<TABLE>
<CAPTION>
                                                  SELECTED FINANCIAL DATA


                                                                                     Year Ended December 31,
                                                                  --------------------------------------------------------
                                                                     1998         1997      1996        1995       1994
                                                                  ----------  ----------  ---------  ---------  ----------  
                                                                                      (dollars in thousands)
<S>                                                               <C>         <C>         <C>        <C>        <C>         
Summary of Operations:
Interest income                                                   $    9,268  $    8,353  $   8,008  $   6,602  $    5,996  
Interest expense                                                       4,270       3,491      3,610      3,607       2,862
                                                                  ----------  ----------  ---------  ---------  ---------- 
Net interest income                                                    4,998       4,862      4,398      2,995       3,134
Provision for loan losses                                                180          60         50        350          26  
                                                                  ----------  ----------  ---------  ---------  ----------  

Net  interest  income after  provision  for      
loan losses                                                            4,818       4,802      4,348      2,645       3,108
Other income                                                             163         145        114        127         111
Other expenses (1)                                                     2,428       2,514      2,123      1,605       1,495
                                                                  ----------  ----------  ---------  ---------  ----------
Income before tax expense                                              2,553       2,433      2,339      1,167       1,724
Income tax expense                                                       945         901        858        430         617
                                                                  ----------  ----------  ---------  ---------  ----------  
     Net income                                                   $    1,608  $    1,532  $   1,481  $     737  $    1,107
                                                                  ==========  ==========  =========  =========  ==========
                                                                   

Selected Year-End Balances:
Total assets                                                      $  127,273  $  108,092  $ 105,807  $  87,751  $   81,560
Loans receivable, net                                                102,549      92,967     82,992     75,097      65,973
Investments (2)                                                       18,134      11,483     18,945      8,884      12,693  
Deposits                                                              73,176      66,973     66,564     73,035      69,140
FHLB Advances                                                         23,967       7,800       -         1,000        -
Stockholders' equity                                                  28,490      31,076     37,368     12,562      11,729

Average Balance Sheet Data:
Total assets                                                      $  117,567  $  105,617  $ 103,874  $  83,921  $   78,890
Total earning assets                                                 111,633     101,909    102,336     83,058      76,125
Loans receivable, net                                                 98,675      87,489     78,797     70,397      61,301
Investments (2)                                                       12,021      13,696     22,907     12,481      14,825
Deposits                                                              68,600      66,520     68,684     70,541      66,713
FHLB Advances                                                         15,134       2,788         83        167        -
Stockholders' equity                                                  32,368      33,869     33,115     12,283      11,317

Selected Financial Ratios:
Return on average assets                                               1.37%      1.45%       1.43%       .88%       1.40%
Return on average equity                                               4.97%      4.52%       4.48%      6.00%       9.78%
Average equity to average assets                                      27.53%     32.07%      31.88%     14.64%      14.34%
Interest rate spread (tax equivalent basis)                            3.20%      3.16%       2.62%      2.86%       3.59%
Net interest margin (tax equivalent basis)                             4.48%      4.77%       4.32%      3.62%       4.12%
Dividend payout ratio                                                 51.12       55.22       54.32        N/A         N/A
Cash dividends declared per common share (3)                      $     0.46  $    4.45   $    0.44        N/A         N/A
Earnings per share - basic (4)                                    $     0.89  $    0.82   $    0.82        N/A         N/A
Earnings per share - diluted (4)                                  $     0.89  $    0.82   $    0.82        N/A         N/A


</TABLE>
<PAGE>
(1)  In 1996, a one time special  assessment  of $456,000 was imposed on Savings
     Association  Insurance Fund (SAIF) insured institutions to recapitalize the
     SAIF.

(2)  Includes  investment  securities,  mortgage  backed-securities,   interest-
     bearing deposits, and federal funds.

(3)  Includes a $4.00 special return of capital dividend paid on July 11, 1997.

(4)  Earnings  per  share - basic  and  diluted  for 1998 was  calculated  using
     weighted average shares outstanding of 1,813,850 shares. Earnings per share
     for  1997  was  computed  using  weighted  average  shares  outstanding  of
     1,872,451  shares.  Earnings  per  share  for 1996 was  computed  as if the
     1,825,050  shares issued on March 29, 1996 had been  outstanding on January
     1, 1996.


                                       1
<PAGE>
                      MANAGEMENT'S DISCUSSION AND ANALYSIS
                             ----------------------

       Management's discussion and analysis is intended to assist readers in the
understanding  and  evaluation  of  the  financial   condition  and  results  of
operations  of  Stone  Street  Bancorp,  Inc.  and  Stone  Street  Bank &  Trust
(collectively  referred to as the  "Company").  It should be read in conjunction
with the  audited  consolidated  financial  statements  and  accompanying  notes
included in this report and the supplemental financial data appearing throughout
this discussion and analysis.

                        ANALYSIS OF RESULTS OF OPERATIONS

       The  Company's  results of  operations  depend  primarily on net interest
income,  which is the difference  between interest income from  interest-earning
assets and interest expense on interest-bearing liabilities. Operations are also
affected by non-interest  income,  such as income from customer service charges,
loan fee income and other sources of income. The Company's  principal  operating
expenses,  aside from interest  expense,  consist of  compensation  and employee
benefits,  federal deposit insurance premiums, data processing expenses,  office
occupancy costs, equipment expense and income taxes.

In 1998 the  Company  completed  an  exceptional  year once  again  with  record
earnings.  Net income increased to $1.61 million for the year ended December 31,
1998 compared to $1.53 million in 1997 and $1.48 million in 1996.  Growth in net
interest  income  combined  with an increase  in other  income  combined  with a
decrease in other expense made 1998 a very profitable year for the Company.

                               Income and Expense
                                 --------------

       Net interest income is the Company's primary source of earnings.  Table 1
shows that  tax-equivalent  net interest income increased by $136,000 or 2.8% in
1998 to $5.0 million from $4.9 in 1997. Tax  equivalent  net interest  income in
1997 was $4.9  million as  compared  to $4.4  million in 1996,  an  increase  of
$464,000 or 10.6%. Net interest income is analyzed on a tax-equivalent  basis to
adjust for the nontaxable status of income earned on certain investments such as
municipal bonds.

The increase in  tax-equivalent  interest income in 1998 as compared to 1997 was
primarily  the result of the increase in the average  balances in 1998  combined
with an increase in the weighted  average  yields.  Average  loans  increased by
$11.2 million or 12.8% to $98.7 million.  Average investments  decreased by $1.3
million  or 13.2% as  matured  investment  proceeds  were  used to fund the loan
growth.  The weighted average yield on  interest-earning  assets increased by 10
basis  points  in 1998.  In  1997,  tax-equivalent  interest  income  rose  4.3%
primarily  due to increases in the weighted  average  yield on  interest-earning
assets from 7.87% to 8.20% combined with an increase in average balances.

Interest expense  increased by $779,000 in 1998 due primarily to the increase in
FHLB borrowings The balance of average  interest-bearing  liabilities  increased
$14.4 million or 20.8%  primarily  due to the $12.3 million  increase in average
balance of  borrowings  from the FHLB  combined  with $2.1  million  increase in
average deposits.  The increased  balances of interest bearing  liabilities were
used to fund loan demands.
<PAGE>
Interest expense  decreased by only $119,000 in 1997.  Average  interest-bearing
liabilities  increased  $541,000 or .79% in 1997 while the average  rate paid on
those  liabilities  decreased by 21 basis points.  As a result,  the decrease in
interest expense in 1997 was due primarily to decreases in average rates.

Interest rate spread (on a tax equivalent basis) increased to 3.20% in 1998 from
3.16% in 1997 due to the increase in the yield on interest earning assets net of
an increase in the average rate on interest  bearing  liabilities.  Net interest
margin  decreased  to 4.48% in 1998 from  4.77% in 1997.  Interest  rate  spread
increased  to 3.16% in 1997 from 2.62% in 1996.  Net  interest  margin (on a tax
equivalent basis) increased to 4.77% in 1997 from 4.32% in 1996.


                                       4
<PAGE>
Table 2 shows the effect of variances  in volume and rate on  taxable-equivalent
interest income, interest expense, and net interest income. The table shows that
increases in net interest income were due to volume and rate changes in 1998 and
1997 while increases in net interest income in 1996 were primarily due to volume
changes.

Table 1:  NET INTEREST INCOME ANALYSIS-TAX EQUIVALENT
<TABLE>
<CAPTION>
                                                      1998                               1997               
                                       --------------------------------    -------------------------------  
                                                                Average                            Average  
                                         Average                Yield/     Average                  Yield/  
                                         Balance    Interest     Rate      Balance     Interest      Rate   
                                         -------    --------     ----      -------     --------      ----   
                                                              (dollars in thousands)
<S>                                     <C>        <C>         <C>         <C>        <C>          <C>      
Assets:
Interest-earning assets:
  Loans receivable (1)                  $  98,675  $   8,457     8.57%     $  87,489  $   7,490      8.56%     
  Investment securities (2)                 8,263        461     5.58%         9,517        519      5.45%     
  Interest-bearing deposits                 3,758        271     7.21%         4,179        291      6.96%     
  FHLB common stock                           937         79     8.43%           724         53      7.32%     
                                        ---------  ---------   ------      ---------  ---------   -------      
Total interest-earning assets             111,633      9,268     8.30%       101,909      8,353      8.20%     
                                                                                                               
Non-interest-earning assets                 5,934                              3,708                           
                                        ---------                          ---------                           
    TOTAL                               $ 117,567                          $ 105,617                           
                                        =========                          =========                           
                                       

Liabilities and stockholders' equity:
Interest-bearing liabilities:
  Deposit accounts                      $  68,600  $   3,426      4.99%    $  66,520  $   3,345      5.03%     
  FHLB advances                            15,134        844      5.58%        2,788        146      5.24%     
                                        ---------  ---------    ------     ---------  ---------   -------      

Total interest-bearing liabilities         83,734      4,270      5.10%       69,308      3,491      5.04%     

Non-interest-bearing liabilities            1,465                              2,440                           

Stockholders' equity                       32,368                             33,869                           
                                        ---------                          ---------                           

    TOTAL                                 117,567                          $ 105,617                           
                                        =========                          =========                           


Net interest income and interest
  rate spread                            $   4,998      3.20%              $   4,862                   3.16%   
                                         =========  =========              =========              =========    
Net interest- earning assets
  and net interest margin                $  27,899                 4.48%   $  32,601                   4.77%   
                                         =========             =========   =========              =========    
Ratio of interest-earning assets
  to interest bearing liabilities                                133.32%                             147.04%   
                                                               =========                          =========    
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
                                                              1996                
                                                --------------------------------     
                                                                         Average     
                                                Average                  Yield/     
                                                Balance     Interest      Rate      
                                                -------     --------      ----      
 <S>                                            <C>        <C>         <C>         
Assets:                               
Interest-earning assets:              
  Loans receivable (1)                         $ 78,797   $   6,662     8.45%            
  Investment securities (2)                       7,617         607     6.75%      
  Interest-bearing deposits                      14,645         692     4.72%      
  FHLB common stock                                 645          47     7.29%      
                                               --------   ---------   ------       
Total interest-earning assets                   101,704       8,008     7.87%      
                                                                                   
Non-interest-earning assets                       2,170                            
                                               --------                            
    TOTAL                                      $103,874                            
                                               ========                            
                                                                                   
                                                                                   
Liabilities and stockholders' equity:                                              
Interest-bearing liabilities:                                                      
  Deposit accounts                             $ 68,684       3,604     5.24%      
  FHLB advances                                      83           6     8.43%      
                                               --------   ---------   ------       
                                                                                   
Total interest-bearing liabilities               68,767      3,610     5.25%       
                                                                                   
Non-interest-bearing liabilities                  1,992                            
                                                                                   
Stockholders' equity                             33,115                            
                                               --------                            
                                                                                   
    TOTAL                                      $103,874                            
                                               ========                            
                                                                                   
                                                                                   
Net interest income and interest                                                   
  rate spread                                             $    4,398     2.62%     
                                                          ==========  ========     
Net interest- earning assets                                                       
  and net interest margin                      $ 32,937                  4.32%     
                                               ========               ========     
Ratio of interest-earning assets                                                   
  to interest bearing liabilities                                      147.90%     
                                                                      =======      
</TABLE>

(1) Includes nonaccrual loans
(2) Interest earned on tax-exempt  investment  securities has been adjusted to a
    tax-equivalent  basis  using the  applicable  federal  rate of 34% and state
    rates in 1998 of 7.25%,  1997 of 7.50% and 1996 of 7.75%,  respectively  and
    reduced by the nondeductible portion of interest expense.
<PAGE>
Table 2:  RATE/VOLUME ANALYSIS
<TABLE>
<CAPTION>
                                          1998 vs 1997                               1997 vs 1996  
                             ---------------------------------------    ---------------------------------------              
                                                  Rate/                                       Rate/              
                              Volume     Rate     Volume        Net      Volume     Rate      Volume       Net   
                             -------    ------    ------      ------    -------    ------    -------     ------  
<S>                          <C>        <C>       <C>         <C>       <C>        <C>       <C>         <C>     
Interest income
   (tax-equivalent) on:
  Loans                      $   958    $    8    $    1      $  967    $   734    $   86    $     8     $  828  
  Investment securities          (68)       12        (2)        (58)       151      (191)       (48)       (88) 
  Interest-bearing deposits      (29)       10        (1)        (20)      (494)      328       (235)      (401) 
  FHLB common stock               16         8         2          26          6         -          -          6  
                             -------    ------    ------      ------    -------    ------    -------     ------ 
   Total interest income         877        38         -         915        397       223       (275)       345  
                             -------    ------    ------      ------    -------    ------    -------     ------  
  Deposit accounts               105       (23)       (1)         81       (113)     (151)         5       (259) 
  FHLB advances                  647         9        42         698        228        (3)       (85)       140  
                             -------    ------    ------      ------    -------    ------    -------     ------ 
   Total interest expense        752       (14)       41         779        115      (154)       (80)      (119) 
                             -------    ------    ------      ------    -------    ------    -------     ------  
Increase (decrease) in
  net interest income        $   125    $   52    $  (41)     $  136    $   282    $  377    $  (195)    $  464  
                             =======    ======    ======      ======    =======    ======    =======     ======  
                      
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
<CAPTION>
                                                    1996 vs 1995   
                                   ---------------------------------------------               
                                                               Rate/                   
                                    Volume        Rate        Volume        Net          
                                   -------      -------      -------      ------                                 
<S>                                <C>          <C>          <C>          <C>                  
Interest income             
   (tax-equivalent) on:     
  Loans                            $   714      $   (31)     $    (4)     $  679               
  Investment securities                (45)         306          (37)        224        
  Interest-bearing deposits            687          (43)        (150)        494        
  FHLB common stock                      6            -            -           6               
                                   -------      -------      -------      ------             
   Total interest income             1,362          232         (191)      1,403      
                                   -------      -------      -------      ------               
  Deposit accounts                     (95)          92            -          (3)              
  FHLB advances                          7            -            -           7               
                                   -------      -------      -------      ------           
   Total interest expense              (88)          92            -           4         
                                   -------      -------      -------      ------               
Increase (decrease) in                                                             
  net interest income              $ 1,450      $   140      $  (191)     $1,399               
                                   =======      =======      =======      ======               
</TABLE>
                                       5
<PAGE>
                          INCOME AND EXPENSES Continued

                            Provision for Loan Losses

The  provision  for loan losses is charged to  earnings  to  maintain  the total
allowance  for loan losses at a level  considered  adequate to cover loan losses
based on  existing  loan  levels and types of loans  outstanding,  nonperforming
loans,  prior loan loss  experience,  industry  standards  and general  economic
conditions. Provisions for loan losses were $180,000 in 1998 compared to $60,000
in 1997, and $50,000 in 1996. During 1995, the provision and resulting allowance
for loan losses were increased based on management's efforts to reflect industry
practices  regarding the allowance for loan losses.  In 1998,  the allowance for
loan loss was  increased  due to  expansion  into more  commercial  lending as a
result of increased market demand.

                                  Other Income

       Other income increased from $145,000 in 1997 to $163,000 in 1998, and was
$114,000 in 1996. The increase in other income was primarily in customer service
charges and other fees which increased $9,000 in 1998 from the 1997 level. Other
income  in 1997  increased  $31,000  over the 1996  amount.  This  increase  was
primarily in customer service charges and other fees which increased  $30,000 in
1997.

                                 Other Expenses

       Other  expenses  decreased  by 3.4% in 1998  compared  to an  increase of
18.4% in 1997. As a percent of average  assets,  other expense for 1998 was 2.1%
as compared to 2.4% in 1997 and 2.04% in 1996.

