<PAGE>
 
                       SECURITIES AND EXCHANGE COMMISSION
                            Washington, D.C.  20549
                                   FORM 10-K

                       FOR ANNUAL AND TRANSITION REPORTS
                    PURSUANT TO SECTIONS 13 OR 15(d) OF THE
                        SECURITIES EXCHANGE ACT OF 1934
(Mark One)
                                      
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
    OF 1934

For the fiscal year ended December 31, 1998
   
                                       OR


[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
    ACT OF 1934

For the transition period from ______________ to _______________

                          Commission File No. 1-11819

                            HAYWOOD BANCSHARES, INC.
                        -------------------------------------
             (Exact name of registrant as specified in its charter)

        North Carolina                                        56-1918006
-------------------------------                               ---------- 
(State or other jurisdiction of                            (I.R.S. Employer
incorporation or organization)                               Identification
No.)

370 North Main Street, Waynesville, North Carolina                28786
--------------------------------------------------      -----------------------
          (Address of principal office)                         (Zip Code)

      Registrant's telephone number, including area code:  (828) 456-9092
                                                           --------------

             Securities registered under Section 12(b) of the Act:

        Title of Class                Name of Exchange on Which Registered
        --------------                ------------------------------------
    Common Stock, par value                 American Stock Exchange
        $1.00 per share                                 


           Securities registered under Section 12(g) of the Act: None
                                                                 ----

Indicate by check mark whether the registrant (1) has filed all reports required
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or 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 
                    -----        -----

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.  [X]

Based on the closing sale price of $14.375 on March 24, 1999 on the American
Stock Exchange, the aggregate market value of the voting stock held by
nonaffiliates of the registrant, at March 24, 1999, was $12,342,806 (858,630
shares at $14.375 per share).  Solely for purposes of this computation, it is
assumed that directors, officers and 5% stockholders are affiliates.

As of March 24, 1999, there were issued and outstanding 1,250,356 shares of the
Registrant's common stock.


                      DOCUMENTS INCORPORATED BY REFERENCE

              1.  Portions of Proxy Statement for the 1999 Annual Meeting of
Stockholders.  (Part III)

<PAGE>
 
                                     PART I
Item 1.  Business
-----------------

General

          The Company.  Haywood Bancshares, Inc. (the "Company") is a registered
bank holding company incorporated in North Carolina in 1995.  The Company was
formed for the purpose of serving as the holding company for Haywood Savings
Bank, Inc., SSB ("Haywood Savings" or the "Bank"), a North Carolina chartered
savings bank.  On June 30, 1995, the holding company reorganization was
consummated when the Company acquired all of the outstanding stock of Haywood
Savings and the stockholders of Haywood Savings became stockholders of the
Company.  The Company's primary activities consist of holding the stock of
Haywood Savings and operating the business of the Bank.  Accordingly, the
information set forth in this report, including financial statements and related
data, relates primarily to Haywood Savings.

          The principal executive offices of the Company are located at 370
North Main Street, Waynesville, North Carolina 28786 and its main telephone
number is (828) 456-9092.

          Haywood Savings.  The Bank began operations as a North Carolina
chartered savings and loan association in 1919 and converted from mutual to
stock form on December 18, 1987.  The Bank is a member of the Federal Home Loan
Bank ("FHLB") System and its deposits have been federally insured since 1948.

          Effective November 30, 1992, Haywood Savings converted from a North
Carolina savings and loan association to a North Carolina savings bank.  The
conversion to a savings bank was undertaken primarily to reduce the regulatory
and compliance burden imposed previously on the Bank by the overlapping and
duplicative federal regulatory system governing state-chartered savings
associations.  As a result of the conversion, the Bank is now only subject to
examination and supervision by one federal regulator rather than two.  As a
savings bank, the Bank's deposit accounts continue to be insured up to
applicable limits by the Savings Association Insurance Fund ("SAIF") of the
Federal Deposit Insurance Corporation ("FDIC").

          Haywood Savings is primarily engaged in the business of accepting
deposits from the general public and investing such funds primarily in loans
secured by residential real estate and, to a lesser extent, in investment
securities.  The Bank also makes second mortgage, home improvement and
commercial real estate loans, and home equity lines of credit.

          In 1982, the Bank acquired Cherokee Savings and Loan Association in a
transaction accounted for as a purchase.  At the time of the acquisition,
Cherokee Savings and Loan Association had approximately $6 million in assets and
one office in Murphy, North Carolina.  As a result of the acquisition, Haywood
Savings had $675,000 in goodwill on its balance sheet as of December 31, 1998,
which is being amortized over a remaining period of approximately 13 years at a
rate of $52,500 per year.

          Haywood Savings conducts its business through  its home office in
Waynesville, North Carolina, and through three branch offices located in Sylva,
Andrews and Murphy, North Carolina.  The Bank's principal executive offices are
located at 370 North Main Street, Waynesville, North Carolina 28786; telephone
number (828) 456-9092.

Primary Market Area

          Haywood Savings' primary market area consists of Haywood, Cherokee and
Jackson Counties and adjacent counties in western North Carolina near the Great
Smoky Mountains, where its offices are located.  Management estimates that
approximately 80% of the Bank's savings deposits are derived from residents of
Haywood, Cherokee and Jackson Counties and approximately 95% of its loans are
secured by properties in this area.

                                       2
<PAGE>
 
Lending Activities

     General.  Haywood Savings' principal lending activities have historically
consisted of the origination of conventional first mortgage loans (i.e., loans
that have neither been insured nor partially guaranteed by a government agency)
for the construction or purchase of single-family properties.  The Bank has also
originated loans secured by commercial real estate.  The Bank also makes mobile
home loans if the mobile home meets strict construction standards and is affixed
to real property which can be included in a mortgage so that the Bank has both a
real estate mortgage and a lien on the title to the mobile home.  Although the
Bank is authorized to make or purchase loans on a nationwide basis, the Bank's
lending has generally been confined to loans secured by properties within its
primary market areas in western North Carolina with most loans secured by
properties in Haywood, Cherokee and Jackson Counties.

     At December 31, 1998, the Bank's net loan portfolio totaled $110.8 million
representing 73% of its total assets.  On that date, 83.39% of gross outstanding
loans consisted of loans secured by first mortgages on residential real estate.
The balance of the Bank's loan portfolio consisted of commercial real estate
loans, construction loans, home improvement loans, home equity lines of credit
and loans secured by deposit accounts.

     Loan Portfolio Analysis.  Set forth below is selected data relating to the
composition of the Bank's loan portfolio by type of loan and type of security on
the dates indicated.  Other than as disclosed below, there were no
concentrations of loans which exceeded 10% of total loans at December 31, 1998.
<TABLE>
<CAPTION>
 
 
                                                                         At December 31,
                                       --------------------------------------------------------------------------------
                                                    1998                       1997                       1996
                                       ---------------------------  ---------------------------  ----------------------
                                             $              %              $             %              $           %
                                       -------------  ------------  -------------  ------------  -------------  -------
<S>                                    <C>            <C>           <C>            <C>           <C>            <C>
Type of Loan:
Conventional real estate loans
 Interim construction loans..........  $  6,716,000          5.81%  $  6,953,200          5.87%  $  6,729,300     5.92%
 Loans on existing property(1).......   105,142,885         90.89    107,835,389         91.02    103,312,198    90.87
 Participation loans purchased.......       407,060          0.35        478,240          0.40        417,329     0.37
Loans secured by deposit accounts....       750,954          0.65        580,639          0.49        701,428     0.61
Home improvement loans...............       189,016          0.16        164,827          0.14        145,651     0.13
Home equity lines of credit..........     2,478,517          2.14      2,467,831          2.08      2,388,470     2.10
                                       ------------   -----------   ------------   -----------   ------------   ------
                                        115,684,432        100.00%   118,480,126        100.00%   113,694,376   100.00%
                                                      ===========                  ===========                  ======
Less:
 Loans in process....................    (3,530,853)                  (3,049,214)                  (3,142,363)
 Allowance for loan losses...........      (758,547)                    (738,547)                    (718,547)
 Allowance for uncollected interest..       (53,081)                     (34,537)                     (37,375)
 Deferred loan fees..................      (548,960)                    (507,472)                    (451,685)
                                       ------------                 ------------                 ------------
  Total..............................  $110,792,991                 $114,150,356                 $109,344,406
                                       ============                 ============                 ============
 
Type of Security:
Residential real estate..............  $ 96,475,140         83.39%  $ 99,597,227         84.06%  $ 97,343,634    85.62%
Commercial real estate...............    15,790,805         13.65     15,669,602         13.23     13,115,193    11.54
Deposit accounts.....................       750,954           .65        580,639          0.49        701,428     0.61
Other................................     2,667,533          2.31      2,632,658          2.22      2,534,121     2.23
                                       ------------   -----------   ------------   -----------   ------------   ------
  Total..............................   115,684,432        100.00%   118,480,126        100.00%   113,694,376   100.00%
                                                      ===========                  ===========                  ======
 
Less:
 Loans in process....................    (3,530,853)                  (3,049,214)                  (3,142,363)
 Allowance for loan losses...........      (758,547)                    (738,547)                    (718,547)
 Allowance for uncollected interest..       (53,081)                     (34,537)                     (37,375)
 Deferred loan fees..................      (548,960)                    (507,472)                    (451,685)
                                       ------------                 ------------                 ------------
  Total..............................  $110,792,991                 $114,150,356                 $109,344,406
                                       ============                 ============                 ============
</TABLE> 
-------------------------

(1)  Includes construction loans converted to permanent loans.

                                       3
<PAGE>
 
     Loan Maturity Schedule and Rate Sensitivity.  The following table sets
forth certain information at December 31, 1998 regarding the dollar amount of
loans maturing in the Bank's portfolio based on their contractual terms to
maturity.  Demand loans having no stated schedule of repayments and no stated
maturity and overdrafts are reported as due in one year or less.
<TABLE>
<CAPTION>
 
                                 Due      Due Within       Due
                               Within       One to        After
                              One Year    Five Years   Five Years      Total
                             -----------  -----------  -----------  ------------
<S>                          <C>          <C>          <C>          <C>
 
Real estate loans..........  $62,854,000  $ 9,279,000  $26,294,000  $ 92,427,000
Construction loans (1).....    3,185,000           --           --     3,185,000
Commercial loans...........      266,000    2,311,000   13,214,000    15,791,000
Loans secured by deposits..      751,000           --           --       751,000
                             -----------  -----------  -----------  ------------
                             $67,056,000  $11,590,000  $33,508,000  $112,154,000
                             ===========  ===========  ===========  ============
-------------------------
</TABLE>
(1)  Amount shown net of loans in process.


     The next table sets forth the dollar amount of all loans due after one year
from December 31, 1998 which have predetermined interest rates and the amount of
such loans which have floating or adjustable interest rates.
<TABLE>
<CAPTION>
 
                                                     Amount
                                                   -----------
<S>                                                <C>
                              
Predetermined rates.............................   $15,874,000
Adjustable or floating rates....................    29,224,000
                                                   -----------
 Total..........................................   $45,098,000
                                                   ===========
 
</TABLE>

     Residential Lending.  The Bank offers adjustable-rate mortgage loans
("ARMs") on residential properties which generally provide for interest rate
adjustments on an annual basis.  The interest rates on these loans are generally
tied to the National Average Contract Interest Rate for Major Lenders on
Previously Occupied Homes ("National Average Index"), an index prepared by the
Federal Housing Finance Board ("FHFB") with specified minimum and maximum
interest rate adjustments.  The Bank has not used discounted introductory rates
on its ARMs and the Bank's ARMs do not provide for negative amortization.  At
December 31, 1998, approximately $56.1 million, or 58%, of Haywood Savings'
mortgage loans consisted of ARMs.  Most ARMs are subject to a maximum annual
change in rates of two percentage points each year and a maximum interest rate
from 12-15%.  Fixed-rate loans are offered for a maximum term of 20 years.
These loans are originated on Federal National Mortgage Association
("FNMA")/Federal Home Loan Mortgage Corporation ("FHLMC") documentation in order
to facilitate their resale in the secondary market.  The Bank has also
participated in loan swaps with FHLMC, swapping fixed-rate loans for FHLMC
Participation Certificates which are marketable and have a lower risk-weight
under the FDIC's risk-based capital regulations.  See "Regulation -- Capital
Requirements."

     Haywood Savings' conventional first mortgage loans customarily include due-
on-sale clauses giving Haywood Savings the right to declare a loan immediately
due and payable in the event, among other things, that the borrower sells or
otherwise disposes of the property subject to the mortgage and the loan is not
repaid.  Haywood Savings has actively enforced due-on-sale clauses in its
mortgage contracts for the purpose of increasing its loan portfolio yield, often
through the authorization of assumptions of existing loans at market rates of
interest.

                                       4
<PAGE>
 
     Residential loans made by the Bank on single-family properties have been
predominantly originated in amounts up to 80% of appraised value, although loans
may be made up to 95% of appraised value for owner-occupied residences.  The
Bank requires private mortgage insurance on all conventional loans with loan-to-
value ratios in excess of 80%.  The initial contractual loan payment period for
residential mortgage loans does not exceed 20 years on fixed rate loans and 30
years on adjustable rate loans.  Borrowers may refinance or prepay loans at
their option without penalty. The federal banking agencies, including the FDIC,
have adopted regulations that establish loan-to-value ratio requirements for
specific categories of real estate loans.

     Construction Lending.  The Bank also originates loans for the construction
of single-family homes and commercial properties.  These loans are originated as
construction loans with a term of six months with provision for conversion of
the construction loan into a permanent loan upon completion of construction.
Essentially all of the Bank's construction loans convert into permanent loans.
Permanent loans are made at fixed or adjustable rates, which adjust annually,
and have terms not to exceed 20 years on fixed rate loans and 30 years on
adjustable rate loans.  At December 31, 1998, the Bank had $3.2 million of
construction loans outstanding (net of loans in process balances).

     Construction loans are generally at a rate adjusting annually.  These
loans, which are made to qualified builders, are generally limited to 80% of the
appraised value of the property upon completion.  Construction loan funds are
periodically disbursed but only for phases of construction completed.  The Bank
does not require construction borrowers to obtain takeout commitments for
permanent financing.  As a general matter, the Bank will not make a residential
construction loan with a principal amount in excess of $250,000.

     Construction financing is generally considered to involve a higher degree
of risk of loss than long-term financing on improved occupied real estate.  The
Bank's risk of loss on a construction loan is dependent largely upon the
accuracy of the initial estimate of the property's value at completion of
construction or development and the estimated cost (including interest) of
construction.  If the estimate of construction cost proves to be inaccurate, the
Bank may be required to advance funds beyond the amount originally committed to
permit completion of the development.  If the estimate of value proves to be
inaccurate, the Bank may be confronted, at or prior to the maturity of the loan,
with a project with a value which is insufficient to assure full repayment.

     The Bank's underwriting criteria are designed to evaluate and minimize the
risks of each construction loan.  Among other things, the Bank considers the
reputation of the borrower and the contractor, the amount of the borrower's
equity in the project, independent valuations and reviews of cost estimates,
pre-construction sale and leasing information, and cash flow projections of the
borrower.  To reduce the risks inherent in construction lending, the Bank also
requires, where appropriate, personal guarantees of the principals of the
borrower.

     Commercial Real Estate Lending.  At December 31, 1998, the Bank's
commercial real estate portfolio totaled $15.8 million, or 13.65%, of the Bank's
gross loan portfolio.  At December 31, 1998, the Bank's largest commercial real
estate loan consisted of a $1.9 million loan secured by the Waynesville Plaza
Shopping Center in Waynesville, North Carolina.  The Bank does not anticipate a
significant increase in commercial real estate loan originations in the near
future.   The Bank generally requires all commercial real estate loans to have a
loan-to-value ratio no greater than 80%.  Commercial real estate loans are
generally made with provision for annual rate adjustments and for terms not to
exceed 20 years.

     Commercial real estate lending entails significant additional risks,
compared to residential property lending.  Commercial real estate loans
typically involve large loan balances to single borrowers or groups of related
borrowers.  The payment experience of such loans is typically dependent upon the
successful operation of the real estate project.  These risks can be
significantly affected by supply and demand conditions in the market for office,
retail or industrial space and as such may be subject, to a greater extent, to
adverse conditions in the economy.  In dealing with these risks, the Bank
reviews the financial condition of the borrower, limits the size of such loans
and generally lends on the security of property located within its primary
market area.

                                       5
<PAGE>
 
     Under North Carolina law, with certain limited exceptions, loans and
extensions of credit by a savings bank to a person outstanding at one time
generally shall not exceed the greater of (i) 15% of net worth and (ii)
$500,000.  At December 31, 1998, the largest amount lent by the Bank to one
borrower was $1.75 million, which was approximately 8.12% of the Bank's
stockholders' equity at that date.

     Consumer Lending.  The Bank's consumer loan portfolio consists of home
equity lines of credit which the Bank began making in 1991, home improvement
loans and loans secured by deposit accounts.  The Bank does not make consumer
installment loans.  At December 31, 1998, consumer loans totaled $3.4 million or
approximately 2.95% of the gross loan portfolio and included $750,954 in loans
secured by deposit accounts in the Bank.

     Home equity loans are extended in the form of lines of credit with interest
on outstanding balances indexed to the prime rate.  The maximum loan term is 15
years and all outstanding indebtedness against the security property may not
exceed 80% of appraised value.  Home equity loans are initially being marketed
to existing mortgage customers. As of December 31, 1998, $2.5 million in home
equity loans were outstanding, which was approximately 2.14% of the loan
portfolio.

     Loan Solicitation and Processing.  The Bank actively solicits mortgage loan
applications from existing customers, local real estate agents, builders, real
estate developers, and various other persons.  Upon receipt of a loan
application from a prospective borrower, a credit report is ordered to verify
specific information relating to the loan applicant's employment, income and
credit standing.  This information may be further verified by personal contacts
with other reference sources.  An appraisal of the real estate intended to
secure the proposed loan is undertaken by a staff appraiser who is accompanied
by a member of the Board of Directors.  As soon as the required information has
been obtained and the appraisal completed, the loan is submitted to a loan
committee, composed of Directors Ammons, Burgin and Stovall and seven
alternates, which has the authority to approve loans up to $150,000, with all
loans in excess of that amount being subject to approval by the full Board of
Directors.  All borrowers are required to obtain fire and casualty insurance in
an amount equal to the value of the structures located on the property.

     Loan commitments are typically made for periods of up to 60 days from the
date of approval of the application and a fee equal to 1% of loan principal is
charged if a letter of commitment is issued to be used to obtain funds for
construction from a source other than the Bank.

     Loan Originations, Purchases and Sales.  In general, Haywood Savings
originates residential loans solely for retention in its own loan portfolio.
However, occasionally the Bank originates loans on terms and conditions which
make them eligible for sale in the secondary market.  The Bank generally
continues to collect payments on and otherwise service any loans sold for which
it is allowed by the loan purchaser to retain a portion of the loan payment.  At
December 31, 1998, the Bank was servicing loans for others aggregating $132,000.

     A portion of the Bank's loan originations consists of construction loans.
For the years ended December 31, 1996, 1997 and 1998, the Bank originated
construction loans in the amount of $6.0 million, $9.1 million and $7.1 million,
respectively.  The majority of the construction loans are for the construction
of residential real estate and are made on an adjustable-rate basis.

                                       6
<PAGE>
 
<TABLE>
<CAPTION>
 
                                                     At December 31,
                                          --------------------------------------
                                             1998         1997          1996
                                          -----------  -----------  ------------
<S>                                       <C>          <C>          <C>
Loans originated:
  Conventional real estate loans:
    Construction loans..................  $ 7,051,000  $ 9,054,250  $ 5,986,844
    (Increase) decrease in undisbursed
      loans in process..................      481,640       93,150     (479,106)
    Loans on existing property..........    3,877,320    5,809,775    9,946,660
    Loans refinanced....................    6,751,625    7,540,200    5,668,300
  Other loans...........................   12,039,775    8,041,350    4,466,200
                                          -----------  -----------  -----------
      Total loans originated (net)......  $30,201,360  $30,538,725  $25,588,898
                                          ===========  ===========  ===========
 
</TABLE>

     Loan originations decreased by $337,000, or 1.10%, during 1998 as a result
of decreases in originations of construction loans, refinancings and loans on
existing property.  These decreases were offset by increased originations of
other loans.  Overall, the loan portfolio decreased by approximately 
$3.4 illion, or 2.94%.

     Loan Origination Fees and Other Fees.  In addition to interest earned on
loans and fees for making loan commitments, the Bank receives loan origination
fees for originating loans.  Loan fees are a percentage of the principal amount
of the mortgage loan which are charged to the borrower for creation of the loan.
In accordance with generally accepted accounting principles, loan origination
fees and certain origination expenses are deferred and amortized over the life
of the loan.

     The Bank also receives other fees and charges relating to existing loans,
which include late charges and fees collected in connection with a change in
borrower or other loan modifications.  These fees and charges, however, have not
constituted a material source of income to the Bank.

     Non-Performing Assets and Allowance for Loan Losses.  The Bank provides for
loan losses on the allowance method.  Additions to the allowance for loan losses
are provided by charges to operations based on inherent loss considerations
within the loan portfolio and various other factors which, in management's
judgment, warrant current recognition in estimating possible losses.  Such
factors considered include collateral values, growth and composition of the loan
portfolio, the relationship of the allowance for loan losses to outstanding
loans, delinquency trends, and economic conditions.  Management evaluates
available information periodically and the allowance is adjusted accordingly.
While management uses the best information available to make evaluations, future
adjustments to the allowance may be necessary if conditions differ from the
assumptions used in making the evaluations.  In addition, various regulatory
agencies, as an integral part of their examination process, periodically review
the Bank's allowance for loan losses.  Such agencies may require the Bank to
recognize additions to the allowance based on their judgments about information
available to them at the time of their examination.

     Loans are reviewed on a regular basis and an allowance for uncollected
interest is established when, in the opinion of management, the collection of
additional interest is doubtful.  An allowance for uncollected interest is
established for residential mortgage loans when either principal or interest is
90 days or more past due.  Consumer loans generally are charged off when the
loan becomes over 120 days delinquent.  An allowance for uncollected interest is
established with respect to commercial business and real estate loans when the
loan is 90 days or more past due.  Interest accrued and unpaid at the time a
loan is placed on non-accrual status is charged against interest income.
Subsequent payments are either applied to the outstanding principal balance or
recorded as interest income, depending on the assessment of the ultimate
collectibility of the loan.

                                       7
<PAGE>
 
     Real estate acquired by the Bank as a result of foreclosure or by deed in
lieu of foreclosure is classified as real estate owned until such time as it is
sold.  When such property is acquired, it is recorded at the lower of the unpaid
principal balance of the related loan or its fair market value (net of estimated
selling costs).  Any write-down of the property reduces the amount recorded as
real estate acquired.

     The following table sets forth information with respect to the Bank's non-
performing assets for the periods indicated.  During the periods presented, the
Bank had no loans accounted for as troubled debt restructurings.
<TABLE>
<CAPTION>
 
                                                    At December 31,
                                                --------------------   
                                                1998    1997    1996
                                                ----    ----    ----
<S>                                            <C>     <C>     <C>
                                                  (Dollars in thousands)
 
Non-accrual loans.......................       $ 841   $ 583   $  814
Accruing loans which are contractually        
 past due 90 days or more...............          --      --       --
                                               -----   -----   ------
                                              
Total non-accruing loans and accruing         
 loans past due 90 days or more.........       $ 841   $ 583   $  814
                                               =====   =====   ======
                                              
Percentage of total loans...............         .75%   0.51%    0.74%
                                               =====   =====   ======
                                              
Other non-performing assets (1).........       $   7   $ 246   $1,790
                                               =====   =====   ======
 
-------------------------
</TABLE>
(1)  Other non-performing assets represent property acquired through foreclosure
     or repossession.  See Note 4 of Notes to Consolidated Financial Statements
     for a description of the Company's accounting policies related to
     acquisition of such property.

