one-time charge to the Bank in 1996 of approximately
$321,000 pre-tax, the recapitalization of the SAIF had the effect of reducing
the Bank's future deposit insurance premiums to the SAIF. Under the recently
enacted legislation, both BIF and SAIF members will be assessed an amount for
the Financing Corporation Bond payments. BIF members will be assessed
approximately 1.3 basis points while the SAIF rate will be approximately 6.4
basis points until January 1, 2000. At that time, BIF and SAIF members will
begin pro rata sharing of the payment at an expected rate of 2.43 basis points.

         Community Reinvestment Act. The Bank, like other financial
institutions, is subject to the Community Reinvestment Act, as amended ("CRA").
A purpose of this Act is to encourage financial institutions to help meet the
credit needs of its entire community, including the needs of low- and
moderate-income neighborhoods. During the Bank's last compliance examination the
Bank received a "satisfactory" rating with respect to CRA compliance. The Bank's
rating with respect to CRA compliance would be a factor to be considered by the
Federal Reserve and FDIC in considering applications submitted by the Bank to
acquire branches or to acquire or combine with other financial institutions and
take other actions and could result in the denial of such applications.

         The federal banking regulatory agencies have issued a rewrite of the
CRA regulations, which became effective on January 1, 1996, to implement a new
evaluation system that rates institutions based on their actual performance in
meeting community credit needs. Under the regulations, a savings bank will be
evaluated and rated under three categories: a lending test, an investment test
and a service test. For each of these three tests, the savings bank will be
given a rating of either "outstanding," "high satisfactory," "low satisfactory,"
"needs to improve" or "substantial non-compliance." A set of criteria for each
rating has been developed and is included in the regulation. If an institution
disagrees with a particular rating, the institution has the burden of rebutting
the presumption by clearly establishing that the quantitative measures do not
accurately present its actual performance, or that demographics, competitive
conditions or economic or legal limitations peculiar to the service area should
be considered. The ratings received under the three tests will be used to
determine the overall composite CRA rating. The composite ratings will be the
same as those that are currently given: "outstanding," "satisfactory," "needs to
improve" or "substantial non-compliance."

         Capital Requirements Applicable to the Bank. The FDIC requires the Bank
to have a minimum leverage ratio of Tier I capital (principally consisting of
common stockholders' equity, noncumulative perpetual preferred stock and
minority interests in consolidated subsidiaries, less certain intangible items,
goodwill items, identified losses and investments in securities subsidiaries) to
total assets of at least 3%; provided, however that all institutions, other than
those (i) receiving the highest rating during the examination process and (ii)
not anticipating or experiencing any significant growth, are required to
maintain a ratio of 1% or 2% above the stated minimum, with an absolute minimum
leverage ratio of not less than 4%. The FDIC also requires the Bank to have a
ratio of total capital to risk-weighted assets, including certain off-balance
sheet activities, such as standby letters of credit, of at least 8%. At least
half of the total capital is required to be Tier I capital. The remainder ("Tier
II capital") may consist of a limited amount of subordinated debt, certain
hybrid capital instruments, other debt securities, certain types of preferred
stock and a limited amount of loan loss allowance.

         An institution which fails to meet minimum capital requirements may be
subject to a capital directive which is enforceable in the same manner and to
the same extent as a final cease and desist order, and must submit a capital
plan within 60 days to the FDIC. If the leverage ratio falls to 2% or less, the
bank may be deemed to be operating in an unsafe or unsound condition, allowing
the FDIC to take various enforcement actions, including possible termination of
insurance or placement of the institution in receivership. At September 30,
1998, the Bank had a leverage ratio of 20.26%.

                                       22
<PAGE>
 
         The Administrator requires that net worth equal at least 5% of total
assets. Intangible assets must be deducted from net worth and assets when
computing compliance with this requirement.

         At September 30, 1998, the Bank complied with each of the capital
requirements of the FDIC and the Administrator.