Other expenses totaled  $2,428,000 in 1998 compared to $2,514,000 and $2,123,000
in 1997 and 1996, respectively. This was primarily attributable to a decrease in
the compensation expense recognized in the second quarter of 1998 related to MRP
plan of the Company combined with a reduction in the ESOP  compensation  expense
in 1998. First, in 1997, the Company recorded  $351,000 of compensation  expense
related to the Company's  employee  stock  ownership  plan  ("ESOP"),  primarily
associated  with the release and  allocation of  approximately  23,617 shares of
common stock of the Parent to  participants of the ESOP during 1997. The special
dividend paid on the Parents stock on July 11, 1997 and management's decision to
use the special dividends paid on the unallocated  shares of the Parent's common
stock  held by the ESOP to  pre-pay  the ESOP loan  from the  Parent to the ESOP
resulted in a significant  portion of that share release,  approximately  15,869
shares. As a result,  approximately,  $171,000 of the ESOP-related  compensation
expense is deemed to be of a non-recurring nature.

Other expenses in 1998 which totaled $2,428,000,  compared to 1997 total without
the effect of the  non-recurring  portion of ESOP-related  compensation  expense
would have totaled  $2,343,000,  an $85,000  increase in 1998.  Compensation and
fringe  benefits,   excluding  non-recurring  items,  increased  by  $49,000  to
$1,631,000  compared to $1,582,000 in 1997,  primarily  related to annual salary
increases  and  additional  employees.  The  recurring  portion of  ESOP-related
compensation expense for 1998 totaled $190,000 compared to $180,000 recorded for
1997 and $175,000 for 1996. Also included in  compensation  expense was $273,000
in 1998 and $353,000 in 1997 of amortization of deferred compensation associated
with the MRP plan.
<PAGE>
Within other expenses the 'other' expense category  increased $5,000 to $395,000
in  1998  from  $390,000  in  1997  due  to  increases  in  marketing  expenses,
shareholder  reporting  expenses,  and franchise tax expenses.  These  increased
expenses  are  mitigated  to a degree  by a $3,000  decrease  in  FDIC-insurance
premiums  to $43,000  for 1998 from  $46,000  for 1997.  In 1996 FDIC  insurance
premiums  included a special one time assessment of $456,000.  Deposit insurance
premiums  decreased  starting  with the quarter  ended  December 31,  1996.  The
reduced level of  FDIC-insurance  premiums is  anticipated  to continue into the
future.

Occupancy and equipment  expense increased by $61,000 or 23.4% in 1998 over 1997
as the Bank changed its data processing  service bureau and continued to improve
its customer  information  technology.  Professional fees decreased $27,000 from
1997  because  there  were  no  additional  costs  related  to  assistance  with
conversion, regulatory filings or employee benefit programs incurred in 1998.


                                       6
<PAGE>
                         ANALYSIS OF FINANCIAL CONDITION
                                ---------------

Other expenses increased by $391,000 or 18.4% in 1997 compared to an increase of
32.3% in 1996. As a percent of average  assets,  other expense for 1997 was 2.4%
as compared to 2.0% in 1996.

Compensation and fringe benefits in 1997  representing over 69.7% of total other
expenses  increased  by  $740,000  or 73.1% over  1996.  The large  increase  in
compensation and related benefits is due to the  implementation of the Company's
MRP and ESOP plans. The costs associated with these employee benefit programs in
1997 was $351,000  for the ESOP plan and $353,000 for the MRP plan.  In 1996 the
only cost incurred by the Company was an ESOP contribution expense of $175,000.

Occupancy and equipment expense increased by $45,000 in 1997 over 1996.  Reasons
for the increase in 1997 included  investments in technology primarily the costs
associated with an ATM machine and additional computer costs.  Deposit insurance
premiums  decreased  $535,000  from the 1996 level due to the  special  one time
assessment by the FDIC  incurred by the Company in September,  1996 of $456,000.
Professional  fees  increased by $28,000 in 1997 compared to 1996 as the Company
obtained  assistance in implementing the employee benefit program related to the
ESOP and MRP plans as well as regulatory filings.

Management  continues to look for ways to improve cost efficiency while offering
new services to its customers.

                               Income Tax Expense

       Income tax  expense  increased  $44,000 or 4.9% to  $945,000 in 1998 from
$901,000 in 1997. The effective tax rate was 37.0% in 1998 and 1997.  Income tax
expense totaled $858,000 in 1996, and the effective tax rate was 36.7%.  Changes
in income tax expenses were caused primarily by changes in net income.


                         ANALYSIS OF FINANCIAL CONDITION
                              --------------------

       On March 29, 1996 Mocksville Savings Bank, Inc. SSB now Stone Street Bank
& Trust (the "Bank")  completed its conversion  from a mutual to a stock savings
bank through the sale of 1,825,050 shares of no par common stock of Stone Street
Bancorp,  Inc. (the  "Parent").  Total proceeds of  $27,375,750  were reduced by
Conversion expenses of $1,116,905. The Parent retained 50% of the net conversion
proceeds  after  deducting the proceeds of a loan to the Bank's  Employee  Stock
Ownership  Plan  ("ESOP")  and paid the balance to the Bank in exchange  for the
common stock of the Bank issued in the  Conversion.  The increase in assets from
$87.8  million at December  31, 1995 to $105.8  million at December  31, 1996 is
directly attributable to proceeds of the Conversion which were invested in loans
and investment securities.

                                      Loans

       The Company's  primary  source of revenue is interest and fee income from
lending  activities,  consisting  primarily of  one-to-four  family  residential
mortgage  loans located in its primary market area. The Company also makes loans
secured by  improved  nonresidential  real  estate,  construction  loans,  loans
secured by undeveloped real estate,  home equity loans, and consumer loans, both
secured and unsecured.
<PAGE>
At  December  31,  1998,  the net loan  portfolio  totaled  $102.5  million  and
represented 80.6% of total assets.  During 1998, loans increased by $9.6 million
or 10.3%.  Loan  originations  increased  from  $27.6  million  in 1997 to $43.0
million in 1998, largely in response to the Company's efforts to expand its loan
programs into adjacent counties.  The relative composition of the Company's loan
portfolio  has  remained   consistent  during  recent  years,  with  residential
one-to-four  family loans  comprising  approximately  82% of the portfolio as of
December 31, 1998.  Table 3 sets forth the  composition of the loan portfolio at
the dates indicated.

                                       7
<PAGE>
Table 3:  TYPES OF LOANS
<TABLE>
<CAPTION>
                                                                           December 31,
                                  -----------------------------------------------------------------------------------------------
                                            1998                  1997                      1996                      1995  
                                  --------------------    --------------------     ---------------------     --------------------
                                   Amount   Percentage    Amount    Percentage     Amount    Percentage      Amount    Percentage 
<S>                                <C>          <C>        <C>         <C>         <C>           <C>         <C>          <C>       
Percentage
Real estate loans:                                                                    (dollars in thousands)
 Residential 1-4 family           $  84,094      82.00%    $ 76,894     82.71%     $  67,844      81.75%     $  63,329     84.33%   
  Nonresidential real estate          9,619       9.38        9,541     10.26          5,716       6.88          4,260      5.67    
  Home equity and other
  second mortgage                     2,477       2.42        2,675      2.88          2,473       2.98          2,185      2.91    
 Construction                        12,670      12.35        8,571      9.22         12,492      15.05         11,735     15.63    
                                  ---------     ------     --------    ------      ---------    -------      ---------    ------    
  Total real estate loans           108,860     106.15       97,681    105.07         88,525     106.66         81,509    108.54    
Other installment loans               1,265       1.23          632       .68            372        .45            222       .30    
   Less:
 Unearned fees                        1,212       1.18        1,058      1.14          1,009       1.22            962      1.29    
 Loans in process                     5,614       5.47        3,718      4.00          4,385       5.28          5,211      6.94  
 Allowance for loan losses              750        .73          570       .61            511        .61            462       .61    
                                  ---------     ------     --------    ------      ---------     ------      ---------    ------    
 Total reductions                     7,576       7.38        5,346      5.75          5,905       7.11          6,635      8.84    
                                  ---------     ------     --------    ------      ---------     ------      ---------    ------    

   Total loans, net               $ 102,549     100.00%    $ 92,967    100.00%     $  82,992     100.00%     $  75,096    100.00%   
                                  =========     ======     ========    ======      =========     ======      =========    ======    
<CAPTION>
                                         December 31,
                                   -----------------------
                                             1994
                                   -----------------------
                                     Amount     Percentage
                                     ------     ----------
<S>                                <C>            <C>             
Percentage                     
Real estate loans:             
 Residential 1-4 family            $  54,321       82.34%          
  Nonresidential real estate           4,987        7.56    
  Home equity and other                                       
  second mortgage                      1,423        2.16             
 Construction                         11,589       17.56            
                                   ---------      ------           
  Total real estate loans             72,320      109.62      
Other installment loans                  197        0.30             
   Less:                                                      
 Unearned fees                         1,095        1.66             
 Loans in process                      5,334        8.09
 Allowance for loan losses               115        0.17             
                                   ---------      ------           
 Total reductions                    6,544          9.92             
                                   ---------      ------           
                                                              
   Total loans, net                $  65,973      100.00%         
                                   =========      ======          
                                  
</TABLE>
<PAGE>
In order to protect the Company's net interest  margin,  management has, as part
of its interest rate risk management  program,  placed an emphasis on increasing
adjustable rate mortgage loans and home equity lines of credit in its portfolio.
This  strategy  will result in more  consistent  net  interest  income and lower
interest  sensitivity  than  experienced by traditional  fixed-rate  residential
mortgage lending.

The following table sets forth the time to repricing or contractual  maturity of
the Company's loan portfolio at December 31, 1998.  Loans which have  adjustable
rates are shown as being due in the period  during  which rates are next subject
to change,  while  fixed rate and other  loans 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 or scheduled principle  repayments.  Amounts in the table are net of
loans in process.

Table 4:  LOAN MATURITIES
<TABLE>
<CAPTION>
                                                                              December 31, 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
                                                   ---------   ---------   ---------   ----------   ----------  -----------
                                                                            (dollars in thousands)
<S>                                                <C>         <C>         <C>         <C>          <C>         <C>        
Fixed rate 1-4 family                              $      22   $   1,134   $   4,246   $   38,953   $   44,249  $    88,604
Adjustable rate 1-4 family                             1,455           -           -            -            -        1,455
Adjustable home equity                                 2,356           -           -            -            -        2,356
Fixed rate-nonresidential                                 46         515         313        3,397        5,348        9,619
Other loans                                            1,265           -           -            -            -        1,265
Less:
 Allowance for loan losses                              (750)          -           -            -            -         (750)
                                                   ---------   ---------   ---------   ----------   ----------  -----------
  Total Loans                                      $   4,394   $   1,649   $   4,559   $   42,350   $   49,597  $   102,549
                                                   =========   =========   =========   ==========   ==========  ===========

</TABLE>
                                       9
<PAGE>
                   Asset Quality and Allowance for Loan Losses


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

Table 5:  SUMMARY OF NONPERFORMING AND PROBLEM ASSETS
<TABLE>
<CAPTION>
                                                                         December 31,
                                                   ------------------------------------------------------
                                                     1998        1997        1996      1995       1994
                                                   ---------   ---------  ---------  ---------  ---------
                                                                      (dollars in thousands)
<S>                                                <C>         <C>        <C>        <C>        <C>      
Total nonaccrual loans                             $       -   $       -  $       -  $       -  $       -
Total restructured loans                                   -           -          -          -          -
                                                   ---------   ---------  ---------  ---------  ---------
   Total nonperforming loans                               -           -          -          -          -
                                                   ---------   ---------  ---------  ---------  ---------
Real estate owned                                          -           -          -          -          -
In-substance foreclosures                                  -           -          -          -          -
                                                   ---------   ---------  ---------  ---------  ---------
   Total foreclosed property                               -           -          -          -          -
                                                   ---------   ---------  ---------  ---------  ---------
Total nonperforming assets                         $       -   $       -  $       -  $       -  $       -
                                                   =========   =========  =========  =========  =========

Accruing loans, delinquent 90 days or more         $     243   $     295  $     423  $     201  $     280
                                                   =========   =========  =========  =========  =========

Nonperforming loans to total loans                     0.00%      0.00%       0.00%      0.00%       0.00%
Nonperforming assets to total assets                   0.00%      0.00%       0.00%      0.00%      0.00%
Total assets                                        $127,273   $108,092  $ 105,807  $  87,751  $   81,560
Total loans, net                                    $102,549   $ 92,967  $  82,992  $  75,097  $   65,973

</TABLE>

The  allowance  for loan losses  represents  management's  estimate of an amount
adequate to provide for potential  losses  inherent in the loan  portfolio.  The
adequacy of the  allowance  for loan losses and the related  provision are based
upon management's  evaluation of the risk  characteristics of the loan portfolio
under  current  economic  conditions  with  consideration  to  such  factors  as
financial condition of the borrowers,  collateral values, growth and composition
of the loan  portfolio,  the  relationship  of the  allowance for loan losses to
outstanding  loans,  and  delinquency  trends.   Management  believes  that  the
allowance  for loan losses is  adequate.  While  management  uses all  available
information to recognize losses on loans,  future additions to the allowance may
be  necessary  based on  changes  in  economic  conditions.  Various  regulatory
agencies, as an integral part of their examination process,  periodically review
the Company's  allowance for loan losses.  Such agencies may require the Company
to  recognize  additions  to  the  allowance  based  on  their  judgments  about
information available to them at the time of their examination.
<PAGE>
The provision for loan losses is calculated  and charged to earnings to maintain
the total allowance for loan losses at a level considered adequate to cover loan
losses based on existing loan levels, types of loans outstanding,  nonperforming
loans,  prior loan loss  experience,  industry  standards  and general  economic
conditions. Provisions for loan losses were $180,000 in 1998 compared to $60,000
in 1997, and $50,000 in 1996. During 1995, the provision and resulting allowance
for loan losses were increased based on management's efforts to reflect industry
practices  regarding the allowance  for loan losses.  During 1996 and 1997,  the
provision  was  lowered,  largely  as a  result  of an  improved  level  of  the
relationship  between  the  allowance  and  outstanding  loans.  During 1998 the
provision was increased as the Company  increased its lending in the  commercial
real estate market.


                                       9
<PAGE>
The  following  tables  describe the activity  related to the allowance for loan
losses and the allocation of the allowance for loan losses to various categories
of loans for the periods indicated.

Table 6:  ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES
<TABLE>
<CAPTION>
                                                                                  Year Ended December 31,
                                                              -------------------------------------------------------------
                                                                 1998         1997        1996         1995          1994
                                                              ---------    ---------    ---------    --------      --------
                                                                                       (in thousands)
<S>                                                           <C>          <C>          <C>          <C>           <C>     
Balance, beginning of period                                  $     570    $     511    $     462    $     115     $     89
Provision for loan losses                                           180           60           50          350           26
Charge-offs                                                           -            1            1            3           -
Recoveries                                                            -            -            -            -
                                                              ---------    ---------    ---------    --------      --------
Balance, end of period                                        $     750    $     570    $     511    $     462     $    115
                                                              =========    =========    =========    =========     ========

Allowance as a percentage of loans                                 .73%         .61%         .62%         .62%        .17%

</TABLE>

Table 7:  ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
<TABLE>
<CAPTION>
                                                                                       December 31,
                                                              -------------------------------------------------------------
                                                                 1998         1997         1996         1995         1994
                                                              ---------    ---------    ---------    ---------     --------
                                                                                       (in thousands)
<S>                                                           <C>          <C>          <C>          <C>           <C>     
Residential 1-4 family                                        $     188    $     154    $     138    $     127     $     45
Nonresidential real estate                                          263          171          153          138           23
Home equity and other second mortgage                                53           58           52           46           12
Construction                                                        188          143          128          115           24
                                                              ---------    ---------    ---------    ---------     --------
 Total real estate loans                                            692          526          471          426          104
Other loans                                                          58           44           40           36           11
                                                              ---------    ---------    ---------    ---------     --------
 Total allowance for loan losses                              $     750    $     570    $     511    $     462     $    115
                                                              =========    =========    =========    =========     ========
</TABLE>

The  allocation  of  the  allowance  for  loan  losses  to the  respective  loan
classifications  is not  necessarily  indicative  of  future  losses  or  future
allocations. Refer to Table 3 for percentages of loans in each category to total
loans.
<PAGE>
                              Investment Securities

       Interest  and  dividend  income  from  interest   bearing   deposits  and
investment  securities generally provides the second largest source of income to
the Company after interest on loans.  The Company's  interest  bearing  deposits
primarily include deposits with the FHLB of Atlanta and federal funds, while its
portfolio  of  investment   securities   includes  U.S.  government  and  agency
securities,   mortgage-backed  securities,   obligations  of  states  and  local
governments  and  mutual  funds.  The  mortgage-backed   securities  consist  of
collateralized  mortgage obligations issued by the GNMA, FHLMC and SBA which are
secured by mortgage-backed securities guaranteed by the GNMA, FHLMC or SBA.

Interest bearing deposits totaled $4.4 million at December 31, 1998, an increase
of $1.7  million from 1997.  This  increase is  attributable  to the increase in
deposits  during 1998.  The Company  also had $878,000 of federal  funds sold at
December 31, 1998, a decrease of $156,000 from the 1997 level of $1,034,000.



