UNITED STATES SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

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

                                   FORM 10-QSB

(Mark One)

|X|   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
      EXCHANGE ACT OF 1934

      For the quarterly period ended September 30, 2001

|_|   TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES
      EXCHANGE ACT OF 1934

      For the transition period from _________________ to _____________________

                         Commission File Number 0-23971

                          GASTON FEDERAL BANCORP, INC.
             ------------------------------------------------------
             (Exact name of registrant as specified in its charter)

         United States                                          56-2063438
-------------------------------                           ----------------------
(State or other jurisdiction of                              (I.R.S. Employer
incorporation or organization)                            Identification Number)

            245 West Main Avenue, Gastonia, North Carolina 28052-4140
            ---------------------------------------------------------
                    (Address of principal executive offices)

       Registrant's telephone number, including area code: (704)-868-5200
                                                           --------------

--------------------------------------------------------------------------------
Former name, former address and former fiscal year, if changed since last report

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

                      APPLICABLE ONLY TO CORPORATE ISSUERS:

      Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date: There were 4,209,434 shares
of the Registrant's common stock outstanding as of November 9, 2001.
<PAGE>

GASTON FEDERAL BANCORP, INC.

                                      INDEX

                                                                            Page
                                                                            ----

PART I.  FINANCIAL INFORMATION

     Item 1.  Consolidated Financial Statements............................    2

          Consolidated Statements of Financial Condition as of
              September 30, 2001 and December 31, 2000 ....................    2

          Consolidated Statements of Operations for the three and nine
              months ended September 30, 2001 and 2000.....................    3

          Consolidated Statements of Comprehensive Income for the
              nine months ended September 30, 2001 and 2000................    4

          Consolidated Statements of Cash Flows for the nine months ended
              September 30, 2001 and 2000..................................    5

          Notes to Consolidated Financial Statements.......................    6

     Item 2.  Management's Discussion and Analysis of Financial Condition
              and Results of Operations....................................    8

PART II. OTHER INFORMATION.................................................   12


                                       1
<PAGE>

PART I. FINANCIAL INFORMATION

      ITEM 1. Consolidated Financial Statements

Gaston Federal Bancorp, Inc. and Subsidiary
Consolidated Statements of Financial Condition
(in thousands)

<TABLE>
<CAPTION>
                                                                    September30,   December 31,
                                                                        2001          2000
                                                                    ------------   ------------
                                                                    (unaudited)
<S>                                                                  <C>            <C>
Assets
Cash and cash equivalents ......................................       32,796         26,709
Investment securities available-for-sale, at fair value ........       28,332         32,822
Mortgage-backed securities available-for-sale, at fair value ...       25,015         22,955
Loans, net .....................................................      165,743        158,820
Premises and equipment, net ....................................        4,857          4,163
Accrued interest receivable ....................................        1,303          1,352
Federal Home Loan Bank stock ...................................        2,177          2,177
Other assets ...................................................        6,375          3,752
                                                                     --------       --------
   Total assets ................................................     $266,598       $252,750
                                                                     ========       ========

Liabilities and Equity
Deposits .......................................................     $180,155       $167,931
Advances from borrowers for taxes and insurance ................          918            351
Borrowed money .................................................       42,158         42,737
Other liabilities ..............................................        1,740          1,968
                                                                     --------       --------
   Total liabilities ...........................................      224,971        212,987

Retained earnings, substantially restricted ....................       25,015         23,931
Common stock and additional paid in capital, net of ESOP loan ..       15,211         15,241
Unrealized gain on securities available-for-sale, net of tax ...        1,401            591
                                                                     --------       --------
   Total equity ................................................       41,627         39,763
                                                                     --------       --------

Total liabilities and equity ...................................     $266,598       $252,750
                                                                     ========       ========
</TABLE>

See accompanying notes to consolidated financial statements.