         Each federal banking agency is required to establish risk-based capital
standards that take adequate account of interest rate risk, concentration of
credit risk, and the risk of nontraditional activities, as well as reflect the
actual performance and expected risk of loss on multifamily mortgages.

         On August 2, 1995, the federal banking agencies issued a joint notice
of adoption of final risk based capital rules to take account of interest rate
risk. The final regulation required an assessment of the need for additional
capital on a case-by-case basis, considering both the level of measured exposure
and qualitative risk factors. The final rule also stated an intent to, in the
future, establish an explicit minimum capital charge for interest rate risk
based on the level of a bank's measured interest rate risk exposure.

         Effective June 26, 1996, the federal banking agencies issued a joint
policy statement announcing the agencies' election not to adopt a standardized
measure and explicit capital charge for interest rate risk at that time. Rather,
the policy statement (i) identifies the main elements of sound interest rate
risk management, (ii) describes prudent principles and practices for each of
those elements, and (iii) describes the critical factors affecting the agencies'
evaluation of a bank's interest rate risk when making a determination of capital
adequacy. The joint policy statement is not expected to have a material impact
on Bank's management of interest rate risk.

         Loans-To-One-Borrower. The Bank is subject to the Administrator's
loans-to-one-borrower limits. Under these limits, no loans and extensions of
credit to any borrower outstanding at one time and not fully secured by readily
marketable collateral shall exceed 15% of the net worth of the savings bank.
Loans and extensions of credit fully secured by readily marketable collateral
may comprise an additional 10% of net worth. These limits also authorize savings
banks to make loans-to-one-borrower, for any purpose, in an amount not to exceed
$500,000. A savings bank also is authorized to make loans-to-one-borrower to
develop domestic residential housing units, not to exceed the lesser of $30
million or 30% of the savings bank's net worth, provided that the purchase price
of each single-family dwelling in the development does not exceed $500,000 and
the aggregate amount of loans made under this authority does not exceed 150% of
net worth. These limits also authorize a savings bank to make
loans-to-one-borrower to finance the sale of real property acquired in
satisfaction of debts in an amount up to 50% of net worth.

         As of September 30, 1998, the largest aggregate amount of loans which
the Bank had to any one borrower was $684,000. The Bank had no loans outstanding
which management believes violate the applicable loans-to-one-borrower limits.
The Bank does not believe that the loans-to-one-borrower limits will have a
significant impact on its business, operations and earnings.

         Federal Home Loan Bank System. The FHLB system provides a central
credit facility for member institutions. As a member of the FHLB of Atlanta, the
Bank is required to own capital stock in the FHLB of Atlanta in an amount at
least equal to the greater of 1% of the aggregate principal amount of its unpaid
residential mortgage loans, home purchase contracts and similar obligations at
the end of each calendar year, or 5% of its outstanding advances (borrowings)
from the FHLB of Atlanta. On September 30, 1998, the Bank was in compliance with
this requirement with an investment in FHLB of Atlanta stock of $595,400.

         Each FHLB is required to contribute at least 10% of its reserves and
undivided profits to fund the principal and a portion of the interest on certain
bonds and certain other obligations which are used to fund the resolution of
troubled savings association cases, and to transfer a percentage of its annual
net earnings to the Affordable Housing 

                                       23
<PAGE>
 
Program. These contributions continue to reduce the FHLB of Atlanta's earnings
and the Bank's dividends on its FHLB of Atlanta stock.