                                       10
<PAGE>
Investment securities totaled $12.9 million at December 31, 1998, an increase of
$5.2  million  from  $7.7  million  at  December  31,  1997.   The  increase  is
attributable  to the growth in  deposits  in 1998.  At December  31,  1998,  net
unrealized  losses of $67,788 were included in the carrying  value of securities
classified available-for-sale compared to net unrealized gains of $4,678 on such
securities at December 31, 1997. Net  unrealized  gains or losses were caused by
fluctuations in market interest rates rather than by concerns about the issuer's
ability to meet their obligations.

Table 8 shows  maturities  of  investment  securities  held  by the  Company  at
December 31, 1998 and the weighted average  tax-equivalent  yields for each type
of security and maturity.  Further  information  about the Company's  investment
securities as of December 31, 1998,  1997 and 1996 is presented in Note 2 of the
notes to the consolidated financial statements.

Table 8:  INVESTMENT SECURITIES - MATURITY/YIELD SCHEDULE
<TABLE>
<CAPTION>

                                                                                         More than
                                     One Year or Less      1 Year to 5 Years      5 Years to 10 Years           Over 10 Years       
                                   --------------------    ---------------------  ----------------------   ----------------------   
                                               Weighted                Weighted                Weighted                  Weighted   
                                   Carrying    Average     Carrying    Average    Carrying     Average     Carrying      Average    
                                    Value       Yield        Value      Yield      Value        Yield        Value        Yield     
                                    -----       -----        -----      -----      -----        -----        -----        -----     
                                                                           (dollars in thousands)
<S>                                <C>            <C>         <C>                  <C>                      <C>                     
Held-to-Maturity:
U.S. government and agency ...     $   748        6.35%       $  --        --%     $    --          --%     $   --           --     
Mortgage-backed securities (1)          --          --           --        --           --          --        1,744        7.24%    
                                   -------       -----       ------      ----      -------     -------      -------       -----     
   Total held-to-maturity ....     $   748        6.35%       $  --        --%     $    --          --%     $ 1,744        7.24%    
                                   -------       -----        -----      ----      -------     -------      -------       -----     

Available-for-sale:
State and local government (2)     $  --            --        $ 386      6.81%     $   378        6.01% $        --          --%    
Mortgage-backed securities (1)        --            --           --       --            --          --        9,662        5.79     
                                   -------       -----        -----      ----      -------     -------      -------       -----     
   Total available-for-sale ..        --            --          386      6.81%         378        6.01%       9,662        5.79%    
                                   -------       -----        -----      ----      -------     -------      -------       -----     
Total investments
   at carrying value .........     $   748        6.35%       $ 386      6.81%     $   378        6.01%     $11,406        6.01%    
                                   =======       =====        =====      ====      =======     =======      =======       =====     

</TABLE>
<PAGE>
<TABLE>
<CAPTION>
                                                Total                              
                                        ----------------------                        
                                                      Weighted    
                                         Carrying     Average  
                                          Value        Yield   
                                         -------         ----                       
<S>                                      <C>             <C>                           
Held-to-Maturity:               
U.S. government and agency ...           $   748         6.35%                         
Mortgage-backed securities (1)             1,744         7.24                     
                                         -------         ----                       
   Total held-to-maturity ....           $ 2,492         6.97%                           
                                         -------         ----                       
                                                                               
Available-for-sale:                                                            
State and local government (2)           $   764         6.45%              
Mortgage-backed securities (1)             9,662           --                          
                                         -------         ----                       
   Total available-for-sale ..            10,426         5.79%                    
                                         -------         ----                       
Total investments                                                              
   at carrying value .........           $12,918         6.05%                        
                                         =======         ====                        
                                   
</TABLE>
(1) Mortgage-backed securities are shown at their weighted average expected life
obtained  from an  outside  evaluation  of the  average  remaining  life of each
security  based on historic  prepayment  speeds of the  underlying  mortgages at
December 31, 1998.

(2) Yields are stated on taxable  equivalent basis assuming  statutory tax rates
of 34% for federal and 7.25% for state  purposes.  Book yields without regard to
tax-equivalent  adjustments  are:  one year or less,  6.37%;  two to five years,
4.73%; six to ten years, 4.25%; more than ten year, 6.01%; total, 5.94%.

In addition to the investment securities discussed above, the Company also earns
interest  on its  correspondent  bank  account  at the  Federal  Home  Loan Bank
("FHLB") of Atlanta  and  dividends  on its FHLB stock.  The Bank is required to
maintain,  as a condition of  membership,  an investment in stock of the FHLB of
Atlanta  equal  to the  greater  of 1% of  outstanding  home  loans or 5% of its
outstanding  advances.  A ready  market does not exist for such stock,  which is
carried at cost.  The Bank however,  can redeem the stock at cost with the FHLB.
As of  December  31,  1998,  the  Company's  investment  in stock of the FHLB of
Atlanta was $1,570,000.

                                 Funding Sources

       Deposits are the primary  source of the  Company's  funds for lending and
other  investment  purposes.  The Company attracts both short-term and long-term
deposits from the general  public by offering a variety of accounts with varying
maturities. Deposit inflows and outflows are significantly influenced by general
interest  rates  and  other  market  conditions,   primarily   competition.   As
competition for deposits has increased both from larger  financial  institutions
in its  local  market  place  and  from  mutual  funds  and  other  investments,
borrowings  have provided an additional  source of funding.  The use of borrowed
funds to provide liquidity assists the Company in matching the interest rates on
its assets and liabilities because the interest rates on most borrowed funds are
fixed  and  therefore  more  predictable  than the costs of  deposits  which are
subject to change based upon market conditions and other factors.


                                       11
<PAGE>
                                    Deposits

          Deposits totaled $73.2 million at December 31, 1998, compared to $67.0
million at December 31, 1997, an increase of  approximately  $6.2  million.  The
following table sets forth certain  information  regarding the Company's average
savings deposits for the last three years.

Table 9:  AVERAGE DEPOSITS
<TABLE>
<CAPTION>
                                                             1998                      1997                     1996
                                                    --------------------       -------------------      -------------------
                                                     Average     Average       Average     Average      Average     Average
                                                      Amount       Rate         Amount      Rate         Amount      Rate
                                                      ------       ----         ------      ----         ------      ----
                                                                             (dollars in thousands)
<S>                                                 <C>            <C>       <C>             <C>       <C>            <C>  
NOW and money market deposit account                $  4,698       1.53%     $  4,260        1.71%     $   3,996      1.80%

Savings account                                        9,218       2.84         11,928       3.00          9,270      3.51
Certificates of deposit                               54,684       5.61         50,332       5.79         55,418      5.84
                                                    --------      -----      ---------     ------      ---------     -----

  Total deposits                                    $ 68,600       4.99%     $ 66,520        5.03%     $  68,684      5.24%
                                                    ========     ======      ========      ======      =========     ===== 
</TABLE>

As of  December  31,  1998,  the  Company  had  outstanding  $8,273,195  in time
certificates  of deposit of  $100,000 or more.  Maturities  of  certificates  of
deposits of $100,000 or more at December 31, 1998 were as follows:  three months
or less, $958,362;  over three months through six months,  $1,064,877,  over six
months through twelve months $1,831,165;  and over one year through  twenty-four
months, $4,418,791.

                                   Borrowings

       The Company's principal source of long-term  borrowings are advances from
the FHLB of Atlanta.  As a requirement for  membership,  the Bank is required to
own capital stock in the FHLB of Atlanta and is authorized to apply for advances
on the  security  of that  stock and a floating  lien on its family  residential
mortgage  loans.  Each  credit  program has its own  interest  rate and range of
maturities.  At December 31, 1998,  the Company had  outstanding  FHLB  advances
totaling $23,967,000,  compared to $7,800,000  outstanding at December 31, 1997.
Additional  information  on borrowings is provided in Note 6 of the notes to the
consolidated financial statements.

                   Liquidity and Interest Rate Risk Management
                             ---------------------

       Liquidity  is the  ability to raise  funds or  convert  assets to cash in
order to meet customer and operating  needs.  The Company's  primary  sources of
liquidity  are  its  portfolio  of  investment  securities   available-for-sale,
principal  and  interest  payments  on  loans  and  mortgage-backed  securities,
interest income from investment securities,  maturities of investment securities
held-to-maturity,  increases in deposits, and advances from the FHLB of Atlanta.
The total  available line of credit from the FHLB is $37.0 million.  At December
31, 1998, the Bank had an additional  $13.0 million of credit available from the
<PAGE>
FHLB which would be collateralized by a blanket lien on qualifying loans secured
by  first  mortgages  on  family  residences.  Additional  amounts  may be  made
available under this blanket floating lien or by using investment  securities as
collateral.  Management believes that it will have sufficient funds available to
meet its anticipated future loan commitments as well as other liquidity needs.

Interest rate risk is the sensitivity of interest income and interest expense to
changes in interest  rates.  Management  continues to  structure  its assets and
liabilities in an attempt to protect net interest income from large fluctuations
associated  with  changes  in  interest  rates.  Table 10 shows  the  amount  of
interest-earning assets and interest-bearing liabilities outstanding at December
31,  1998 which are  projected  to reprice or mature in each of the future  time
periods shown.  At December 31, 1998, the Company had a negative  cumulative one
year asset-sensitive gap position of $48.3 million or 39.26% of interest-earning
assets.  This generally  indicates that net interest  income would decrease in a
rising rate  environment and would  experience  upward trend in a declining rate
environment.


                                       12
<PAGE>
A static  interest rate "gap"  analysis may not be an accurate  indicator of how
net  interest  income  will  react to changes in  interest  rates.  A static gap
computation  uses  contractual  maturities  and does not  make  assumptions  for
prepayments,  scheduled  loan  principal  payments  or  deposit  decays.  Income
associated   with   interest-earning    assets   and   costs   associated   with
interest-bearing  liabilities  may not react  uniformly  to changes in  interest
rates. In addition,  the magnitude and duration of changes in interest rates may
have a significant impact on net interest income. For example,  although certain
assets and liabilities may have similar maturities or periods to repricing, they
may react in different  degrees to changes in market  interest  rates.  Interest
rates on certain types of assets and liabilities  typically fluctuate in advance
of changes in general market interest rates, while interest rates on other types
may lag behind changes in general market rates.

It should be noted  that this table  reflects  the  interest-sensitivity  of the
balance sheet as of a specific date and is not necessarily  indicative of future
results.   The  computations  were  made  without  using  assumptions  for  loan
repayments or deposit delays.  Except as stated below, the amounts of assets and
liabilities  shown which reprice or mature within a given period were determined
in accordance with contractual terms of the assets or liabilities. In making the
computations,  all adjustable rate loans were considered to be due at the end of
the next upcoming adjustment period. Fixed rate loans were considered to reprice
at their  contractual  maturities with no consideration  given to prepayments or
scheduled  payments.  Loans with thirty year  amortizations have a ten year call
provision  which  enables the Company to adjust the  interest  rate given market
conditions.  Liquid interest-earning  investments with no contractual maturities
are assumed to be subject to immediate  repricing.  Statement  savings and money
market  accounts are subject to immediate  availability  and  repricing and have
been placed in the earliest gap category.  In addition,  fixed maturity deposits
were assumed to reprice at their contractual  maturities  without  consideration
for early withdrawals. The interest rate sensitivity of the Company's assets and
liabilities  illustrated  in the  following  table would vary  substantially  if
different  assumptions  were  used or if  actual  experience  differs  from that
indicated  by  such  assumptions.   Because  of  these  and  other  limitations,
management also monitors  interest rate  sensitivity  through the use of a model
which  estimates  the change in net portfolio  value and net interest  income in
response  to a range of  assumed  changes  in market  interest  rates.  Based on
interest sensitivity  measures as of December 31, 1998,  management realizes its
need  to  improve  the  Company's  interest  rate  exposure  and  has  developed
strategies to address this issue.
<PAGE>
Table 10:  INTEREST SENSITIVITY
<TABLE>
<CAPTION>
                                                                                 December 31, 1998
                                                    ---------------------------------------------------------------------------
                                                                          More than  More than      Over
                                                    3 Months    4 to 12   1 Year to  3 Years to  5 Years to    Over
                                                    Or Less    Months     3 Years    5 Years     10 Years   10 Years     Total
                                                    --------   -------  ----------   ---------   ---------   -------    -------
Interest earning assets ................                                      (dollars in thousands)
<S> ....................................     <C>          <C>          <C>          <C>          <C>          <C>          <C>
 Mortgage loans:
  Fixed rate residential 1-4 family ....     $   --       $     22     $  1,134     $  4,246     $ 38,953     $ 44,249     $ 88,604
  Adjustable rate residential 1-4 family         --          1,455         --           --           --           --          1,455
  Adjustable home equity ...............        2,356         --           --           --           --           --          2,356
  Fixed rate-nonresidential ............         --             46          515          313        3,397        5,348        9,619
                                             --------     --------     --------     --------     --------     --------     --------
   Total mortgage loans ................        2,356        1,523        1,649        4,559       42,350       49,597      102,034
  Other loans ..........................        1,265         --           --           --           --           --          1,265
                                             --------     --------     --------     --------     --------     --------     --------
   Total loans .........................        3,621        1,523        1,649        4,559       42,350       49,597      103,299
Interest-bearing deposits(2) ...........        5,284         --           --           --           --           --          5,284
Investment securities (1) ..............       10,410            0          386          378         --          1,744       12,918
FHLB common stock ......................        1,570         --           --           --           --           --          1,570
                                             --------     --------     --------     --------     --------     --------     --------
   Total interest-earning assets .......     $ 20,885     $  1,523     $  2,035     $  4,937     $ 42,350     $ 51,341     $123,071
                                             --------     --------     --------     --------     --------     --------     --------

Interest-bearing liabilities
 Deposits:
  Fixed maturity deposits ..............     $ 13,668     $ 36,185     $  9,419     $   --       $   --       $   --       $ 59,272
  NOW accounts money market accounts ...        5,208         --           --           --           --           --          5,208
  Savings accounts .....................        8,696         --           --           --           --           --          8,696
                                             --------     --------     --------     --------     --------     --------     --------
   Total deposits ......................       27,572       36,185        9,419         --           --           --         73,176
  FHLB advances ........................         --          6,967         --          2,000       15,000         --         23,967
                                             --------     --------     --------     --------     --------     --------     --------
   Total interest-bearing liabilities ..     $ 27,572     $ 43,152     $  9,419     $  2,000     $ 15,000     $   --       $ 97,143
                                             --------     --------     --------     --------     --------     --------     --------

Interest sensitivity gap per period          $ (6,687)    $(41,629)    $ (7,384)    $  2,937     $ 27,350     $ 51,341     $ 25,928
Cumulative interest-sensitivity gap          $ (6,687)    $(48,316)    $(55,700)    $(52,763)    $(25,413)    $ 25,928     $ 25,928
Cumulative gap as a percentage of
 total interest-earning assets                  (5.43)%     (39.26)%     (45.26)%     (42.87)%     (20.65)%      21.07%       21.07%
Cumulative interest-earning assets as a
 percentage of interest-bearing liabilities      75.75%      31.68%       30.50%       35.77%        73.84%     126.69%      126.69%
</TABLE>

(1) Includes investments and mortgage-backed securities
(2) Includes interest-bearing deposits and federal funds

                                       13
<PAGE>
                                Capital Resources
                                   ----------

       Stockholders' equity decreased from $31.1 million at December 31, 1997 to
$28.5  million at  December  31,  1998,  due to the  purchase of  $3,692,000  in
treasury stock during 1998.

As a state savings bank holding company, the Parent is regulated by the Board of
Governors  of the Federal  Reserve  Board  ("FRB") and is subject to  securities
registration  and public  reporting  regulations  of the Securities and Exchange
Commission.  The Bank is regulated by the Federal Deposit Insurance  Corporation
("FDIC)" and the Savings  Institutions  Division,  North Carolina  Department of
Commerce ("the Administrator").

The  Bank  must  comply  with  the  capital  requirements  of the  FDIC  and the
Administrator.  The FDIC requires the Bank to maintain  minimum ratios of Tier I
capital to total risk-weighted  assets and total capital to risk-weighted assets
of 4% and 8%,  respectively.  Tier I  capital  consists  of total  stockholders'
equity calculated in accordance with generally  accepted  accounting  principles
less  intangible  assets,  and total capital is comprised of Tier 1 capital plus
certain  adjustments,  the  only  one of  which  applicable  to the  Bank is the
allowance  for loan  losses.  Risk  weighted  assets  reflect the Bank's  on-and
off-balance  sheet  exposures  after such exposures have been adjusted for their
relative risk levels using formulas set forth in FDIC  regulations.  The Bank is
also subject to a leverage capital requirement,  which calls for a minimum ratio
of Tier I capital (as defined above) to quarterly  average total assets of 3% to
5%,  depending  on the  institution's  composite  ratings as  determined  by its
regulators.  The  Administrator  requires  a net  worth  equal to at least 5% of
assets.