     Non-accrual loans increased by $258,000, or 44%, in 1998.  Nonaccrual loans
are comprised of 23 loans, of which the majority are single family residential
loans.  Other non-performing assets  decreased during 1998 primarily due to the
sale of two outparcels to the Waynesville Plaza Shopping Center with a book
value of approximately $210,000.  The Corporation recognized a gain on the sale
of approximately $403,000.  The remaining other non-performing assets at
December 31, 1998 consists of $7,000 of single-family residences.

     The Bank had non-accrual loans of approximately $841,000 at December 31,
1998.  Had these loans performed in accordance with their contractual terms,
approximately $53,000 in additional interest income would been recorded during
1998.  Interest income of $25,000 was recognized in connection with non-accrual
loans during 1998.

     At December 31, 1998, there were no loans which were not classified as non-
accrual, past due 90 days or more or restructured, but where known information
about possible credit problems of borrowers caused management to have serious
doubts as to the ability of the borrowers to comply with present loan repayment
terms and may result in disclosure as non-accrual, 90 days past due or
restructured.

                                       8
<PAGE>
 
     The following table sets forth an analysis of the allowance for loan losses
for the periods indicated.
<TABLE>
<CAPTION>
 
                                                     At December 31,
                                             -------------------------------
                                               1998       1997       1996
                                             ---------  ---------  ---------
<S>                                          <C>        <C>        <C>
 
Balance at beginning of year...............  $738,547   $718,547   $703,547
 
Loans charged-off:
 Real estate:
  Residential..............................        --         --         --
  Non-residential..........................        --         --         --
  Construction.............................        --         --         --
 Consumer and other........................        --         --         --
                                             --------   --------   --------
Total charge-offs..........................        --         --         --
                                             --------   --------   --------
 
Recoveries:
 Real estate:
  Residential..............................        --         --         --
  Non-residential..........................        --         --         --
  Construction.............................        --         --         --
 Consumer and other........................        --         --         --
                                             --------   --------   --------
Total recoveries...........................        --         --         --
                                             --------   --------   --------
 
Net loans charged-off......................        --         --         --
                                             --------   --------   --------
Provision for possible loan losses.........    20,000     20,000     15,000
                                             --------   --------   --------
 
Balance at end of year.....................  $758,547   $738,547   $718,547
                                             ========   ========   ========
 
Ratio of net charge-offs to average loans
 outstanding during the fiscal year........       -- %       -- %       -- %
                                             ========   ========   ========
 
</TABLE>

     The following table breaks down the allowance for loan losses by loan
category for the periods indicated.  Management believes that the allowance can
be allocated by category only on an approximate basis.  The allocation of the
allowance to each category is not necessarily indicative of future losses and
does not restrict the use of the allowance to absorb losses in any category.
<TABLE>
<CAPTION>
 
                                                                        At December 31,
                                      ------------------------------------------------------------------------------------  
                                                   1998                      1997                        1996
                                      ---------------------------  ---------------------------  -------------------------- 
                                                     Percent of                   Percent of                   Percent of  
                                                     Loans in Each                Loans in Each                Loans in Each 
                                                     Category to                  Category to                  Category to  
                                         Amount      Total Loans       Amount     Total Loans      Amount      Total Loans  
                                      -------------  ------------  -------------  ------------  -------------  -----------
                                                                                                               
<S>                                   <C>            <C>           <C>            <C>           <C>            <C>
 
Real estate:
  Residential.......................       $227,564        78.05%       $385,522        78.19%       $375,082       79.70%
  Non-residential...................        227,564        13.65         184,637        13.23         179,637       11.54
  Construction......................        151,709         5.35         131,461         5.87         127,901        5.92
  Equity lines of credit............         75,855         2.14          36,927         2.08          35,927        2.10
Consumer installment and other......         75,855         0.81              --         0.63              --        0.74
                                           --------       ------        --------       ------        --------      ------
   Total allowance for loan losses..       $758,547       100.00%       $738,547       100.00%       $718,547      100.00%
                                           ========       ======        ========       ======        ========      ======
</TABLE>

                                       9
<PAGE>
 
     Management considers loans to be impaired when based on current information
and events, it is probable that a creditor will be unable to collect all amounts
due according to contractual terms of the loan agreement.  Factors that
influence management's judgments include, but are not limited to, loan payment
pattern, source of repayment, and value of collateral.  A loan would not be
considered impaired if an insignificant delay in loan payment occurs and
management expects to collect all amounts due.  The major sources for
identification of loans to be evaluated for impairment include past due and
nonaccrual reports, internally generated lists of loans of certain risk grades,
and regulatory reports of examination.  Impaired loans are measured using either
the discounted expected cash flow method or the value of collateral method.
When the ultimate collectibility of an impaired loan's principal is in doubt,
wholly or partially, all cash receipts are applied to principal.  Large groups
of smaller balance homogeneous 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.

     At December 31, 1998, the Bank had no loans considered to be impaired under
Statement 114.

Investment Activities

     Investment Securities.  Haywood Savings is permitted to invest in certain
securities.  Investment decisions are made by authorized officers of the Bank
within policies established by the Bank's Board of Directors.  At December 31,
1998, the Bank's investment securities portfolio had a net book value of 
$30.0 million and a quoted market value of $29.8 million and consisted of United
States Government agency obligations, mortgage-backed securities and
collateralized mortgage obligations. Purchases of securities are funded either
through the sale or maturity of other securities or from cash flow arising in
the ordinary course of business.  Under North Carolina law, savings banks are
required to maintain cash and readily marketable investments in an amount that
may be established by the Administrator of the North Carolina Savings
Institution Division (the "Administrator") but which may not be less than 10% of
the Bank's assets.  The Bank was in compliance with the current 10% liquidity
requirement at December 31, 1998.

     Mortgage-Backed Securities and Collateralized Mortgage Obligations.  The
Bank maintains a significant portfolio of mortgage-backed securities in the form
of Government National Mortgage Association ("GNMA") and FHLMC participation or
pass-through certificates.  GNMA certificates are guaranteed as to principal and
interest by the full faith and credit of the United States, while FHLMC
certificates are guaranteed by that agency only.  Mortgage-backed securities
generally entitle the Bank to receive a pro rata portion of the cash flows from
an identified pool of mortgages.  The Company has also invested in
collateralized mortgage obligations ("CMOs") which are securities issued by
special purpose entities generally collateralized by pools of mortgage-backed
securities.  The cash flows from such pools are segmented and paid in accordance
with a predetermined priority to various classes of securities issued by the
entity.  Although mortgage-backed securities generally yield less than the loans
for which they are exchanged, they present substantially lower credit risk and
are more liquid than the individual mortgage loans and may be used to
collateralize obligations of the Bank.  Because the Bank receives regular
payments of principal and interest from its mortgage-backed securities, these
investments provide more consistent cash flows than investments in other debt
securities which generally only pay principal at maturity.

                                       10
<PAGE>
 
     Mortgage-backed securities typically are issued with stated principal
amounts and the securities are backed by pools of mortgages that have loans with
interest rates within a range and have similar maturities.  The underlying pool
of mortgages can be composed of either fixed-rate or ARM loans.  As a result,
the interest rate risk characteristics of the underlying pool of mortgages,
i.e., fixed-rate or adjustable-rate, as well as prepayment risk, are passed on
to the certificate holder.  The life of a mortgage-backed pass-through security
is equal to the life of the underlying mortgages.

     Mortgage-backed securities, however, expose the Bank to certain unique
risks.  In a declining rate environment, accelerated prepayments of loans
underlying these securities expose the Bank to the risk that it will be unable
to obtain comparable yields upon reinvestment of the proceeds.  In the event the
mortgage-backed security has been funded with an interest-bearing liability with
a maturity comparable to the original estimated life of the mortgage-backed
security, the Bank's interest rate spread could be adversely affected.
Conversely, in a rising interest rate environment, the Bank may experience a
lower than estimated rate of repayment on the underlying mortgages, effectively
extending the estimated life of the mortgage-backed security and exposing the
Bank to the risk that it may be required to fund the asset with a liability
bearing a higher rate of interest.

     The following table sets forth the carrying value of the Bank's investment
portfolio at the dates indicated.
<TABLE>
<CAPTION>
 
                                                           At December 31,
                                                      -------------------------
                                                       1998     1997     1996
                                                      -------  -------  -------
<S>                                                  <C>      <C>      <C>
                                                        (Dollars in thousands)
Investment securities available for sale:
 U.S. government and agency securities..............  $ 4,247  $ 5,012  $    --
 Collateralized mortgage obligations:
   FHLMC certificates...............................   10,510   10,794       --
   FNMA certificates................................    4,709       --       --
                                                      -------  -------  -------
    Total investment securities available for sale..   19,466   15,806       --
                                                      -------  -------  -------
 
Investment securities held-to-maturity:
 U.S. government and agency securities..............    9,823   10,437   10,894
 Mortgage-backed securities:
  FHLMC certificates................................      335      520      674
  GNMA certificates.................................      145      286  $   395
                                                      -------  -------  -------
    Total investment securities held to maturity....   10,303   11,243  $11,963
                                                      -------  -------  -------
 
    Total investment securities.....................  $29,769  $27,049  $11,963
                                                      =======  =======  =======
</TABLE>

                                       11
<PAGE>
 
     The following table sets forth the scheduled maturities, carrying values,
market values and average yields for the Bank's investment portfolio at December
31, 1998.

<TABLE>
<CAPTION>
 


                                                                                                          
                                                                                                                   
                                        One Year or Less   One to Five Years    Five to Ten Years  
                                       ------------------  ------------------  ------------------           
                                       Carrying  Average   Carrying  Average   Carrying  Average            
                                        Value     Yield     Value     Yield     Value     Yield             
                                       --------  --------  --------  --------  --------  --------           
                                                             (Dollars in thousands)                         
<S>                                    <C>       <C>       <C>       <C>       <C>       <C>                
Investment securities                                                                                       
 available for sale:                                                                                        
  U.S. government and                                                                                       
   agency securities................       $ --       --%   $ 4,247     6.08%      $ --       --%           
  Collateralized mortgage                                                                                   
   obligations:                                                                                             
     FHLMC certificates.............         --       --         --       --         --       --            
     FNMA certificates..............         --       --         --       --         --       --            
                                       --------  -------    -------     ----   --------  -------            
        Total investment                                                                                    
         securities                                                                                         
          available for                                                                                     
          sale......................         --       --      4,247     6.08         --       --            
                                       --------  -------    -------     ----   --------  -------            
                                                                                                            
Investment securities                                                                                       
 held-to-maturity:                                                                                          
  U.S. government and                                                                                       
   agency                                                                                                   
   securities.......................        437     7.66%     9,386     5.62%        --       --            
  Mortgage-backed                                                                                           
   securities:                                                                                              
     FHLMC certificates.............         --       --         --       --        335     8.50            
     GNMA certificates..............         --       --         --       --         13     9.00            
                                       --------  -------    -------     ----   --------  -------            
        Total investment                                                                                    
         securities                                                                                         
          held to maturity..........        437     7.66      9,386     5.62        348     8.52            
                                       --------  -------    -------     ----   --------  -------            
                                                                                                            
        Total investment                                                                                    
         securities.................       $437     7.66%   $13,633     5.76%      $348     8.52%           
                                       ========  =======    =======     ====   ========  =======            


<CAPTION>

                                                        
                                                        
                                             Over Ten Years           Total Investments     
                                            -------------------   --------------------------
                                             Carrying  Market      Carrying  Market   Average
                                              Value     Value       Value     Value    Yield
                                             --------  -------     --------  -------  --------
                                                                                     
<S>                                          <C>       <C>         <C>       <C>      <C>
Investment securities                                                                
 available for sale:                                                                 
  U.S. government and                                                                
   agency                                                                            
   securities...........................      $    --  $    --%     $ 4,247  $ 4,247     6.08%
  Collateralized mortgage                                                            
   obligations:                                                                      
     FHLMC certificates.................       10,510     6.64       10,510   10,510     6.64
     FNMA certificates..................        4,709     5.93        4,709    4,709     5.93
                                              -------  -------      -------  -------     ----
        Total investment                                                             
         securities                                                                  
          available for                                                              
          sale..........................       15,219     6.42       19,466   19,466     6.34%
                                              -------  -------      -------  -------     ----
                                                                                     
Investment securities                                                                
 held-to-maturity:                                                                   
  U.S. government and                                                                
   agency                                                                            
   securities...........................           --       --        9,823    9,822     5.71
  Mortgage-backed                                                                    
   securities:                                                                       
     FHLMC certificates.................           --       --          335      348     8.50
     GNMA certificates..................          132     8.84          145      162     8.85
                                              -------  -------      -------  -------     ----
        Total investment                                                             
         securities                                                                  
          held to maturity..............          132     8.84       10,303   10,332     5.85
                                              -------  -------      -------  -------     ----
                                                                                     
        Total investment                                                             
         securities.....................      $15,351     6.44%     $29,769  $29,798     6.17%
                                              =======  =======      =======  =======     ====

</TABLE>

                                       12
<PAGE>
 
     The Bank classifies investment securities into one of three categories:

     Held-to-maturity - includes investment securities which the Bank has the
positive intent and ability to hold to maturity.  Held-to-maturity securities
are carried at amortized cost, adjusted for amortization of premiums and
accretion of discounts using the interest method.

     Trading securities - includes investment securities purchased and held
principally for the purpose of selling in the near future.   Trading securities
are carried at fair value with realized and unrealized gains and losses included
in income.

     Available-for-sale - includes investment securities not classified as held-
to-maturity or trading.  Available-for-sale securities, if acquired, will be
carried at fair value.  Realized gains and losses, based on the amortized  cost
of the specific security, will be included in income.  Unrealized gains and
losses will be recorded, net of related income tax effects, in a separate
component of stockholders' equity until realized.

     The classification of investment securities as held-to-maturity, trading or
available for sale is determined at the date of purchase.

     Mortgage Servicing Rights.  The Company has made a $3.0 million commitment
to be a limited partner in Dovenmuehle Mortgage Company L.P. ("DMCLP") Tranche
VIII Servicing Division of Dovenmuehle Mortgage Inc. ("DMI").  DMI provides
mortgage servicing for a national portfolio of residential, multi-family and
commercial mortgage loans.  These loans are owned or securitized by national
mortgage agencies, and by a variety of private banks, thrifts, insurance
companies and other loan investors.  DMI formed DMCLP as a funding vehicle to
purchase portfolios of the FNMA and the FHLMC nonrecourse residential servicing.
DMI provides the mortgage servicing for these portfolios for a fixed fee.  Under
this structure, investors in DMCLP invest in separate tranches, each of which
has its own identified servicing rights and each of which may be owned by one or
a group of investors.  The equity investors in each tranche benefit from a
financial return based solely on the performance of the mortgage servicing
rights purchased for the tranche.  The tranche will be liquidated no later than
the seventh anniversary of the closing of the Offering.

     Servicing rights represent the right to service loans for which the
servicer generally receives a fee based on the outstanding principal of the loan
being serviced.  The costs of acquiring servicing rights are capitalized and
amortized over the estimated life of the servicing right.  Investments in
mortgage servicing rights may be subject to certain volatility because the
carrying values of such assets must be periodically evaluated in relation to
future estimated servicing revenues.  As interest rates decline, prepayment
rates tend to accelerate, thereby decreasing the average life of the servicing
portfolio and adversely impacting its servicing-related earnings primarily due
to increased amortization of the servicing assets, a decreased rate of interest
earned on custodial balances, and increased interest costs incurred on payoffs.

     In June 1998, the Company determined that its investment was impaired when
it received notification of such impairment from an affiliate of  DMI, supported
by an independent appraisal.  In determining the impairment charges for the year
ended December 31, 1998, the Company relied on appraisal reports prepared by
United Financial, Inc. ("UFI").  At December 31, 1998, the principal amount of
the loans in the Tranche VIII servicing portfolio was $1.95 billion. The UFI
appraisal report indicated an economic value of approximately $27.5 million for
the portfolio at that date using a discounted cash flow analysis and a fair
market value of approximately $24.6 million based on estimated market prices for
similar servicing rights.  Because UFI's economic value method relied on certain
assumptions related

                                       13
<PAGE>
 
to DMI's portfolio retention program, the Company used the fair market value to
calculate the value of its interest in Tranche VIII.  As indicated in the
appraisal reports, the assumed interest rate on 30-year Treasury bonds had
declined to 5.08% at December 31, 1998.  This significant decline in interest
rates led to an increase in refinancing activities with a corresponding negative
impact on the value of the underlying mortgage servicing rights.   During the
year ended December 31, 1998, the Company recognized impairment valuation
adjustments totaling approximately $2,161,000.  Total loss of DMI recognized by
the Company on the equity method of accounting was $2,158,000 as compared to net
earnings of $136,000 for fiscal year 1997.

Sources of Funds

     General.  Deposits are the major source of the Bank's funds for lending and
other investment purposes.  In addition to deposits, Haywood Savings derives
funds from loan principal repayments, interest payments and periodic borrowings.
Loan repayments are a relatively stable source of funds, while deposit inflows
and outflows are significantly influenced by general interest rates and money
market conditions.  Borrowings may be used on a short-term basis to compensate
for reductions in the availability of funds from other sources.  They may also
be used on a longer term basis for general business purposes.

     Deposits.  Consumer and commercial deposits are attracted principally from
within the Bank's primary market area through the offering of a broad selection
of deposit instruments including NOW accounts, money market accounts, regular
savings accounts, term certificate accounts (including "Mini Jumbo" and "Jumbo"
certificates in denominations of $50,000 and $100,000 or more, respectively) and
retirement savings plans.  The Bank solicits jumbo certificates from individuals
and corporations located in its market area.  The Bank does not obtain funds
through brokers, nor does it solicit funds outside the State of North Carolina.

     The Bank has emphasized the attraction of one-year certificate of deposits
through competitive pricing of these types of accounts.  In addition, the Bank
has attempted to develop and price deposit accounts in order to appeal to
retirees in the Bank's market area.  During fiscal year 1998, the Bank
experienced an increase in jumbo certificate accounts and savings and NOW
accounts.  Management attributes the inflow in these accounts to paying
competitive rates on such accounts as compared to the marketplace.

                                       14
<PAGE>
 
     Deposits in the Bank at December 31, 1998 were represented by the various
types of deposits described below.

<TABLE>
<CAPTION>
 
 
Average
Interest    Minimum                                       Minimum                    Percentage of
Rate        Term                  Category                 Amount       Balances    Total Deposits
-------  -----------  --------------------------------  ------------  ------------  ---------------
<C>      <S>          <C>                               <C>           <C>           <C>
 
   -- %      none         Commercial checking                 none     $   241,823        0.21%
   1.84      none         NOW accounts                        none      10,338,966        8.86
   2.17      none         Super NOW accounts                  none       1,556,956        1.33
   2.95      none         Optional savings accounts           none      12,742,414        0.91
   5.24      none         Full-paid savings accounts          none           7,000        0.01
   3.20      none         90-day savings accounts             none         841,799        0.72
   2.95      none         Money market deposit accounts    $ 2,500       6,335,664        5.43
   3.50      none         Optional public funds               none         122,394        0.11

                          Certificates of Deposit
                      --------------------------------  
 
   4.70  91 day       91-day certificate                       500       3,168,833        2.71
   5.17  6 months     6-month money market certificate         500      19,866,263       17.01
   5.52  1 year       1-year certificate                       500      24,078,092       20.62
   5.84  18 months    18-month certificate                     500       4,242,417        3.63
   5.73  30 months    30-month certificate                     500       8,169,875        7.00
   5.70  18 months    IRA certificates                         500       4,778,342        4.09
   6.50  2 years      6-1/2% certificates                      500             519          --
   6.75  30 months    6-3/4% certificates                      500           4,486          --
   7.50  4 years      7-1/2% certificates                      500         232,272        0.20
   7.75  6 years      7-3/4% certificates                      500          23,667        0.02
   8.00  8 years      8% certificates                          500         195,400        0.17
   5.04  6 months     6-month Mini-Jumbo certificates       50,000         106,563        0.09
   5.42  12 months    12-month Mini-Jumbo certificates      50,000          24,733        0.02
   5.23  90 days      Jumbo certificates                   100,000      15,245,006       13.06
   5.76  various      Public Funds                         various         116,784        0.10
   5.42  various      Negotiated CDs                       various         842,776        0.72
   6.42  15 months    Negotiated CDs                       various       2,031,126        1.74
   6.21  24 months    Negotiated CDs                       various       1,447,203        1.24
                                                                      ------------       -----
                                                                      $116,761,373      100.00%
                                                                      ============      ======
</TABLE>

                                       15
<PAGE>
 
     The following table sets forth the change in dollar amount of savings
deposits in the various types of savings accounts offered by the Bank between
the dates indicated.
<TABLE>
<CAPTION>
 
 
                                                         Increase                                Increase
                                                        (Decrease)                              (Decrease)
                               Balance at                  From        Balance at                  From       Balance at
                              December 31,      %       December 31,   December 31,    %        December 31,  December 31,     %
                                 1998       Deposits       1997           1997      Deposits       1996          1996      Deposits
                             ------------  ---------  -------------  ------------  ---------  ------------  ------------  ---------
<S>                          <C>           <C>        <C>            <C>           <C>        <C>           <C>           <C>
 
Commercial checking........  $    241,823      0.21%   $    42,653   $    199,170      0.17%  $     2,644   $    196,526      0.18%
NOW checking accounts......    10,338,966      8.86        623,838      9,715,128      8.19       499,990      9,215,138      8.58
Super NOW checking accounts     1,556,956      1.33        238,652      1,318,304      1.11       394,177        924,127      0.86
Passbook and regular
 savings...................    13,713,607     11.74        746,575     12,967,032     10.93      (578,110)    13,545,142     12.62
Money market deposit
 accounts..................     6,335,664      5.43       (140,714)     6,476,378      5.46        (3,514)     6,479,892      6.04
Fixed-rate certificate
 accounts..................       456,344      0.39         (2,251)       458,595      0.39         7,946        450,649      0.41
Money market certificates..    19,866,263     17.01     (1,556,293)    21,422,556     18.05    (2,951,725)    24,374,281     22.71
Jumbo certificates.........    15,245,006     13.06      1,271,167     13,973,839     11.77     2,844,474     11,129,365     10.37
Other certificates.........    49,006,744     41.97     (3,132,710)    52,139,454     43.93    11,111,195     41,028,259     38.23
                             ------------    ------    -----------   ------------    ------   -----------   ------------    ------
                             $116,761,373    100.00%   $(1,909,083)  $118,670,456    100.00%  $11,327,077   $107,343,379    100.00%
                             ============    ======    ===========   ============    ======   ===========   ============    ======
</TABLE>

                                       16
<PAGE>
 
     The following table sets forth the time deposits in the Bank classified by
rates as of the dates indicated.

                                             At December 31,
                                  -------------------------------------   
                                      1998        1997          1996
                                  -----------  -----------  -----------
<TABLE>                
<CAPTION>              
                       
<S>                               <C>          <C>          <C>
        4.01 - 6.00%............  $80,639,684  $82,695,686  $74,849,368
        6.01 - 8.00%............    3,934,673    5,298,758    2,133,186
                                  -----------  -----------  -----------
           Total................  $84,574,357  $87,994,444  $76,982,554
                                  ===========  ===========  ===========
 
 
</TABLE>
     The following table sets forth the amount and maturities of time deposits
at December 31, 1998.
<TABLE>
<CAPTION>
 
                                               Amount Due
                             -----------------------------------------------
                              Less Than                  After
     Rate                     One Year     1-5 Years   5 Years      Total
---------------              -----------  -----------  --------  -----------
<S>                          <C>          <C>          <C>       <C>
                
   4.01-6.00%..............  $58,724,000  $21,916,000  $     --  $80,640,000
   6.01-8.00%..............    2,024,000    1,459,000   451,000    3,934,000
                             -----------  -----------  --------  -----------
     Total.................  $60,748,000  $23,375,000  $451,000  $84,574,000
                             ===========  ===========  ========  ===========
 
 
</TABLE>
     The following table sets forth the deposit account activities of the Bank
for the periods indicated.
<TABLE>
<CAPTION>
 
                                                                     At December 31,
                                                      ----------------------------------------------
                                                           1998            1997            1996
                                                      --------------  --------------  --------------
<S>                                                   <C>             <C>             <C>
 
Deposits............................................  $ 132,954,649   $ 141,756,284   $ 120,887,730
Withdrawals.........................................   (139,068,594)   (134,947,031)   (125,756,781)
                                                      -------------   -------------   -------------
  Net increase (decrease) before interest credited..     (6,113,945)      6,809,253      (4,869,051)
Interest credited...................................      4,204,862       4,517,824       3,449,175
                                                      -------------   -------------   -------------
  Net increase (decrease) in deposits...............  $  (1,909,083)  $  11,327,077   $  (1,419,876)
                                                      =============   =============   =============
 
</TABLE>

     The decrease in the Bank's deposits during fiscal year 1998 occurred
primarily in certificates of deposit (other than jumbo).  Management attributes
the decrease to a migration from traditional deposits.