         Restrictions on Acquisitions. Federal law generally provides that no
"person," acting directly or indirectly or through or in concert with one or
more other persons, may acquire "control," as that term is defined in FDIC
regulations, of a state savings bank without giving at least 60 days' written
notice to the FDIC and providing the FDIC an opportunity to disapprove the
proposed acquisition. Pursuant to regulations governing acquisitions of control,
control of an insured institution is conclusively deemed to have been acquired
by, among other things, the acquisition of more than 25% of any class of voting
stock. In addition, control is presumed to have been acquired, subject to
rebuttal, upon the acquisition of more than 10% of any class of voting stock.
Such acquisitions of control may be disapproved if it is determined, among other
things, that (i) the acquisition would substantially lessen competition; (ii)
the financial condition of the acquiring person might jeopardize the financial
stability of the savings bank or prejudice the interests of its depositors; or
(iii) the competency, experience or integrity of the acquiring person or the
proposed management personnel indicates that it would not be in the interest of
the depositors or the public to permit the acquisitions of control by such
person.

         Liquidity. The Bank is subject to the Administrator's requirement that
the ratio of liquid assets to total assets equal at least 10%. The computation
of liquidity under North Carolina regulation allows the inclusion of
mortgage-backed securities and investments which, in the judgment of the
Administrator, have a readily marketable value, including investments with
maturities in excess of five years. On September 30, 1998, the Bank's liquidity
ratio, calculated in accordance with North Carolina regulations, was
approximately 16.5%.

         Additional Limitations on Activities. Recent FDIC law and regulations
generally provide that the Bank may not engage as principal in any type of
activity, or in any activity in an amount, not permitted for national banks, or
directly acquire or retain any equity investment of a type or in an amount not
permitted for national banks. The FDIC has authority to grant exceptions from
these prohibitions (other than with respect to non-service corporation equity
investments) if it determines no significant risk to the insurance fund is posed
by the amount of the investment or the activity to be engaged in and if the Bank
is and continues to be in compliance with fully phased-in capital standards.
National banks are generally not permitted to hold equity investments other than
shares of service corporations and certain federal agency securities. Moreover,
the activities in which service corporations are permitted to engage are limited
to those of service corporations for national banks.

         Savings banks are also generally prohibited from directly or indirectly
acquiring or retaining any corporate debt security that is not of investment
grade (generally referred to as "junk bonds"). State savings banks are also
required to notify the FDIC at least 30 days prior to the establishment or
acquisition of any subsidiary, or at least 30 days prior to conducting any such
new activity. Any such activities must be conducted in accordance with the
regulations and orders of the FDIC and the Administrator.

         Prompt Corrective Regulatory Action. Federal law provides the federal
banking agencies with broad powers to take corrective action to resolve problems
of insured depository institutions. The extent of these powers depends upon
whether the institutions in question are "well capitalized," "adequately
capitalized," "undercapitalized," "significantly undercapitalized," or
"critically undercapitalized." Under the FDIC regulations applicable to the
Bank, an institution is considered "well capitalized" if it has (i) a total
risk-based capital ratio of 10% or greater, (ii) a Tier I risk-based capital
ratio of 6% or greater, (iii) a leverage ratio of 5% or greater and (iv) is not
subject to any order or written directive to meet and maintain a specific
capital level for any capital measure. An "adequately capitalized" institution
is defined as one that has (i) a total risk-based capital ratio of 8% or
greater, (ii) a Tier I risk-based capital ratio of 4% or greater and (iii) a
leverage ratio of 4% or greater (or 3% or greater in the case of an institution
with the highest examination rating and which is not experiencing or
anticipating 

                                       24
<PAGE>
 
significant growth). An institution is considered (A) "undercapitalized" if it
has (i) a total risk-based capital ratio of less than 8%, (ii) a Tier I risk-
based capital ratio of less than 4% or (iii) a leverage ratio of less than 4%
(or 3% in the case of an institution with the highest examination rating and
which is not experiencing or anticipating significant growth); (B)
"significantly undercapitalized" if the institution has (i) a total risk-based
capital ratio of less than 6%, or (ii) a Tier I risk-based capital ratio of less
than 3% or (iii) a leverage ratio of less than 3% and (C) "critically
undercapitalized" if the institution has a ratio of tangible equity to total
assets equal to or less than 2%.