At  December  31,  1998 and  1997,  the Bank was in  compliance  with all of the
aforementioned  capital  requirements as summarized in Table 11. Refer to Note 7
of the consolidated  financial statements for a discussion of other matters that
may affect the Company's capital resources.
<PAGE>
Table 11:  REGULATORY CAPITAL
<TABLE>
<CAPTION>

                                                                                  At December 31,
                                                                          ----------------------------
                                                                              1998             1997
                                                                          -----------       ----------
<S>                                                                       <C>               <C>       
Risk-Based and Leverage Capital (dollars in thousands) Tier I capital:
 Common stockholders' equity ..........................................   $    27,083       $   26,030
 Unrealized holding loss (gain) on securities available-for-sale ......           (39)              (3)   
                                                                          -----------       ----------
 Total Tier I leverage capital .........................................       27,044           26,027
Tier II Capital:
 Qualifying allowances for loan losses
       Tier II capital additions ......................................           750              570
                                                                          -----------       ----------
Total risk-based capital ..............................................   $    27,794       $   26,597
Risk-weighted assets ..................................................        71,217           61,531
Fourth quarter average assets .........................................       126,388          102,598
Risk-based capital ratios:
 Tier-I capital as a percent of risk-weighted assets ..................         36.01%            42.30%
 Minimum Required Tier I capital ......................................          4.00%             4.00%
 Total risk-based capital as a percent of risk-weighted assets ........         37.01%            43.23%
 Minimum required total risk-based capital ............................          8.00%             8.00%
Leverage capital ratios:
 Tier I leverage capital as a percent of fourth quarter average assets          21.35%            25.37%
 Minimum required Tier I leverage capital .............................    3.00%-5.00%       3.00-5.00%
North Carolina regulatory capital:
 Total risk-based capital as a percent of fourth quarter average assets         22.00%            25.92%
 Minimum required North Carolina capital ..............................          5.00%             5.00%


</TABLE>
                                       14
<PAGE>
                     Impact of Inflation and Changing Prices

       The consolidated  financial  statements and  accompanying  footnotes have
been prepared in accordance with generally accepted accounting principles, which
require the measurement of financial  position and operating results in terms of
historical dollars without  consideration for changes in the relative purchasing
power of money over time due to  inflation.  The assets and  liabilities  of the
Company are primarily  monetary in nature,  and changes in interest rates have a
greater impact on the Company's performance than do the effects of inflation.

                                Accounting Issues
                                 --------------

       The Company  prepares its consolidated  financial  statements and related
disclosures  in conformity  with  standards  established  by, among others,  the
Financial  Accounting  Standards  Board (the  "FASB").  Because the  information
needed by users of financial  reports is dynamic,  the FASB  frequently  has new
rules  and  proposed  new  rules  for  companies  to  apply in  reporting  their
activities.  The following  discussion addresses such changes as of December 31,
1998 that will affect the Company's future reporting.

       In June 1997, the FASB issued Statement of financial Accounting Standards
No. 130 ("SFAS 130"),  "Reporting  Comprehensive  Income".  SFAS 130 establishes
standards for reporting and displaying  comprehensive  income and its components
(revenues,  expenses,  gains,  and  losses)  in a full  set  of  general-purpose
financial  statements.  This Statement  requires that an enterprise (a) classify
items of other  comprehensive  income by their nature in the financial statement
and (b) display the accumulated balance of other comprehensive income separately
from retained earnings and additional paid-in-capital in the equity section of a
statement  of  financial  position.  SFAS  130 is  effective  for  fiscal  years
beginning after December 15, 1997.  Reclassification of financial statements for
earlier  periods  provided for  comparative  purposes is  required.  The company
adopted the SFAS 130 is fiscal year 1998 without any  significant  impact on its
consolidated financial statements.

       In June 1997, the FASB issued Statement of Financial Accounting Standards
No. 131 ("SFAS 131"),  "Disclosures  about Segments of an Enterprise and Related
Information".  SFAS 131 established standards for the way that public businesses
report information about operating  segments in annual financial  statements and
requires that those  enterprises  report  selected  information  about operating
segments  in  interim  financial   reports  issued  to  shareholders.   It  also
establishes  standards  for related  disclosures  about  products and  services,
geographic areas, and major customers. This Statement is effective for financial
statements for periods beginning after December 15, 1997 and in the initial year
of application, comparative information for earlier years is to be restated. The
Company adopted SFAS 131 in fiscal year 1998 without any  significant  impact on
its consolidated financial statements.

       The FASB has issued SFAS No. 133,  Accounting for Derivative  Instruments
and Hedging  Activities,  which the Company has not been required to adopt as of
December 31, 1998. This Statement, which is effective for fiscal years beginning
after  June  15,  1998,  established  accounting  and  reporting  standards  for
derivative instruments embedded in other contracts, (collectively referred to as
derivatives)  and for hedging  activities.  It requires that an entity recognize
all  derivatives  as either assets or  liabilities in the statement of financial
<PAGE>
position and measure those instruments at fair value. If certain  conditions are
met, a derivative may be specifically  designated as (a) a hedge of the exposure
to  changes  in  the  fair  value  of a  recognized  asset  or  liability  or an
unrecognized firm commitment, (b) a hedge of the exposure to variable cash flows
of a forecasted transaction,  or (c) a hedge of the foreign currency exposure of
a net investment in a foreign  operation an  unrecognized  firm  commitment,  an
available  for sale  security,  or a  foreign  currency  denominated  forecasted
transaction.  This Statement is not expected to have a significant impact on the
Company.

       The  FASB  has  issued  SFAS  No.  134,  Accounting  for  Mortgage-Backed
Securities  Retained after the Securitization of Mortgage Loans Held for Sale by
a Mortgage Banking Enterprise,  an amendment of FASB Statement No. 65, which the
Company has not been  required to adopt as of December 31, 1998.  Statement  No.
65, as amended by FASB Statements No. 115, Accounting for Certain Investments in
Debt and Equity Securities,  and No 125,  Accounting for Transfers and Servicing
of Financial Assets and Extinguishments of Liabilities,  requires that after the
securitization  of a mortgage loan held for sale, an entity  engaged in mortgage
banking activities classify the resulting  mortgage-backed security as a trading
security.

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

                                 Year 2000 Issue
                                  ------------

       The Year 2000 challenge touches many facets of the financial  activity of
a business. It affects mainframe computer systems, networks and desktop personal
computers.  The problem even  effects  security  and  maintenance,  because most
modern offices rely on computerized systems.  Stone Street Bank and Trust (Stone
Street) and the Company  considers the Year 2000 issue a top customer  priority.
The issue has received a lot of public  attention  because of concern  about how
businesses plan to meet this challenge.  At Stone Street we began discussing the
issue more than two years ago and started  executing a plan for the challenge in
1997. To help us address this issue in a methodical,  comprehensive  manner,  we
created our Year 2000 Strategic Project Plan, designed to protect and inform our
business partners and customers.

At first  glance,  the  challenge  may seem simple.  For example,  many computer
programs and computer  chips store the calendar  year portion of the date as two
digits  rather than four digits.  These  software  programs and chips record the
year 1999 as "99".  This approach works until the year 2000 when the "00" may be
interpreted  as the year 1900  instead  of the year  2000.  Banks  use  computer
systems to perform financial  calculations,  transfer funds, record deposits and
loan payments,  run security systems and vaults and a myriad of other functions.
Because  banks rely heavily on their  computer  systems,  the Federal  Financial
Institutions  Examination  Council ("FFIEC") has placed significant  emphasis on
the  problems  surrounding  the year  2000  issues  and has  required  financial
institutions to document the assessment,  testing and corrections  made to ready
their computer systems and programs for the year 2000 date change. The FFIEC has
strict  regulations,  guidelines  and milestones in place that each FDIC insured
financial institution must follow in order to remain operational.  The Company's
board of directors has remained informed of the Company's  position and progress
in its year 2000 project.

The Company's year 2000 project remains on schedule  according to the guidelines
set forth by the FFIEC.  The Company's most critical  external  exposure to year
2000  system  problems  is with its data  processing  provider,  Fiserv.  Fiserv
renovated  its  systems in June 1998 and  conducted a full test of the system in
November,  1998.  Fiserv has  responded  to the Company that  renovation  of its
program is virtually complete and a final test is scheduled in April, 1999.

In  addition,  the  Company has  contacted  its major  customers  and vendors to
inquire about their  progress in  addressing  the year 2000 program and does not
believe  that the  problems of such  customers  and vendors will have a material
adverse  effect on the  Company  or its  operations.  The  Company  completed  a
scheduled  upgrade to its computer  terminals and software at a cost of $155,000
<PAGE>
during  1998 due to the  aging of  previous  systems  that  were not  considered
directly related to the year 2000. Costs directly  associated with resolving any
year 2000 issues  during 1999 is  estimated  to cost  $15,000.  The Company will
continue to monitor the progress of these  parties in  addressing  the year 2000
problem as the new millennium approaches.

The year 2000  problems can affect the  Company's  operation in a number of ways
but the mission  critical issue is maintaining  customers'  account  information
including tracking deposits, interest accruals and loan payments. The Company is
dependent upon electricity, telephone lines, computer hardware and Fiserv's data
processing  capability.  The Company is in contact with its electric utility and
phone company,  and assurances  have been given that no major problems exist and
that both  companies  will have all year 2000  problems  addressed  well  before
December 31, 1999.

Banking,  like other  interconnected  industries,  relies on relationships  with
outside partners to provide services to our customers.  We are working with card
processors,  ATM  networks  and  others to help  ensure a smooth  transition  on
January 1, 2000; however,  we cannot ensure  compatibility with non-Stone Street
networks and services.  We are not responsible for failures due to circumstances
beyond our control.  We do not,  therefore,  provide  guarantees  or  warranties
beyond those we normally provide to our customers.


                                       16
<PAGE>

                          INDEPENDENT AUDITORS' REPORT
                          ----------------------------




The Board of Directors and Stockholders
Stone Street Bancorp, Inc.


We have audited the  accompanying  consolidated  balance  sheets of Stone Street
Bancorp,  Inc. and  subsidiary as of December 31, 1998 and 1997, and the related
consolidated statements of income,  stockholders' equity and cash flows for each
of  the  years  in  the  three  year  period  ended  December  31,  1998.  These
consolidated  financial  statements  are  the  responsibility  of the  Company's
management.  Our  responsibility is to express an opinion on these  consolidated
financial statements based on our audits.

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

In our opinion, the consolidated  financial statements referred to above present
fairly,  in all  material  respects,  the  financial  position  of Stone  Street
Bancorp,  Inc. and  subsidiary as of December 31, 1998 and 1997, and the results
of their operations and their cash flows for each of the years in the three year
period ended December 31, 1998, in conformity with generally accepted accounting
principles.


/s/Weir Smith Jones Miller & Elliott
------------------------------------
Weir Smith Jones Miller & Elliott

Statesville, North Carolina
January 30, 1999
<PAGE>
<TABLE>
<CAPTION>
                               CONSOLIDATED BALANCE SHEETS
                               ---------------------------
                                December 31, 1998 and 1997

                                                                   1998          1997
                                                                ---------      ---------
                                                                 (dollars in thousands)
<S>                                                             <C>            <C>      
ASSETS
Cash ......................................................     $   2,404      $     968
Federal funds sold ........................................           878          1,034
Interest-bearing deposits in other financial institutions .         4,406          2,701
Investment securities (note 2)
Held-to-maturity (Market value: $2,491 in 1998
  and $5,940 in 1997) .....................................         2,492          5,889
Available-for-sale (Cost: $10,426 in 1998
  and $1,854 in 1997) .....................................        10,358          1,859
Loans  receivable  (net of allowance
  for loan losses of
 $750 in 1998 and $570 in 1997) (note 3) ..................       102,549         92,967
Federal Home Loan Bank stock at cost ......................         1,570            741
Premises and equipment (note 4) ...........................           909            824
Accrued interest receivable ...............................           670            284
Deferred income tax (note 8) ..............................           627            412
Refundable income tax .....................................           116            126
Prepaid expenses and other assets .........................           102            141
Cash surrender value of life insurance ....................           192            146
                                                                ---------      ---------
   Total assets ...........................................     $ 127,273      $ 108,092
                                                                =========      =========

LIABILITIES AND STOCKHOLDERS' EQUITY

Deposits (note 5):
 Savings accounts .........................................     $   8,696      $   9,190
 NOW and MMDA .............................................         5,208          4,704
 Other certificates of deposit ............................        50,999         47,565
 Certificates of deposit, $100,000 and over ...............         8,273          5,514
   Total deposits .........................................        73,176         66,973
                                                                ---------      ---------

Advances from the Federal Home Loan Bank (note 6) .........        23,967          7,800
 Amounts  payable  under  remittance service agreement ....           358          1,175
Accrued interest payable ..................................           296            144
Accrued expenses and other liabilities ....................           986            924
                                                                ---------      ---------
       Total liabilities ..................................        98,783         77,016
                                                                ---------      ---------
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
<S>                                                             <C>            <C>      
Stockholders' Equity:
Preferred stock, no par value, 5,000,000 shares authorized;
  none issued (note 1)
Common stock, no par value 20,000,000 shares authorized:
1,898,052 shares issued and 1,898,052 and 1,692,352
  outstanding, respectively (note 1) ......................        18,433         20,611
Unearned ESOP shares ......................................        (1,859)        (1,948)
Unamortized deferred compensation .........................        (1,245)        (1,518)
Retained earnings, substantially restricted (notes 7 and 8)        13,200         13,928
Accumulated other comprehensive income, net ...............           (39)             3
                                                                ---------      ---------
   Total stockholders' equity .............................        28,490         31,076
                                                                ---------      ---------

Commitments and contingencies (notes 3 and 9)
       Total liabilities and stockholders' equity .........     $ 127,273      $ 108,092
                                                                =========      =========

</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE>
<TABLE>
<CAPTION>
                             CONSOLIDATED FINANCIAL STATEMENTS OF INCOME
                             -------------------------------------------
                            Years ended December 31, 1998, 1997 and 1996
                                        
                                                                         1998       1997       1996
                                                                       ------     ------     ------     
                                                               (dollars in thousands, except per share data)
<S>                                                                    <C>        <C>        <C>        
Interest income:                                                                                        
 Interest on loans .....................................               $8,457     $7,490     $6,662     
 Interest on deposits in other financial institutions ..                  271        291        692     
 Interest and dividends on investment securities:                                                       
  Taxable ..............................................                  489        486        563     
  Non-taxable ..........................................                   51         86         91     
                                                                       ------     ------     ------     
   Total interest income ...............................                9,268      8,353      8,008     
                                                                       ------     ------     ------ 
Interest expense:                                                                                       
 Interest on deposits (note 5) .........................                3,426      3,345      3,604     
 Interest on borrowings ................................                  844        146          6     
                                                                       ------     ------     ------     
   Total interest expense ..............................                4,270      3,491      3,610     
                                                                       ------     ------     ------     
                                                                                                        
Net interest income ....................................                4,998      4,862      4,398     
Provision for loan losses (note 3) .....................                  180         60         50     
                                                                       ------     ------     ------     
   Net interest income after provision for loan losses .                4,818      4,802      4,348     
                                                                       ------     ------     ------  
Other income:                                                                                           
 Loan fees and charges .................................                   55         49         45     
 Customer service and other fees .......................                   95         86         56     
 Other .................................................                   13         10         13     
                                                                       ------     ------     ------     
   Total other income ..................................                  163        145        114     
                                                                       ------     ------     ------ 

</TABLE>
<PAGE>
<TABLE>
<CAPTION>
<S>                                                                    <C>        <C>        <C>        
Other expenses:                                                                                         
 Compensation and related benefits (note 9) ............                1,631      1,753      1,013     
 Deposit insurance premiums ............................                   43         46        581     
 Occupancy and equipment expense .......................                  322        261        216     
 Professional fees .....................................                   37         64         36     
 Other .................................................                  395        390        277     
                                                                       ------     ------     ------     
   Total other expenses ................................                2,428      2,514      2,123     
                                                                       ------     ------     ------     
                                                                                                        
   Income before income tax expense ....................                2,553      2,433      2,339     
                                                                                                        
Income tax expense (note 8) ............................                  945        901        858     
                                                                       ------     ------     ------     
                                                                                                        
Net income .............................................               $1,608     $1,532     $1,481     
                                                                       ======     ======     ======     
                                                                                                        
Net income per share - basic (note 1) ..................               $ 0.89     $ 0.82     $ 0.82     
                                                                       ======     ======     ======     
                                                                                                        
Net income per share - diluted (note 1) ................               $ 0.89     $ 0.82     $ 0.82     
                                                                       ======     ======     ======     
</TABLE>
See accompanying notes to consolidated financial statements.