     Borrowings.  Savings deposits are the primary source of funds for the
Bank's lending activities and other general business activities.  Haywood
Savings does, however, periodically use borrowed money to supplement its supply
of lendable funds and for other operational purposes.

     The Bank has established a $2.0 million line of credit with First Union
National Bank with an interest rate equal to First Union National Bank's prime
rate.  The Bank is required to pay off this line of credit at some point during
each year and to leave it unused for a period of 60 days.   At December 31,
1998, the Bank had no borrowings outstanding under this line of credit.

                                       17
<PAGE>
 
Competition

     Haywood Savings faces strong competition both in attracting and making real
estate and other loans.  Its most direct competition for deposits has
historically come from other savings and loan associations, commercial banks and
credit unions, many of which have substantially greater resources than the Bank.
Particularly in times of high interest rates, the Bank faces additional
significant competition for investors' funds from short-term money market
securities and other corporate and government securities.

     Haywood Savings' competition for real estate loans comes principally from
other savings and loan associations, commercial banks, mortgage banking
companies, insurance companies and other institutional lenders.  The Bank
competes for loans principally through the interest rates and loan fees it
charges and the efficiency and quality of services it provides borrowers and
their real estate brokers.  It competes for savings by offering a variety of
savings accounts at competitive rates and convenient branch locations.

Subsidiaries

     In 1984, the Bank formed Great Smokies Financial Corporation ("Great
Smokies"), a wholly-owned subsidiary service corporation organized under North
Carolina law.  Great Smokies' primary activity had been to build houses on
properties which the Bank had acquired through foreclosure.  In addition, Great
Smokies holds second mortgage loans on properties on which the Bank has
foreclosed in order to facilitate the sale of the property by the Bank.

     In 1988, Haywood Savings purchased a small insurance agency for $36,000,
now named Great Smokies Insurance Agency, Inc.  The agency acts as an insurance
broker for property and casualty insurance.  During 1998, Great Smokies
Insurance Agency earned approximately $187,000 in commissions on policies sold.

     As a North Carolina-chartered savings bank, the Bank is authorized to
invest up to 10% of its assets in subsidiary or service corporations engaged in
activities that are permissible to subsidiaries of federal savings associations.
After December 19, 1992, subsidiaries of state-chartered savings banks
generally, however, may not engage as principal in any activity that is not
permissible for a subsidiary of a national banks unless the FDIC determines that
the activities do not pose a significant risk to the appropriate insurance fund
and the bank complies with all applicable capital requirements. Under
regulations adopted by the FDIC to clarify the foregoing restriction, a
subsidiary acting as agent for the sale of insurance would not be considered
engaged as principal in an activity that is not permissible for a subsidiary of
a national bank.  Accordingly, neither of the Bank's subsidiaries would be
considered engaged as principal in an activity that is not permissible for a
subsidiary of a national bank.

Regulation

     General.  As a North Carolina chartered savings bank with deposits insured
by the SAIF, the Bank is extensively regulated by the Administrator of the
Savings Institutions Division of the State of North Carolina (the
"Administrator") and the FDIC.  As a bank holding company, the Company is also
subject to extensive regulation under federal and state law.  These laws and
regulations are intended primarily for the protection of depositors and of the
FDIC.

     The following discussion of statutes and regulations affecting North
Carolina-chartered savings banks and bank holding companies does not purport to
be complete.  To the extent that the following information describes statutory
or regulatory provisions, it is qualified in its entirety by reference to the
particular statutory and regulatory provisions.  The operations of the Company
and the Bank may be affected by legislative changes and by the policies of
various regulatory authorities.  The Company and the Bank are unable to predict
the nature or the extent of the effects on their business and earnings that
fiscal or monetary policies or new federal or state legislation or regulation
may have in the future.

                                       18
<PAGE>
 
     Regulation of the Company.  The Company is a bank holding company subject
to regulation by the Federal Reserve Board under the Bank Holding Company Act of
1956, as amended (the "BHCA").  The Company is also a savings institution
holding company subject to supervision by the Administrator under North Carolina
law.  As a result, the activities of the Company are subject to certain
limitations, which are described below.  In addition, as a bank holding company,
the Company is required to file annual and quarterly reports with the Federal
Reserve Board and to furnish such additional information as the Federal Reserve
Board may require pursuant to the BHCA.  The Company is also subject to regular
examination by the Federal Reserve Board.

     With certain exceptions, the BHCA prohibits a bank holding company from
acquiring direct or indirect ownership or control of more than 5% of the voting
shares of a company that is not a bank or a bank holding company, or from
engaging directly or indirectly in activities other than those of banking,
managing or controlling banks, or providing services for its subsidiaries.  The
principal exceptions to these prohibitions involve certain non-bank activities
which, by statute or by Federal Reserve Board regulation or order, have been
identified as activities closely related to the business of banking.  The
activities of the Company are subject to these legal and regulatory limitations
under the BHCA and the related Federal Reserve Board regulations.
Notwithstanding the Federal Reserve Board's prior approval of specific
nonbanking activities, the Federal Reserve Board has the power to order a
holding company or its subsidiaries to terminate any activity, or to terminate
its ownership or control of any subsidiary, when it has reasonable cause to
believe that the continuation of such activity or such ownership or control
constitutes a serious risk to the financial safety, soundness or stability of
any bank subsidiary of that holding company.  In addition to the above
restrictions under the BHCA, the Company's investments are limited under North
Carolina law to those investments permitted for North Carolina savings banks.

     Under the BHCA, a bank holding company must obtain the prior approval of
the Federal Reserve Board before (1) acquiring direct or indirect ownership or
control of any voting shares of any bank or bank holding company if, after such
acquisition, the bank holding company would directly or indirectly own or
control more than 5% of such shares; (2) acquiring all or substantially all of
the assets of another bank or bank holding company; or (3) merging or
consolidating with another bank holding company.  Satisfactory financial
condition, particularly with regard to capital adequacy, and satisfactory
Community Reinvestment Act ("CRA") ratings generally are prerequisites to
obtaining federal regulatory approval to make acquisitions.

     Effective September 29, 1995, the Riegle-Neal Interstate Banking and
Branching Efficiency Act of 1994 (the "Riegle-Neal Act") allows the Federal
Reserve Board to approve an application of an adequately capitalized and
adequately managed bank holding company to acquire control of, or acquire all or
substantially all of the assets of, a bank located in a state other than such
holding company's home state, without regard to whether the transaction is
prohibited by the laws of any state.  The Federal Reserve Board may not approve
the acquisition of bank that has not been in existence for the minimum time
period (not exceeding five years) specified by the statutory law of the host
state.  The Riegle-Neal Act also prohibits the Federal Reserve Board from
approving an application if the applicant (and its depository institution
affiliates) controls or would control more than 10% of the insured deposits in
the United States or 30% or more of the deposits in the target bank's home state
or in any state in which the target bank maintains a branch.  The Riegle-Neal
Act does not affect the authority of states to limit the percentage of total
insured deposits in the state which may be held or controlled by a bank or bank
holding company to the extent such limitation does not discriminate against out-
of-state banks or bank holding companies.  Individual states may also waive the
30% state-wide concentration limit contained in the Riegle-Neal Act.

     The federal banking agencies are authorized to approve interstate merger
transactions without regard to whether such transaction is prohibited by the law
of any state, unless the home state of one of the banks has opted out of the
Riegle-Neal Act by adopting a law which applies equally to all out-of-state
banks and expressly prohibits merger transactions involving out-of-state banks.
Interstate acquisitions of branches are permitted only if the law of the state
in which the branch is located permits such acquisitions.  Interstate mergers
and branch acquisitions are also subject to the nationwide and statewide insured
deposit concentration amounts described above.

                                       19
<PAGE>
 
     The Riegle-Neal Act authorizes the OCC and FDIC to approve interstate
branching de novo by national and state banks, respectively, only in states
which specifically allow for such branching.  The Riegle-Neal Act also required
the appropriate federal banking agencies to prescribe regulations which
prohibited any out-of-state bank from using the interstate branching authority
primarily for the purpose of deposit production.  These regulations include
guidelines to ensure that interstate branches operated by an out-of-state bank
in a host state are reasonably helping to meet the credit needs of the
communities which they serve.  Under North Carolina law, a North Carolina
savings bank may establish a branch in any other state in accordance with the
laws of such other state.

     Under the BHCA, any company must obtain approval of the Federal Reserve
Board prior to acquiring control of the Company or the Bank.  For purposes of
the BHCA, "control" is defined as ownership of more than 25% of any class of
voting securities of the Company or the Bank, the ability to control the
election of a majority of the directors, or the exercise of a controlling
influence over management or policies of the Company or the Bank.  In addition,
the Change in Bank Control Act and the related regulations of the Federal
Reserve Board require any person or persons acting in concert (except for
companies required to make application under the BHCA), to file a written notice
with the Federal Reserve Board before such person or persons may acquire control
of the Company or the Bank.  The Change in Bank Control Act defines "control" as
the power, directly or indirectly, to vote 25% or more of any voting securities
or to direct the management or policies of a bank holding company or an insured
bank.  Furthermore, no person or company may acquire control of the Company or
the Bank without the prior written approval of the Administrator.  The
definition of "control" for this purpose is the same as the definition under the
Change in Bank Control Act.

     The Federal Reserve Board has adopted guidelines regarding the capital
adequacy of bank holding companies, which require bank holding companies to
maintain specified minimum ratios of capital to total assets and capital to
risk-weighted assets.  See "-- Capital Requirements."

     Holding Company Dividends and Stock Repurchases. The Federal Reserve Board
has the power to prohibit dividends by bank holding companies if their actions
constitute unsafe or unsound practices.  The Federal Reserve Board has issued a
policy statement on the payment of cash dividends by bank holding companies,
which expresses the Federal Reserve Board's view that a bank holding company
should pay cash dividends only to the extent that the company's net income for
the past year is sufficient to cover both the cash dividends and a rate of
earnings retention that is consistent with the company's capital needs, asset
quality, and overall financial condition.  The Federal Reserve Board also
indicated that it would be inappropriate for a bank holding company experiencing
serious financial problems to borrow funds to pay dividends.  Under the prompt
corrective action regulations adopted by the Federal Reserve Board pursuant to
the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"),
the Federal Reserve Board may prohibit a bank holding company from paying any
dividends if the holding company's bank subsidiary is classified as
"undercapitalized."   See "-- Prompt Corrective Regulatory Action."

     As a bank holding company, the Company is required to give the Federal
Reserve Board prior written notice of any purchase or redemption of its
outstanding equity securities if the gross consideration for the purchase or
redemption, when combined with the net consideration paid for all such purchases
or redemptions during the preceding 12 months, is equal to 10% or more of the
Company's consolidated net worth.  The Federal Reserve Board may disapprove such
a purchase or redemption if it determines that the proposal would violate any
law, regulation, Federal Reserve Board order, directive, or any condition
imposed by, or written agreement with, the Federal Reserve Board.  This
requirement does not apply to bank holding companies that are "well-
capitalized," received one of the two highest examination ratings at their last
examination and are not the subject of any unresolved supervisory issues.

     Bank Regulation.  As a state-chartered savings bank which is not a member
of the Federal Reserve System (a "state non-member bank"), the Bank is subject
to the primary federal supervision of the FDIC under the Federal Deposit
Insurance Act (the "FDIA").  The Bank also is subject to comprehensive
regulation and supervision by the Administrator.  The prior approval of the FDIC
and of the Administrator is required for the Bank to establish or relocate a
branch office or to engage in any merger, consolidation or significant purchase
of assets. In addition, the Bank is subject to numerous federal and state laws
and regulations that set forth specific restrictions and procedural requirements

                                       20
<PAGE>
 
with respect to the establishment of branches, investments, interest rates on
loans, credit practices, the disclosure of credit terms and discrimination in
credit transactions.

     The FDIC and the Administrator regularly examine the operations and
condition of the Bank, including but not limited to capital adequacy, reserves,
loans, investments and management practices.  These examinations are for the
protection of the Bank's depositors and the SAIF and not its stockholders.  In
addition, the Bank is required to furnish quarterly and annual reports to the
FDIC as well as annual reports to the Administrator.  The FDIC's enforcement
authority includes the power to remove officers and directors and the authority
to issue orders to prevent a bank from engaging in unsafe or unsound practices
or violating laws or regulations governing its business.  Any North Carolina
savings bank that does not operate in accordance with the regulations, policies
and directives of the Administrator may be subject to sanctions for non-
compliance.  The Administrator may under certain circumstances suspend or
remove, directors or officers who have violated the law, conducted the bank's
business in a manner which is unsafe, unsound or contrary to the depositors'
interests, or been negligent in the performance of their duties.

     The CRA requires that, in connection with examinations of financial
institutions within their jurisdiction, the Federal Reserve Board and the FDIC
evaluate the record of the financial institutions in meeting the credit needs of
their local communities, including low and moderate income neighborhoods,
consistent with the safe and sound operation of those banks.  These factors are
also considered by the Federal Reserve Board and the FDIC in evaluating mergers,
acquisitions and applications to open a branch or facility.

     North Carolina savings banks are authorized to operate branches through the
State of North Carolina.  Branch approvals are subject to statutory standards
relating to safety and soundness, competition, public convenience and CRA
performance.

     Capital Requirements.  The Federal Reserve Board and the FDIC have
established guidelines with respect to the maintenance of appropriate levels of
capital by bank holding companies with consolidated assets of $150 million or
more and state non-member banks, respectively.  For bank holding companies with
less than $150 million  in consolidated assets, the Federal Reserve Board
applies the guidelines on a bank-only basis unless the bank holding company has
publicly held debt securities or is engaged in non-bank activities involving
significant leverage.  The regulations impose two sets of capital adequacy
requirements:  minimum leverage rules, which require bank holding companies and
state non-member banks to maintain a specified minimum ratio of capital to total
assets, and risk-based capital rules, which require the maintenance of specified
minimum ratios of capital to "risk-weighted" assets.  The regulations of the
FDIC and the Federal Reserve Board require bank holding companies and state non-
member banks, respectively, to maintain a minimum leverage ratio of "Tier 1
capital" to total assets of 3.0%.  Tier 1 capital is the sum of common
stockholders' equity, certain perpetual preferred stock (which must be
noncumulative with respect to banks), including any related surplus, and
minority interests in consolidated subsidiaries; minus all intangible assets
(other than certain purchased mortgage servicing rights and purchased credit
card receivables), identified losses and investments in certain subsidiaries.
As a SAIF-insured, state-chartered bank, the Bank must also deduct from Tier 1
capital an amount equal to its investments in, and extensions of credit to,
subsidiaries engaged in activities that are not permissible for national banks,
other than debt and equity investments in subsidiaries engaged in activities
undertaken as agent for customers or in mortgage banking activities or in
subsidiary depository institutions or their holding companies.  Although setting
a minimum 3.0% leverage ratio, the capital regulations state that only the
strongest bank holding companies and banks, with composite examination ratings
of 1 under the rating system used by the federal bank regulators, would be
permitted to operate at or near such minimum level of capital.  All other bank
holding companies and banks are expected to maintain a leverage ratio of at
least 1% to 2% above the minimum ratio, depending on the assessment of an
individual organization's capital adequacy by its primary regulator.  Any bank
or bank holding companies experiencing or anticipating significant growth would
be expected to maintain capital well above the minimum levels.  In addition, the
Federal Reserve Board has indicated that whenever appropriate, and in particular
when a bank holding company is undertaking expansion, seeking to engage in new
activities or otherwise facing unusual or abnormal risks, it will consider, on a
case-by-case basis, the level of an organization's ratio of tangible Tier 1
capital to total assets in making an overall assessment of capital.

                                       21
<PAGE>
 
     In addition to the leverage ratio, the regulations of the Federal Reserve
Board and the FDIC require bank holding companies and state-chartered nonmember
banks to maintain a minimum ratio of qualifying total capital to risk-weighted
assets of at least 8.0% of which at least four percentage points must be Tier 1
capital.  Qualifying total capital consists of Tier 1 capital plus Tier 2 or
supplementary capital items which include allowances for loan losses in an
amount of up to 1.25% of risk-weighted assets, cumulative preferred stock and
preferred stock with a maturity of 20 years or more and certain other capital
instruments.  The includable amount of Tier 2 capital cannot exceed the
institution's Tier 1 capital.  Qualifying total capital is further reduced by
the amount of the bank's investments in banking and finance subsidiaries that
are not consolidated for regulatory capital purposes, reciprocal cross-holdings
of capital securities issued by other banks and certain other deductions.  The
risk-based capital regulations assign balance sheet assets and the credit
equivalent amounts of certain off-balance sheet items to one of four broad risk
weight categories. The aggregate dollar amount of each category is multiplied by
the risk weight assigned to that category based principally on the degree of
credit risk associated with the obligor.  The sum of these weighted values
equals the bank holding company or the bank's risk-weighted assets.

     As of December 31, 1998, the Bank's level of Tier 1 Capital was well in
excess of the minimum required by the FDIC capital regulations.

     The federal bank regulators, including the Federal Reserve Board and the
FDIC, have proposed to revise their risk-based capital requirements to ensure
that such requirements provide for explicit consideration of interest rate risk.
Under the proposed rule, a bank's interest rate risk exposure would be
quantified using either the measurement system set forth in the proposal or the
bank's internal model for measuring such exposure, if such model is determined
to be adequate by the bank's examiner.  If the dollar amount of a bank's
interest rate risk exposure, as measured under either measurement system,
exceeds 1% of the bank's total assets, the bank would be required under the
proposed rule to hold additional capital equal to the dollar amount of the
excess.  Management of the Bank has not determined what effect, if any, the
FDIC's proposed interest rate risk component would have on the Bank's capital if
adopted as proposed.  The FDIC has adopted a regulation that provides that the
FDIC may take into account whether a bank has significant risks from
concentrations of credit or nontraditional activities in determining the
adequacy of its capital.  The Bank has not been advised that it will be required
to maintain any additional capital under this regulation.  The proposed interest
rate risk component would not apply to bank holding companies on a consolidated
basis.

     Under North Carolina law, savings banks must maintain a net worth of not
less than 5% of assets.  In computing its compliance with this requirement, the
savings bank must deduct intangible assets from both net worth and assets.  In
connection with the approval by the Administrator of the Bank's holding company
reorganization, the Company executed a Capital Maintenance Agreement, pursuant
to which the Company agreed to infuse additional capital into the Bank in the
event the Bank's net worth fell below the minimum net worth requirement under
North Carolina law.  The Bank was in compliance with the North Carolina net
worth requirement at December 31, 1998.

     Prompt Corrective Regulatory Action.  FDICIA requires the federal banking
regulators to take prompt corrective action if an insured depository institution
fails to satisfy certain minimum capital requirements including a leverage
limit, a risk-based capital requirement, and any other measure of capital deemed
appropriate by the federal banking regulators for measuring the capital adequacy
of an insured depository institution.  All institutions, regardless of their
capital levels, are restricted from making any capital distribution or paying
any management fees that would cause the institution to fail to satisfy the
minimum levels for any of its capital requirements.  An institution that failed
to meet the minimum level for any relevant capital measure (an "undercapitalized
institution") may be: (i) subject to increased monitoring by the appropriate
federal banking regulator; (ii) required to submit an acceptable capital
restoration plan within 45 days; (iii) subject to asset growth limits; and (iv)
required to obtain prior regulatory approval for acquisitions, branching and new
lines of businesses.  The capital restoration plan must include a guarantee by
the institution's holding company that the institution will comply with the plan
until it has been adequately capitalized on average for four consecutive
quarters, under which the holding company would be liable up to the lesser of 5%
of the institution's total assets or the amount necessary to bring the
institution into capital compliance as of the date it failed to comply with its
capital restoration plan.  A "significantly undercapitalized" institution, as
well as any undercapitalized

                                       22
<PAGE>
 
institution that did not submit an acceptable capital restoration plan, may be
subject to regulatory demands for recapitalization, broader application of
restrictions on transactions with affiliates, limitations on interest rates paid
on deposits, asset growth and other activities, possible replacement of
directors and officers, and restrictions on capital distributions by any bank
holding company controlling the institution.  Any company controlling the
institution could also be required to divest the institution or the institution
could be required to divest subsidiaries.  The senior executive officers of a
significantly undercapitalized institution may not receive bonuses or increases
in compensation without prior approval and the institution is prohibited from
making payments of principal or interest on its subordinated debt.  If an
institution's ratio of tangible capital to total assets falls below a level
established by the appropriate federal banking regulator, the institution will
be deemed "critically undercapitalized" and subject to conservatorship or
receivership within specified periods of time.

     Under the regulations implementing the prompt corrective action provision
of FDICIA, the federal banking regulators measure a depository institution's
capital adequacy on the basis of the institution's total risk-based capital
ratio (the ratio of its qualifying total capital to risk-weighted assets), Tier
1 risk-based capital ratio (the ratio of its Tier 1 capital to risk-weighted
assets) and leverage ratio (the ratio of its Tier 1 capital to adjusted total
assets).  A savings bank that is not subject to an order or written directive to
meet or maintain a specific capital level will be deemed "well capitalized" if
it also has: (i) a total risk-based capital ratio of 10% or greater; (ii) a Tier
1 risk-based capital ratio of 6.0% or greater; and (iii) a leverage ratio of
5.0% or greater.  An "adequately capitalized" institution is an institution that
does not meet the definition of well capitalized and has: (i) a total risk-based
capital ratio of 8.0% or greater; (ii) a Tier 1 capital risk-based ratio of 4.0%
or greater; and (iii) a leverage ratio of 4.0% or greater (or 3.0% or greater if
the institution has a composite 1 CAMELS rating).  An "undercapitalized
institution" is an institution that has (i) a total risk-based capital ratio
less than 8.0%; or (ii) a Tier 1 risk-based capital ratio of less than 4.0%; or
(iii) a leverage ratio of less than 4.0% (or 3.0% if the institution has a
composite 1 CAMELS rating).  A "significantly undercapitalized" institution is
defined as an institution that has: (i) a total risk-based capital ratio of less
than 6.0%; or (ii) a Tier 1 risk-based capital ratio of less than 3.0%; or 
(iii) leverage ratio of less than 3.0%. A "critically undercapitalized"
institution is defined as an institution that has a ratio of "tangible equity"
to total assets of less than 2.0%.

     Dividend Limitations.  The Bank may not pay dividends on its capital stock
if its regulatory capital would thereby be reduced below the amount then
required for the liquidation account established for the benefit of certain
depositors of the Bank at the time of its conversion to stock form.

     Earnings of the Bank appropriated to bad debt reserves and deducted for
Federal income tax purposes are not available for payment of cash dividends or
other distributions to stockholders without payment of taxes at the then current
tax rate by the Bank on the amount of earnings removed from the reserves for
such distributions.  The Bank intends to make full use of this favorable tax
treatment and does not contemplate use of any earnings in a manner which would
limit the Bank's bad debt deduction or create federal tax liabilities.

     Under FDIC regulations, the Bank is prohibited from making any capital
distributions if after making the distribution, the Bank would have: (i) a total
risk-based capital ratio of less than 8.0%; (ii) a Tier 1 risk-based capital
ratio of less than 4.0%; or (iii) a leverage ratio of less than 4.0%.

     The Company is subject to limitations on dividends imposed by the Federal
Reserve Board.  See "-- Holding Company Dividends and Stock Repurchases."

     Deposit Insurance.  The Bank is required to pay assessments to the FDIC
based on a percent of its insured deposits for insurance of its deposits by the
SAIF.  Under the Federal Deposit Insurance Act, the FDIC is required to set
semi-annual assessments for SAIF-insured institutions to maintain the designated
reserve ratio of the SAIF at 1.25% of estimated deposits or at a higher
percentage of estimated insured deposits that the FDIC determines to be
justified for that year by circumstances raising a significant risk of
substantial future losses to the SAIF.