                                       2
<PAGE>

Gaston Federal Bancorp, Inc. and Subsidiary
Consolidated Statements of Operations (unaudited)
(in thousands, except per share data)

<TABLE>
<CAPTION>
                                                                 Three Months Ended           Nine Months Ended
                                                                   September 30,                 September 30,
                                                                   -------------                 -------------
                                                                2001           2000           2001           2000
                                                                ----           ----           ----           ----
<S>                                                          <C>            <C>            <C>            <C>
Interest income
Loans ..................................................     $    3,091     $    3,417     $    9,392     $    9,884
Investment securities ..................................            421            517          1,386          1,507
Interest-bearing deposits ..............................            215             13            771             70
Mortgage-backed and related securities .................            363            329          1,127          1,002
                                                             ----------     ----------     ----------     ----------
  Total interest income ................................          4,090          4,276         12,676         12,463

Interest Expense
Deposits ...............................................          1,848          1,864          5,938          5,299
Borrowed funds .........................................            593            614          1,813          1,788
                                                             ----------     ----------     ----------     ----------
Total interest expense .................................          2,441          2,478          7,751          7,087
                                                             ----------     ----------     ----------     ----------

Net interest income ....................................          1,649          1,798          4,925          5,376

Provision for loan losses ..............................             30              8             90             22
                                                             ----------     ----------     ----------     ----------

  Net interest income after provision for loan losses ..          1,619          1,790          4,835          5,354

Noninterest Income
Service charges on deposit accounts ....................            459            175          1,301            460
Gain on sale of assets .................................              0             33              0            260
Other income ...........................................            280            387            853          1,031
                                                             ----------     ----------     ----------     ----------
  Total noninterest income .............................            739            595          2,154          1,751

Noninterest Expense
Compensation and benefits ..............................            940            941          2,710          2,838
Occupancy and equipment expense ........................            179            152            510            469
Loss on sale of assets .................................              0              2              9              3
Other expenses .........................................            548            378          1,588          1,270
                                                             ----------     ----------     ----------     ----------
  Total noninterest expense ............................          1,667          1,473          4,817          4,580

Income before income taxes .............................            691            912          2,172          2,525

Provision for income taxes .............................            230            304            689            840
                                                             ----------     ----------     ----------     ----------

Net income .............................................     $      461     $      608     $    1,483     $    1,685
                                                             ==========     ==========     ==========     ==========

Basic earnings per share ...............................     $     0.11     $     0.15     $     0.36     $     0.41
Diluted earnings per share .............................     $     0.11     $     0.15     $     0.36     $     0.41

Basic weighted average outstanding shares ..............      4,068,575      4,058,156      4,080,122      4,096,542
Diluted weighted average outstanding shares ............      4,100,312      4,058,156      4,091,723      4,097,648

Dividends paid per share ...............................     $    0.075     $    0.060     $    0.225     $    0.180
</TABLE>


                                       3
<PAGE>

Gaston Federal Bancorp, Inc. and Subsidiary
Consolidated Statements of Comprehensive Income (unaudited)
(in thousands)

<TABLE>
<CAPTION>
                                                                               Nine Months Ended
                                                                                 September 30,
                                                                              ------------------
                                                                               2001        2000
                                                                              ------     -------
<S>                                                                           <C>        <C>
Net income ..............................................................     $1,483     $ 1,685
Other comprehensive income, net of tax:
    Unrealized gains on securities:
        Unrealized holding gains arising during  period .................        804         278
        Reclassification adjustment for losses included in net income ...          6        (144)
                                                                              ------     -------
    Other comprehensive income ..........................................        810         134
                                                                              ------     -------

Comprehensive income ....................................................     $2,293     $ 1,819
                                                                              ------     -------
</TABLE>


                                       4
<PAGE>

Gaston Federal Bancorp, Inc. and Subsidiary
Consolidated Statements of Cash Flows (unaudited)
(in thousands)

<TABLE>
<CAPTION>
                                                                                             Nine Months Ended
                                                                                               September 30,
                                                                                           ----------------------
                                                                                             2001          2000
                                                                                           --------      --------
<S>                                                                                        <C>           <C>
Cash flows from operating activities:
  Net income .........................................................................     $  1,483      $  1,685
  Adjustments to reconcile net income to net cash provided by operating activities:
      Provision for loan losses ......................................................           90            22
      Depreciation ...................................................................          302           304
      Purchase of bank-owned life insurance ..........................................       (2,578)       (2,097)
      (Gain) loss on sale of investments, available for sale .........................            9          (225)
      (Gain) on sale of loans ........................................................            0            (1)
      (Gain) on sale of other assets .................................................            0           (31)
      (Increase) decrease in other assets ............................................           17           480
      Increase (decrease) in other liabilities .......................................         (228)           11
                                                                                           --------      --------