                                                 19
<PAGE>
<TABLE>
<CAPTION>
                               CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                               -----------------------------------------------
                            For the Years ended December 31, 1998, 1997 and 1996
                                                                                                              
                                                           Unearned     Unamortized                 Compre-   
                                   Shares       Common       ESOP        Deferred     Retained      hensive   
                                Outstanding     Shares       Shares    Compensation   Earnings      Income    
                                -----------     ------       ------    ------------   --------      ------    
                                                  (in thousands, except shares outstanding)
<S>                              <C>         <C>         <C>          <C>            <C>            <C>                  
Balance at
   December 31, 1995                     -   $        -  $       -    $      -       $   12,563               
 Net income                              -            -          -           -            1,481       1,481   
 Net proceeds from issuance
  of no par common stock         1,825,050       26,333          -           -                -               
 Common stock acquired
  by ESOP                                -            -     (2,198)          -                -               
 Cash dividends declared
  ($.44 per share)                       -            -          -           -             (803)              
 Change in unrealized
   holding gains (losses)
   net of income taxes of $3             -            -          -           -                -          (7)  
                                                                                                    ------- 
   Total comprehensive income                                                                       $ 1,474
                                                                                                    =======
Balance at
 December 31, 1996               1,825,050      26,333      (2,198)          -           13,241               
 Net income                                                                               1,532       1,532   
  Common stock acquired
  by ESOP                                                     (329)                                           
 Release of ESOP shares                                        579                                            
 Cash dividends declared
  ($4.45 per share)**                           (7,593)                                   (845)               
 Issuance of restricted stock       73,002       1,871                  (1,871)
 Amortization of earned
 compensation                                                              353                                
 Change in unrealized
  holding gains (losses),
  net of income taxes of $4                                                                              11   
                                                                                                    ------- 
   Total comprehensive income                                                                       $ 1,543
                                                                                                    ======= 
Balance at
 December 31, 1997               1,898,052      20,611      (1,948)     (1,518)          13,928               
 Net income                                                                               1,608       1,608   
Purchase of Treasury Stock        (205,700)     (2,178)                                  (1,514)              
Release of ESOP shares                                          89                                            
 Cash dividends
  ($.45 per share) **                                                                      (822)              
 Amortization of unearned
  compensation                                                             273                                
 Change in unrealized
  holding gains (losses)
  net of income taxes of $28                                                                                  
    Total comprehensive income                                                                          (42)           
                                                                                                    ------- 
Balance at
 December 31, 1998               1,692,352   $  18,433   $  (1,859)   $ (1,245)       $  13,200               
                                 =========   =========   =========    ========        =========               
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
                                      Accumulated                 
                                         Other           Total    
                                   Comprehensive    Stockholders' 
                                        Income          Equity   
                                        ------          ------   
<S>                                      <C>       <C>                                                                
Balance at                                                      
   December 31, 1995                       (1)     $    12,562       
 Net income                                 -            1,481  
 Net proceeds from issuance                                     
  of no par common stock                    -           26,333  
 Common stock acquired                                          
  by ESOP                                   -           (2,198) 
 Cash dividends declared                                        
  ($.44 per share)                          -             (803) 
 Change in unrealized                                           
   holding gains (losses)                                       
   net of income taxes of $3               (7)              (7)                                                                
   Total comprehensive income                                   
                                         ----      -----------                      
Balance at                                                      
 December 31, 1996                         (8)          37,368  
 Net income                                              1,532  
  Common stock acquired                                         
  by ESOP                                                 (329) 
 Release of ESOP shares                                    579  
 Cash dividends declared                                        
  ($4.45 per share)**                                   (8,438) 
 Issuance of restricted stock                                   
 Amortization of earned                                         
 compensation                                              353  
 Change in unrealized                                           
  holding gains (losses),                                       
  net of income taxes of $4                11               11  
   Total comprehensive income                                   
                                          ----      -----------                  
Balance at                                                      
 December 31, 1997                          3           31,076  
 Net income                                              1,608  
Purchase of Treasury Stock                              (3,692) 
Release of ESOP shares                                      89  
 Cash dividends                                                 
  ($.45 per share) **                                     (822) 
 Amortization of unearned                                       
  compensation                                             273  
 Change in unrealized                                           
  holding gains (losses)                                        
  net of income taxes of $28                                    
    Total comprehensive income            (42)             (42) 
                                         ----      -----------                     
                                                               
Balance at                                                      
 December 31, 1998                     $  (39)     $     28,490 
                                       ======      ============                                   
</TABLE>

** Includes $4.00 special return of capital  dividend paid on July 11, 1997. See
 accompanying notes to consolidated financial statements.

                                                     20
<PAGE>
<TABLE>
<CAPTION>
                                         CONSOLIDATED STATEMENTS OF CASH FLOWS
                                         -------------------------------------
                                 For the Years ended December 31, 1998, 1997 and 1996


                                                                                   1998           1997          1996
                                                                                 --------      --------      -------- 
Operating activities:                                                                     (dollars in thousands)
<S>                                                                              <C>           <C>           <C>     
 Net income ................................................................     $  1,608      $  1,532      $  1,481
 Adjustments to reconcile net income to net cash
 provided  by  operating activities:
   Depreciation ............................................................           96            86            96
   Provision for loan losses ...............................................          180            60            50
   Deferred income taxes ...................................................         (215)          (36)          (42)
   Contributions allowing the release of ESOP shares .......................           89           579
   Compensation earned under the Management Recognition Plan ...............          273           353
   Decrease (increase) in accrued interest receivable ......................         (386)           26          (206)
   Increase in cash surrender value of life insurance ......................          (46)          (18)          (64)
   Decrease (increase) in refundable income taxes ..........................           10           (49)          (56)
   Increase (decrease) in amounts payable under remittance
    service agreement ......................................................         (817)          539            41
   (Increase) decrease in other assets .....................................           39           (48)           44
   Increase (decrease) in accrued interest payable .........................          152           (26)           23
   Increase (decrease)  in accrued cash dividends payable ..................         --            (402)          402
   Increase (decrease) in other liabilities ................................           62           257           281
                                                                                 --------      --------      --------
       Net cash provided by operating activities ...........................        1,045         2,853         2,050
                                                                                 --------      --------      --------

Investing activities:
 Net increase in loans held for investment .................................       (9,762)      (10,035)       (7,996)
 Principal collected on mortgage-backed securities .........................         --             597           108
 Purchase of investment securities classified as available-for-sale ........       (8,541)         --            (860)
 Purchase of investment securities classified as held-to-maturity ..........         --            (750)       (2,760)
 Purchase of mortgage-backed securities classified as held-to-maturity .....         --            --          (2,298)
 Proceeds from maturities of investment securities classified
  as available-for-sale ....................................................         --             875           439
 Proceeds from maturities of investment securities held-to-maturity ........        3,397         2,000           500
 Purchase of FHLB Stock ....................................................         (829)          (74)          (91)
   Purchase of premises and equipment ......................................         (181)          (10)          (47)
   Net cash used by investing activities ...................................      (15,916)       (7,397)      (13,005)
                                                                                 --------      --------      --------
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
<S>                                                                              <C>           <C>           <C>     
Financing activities:
 Net increase (decrease) in deposits .......................................        6,203           409        (6,471)
 Proceeds from borrowings ..................................................       16,167         7,800
 Repayments of borrowings ..................................................         --            --          (1,000)
 Proceeds from issuance of no par common stock .............................         --            --          26,333
 Loan to ESOP for the purchase of common stock .............................         --            (329)       (2,198)
 Cash dividends paid to shareholders .......................................         (822)       (8,438)         (803)
 Purchase of treasury stock ................................................       (3,692)         --            --            
 Net cash provided by financing activities .................................       17,856          (558)       15,861
                                                                                 --------      --------      --------

         Increase (decrease) in cash and cash equivalents ..................        2,985        (5,102)        4,906
Cash and cash equivalents at beginning of period ...........................        4,703         9,805         4,899
                                                                                 --------      --------      --------
Cash and cash equivalents at end of period .................................     $  7,688      $  4,703      $  9,805
                                                                                 ========      ========      ========
Supplemental  disclosure of cash flow  information:
  Cash paid during the period for:
  Interest .................................................................     $  4,118      $  3,517      $  3,587
                                                                                 ========      ========      ========
  Income taxes .............................................................     $    935      $    949      $    914
                                                                                 ========      ========      ========
Supplemental disclosure of noncash transactions:
 Unrealized gains (losses) on available-for-sale securities, net of deferred
  taxes (benefit) of $(28) for 1998 and $2 for 1997 ........................     $    (39)     $      3      $      8
                                                                                 ========      ========      ========
 Dividends declared but unpaid .............................................     $      -      $     --      $    402
                                                                                 ========      ========      ========
</TABLE>
See accompanying notes to consolidated financial statements.


                                       21
<PAGE>
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


(1)   Significant Accounting Policies
      -------------------------------

      Organization and Operations
      ---------------------------

      On March  29,  1996,  pursuant  to a Plan of  Conversion  approved  by its
      members and regulators, Mocksville Savings Bank, Inc. SSB now Stone Street
      Bank & Trust (the  "Bank")  amended and restated its charter to effect its
      conversion from a North Carolina  chartered mutual savings bank to a North
      Carolina  chartered  stock savings bank (the  "Conversion"),  and became a
      wholly-owned  subsidiary of Stone Street Bancorp,  Inc. (the "Parent"),  a
      holding  company  formed in connection  with the  Conversion.  The Bank is
      primarily  engaged in the  business  of  obtaining  savings  deposits  and
      providing  loans to the  general  public.  The  principal  activity of the
      Parent is ownership of the Bank.  In 1997,  the Bank formed a  subsidiary,
      Stone  Street  Financial  Services,  Inc.  for  the  purpose  of  offering
      investment discount brokerage services to the public.

      Basis of Presentation
      ---------------------

      The consolidated  financial  statements include the accounts of the Parent
      and the Bank and its wholly-owned subsidiary, together referred to as "the
      Company".  All  significant  intercompany  transactions  and  balances are
      eliminated in  consolidation.  The preparation of financial  statements in
      conformity  with  generally  accepted   accounting   principles   requires
      management  to make  estimates  and  assumptions  that affect the reported
      amounts of assets and liabilities and disclosure of contingent  assets and
      liabilities as of the date of the balance sheets and the reported  amounts
      of income and expenses for the periods  presented.  Actual  results  could
      differ  significantly  from those estimates.  Material  estimates that are
      particularly susceptible to significant changes in the near-term relate to
      the determination of the allowance for loan losses.

      Investment and Mortgage-Backed Securities
      -----------------------------------------

      Management  determines the  appropriate  classification  of investment and
      mortgage-backed  securities at the time of purchase and  reevaluates  such
      designation  at  each  reporting   date.   Securities  are  classified  as
      held-to-maturity when the Company has both the positive intent and ability
      to hold the securities to maturity. Held-to-maturity securities are stated
      at amortized  cost.  Securities  not  classified as  held-to-maturity  are
      classified as available-for-sale. Available-for-sale securities are stated
      at fair value, with the unrealized gains and losses,  net of tax, reported
      as a separate  component  of  stockholders'  equity.  The  Company  has no
      trading securities.
<PAGE>
      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.
 
      Loans Receivable
      ----------------

      Loans  held  for  investment  are  carried  at  their   principal   amount
      outstanding, net of deferred loan origination fees.

      Interest on loans is recorded as borrowers'  monthly  payments become due.
      Accrual of interest  income on loans is suspended  when,  in  management's
      judgment, doubts exist as to the collectibility of principal and interest.
      Loans are returned to accrual status when management determines,  based on
      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.

      Loan fees are  accounted  for in  accordance  with  Statement of Financial
      Accounting Standards No. 91. Loan origination fees and certain direct loan
      origination  costs  are  deferred  and  the  net  amount  amortized  as an
      adjustment of the related  loans' yield over the life of the related loans
      using a level-yield  method.  Unamortized  net loan fees or costs on loans
      sold are recorded as gain or loss on sale in the year of disposition.

                                       22
<PAGE>
              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Continued
              ----------------------------------------------------

(1)   Significant Accounting Policies, Continued
      ------------------------------------------

      Allowance for Loan Losses
      -------------------------

      The Company provides for loan losses on the allowance method. Accordingly,
      all loan  losses  are  charged to the  allowance  and all  recoveries  are
      credited to it. Additions to the allowance for loan losses are provided by
      charges to operating  expense.  The  provision is based upon  management's
      evaluation of the risk characteristics of the loan portfolio under current
      economic  conditions and considers such factors as financial  condition of
      the  borrower,  collateral  values,  growth  and  composition  of the loan
      portfolio,   the   relationship  of  the  allowance  for  loan  losses  to
      outstanding loans, and delinquency trends.

      At  December  31,  1998,  substantially  all of the  Company's  loans were
      collateralized  by  real  estate  in  Davie  and  adjacent  counties.  The
      collateral  is  predominately  owner-occupied  residential  real estate in
      which  the  borrower  does  not rely on  underlying  cash  flows  from the
      property  to  satisfy  debt  service.  The  ultimate  collectibility  of a
      substantial  portion of the loan  portfolio is  susceptible  to changes in
      market  conditions in the Company's  market area.  While  management  uses
      available  information to recognize  losses on loans,  future additions to
      the  allowance may be necessary  based on changes in economic  conditions.
      Various  regulatory  agencies,  as an integral  part of their  examination
      processes,  periodically  review the Company's  allowance for loan losses.
      Such  agencies  may  require  the Company to  recognize  additions  to the
      allowance based on their judgments about information  available to them at
      the time of their examinations.

      For all specifically reviewed loans for which it is probable that the Bank
      will be unable to collect all amounts  due  according  to the terms of the
      loan agreement,  the Bank determines fair value either based on discounted
      cash flows using the loans' initial interest rate or the fair value of the
      collateral  if the loan is collateral  dependent.  Large groups of smaller
      balance  homogenous loans that are  collectively  evaluated for impairment
      (such as residential mortgage and consumer installment loans) are excluded
      from  impairment  evaluation,  and  their  allowance  for loan  losses  is
      calculated  in  accordance  with  the  allowance  for loan  losses  policy
      described above.

      Investment in Federal Home Loan Bank Stock
      ------------------------------------------

      As a requirement for membership,  the Bank invests in stock of the Federal
      Home Loan Bank of Atlanta  (FHLB) in the  amount of 1% of its  outstanding
      residential  loans  or 5% of  its  outstanding  advances  from  the  FHLB,
      whichever is greater.  At December 31, 1998,  the Bank owned 15,698 shares
      of the FHLB's $100 par value capital  stock. A ready market does not exist
      for such stock,  which is carried at cost.  The Bank  however,  can redeem
      this stock at cost with the FHLB.
<PAGE>
      Premises and Equipment
      ----------------------

      Premises and equipment are stated at cost. Provisions for depreciation are
      computed  principally  using  the  straight-line  method  and  charged  to
      operations over the estimated useful lives of the assets over 20 years for
      office buildings and 3 to 10 years for furniture,  fixtures, and equipment
      and other improvements.

      Retirement Plan
      ---------------

      The Bank has an employee stock  ownership plan which covers  substantially
      all of its employees. Contributions to the plan are determined annually by
      the  Board  of  Directors  based  on  employee   compensation.   Prior  to
      establishment  of the employee  stock  ownership  plan,  the Company had a
      self-administered,  defined contribution  retirement plan that covered all
      eligible  employees.  This plan was  terminated  as of  January 1, 1996 in
      conjunction  with the  Conversion.  The Bank  also has a 401(k)  plan that
      covers all eligible employees.


                                       23
<PAGE>
              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Continued
              ----------------------------------------------------

(1)   Significant Accounting Policies, Continued
      ------------------------------------------

      Cash and Cash Equivalents
      -------------------------

      For purposes of reporting cash flows, the Company considers cash,  federal
      funds  sold  and  interest-bearing  deposits  in other  institutions  with
      original maturities of three months or less to be cash equivalents.

      Earnings Per Share
      ------------------

      The Company adopted the provisions for SFAS No. 128, "Earnings Per Share,"
      during  1997.  Presentation  of both basic and diluted  earnings per share
      have been  presented in the  financial  statements.  Because the Company's
      stock options would have an antidilutive  effect on earnings per share due
      to the average  market price not exceeding  the exercise  price during the
      period,  both basic and diluted earnings per share are the same.  Weighted
      average shares outstanding for 1998 and 1997 were 1,813,850 and 1,872,451,
      respectively,   shares  and  for  1996,   1,825,050  shares  were  assumed
      outstanding for the full year.

      New Accounting Pronouncements
      -----------------------------

      The Company  prepares its  consolidated  financial  statements and related
      disclosures in conformity with standards established by, among others, the
      Financial Accounting Standards Board (the "FASB"). Because the information
      needed by users of financial  reports is dynamic,  the FASB frequently has
      new rules and proposed new rules for companies to apply in reporting their
      activities. The following discussion addresses such changes as of December
      31, 1998 that will affect the Company's future reporting.