                                       23
<PAGE>
 
     Under the risk-based deposit insurance system adopted by the FDIC, the
assessment rate for an insured depository institution depends on the assessment
risk classification assigned to the institution by the FDIC which is determined
by the institution's capital level and supervisory evaluations.  Based on the
data reported to regulators for the date closest to the last day of the seventh
month preceding the semi-annual assessment period, institutions are assigned to
one of three capital groups -- well capitalized, adequately capitalized or
undercapitalized -- using the same percentage criteria used under the prompt
corrective action regulations.  Within each capital group, institutions are
assigned to one of three subgroups on the basis of supervisory evaluations by
the institution's primary supervisory authority and such other information as
the FDIC determines to be relevant to the institution's financial condition and
the risk posed to the deposit insurance fund.

     The FDIC has adopted a new assessment schedule for SAIF deposit insurance
pursuant to which the assessment rate for well-capitalized institutions with the
highest supervisory ratings would be reduced to zero and institutions in the
lowest risk assessment classification will be assessed at the rate of 0.27% of
insured deposits.  Until December 31, 1999, however, SAIF member institutions
will be required to pay assessments to the FDIC at the rate of 6.5 basis points
to help fund interest payments on certain bonds issued by FICO an agency of the
federal government established to finance takeovers of insolvent thrifts.
During this period, BIF members will be assessed for these obligations at the
rate of 1.3 basis points.  After December 31, 1999, both BIF and SAIF members
will be assessed at the same rate for FICO payments.

     Restrictions on Certain Activities.  Under FDICIA, state-chartered banks
with deposits insured by the FDIC are generally prohibited from acquiring or
retaining any equity investment of a type or in an amount that is not
permissible for a national bank.  The foregoing limitation, however, does not
prohibit FDIC-insured state banks from acquiring or retaining an equity
investment in a subsidiary in which the bank is a majority owner.  State-
chartered banks are also prohibited from engaging as principal in any type of
activity that is not permissible for a national bank and subsidiaries of state-
chartered, FDIC-insured state banks may not engage as principal in any type of
activity that is not permissible for a subsidiary of a national bank unless in
either case the FDIC determines that the activity would pose no significant risk
to the appropriate deposit insurance fund and the bank is, and continues to be,
in compliance with applicable capital standards.

     The FDIC has adopted regulations to clarify the foregoing restrictions on
activities of FDIC-insured state-chartered banks and their subsidiaries.  Under
the regulations, the term activity refers to the authorized conduct of business
by an insured state bank and includes acquiring or retaining any investment
other than an equity investment. A bank or subsidiary is considered acting as
principal when conducted other than as an agent for a customer, as trustee, or
in a brokerage, custodial, advisory or administrative capacity. An activity
permissible for a national bank includes any activity expressly authorized for
national banks by statute or recognized as permissible in regulations, official
circulars or bulletins or in any order or written interpretation issued by the
Office of the Comptroller of the Currency ("OCC"). In its regulations, the FDIC
indicates that it will not permit state banks to directly engage in commercial
ventures or directly or indirectly engage in any insurance underwriting activity
other than to the extent such activities are permissible for a national bank or
a national bank subsidiary or except for certain other limited forms of
insurance underwriting permitted under the regulations. Under the regulations,
the FDIC permits state banks that meet applicable minimum capital requirements
to engage as principal in certain activities that are not permissible to
national banks including guaranteeing obligations of others, activities which
the Federal Reserve Board has found by regulation or order to be closely related
to banking and certain securities activities conducted through subsidiaries.

     Safety and Soundness Standards.  Under FDICIA, as amended by the Riegle
Community Development and Regulatory Improvement Act of 1994 (the "CDRI Act"),
each Federal banking agency is required to establish safety and soundness
standards for institutions under its authority.  The guidelines adopted by the
FDIC require depository institutions to maintain internal controls and
information systems and internal audit systems that are appropriate for the
size, nature and scope of the institution's business.  The guidelines also
establish certain basic standards for loan documentation, credit underwriting,
interest rate risk exposure, and asset growth.  The guidelines further provide
that depository institutions should maintain safeguards to prevent the payment
of compensation, fees and benefits that are

                                       24
<PAGE>
 
excessive or that could lead to material financial loss, and should take into
account factors such as comparable compensation practices at comparable
institutions.  If the appropriate federal banking agency determines that a
depository institution is not in compliance with the safety and soundness
guidelines, it may require the institution to submit an acceptable plan to
achieve compliance with the guidelines.  A depository institution must submit an
acceptable compliance plan to its primary federal regulator within 30 days of
receipt of a request for such a plan.  Failure to submit or implement a
compliance plan may subject the institution to regulatory sanctions.  Management
believes that the Bank already meets substantially all the standards adopted in
the interagency guidelines, and therefore does not believe that implementation
of these regulatory standards will materially affect the operations of the Bank.

     Additionally under FDICIA, as amended by the CDRI Act, the federal banking
agencies are required to establish standards relating to the asset quality and
earnings that the agencies determine to be appropriate.  On July 10, 1995, the
federal banking agencies, including the FDIC and the Federal Reserve Board,
issued proposed guidelines relating to asset quality and earnings.  Under the
proposed guidelines, an FDIC insured depository institution should maintain
systems, commensurate with its size and the nature and scope of its operations,
to identify problem assets and prevent deterioration in those assets as well as
to evaluate and monitor earnings and ensure that earnings are sufficient to
maintain adequate capital and reserves.  Management believes that the asset
quality and earnings standards, in the form proposed by the banking agencies,
would not have a material effect on the operations of the Bank.

     Transactions with Affiliates.  The affiliate transaction restrictions
contained in Sections 23A and 23B of the Federal Reserve Act apply to
transactions between the Bank and the Company or the Bank's other affiliates.
Generally, Sections 23A and 23B (i) limit the extent to which the savings bank
or its subsidiaries may engage in "covered transactions" with any one affiliate
to an amount equal to 10% of such institution's capital stock and surplus, and
contain an aggregate limit on all such transactions with all affiliates to an
amount equal to 20% of such capital stock and surplus and (ii) require that all
such transactions be on terms substantially the same, or at least as favorable,
to the institution or subsidiary as those provided to a non-affiliate.  A bank
holding company and its subsidiaries, as well as any company under common
control with a bank, are considered "affiliates" of the Bank under Sections 23A
and 23B.  The term "covered transaction" includes the making of loans, purchase
of assets, issuance of a guarantee and similar other types of transactions.  In
addition to the restrictions imposed by Sections 23A and 23B, the Bank may not
(i) loan or otherwise extend credit to an affiliate, except for any affiliate
which engages only in activities which are permissible for bank holding
companies, or (ii) purchase or invest in any stocks, bonds, debentures, notes or
similar obligations of any affiliate, except for affiliates which are
subsidiaries of the Bank.

     Federal Home Loan Bank System.  The Bank is a member of the FHLB System,
which consists of 12 district FHLBs subject to supervision and regulation by the
Federal Housing Finance Board ("FHFB").  The FHLBs provide a central credit
facility primarily for member institutions.  As a member of the FHLB of Atlanta,
the Bank is required to acquire and hold shares of capital stock in the FHLB of
Atlanta in an amount at least equal to 1% of the aggregate unpaid principal of
its home mortgage loans, home purchase contracts, and similar obligations at the
beginning of each year, or 1/20 of its advances (borrowings) from the FHLB of
Atlanta, whichever is greater.  The Bank was in compliance with this requirement
with investment in FHLB of Atlanta stock at December 31, 1998, of $1.4 million.

     Federal Reserve System.  Pursuant to regulations of the Federal Reserve
Board, all FDIC-insured depository institutions must maintain average daily
reserves against their transaction accounts equal to 3% on the first $46.5
million of transaction accounts plus 10% on the remainder.  This percentage is
subject to adjustment by the Federal Reserve Board.  Because required reserves
must be maintained in the form of vault cash or in a non-interest bearing
account at a Federal Reserve Bank, the effect of the reserve requirement is to
reduce the amount of the institution's interest-earning assets.  As of December
31, 1998, the Bank met its reserve requirements.

                                       25
<PAGE>
 
Federal and State Taxation

     Federal Taxation.  Thrift institutions are subject to provisions of the
Internal Revenue Code of 1986, as amended (the "Code") in the same general
manner as other corporations.  Prior to recent legislation, institutions such as
the Bank which met certain definitional tests and other conditions prescribed by
the Code benefitted from certain favorable provisions regarding their deductions
from taxable income for annual additions to their bad debt reserve.  For
purposes of the bad debt reserve deduction, loans were separated into
"qualifying real property loans," which generally are loans secured by certain
interests in real property, and "nonqualifying loans," which are all other
loans.  The bad debt reserve deduction with respect to nonqualifying loans must
be based on actual loss experience.  The amount of the bad debt reserve
deduction with respect to qualifying real property loans could be based upon (a)
actual loss experience or (b) a percentage of taxable income before such
deduction.

     The Bank, which files its federal income tax returns on a calendar year
basis, could generally elected to use the method which resulted in the greatest
deduction for federal income tax purposes, which generally was the percentage of
taxable income method.

     Earnings appropriated to an institution's bad debt reserve and claimed as a
tax deduction were not available for the payment of cash dividends or for
distribution to shareholders (including distributions made on dissolution or
liquidation), unless such amount was included in taxable income, along with the
amount deemed necessary to pay the resulting federal income tax.

     Legislation enacted in 1996 repealed the percentage of taxable income
method of calculating the bad debt reserve.  Savings associations, like the
Bank, which had previously used that method are required to recapture into
taxable income post-1987 reserves in excess of the reserves calculated under the
experience method over a six-year period beginning with the first taxable year
beginning after December 31, 1995.  The start of such recapture may be delayed
until the third taxable year beginning after December 31, 1995 if the dollar
amount of the institution's residential loan originations in each year is not
less than the average dollar amount of residential loan originated in each of
the six most recent years disregarding the years with the highest and lowest
originations during such period.  For purposes of this test, residential loan
originations would not include refinancings and home equity loans.  The Bank has
provided deferred taxes for the amount of the recapture.

     Beginning with the first taxable year beginning after December 31, 1995,
savings institutions, such as the Bank, will be treated the same as commercial
banks.  Institutions with $500 million or more in assets will only be able to
take a tax deduction when a loan is actually charged off.  Institutions with
less than $500 million in assets will still be permitted to make deductible bad
debt additions to reserves, but only using the experience method.

     The Bank's income tax returns for 1995 and subsequent years are subject to
final determination by the taxing authorities.

     State Income Taxation.  Under North Carolina law, the Company is subject to
an annual corporate income tax of 7.25% of its federal taxable income as
computed under the Code, subject to certain prescribed adjustments.  In addition
to the state income tax, Haywood Savings is also subject to an annual state
franchise tax.

     The Bank's state income tax returns have not been audited for the past five
years.

     For further information regarding federal and state taxes payable by the
Bank, see Note 9 of Notes to Consolidated Financial Statements.

                                       26
<PAGE>
 
Employees

     As of December 31, 1998, the Bank had 34 full-time and three part-time
employees.  The employees are not represented by a collective bargaining
agreement.  The Bank believes its employee relations are good.

Executive Officers of the Registrant

     At December 31, 1998, the executive officers of the Company were as
follows:
<TABLE>
<CAPTION>
 
         Name           Age           Position
         ----           ---           --------                 
<S>                     <C>           <C>
     Larry R. Ammons     54           President and Managing Officer
     Jack T. Nichols     58           Treasurer and Chief Financial Officer
 
</TABLE>

     Larry R. Ammons has been employed by the Bank in various positions since
1972.  In 1976, he was elected Executive Vice President and Managing Officer,
and in 1987 became President of the Company upon its incorporation.  Mr. Ammons
is responsible for the daily operations of the Company and the Bank under
policies and procedures established by the Board of Directors.

     Jack T. Nichols has been employed by the Bank since 1966 and currently
serves as Chief Financial Officer, Treasurer and Controller.

Item 2.  Properties
-------------------

     The following table sets forth the location of the Bank's office properties
(including furniture, fixtures and equipment), as well as additional information
relating to these offices at December 31, 1998.  All such properties are owned
by the Bank.
<TABLE>
<CAPTION>
 
                                Year     Net Book
Office Location             Constructed   Value
---------------             -----------  --------
<S>                         <C>          <C>
 
Main Office................     1974     $881,444
 370 North Main Street
 Waynesville, NC 28786
 
Sylva Branch...............     1981      161,467
 6 Grindstaff Cover Road
 Sylva, NC 28779
 
Murphy Branch..............     1984      302,667
 251 King Street
 Murphy, NC 28906
 
Andrews Branch.............     1986      193,792
 741 Main Street
Andrews, NC 28901

</TABLE>

     The Bank utilizes an in-house data processing system for accounting and
record-keeping purposes.

                                       27
<PAGE>
 
     The total net book value of all the Bank's property and equipment at
December 31, 1998 was $1.6 million.  For further information, see Note 5 of
Notes to the Consolidated Financial Statements.

Item 3.  Legal Proceedings
--------------------------

     From time to time the Company and/or the Bank is a party to legal
proceedings in the ordinary course of business.  At December 31, 1998, none of
the Company or any of its subsidiaries is engaged in any legal proceedings of a
material nature.

Item 4.  Submission of Matters to a Vote of Security Holders
------------------------------------------------------------

     No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year ended December 31, 1998.


                                    PART II

Item 5.  Market for the Registrant's Common Equity and Related Stockholder
--------------------------------------------------------------------------
Matters
-------

     The Company's common stock trades on the American Stock Exchange under the
symbol "HBS."  The following table sets forth for each quarter during the past
two fiscal years the high and low closing sales prices for the common stock on
the American Stock Exchange as well as dividends declared on the common stock in
each quarter.
<TABLE>
<CAPTION>
 
                                       Dividends
                      High      Low    Declared
                    ---------  ------  --------
<S>                 <C>        <C>     <C>
  1998
  ----                    
 
  First Quarter      $22.50    $20.75   $0.15
  Second Quarter      23.00     22.25    0.15
  Third Quarter       22.00     17.75    0.15
  Fourth Quarter      17.75     15.75    0.16
                                        
  1997                                  
  ----                                  
                                        
  First Quarter      $18.25    $16.68   $0.14
  Second Quarter      17.13     15.75    0.14
  Third Quarter       21.68     17.06    0.14
  Fourth Quarter      22.50     20.50    0.15
 
</TABLE>

     At December 31, 1998 there were 1,250,356 shares of common stock
outstanding and 427 stockholders of record.

                                       28
<PAGE>
 
Item 6.  Selected Financial Data
--------------------------------

     The following tables set forth certain information concerning the financial
position and results of operations of the Company at the dates and for the
periods indicted:
<TABLE>
<CAPTION>
 
 
                                                                     December 31,
                                                 -----------------------------------------------------
                                                   1998       1997       1996       1995       1994
                                                 ---------  ---------  ---------  ---------  ---------
                                                         (In Thousands Except Per Share Data)
<S>                                              <C>        <C>        <C>        <C>        <C>
Summary of Financial Condition
------------------------------                 
Cash and cash equivalents (1)..................  $  4,044   $  4,195   $  1,327   $  2,725   $  1,708
Investment securities - available for sale.....    19,466     15,806         --         --         --
Investment securities - held-to-maturity.......    10,303     11,243     11,963     18,520     23,998
Loans, net.....................................   110,793    114,150    109,344    104,019     99,879
Goodwill.......................................       675        728        780        832        885
Investment in mortgage servicing rights........       978      3,027      1,728         --         --
All other assets...............................     4,697      4,331      5,759      5,973      5,961
                                                 --------   --------   --------   --------   --------
  Total assets.................................  $150,956   $153,480   $130,901   $132,069   $132,431
                                                 ========   ========   ========   ========   ========
 
Deposits.......................................  $116,762   $118,670   $107,343   $108,763   $110,205
Borrowings.....................................    10,500     10,500      1,200         --         --
All other liabilities..........................     2,147      2,136      1,831      1,900      1,818
Stockholders' equity...........................    21,547     22,174     20,527     21,406     20,408
                                                 --------   --------   --------   --------   --------
  Total liabilities and stockholders' equity...  $150,956   $153,480   $130,901   $132,069   $132,431
                                                 ========   ========   ========   ========   ========
 
Summary of Operations
---------------------                              
Interest income................................  $ 11,086   $ 10,846   $  9,867   $ 10,043   $  9,479
Interest expense...............................    (6,061)    (6,152)    (5,036)    (5,217)    (4,156)
                                                 --------   --------   --------   --------   --------
  Net interest income..........................     5,025      4,694      4,831      4,826      5,323
 
Provision for loan losses......................       (20)       (20)       (15)       (20)       (60)
                                                 --------   --------   --------   --------   --------
 
  Net interest income after provision for
    loan losses................................     5,005      4,674      4,816      4,806      5,263
 
Total other income (loss), net (2).............    (1,345)     1,426        661        512        421
Total general and administrative expenses (3)..    (3,247)    (3,058)    (3,812)    (3,144)    (2,975)
                                                 --------   --------   --------   --------   --------
 
Income before income taxes.....................       413      3,042      1,665      2,174      2,709
Income taxes...................................      (155)    (1,166)      (571)      (813)    (1,004)
                                                 --------   --------   --------   --------   --------
Net income.....................................  $    258   $  1,876   $  1,094   $  1,361   $  1,705
                                                 ========   ========   ========   ========   ========
 
Per share data:
  Net income - basic...........................     $0.21      $1.52      $0.89   $   1.11   $   1.34
  Net income - diluted.........................      0.21       1.52       0.87       1.08       1.30
                                                 --------   --------   --------   --------   --------
  Cash dividends declared......................     $0.61      $0.57      $0.53   $   0.49   $   0.45
                                                 ========   ========   ========   ========   ========
  Book value...................................    $17.23     $17.73     $16.94   $  16.63   $  15.93
                                                 ========   ========   ========   ========   ========
 
-------------------------
</TABLE>
(1)  Includes cash on hand and in banks, interest-bearing balances in other
     banks, and federal funds sold.
(2)  Includes gains on the sale of real estate acquired in settlement of loans
     of $427,000 in 1998 and $679,000 in 1997 and an impairment loss on
     investment in mortgage servicing rights of $2,161,000 in 1998.
(3)  For the year ending December 31, 1997, includes a special assessment paid
     to the FDIC in the amount of $720,000.

                                       29
<PAGE>
 
Key Operating Ratios

     The table below sets forth certain performance ratios of the Company for
the periods indicated.
<TABLE>
<CAPTION>
 
                                                                        Year Ended December 31,
                                                                ---------------------------------------
                                                                 1998     1997    1996    1995    1994
                                                                -------  ------  ------  ------  ------
<S>                                                             <C>      <C>     <C>     <C>     <C>
 
                Return on average assets (net income divided
                  by average total assets)....................    0.17%   1.26%   0.83%   1.02%   1.25%
                Return on average equity (net income divided
                  by average equity)..........................    1.18    9.12    5.43    6.49    8.50
                Equity to assets ratio (average equity
                  divided by average total assets)............   14.48   13.78   15.24   15.72   14.75
                Dividend payout ratio (dividends declared
                  per share divided by net income per share)..  290.48   37.50   59.55   44.14   33.58
 
</TABLE>


Item 7.  Management's Discussion and Analysis of Financial Condition and Results
--------------------------------------------------------------------------------
of Operations
-------------

     The purpose of this discussion and analysis is to provide the reader with a
description of the financial condition and results of operations of the Company
and Haywood Savings.  The discussion and analysis of financial condition and
results of operation should be read in conjunction with the audited consolidated
financial statements and accompanying notes included in this report.

     This discussion may contain statements that could be deemed forward-looking
statements within the meaning of the Securities Exchange Act of 1934 and the
Private Securities Litigation Reform Act of 1995, which statements are
inherently subject to risks and uncertainties.  Forward-looking statements are
statements that include projections, predictions, expectations or beliefs about
future events or results.  Words such as "expect," "believe," "estimate,"
"plan," or "project," are intended to identify these forward-looking statements.
These forward-looking statements are based on estimates, beliefs and assumptions
made by management and are not guarantees of future performance.  Factors that
could influence the accuracy of such forward-looking statements include, but are
not limited to, the changes in political and economic conditions, interest rate
movements, competitive product and pricing pressures within the Company's
markets, technological change and changes in legal, regulatory and tax policies.

     Asset/Liability Management.  The Bank's net interest income is dependent
primarily upon the difference or spread between the average yield earned on
loans, investment securities and the average rate paid on deposits, as well as
the relative amounts of such assets and liabilities.  Haywood Savings, as other
financial institutions, is subject to interest rate risk to the degree that its
interest-bearing liabilities mature or reprice at different times, or on a
different basis, than its interest-earning assets.

     Key components of a successful asset/liability management strategy are the
monitoring and managing of interest rate sensitivity of both the interest-
earning asset and interest-bearing liability portfolios.  Financial institutions
are subject to interest rate risk to the degree that their interest-bearing
liabilities (consisting  primarily of customer deposits) mature or reprice more
or less frequently, or on a different basis, than their interest-earning assets
(generally consisting of intermediate or long-term loans and investment
securities).  The regular evaluation of the sensitivity of net interest income
to changes in interest rates is an integral part of the Company's interest rate
risk management.

     The Bank has employed various strategies intended to minimize the adverse
effect of interest rate risk on future operations by providing a better match
between the interest rate sensitivity of its assets and liabilities. In
particular, the Bank's strategies are intended to stabilize net interest income
for the long-term by protecting its interest rate spread

                                       30
<PAGE>
 
against increases in interest rates. Such strategies include the origination for
portfolio of one-year, adjustable-rate loans and the origination of other types
of adjustable-rate and short-term loans with greater interest rate sensitivities
than long-term, fixed-rate loans. Management intends to continue employing these
strategies to minimize the potential negative impact on earnings due to interest
rate fluctuations.

Gap Analysis

     The term "interest rate sensitivity" refers to those assets and liabilities
which reprice periodically in response to fluctuations in market rates and
yields.  Thrift institutions have historically operated in a mismatched position
with interest-sensitive liabilities greatly exceeding interest-sensitive assets.
The Bank is attempting, through the use of adjustable rate mortgages and short-
term investments, to achieve a better match of the maturities of its assets and
liabilities.

     Increases in the Bank's adjustable-rate mortgage loan portfolio and
construction loans reflects management's strategy of reducing the Bank's gap
between interest-bearing liabilities and interest-earning assets that mature (or
reprice) in similar time periods.

     The following table sets forth the Bank's interest sensitivity gap between
interest-earning assets and interest-bearing liabilities as of December 31, 1998
based on their contractual terms to repricing or maturity.
<TABLE>
<CAPTION>
 
                                             Six Months   Over One
                                  Less Than    Through     Through    Over Five
                                 Six Months   One Year   Five Years     Years       Total
                                 -----------  ---------  -----------  ----------  ---------
                                                   (Dollars In thousands)
<S>                              <C>          <C>        <C>          <C>         <C>
 
Interest-earning assets:
 Investment securities(1)......    $  2,956   $     --     $ 13,633     $17,126   $ 33,715
 Fixed-rate loans..............       1,980        160        4,242      33,328     39,710
 Adjustable-rate loans.........      16,022     48,534        7,286          --     71,842
                                   --------   --------     --------     -------   --------
   Total.......................      20,958     48,694       25,161      50,454    145,267
                                   --------   --------     --------     -------   --------
Interest-bearing liabilities:
 Deposits......................      61,256     31,438       23,375         451    116,520
 Borrowings....................      10,500         --           --          --     10,500
                                   --------   --------     --------     -------   --------
   Total.......................    $ 71,756   $ 31,438     $ 23,375     $   451   $127,020
                                   ========   ========     ========     =======   ========
 
Interest sensitivity gap.......     (50,798)    17,256        1,786      50,003     18,247
 
Cumulative difference between
 interest-earning assets and
 interest-bearing liabilities..    $(50,798)  $(33,542)    $(31,756)    $18,247   $ 18,247
                                   ========   ========     ========     =======   ========
 
Cumulative difference between
 interest-earning assets and
 interest-bearing liabilities
 as a percent of total assets..     (33.65)%   (22.22)%     (21.04)%      12.09%     12.09%
                                   ========   ========     ========     =======   ========
 
-------------------------
</TABLE>
(1)  Includes investment securities and Federal Home Loan Bank stock, interest
     bearing balances in other banks, federal funds sold and other investments.