        Net cash provided by (used for) operating activities .........................         (905)          148
                                                                                           --------      --------

Cash flows from investing activities:
  Net (increase) in loans receivable .................................................       (6,942)       (7,043)
  Proceeds from the sale of investment securities ....................................            0         2,257
  Proceeds from the sale of mortgage-backed securities ...............................        1,257           595
  Proceeds from the sale of loans ....................................................            0            10
  Proceeds from the sale of other assets .............................................          196           276
  Maturities and prepayments of investment securities ................................       10,720         1,107
  Maturities and prepayments of mortgage-backed securities ...........................        5,716         2,648
  Purchases of investments ...........................................................       (5,420)       (4,600)
  Purchases of mortgage-backed securities ............................................       (9,041)       (4,149)
  Purchases of FHLB stock ............................................................            0          (402)
  Net cash flows from other investing activities .....................................       (1,192)       (1,484)
                                                                                           --------      --------

        Net cash (used for) investment activities ....................................       (4,706)      (10,785)
                                                                                           --------      --------

Cash flows from financing activities:
  Net increase in deposits ...........................................................       12,224         2,749
  Dividends to stockholders ..........................................................         (398)         (621)
  Repurchase of common stock .........................................................         (115)         (897)
  Net increase (decrease) in borrowed money ..........................................         (579)        5,105
  Increase in advances from borrowers for insurance and taxes ........................          566           659
                                                                                           --------      --------

        Net cash provided by financing activities ....................................       11,698         6,995
                                                                                           --------      --------

Net increase (decrease) in cash and cash equivalents .................................        6,087        (3,642)

Cash and cash equivalents at beginning of period .....................................       26,709         7,197
                                                                                           --------      --------

Cash and cash equivalents at end of period ...........................................     $ 32,796      $  3,555
                                                                                           ========      ========
</TABLE>


                                       5
<PAGE>

                   GASTON FEDERAL BANCORP, INC. AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note A - Basis of Presentation

      In management's opinion, the financial information, which is unaudited,
reflects all adjustments (consisting solely of normal recurring adjustments)
necessary for a fair presentation of the financial information as of and for the
three and nine month periods ended September 30, 2001 and 2000, in conformity
with generally accepted accounting principles. The financial statements include
the accounts of Gaston Federal Bancorp, Inc. (the "Company") and its
wholly-owned subsidiary, Gaston Federal Bank (the "Bank"). Operating results for
the three and nine month periods ended September 30, 2001, are not necessarily
indicative of the results that may be expected for future periods.

      The organization and business of the Company, accounting policies
followed, and other information are contained in the notes to the consolidated
financial statements of the Company as of and for the years ended September 30,
2000 and 1999, filed as part of the Company's annual report on Form 10-KSB.
These consolidated financial statements should be read in conjunction with the
annual consolidated financial statements.

      During the quarter ended December 31, 2000, the Company's Board of
Directors adopted a resolution to change the Company's fiscal year end from
September 30th to December 31st, effective October 1, 2000. The Company filed a
Form 8-K providing public notice of the change in the Company's fiscal year. All
prior period financial information is presented for comparable periods of the
preceding calendar year.

Note B - Earnings per Share

      Earnings per share has been determined under the provisions of the
Statement of Financial Accounting Standards No. 128, Earnings Per Share. For the
quarters ended September 30, 2001 and 2000, basic earnings per share has been
computed based upon the weighted average common shares outstanding of 4,068,575
and 4,058,156, respectively. For the nine months ended September 30, 2001 and
2000, basic earnings per share has been computed based upon the weighted average
common shares outstanding of 4,080,122 and 4,096,542, respectively.