      The FASB has issued SFAS No. 130, Reporting  Comprehensive  Income,  which
      the Company  adopted during 1998.  The  Statement,  which is effective for
      fiscal years beginning after December 15, 1997,  establishes standards for
      reporting  and  display  of   comprehensive   income  and  its  components
      (revenues,  expenses,  gains and losses) in a full set of  general-purpose
      financial  statements.  This  statement  requires  that all items that are
      recognized  under  accounting  standards as  components  of  comprehensive
      income be reported in a financial  statement  that is  displayed  with the
      same prominence as other financial  statements.  All required  disclosures
      are included in the 1998 financial statements.

      The FASB has  issued  SFAS  No.  131,  Disclosures  about  Segments  of an
      Enterprise and Related  Information,  which the Company has adopted during
      1998. This Statement,  which is effective for fiscal years beginning after
      December 15,  1997,  requires  that a public  business  enterprise  report
      financial  and  descriptive  information  about its  reportable  operating
      segments.  Operating  segments are components of an enterprise about which
      separate financial information is available that is evaluated regularly by
      the chief operating  decision maker in deciding how to allocate  resources
      and in assessing performance. Generally, financial information is required
      to be  reported  on the basis that it is used  internally  for  evaluating
      segment  performance  and deciding how to allocate  resources to segments.
      This statement did not have a significant impact on the Company.
<PAGE>
      The FASB has issued SFAS No. 133,  Accounting for  Derivative  Instruments
      and Hedging  Activities,  which the Company has not been required to adopt
      as of December 31, 1998.  This  Statement,  which is effective  for fiscal
      years beginning after June 15, 1998,  established accounting and reporting
      standards  for  derivative   instruments   embedded  in  other  contracts,
      (collectively  referred to as derivatives) and for hedging activities.  It
      requires  that an entity  recognize  all  derivatives  as either assets or
      liabilities  in the  statement  of financial  position  and measure  those
      instruments at fair value. If certain conditions are met, a derivative may
      be  specifically  designated  as (a) a hedge of the exposure to changes in
      the fair value of a recognized asset or liability or an unrecognized  firm
      commitment,  (b) a hedge  of the  exposure  to  variable  cash  flows of a
      forecasted transaction, or (c) a hedge of the foreign currency exposure of
      a net investment in a foreign operation,  an unrecognized firm commitment,
      an  available  for  sale  security,  or  a  foreign  currency  denominated
      forecasted  transaction.   This  Statement  is  not  expected  to  have  a
      significant impact on the Company.


                                       24
<PAGE>
              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Continued
              ----------------------------------------------------

      The  FASB  has  issued  SFAS  No.  134,   Accounting  for  Mortgage-Backed
      Securities  Retained after the  Securitization  of Mortgage Loans Held for
      Sale by a Mortgage Banking Enterprise,  an amendment of FASB Statement No.
      65,  which the Company has not been  required to adopt as of December  31,
      1998.  Statement No. 65, as amended by FASB Statements No. 115, Accounting
      for  Certain  Investments  in Debt and  Equity  Securities,  and No.  125,
      Accounting   for  Transfers   and   Servicing  of  Financial   Assets  and
      Extinguishments of Liabilities,  requires that after the securitization of
      a  mortgage  loan held for sale,  an entity  engaged in  mortgage  banking
      activities  classify the resulting  mortgage-backed  security as a trading
      security.  This statement  further amends Statement No. 65 to require that
      after the  securitization  of  mortgage  loans  held for  sale,  an entity
      engaged  in   mortgage   banking   activities   classify   the   resulting
      mortgage-backed  securities  or  other  retained  interests  based  on its
      ability  and  intent to sell or hold  those  investments.  This  Statement
      conforms the  subsequent  accounting  for  securities  retained  after the
      securitization of mortgage loans by a mortgage banking enterprise with the
      subsequent  accounting for securities retained after the securitization of
      other types of assets by a nonmortgage banking enterprise.  This Statement
      is effective for fiscal years  beginning  after  December 15, 1998, and is
      not expected to have a significant impact on the Company.

      Reclassifications

      Certain reclassifications have been made for 1997 and 1996 to conform with
      the 1998 presentation.  The  reclassifications had no effect on previously
      reported net income or stockholders' equity.

(2)   Investment Securities
      ---------------------

      The  following is a summary of the  investment  securities  portfolios  by
      major classification:
<TABLE>
<CAPTION>
                                                                                     December 31, 1998
                                                                        -------------------------------------------------
                                                                                         (in thousands)
                                                                                                               Estimated
                                                                        Amortized    Unrealized  Unrealized      market
                                                                          cost          gains        losses       value
<S>                                                                     <C>         <C>           <C>          <C>       
      Securities held-to-maturity:
       US government and agency securities                              $      748  $          2  $        -   $      750
       Mortgage-backed securities (a)                                        1,744             6            9       1,741
                                                                       -----------  ------------  -----------  ----------
        Total securities held-to-maturity                                    2,492             8            9       2,491
                                                                       ===========  ============  ===========  ==========
      Securities available-for-sale:
       States and local governments                                    $       764  $         19  $         -  $      783
       Mortgage-backed securities                                            9,662             -           87       9,575
                                                                       -----------  ------------  -----------  ----------
        Total securities available-for-sale                            $    10,426  $         19  $        87  $   10,358
                                                                       ===========  ============  ===========  ==========
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
                                                                                       December 31, 1997
                                                                        -------------------------------------------------
                                                                                          (in thousands)
                                                                                                                Estimated
                                                                        Amortized    Unrealized   Unrealized     market
                                                                          cost          gains        losses       value
                                                                       -----------  ------------  -----------  ----------
<S>                                                                     <C>         <C>           <C>          <C>       
     Securities held-to-maturity:
       US government and agency securities                              $    3,489  $          6  $         1  $    3,494
       Mortgage-backed securities (a)                                        2,400            46                    2,446
                                                                       -----------  ------------  -----------  ----------
        Total securities held-to-maturity                                    5,889            52            1       5,940
                                                                       ===========  ============  ===========  ==========
      Securities available-for-sale:
       States and local governments                                    $     1,854  $          6  $         1  $    1,859
                                                                       -----------  ------------  -----------  ----------
        Total securities available-for-sale                            $     1,854  $          6  $         1  $    1,859
                                                                       ===========  ============  ===========  ==========
</TABLE>


                                       25
<PAGE>
              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Continued
              ----------------------------------------------------

(2)  Investment Securities, Continued
     --------------------------------
<TABLE>
<CAPTION>
                                                                                        December 31, 1996
                                                                                          (in thousands)
                                                                       --------------------------------------------------
                                                                                                                Estimated
                                                                         Amortized   Unrealized   Unrealized      Market
                                                                           Cost         Gains       Losses        Value
                                                                       -----------  ------------  -----------  ----------
<S>                                                                     <C>         <C>           <C>          <C>       
    Securities held-to-maturity:
     US government and agency securities                               $     4,753  $         21  $        18  $    4,756
     Mortgage-backed securities (a)                                          2,983            41            -       3,024
                                                                       -----------  ------------  -----------  ----------
      Total securities held-to-maturity                                $     7,736  $         62  $        18  $    7,780
                                                                       ===========  ============  ===========  ==========
    Securities available-for-sale
     State and local governments                                       $     2,019  $          4  $        12  $    2,011
     Mutual Funds                                                              712             -            -         712
                                                                       -----------  ------------  -----------  ----------
      Total securities available-for-sale                              $     2,731  $          4  $        12  $    2,723
                                                                       ===========  ============  ===========  ==========
</TABLE>

(a)  At December 31, 1998 the Company owned mortgage-backed securities issued by
     the General National  Mortgage  Association  (GNMA),  the Federal Home Loan
     Mortgage  Corporation (FHLMC) and the Small Business Association (SBA) with
     an  aggregate   amortized  cost  of  $11,406,000  and  a  market  value  of
     $11,316,000.  At  December  31,  1997,  the Company  owned  mortgage-backed
     securities  issued by GNMA and FHLMC with an  aggregate  amortized  cost of
     $2,400,000 and a market value of $2,446,000.

     The  aggregate   amortized  cost  and  approximate   market  value  of  the
     available-for-sale  and held-to-maturity  securities portfolios at December
     31, 1998, by remaining contractual maturity are as follows:
<TABLE>
<CAPTION>
                                                             Securities available-for-sale    Securities held-to-maturity
                                                             -----------------------------    ---------------------------
                                                                                    (in thousands)

                                                                               Estimated                       Estimated
                                                                  Amortized     market           Amortized       market
                                                                    cost        value             cost           value
                                                                 ---------     ---------         -------        ---------
<S>                                                              <C>           <C>               <C>            <C>
     US government agencies securities:
       Due in 1 year or less                                     $             $                 $   748        $    750
     Obligations of states and local governments:
       Due 1 year through 5 years                                      386           400
       Due after 5 through 10 years                                    378           383
       Mortgage-backed securities                                    9,662         9,575           1,744            1,741
                                                                 ---------     ---------         -------        ---------
       Total securities                                          $  10,426     $  10,358         $ 2,492        $   2,491
                                                                 =========     =========         =======        =========
</TABLE>


                                       26
<PAGE>
              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Continued
              ----------------------------------------------------

     There was no sales  activity  for  held-to-maturity  or  available-for-sale
securities for the years ended December 31, 1998, 1997, and 1996.

(3)  Loans Receivable
<TABLE>
<CAPTION>
                                                                                                         December 31,
                                                                                                -------------------------
     Loans receivable consist of the following:                                                      1998          1997
                                                                                                -----------   -----------
                                                                                                       (in thousands)
<S>                                                                                             <C>           <C>        
     Loans secured by first mortgages on real estate:
       Mortgage loans held for investment, primarily one-to-four family                         $    84,094   $    76,894
       Construction loans                                                                            12,670         8,571
       Nonresidential real estate                                                                     9,619         9,541
                                                                                                -----------   -----------
                                                                                                    106,383        95,006
     Home equity lines of credit                                                                      2,356         2,438
     Other second mortgage loans                                                                        121           237
     Other installment loans                                                                          1,265           632
                                                                                                -----------   -----------
                                                                                                    110,125        98,313
     Undisbursed proceeds on loans in process                                                        (5,614)       (3,718)
     Deferred loan fees                                                                              (1,212)       (1,058)
     Allowance for loan losses                                                                         (750)         (570)
                                                                                                -----------   -----------
                                                                                                $   102,549     $  92,967
                                                                                                ===========     =========
</TABLE>
     An analysis of the allowance for loan losses follows:
<TABLE>
<CAPTION>
                                                                                      1998          1997          1996
                                                                                  -----------   -----------   ----------
                                                                                                (in thousands)
<S>                                                                               <C>           <C>           <C>        
     Balance at beginning of period                                               $       570   $       511   $       462
       Provision for loan losses                                                          180            60            50     
               Loans charged off                                                            -            (1)           (1)
       Recoveries                                                                           -             -            -
                                                                                  -----------   -----------   ----------
     Balance at end of period                                                     $       750   $       570   $       511
                                                                                  ===========   ===========   ===========
</TABLE>
     At  December  31,  1998 and 1997,  the  Company  had no loans which were in
     nonaccrual  status  and  $243,318  and  $294,858  respectively,  which were
     contractually delinquent for 90 days or more and still accruing.
<PAGE>
     At December 31, 1998, the Company had mortgage loan commitments outstanding
     of  $5,614,315  and   preapproved   but  unused  lines  of  credit  totaled
     $2,824,250. The Company's exposure to credit loss for commitments to extend
     credit and  standby  letters of credit is the  contractual  amount of those
     financial instruments. The Company uses the same credit policies for making
     commitments and issuing standby letters of credit as it does for on-balance
     sheet financial instruments.  Each customer's creditworthiness is evaluated
     on an  individual  basis.  The  amount  and type of  collateral,  if deemed
     necessary by management, is based upon this evaluation of creditworthiness.
     Collateral obtained varies but may include marketable securities, deposits,
     real estate, investment assets, and property and equipment. In management's
     opinion,  these commitments,  and undisbursed  proceeds on loans in process
     reflected above,  represent no more than normal lending risk to the Company
     and will be funded from normal sources of liquidity.

     The Bank makes loans to executive officers and directors of the Company and
     to their associates. It is management's opinion that such loans are made on
     substantially the same terms,  including interest rates and collateral,  as
     those  prevailing at the time for  comparable  transactions  with unrelated
     persons  and do not involve  more than the normal  risk of  collectibility.
     Following is a reconciliation of loans  outstanding to executive  officers,
     directors, and their associates for the year ending December 31, 1998.


         Balance at December 31, 1997                       $   2,028,952
         New loans                                                445,500
         Repayments                                              (429,080)
                                                            -------------
         Balance at December 31, 1998                       $   2,045,372
                                                            =============



                                       27
<PAGE>
              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Continued
              ----------------------------------------------------

(4)  Premises and Equipment

     Premises and equipment consist of the following:
<TABLE>
<CAPTION>
                                             December 31, 1998                             December 31, 1997
                                    --------------------------------------        ------------------------------------
                                                  Accumulated     Net book                     Accumulated     Net book
                                        Cost      depreciation     value            Cost      depreciation       value
                                                                        (in thousands)
<S>                                 <C>            <C>           <C>              <C>            <C>             <C>  
     Land                           $    262       $     -       $    262         $    258       $    -          $ 258
     Office buildings and
       improvements                      847           461            386              834          423            411
     Furniture, fixtures and
       equipment                         574           327            247              507          371            136
     Vehicles                             26            12             14               26            7             19
                                    --------       -------        -------         --------       ------          -----
                                    $  1,709       $   800        $   909         $  1,625       $  801          $ 824
                                    ========       =======        =======         ========       ======          =====
</TABLE>

(5)  Deposits

     Time  deposits of $100,000 or more totaled  $8,273,195  and  $5,514,098  at
December 31, 1998 and 1997, respectively.

     Interest expense on deposits includes  $324,288,  $196,905 and $343,000 for
the years ended December 31, 1998, 1997 and 1996, respectively, on time deposits
of $100,000 or more.

     Contractual  maturities  of time  deposits  at  December  31,  1998  are as
follows:

                                                             Total
       Year Ending December 31,                            Maturities
                                                    (dollars in thousands)

         1999                                            $     49,853
         2000                                                   7,965
         2001                                                   1,454
                                                         ------------
             Total time deposits                         $     59,272
                                                         ============

(6)  Advances from the Federal Home Loan Bank

     Advances from the Federal Home Loan Bank of Atlanta,  with weighted average
interest rates, are as follows:
<PAGE>
<TABLE>
<CAPTION>
                                                                  December 31,
                                                        ------------------------------
                                                           1998                1997
                                                        ------------       -----------
                                                               (in thousands)
<S>                                                     <C>                <C>        
     6.50% due on or before December 31, 1998           $          -       $     7,800
     5.78% due on or before December 31, 1999                  6,967                 -
     5.52% due on or before August 2, 2003                     2,000                 -
     5.09% due on or before August 28, 2008                   15,000                 -
                                                        ------------       -----------
                                                        $     23,967       $     7,800
                                                        ============       ===========
</TABLE>


     The Bank has a total  available  line of credit of $37.0  million  with the
     FHLB. At December 31, 1998,  the Bank had  additional  credit  availability
     from the Federal Home Loan Bank of $13.0 million.

     All  advances  are secured by all stock in the Federal Home Loan Bank and a
     blanket  floating  lien  on the  Bank's  one-to-  four  family  residential
     mortgage loans.

                                       28
<PAGE>
              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Continued
              ----------------------------------------------------

(7)  Stockholders' Equity
     --------------------

     Common Stock
     ------------

     The Company is authorized to issue  20,000,000  shares of common stock. The
     common stock has no par value. As of December 31, 1998 and 1997, there were
     1,692,352  and  1,898,052  shares of common stock  issued and  outstanding,
     respectively.  The  decrease  is  attributable  to the  Company  purchasing
     $3,692,443 in treasury stock during 1998.

     Preferred Stock
     ---------------

     The Company is  authorized  to issue up to  5,000,000  shares of  preferred
     stock. No shares of preferred stock have been issued or were outstanding at
     December  31, 1998 or 1997.  Such  preferred  stock may be issued in one or
     more series with such rights, preferences, and designations as the Board of
     Directors  of the  Parent  may  from  time to  time  determine  subject  to
     applicable law and regulations. If and when such shares are issued, holders
     of such shares may have certain preferences,  powers, and rights (including
     voting  rights)  senior to the rights of the holders of the common stock of
     the Company.  The Board of Directors of the Parent can (without stockholder
     approval)  issue  preferred  stock with voting and conversion  rights which
     could, among other things, adversely affect the voting power of the holders
     of the common stock of the company and assist  management  in an unfriendly
     takeover  or  attempted   change  in  control  of  the  Company  that  some
     stockholders  may  consider  to be in  their  best  interest  but to  which
     management is opposed.  The Company has no current plans to issue preferred
     stock.