                                       31
<PAGE>
 
Average Balance, Interest and Average Yields and Rates

     The following table sets forth certain information relating to the Bank's
average interest-earning assets and interest-bearing liabilities and reflects
the average yield on assets and the average cost of liabilities for the periods
indicated.  Such yields and costs are derived by dividing income or expense by
the average daily balance of assets or liabilities, respectively, for the
periods indicated.  The average balances of loans and mortgage-backed securities
include loans on non-accrual status for each period.  The table also presents
information for the periods indicated with respect to the Company's "net
interest margin," which is its net interest income divided by the average
balance of interest-earning assets, and is a statistic which financial
institutions have traditionally used as an indicator of profitability.  Net
interest margin is affected by the interest rate spread (the difference between
the weighted average yield earned on interest-earning assets and weighted
average rate paid on interest-bearing liabilities) and by the relative amounts
of interest-earning assets and interest-bearing liabilities.
<TABLE>
<CAPTION>
 
                                                      Year Ended December 31,
                             ------------------------------------------------------------------------ 
                                            1998                                   1997     
                             -----------------------------------  ----------------------------------- 
                                                        Average                               Average               
                               Average                   Yield/     Average                   Yield/                            
                               Balance      Interest      Cost      Balance      Interest      Cost     
                             ------------  -----------  --------  ------------  -----------  --------   
<S>                          <C>           <C>          <C>       <C>           <C>          <C>        
                                                                                                        
Interest-earning assets:                                                                                
  Loans, net...............  $113,566,535  $ 9,062,275     7.98%  $112,728,628  $ 9,101,733     8.07%   
  Investment securities....    28,172,268    1,806,811     6.41     23,089,913    1,541,134     6.67    
  Interest-bearing                                                                                      
   balances in                                                                                          
   other banks.............       568,278       32,676     5.75        426,423       20,736     4.86    
  Other interest-earning                                                                                
   assets..................     2,872,071      184,081     6.41      2,743,162      182,657     6.66    
                             ------------  -----------            ------------  -----------             
     Total                                                                                              
      interest-earning                                                                                  
      assets...............   145,179,152   11,085,843     7.64    138,988,126   10,846,260     7.80    
                                           -----------                          -----------             
Noninterest-earning assets.     5,867,862                           10,189,874                          
                             ------------                         ------------                          
     Total assets..........  $151,047,014                         $149,178,000                          
                             ============                         ============                          
                                                                                                        
Interest-bearing                                                                                        
 liabilities:                                                                                           
  Deposits.................  $116,730,558  $ 5,465,072     4.68%  $115,581,893  $ 5,633,453     4.87%   
  Other borrowed money.....    10,534,409      596,126     5.66      8,873,650      519,101     5.85    
                             ------------  -----------            ------------  -----------             
     Total                                                                                              
      interest-bearing                                                                                  
      liabilities..........   127,264,967    6,061,198     4.76    124,455,543    6,152,554     4.94    
                                           -----------                          -----------             
Noninterest-bearing                                                                                     
 liabilities...............     1,906,153                            4,160,109                          
                             ------------                         ------------                          
     Total liabilities.....   129,171,120                          128,615,652                          
Stockholders' equity.......    21,875,894                           20,562,348                          
                             ------------                         ------------                          
     Total liabilities and                                                                              
      stockholders'                                                                                     
       equity..............  $151,047,014                         $149,178,000                          
                             ============                         ============                          
                                                                                                                      
Net interest income........                $ 5,024,645                          $ 4,693,706                           
                                           ===========                          ===========                           
                                                                                                                      
Interest rate spread.......                                2.88%                                2.86%                 
                                                           ====                                 ====                  
                                                                                                                      
Net interest margin........                                3.46%                                3.38%                 
                                                           ====                                 ====                  


<CAPTION>



                                             Year Ended December 31,
                                    ----------------------------------------
                                                       1996
                                    ----------------------------------------
                                                                      Average
                                      Average                          Yield/
                                      Balance         Interest         Cost
                                    ------------     ----------        -----
<S>                                 <C>              <C>               <C>
                                                                   
Interest-earning assets:                                           
  Loans, net...............         $107,296,135     $8,760,804        8.17%
  Investment securities....           16,412,777        940,568        5.73
  Interest-bearing                                                 
   balances in                                                     
   other banks.............              337,926         19,876        5.88
  Other interest-earning                                           
   assets..................            2,228,336        145,549        6.53
                                    ------------     ----------    
     Total                                                         
      interest-earning                                             
      assets...............          126,275,174      9,866,797        7.81
                                                     ----------     
Noninterest-earning assets.            5,839,576                   
                                    ------------                   
     Total assets..........         $132,114,750                   
                                    ============                   
                                                                   
Interest-bearing                                                   
 liabilities:                                                      
  Deposits.................         $110,111,811      5,018,715        4.56%
  Other borrowed money.....              209,685         17,299        8.25
                                    ------------     ----------    
     Total                                                         
      interest-bearing                                             
      liabilities..........          110,321,496      5,036,014        4.56
                                                     ----------    
Noninterest-bearing                                
 liabilities...............            1,661,097    
                                    ------------    
     Total liabilities.....          111,982,593    
Stockholders' equity.......           20,132,157    
                                    ------------    
     Total liabilities and                         
      stockholders'                                
       equity..............         $132,114,750    
                                    ============    
                                     
Net interest income........                          $4,830,783
                                                     ==========
                                     
Interest rate spread.......                                            3.25%
                                                                       ====
                                     
Net interest margin........                                            3.83%
                                                                       ====
</TABLE>

                                       32
<PAGE>
 
Rate/Volume Analysis

     The table below sets forth certain information regarding changes in
interest income and interest expense of the Bank for the periods indicated.  For
each category of interest-earning asset and interest-bearing liability,
information is provided on changes attributable to (1) changes in volume
(changes in volume, multiplied by old rate); (2) changes in rate (changes in
rate, multiplied by old volume); and (3) changes in rate-volume (changes in rate
multiplied by the change in volume.)  The change in interest income or expense
attributable to the combination of rate variance and volume variance is included
in the table, but such amount has also been allocated between, and included in
the amounts shown as, changes due to rate and changes due to volume.  The change
due to rate/volume variance has been allocated equally between the amounts due
solely to rate variance and solely to volume variance.

<TABLE>
<CAPTION>
 
 
                                                            Year Ended December 31,
                                  -----------------------------------------------------------------     
                                     1998       vs.        1997        1997       vs.        1996   
                                  --------------------------------  -------------------------------     
                                           Increase (Decrease)            Increase (Decrease)       
                                  --------------------------------  -------------------------------     
                                     Rate      Volume     Total        Rate      Volume      Total  
                                  ----------  --------  ----------  ----------  --------  ---------     
<S>                               <C>         <C>       <C>         <C>         <C>       <C>
 
Interest income:
 Loans..........................  $(106,717)  $ 67,259  $ (39,458)  $(100,166)  $441,095   $  340,929
 Investment securities..........    (66,910)   332,587    265,677     186,411    414,155      600,566
 Interest-bearing balances in                                                              
   other banks..................      4,413      7,527     11,940      (3,894)     4,754          860
 Other interest-earning assets..     (6,999)     8,423      1,424       3,154     33,954       37,108
                                  ---------   --------  ---------   ---------   --------   ----------
    Total interest income.......   (176,213)   415,796    239,583      85,505    893,958      979,463
                                                                                           
Interest expense:                                                                          
 Deposits.......................   (223,264)    54,883   (168,381)    356,773    257,965      614,738
 Borrowings.....................    (18,542)    95,567     77,025    (112,337)   614,139      501,802
                                  ---------   --------  ---------   ---------   --------   ----------
  Total interest expense........   (241,806)   150,450    (91,356)    244,436    872,104    1,116,540
                                  ---------   --------  ---------   ---------   --------   ----------
Net interest income.............  $  65,593   $265,346  $ 330,939   $(158,931)  $ 21,854   $ (137,077)
                                  =========   ========  =========   =========   ========   ==========
 
</TABLE>
General

     The Company realized net earnings in 1998 of $258,000, or $0.21 basic net
income per share, resulting in a return of 0.17% on average assets and 1.18% on
average equity.  Net income for 1997 was $1,875,518, or $1.52 basic net income
per share, which resulted in a return of 1.26% on average assets and 9.12% on
average equity.

Comparison of Financial Condition at December 31, 1998 and 1997

          Total assets decreased by $2.5 million, or 1.6%, from $153.5 million
at December 31, 1997 to $151.0 million at December 31, 1998.  A significant
portion of the decrease is due to an approximately $2.2 million impairment
valuation adjustment to investment in mortgage servicing rights.  As discussed
above, the impairment and subsequent write-down of the mortgage servicing rights
is due to significant prepayments of the underlying mortgage loans due to a
decline in mortgage loan interest rates.  The mortgage servicing rights were
written down to their fair value based on an appraisal prepared by an
independent third party.

          In addition, loans receivable decreased by $3.4 million or 2.9% to
$110.8 million at December 31, 1998 compared to $114.2 million at December 31,
1997.  The decrease is mainly in single family residential mortgage loans due to
competitive pressures in the Company's marketplace created in part by the
falling interest rate environment during 1998.

          The Company invested excess funds from loan run-off  in investment
securities available for sale, which increased from $15.8 million at December
31, 1997 to $19.5 million at December 31, 1998.

                                       33
<PAGE>
 
          Deposits decreased $1.9 million or 1.6% to $116.8 million at December
31, 1998 from $118.7 million at December 31, 1997.  This is mainly due to a
decrease in certificate of deposit accounts of approximately $3.4 million
resulting from competitive pressures in the marketplace for such deposits.  The
decrease in certificates of deposits was offset in part by increases in
interest-bearing demand accounts of approximately $1.5 million.  The increase in
interest-bearing demand accounts is due to the Company offering competitive
interest rates on such accounts as compared to the marketplace.

          Stockholders' equity decreased approximately $626,000 from 1997 to
1998.  This is due to the decreased level of earnings in 1998 coupled with the
increase in cash dividends declared. Net income for the year ended December 31,
1998 was $258,000 and cash dividends declared were $763,000 or $.61 per share.
This compares to net income of $1.9 million in 1997 and cash dividends of
$714,000 or $.57 per share.  Also attributing to the decrease is an unrealized
loss on securities available for sale of $162,000 at December 31, 1998 compared
to an unrealized gain on securities available for sale of $57,000 at December
31, 1997.

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 servicing 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, and income taxes.

Comparison of Operating Results 1998 Versus 1997

          Summary.  Net income for the year ended December 31, 1998 decreased to
$258,000, or $.21 basic net income per share, from $1,876,000, or $1.52 basic
net income per share, in 1997.  The decrease in net income is due to a
$2,158,000 loss on investment in mortgage servicing rights.  This loss was
partially offset by a $403,000 pre-tax gain on the sale of two outparcels to the
Waynesville Plaza Shopping Center, which the Company had been holding as real
estate acquired in settlement of loans.  In addition, net interest income
increased by $331,000 and general and administrative expenses increased by
$188,000.

          Net Interest Income.  Total interest income in 1998 was $11.1 million,
a $240,000, or 2.2%, increase from 1997.  The primary reason for the change was
an increase in the balance of average interest earning assets of approximately
$6.2 million.  This was due to an increase in average investment securities of
$5.1 million and average loans of $838,000.  The growth in average interest
earning assets was offset by a decrease in average yield on interest-earning
assets from 7.80% in 1997 to 7.64% in 1998.  The average yield on loans
receivable decreased 9 basis points to 7.98% in 1998 from 8.07% in 1997 due to
the falling rate environment during 1998 and competitive pressures in the
marketplace.  In addition, the average yield on investment securities decreased
from 6.67% in 1997 to 6.41% in 1998.

          Total interest expense decreased $91,000, or 1.48%, in 1998 due a
decrease in the average cost of funds on the Company's deposit base from 4.87%
in 1997 to 4.68% in 1998.  This was offset in part by an increase in the average
balance of interest bearing liabilities of $2.8 million.  The increase in the
average balance is due to a $1.7 million increase in average borrowings and a
$1.1 million increase in average deposits.  The increase in borrowings is due to
$10.5 million in advances from the Federal Home Loan Bank borrowed during the
first quarter of 1997.

          The overall net effect of these changes was a $331,000, or 7.1%,
increase in net interest income in 1998 compared to 1997.  The interest rate
spread increased slightly to 2.88% in 1998 from 2.86% in 1997.  Net interest
income as a percentage of average interest-earning assets was 3.46% in 1998
compared to 3.38% in 1997.

          Provisions 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 absorb estimated probable losses inherent in the loan
portfolio based on existing loan levels and types of loans outstanding,
nonperforming loans, prior loan loss experience,

                                       34
<PAGE>
 
general economic conditions and other factors.  Provisions for loan losses
totaled $20,000 in both 1998 and 1997.  The Company had no charge-offs and no
recoveries in either 1998 or 1997.

          Other Income.  Other income decreased $2.8 million or 194% in 1998
compared to 1997 due to an approximately $2,161,000 impairment valuation
adjustment to an equity investment in a mortgage servicing partnership.  The
underlying mortgage servicing rights were written down to their fair value based
on an independent appraisal.  The impairment and subsequent write-down of the
mortgage servicing rights is due to significant prepayments of the underlying
mortgage loans due to a decline in mortgage loan interest rates.  Total loss on
mortgage servicing rights was $2,158,000 in 1998 compared to income of $136,000
in 1997.

          The investment in mortgage servicing rights is evaluated periodically
by management for impairment and no assurance can be given that additional
impairment valuation adjustments will not be required in the future.  For
additional information, see footnote (6) to the consolidated financial
statements.

          Also attributing to the change in other income was a decrease in net
gains on sales of real estate acquired in settlement of loans of approximately
$252,000 and a decrease in income from real estate operations, net of
approximately $266,000.  In 1997, the Company sold the Waynesville Plaza
Shopping Center for a pre-tax gain of approximately $679,000, and as a result,
no longer receives rental and other income associated with operating the
shopping center.  In 1998, the Company sold two outparcels to the Waynesville
Plaza Shopping Center for a pre-tax gain of approximately $403,000.

          General and Administrative Expenses.  General and administrative
expenses increased $188,000, or 6.2%.  The increase is mainly due to an increase
in salaries and employee benefits of $162,000.  This is due to normal salary
increases and increases in deferred compensation expense due to a change in the
discount rate from 8% to 7%.  Other changes in general and administrative
expenses were due to normal increases arising from growth in the Company's
operation and inflationary factors.

          Income Taxes.  The Company's effective income tax rate was 37.5% in
1998 compared to 38.3% in 1997.  The decrease in the effective tax rate in 1998
is largely attributable to a decrease in state income taxes.

Comparison of Financial Condition and Operating Results 1997 Versus 1996

          Summary.  Net income was $1,875,518, or $1.52 basic net income per
share, in 1997 compared to net income of $1,093,796, or $.89 basic net income
per share, in 1996 which represents a 71% increase.  The Company's net income
was affected by certain non-recurring items in both 1997 and 1996.  In 1997, the
Company recognized a $679,000 pre-tax gain on the sale of Waynesville Plaza
Shopping Center, which the Company has been holding as real estate acquired in
settlement of loans.  By contrast in 1996, the Company recognized a one-time
$720,000 pre-tax expense for its portion of a special assessment imposed by the
FDIC to recapitalize the SAIF.

          Net Interest Income.  Total interest income increased $979,000, or
9.9%, to $10.8 million in 1997 from $9.9 million in 1996.  The increase in
interest income is principally due to an increase in the average balance of
interest earning assets of approximately $12.7 million.  The average yield on
interest earning assets decreased slightly from 7.81% in 1996 to 7.80% in 1997.

          Total interest expense increased $1,117,000, or 22.2%, in 1997, due to
an increase in both the average balance of interest bearing liabilities and the
average cost of funds.  The average balance of interest bearing liabilities
increased from $110.3 million in 1996 to $124.5 million in 1997, while the cost
of funds increased from 4.56% in 1996 to 4.94% in 1997.  The increase in the
average balance is mainly due to the Company borrowing $10.5 million in advances
from the FHLB of Atlanta during the first quarter of 1997.  In addition, average
deposits increased approximately $5.5 million.  The increase in the cost of
funds is due to the rates paid on FHLB advances and an increase in rates on
certificate of deposit accounts due to competitive pressures in the marketplace.

                                       35
<PAGE>
 
          The overall net effect of these changes was a $137,000, or 2.84%,
increase in net interest income in 1997 compared to 1996.  The interest rate
spread decreased to 2.86% in 1997 from 3.25% in 1996.  Net interest income as a
percentage of average interest-earning assets was 3.38% in 1997 compared to
3.83% in 1996.

          Provisions for Loan Losses.  During 1997 and 1996, management recorded
provisions for loan losses of $20,000 and $15,000, respectively.  The increase
in the provision for loan losses in 1997 was due to the growth in the Company's
loan portfolio.  The Company had no charge-offs and no recoveries in either 1997
or 1996.  As discussed above, management determines the provision for loan
losses based on their review of the loan portfolio and their estimate of the
allowance for loan losses required to absorb estimated probable losses inherent
in the loan portfolio.

          Other Income.  Other income increased $766,000 or 115.9% in 1997
compared to the same period in 1996 primarily as a result of the sale of the
Waynesville Plaza Shopping Center for a gain of approximately $679,000.  As a
result of the sale, the Company will no longer receive rental and other income
attributable to its operation of the shopping center.  In addition, the Company
recognized income of $136,000 on mortgage servicing rights compared to no such
income during 1996.

          General and Administrative Expenses.  General and administrative
expenses decreased $754,000, or 19.8% in 1997.  The decrease is primarily due to
a one-time cost of approximately $720,000 pre-tax pertaining to a special
assessment by the FDIC on all SAIF insured financial institutions to
recapitalize the SAIF which was recorded in 1996.  Federal and other insurance
premiums decreased $844,000 to $86,000 as a result of this special assessment in
the prior year.  As a result of the recapitalization of the SAIF, the FDIC
reduced Haywood Savings' annual assessment rate for deposit insurance from 0.23%
of insured deposits to zero effective October 1, 1996 and Haywood Savings
received a refund of a previously paid deposit insurance premium of
approximately $63,000 in December 1996.  Until December 31, 1999, however,
Haywood Savings and all other SAIF insured institutions will be required to pay
assessments to the FDIC at the rate of 6.5 basis points to help fund interest
payments on certain bonds issued by the Financing Corporation ("FICO"), an
agency of the federal government established to finance takeovers of insolvent
thrifts.

          Income Taxes.  The Company's effective income tax rate was 38.3% in
1997 compared to 34.3% in 1996.  The increase in the effective tax rate is due
to part to an increase in state income taxes due to a decrease in the level of
investment securities that are exempt for state tax purposes.

Asset Quality

          The Company's loan portfolio consists primarily of lower risk single
family, 1-4 unit, residential loans.  At December 31, 1998, the Company had
approximately $841,000 of loans in nonaccrual status as compared to $583,000 at
December 31, 1997.  At December 31, 1998 and 1997, the Company had no loans that
were considered to be impaired.  There were no loans contractually past due 90
days or more and still accruing at December 31, 1998 and 1997.  In the opinion
of management, there are no other loans which cause management to have serious
doubts as to the ability of such borrowers to comply with the present repayment
terms which could result in becoming classified as problem assets.  During 1998,
1997 and 1996, the Company had no loan charge-offs.  The Company's year-end
allowance for loan losses was $759,000, or .68% of outstanding loans.  This
compares to .64% and .65% for 1997 and 1996, respectively.

          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 given to 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.  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.

                                       36
<PAGE>
 
          At December 31, 1998, the Company had real estate acquired in
settlement of loans of approximately $7,000 as compared to $246,000 at December
31, 1997.  During 1998, the Company sold two outparcels to the Waynesville Plaza
Shopping Center, with book values of approximately $210,000 for gains of
approximately $403,000.  Real estate acquired in settlement of loans consists of
single family residences at December 31, 1998.

Year 2000 Readiness Disclosure

          The Company recognizes and is addressing the potentially severe
implications of the "Year 2000 Issue."  The Year 2000 Issue is a general term
used to describe the various problems that may result from the improper
processing of dates and date-sensitive calculations as the Year 2000 approaches.
This issue is caused by the fact that many of the world's existing computer
programs use only two digits to identify the year in the date field of a
program.  These programs were designed and developed without considering the
impact of the upcoming change in the century and could experience serious
malfunctions when the last two digits of the year change to "00" as a result of
identifying a year designated "00" as the year 1900 rather than the year 2000.
This misidentification could prevent the Company from being able to engage in
normal business operations, including, among other things, miscalculating
interest accruals and the inability to process customer transactions.

          The Company's Board of Directors has approved a Year 2000 Plan that
was developed in accordance with guidelines set forth by the Federal Financial
Institutions Examination Council.  This plan has three primary phases related to
internal Year 2000 compliance.

          The first phase of the Company's efforts to address the Year 2000
Issue was to inventory all known Company processes that could reasonably be
expected to be impacted by the Year 2000 Issue and their related vendors, if
applicable.  This phase is complete, although it is periodically updated as
necessary.

          The Company's second phase in addressing the Year 2000 Issue was to
contact all third party vendors, request documentation regarding their Year 2000
compliance efforts, and analyze the responses.  This was a significant phase
because the Company does not perform in-house programming, and thus is dependent
on external vendors to ensure and modify, if necessary, the hardware, software,
or service it provides to the Company to be Year 2000 compliant.  This phase is
now complete and the Company has followed up on any issues or concerns
identified from the responses received.

          The next phase for the Company under the plan is to complete a
comprehensive testing of all known processes.  The most significant phases of
testing is the testing of the Company's mainframe computer system, teller
terminals and core software applications.  The Company installed a new mainframe
computer system and teller terminals in September 1998 that are Year 2000
compliant.  Both systems were tested in September 1998.  Upgrades of the core
software applications currently used by the Company were received from the
software vendor in September and were represented to be Year 2000 compliant by
the vendor.  These applications were successfully loaded on the Company's
hardware system in September and Year 2000 testing was also completed
immediately after installation.

          Another part of the Company's Year 2000 plan is to assess the Year
2000 readiness of its significant borrowers and depositors.  Through the use of
questionnaires and personal contacts, the Company is in the process of assessing
the Year 2000 readiness of significant borrowers and depositors of the Company.
Since the majority of the loans are to individuals and secured by one to four
family residences, this step is not expected to require a significant amount of
time or resources.

          The Company had previously estimated the total costs to address the
Year 2000 Issue to be $180,000.  Approximately $117,500 of these costs related
to the installation of the mainframe computer system and were capitalized in
accordance with the Company's capitalization policy.  Year 2000 project costs
incurred and expensed during the year ended December 31, 1998 were approximately
$149,000.  Funding of the Year 2000 project costs will come from normal
operating cash flows, however, the expenses associated with the Year 2000 Issue
will directly reduce otherwise reported net income for the Company.

                                       37
<PAGE>
 
          Management of the Company believes that the potential effects of the
Company's internal operations of the Year 2000 Issue can and will be addressed
prior to the Year 2000.  However, if required modifications or conversions are
not made or are not completed on a timely basis prior to the Year 2000, the Year
2000 Issue could disrupt normal business operations.  The most reasonably likely
worst case Year 2000 scenarios foreseeable at this time would include the
Company temporarily not being able to process, in some combination, various
types of customer transactions.  This could affect the ability of the Company
to, among other things, originate new loans, post loan payments, accept deposits
or allow immediate withdrawals, and, depending on the amount of time such a
scenario lasted, could have a material adverse effect on the Company.  Because
of the serious implications of these scenarios, the primary emphasis of the
Company's Year 2000 plan is to correct, with complete replacement, if necessary,
any systems or processes whose Year 2000 test results are not satisfactory prior
to the Year 2000.  Nevertheless, should one of the most reasonably likely worst
case scenarios occur in the Year 2000, the Company is also in the process of
formalizing a contingency plan that would allow for limited transactions,
including the ability to make certain deposit withdrawals, until the Year 2000
problems are fixed.