      The only potential stock of the Company as defined in the Statement of
Financial Accounting Standards No. 128, Earnings Per Share, is stock options
granted to various directors and officers of the Bank. The following is a
summary of the diluted earnings per share calculation for the three and nine
months ended September 30, 2001, and 2000: (in thousands, except share data)

<TABLE>
<CAPTION>
                                               Three Months Ended             Nine Months Ended
                                                  September 30,                 September 30,
                                                  -------------                 -------------
                                               2001           2000           2001           2000
                                               ----           ----           ----           ----
<S>                                         <C>            <C>            <C>            <C>
Net income ............................     $      461     $      608     $    1,483     $    1,685

Weighted average outstanding shares ...      4,068,575      4,058,156      4,080,122      4,096,542
Dilutive effect of stock options ......         31,737              0         11,601          1,106
                                            ----------     ----------     ----------     ----------

Weighted average diluted shares .......      4,100,312      4,058,156      4,091,723      4,097,648

Diluted  earnings per share ...........     $     0.11     $     0.15     $     0.36     $     0.41
</TABLE>


                                       6
<PAGE>

Options were excluded from the calculation of diluted earnings per share for the
three month period ended September 30, 2000, because the exercise prices of
$12.00 for 192,569 shares and $13.00 for 10,000 shares exceeded the average
market price of $10.53 for the quarter.

Note C - Stock Compensation Plans

      On April 12, 1999, the Company's shareholders approved the Gaston Federal
Bank 1999 Stock Option Plan that provided for the issuance of 211,335 options
for directors and officers to purchase the Company's common stock. As of
September 30, 2001, 191,748 options had been awarded under the plan at a
weighted average exercise price of $12.05 and a weighted average contractual
life of 91 months. There were 134,449 options fully vested as of September 30,
2001. The Company applies the provisions of Accounting Principles Board Opinion
No. 25 in accounting for the Stock Option Plan described above and, accordingly,
no compensation expense has been recognized in connection with the granting of
the stock options.

Note D - Impact of Recently Adopted Accounting Standards

      SFAS No. 133, Accounting for Derivative Instruments and Hedging
Activities, issued in June 1998, as amended by SFAS No. 137 and SFAS No. 138,
establishes accounting and reporting requirements for derivative instruments,
including derivative instruments embedded in other contracts. The Company
adopted the provisions of this statement effective October 1, 2000. In
connection with the adoption of the provisions of SFAS No. 133, the Company
transferred all securities previously designated as held-to-maturity at
September 30, 2000, into the available-for-sale category. The transfer was
accounted for at the fair values of the securities at September 30, 2000. The
effect of the transfer was to decrease carrying values of these securities by
approximately $603,000 and increase deferred tax assets by approximately
$236,000.


                                       7
<PAGE>

ITEM 2. Management's Discussion and Analysis of Financial Condition and Results
        of Operations

      From time to time, the Company may publish forward-looking statements
relating to such matters as anticipated financial performance, business
prospects, technological developments, new products, and similar matters. The
Private Securities Litigation Reform Act of 1995 provides a safe harbor for
forward-looking statements provided that the Company notes that a variety of
factors could cause the Company's actual results to differ materially from the
anticipated results expressed in the Company's forward-looking statements. The
risks and uncertainties that may affect the operations, performance, and results
of the Company's business include, but are not limited to, changes in economic
conditions, changes in interest rates, and changes in laws and regulations.
Accordingly, past results and trends should not be used by investors to
anticipate future results or trends. Statements included in this report should
be read in conjunction with the Company's Annual Report on Form 10-KSB and are
incorporated into this discussion by this reference.

Comparison of Financial Condition

      Assets. Total assets of the Company increased by $13.8 million, or 5.2%,
from $252.8 million as of December 31, 2000, to $266.6 million as of September
30, 2001. During the nine month period ended September 30, 2001, net mortgage
loans decreased by $11.4 million, or 10.1%, to $101.5 million, while net
nonmortgage loans increased by $18.3 million, or 39.9%, to $64.2 million. This
shift in the loan portfolio composition reflects management's efforts to make
the Company's balance sheet more reflective of a community bank. Management
plans to continue to grow the loan portfolio in a safe and sound manner with an
emphasis on the origination and retention of short-term, high-yielding
nonmortgage loans and the origination and sale of mortgage loans. Nonperforming
assets remained low at 0.16% of total assets, and loan loss reserves amounted to
0.93% of total loans. Also during the period, cash and cash equivalents
increased $6.1 million to $32.8 million, investment securities decreased by $4.5
million to $28.3 million, and mortgage-backed securities increased by $2.1
million to $25.0 million. The increases in cash and cash equivalents and
mortgage-backed securities were primarily funded by increases in deposits and
maturities and calls of investment securities.