         Interstate Banking. The Riegle-Neal Interstate Banking and Branching
Efficiency Act of 1994 (the "Interstate Banking Act"), effective September 29,
1995, permits adequately capitalized bank and savings bank holding companies to
acquire control of banks and savings banks in any state.

         Such interstate acquisitions are subject to certain restrictions.
States may require the bank or savings bank being acquired to have been in
existence for a certain length of time but not in excess of five years. In
addition, no bank or saving bank may acquire more than 10% of the insured
deposits in the United States or more than 30% of the insured deposits in any
one state, unless the state has specifically legislated a higher deposit cap.
States are free to legislate stricter deposit caps.

         The Interstate Banking Act also provides for interstate branching,
effective June 1, 1997, allowing interstate branching in all states, provided
that a particular state has not specifically denied interstate branching by
legislation prior to such time. Unlike interstate acquisitions, a state may deny
interstate branching if it specifically elects to do so by June 1, 1997. States
may choose to allow interstate branching prior to June 1, 1997 by opting-in to a
group of states that permits these transactions. These states generally allow
interstate branching via a merger of an out-of-state bank with an in-state bank,
or on a de novo basis. North Carolina has enacted legislation permitting
branching transactions.

         Restrictions on Dividends and Other Capital Distributions. A North
Carolina-chartered stock savings bank may not declare or pay a cash dividend on,
or repurchase any of, its capital stock if the effect of such transaction would
be to reduce the net worth of the institution to an amount which is less than
the minimum amount required by applicable federal and state regulations. In
addition, a North Carolina-chartered stock savings bank, for a period of five
years after its conversion from mutual to stock form, must obtain the written
approval from the Administrator before declaring or paying a cash dividend on
its capital stock in an amount in excess of one-half of the greater of (i) the
institution's net income for the most recent fiscal year end, or (ii) the
average of the institution's net income after dividends for the most recent
fiscal year end and not more than two of the immediately preceding fiscal year
ends, if applicable. Under FDIC regulations, stock repurchases may be made by
the savings bank only upon receipt of FDIC approval.

         Also, without the prior written approval of the Administrator, a North
Carolina-chartered stock savings bank, for a period of five years after its
conversion from mutual to stock form, may not repurchase any of its capital
stock. The Administrator will give approval to repurchase only upon a showing
that the proposed repurchase will not adversely affect the safety and soundness
of the institution.

         In addition, the Bank is not permitted to declare or pay a cash
dividend on or repurchase any of its capital stock if the effect thereof would
be to cause its net worth to be reduced below the amount required for the
liquidation account established in connection with the Bank's conversion from
mutual to stock ownership.

         Other North Carolina Regulations. As a North Carolina-chartered savings
bank, the Bank derives its authority from, and is regulated by, the
Administrator. The Administrator has the right to promulgate rules and
regulations necessary for the supervision and regulation of North Carolina
savings banks under his jurisdiction and for the protection of the public
investing in such institutions. The regulatory authority of the Administrator
includes, but is not limited to, the establishment of reserve requirements; the
regulation of the payment of dividends; the regulation of stock repurchases, the
regulation of incorporators, stockholders, directors, officers and employees;
the establishment of permitted types of withdrawable accounts and types of
contracts for savings programs, loans and investments; and the regulation of the
conduct and management of savings banks, chartering and branching of

                                       25
<PAGE>
 
institutions, mergers, conversions and conflicts of interest. North Carolina law
requires that the Bank maintain federal deposit insurance as a condition of
doing business.