          The costs of the Year 2000 project and the date on which the Company
plans to complete Year 2000 compliance are based on management's best estimates,
which were derived using numerous assumptions of future events such as the
availability of certain resources (including internal and external resources),
third party vendor plans and other factors.  However, there can be no guarantee
that these estimates will be achieved at the cost disclosed or within the time
frame indicated, and actual results could differ materially from these plans.
Factors that might affect the timely and efficient completion of the Company's
Year 2000 project include, but are not limited to, vendors' abilities to
adequately correct or convert software and the effect on the Company's ability
to test its systems, the availability and cost of personnel trained in the Year
2000 area, the ability to identify and correct all relevant computer programs
and similar uncertainties.

Liquidity and Asset Liability Management

          The Company's asset-liability management policy is to maintain and
enhance the net interest income and provide adequate liquidity to meet
continuing loan demand, withdrawal requirements, and pay for normal operating
expenses.  Liquidity is provided by the ability to attract deposits, short-term
investment strategy, loan repayments, and current earnings.

          At December 31, 1998, the Company had approximately $33.8 million in
cash, interest-bearing balances in other banks, federal funds sold, and
investment securities.  Management believes that the level of liquidity at
December 31, 1998 is adequate and in compliance with regulatory requirements.

          A primary objective in interest rate management is the avoidance of
wide fluctuations in net interest income due to interest rate movements.
Management conducts, on a regular basis, various analyses to determine the gap
representing the difference between repricing assets and repricing liabilities.
At December 31, 1998, the Company's balance sheet is liability sensitive,
meaning that in a given period there will be more liabilities than assets
subject to immediate repricing as market rates change.  Because immediately rate
sensitive interest bearing liabilities exceed rate sensitive assets, the
earnings position could improve in a declining rate environment and could
deteriorate in a rising rate environment, depending on the correlation of rate
changes in these two categories.  At December 31, 1998 total rate sensitive
liabilities maturing or repricing within one year were $103.2 million compared
to rate sensitive assets maturing or repricing in one year of $69.7 million for
a cumulative gap of $33.5 million.  It should be noted that interest-sensitivity
of the balance sheet as of a specific date is not necessarily indicative of the
Company's position on other dates.

Committed Resources

          The Company had loan commitments, including undisbursed proceeds on
loans in process and preapproved but unused lines of credit for home equity
loans, of approximately $5,089,000 outstanding at December 31, 1998.  Of this
amount, $3,019,000 represent adjustable rate commitments and $2,070,000
represent fixed rate commitments.

                                       38
<PAGE>
 
These commitments were primarily for construction and conventional residential
lending and will be funded primarily from loan principal repayments and other
normal sources of liquidity.

Capital Resources

          As a North Carolina-chartered savings bank, Haywood Savings is subject
to the capital requirements of the FDIC and the N.C. Administrator of Savings
Institutions ("the Administrator").  The FDIC requires Haywood Savings 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.  To be "well
capitalized," the FDIC requires ratios of Tier I capital to total risk-weighted
assets and total capital to risk-weighted assets of 6% and 10%, 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 I capital plus certain adjustments, the only one of
which is applicable to Haywood Savings is the allowance for loan losses.  Risk-
weighted assets reflect Haywood Savings' on- and off-balance sheet exposures
after such exposures have been adjusted for their relative risk levels using
formulas set forth in FDIC regulations.  Haywood Savings 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%, and a ratio of 5% to
be "well capitalized."  The Administrator requires a net worth equal to at least
5% of assets.  At December 31, 1998, Haywood Savings was in compliance with the
capital requirements of both the FDIC and the Administrator and is deemed to be
"well capitalized."

Effects of Inflation

          The major portions of a bank's assets and liabilities are monetary in
nature.  As a result of this distinct asset and liability structure, performance
may be more significantly influenced by changes in interest rates than by
inflation.  Although inflation has a lesser influence on a bank's performance,
operating expenses may be affected in that personnel expenses, supply costs, and
outside services tend to increase during periods of inflation.  Also, inflation
affects the level of interest rates prevailing at any one time.

Accounting Issues

          In June 1998, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" (SFAS No. 133).  SFAS No. 133 establishes
accounting and reporting standards for derivative instruments and for hedging
activities.  SFAS No. 133 is effective for all fiscal quarters of fiscal years
beginning after June 15, 1999.  The Company plans to adopt SFAS No. 133 in 2000
without any impact on its financial statements as the Company does not have any
derivative financial instruments and is not involved in any hedging activities.

          In October 1998, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 134, "Accounting for Mortgage-
Backed Securities Retained after the Securitization of Mortgage Loans Held for
Sale by a Mortgage Banking Enterprise" (SFAS No. 134).  SFAS No. 134 establishes
accounting and reporting standards for certain mortgage banking activities.
SFAS No. 134 is effective for financial statements for the first fiscal quarter
beginning after December 15, 1998.  The Company plans to adopt SFAS No. 134 in
1999 without any impact on its financial statements.

Item 7A.  Quantitative and Qualitative Disclosures About Market Risk
--------------------------------------------------------------------

     This item is not applicable to the Registrant which qualifies as a "small
business issuer."

                                       39
<PAGE>
 
Item 8.  Financial Statements and Supplementary Data
----------------------------------------------------

                   Index to Consolidated Financial Statements
                   of Haywood Bancshares, Inc. and Subsidiary
<TABLE>
<CAPTION>
 
<S>                                                                                             <C>
Independent Auditors' Report                                                                         41
 
Consolidated Statements of Financial Condition as of December 31, 1998 and 1997                      42
 
Consolidated Statements of Income for the years ended December 31, 1998, 1997 and 1996               43
 
Consolidated Statements of Stockholders' Equity and Comprehensive Income for the years ended
   December 31, 1998, 1997 and 1996                                                                  44
 
Consolidated Statements of Cash Flows for the years ended December 31,
       1998, 1997 and 1996                                                                      45 - 46
 
Notes to Consolidated Financial Statements for the years ended December 31,
       1998, 1997 and 1996                                                                           47
</TABLE>

                                       40
<PAGE>
 
                          Independent Auditors' Report


The Board of Directors
Haywood Bancshares, Inc.
Waynesville, North Carolina:

We have audited the consolidated statement of financial condition of Haywood
Bancshares, Inc. and subsidiary (the Corporation) as of December 31, 1998 and
1997, and the related consolidated statements of income, stockholders' equity
and comprehensive income, 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 Corporation'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 Haywood Bancshares,
Inc. and subsidiary at 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/ KPMG LLP

Charlotte, North Carolina
February 26, 1999

                                       41
<PAGE>
 
                    HAYWOOD BANCSHARES, INC. AND SUBSIDIARY

                Consolidated Statements of Financial Condition

                          December 31, 1998 and 1997

<TABLE>
<CAPTION>
                                                                                          1998           1997
                                                                                    --------------   -------------
<S>                                                                                  <C>              <C> 
                                ASSETS
Cash on hand and in banks                                                             $  1,525,035       1,736,787
Interest-bearing balances in other banks                                                   805,357         418,967
Federal funds sold                                                                       1,713,611       2,039,247
Investment securities (note 2):
 Available for sale (cost of $19,711,642 and $15,719,503
  at December 31, 1998 and 1997, respectively)                                          19,466,200      15,805,611
 Held-to-maturity (market value of $10,332,472 and
  $11,303,051 at December 31, 1998 and 1997, respectively)                              10,302,987      11,242,929
Loans (net of allowance for loan losses of $758,547 and
 $738,547 at December 31, 1998 and 1997, respectively) (note 3)                        110,792,991     114,150,356
Real estate acquired in settlement of loans (note 4)                                         7,192         246,078
Federal Home Loan Bank stock, at cost                                                    1,427,300       1,427,300
Premises and equipment (note 5)                                                          1,565,173       1,551,510
Investment in mortgage servicing rights (note 6)                                           977,720       3,027,116
Goodwill                                                                                   675,030         727,530
Other assets (note 8)                                                                    1,697,128       1,106,143
                                                                                     -------------   -------------
               Total assets                                                          $ 150,955,724   $ 153,479,574
                                                                                     =============   =============
              LIABILITIES AND STOCKHOLDERS' EQUITY
Deposit accounts:
 Noninterest-bearing                                                                 $     241,823   $     199,170
 Interest-bearing, including $15,245,006 in 1998 and
  $13,973,839 in 1997 of time deposits for $100,000
  or more (note 7)                                                                     116,519,550     118,471,286
                                                                                     -------------   -------------
               Total deposits                                                          116,761,373     118,670,456
FHLB advances (note 15)                                                                 10,500,000      10,500,000
Accrued expenses and other liabilities (notes 8 and 9)                                   2,146,919       2,135,586
                                                                                     -------------   -------------
               Total liabilities                                                       129,408,292     131,306,042
                                                                                     -------------   -------------
Stockholders' equity (notes 11, 12 and 13):
 Serial preferred stock, $1.00 par value, 5,000,000 shares
   authorized; no shares issued or outstanding                                                  --              --
 Common stock, $1.00 par value, 10,000,000 shares authorized;
   issued and outstanding 1,250,356 shares in 1998 and 1997                              1,250,356       1,250,356
 Additional paid-in capital                                                              3,521,612       3,437,275
 Retained income, substantially restricted                                              16,937,456      17,487,686
 Accumulated other comprehensive income:
  Unrealized gain on investment securities available for sale,
    net of tax                                                                            (161,992)         56,831
 Less obligation in connection with funds used to acquire
    common shares by ESOP                                                                       --         (58,616)
                                                                                     -------------   -------------
                Total stockholders' equity                                              21,547,432      22,173,532
Commitments (note 3)
                                                                                     -------------   -------------
                                                                                     $ 150,955,724   $ 153,479,574
                                                                                     =============   =============

</TABLE> 

         See accompanying notes to consolidated financial statements.

                                      42
<PAGE>
 
                    HAYWOOD BANCSHARES, INC. AND SUBSIDIARY

                       Consolidated Statements of Income

                 Years ended December 31, 1998, 1997 and 1996
<TABLE>
<CAPTION>
                                                          1998             1997            1996
                                                     ---------------   -------------   -------------
<S>                                                 <C>                <C>              <C> 
Interest income:                                                                       
 Loans                                               $     9,062,275  $    9,101,733   $   8,760,804
 Investment securities                                     1,806,811       1,541,134         940,568
 Interest-bearing balances in other banks                     32,676          20,736          19,876
 Federal funds sold                                           77,913          79,178          35,948
 Other                                                       106,168         103,479         109,601
                                                     ---------------   -------------   -------------
        Total interest income                             11,085,843      10,846,260       9,866,797
                                                     ---------------   -------------   -------------
Interest expense:                                                                      
 Deposits, including $563,091 in 1998, $577,599 in                                     
  1997, and $434,257 in 1996 on time deposits for                                      
  $100,000 or more                                         5,465,072       5,633,453       5,018,715
 FHLB advances (note 15)                                     594,073         511,246              --
 Other (note 14)                                               2,053           7,855          17,299
                                                     ---------------   -------------   -------------
        Total interest expense                             6,061,198       6,152,554       5,036,014
                                                     ---------------   -------------   -------------
        Net interest income                                5,024,645       4,693,706       4,830,783
Provision for loan losses (note 3)                            20,000          20,000          15,000
                                                     ---------------   -------------   -------------
        Net interest income after provision for                                        
         loan losses                                       5,004,645       4,673,706       4,815,783
                                                     ---------------   -------------   -------------
Other income (loss):                                                                   
 Insurance income, net                                       186,828         179,901         168,063
 Rental income                                                50,244          49,132          50,835
 Service charges on deposits                                  60,826          70,818          66,064
 Gain on sale of investment securities available                                       
  for sale                                                     6,418              --              --
 Gain on sale of real estate acquired in settlement                                    
  of loans (note 4)                                          426,872         679,349          12,695
 Real estate operations, net (note 4)                          2,795         269,061         335,598
 Income (loss) from mortgage servicing rights             (2,158,071)        135,791              --
 Other income                                                 79,104          42,179          27,421
                                                     ---------------   -------------   -------------
        Total other income (loss)                         (1,344,984)      1,426,231         660,676
                                                     ---------------   -------------   -------------
General and administrative expenses:                                                   
 Salaries and employee benefits (notes 9 and 13)           1,895,291       1,733,344       1,673,844
 Occupancy and equipment                                     335,569         346,302         369,390
 Federal and other insurance premiums (note 10)               81,543          85,876         930,297
 Amortization of goodwill                                     52,500          52,500          52,500
 Other expenses                                              881,460         839,897         785,632
                                                     ---------------   -------------   -------------
        Total general and administrative expenses          3,246,363       3,057,919       3,811,663
                                                     ---------------   -------------   -------------
        Income before income taxes                           413,298       3,042,018       1,664,796
Income taxes (note 8)                                        155,000       1,166,500         571,000
                                                     ---------------   -------------   -------------
        Net income                                   $       258,298   $   1,875,518   $   1,093,796
                                                     ===============   =============   =============
Per share amounts (note 11):                                                           
 Net income - basic                                  $          0.21   $        1.52   $        0.89
                                                     ===============   =============   =============
 Net income - diluted                                $          0.21   $        1.52   $        0.87
                                                     ===============   =============   =============
</TABLE> 
         See accompanying notes to consolidated financial statements.
                                      43
<PAGE>
 
                    HAYWOOD BANCSHARES, INC. AND SUBSIDIARY

   Consolidated Statements of Stockholders' Equity and Comprehensive Income

                 Years ended December 31, 1998, 1997 and 1996
<TABLE>
<CAPTION>
                                                                                           Accumulated
                                                              Additional                      Other                        Total
                                                  Common       Paid-in       Retained     Comprehensive   Obligation  Stockholders'
                                                  Stock        Capital        Income         Income        of ESOP        Equity
                                                ----------   ------------   ------------   ------------  -----------  -------------
<S>                                             <C>          <C>            <C>             <C>          <C>          <C> 
Balance at December 31, 1995                    $1,287,372   $  4,652,561   $ 15,825,090   $         --  $  (358,754) $ 21,406,269


Comprehensive income:
 Net income                                             --             --      1,093,796             --           --     1,093,796
                                                                                                                       -----------
  Total comprehensive income                                                                                             1,093,796

Repurchase of common stock                         (92,216)    (1,569,097)            --             --           --    (1,661,313)
Cash dividends declared on common stock,
 $.53 per share                                         --             --       (649,222)            --           --      (649,222)
Stock options exercised                             16,700         70,988             --             --           --        87,688
Principal repayment of ESOP debt                        --             --             --             --      157,346       157,346
Release and allocation of ESOP shares                   --         63,554        (23,443)            --           --        40,111
Tax benefit on stock options exercised                  --             --         52,219             --           --        52,219
                                                ----------   ------------   ------------   ------------  -----------   -----------
Balance at December 31, 1996                     1,211,856      3,218,006     16,298,440             --     (201,408)   20,526,894

Comprehensive income:
 Net income                                             --             --      1,875,518             --           --     1,875,518
 Other comprehensive income - unrealized
  gain on securities available for sale, net
  of income taxes $29,277                               --             --             --         56,831           --        56,831
                                                                                                                       -----------
  Total comprehensive income                                                                                             1,932,349

Repurchase of common stock                          (5,500)       (82,157)            --             --           --       (87,657)
Cash dividends declared on common stock,
 $.57 per share                                         --             --       (713,684)            --           --      (713,684)
Stock options exercised                             44,000        194,750             --             --           --       238,750
Principal repayment of ESOP debt                        --             --             --             --      142,792       142,792
Release and allocation of ESOP shares                   --        106,676        (39,052)            --           --        67,624
Tax benefit on stock options exercised                  --             --         66,464             --           --        66,464
                                                ----------   ------------   ------------   ------------  -----------   -----------
Balance at December 31, 1997                     1,250,356      3,437,275     17,487,686         56,831      (58,616)   22,173,532

Comprehensive income:
 Net income                                             --             --        258,298             --           --       258,298
 Other comprehensive income - unrealized
 gain on securities available for sale, net
  of income taxes of $112,727                           --             --             --       (218,823)          --      (218,823)
                                                                                                                       -----------
  Total comprehensive income                                                                                                39,475

Cash dividends declared on common stock,
 $.61 per share                                         --             --       (762,716)            --           --      (762,716)
Principal repayment of ESOP debt                        --             --                            --       58,616        58,616
Release and allocation of ESOP shares                   --         84,337        (45,812)            --           --        38,525
                                                ----------   ------------    -----------   ------------  -----------   -----------
Balance at December 31, 1998                    $1,250,356   $  3,521,612    $16,937,456   $   (161,992) $        --   $21,547,432
                                                ==========   ============    ===========   ============  ===========   ===========
</TABLE> 

See accompanying notes to consolidated financial statements.

                                      44
<PAGE>
 
                     HAYWOOD BANCSHARES, INC. AND SUBSIDIARY

                      Consolidated Statements of Cash Flows

                  Years ended December 31, 1998, 1997 and 1996
<TABLE> 
<CAPTION> 
                                                                    1998            1997            1996
                                                               --------------   -------------   -------------
<S>                                                            <C>              <C>             <C>      
Cash flows from operating activities:                                                           
    Net income                                                 $      258,298       1,875,518       1,093,796
    Adjustments to reconcile net income to net cash                                             
       provided by operating activities:                                                        
         Provision for loan losses                                     20,000          20,000          15,000
         Depreciation and amortization, net                           193,573         170,512         142,156
         Amortization of goodwill                                      52,500          52,500          52,500
         Loss (income) from mortgage servicing rights               2,158,071        (135,791)             --
         Increase (decrease) in allowance for                                                   
            uncollected interest                                       18,544           2,838         (51,014)
         Net gain on sale of investment securities                                              
            available for sale                                         (6,418)             --              --
         Net gain on sale of fixed assets                                  --          (5,439)             --
         Net gain on sale of real estate acquired in                                            
            settlement of loans                                      (426,872)       (679,349)        (12,695)
         Increase in other assets                                    (478,258)       (254,366)        (81,637)
         Increase in accrued expenses and other                                                 
            liabilities                                                57,445         494,878         139,365
         Increase in deferred loan fees, net                           41,488          55,790          56,927
         Net noncash expense recorded for ESOP                         38,525          67,624          40,111
                                                                --------------  --------------  --------------
                   Net cash provided by operating                                               
                      activities                                    1,926,896       1,664,715       1,394,509
                                                                --------------  --------------  --------------
Cash flows from investing activities:                                                           
    Purchases of investment securities held to maturity           (11,685,676)     (5,400,000)     (4,800,000)
    Purchases of investment securities available for sale         (12,856,066)    (16,726,273)             --
    Proceeds from sale of investment securities                                                 
       available for sale                                           3,505,866              --              --
    Proceeds from maturities/calls of investment                                                
       securities available for sale                                5,250,077       1,000,000              --
    Proceeds from maturities/calls of investment                                                
       securities held to maturity                                 12,300,000       5,857,142      11,005,901
    Principal collected on investment securities held to                                        
       maturity                                                       325,618         263,351         350,384
    Principal collected on ivestment securities                                                 
       available for sale                                              55,388              --              --
    Origination of loans, net                                       3,240,897      (4,913,071)     (5,298,164)
    Proceeds from sales of real estate acquired in                                              
       settlement of loans                                            702,194       2,251,951          57,075
    Purchases of premises and equipment                              (148,222)        (65,426)        (23,710)
    Proceeds from sales of premises and equipment                          --          16,000              --
    Purchase of mortgage servicing rights                            (108,675)     (1,163,250)     (1,728,075)
    Proceeds from redemption of FHLB stock                                 --              --          84,900
                                                                --------------  --------------  --------------
                   Net cash provided by (used in)                                               
                      investing activities                            581,401     (18,879,576)       (351,689)
                                                                --------------  --------------  --------------
</TABLE> 
                                                                     (Continued)

                                      45

<PAGE>
 

                     HAYWOOD BANCSHARES, INC. AND SUBSIDIARY

                      Consolidated Statements of Cash Flows

                  Years ended December 31, 1998, 1997 and 1996

<TABLE> 
<CAPTION> 

                                                                    1998            1997            1996
                                                               --------------   -------------   -------------
<S>                                                            <C>              <C>             <C>      
Cash flows from financing activities:
    Net increase (decrease) in deposits                        $   (1,909,083)     11,327,077      (1,419,876)
    Cash dividends paid                                              (750,212)       (694,811)       (647,900)
    Proceeds from issuance of common stock upon                                                  
       exercise of stock options                                       --             238,750          87,688
    Proceeds from note payable                                         --              --           2,200,000
    Repayment of note payable                                          --          (1,200,000)     (1,000,000)
    Proceeds from FHLB advances                                        --          10,500,000          --
    Repurchase of common stock                                         --             (87,657)     (1,661,313)
                                                               --------------   -------------   -------------
                   Net cash provided by (used in)                                                
                      financing activities                         (2,659,295)     20,083,359      (2,441,401)
                                                               --------------   -------------   -------------
                   Net increase (decrease) in cash and                                           
                      cash equivalents                               (150,998)      2,868,498      (1,398,581)
Cash and cash equivalents, beginning of year                        4,195,001       1,326,503       2,725,084
                                                               ==============   =============   =============
Cash and cash equivalents, end of year                         $    4,044,003       4,195,001       1,326,503
                                                               ==============   =============   =============
Supplemental disclosures of cash flow information:
  Cash paid during the year for:
       Interest                                                $    6,098,358       6,156,200       5,052,824
       Income taxes                                                   300,896       1,016,540         597,937
                                                               ==============   =============   =============
Supplemental schedule of noncash investing and
  financing activities:
       Loans transferred to real estate acquired in
         settlement of loans                                   $       36,436          28,493           --
       Dividends payable                                              200,057         187,553         168,680
                                                               ==============   =============   =============
</TABLE> 

See accompanying notes to consolidated financial statements.

                                      46

<PAGE>
 
                    HAYWOOD BANCSHARES, INC. AND SUBSIDIARY

                  Notes to Consolidated Financial Statements

                       December 31, 1998, 1997 and 1996


(1)  Summary of Significant Accounting Policies

     The following is a description of the more significant accounting and
     reporting policies Haywood Bancshares, Inc. (the Corporation) and its
     subsidiary, Haywood Savings Bank, Inc., SSB (Haywood Savings) follow in
     preparing and presenting their consolidated financial statements.

     (a)  Principles of Consolidation

          The accompanying consolidated financial statements include the
          accounts of the Corporation, Haywood Savings and its wholly owned
          subsidiaries, Great Smokies Financial Corporation, Inc. and Great
          Smokies Insurance Agency, Inc. Haywood Savings subsidiaries' principal
          business activities are the sale of real estate held for investment
          and the sale of insurance products in an agency capacity,
          respectively. For purposes of the consolidated financial statements,
          all significant intercompany accounts and transactions have been
          eliminated. The Corporation's chief operating decision maker reviews
          the results of operations of the Corporation and its subsidiaries as a
          single enterprise.

     (b)  Basis of Presentation

          The preparation of the consolidated 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 liabilities at the
          date of the financial statements, as well as the amounts of income and
          expenses during the reporting period. Actual results could differ from
          those estimates.

          In certain instances, amounts previously reported in the 1997 and 1996
          consolidated financial statements have been reclassified to present
          them in the format selected for 1998. Such reclassifications have no
          effect on the net income or stockholders' equity as previously
          reported.

     (c)  Cash and Cash Equivalents

          Cash and cash equivalents include cash on hand and in banks, interest-
          bearing balances in other banks, and federal funds sold. Generally,
          federal funds are sold for one-day periods.

     (d)  Investment Securities

          Investment securities that the Corporation has the positive intent and
          ability to hold to maturity are classified as held to maturity and
          reported at amortized cost. Investment securities held for current
          resale are classified as trading securities and reported at fair
          value, with unrealized gains and losses included in earnings.
          Investment securities not classified either as securities held to
          maturity or trading securities are classified as available for sale
          and reported at fair value, with unrealized gains and losses (net of
          the related tax effect) excluded from earnings and reported as a
          separate component of stockholders' equity. The classification of
          investment securities as held to maturity, trading, or available for
          sale is determined at the date of purchase.