      Liabilities. Total liabilities increased by $12.0 million, or 5.3%, from
$213.0 million as of December 31, 2000, to $225.0 million as of September 30,
2001. The primary reason for the change was a $12.2 million, or 6.8%, increase
in total deposits from $167.9 million to $180.1 million. Deposits increased due
to competitive interest rates, aggressive marketing, and employee incentives.
All deposit growth came from the Bank's primary market area. Management plans to
continue in its efforts to gain deposit market share through new product
development and branch expansion with an emphasis on demand deposits. Borrowed
money decreased by $579,000, or 1.4%, to $42.2 million. Borrowed money is
primarily comprised of various callable and fixed-term Federal Home Loan Bank
advances with a weighted average interest rate of 5.74%.

      Equity. Total equity increased by $1.9 million, or 4.5%, from $39.8
million as of December 31, 2000, to $41.6 million as of September 30, 2001. This
increase was primarily due to the $1.4 million in earnings during the period and
a $810,000 increase in unrealized gains on available-for-sale securities. Also
during the period, the Company paid $398,000 in cash dividends and repurchased
9,500 shares of common stock at a cost of $115,000, or $12.16 per share. The
Company has been authorized to repurchase a total of 581,797 shares of common
stock, or 136,335 additional shares, as of September 30, 2001. Management will
continue to repurchase common stock of the Company at prices that are considered
to be attractive.


                                       8
<PAGE>

Comparison of Results of Operations for the Three Months Ended September 30,
2001 and 2000

      General. Net income for the Company for the three months ended September
30, 2001, amounted to $461,000, or $0.11 per share, as compared to $608,000, or
$0.15 per share, for the three months ended September 30, 2000. Net income for
the quarter ended September 30, 2000, included a $31,000 nonrecurring net gain
on sale of assets, resulting in net operating income of $588,000, or $0.15 for
the quarter.

      Net interest income. Net interest income decreased by $149,000, or 8.3%,
to $1.6 million for the three months ended September 30, 2001. Interest income
decreased by $186,000 due, in part, to an 85 basis point decrease in the average
yield on interest earning assets to 6.58%. This decrease in yield was offset, in
part, by a $15.7 million increase in average interest earning assets to $246.7
million. The Bank continues to maintain a large balance of low-yielding
short-term bank deposits to be used for funding a portion of the acquisition of
all of the common stock of Innes Street Financial Corp. This transaction, which
is subject to shareholder and regulatory approval, is expected to cost $37.4
million and should be completed by the fourth quarter of 2001. These bank
balances averaged $25.3 million during the quarter at an average yield of 3.43%.
These excess short-term bank balances would normally be used to purchase
higher-yielding investments or fund loan originations. Interest expense
decreased by $37,000, primarily due to 34 basis point decrease in the average
cost of funds to 4.54%. This decrease in cost of funds was offset, in part, by a
$10.6 million increase in average costing liabilities to $212.8 million.

      Provision for loan losses. The provision for loan losses amounted to
$30,000 for the three months ended September 30, 2001, as compared to $7,500 for
the three months ended September 30, 2000. This represents an increase of
$22,500. The amount of the provision for loan losses was increased, in part, due
to the increased emphasis on the origination and retention of higher-yielding
commercial and consumer loans. These loans possess a higher level of risk than
owner-occupied mortgage loans and require a higher level of reserves. The ratio
of loan loss reserves to gross loans was 0.93% as of September 30, 2001, and
0.86% as of September 30, 2000.

      Noninterest income. Noninterest income, net of nonrecurring gains on sales
of assets, amounted to $739,000 for the three months ended September 30, 2001,
as compared to $562,000 for the three months ended September 30, 2000. This
increase of $177,000, or 31.5%, was primarily due to increased fees generated by
the Bank's mortgage-banking department and additional fee income derived from
deposit products. Management plans to continue in its efforts to increase its
outstanding balance of fee-generating demand deposit accounts through targeted
advertising and branch expansion. Total demand deposit accounts increased by
26.0% during the past 12 months to $24.3 million as of September 30, 2001.
During the quarter ended September 30, 2000, the Company recognized a
nonrecurring gain of $33,000 from the sale of originated mortgage loan servicing
rights for 221 loans totaling $17.4 million

      Noninterest expense. Noninterest expense increased by $193,000, or 13.1%,
to $1.7 million as of September 30, 2001. This increase was primarily due to
higher occupancy and equipment associated with the opening of the Bank's sixth
full-service office in February 2001, and increased expenses associated with
servicing the Bank's growing demand deposit account portfolio. This increase was
offset, in part, by lower compensation expense, professional services expense,
and advertising expense.