     Liquidation  Account:  At the time of  Conversion,  the Bank  established a
     liquidation  account in an amount  equal to its net worth at  December  31,
     1995.  The  liquidation  account  will be  maintained  for the  benefit  of
     eligible  deposit  account  holders who continue to maintain  their deposit
     accounts  in the Bank  after  Conversion.  Only in the event of a  complete
     liquidation  will each  eligible  deposit  account  holder be  entitled  to
     receive a  liquidation  distribution  from the  liquidation  account in the
     amount of the then current adjusted subaccount balance for deposit accounts
     then held before any liquidation  distribution  may be made with respect to
     the Parent's common stock.  Dividends  cannot be paid from this liquidation
     account.

     Dividends
     ---------

     Subject to  applicable  law,  the Boards of  Directors  of the Bank and the
     Parent may each provide for the payment of dividends.  Future  declarations
     of cash dividends,  if any, by the Parent may depend upon dividend payments
     by the Bank to the Parent. Subject to regulations of the Administrator, the
     Bank may not  declare or pay a cash  dividend on or  repurchase  any of its
     common stock if its  stockholders'  equity would  thereby be reduced  below
     either the aggregate  amount then required for the  liquidation  account or
<PAGE>
     the minimum  regulatory capital  requirements  imposed by federal and state
     regulations.  In addition, for a period of five years after the Conversion,
     the Bank will be required,  under existing North Carolina  regulations,  to
     obtain prior written  approval of the  Administrator  before it can declare
     and pay a cash  dividend  on its  capital  stock in an  amount in excess of
     one-half of the  greater of (i) its net income for the most  recent  fiscal
     year,  or (ii) the average of its net income after  dividends  for the most
     recent  fiscal  year and not more  than  two of the  immediately  preceding
     fiscal  years,  if  applicable.  As a result of this  limitation,  the Bank
     cannot pay a dividend  in excess of $754,138  without  the  approval of the
     Administrator.

     Capital Adequacy
     ----------------

     The Parent is regulated  by the Board of  Governors of the Federal  Reserve
     System  ("FRB")  and is  subject  to  securities  registration  and  public
     reporting  regulations of the Securities and Exchange Commission.  The Bank
     is regulated by the Federal Deposit Insurance  Corporation ("FDIC") and the
     Administrator,  Savings Institutions Division, North Carolina Department of
     Commerce (the "Administrator").



                                       29
<PAGE>
              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Continued
              ----------------------------------------------------


(7)  Stockholders' Equity - Continued
     --------------------------------

     The  Bank  is  subject  to  capital   requirements  of  the  FDIC  and  the
     Administrator.  The FDIC  requires the Bank to maintain  minimum  ratios of
     Tier  1  capital  to  total  risk-weighted  assets  and  total  capital  to
     risk-weighted assets of 4% and 8%, respectively. Tier 1 capital consists of
     total shareholders' equity calculated in accordance with generally accepted
     accounting   principles  less  intangible  assets,  and  total  capital  is
     comprised of Tier 1 capital plus certain adjustments, the only one of which
     applicable  to  the  Bank  is  the  allowance  for  possible  loan  losses.
     Risk-weighted assets refer to the on and off-balance sheet exposures of the
     Bank adjusted for their  relative  risk levels using  formulas set forth in
     FDIC  regulations.  The Bank is also  subject  to a FDIC  leverage  capital
     requirement,  which calls for a minimum ratio of Tier 1 capital (as defined
     above) to  quarterly  average  total  assets of 3% to 5%,  depending on the
     institution's  composite  ratings  as  determined  by its  regulators.  The
     Administrator requires a net worth equal to at least 5% of total assets.

     As  of   December   31,   1998,   the   FDIC   categorized   the   Bank  as
     "well-capitalized".  The Bank is required to meet minimum  ratios for total
     risk-based,  and Tier I  leverage  (the  ratio of Tier I capital to average
     assets)  as set  forth in the  following  table.  There  are no  events  or
     conditions since the notification that management believes have changed the
     Bank's category.
<TABLE>
<CAPTION>
                                                                                                                  Minimum Ratios
                                                                                                     ------------------------------
                                                                                                        For           To Be Well
                                                                                                       Capital    Capitalized Under
                                                             Capital Amount            Ratio          Adequacy    Prompt Corrective
                                                           1998         1997      1998      1997      Purposes    Action Provisions
                                                        ---------    ---------    ----      ----      --------    ------------------
<S>                                                     <C>          <C>          <C>       <C>        <C>            <C>  
     As of December 31:

       Tier I Capital (ratio to risk-weighted assets):  $  27,044    $  26,027    36.01%    42.30%     4.00%           6.00%

       Tier Capital - Tier II capital (ratio to risk-
         weighted assets):                                 27,794       26,597    37.01%    43.23%     8.00%          10.00%

       Leverage - Tier I capital (ratio to average
         Assets):                                          27,044       26,027    21.35%    25.92%     4.00%           5.00%
</TABLE>

     At December 31, 1998 and 1997,  the Bank was in compliance  with all of the
aforementioned capital requirements.
<PAGE>
(8)  Income Taxes
     ------------

     The components of income tax expense (benefit) were as follows:
<TABLE>
<CAPTION>
                                      Year ended December 31,
                             ---------------------------------------
                                           (in thousands)
                               1998           1997            1996
                             -------        --------        ------- 
<S>                          <C>            <C>             <C>    
     Currently payable:
       Federal               $   913        $    798        $   757
       State                     167             145            139
                             -------        --------        -------
                               1,080             943            896
                             -------        --------        -------

     Deferred:
       Federal                   (91)            (34)           (31)
       State                     (44)             (8)            (7)
                             -------        --------        -------
                                (135)            (42)           (38)
                             -------        --------        -------
                             $   945        $    901        $   858
                             =======        ========        =======

</TABLE>
                                       30
<PAGE>
              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Continued
              ----------------------------------------------------

     The tax  effects of  temporary  differences  that give rise to  significant
portions of the  deferred  tax assets and  deferred  tax  liabilities  are shown
below:
<TABLE>
<CAPTION>

                                                               December 31,
                                                             --------------
                                                             1998      1997
                                                             ----      ----
                                                             (in thousands)

<S>                                                           <C>      <C> 
Allowance for loan losses (net) .........................     $308     $229
Deferred loan  origination  fees, net of deferred costs .      497      424
                                                              ----     ----
     Gross deferred tax assets ..........................      805      653
 Accelerated depreciation ...............................       12        0
 Valuation allowance ....................................        0        0
                                                              ----     ----
     Gross deferred tax assets ..........................      817      653
                                                              ----     ----

 Accelerated depreciation ...............................      --        46
     FHLB stock dividends ...............................      180      180
 Other temporary differences creating deferred tax assets       10       15
                                                              ----     ----
     Gross deferred tax liabilities .....................      190      241
                                                              ----     ----

     Net deferred tax asset .............................     $627     $412
                                                              ====     ====
</TABLE>
     The Company has no valuation allowance at December 31, 1998 or 1997 because
     it has  sufficient  taxable  income in the carryback  period to support the
     realizability of the net deferred tax asset.

     The  reconciliation  of income taxes at  statutory  tax rates to income tax
     expense reported in the statements of income follows:
<TABLE>
<CAPTION>
                                                                            December 31,
                                                             --------------------------------------
                                                                1998            1997          1996
                                                             -------        --------       --------
                                                                        (in thousands)

<S>                                                          <C>            <C>            <C>     
     Income taxes at the statutory federal tax rate          $   868        $    827       $    798
     State income taxes less federal benefit                     118             120            120
     Tax exempt interest                                         (15)            (29)           (38)
     Other                                                       (26)            (17)           (22)
                                                             -------        --------       --------
         Total tax expense                                   $   945        $    901       $    858
                                                             =======        ========       ========
</TABLE>
<PAGE>
     Retained  earnings at December 31, 1998 includes  approximately  $2,577,990
     for which no provision  for federal  income tax has been made.  This amount
     represents  allocations  of income to bad debt  deductions for tax purposes
     only.  Reduction of such amount for purposes other than tax bad debt losses
     will create income for tax purposes only, which will be subject to the then
     current  corporate income tax rate.  Legislation  passed in 1996 eliminates
     the percentage of taxable income method as an option for computing bad debt
     deductions for 1996 and in all future years.  The Bank is permitted to take
     deductions for bad debts,  but is required to compute such deductions using
     an experience method.

(9)  Employee and Director Benefit Plans
     -----------------------------------

     401(k) PLAN
     -----------

     During 1994,  the Bank  implemented  a 401(k) plan that covers all eligible
     employees. The Bank may elect to match 50% of employee contributions,  with
     the Bank's  contribution  limited to 3% of each employee's  salary.  401(k)
     matching  contributions  are funded when accrued.  Matching expense totaled
     approximately $866 in 1997, and $1,900 in 1996.
     There was no company matching in 1998.



                                       31
<PAGE>
              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Continued
              ----------------------------------------------------

(9)  Employee and Director Benefit Plans - Continued
     -----------------------------------------------

     EMPLOYEE STOCK  OWNERSHIP  PLAN  ("ESOP"):  The Bank has an ESOP whereby an
     aggregate  number of shares  amounting to 146,004 were purchased for future
     allocation to employees.  Contributions to the ESOP are made by the Bank on
     a discretionary  basis,  and are allocated  among ESOP  participants on the
     basis of relative  compensation  in the year of  allocation.  Benefits will
     vest in full upon five  years of  service  with  credit  given for years of
     service prior to the conversion.

     The ESOP was  funded in  December,  1996 by a loan  from the  Parent in the
     amount of $2,198,064.  The loan is secured by shares of stock  purchased by
     the ESOP and is not guaranteed by the Bank. Principal and interest payments
     on this loan are funded primarily from  discretionary  contributions by the
     Bank.  Dividends,  if any, paid on shares held by the ESOP may also be used
     to reduce the loan. Dividends on unallocated shares are used by the ESOP to
     repay the debt to the  Parent  and are not  reported  as  dividends  in the
     consolidated  financial  statements.  Dividends  on  allocated  shares  are
     credited to the amounts of the  participants  and  reported as dividends in
     the consolidated financial statements.

     During  1998,  the  Bank  made  a  $257,162   contribution   to  the  ESOP,
     representing  the  normal  principal  payment  due  for  the  year  and the
     application of dividends on unallocated  shares to the principal balance of
     the loan.  This  contribution  resulted in the  release of 9,207  shares to
     individual  participant  accounts.  At December 31, 1998, a total of 40,029
     shares have been released and allocated to participants  and 105,975 shares
     remain unallocated. Total compensation expense associated with the ESOP for
     the years ended  December  31,  1998 and 1997 was  $190,000  and  $180,000,
     respectively.  At December 31, 1998,  there were 105,975  unallocated  ESOP
     shares with a total fair value of approximately  $1,510,144. In fiscal year
     1996, the $175,000 cash  contribution  made for the year ended December 31,
     1996 was used to release 7,205 shares to ESOP participants. During the year
     ended December 31, 1998 and 1997, 9,207 and 23,617 shares respectively were
     considered committed to be released to ESOP participants,  and compensation
     expense of $190,000 and $180,000, respectively associated with those shares
     was recorded.

     Management Recognition Plan ("MRP")
     -----------------------------------
     The  Bank's  MRP was  approved  by  stockholders  of the  Parent and by the
     Parent's and the Bank's Boards of Directors  during  fiscal year 1997.  The
     MRP serves as a means of providing  existing directors and employees of the
     Bank with an  ownership  interest in the Company.  Shares of the  Company's
     common  stock  awarded  under the MRP vest equally over a five year period.
     Compensation   expense   related  to  those  shares  is   recognized  on  a
     straight-line  basis  corresponding  with  the  vesting  period.  Prior  to
     vesting,  each  participant  granted  shares  under the MRP may  direct the
     voting of the shares  allocated to the  participant and will be entitled to
     receive any dividends or other distributions paid on such shares. On May 9,
     1997, 73,002 shares were awarded under the MRP. Total compensation  expense
     associated  with the MRP for the year ended  December 31, 1998 and 1997 was
     $273,000 and $353,000, respectively.

                                       32
<PAGE>
                    NOTES TO FINANCIAL STATEMENTS - Continued
                    -----------------------------------------

(9)  Employee and Director Benefit Plans - Continued
     -----------------------------------------------

     Stock Option Plan
     -----------------

     The Company adopted a Stock Option Plan which has also been approved by the
     stockholders  of the Parent and by the  Parent's  and the Bank's  Boards of
     Directors.  The Stock  Option  Plan makes  available  options  to  purchase
     182,505 shares,  or 10% of the shares issued in the conversion to employees
     and  directors.  Options  granted  under the Stock Option Plan to directors
     vest immediately while options granted to employees have a vesting schedule
     which provides that 20% of the options  granted vest in the first year, and
     20% will vest on each subsequent anniversary date, so that options would be
     completely vested within five years from the date of grant.  Options become
     100%  vested upon death or  disability,  if  earlier.  Unexercised  options
     expire  within ten years  from the date of grant.  The  exercise  price for
     options granted in 1997 was the fair market value at the date of grant (May
     9, 1997) of $25.625  per share and was  adjusted  to $21.75 to reflect  the
     $4.00 special return of capital  dividend paid to  stockholders in 1997. No
     stock options were granted in 1998.

     A summary of the Company's  stock option  activity and related  information
     for the year ended December 31, 1998 follows:
<TABLE>
<CAPTION>
                                             Outstanding                   Exercisable         
                                         ----------------------      ----------------------    
                                                       Weighted                    Weighted    
                                                       Average                     Average     
                                         Option        Exercise      Option        Exercise    
                                         Shares         Price         Shares        Price      
                                         -------      ---------      -------      ---------    
     <S>                                 <C>          <C>             <C>         <C>          
     At December 31, 1997 .........      172,244      $   21.75       78,241      $   21.75    
     Granted ......................         --             --         23,439          21.75    
     Exercised ....................         --             --           --             --      
     Forfeited ....................        1,287           --            456           --      
                                         -------      ---------      -------      ---------    
     At December 31, 1998 .........      170,957      $   21.75      101,224      $   21.75    
                                         =======      =========      =======      =========    
</TABLE>
     The  Company  has  elected  to  follow  APB  Opinion  No.  25  ("APB  25"),
     "Accounting for Stock Issued to Employees" and related  interpretations  in
     accounting  for its stock  options as  permitted  under SFAS No. 123 ("SFAS
     123"),  "Accounting for Stock-Based  Compensation".  In accordance with APB
     25, no  compensation  cost is  recognized by the Company when stock options
     are granted  because the  exercise  price of the  Company's  stock  options
     equals  the  market  price of the  underlying  common  stock on the date of
     grant.  As required by SFAS 123,  disclosures  are presented  below for the
     effect on the net income and net  income per share that would  result  from
     the use of the fair value based method to measure compensation cost related
     to stock option grants using the  Black-Scholes  option  pricing model with
     the following  assumptions:  a risk free  interest rate of 6.75%,  expected
     lives of 7 years, expected volatility of 30% and expected dividends of $.45
     per year.  The  weighted  average  fair value per share of options  granted
     amounted to $6.26.  The effects of applying the  provisions  of SFAS 123 in
     1998 and 1997 are not necessarily indicative of future effects.
<PAGE>
<TABLE>
<CAPTION>
                                                      1998                1997
                                                 -----------          ----------
                                                (in thousands, except per share data)
<S>                                              <C>                  <C>       
Net income
   As reported .........................         $     1,608          $    1,532
   Pro forma ...........................               1,608               1,498

Net income per share
   As reported .........................         $      0.89          $     0.82
   Pro forma ...........................                0.89                0.80

</TABLE>


                                       33
<PAGE>
                    NOTES TO FINANCIAL STATEMENTS - Continued
                    -----------------------------------------

(9)  Employee and Director Benefit Plans - Continued
     -----------------------------------------------

     DIRECTOR'S   DEFERRED   COMPENSATION   PLAN:   The  Bank  has   a  deferred
     compensation plan for its directors under which the directors would be paid
     specified  amounts  during the ten year period  following the date that the
     director  becomes 65 years of age. The Bank has  purchased  life  insurance
     policies with the Bank named as  beneficiary  to fund the  benefits.  Total
     expense related to these plans was approximately $78,208 for 1998, $123,271
     for 1997 and $48,000 for 1996.

     EMPLOYMENT AGREEMENTS: In connection with the Conversion,  the Bank entered
     into an employment  agreement with its chief executive  officer in order to
     ensure a stable and competent management base. The agreement provides for a
     three-year  term, but upon each  anniversary,  the agreement  automatically
     extends  so that the  remaining  term  shall  always  be three  years.  The
     agreement provides that the nature of the covered employee's  compensation,
     duties or benefits  cannot be  diminished  following a change in control of
     the Company.

     SEVERANCE  PLAN:  In  connection  with the  Conversion,  the Bank adopted a
     Severance  Plan for the benefit of its  employees.  The Plan  provides  for
     severance pay benefits in the event of a change in control which results in
     the termination of such employees or diminished  compensation,  duties,  or
     benefits  within two years of a change in control.  The  employees  covered
     would be entitled  to a severance  benefit of the greater of (a) the amount
     equal to two weeks salary at the  existing  salary rate  multiplied  by the
     employee's  number of  completed  years of service or (b) the amount of one
     month's  salary at the employee's  salary rate at the time of  termination,
     subject  to a maximum  payment  equal to two times  the  employee's  annual
     salary.