                                47                                  (Continued)
<PAGE>
 
                    HAYWOOD BANCSHARES, INC. AND SUBSIDIARY

                  Notes to Consolidated Financial Statements

                       December 31, 1998, 1997 and 1996


          Realized gains and losses from sales of securities are determined
          based upon the specific identification method. Premiums and discounts
          are amortized as an adjustment to yield over the remaining lives of
          the securities using the level-yield method.

          As a state chartered savings bank, liquidity (consisting of cash and
          readily marketable securities) must be at least 10% of Haywood
          Savings' assets. Haywood Savings was in compliance with such
          regulation at December 31, 1998.

     (e)  Allowance for Loan Losses

          The Corporation provides for loan losses on the allowance method.
          Additions to the allowance for loan losses are provided by charges to
          operations based on inherent loss considerations within the loan
          portfolio and various other factors which, in management's judgment,
          warrant current recognition in estimating possible losses. Such
          factors considered include collateral values, growth and composition
          of the loan portfolio, the relationship of the allowance for loan
          losses to outstanding loans, delinquency trends, and economic
          conditions.

          Management evaluates available information periodically and the
          allowance is adjusted accordingly. While management uses the best
          information available to make evaluations, future adjustments to the
          allowance may be necessary if conditions differ from the assumptions
          used in making the evaluations. In addition, various regulatory
          agencies, as an integral part of their examination process,
          periodically review the Corporation's allowance for loan losses. Such
          agencies may require the Corporation to recognize additions to the
          allowance based on their judgments about information available to them
          at the time of their examination.

     (f)  Real Estate Acquired in Settlement of Loans

          Real estate acquired in settlement of loans is initially recorded at
          the lower of cost or net fair value (less estimated costs to sell). If
          cost exceeds net fair value, the asset is written down to net fair
          value with the difference being charged against the allowance for loan
          losses. Subsequent to foreclosure, such assets are carried at the
          lower of cost or net fair value with any additional write downs being
          charged as real estate losses. 

      (g) Premises and Equipment

          Premises and equipment are stated at cost less accumulated
          depreciation. Depreciation is provided over the estimated useful lives
          of the related assets principally on a straight-line basis. Estimated
          lives are ten to forty years for buildings, building components and
          improvements; five to ten years for furniture, fixtures, and
          equipment; and four years for automobiles. 

          Maintenance and repairs are charged to expense as incurred and
          improvements are capitalized. The costs and accumulated depreciation
          relating to premises and equipment retired or otherwise disposed of
          are eliminated from the accounts and any resulting gains or losses are
          credited or charged to income.

                                48                                   (Continued)
<PAGE>
 
                    HAYWOOD BANCSHARES, INC. AND SUBSIDIARY

                  Notes to Consolidated Financial Statements

                       December 31, 1998, 1997 and 1996


     (h)  Goodwill

          Goodwill, representing the excess cost of investment over the fair
          value of net assets acquired, is being amortized by charges to
          operations over a remaining period of approximately 13 years at
          December 31, 1998 using the straight-line method.

     (i)  Loans

          Loans are carried at their principal amount outstanding plus any
          accrued interest. The Corporation provides an allowance for
          uncollected interest on accrued interest for loans 90 days or more
          past due. This allowance is a reduction of loans for financial
          statement reporting because such accrued interest is included in the
          related loan balances.

          Management considers loans to be impaired when, based on current
          information and events, it is probable that a creditor will be unable
          to collect all amounts due according to contractual terms of the loan
          agreement. Factors that influence management's judgments include, but
          are not limited to, loan payment pattern, source of repayment, and
          value of collateral. A loan would not be considered impaired if an
          insignificant delay in loan payment occurs and management expects to
          collect all amounts due. The major sources for identification of loans
          to be evaluated for impairment include past due and nonaccrual
          reports, internally generated lists of loans of certain risk grades,
          and regulatory reports of examination. Impaired loans are measured
          using either the discounted expected cash flow method or the value of
          collateral method. When the ultimate collectibility of an impaired
          loan's principal is in doubt, wholly or partially, all cash receipts
          are applied to principal. Large groups of smaller balance homogeneous
          loans that are collectively evaluated for impairment (such as
          residential mortgage) are excluded from impairment evaluations, and
          their allowance for loan losses is calculated in accordance with the
          allowance for loan losses policy described above.

     (j)  Loan Origination Fees and Costs

          The Corporation defers loan origination fees and certain direct loan
          origination costs. Net deferred fees are being amortized to loan
          interest income over the actual life of the loan using a level yield
          method.

     (k)  Pension Plan

          The Corporation adopted Statement of Financial Accounting Standards
          No. 132, "Employers' Disclosures About Pensions and Other
          Postretirement Benefits, an amendment of Statements No. 87, 88 and
          106" ("SFAS No. 132"), during 1998. SFAS No. 132 standardizes the
          disclosure requirements for pensions and other postretirement
          benefits, requires additional information on changes in the benefit
          obligations and fair values of plan assets and eliminates certain
          disclosures previously required. The methods of measurement and
          recognition for such plans remain unchanged. In accordance with the
          provisions of SFAS No. 132, disclosures for earlier periods provided
          for comparative purposes have been restated to reflect the provisions
          of this Statement.

                                49                                  (Continued)

<PAGE>
 
                    HAYWOOD BANCSHARES, INC. AND SUBSIDIARY

                  Notes to Consolidated Financial Statements

                       December 31, 1998, 1997 and 1996

     (l)  Stock Options

          On January 1, 1996, the Corporation adopted SFAS No. 123, "Accounting
          for Stock-Based Compensation," which requires either the (i) fair
          value of employee stock-based compensation plans be recorded as a
          component of compensation expense in the statement of income as of the
          date of grant of awards related to such plans, or (ii) the impact of
          such fair value on net income and earnings per share be disclosed on a
          pro forma basis on a footnote to financial statements for awards
          granted after December 15, 1994, if the accounting for such awards
          continues to be in accordance with Accounting Principles Board Opinion
          No. 25, "Accounting for Stock Issued to Employees" (APB Opinion 25).
          The Corporation has elected to continue to apply the provisions of APB
          Opinion 25.

     (m)  Income Taxes

          The Corporation accounts for income taxes using the asset and
          liability method, the objective of which is to establish deferred tax
          assets and liabilities for the temporary differences between the
          financial reporting basis and the respective income tax basis of the
          Corporation's assets and liabilities using enacted rates expected to
          be in effect when such amounts are realized or settled.

     (n)  Comprehensive Income

          On January 1, 1998, the Corporation adopted SFAS No. 130, "Reporting
          Comprehensive Income". SFAS No. 130 establishes standards for
          reporting and presentation of comprehensive income and its components
          in a full set of financial statements. Comprehensive income consists
          of net income and net unrealized gains (losses) on securities and is
          presented in the statements of stockholders' equity and comprehensive
          income. The Statement requires only additional disclosures in the
          consolidated financial statements; it does not affect the
          Corporation's financial position or results of operations. Prior year
          financial statements have been reclassified to conform to the
          requirements of SFAS No. 130.

          The Corporation's other comprehensive income for the years ended
          December 31, 1998 and 1997 and accumulated other comprehensive income
          as of December 31, 1998 and 1997 are comprised solely of unrealized
          gains and losses on certain investments in debt and equity 

                                     50                              (Continued)
<PAGE>
 
                    HAYWOOD BANCSHARES, INC. AND SUBSIDIARY

                  Notes to Consolidated Financial Statements

                       December 31, 1998, 1997 and 1996


          securities. The Corporation did not have any other comprehensive
          income for the year ended December 31, 1996. Other comprehensive
          income for the years ended December 31, 1998 and 1997 follows:


<TABLE>
<CAPTION>
                                                               1998          1997
                                                             ---------     --------
<S>                                                          <C>           <C>
Unrealized holding gains (losses) arising during period      $(214,844)      56,831
Less:  reclassification adjustment for realized gains,       
 net of tax                                                      3,979           --
                                                             ---------     -------- 
Unrealized gains (losses) on securities, net of
   applicable income taxes                                   $(218,823)      56,831
                                                             =========     ========
</TABLE>

     (o)  Net Income Per Share

          The Corporation adopted the provisions for SFAS No. 128, "Earnings per
          Share," during 1997. The Statement establishes standards for computing
          and presenting earnings per share (EPS). SFAS No. 128 simplifies the
          standards for computing EPS previously found in APB Opinion No. 15,
          "Earnings Per Share," and makes them comparable to international EPS
          standards. It replaces the presentation of primary EPS with a basic
          EPS. It also requires dual presentation of basic and diluted EPS on
          the face of the income statement for all entities with complex capital
          structures and requires a reconciliation of the numerator and
          denominator of the basic EPS computation to the numerator and
          denominator of the diluted EPS computation. In accordance with SFAS
          No. 128, all prior period EPS data has been restated.

     (p)  Disclosures Regarding Segments

          The Corporation adopted SFAS No. 131, "Disclosures about Segments of
          an Enterprise and Related Information" in 1998. SFAS No. 131
          establishes 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.
          The Corporation adopted SFAS No. 131 without any impact on their
          consolidated financial statements as the chief operating decision
          maker reviews the results of operations of the Corporation and its
          subsidiaries as a single enterprise.

                                     51                             (Continued)
<PAGE>
 
                    HAYWOOD BANCSHARES, INC. AND SUBSIDIARY

                  Notes to Consolidated Financial Statements

                       December 31, 1998, 1997 and 1996



(2)  Investment Securities

     The following is a summary of the investment securities portfolios by
     major classification:

<TABLE>
<CAPTION>
                                                                             Gross            Gross
                                                                          Unrealized       Unrealized        Estimated
                                                          Book Value         Gains           Losses         Market Value
                                                        -------------    ------------    ------------     --------------
<S>                                                     <C>              <C>             <C>              <C> 
        December 31, 1998
Investment securities available for sale:
  U.S. government and agency securities                   $ 4,248,875           3,704          (5,625)         4,246,954
  Collateralized mortgage obligations:
    FHLMC certificates, at variable rates,
     maturing from 2023 to 2027                            10,688,852              --        (178,538)        10,510,314
    FNMA certificates, at variable rates,
     maturing in 2028                                       4,773,915              --         (64,983)         4,708,932
                                                        -------------    ------------    ------------     --------------
      Total investment securities
       available for sale                                 $19,711,642           3,704        (249,146)        19,466,200
                                                        =============    ============    ============     ==============
Investment securities held-to-maturity:
  U.S. government and agency securities                    $9,822,634          14,625         (15,238)         9,822,021
  Mortgage-backed securities:
    FHLMC certificates, 8.50%, maturity
     from 2005 to 2009                                        335,143          12,823              --            347,966
    GNMA certificates, 8.50% to 9.00%,
     maturing from 2009 to 2017                               145,210          17,275              --            162,485
                                                        -------------    ------------    ------------     --------------
      Total investment securities
       held to maturity                                   $10,302,987          44,723         (15,238)        10,332,472
                                                        =============    ============    ============     ==============
</TABLE>

                                     52                             (Continued)
<PAGE>
 
                    HAYWOOD BANCSHARES, INC. AND SUBSIDIARY

                  Notes to Consolidated Financial Statements

                       December 31, 1998, 1997 and 1996
<TABLE>
<CAPTION>
 
                                                                         Gross           Gross
                                                                       Unrealized      Unrealized        Estimated
                                                   Book Value            Gains           Losses         Market Value
                                                   -------------    --------------    ------------     --------------
                                                                            December 31, 1997
<S>                                                <C>              <C>               <C>              <C>        
Investment securities available for sale:
  U.S. government and agency securities            $     5,000,574          11,458            (234)         5,011,798 
  Collateralized mortgage obligations:
    FHLMC certificates, at variable rates,
      maturing from 2023 to 2024                        10,718,929          75,013            (129)        10,793,813     
                                                     -------------    ------------    ------------     --------------
                     Total investment securities
                       available for sale          $    15,719,503          86,471            (363)        15,805,611
                                                     =============    ============    ============     ==============
Investment securities held-to-maturity:
   U.S. government and agency securities           $    10,436,957          25,263         (13,010)        10,449,210 
   Mortgage-backed securities:
     FHLMC certificates, 8.50%, maturity
       from 2005 to 2009                                   520,098          24,699              --            544,797
     GNMA certificates, 8.50% to 9.00%,
       maturing from 2009 to 2017                          285,874          23,170              --            309,044
                                                     -------------    ------------    ------------     --------------
                     Total investment securities
                       held to maturity            $    11,242,929          73,132         (13,010)        11,303,051
                                                     =============    ============    ============     ==============
</TABLE>

     Gross gains from sales of investment securities available for sale totaled
     $6,418 in 1998. There were no sales of investment securities available for
     sale or held-to-maturity during 1997 and 1996.

     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>
                                                    Available for Sale                    Held-to-Maturity
                                              ------------------------------    -----------------------------------
                                                                  Estimated                              Estimated
                                                 Amortized         Market            Amortized            Market
                                                   Cost             Value               Cost               Value
                                              -------------    -------------    ------------------    -------------
<S>                                         <C>                  <C>              <C>                   <C>
U.S. government and agency securities:
   Due in one year or less                  $            --               --               436,957          437,399 
   Due after one year through five years          4,248,875        4,246,954             9,385,677        9,384,622 
Mortgage-backed securities                               --               --               480,353          510,451
Collateralized mortgage obligations              15,462,767       15,219,246                    --               --
                                              -------------    -------------    ------------------    -------------
                Total                       $    19,711,642       19,466,200            10,302,987       10,332,472
                                              =============    =============    ==================    =============
</TABLE>

                                53                                 (Continued)
<PAGE>
 
                    HAYWOOD BANCSHARES, INC. AND SUBSIDIARY

                  Notes to Consolidated Financial Statements

                       December 31, 1998, 1997 and 1996

(3)    Loans

Loans consist of the following:

<TABLE>
<CAPTION>
                                                                                December 31,
                                                                           1998                 1997
                                                                    ----------------     ----------------
<S>                                                               <C>                    <C>
Loans secured by first mortgages on real estate:                 
   Conventional, primarily one to four family                     $       89,352,080           92,165,787
   Commercial                                                             15,790,805           15,669,602
   Construction                                                            6,716,000            6,953,200
   Participation loans purchased                                             407,060              478,240
                                                                    ----------------     ----------------
                                                                         112,265,945          115,266,829
Home equity lines of credit                                                2,478,517            2,467,831
Loans secured by deposit accounts                                            750,954              580,639
Home improvement loans                                                       189,016              164,827
                                                                    ----------------     ----------------
                                                                         115,684,432          118,480,126
Undisbursed proceeds on loans in process                                  (3,530,853)          (3,049,214)
Deferred loan fees                                                          (548,960)            (507,472)
Allowance for loan losses                                                   (758,547)            (738,547)
Allowance for uncollected interest                                           (53,081)             (34,537)
                                                                    ----------------     ----------------
                                                                  $      110,792,991          114,150,356
                                                                    ================     ================
</TABLE>

     The Corporation grants residential, residential and non-residential
     construction, and commercial real estate loans to customers throughout its
     general market area of Haywood, Cherokee, and Jackson counties of western
     North Carolina. As reflected in the summary of loans at December 31, 1998,
     the largest component of the Corporation's loan portfolio consists of 
     lower-risk single-family, 1-4 unit, residential loans. The higher risk
     component of the loan portfolio consists of real estate construction loans
     and commercial real estate loans for which repayment is more dependent on
     current real estate markets and general economic conditions. Management
     actively monitors the higher risk portion of the portfolio and provides
     increased provision for loan losses when considered necessary.

                                54                              (Continued)

<PAGE>
 
                    HAYWOOD BANCSHARES, INC. AND SUBSIDIARY

                  Notes to Consolidated Financial Statements

                       December 31, 1998, 1997 and 1996

     The following summarizes the activity in the allowance for loan losses for
     the years ended December 31, 1998, 1997, and 1996:

<TABLE>
<CAPTION>
                                                                 1998                1997                1996
                                                          ----------------    ----------------    ----------------
<S>                                                     <C>                     <C>                 <C>
Balance at beginning of year                            $          738,547             718,547             703,547
Provision for loan losses                                           20,000              20,000              15,000
Less loan charge-offs                                                   --                  --                  --
                                                          ----------------    ----------------    ----------------
Balance at end of year                                  $          758,547             738,547             718,547
                                                          ================    ================    ================
</TABLE>


     The Corporation had nonaccrual loans of approximately $841,000, $583,000
     and $814,000 at December 31, 1998, 1997 and 1996, respectively. Had these
     loans performed in accordance with their contractual terms, approximately
     $53,000 , $37,000 and $57,000 of interest income would have been recorded
     during the years ended December 31, 1998, 1997, and 1996, respectively.
     Interest income of approximately $25,000, $22,000, and $30,000 was recorded
     in connection with loans classified as nonaccrual in 1998, 1997 and 1996,
     respectively.

     At December 31, 1998 and 1997, the Corporation has no loans considered to
     be impaired under SFAS No. 114.

     At December 31, 1998, the Corporation had adjustable rate loan commitments
     outstanding aggregating $1,789,000, and fixed rate loan commitments
     outstanding aggregating $1,435,000. In addition, the Corporation has
     committed to participate in 45 "affordable housing" fixed rate construction
     projects in the aggregate sum of $635,000. Also, preapproved but unused
     variable rate lines of credit for home equity loans approximate $1,230,000
     at December 31, 1998. In the opinion of management, these loan commitments,
     including undisbursed proceeds on loans in process reflected above,
     represent no more than normal lending risk to the Corporation and will be
     funded from normal sources of liquidity.

     Loans serviced for others approximated $132,000, $283,000, and $401,000 at
     December 31, 1998, 1997, and 1996, respectively.

     The following is a reconciliation of aggregate loans outstanding to
     executive officers, directors, and their immediate families for the year
     ended December 31, 1998, for such loan amounts aggregating in excess of
     $60,000.

<TABLE>
<S>                                                <C> 
Balance at beginning of year                       $         1,588,000
New loans                                                      243,000
Principal repayments                                          (236,000)
                                                     -----------------
Balance at end of year                             $         1,595,000
                                                     =================
</TABLE>

                                55                              (Continued)
<PAGE>
 
                    HAYWOOD BANCSHARES, INC. AND SUBSIDIARY

                  Notes to Consolidated Financial Statements

                       December 31, 1998, 1997 and 1996

(4)  Real Estate Acquired in Settlement of Loans

     Real estate acquired in settlement of loans, net of related allowance for
     real estate losses, consists of the following:

<TABLE>
<CAPTION>
                                                                                    December 31,
                                                                               1998                 1997
                                                                        -----------------    -----------------
<S>                                                                   <C>                      <C>
Commercial real estate                                                $                --              210,393
Other, primarily single family residence                                            7,192               35,685
                                                                        -----------------    -----------------
                                                                      $             7,192              246,078
                                                                        =================    =================
</TABLE>


     In 1998, the Corporation sold commercial real estate consisting of
     outparcels to the Waynesville Shopping Center with a book value of
     approximately $210,000 and recognized a gain of approximately $403,000 on
     the sale. The Corporation sold commercial real estate (Waynesville Plaza
     Shopping Center) with a book value of approximately $1,573,000 during 1997
     and recognized a gain of approximately $679,000 on the sale.

     Net rental income related to the operations of real estate acquired in
     settlement of loans was approximately $3,000, $269,000, and $348,000 in
     1998, 1997, and 1996, respectively.

(5)  Premises and Equipment

     Premises and equipment consists of the following:

<TABLE>
<CAPTION>
                                                                          Accumulated           Net Book
                                                          Cost            Depreciation           Value
                                                   ----------------    ----------------    ----------------
<S>                                              <C>                     <C>                 <C>
December 31, 1998:
   Land and land improvements                    $          368,064                  --             368,064 
   Office buildings and improvements                      2,528,570           1,573,268             955,302 
   Furniture, fixtures and equipment                      1,558,568           1,342,564             216,004 
   Automobiles                                               35,188               9,385              25,803
                                                   ----------------    ----------------    ----------------
                                                 $        4,490,390           2,925,217           1,565,173
                                                   ================    ================    ================
December 31, 1997:
   Land and land improvements                    $          368,064                  --             368,064 
   Office buildings and improvements                      2,517,311           1,509,233           1,008,078 
   Furniture, fixtures and equipment                      1,421,605           1,279,078             142,527 
   Automobiles                                               35,188               2,347              32,841
                                                   ----------------    ----------------    ----------------
                                                 $        4,342,168           2,790,658           1,551,510
                                                   ================    ================    ================
</TABLE>

                                56                              (Continued)
<PAGE>
 
                    HAYWOOD BANCSHARES, INC. AND SUBSIDIARY

                  Notes to Consolidated Financial Statements

                       December 31, 1998, 1997 and 1996

(6)  Investment in Mortgage Servicing Rights

     During 1996, the Corporation made a $3,000,000 commitment to be a limited
     partner in Dovenmuehle Mortgage Company L.P. ("DMCLP") Tranche VIII
     Servicing Division of Dovenmuehle Mortgage Inc. ("DMI"). DMI provides
     mortgage servicing for a national portfolio of residential, multi-family
     and commercial mortgage loans. These loans are owned or securitized by
     national mortgage agencies, and by a variety of private banks, thrifts,
     insurance companies and other loan investors. DMI formed DMCLP as a funding
     vehicle to purchase portfolios of the Federal National Mortgage Association
     and the Federal Home Loan Mortgage Corporation nonrecourse residential
     servicing. DMI provides the mortgage servicing for these portfolios. Under
     this structure investors in DMCLP invest in separate tranches, each of
     which has its own identified servicing rights and each of which may be
     owned by one or a group of investors. The equity investors in each tranche
     benefit from a financial return based solely on the performance of the
     mortgage servicing rights purchased for the tranche. The Corporation has
     funded all of its $3,000,000 commitment.

     The investment is accounted for under the equity method. Management
     periodically evaluates the fair value of the mortgage servicing rights
     owned by DMCLP using appraisals prepared by a third party and adjusts the
     carrying value of their investment when there is impairment.

     During the year ended December 31, 1998, the Corporation recognized an
     impairment valuation adjustment totaling approximately $2,161,000. The
     impairment and write-down of the mortgage servicing rights is due to
     significant prepayments of the underlying mortgage loans due to a decline
     in mortgage loan interest rates. Total earnings (loss) of DMCLP recognized
     by the Corporation on the equity method of accounting were $(2,158,000) and
     $136,000 for the years ended December 31, 1998 and 1997, respectively.