      Income taxes. Income taxes amounted to $230,000, or 33.3% of taxable
income, for the quarter ended September 30, 2001, as compared to $304,000, or
33.4% of taxable income, for the quarter ended September 30, 2000.


                                       9
<PAGE>

Comparison of Results of Operations for the Nine Months Ended September 30, 2001
and 2000

      General. Net income for the Company for the nine months ended September
30, 2001, amounted to $1,483,000, or $0.36 per share, as compared to $1,685,000,
or $0.41 per share, for the nine months ended September 30, 2000. Net income for
the nine months ended September 30, 2000, included a $257,000 nonrecurring net
gain on sale of assets, resulting in net operating income of $1,528,000, or
$0.37 per share, for the period.

      Net interest income. Net interest income decreased by $451,000, or 8.4%,
to $4.9 million for the nine months ended September 30, 2001. Interest income
increased by $213,000, primarily due to a $14.3 million increase in average
interest earning assets to $244.5 million. This increase was offset, in part, by
a 36 basis point decrease in the average yield on interest earning assets to
6.92%. The Bank continues to maintain a large balance of low-yielding short-term
bank deposits to be used for funding a portion of the acquisition of all of the
common stock of Innes Street Financial Corp. This transaction, which is subject
to shareholder and regulatory approval, is expected to cost $37.4 million and
should be completed by the fourth quarter of 2001. These excess short-term bank
balances would normally be used to purchase higher-yielding investments or fund
loan originations. Interest expense increased by $664,000, primarily due to a
$11.6 million increase in average costing liabilities to $212.3. This increase
in costing liabilities was offset, in part, by a 16 basis point decrease in the
average cost of funds to 4.88% during the nine month period ended September 30,
2001.

      Provision for loan losses. The provision for loan losses amounted to
$90,000 for the nine months ended September 30, 2001, as compared to $22,500 for
the nine months ended September 30, 2000. This represents an increase of
$67,500. The amount of the provision for loan losses was increased, in part, due
to the increased emphasis on the origination and retention of higher-yielding
commercial and consumer loans. These loans possess a higher level of risk than
owner-occupied mortgage loans and require a higher level of reserves. The ratio
of loan loss reserves to gross loans was 0.93% as of September 30, 2001, and
0.86% as of September 30, 2000.

      Noninterest income. Noninterest income, net of nonrecurring gains on sales
of assets, amounted to $2.2 million for the nine months ended September 30,
2001, as compared to $1.5 million for the nine months ended September 30, 2000.
This increase of $663,000, or 44.5%, was primarily due to increased fees
generated by the Bank's mortgage-banking department and additional fee income
derived from deposit products. Management plans to continue in its efforts to
increase its outstanding balance of fee-generating demand deposit accounts
through targeted advertising and branch expansion. Outstanding demand deposit
accounts increased by 23.9% during the past 12 months to $25.2 million as of
September 30, 2001. During the nine months ended September 30, 2000, the Company
recognized a nonrecurring gain of $227,000 from the sale of $2.7 million in
investment and mortgage-backed securities and a $33,000 gain on the sale of the
sale of originated mortgage loan servicing rights for 221 loans totaling $17.4
million.

      Noninterest expense. Noninterest expense increased by $239,000, or 5.2%,
to $4.8 million as of September 30, 2001. This increase was primarily due to
higher occupancy and equipment associated with the opening of the Bank's sixth
full-service office in February 2001, and increased expenses associated with
servicing the Bank's growing demand deposit account portfolio. This increase was
offset, in part, by lower compensation expense, data processing expense,
professional services expense, and advertising expense.