         The Administrator conducts regular examinations of North Carolina-
chartered savings banks. The purpose of such examinations is to assure that
institutions are being operated in compliance with applicable North Carolina law
and regulations and in a safe and sound manner. These examinations are usually
conducted on a joint basis with the FDIC. In addition, the Administrator is
required to conduct an examination of any institution when he has good reason to
believe that the standing and responsibility of the institution is of doubtful
character or when he otherwise deems it prudent. The Administrator is empowered
to order the revocation of the license of an institution if he finds that it has
violated or is in violation of any North Carolina law or regulation and that
revocation is necessary in order to preserve the assets of the institution and
protect the interests of its depositors. The Administrator has the power to
issue cease and desist orders if any person or institution is engaging in, or
has engaged in, any unsafe or unsound practice or unfair and discriminatory
practice in the conduct of its business or in violation of any other law, rule
or regulation.

         A North Carolina-chartered savings bank must maintain net worth,
computed in accordance with the Administrator's requirements, of 5% of total
assets and liquidity of 10% of total assets, as discussed above. Additionally, a
North Carolina-chartered savings bank is required to maintain general valuation
allowances and specific loss reserves in the same amounts as required by the
FDIC.

         Subject to limitation by the Administrator, North Carolina-chartered
savings banks may make any loan or investment or engage in any activity which is
permitted to federally chartered institutions. However, a North
Carolina-chartered savings bank cannot invest more than 15% of its total assets
in business, commercial, corporate and agricultural loans. In addition to such
lending authority, North Carolina-chartered savings banks are authorized to
invest funds, in excess of loan demand, in certain statutorily permitted
investments, including but not limited to (i) obligations of the United States,
or those guaranteed by it; (ii) obligations of the State of North Carolina;
(iii) bank demand or time deposits; (iv) stock or obligations of the federal
deposit insurance fund or a FHLB; (v) savings accounts of any savings
institution as approved by the board of directors; and (vi) stock or obligations
of any agency of the State of North Carolina or of the United States or of any
corporation doing business in North Carolina whose principal business is to make
education loans.

         North Carolina law provides a procedure by which savings institutions
may consolidate or merge, subject to approval of the Administrator. The approval
is conditioned upon findings by the Administrator that, among other things, such
merger or consolidation will promote the best interests of the members or
stockholders of the merging institutions. North Carolina law also provides for
simultaneous mergers and conversions and for supervisory mergers conducted by
the Administrator.

         Future Requirements. Statutes and regulations are regularly introduced
which contain wide-ranging proposals for altering the structures, regulations
and competitive relationships of financial institutions. It cannot be predicted
whether or what form any proposed statute or regulation will be adopted or the
extent to which the business of the Company and the Bank may be affected by such
statute or regulation.

ITEM 2.           DESCRIPTION OF PROPERTY

         The following table sets forth the location of the Bank's principal
office in Laurinburg and its full service branch office in Pinehurst, as well as
certain other information relating to these offices as of September 30, 1998.
The Bank owns the Laurinburg office. The Bank is a 50% owner of the Pinehurst
office. A golf course designer owns and has offices in the other half of the
building. All taxes, insurance, utilities and maintenance are paid by each owner
for their respective one-half of the building. The net book value of the
Pinehurst property listed below is for the Bank's one-half interest.

                                       26
<PAGE>
 
                                       Net Book Value             Deposits
         Address                         of Property            (In Thousands)
         -------                       --------------            ------------
Laurinburg:                              $556,058                  $37,116
505 South Main Street
P.O. Box 1468
Laurinburg, North Carolina 28352
Pinehurst:                                162,340                    7,155
                                         --------                   ------
77 Cherokee Road
Pinehurst, North Carolina 28374
                                         $718,398                  $44,271
                                         ========                  =======

         The Bank's management considers the property to be in good condition
and is of the opinion that it is adequately covered by insurance. The total net
book value of the Bank's furniture, fixtures and equipment on September 30, 1998
was $37,583. Any property acquired as a result of foreclosure or by deed in lieu
of foreclosure is classified as real estate owned until such time as it is sold
or otherwise disposed of by the Bank in an effort to recover its investment. As
of September 30, 1998, the Bank had no recorded real estate acquired in
settlement of loans.