     SPECIAL TERMINATION AGREEMENTS: In order to assure the continued employment
     of Allen W. Carter and  Marjorie D.  Foster,  the Bank entered into special
     termination  agreements with each of them to provide  benefits in the event
     of a change in  control of the Bank or the  Company.  Such  agreements  are
     intended  to ensure  that the Bank will be able to  maintain  a stable  and
     competent  employee base. The continued  success of the Bank depends,  to a
     significant degree, on the skill and competence of its employees.



                                       34
<PAGE>
              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Continued
              ----------------------------------------------------

(10) Quarterly Financial Data (Unaudited)
     ------------------------------------

     Summarized  unaudited  quarterly financial data for the year ended December
     31, 1998 is as follows:
<TABLE>
<CAPTION>
                                                                    First         Second          Third        Fourth
                                                                    Quarter       Quarter         Quarter      Quarter
                                                                  --------     ----------      ----------    ---------
       Operating Summary:                                               (in thousands except per share amounts)
<S>                                                                <C>          <C>             <C>           <C>      
       Interest income                                             $  2,190     $    2,253      $    2,360    $   2,465
       Interest expense                                                 952            975           1,121        1,222
                                                                   --------     ----------      ----------    ---------
       Net interest income                                            1,238          1,278           1,239        1,243       
       Provision for loan losses                                         30             30              30           90
        Net interest income after provision for loan losses            1,208          1,248           1,209        1,153
       Other income                                                      34             36              31           62
       Other expenses                                                   493            798             551          586
                                                                  ---------     ----------      ----------    ---------
       Income before income tax expense                                 749            486             689          629
       Income taxes                                                     286            185             263          211
                                                                  ---------     ----------      ----------    ---------
       Net income                                                       463            301             426          418
       Per Share Data:
       Net income per share - basic                                    .25             .16             .24          .24
       Net income per share - diluted                                  .25             .16             .24          .24
       Cash dividends declared                                        .1150          .1150           .1150        .1150
       Dividend payout                                                46.69          70.94           43.35        46.62
       Book value per share                                           16.47          16.64           16.68        16.83
       Selected Average Balances:
       Assets                                                     $  109,518    $  111,599      $ 118,175     $ 125,684
       Investment securities                                          10,910         9,674         13,153        17,715
       Loans, net                                                     94,344        96,931         99,589       101,794
       Interest-bearing deposits                                      67,365        68,291         68,827        71,003
       FHLB advances                                                  31,025        30,824         29,665        28,572

</TABLE>
                                       35

<PAGE>
                    NOTES TO FINANCIAL STATEMENTS - Continued

(10) Quarterly Financial Data (Unaudited) - (Continued)
     --------------------------------------------------

     Summarized  unaudited  quarterly financial data for the year ended December
     31, 1997 is as follows:
<TABLE>
<CAPTION>
                                                                    First         Second         Third        Fourth
                                                                    Quarter       Quarter        Quarter      Quarter
                                                                  ----------    ----------      ---------     ---------
       Operating Summary:                                                (in thousands except per share amounts)
<S>                                                               <C>           <C>             <C>           <C>      
       Interest income                                            $    2,110    $    2,050      $   2,099     $   2,094
       Interest expense                                                  826           840            890           935
                                                                  ----------    ----------      ---------     ---------
       Net interest income                                             1,284         1,210          1,209         1,159
       Provision for loan losses                                          15            15             15            15
                                                                  ----------    ----------      ---------     ---------
       Net interest income after provision for loan losses             1,269         1,195          1,194         1,144
       Other income                                                       34            33             36            42
       Other expenses                                                    450           826            604           634
                                                                  ----------    ----------      ---------     ---------
       Income before income tax expense                                  853           402            626           552
       Income taxes                                                      327           144            240           190
                                                                  ----------    ----------      ---------     ---------
       Net income                                                        526           258            386           362
       Per Share Data:
       Net income per share - basic                                      .29           .14             .20          .19
       Net income per share - diluted                                    .29           .14             .20          .19
       Cash dividends declared                                         .1125         .1125          4.1125        .1125
       Dividend payout                                                 39.04         82.74           55.27        59.01
       Book value per share                                            20.76         16.13           16.32        16.37
       Selected Average Balances:
       Assets                                                     $  104,971    $  105,946      $ 103,526     $ 105,630
       Investment securities                                          17,149        14,494         11,471        10,529
       Loans, net                                                     84,256        86,024         87,469        91,095
       Interest-bearing deposits                                      65,938        91,490         65,553        66,414
       FHLB advances                                                       -             -          3,390         6,555
       Stockholders' equity                                           37,587        34,212         30,799        31,027

</TABLE>
                                       36
<PAGE>
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
             ------------------------------------------------------

(11) Parent Company Financial Data
     -----------------------------

     Condensed  financial  information  for Stone Street Bancorp,  Inc.  (Parent
     Company) is as follows:
<TABLE>
<CAPTION>
                                                                                               December 31,   December 31,
                                                                                                   1998           1997
                                                                                              -------------  -------------
       Condensed Balance Sheet                                                                       (in thousands)
<S>                                                                                            <C>            <C>         
       Assets:
         Cash on deposit with bank subsidiary                                                  $         931  $      3,957
         Interest bearing deposits                                                                       473           204
         Investment securities available for sale at market value:
           Obligations of states and local governments, cost $860,000                                      -            859
         Investment in bank subsidiary                                                                27,046         26,030
         Other assets                                                                                    164            118
                                                                                               -------------  -------------
             Total assets                                                                      $      28,614  $     31,168
                                                                                               =============  ============

         Liabilities and stockholders' equity:
           Accrued expenses and other liabilities                                              $         124  $         92
           Stockholders' equity, net                                                                  28,490         31,076
                                                                                               -------------  -------------
             Total liabilities and stockholders' equity                                        $      28,614  $      31,168
                                                                                               =============  =============
<CAPTION>
                                                                                                   Year Ended December 31,
                                                                                                     1998           1997
                                                                                               -------------  -------------
       Condensed Statement of Income                                                                 (in thousands)
<S>                                                                                            <C>            <C>         
         Dividends from bank subsidiary                                                        $         725  $         619
         Interest income from bank subsidiary                                                             92            203
         Interest on interest bearing deposits                                                            20            149
         Interest on loan from bank subsidiary ESOP                                                      167            182
         Interest on investment securities                                                                15             33
                                                                                               -------------  -------------
           Total income                                                                                1,019          1,186
         Operating expenses                                                                              131            241
                                                                                               -------------  -------------
           Income before income taxes                                                                    888            945
         Income tax expense                                                                               63            120
                                                                                               -------------  -------------
         Income before equity in undistributed net income of subsidiary                                  825            825
         Equity in undistributed net income of bank subsidiary                                           783            707
                                                                                               -------------  -------------
             Net income                                                                        $       1,608  $       1,532
                                                                                               =============  =============
</TABLE>
                                       37
<PAGE>
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
             ------------------------------------------------------

(11) Parent Company Financial Data - Continued
     -----------------------------------------
<TABLE>
<CAPTION>

                                                                                      Year Ended December 31,  
                                                                            -------------------------------------
                                                                                  1998                    1997
                                                                            ------------            -------------          
         Condensed Statement of Cash Flows                                               (in thousands)
<S>                                                                          <C>                     <C>                    
         Cash flows from operating activities:
         Net income                                                          $       1,608           $       1,532          
         Adjustments to reconcile net income to                                                                             
           net cash provided by operating activities:                                                                       
         Undistributed earnings of bank subsidiary                                   (783)                    (707)         
         Payments on ESOP loan receivable from bank subsidiary                          89                     579          
         (Increase) (decrease) in other assets                                          46                      47          
         Increase in other liabilities                                                (32)                    (326)         
                                                                             ------------            -------------          
               Net cash provided by operating activities                               928                   1,125          
                                                                             -------------           -------------          
                                                                                                                            
         Cash flows from investing activities:                                                                              
         Maturity of available for sale securities                                     829                       -          
                                                                             -------------           -------------          
               Net cash provided by investing activities                               829                       -          
                                                                                                                            
         Cash flows from financing activities:                                                                              
         Proceeds of issuance of no par common stock                                     -                       -          
         Loan to ESOP for purchase of common stock                                       -                    (329)         
         Capital contribution to bank subsidiary                                         -                       -          
         Cash dividends paid to stockholders                                         (822)                  (8,438)         
         Purchase of treasury stock                                                (3,692)                       -          
                                                                             ------------            -------------          
               Net cash provided by financing activities                           (4,514)                  (8,767)         
                                                                             ------------            -------------          
                                                                                                                            
               Net increase in cash and cash equivalents                           (2,757)                  (7,642)         
         Cash and cash equivalents at beginning of year                              4,161                  11,803          
                                                                             -------------           -------------          
         Cash and cash equivalents at end of year                            $       1,404           $       4,161          
                                                                             =============           =============          
                                                                                                                            
         Supplemental disclosure of cash flow information:                                                                  
           Cash paid during the year for income taxes                        $          95           $         149          
                                                                             =============           =============          
         Supplemental disclosure of noncash transactions:                                                                   
           Unrealized gains (losses) on securities available for sale                                                       
             net of deferred tax benefit of $1 in each year                  $         (39)          $          (1)         
                                                                             =============           =============          
           Unrealized gains (losses) on subsidiary's securities                                                             
             available for sale, net of deferred tax benefit of                                                             
             $2 and $3 in 1997 and 1996, respectively                        $           0           $           4          
                                                                             =============           =============          
           Dividends declared but unpaid                                     $           -           $           -          
                                                                             =============           =============          
</TABLE>
                                       38
<PAGE>
              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Continued
              ----------------------------------------------------

(12) Fair Value of Financial Instruments
     -----------------------------------

     Fair value  estimates are made by  management at a specific  point in time,
     based on  relevant  information  about  the  financial  instrument  and the
     market.  These  estimates do not reflect any premium or discount that could
     result from offering for sale at one time the Company's  entire holdings of
     a  particular  financial  instrument  nor are  potential  taxes  and  other
     expenses  that would be incurred in an actual sale  considered.  Fair value
     estimates are based on judgments regarding future expected loss experience,
     current economic  conditions,  risk  characteristics  of various  financial
     instruments,  and other factors.  These  estimates are subjective in nature
     and involve uncertainties and matters of significant judgment and therefore
     cannot be determined  with  precision.  Changes in  assumptions  and/or the
     methodology  used  could  significantly  affect  the  estimates  disclosed.
     Similarly,  the fair values disclosed could vary significantly from amounts
     realized in actual transactions.

     Fair  value  estimates  are  based on  existing  on and  off-balance  sheet
     financial   instruments   without  attempting  to  estimate  the  value  of
     anticipated  future business and the value of assets and  liabilities  that
     are not considered financial instruments.

     The following  table presents the carrying values and estimated fair values
     of the Company's financial instruments at December 31, 1998 and 1997:
<TABLE>
<CAPTION>
                                                                                  1998                       1997
                                                                       ------------------------   ------------------------
                                                                        Carrying     Estimated      Carrying     Estimated
                                                                         Value       Fair Value      Value       Fair value
                                                                       ---------    -----------    --------      --------
                                                                                        (dollars in thousands)
<S>                                                                    <C>          <C>            <C>           <C>     
         Financial assets:
           Cash and interest-bearing deposits                          $   7,688    $     7,688    $  4,703      $  4,703
         Investment securities:
           Available-for-sale                                             10,426         10,358       1,854         1,859
           Held-to-maturity                                                2,492          2,491       5,889         5,940
         Net loans                                                       102,549        103,574      92,967        92,549
         Federal Home Loan Bank stock                                      1,570          1,570         741           741

         Financial liabilities:
           Deposits                                                       73,176         73,468      66,973        67,106
           Advance from FHLB                                              23,967         23,967       7,800         7,805
</TABLE>
     The estimated fair values of net loans and deposits are based on cash flows
     discounted at market interest rates. The carrying values of other financial
     instruments,  including various receivables and payables,  approximate fair
     value.

     At December 31, 1998,  the Company had  outstanding  commitments  to extend
     credit.  These  off-balance  sheet  financial   instruments  are  generally
     exercisable  at the  market  rate  prevailing  at the date  the  underlying
     transaction will be complete,  and,  therefore,  they are deemed to have no
     current fair market value. Refer to note 3.


                                       39
<PAGE>
                              CORPORATE INFORMATION
                                ----------------

                               BOARD OF DIRECTORS

Robert B. Hall, Chairman of the Board                 Claude R. Horn, Jr.
Retired Pharmacist                                    President of Horn Oil Co.

William F. Junker, Vice Chairman
President of Featherlite Trailer                      George W. Martin
                                                      Attorney and Partner
Donald G. Bowles in Martin, VanHoy,
Certified Public Accountant                           Smith & Raisbeck

J. Charles Dunn                                       Ronald H. Vogler
President of the Company and Stone Street Bank        Financial Consultant
                                                      with Paine Webber
Terry Bralley                                         since 1993, formerly
Town Manager   with Merrill Lynch
Mocksville, North Carolina





                               EXECUTIVE OFFICERS

J. Charles Dunn                                   Allen W. Carter               
President and Chief Executive Officer             Senior Vice President         
of The Company and Bank                           of the Company and Bank    


                                 Marjorie D. Foster
                                 Vice President
                                 and Controller of The
                                 Company and Bank
                                                                                


CORPORATE OFFICE INDEPENDENT CERTIFIED
STONE STREET BANCORP, INC.                PUBLIC ACCOUNTANTS
232 South Main Street                     Weir Smith Jones Miller & Elliott
Mocksville, NC 27028                      310 West Broad Street
(336) 751-5936   Statesville, NC 28677

STOCK TRANSFER AGENT                      FORM 10-K
Registrar and Transfer Company            A copy of the Form 10-K as filed with
10 Commerce Drive                         the Securities and Exchange Commission
Cranford,  New Jersey  07016-3572         will be furnished without charge to 
                                          stockholders upon written request to:

SPECIAL LEGAL COUNSEL                                 Marjorie D. Foster
Brooks, Pierce, McLendon, Humphrey and Leonard        Stone Street Bancorp, Inc.
Post Office Box 26000                                 232 South Main Street
Greensboro, NC 27420                                  Mocksville, NC 27028

<PAGE>

                                 ANNUAL MEETING

The 1999 Annual Meeting of stockholders  of Stone Street  Bancorp,  Inc. will be
held at 5:00  p.m.  on  April  20,  1999 at the  Davie  County  Public  Library,
Mocksville, North
Carolina.


                                       40
<PAGE>
                                  CAPITAL STOCK
                                 --------------

     Stone  Street  Bancorp's  common  stock is  traded  on the  American  Stock
     Exchange  under the symbol  "SSM".  As of  December  31,  1998,  there were
     1,692,352 shares  outstanding and 667 shareholders of record, not including
     the number of persons or entities  whose stock is held in nominee or street
     name through various brokerage firms or banks.  Payment of dividends by the
     Bank  subsidiary  to the Parent is subject to various  restrictions.  Under
     applicable banking regulations, the Bank may not declare a cash dividend if
     the effect  thereof would be to reduce its net worth to an amount less than
     the minimum required by federal and state banking regulations. In addition,
     for a period of five  years  after the  consummation  of the  Bank's  stock
     conversion,  which occurred on March 29, 1996, the Bank will be required to
     obtain  prior  written  approval  from  the  Administrator  of the  Savings
     Institutions Division, North Carolina Department of Commerce, before it can
     declare a cash  dividend in an amount in excess of one-half  the greater of
     (i) its net income for the most  recent  fiscal year or (ii) the average of
     its net income after dividends for the most recent fiscal year and not more
     than two of the immediately preceding fiscal years, as applicable.

            Quarterly Common Stock Performance and Dividends Declared
<TABLE>
<CAPTION>

                                                      Stock Price            Dividends Declared, Per Share
                                             --------------------------      -----------------------------
                                                  High           Low

     1998:

<S>                                          <C>             <C>                <C>       
     First Quarter ended March 31            $   22 1/4      $  19  3/4       $    .1150

     Second Quarter ended June 30                21             19  1/8            .1150

     Third Quarter ended September 30            19 3/4         15  1/4            .1150
     Fourth Quarter ended December 31            15 3/8         14                 .1150

     1997:

     First Quarter ended March 31            $   27 1/2      $  20  1/8       $    .1125

     Second Quarter ended June 30                27 1/2         20 15/16           .1125

     Third Quarter ended September 30(1)         22 1/8         21  1/8           4.1125

     Fourth Quarter ended December 31            22 7/8         18  1/2            .1125
</TABLE>

(1) Includes a regular cash dividend of $.1125 per share and a return of capital
    dividend of $4.00 per share.

                                       41