      Income taxes. Income taxes amounted to $689,000, or 31.7% of taxable
income, for the nine month period ended September 30, 2001, as compared to
$840,000, or 33.3% of taxable income, for the nine month period ended September
30, 2000. The decrease in the effective tax rate was primarily due to the
increased income received from tax-advantaged assets such as Federal Home Loan
Bank deposits and Bank-Owned Life Insurance ("BOLI").


                                       10
<PAGE>

Liquidity and Capital Resources

      The objective of the Bank's liquidity management is to ensure the
availability of sufficient cash flows to meet all financial commitments and to
capitalize on opportunities for expansion. Liquidity management addresses the
Bank's ability to meet deposit withdrawals on demand or at contractual maturity,
to repay borrowings as they mature, and to fund new loans and investments as
opportunities arise.

      The Bank's primary sources of internally generated funds are principal and
interest payments on loans receivable and cash flows generated from operations.
External sources of funds include increases in deposits and advances from the
Federal Home Loan Bank of Atlanta.

      The Bank is subject to various regulatory capital requirements
administered by the banking regulatory agencies. Failure to meet minimum capital
requirements can initiate certain mandatory and possibly discretionary actions
by the regulators that, if undertaken, could have a direct material effect on
the Bank's financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Bank must meet specific
capital guidelines that involve quantitative measures of the Bank's assets,
liabilities, and certain off-balance sheet items as calculated under regulatory
accounting practices. The Bank's capital amounts and classifications are subject
to qualitative judgments by the regulators about components, risk-weightings,
and other factors. As of September 30, 2001, Gaston Federal Bank's level of
capital substantially exceeded all applicable regulatory requirements.


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<PAGE>

PART II. OTHER INFORMATION

Legal Proceedings

      There are various claims and lawsuits in which the Bank is periodically
involved incidental to the Bank's business. In the opinion of management, no
material loss is expected from any of such pending claims or lawsuits.

Changes in Securities

      Not applicable.

Defaults Upon Senior Securities

      Not applicable.

Submission of Matters to a Vote of Security Holders

      There were no meetings of the Company's shareholders during the quarter
ended September 30, 2001.

Exhibits and Report on Form 8-K.

      On July 25, 2001, Gaston Federal Bancorp, Inc. ("the Company") filed a
Form 8-K to provide public notice that on July 16, 2001, the Company entered
into an Agreement and Plan of Merger with Innes Street Financial Corporation
("Innes Street"). Innes Street is the holding company for Citizens Bank, Inc., a
savings bank headquartered in Salisbury, North Carolina, which operates three
full-service offices in Salisbury, Statesville, and Rockwell, North Carolina. As
of September 30, 2001, Citizens Bank had total assets of $218.3 million, total
loans of $190.9 million, total deposits of $175.1 million, and stockholders'
equity of $25.5 million. Under the terms of the agreement, the Company will pay
$18.50 per share in cash for each of the 1,974,325 outstanding shares of Innes
Street's common stock. This represents 138% of Innes Street's tangible book
value per share as of March 31, 2001, and 28.5 times Innes Street's earnings per
share for the 12 months ended March 31, 2001. Innes Street will be merged into a
subsidiary of the Company and all shares of Innes Street will be cancelled. The
aggregate purchase price is approximately $37.4 million. Upon completion of the
transaction, the Company will have approximately $485 million in assets and will
have a total of nine offices in the southern piedmont region of North Carolina.
Management estimates that the cost savings opportunities between the two
companies equals 38% of Innes Street's annualized operating income, or $1.7
million pretax. As a result of the anticipated cost savings, management believes
that the transaction will be immediately accretive to earnings. Consummation of
the merger is subject to approval by Innes Street's shareholders and the receipt
of all required regulatory approvals. It is anticipated that the transaction
will be completed in the fourth quarter of 2001.


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<PAGE>

SIGNATURES

      Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed by the undersigned thereunto
duly authorized.

                                       GASTON FEDERAL BANCORP, INC.


Date: November 13, 2001                By: /s/ Kim S. Price
                                           -------------------------------------
                                           Kim S. Price
                                           President and Chief Executive Officer


Date: November 13, 2001                By: /s/ Gary F. Hoskins
                                           -------------------------------------
                                           Gary F. Hoskins
                                           Senior Vice President, Chief
                                           Financial Officer and Treasurer


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