ITEM 3.           LEGAL PROCEEDINGS

         In the opinion of management, neither the Company nor the Bank is
involved in any pending legal proceedings other than routine, non-material
proceedings occurring in the ordinary course of business.


ITEM 4.           SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

         No matter was submitted to a vote of the Company's stockholders during
the quarter ended September 30, 1998.


                                    PART II

ITEM 5.           MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

         See the information under the section captioned "Common Stock
Information" on the inside back cover of the Company's 1998 Annual Report, which
section is incorporated herein by reference. See "Item 1. DESCRIPTION OF
BUSINESS--Regulation of the Bank--Restrictions on Dividends and Other Capital
Distributions" above for regulatory restrictions which limit the ability of the
Bank to pay dividends to the Company.

ITEM 6.           MANAGEMENT'S DISCUSSION AND ANALYSIS

                                       27
<PAGE>
 
         See the information set forth under Item I above and the information
set forth under the section captioned "Management's Discussion and Analysis" on
pages 4 through 14 in the Company's 1998 Annual Report, which section is
incorporated herein by reference.

ITEM 7.           FINANCIAL STATEMENTS

         The consolidated financial statements of the Company set forth on pages
15 through 45 in the Company's 1998 Annual Report are incorporated herein by
reference.


ITEM 8.           CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
                  AND FINANCIAL DISCLOSURE

         Not Applicable.


                                   PART III

ITEM 9.           DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
                  COMPLIANCE WITH 16(a) OF THE EXCHANGE ACT

         The information required by this Item regarding directors and executive
officers of the Company is set forth under the sections captioned "Proposal 2 -
Election of Directors" on page 30 of the Proxy Statement and "Executive
Officers" on page 32 of the Proxy Statement, which sections are incorporated
herein by reference.

         The information required by this Item regarding compliance with Section
16(a) of the Securities Exchange Act of 1934 is set forth under the section
captioned "Section 16(a) Beneficial Ownership Reporting Compliance" set forth on
page 8 of the Proxy Statement, which is incorporated herein by reference.

ITEM 10.          EXECUTIVE COMPENSATION

         The information required by this Item is set forth under the sections
captioned "Proposal 2 - Election of Directors - Directors Compensation" on page
31 and " - Management Compensation" on pages 32 through 37 of the Proxy
Statement, which sections are incorporated herein by reference.

ITEM 11.          SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

         The information required by this Item is incorporated by reference from
the section captioned "Security Ownership of Certain Beneficial Owners" on pages
6 through 8 of the Proxy Statement.

ITEM 12.          CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

         There have been no reportable transactions during the two most recent
fiscal years nor are any reportable transactions proposed as of the date of this
Form 10-KSB.

                                       28
<PAGE>
 
ITEM 13.          EXHIBITS AND REPORTS ON FORM 8-K

13(a)                      Exhibits

         (3)(i)            Certificate of Incorporation, incorporated herein by
                           reference to Exhibit (3)(i) to the Registration
                           Statement on Form S-1, Registration No. 33-99916,
                           dated November 30, 1995 and amended on January 31,
                           1996 and February 7, 1996.

         (3)(ii)           Bylaws, incorporated herein by reference to Exhibit
                           (3)(ii) to the Registration Statement on Form S-1,
                           Registration No. 33-99916, dated November 30, 1995
                           and amended on January 31, 1996 and February 7, 1996.

         (4)               Specimen Stock Certificate incorporated herein by
                           reference to Exhibit 4 to the Registration Statement
                           on Form S-1, Registration No. 33-99916, dated
                           November 30, 1995 and amended on January 31, 1996 and
                           February 7, 1996.

         10(a)             Employment Agreement with William C. Fitzgerald, III
                           incorporated herein by reference to the Form 10-KSB
                           for the fiscal year ended September 30, 1996, file
                           number 1-14266, filed with the SEC on December 23,
                           1996.

         10(b)             Special Termination Agreement with John B. Clark
                           incorporated herein by reference to the Form 10-KSB
                           for the fiscal year ended September 30, 1996, file
                           number 1-14266, filed with the SEC on December 23,
                           1996.

         10(c)             Deferred Compensation Agreements with James E.
                           Milligan, James S. Mitchener and Sam T. Snowdon, Jr.
                           incorporated herein by reference to the Form 10-KSB
                           for the fiscal year ended September 30, 1996, file
                           number 1-14266, filed with the SEC on December 23,
                           1996.

         10(d)             Scotland Savings Bank, Inc. SSB Management
                           Recognition Plan and Trust incorporated herein by
                           reference to the Form 10-KSB for the fiscal year
                           ended September 30, 1997, file number 1-14266, filed
                           with the SEC on December 16, 1997.

         10(e)             Scotland Bancorp, Inc. Stock Option Plan incorporated
                           herein by reference to the Form 10-KSB for the fiscal
                           year ended September 30, 1997, file number 1-14266,
                           filed with the SEC on December 16, 1997.

         (11)              Statement Regarding Computation of Per Share Earnings

         (13)              Portions of 1998 Annual Report to Stockholders

         (21)              See Item 1. Description of Business for discussion of
                           subsidiaries

         (23)              Consent of McGladrey & Pullen, LLP

         (27)              Financial Data Schedule

(13)(b)  On August 28, 1998, the Company filed a Form 8-K disclosing that it had
         entered into an Agreement and Plan of Reorganization and Merger with
         Centura Banks, Inc.


                                       29
<PAGE>
 
                                  SIGNATURES

         Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.

                                 SCOTLAND BANCORP, INC.


Date:  December 18, 1998         By:      /s/ William C. Fitzgerald, III
                                          ------------------------------
                                          William C. Fitzgerald, III
                                          President and Chief Executive Officer

         Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated:

<TABLE>
<CAPTION>

<S>                                                     <C>                                     <C>  
Signature                                                     Title                                        Date
---------                                                     -----                                        ----

/s/ William C. Fitzgerald, III                        President, Chief Executive                     December 18, 1998
-----------------------------------------------       Officer and Director 
William C. Fitzgerald, III                          

/s/ John B. Clark                                     Senior Vice-President and                      December 18, 1998
-----------------------------------------------       Director 
John B. Clark                                        

/s/ Debora B. Steagall                                Assistant Treasurer                            December 18, 1998
-----------------------------------------------
Debora B. Steagall

/s/ Clifton P. Buie                                   Director                                       December 18, 1998
-----------------------------------------------
Clifton P. Buie

/s/ E. S. Hill, Jr.                                   Director                                       December 18, 1998
-----------------------------------------------
E.S. Hill, Jr.

/s/ John W. Hudson                                    Director                                       December 18, 1998
-----------------------------------------------
John W. Hudson

/s/ James W. Mason                                    Director                                       December 18, 1998
-----------------------------------------------
James W. Mason

/s/ James E. Milligan                                 Director                                       December 18, 1998
-----------------------------------------------
James E. Milligan

/s/ James S. Mitchener, Jr.                           Director                                       December 18, 1998
-----------------------------------------------
James S. Mitchener, Jr.

/s/ S. T. Snowdon, Jr.                                Director                                        December 18, 1998
-----------------------------------------------
S. T. Snowdon, Jr.

/s/ James T. Willis                                   Director                                        December 18, 1998
-----------------------------------------------
James T. Willis
</TABLE>

                                       30
<PAGE>
 
                               INDEX TO EXHIBITS


Exhibit No.                                      Description

11                         Statement Regarding Computation of Per Share Earnings

13                         Portions of the 1998 Annual Report to Stockholders

23                         Consent of McGladrey & Pullen, LLP

27                         Financial Data Schedule