(7)  Time Deposits

     Maturities of time deposits are as follows:

<TABLE>
<S>                                          <C> 
   1999                                      $       60,748,000
   2000                                              21,231,000
   2001                                               2,307,000
   2002                                                 167,000
   2003                                                 121,000
                                               ---------------- 
   Total                                     $       84,574,000
                                               ================
</TABLE>

                                57                              (Continued)
<PAGE>
 
                    HAYWOOD BANCSHARES, INC. AND SUBSIDIARY

                  Notes to Consolidated Financial Statements

                       December 31, 1998, 1997 and 1996

(8)  Income Taxes

Income tax expense consists of:

<TABLE>
<CAPTION>
                                             1998        1997         1996
                                          ----------   ---------   ----------
<S>                                       <C>          <C>         <C> 
Current expense:
  Federal                                  $ 541,934     848,658      596,781
  State                                       74,066     115,842       54,219
                                          ----------   ---------   ----------
                                             616,000     964,500      651,000
                                          ----------   ---------   ---------- 
Deferred expense (benefit):
  Federal                                   (332,993)    163,829      (65,781)
  State                                     (128,007)     38,171      (14,219)
                                          ----------   ---------   ----------
                                            (461,000)    202,000      (80,000)
                                          ----------   ---------   ----------
                                           $ 155,000   1,166,500      571,000
                                          ==========   =========   ==========
</TABLE> 
     The statutory income tax amounts are reconciled with the effective income
     tax amounts as follows:

<TABLE>
<CAPTION>

                                             1998        1997         1996
                                          ----------   ---------   ----------
<S>                                       <C>          <C>         <C> 

Tax at federal rate (34%)                  $ 140,521   1,034,286      566,031
Differences:
  State income taxes, net of federal 
   income tax benefit                        (35,601)    101,649       26,400
    Other, net                                50,080      30,565      (21,431)
                                          ----------   ---------   ---------- 
                                           $ 155,000   1,166,500      571,000
                                          ==========   =========   ==========
Effective tax rates                             37.5%       38.3%        34.3%
                                          ==========   =========   ==========
</TABLE>

                                     58                              (Continued)
<PAGE>
 
                    HAYWOOD BANCSHARES, INC. AND SUBSIDIARY

                  Notes to Consolidated Financial Statements

                       December 31, 1998, 1997 and 1996

     The sources and tax effects of temporary differences that give rise to
     significant portions of the deferred tax assets (liabilities) at December
     31, 1998 and 1997 are presented below:

<TABLE>
<CAPTION>
                                                     1998         1997
                                                  -----------  -----------
<S>                                               <C>          <C> 
Deferred tax assets:
  Unrealized gain on available sale             
   for securities                                 $    83,450           --
  Allowance for loan losses                           294,202      286,445
  Deferred compensation                               446,800      362,786
  Net loan fees, deferred for 
   financial reporting                                 55,174       73,565
  Accrued pension liability                           143,183      139,528
  Investment in partnership, tax 
   basis in excess of book                            440,356           --
  Other                                                10,394       29,729
                                                  -----------  -----------
      Total gross deferred tax assets               1,473,559      892,053

      Less valuation allowance                             --           --
                                                  -----------  -----------      
      Net deferred tax assets                       1,473,559      892,053
                                                  -----------  -----------
                                                                   
Deferred tax liabilities:
  Unrealized gain on available-for-sale 
   securities                                              --      (29,277)
  Tax bad debt reserve                               (699,208)    (605,554)
  Depreciable basis of fixed assets                  (135,858)    (132,568)
  Mortgage-backed securities, 
   book basis in excess of tax                             --      (44,535)
  FHLB stock, book basis in excess of tax            (232,200)    (232,200)
  Other                                               (27,843)     (43,196)
                                                  -----------  -----------
      Total gross deferred tax liabilities         (1,095,109)  (1,087,330)
                                                  -----------  -----------      
      Net deferred tax asset (liability)          $   378,450     (195,277)
                                                  ===========  ===========
</TABLE>

                                     59                              (Continued)
<PAGE>
 
                    HAYWOOD BANCSHARES, INC. AND SUBSIDIARY

                  Notes to Consolidated Financial Statements

                       December 31, 1998, 1997 and 1996

     A portion of the change in the net deferred tax asset (liability) relates
     to unrealized loss (gain) on available-for-sale securities. The related
     current period deferred tax benefits of $112,727 has been recorded directly
     to stockholders' equity. The balance of the change in the net deferred tax
     asset (liability) results from the current period deferred tax benefit of
     $461,000.

     There was no valuation allowance during 1998 or 1997. It is management's
     contention that realization of the deferred tax assets is more likely than
     not, based upon the history of taxable income and estimates of future
     taxable income.

     Retained income at December 31, 1998 and 1997 includes approximately $1.07
     million (tax effect) representing pre-1988 bad debt reserve base year
     reserve amounts for which no deferred income tax liability has been
     provided since these reserves are not expected to reverse and may never
     reverse. Circumstances that would require an accrual of a portion or all of
     this unrecorded tax liability are failure to meet the definition of a bank,
     dividend payments in excess of current year or accumulated tax earnings and
     profits or other distributions in dissolution, liquidation or redemption of
     the Corporation's stock.

     The Corporation has historically been permitted under the Internal Revenue
     Code to deduct an annual addition to the tax reserve for bad debts based on
     8% of taxable income (the "percentage of taxable income method") or actual
     loan loss experience (the "experience method"). For the period ending
     December 31, 1996, Haywood Savings was required to change its overall tax
     method of accounting for bad debts to either the experience method or the
     specific charge-off method to comply with tax legislation enacted in 1996.
     Beginning in 1996, the legislation requires the recapture of any tax
     reserves in excess of pre-1988 base year amounts over approximately eight
     years.

     The Corporation's income tax returns for 1995 and subsequent years are
     subject to final determination by the taxing authorities.

                                     60                              (Continued)
<PAGE>
 
                    HAYWOOD BANCSHARES, INC. AND SUBSIDIARY

                  Notes to Consolidated Financial Statements

                       December 31, 1998, 1997 and 1996

(9)  Pension and Deferred Compensation Plans

     The Corporation has a defined benefit pension plan covering substantially
     all of its employees. Based upon actuarial computations at December 31,
     1998 and 1997, the plan's funded status and amounts recognized in the
     Corporation's consolidated statements of financial condition at December
     31, 1998 and 1997, are as follows:

<TABLE>
<CAPTION>
                                                    1998        1997
                                                 ----------  ----------
<S>                                              <C>         <C> 
Change in benefit obligation:
   Benefit obligation at January 1               $1,012,084     932,566
   Service cost                                      67,774      63,799
   Interest cost                                     70,668      67,040
   Actuarial gain (loss)                                 --      27,502
   Benefit payments                                  (5,162)    (78,823)
                                                 ----------  ----------   
   Benefit obligation at December 31             $1,145,364   1,012,084
                                                 ==========  ==========
 
Change in plan assets:
   Fair value of plan assets at January 1        $  553,970     509,630
   Actual return on plan assets                      40,722      44,934
   Employer contributions                            73,398      78,229
   Benefit payments                                  (5,162)    (78,823)
                                                 ----------  ----------   
   Fair value of plan assets 
    at December 31                               $  662,928     553,970
                                                 ==========  ==========
 
Funded status:
   As of end of year                             $ (482,436)   (458,114)
   Unrecognized transition (asset) obligation        36,418      40,970
   Unrecognized prior service cost                   80,934      87,159
   Unrecognized net (gain) loss                      (4,764)     (5,468)
                                                 ----------  ----------      
   Accrued pension expense                       $ (369,848)   (335,453)
                                                 ==========  ==========  
</TABLE>


     Net periodic pension cost included the following components:

<TABLE>
<CAPTION>
                                                 Years ended December 31,
                                                 1998       1997     1996
                                                --------  -------  --------
<S>                                             <C>       <C>      <C>
Service cost - benefits earned during 
 the period                                     $ 67,774   63,799    69,243
Interest cost on projected benefit obligation     70,668   67,040    71,801
Actual return on plan assets                      (8,885) (45,700)  (44,541)
Net amortization and deferral                    (20,574)  18,175    12,811
                                                --------  -------  --------
    Net periodic pension cost included 
     in salaries and employee benefits          $108,983  103,314   109,314
                                                ========  =======   =======
</TABLE>

                                     61                              (Continued)
<PAGE>
 
                    HAYWOOD BANCSHARES, INC. AND SUBSIDIARY

                  Notes to Consolidated Financial Statements

                       December 31, 1998, 1997 and 1996

     Assumptions used in computing the actuarial present value of the
     Corporation's projected benefit obligation were as follows:

<TABLE>
<CAPTION>
                                                            1998   1997   1996
                                                            ------------------
<S>                                                         <C>    <C>    <C>
Discount rate                                               7.0%   7.5%   7.5%
Rate of increase in compensation level of employees         5.5%   5.5%   5.5%
Expected long-term rate of return on pension plan assets    7.5%   7.5%   7.5%
</TABLE>


     The Corporation has a retirement plan for non-employee directors. The plan
     states that the Corporation will annually pay directors, based on a vesting
     schedule, for up to ten years following retirement, an amount equal to the
     directors' fees paid during the year immediately preceding the retirement
     date. The Corporation recorded expense of approximately $126,000 in 1998
     and $51,000 in 1997 and 1996, respectively, related to this plan. The
     assumed weighted average discount rate used to measure the projected
     benefit obligation was 7% in 1998 and 8% in 1997 and 1996.

     Certain directors of the Corporation have elected to forego current
     payments for directors' fees and to participate in a deferred compensation
     plan. Expense for service cost for benefits earned during 1998, 1997, and
     1996 was approximately $118,000, $53,000, and $49,000, respectively. The
     assumed weighted average discount rate used to measure the projected
     benefit obligation was 7% in 1998 and 8% in 1997 and 1996.

     Also, effective since 1991, certain employees of the Corporation have been
     provided with supplemental income agreements for the purpose of additional
     retirement benefits. Expense for service cost for benefits earned during
     1998, 1997, and 1996 was approximately $22,000, $34,000, and $24,000,
     respectively. The assumed weighted average discount rate used to measure
     the projected benefit obligation was 7% in 1998 and 8% in 1997 and 1996.


(10) Federal Deposit Insurance Expense

     Eligible deposit accounts are insured up to $100,000 by the Savings
     Association Insurance Fund ("SAIF") of the Federal Deposit Insurance
     Corporation ("FDIC"). Federal deposit insurance expense amounted to
     approximately $71,000, $71,000, and $908,000 for the years ended December
     31, 1998, 1996 and 1995, respectively.

     On September 30, 1996, Congress passed legislation allowing a special
     assessment to be levied by the FDIC to recapitalize the SAIF. The special
     assessment was based on the level of SAIF assessable deposits a financial
     institution had as of March 31, 1995 subject to a 20% reduction for certain
     qualifying deposits. Haywood Savings' special assessment totaled
     approximately $720,000 and is included in the 1996 federal deposit
     insurance expense above. On December 11, 1996, the FDIC approved a final
     rule retroactive to October 1, 1996 which lowered rates on assessments paid
     to the


                                     62                              (Continued)
 
<PAGE>
 
                    HAYWOOD BANCSHARES, INC. AND SUBSIDIARY

                  Notes to Consolidated Financial Statements

                       December 31, 1998, 1997 and 1996



SAIF.  Haywood Savings received a refund of approximately $63,000, which 
reduced federal deposit insurance expense and is also included above.


(11) Stockholders' Equity

     (a)  Earnings per Share

          Basic net income per share is computed by dividing net income by the
          weighted average number of common shares outstanding for the period.
          Diluted net income per share reflects the potential dilution that
          could occur if the Corporation's dilutive stock options were
          exercised. Shares owned by the employee stock ownership plan (ESOP)
          that are unallocated and not committed to be released are not included
          in either basic or diluted weighted average shares outstanding. ESOP
          shares that are committed to be released are included in both basic
          and diluted weighted average shares outstanding. The numerator of the
          basic net income per share computation is the same as the numerator of
          the diluted net income per share computation for all periods
          presented. A reconciliation of the denominators for the EPS
          computations are as follows:

<TABLE>
<CAPTION>
                                                                             1998             1997             1996
                                                                        -------------    -------------    -------------
<S>                                                                     <C>              <C>              <C>
Basic EPS denominator:  weighted average
   number of common  shares outstanding                                     1,248,153        1,233,408        1,226,850    
Dilutive effect arising from assumed exercise
   of stock  options                                                               --               --           32,745
                                                                        -------------    -------------    -------------  
             Diluted EPS denominator                                        1,248,153        1,233,408        1,259,595
                                                                        =============    =============    =============
</TABLE>


     (b) Regulatory Matters

          The Corporation may not pay cash dividends on its common stock if
          its regulatory capital would be reduced below the amount required for
          the liquidation account established for the benefit of certain
          depositors of Haywood Savings at the time of its 1987 conversion to
          stock ownership.

          The Corporation repurchased 5,500 shares of common stock at $15.94 per
          share in May 1997 in connection with the stock repurchase program
          announced on August 8, 1995, which permits repurchases of up to 10% of
          the 1,287,372 shares outstanding at the program's inception. The
          Corporation retires all repurchased shares under this program. The
          Corporation repurchased 86,516 shares of common stock under such plan
          at $18 per share in April and May 1996, and 5,700 shares of common
          stock at $18.25 per share in July of 1996.

          As a North Carolina-chartered savings bank, Haywood Savings is
          subject to the capital requirements of the FDIC and the N.C.
          Administrator of Savings Institutions ("the Administrator"). The FDIC
          requires Haywood Savings to maintain minimum ratios of Tier I

                                63                              (Continued)
<PAGE>
 
                    HAYWOOD BANCSHARES, INC. AND SUBSIDIARY

                  Notes to Consolidated Financial Statements

                       December 31, 1998, 1997 and 1996



     capital to total risk-weighted assets and total capital to risk-weighted
     assets of 4% and 8%, respectively. To be "well capitalized," the FDIC
     requires ratios of Tier I capital to total risk-weighted assets and total
     capital to risk-weighted assets of 6% and 10%, 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 I capital plus certain adjustments, the only
     one of which is applicable to Haywood Savings is the allowance for loan
     losses. Risk-weighted assets reflect Haywood Savings' on- and off-balance
     sheet exposures after such exposures have been adjusted for their relative
     risk levels using formulas set forth in FDIC regulations. Haywood Savings
     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%, and a ratio of 5% to be "well capitalized." The
     Administrator requires a net worth equal to at least 5% of assets.

     At December 31, 1998 and 1997, Haywood Savings was in compliance with all
     of the aforementioned capital requirements as summarized below.

     At December 31, 1998, the FDIC categorized Haywood Savings as "well
     capitalized" under the regulatory framework for prompt corrective action.
     There are no events or conditions since the notification that management
     believes have changed Haywood Savings' category.


<TABLE>
<CAPTION>
                                                                            At December 31,
                                                                          1998             1997
                                                                     ------------     ------------
Risk-based capital ratios:
<S>                                                                    <C>              <C>
   Tier I capital as a percent of risk-weighted assets                      27.17%           26.38% 
   Minimum required Tier I capital                                           4.00%            4.00% 
   Total capital as a percent of risk-weighted assets                       28.16%           27.30% 
   Minimum  required total capital                                           8.00%            8.00% 
Leverage capital ratios:
   Tier I capital as a percent of fourth quarter average assets             13.83%           13.72% 
   Minimum required Tier I leverage capital                                  3.00%            3.00% 
North Carolina regulatory capital:
   Total capital as a percent of fourth quarter average assets              14.33%           14.20% 
   Minimum required North Carolina capital                                   5.00%            5.00% 
</TABLE>

(12) Stock Options and Incentive Plan

     The Corporation has a Stock Option and Incentive Plan. An aggregate number
     of shares, amounting to 126,208 or 10% of the stock issued in the
     conversion, was reserved for future issuance by the Corporation for stock
     options to be granted to certain directors, officers, and employees under
     the plan. The plan provides for incentive options for officers and
     employees and non-incentive options and stock

                                     64  
                                                                     (Continued)
<PAGE>
 
                   HAYWOOD BANCSHARES, INC. AND SUBSIDIARY 

                  Notes to Consolidated Financial Statements 

                       December 31, 1998, 1997 and 1996

     appreciation rights for directors, officers, and employees. The plan is
     administered by a three member committee of the board of directors
     (Committee).

     Incentive stock options granted under the Stock Option and Incentive Plan
     may be granted only to full-time officers and employees at the fair market
     value of the stock on the date of grant. Non-incentive stock options were
     granted to non-employee members of the board of directors at an exercise
     price equal to the actual offering price of the common stock issued in
     conjunction with Haywood Savings' conversion from a mutual to a stock
     association in 1987. Both types of options are exercisable upon issuance
     and for a ten year period thereafter. Incentive stock options are generally
     forfeited at or within 3 months following termination of employment.
     Forfeiture of non-incentive stock options is at the sole discretion of the
     Committee.

     All incentive and non-incentive stock options granted to date were granted
     on January 11, 1988. During 1997, the 30,000 remaining incentive stock
     options were exercised at an option price of $5.63 per share and the 14,000
     remaining non-incentive stock options were exercised at $5.00 per share.
     The Stock Option and Incentive Plan expired in January 1998.

     Upon adoption of SFAS No. 123, the Corporation elected to continue to
     measure compensation cost using APB 25. The Corporation made no grants of
     stock options during the years ended December 31, 1998, 1997 or 1996, and
     therefore no pro forma disclosures have been made as prescribed by SFAS No.
     123.


(13) Employee Stock Ownership Plan

     The Corporation has an employee stock ownership plan (ESOP) whereby 126,000
     shares, or approximately 10% of the stock issued in conjunction with
     Haywood Savings' 1987 conversion from a mutual to a stock association, were
     purchased for future issuance to employees. Additionally, in 1994, the Plan
     purchased 49,000 shares of common stock at $12.00 per share for future
     issuance to employees.

     Contributions to the plan are made by the Corporation on a discretionary
     basis, and are allocated to each eligible employee based on his/her salary
     in relation to total compensation expense. At retirement or termination of
     employment each employee will receive an amount equal to his/her vested
     interest in previous contributions in the form of Corporation common stock.
     The original purchase of 126,000 shares was funded by a loan with an
     original amount of $630,000 from a North Carolina bank. All of these shares
     have been released to employees and the loan was paid off in 1994. The
     purchase of 49,000 shares was also funded by a loan from a North Carolina
     bank with an original amount of $588,000. Such loan was repaid in full
     during 1998. At December 31, 1998, all shares have been released.

                                     65  
                                                                     (Continued)
<PAGE>
 
                    HAYWOOD BANCSHARES, INC. AND SUBSIDIARY

                  Notes to Consolidated Financial Statements

                       December 31, 1998, 1997 and 1996


     In accordance with Statement of Position 93-6, the Corporation records
     compensation expense for shares released to employees, as a result of
     contributions by the Corporation or dividends paid on unreleased shares in
     the ESOP, equal to the fair value of the shares. For the three years ended
     December 31, 1998, the Corporation recorded ESOP related expenses of
     approximately $104,000, $100,000, and $121,000, respectively.


(14) Line of Credit

     The Corporation has established a $2,000,000 line of credit with a North
     Carolina bank with an interest rate equal to prime. The Corporation is
     required to pay off this line of credit at some point during each year and
     to leave it unused for a period of 60 days. At December 31, 1998 and 1997,
     the Corporation had no outstanding borrowings against this line. Interest
     expense associated with borrowings under this line of credit during 1998,
     1997 and 1996 totaled approximately $2,100, $8,000 and $17,000,
     respectively.


(15) FHLB Advances

     At December 31, 1998 and 1997, the Corporation had advances of $10,500,000
     from the FHLB. These advances bear interest at variable rates (5.62% at
     December 31, 1998) and mature on February 24, 1999.

     The Corporation has entered into a blanket floating lien agreement with the
     FHLB as collateral for these advances. According to this agreement, the
     Corporation maintains, free of other encumbrances, its residential first
     mortgage loan portfolio with unpaid principal balances at least equal to,
     when discounted at 75% of the unpaid principal balances, 100% of the total
     FHLB advances.


(16) Fair Value of Financial Instruments

     The Corporation is required under Statement of Financial Accounting
     Standards No. 107, "Disclosures about Fair Value of Financial Instruments"
     to disclose in its financial statements the fair value of all financial
     instruments, including assets and liabilities both on- and off-balance
     sheet, for which it is practicable to estimate such fair value. Fair value
     estimates, methods, and assumptions for the Corporation are set forth below
     and are subject to the following limitations.

     Fair value estimates are made at a specific point in time, based on
     relevant market information and information about the financial instrument.
     These estimates do not reflect any premium or discount that could result
     from offering for sale at one time the Corporation's entire holdings of a
     particular financial instrument. Because no market exists for a portion of
     the Corporation's financial instruments, fair value estimates are based on
     judgments regarding future expected loss experience, current economic
     conditions, risk characteristics of various financial instruments, and
     other factors.

                                     66  
                                                                     (Continued)
<PAGE>
 
                    HAYWOOD BANCSHARES, INC. AND SUBSIDIARY

                  Notes to Consolidated Financial Statements

                       December 31, 1998, 1997 and 1996

     These estimates are subjective in nature and involve uncertainties and
     matters of significant judgment and therefore cannot be determined with
     precision. Changes in assumptions could significantly affect the estimates.

     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. Significant assets and
     liabilities that are not considered financial assets or liabilities include
     deferred tax assets and premises and equipment. In addition, the tax
     ramifications related to the realization of the unrealized gains and losses
     can have a significant effect on fair value estimates and have not been
     considered.

     The Corporation's fair value methods and assumptions are as follows:

     .  Cash on hand and in banks, interest-bearing balances in other banks,
        federal funds sold, Federal Home Loan Bank Stock, accrued interest
        receivable, and accrued interest payable -- the carrying value is a
        reasonable estimate of fair value.

     .  Investment securities -- fair value is based on available quoted market
        prices or quoted market prices for similar securities if a quoted market
        price is not available.

     .  Loans -- the carrying value for variable rate loans is a reasonable
        estimate of fair value due to contractual interest rates based on prime.
        Fair value for fixed rate loans is estimated based upon discounted
        future cash flows using discount rates comparable to rates currently
        offered for such loans.

     .  Deposit accounts -- the fair value of certificates of deposit is
        estimated using rates currently offered for deposits of similar
        remaining maturities. The fair value of all other deposit account types
        is the amount payable on demand at year-end.

     .  FHLB Advances -- the fair value approximates the carrying value due to
        the variable nature of such borrowings.

     .  Commitments to extend credit and standby letters of credit -- the large
        majority of the Corporation's loan commitments are at variable rates
        and, therefore, are subject to minimal interest rate risk exposure.

                                     67  
                                                                     (Continued)
<PAGE>
 
                    HAYWOOD BANCSHARES, INC. AND SUBSIDIARY

                  Notes to Consolidated Financial Statements

                       December 31, 1998, 1997 and 1996


Based on the limitations, methods, and assumptions noted above, the estimated
fair values of the Corporation's financial instruments at December 31, 1998 and
1997 are as follows:

<TABLE>
<CAPTION>
                                                                                      1998
                                                                       ------------------------------------ 
                                                                            Carrying                        
                                                                             Amount            Fair Value   
                                                                       ----------------    ---------------- 
Financial assets:
<S>                                                                    <C>                 <C> 
   Cash on hand and in banks                                            $  1,525,035             1,525,035
                                                                                               
   Interest-bearing balances in other banks                                   805,357              805,357
   Federal funds sold                                                       1,713,611            1,713,611
   Investment securities -- available for sale                             19,466,200           19,466,200
   Investment securities -- held-to-maturity                               10,302,987           10,332,472
   Loans                                                                  110,792,991          112,191,000
   Federal Home Loan Bank stock                                             1,427,300            1,427,300
   Accrued interest receivable                                                250,652              250,652
                                                                       ==============          ===========
Financial liabilities:                                                                         
   Deposit accounts                                                    $  116,761,373          117,114,000
   Accrued interest payable                                                   254,311              254,311
   FHLB advances                                                           10,500,000           10,500,000
                                                                       ==============          =========== 
                                                                                            
                                                                        

                     
                                                                                        1997       
                                                                       ------------------------------------        
                                                                            Carrying                       
                                                                             Amount            Fair Value        
                                                                       ----------------    ----------------       

<S>                                                                    <C>                 <C> 
Financial assets:                                                                            
   Cash on hand  and in banks                                          $   1,736,787             1,736,787
   Interest-bearing balances in other banks                                  418,967               418,967
   Federal funds sold                                                      2,039,247             2,039,247
   Investment securities -- available for sale                            15,805,611            15,805,611
   Investment securities -- held-to-maturity                              11,242,929            11,303,051
   Loans                                                                 114,150,356           114,774,000
   Federal Home Loan Bank stock                                            1,427,300             1,427,300
   Accrued interest receivable                                               288,037               288,037
                                                                       =============            =========== 
Financial liabilities:                                                                       
   Deposit accounts                                                    $ 118,670,456           118,834,000
   Accrued interest payable                                                  292,064               292,064
   Borrowings                                                             10,500,000            10,500,000
                                                                       =============           ===========
</TABLE>

                                                                     (Continued)

                                68              
<PAGE>
 
                    HAYWOOD BANCSHARES, INC. AND SUBSIDIARY

                  Notes to Consolidated Financial Statements

                       December 31, 1998, 1997 and 1996

(17) Selected Quarterly Financial Information (unaudited)

     Selected quarterly financial information for the years ended December 31,
     1998 and 1997 is as follows:

<TABLE>
<CAPTION>
                                                                                  1998
                                                 ------------------------------------------------------------------------
                                                                     (in thousands, except per share)
                                                      First              Second              Third              Fourth
                                                 --------------    ---------------     ---------------     --------------
<S>                                            <C>                 <C>                 <C>                 <C>
Interest income                                $          2,806              2,790               2,744              2,746
Interest expense                                          1,537              1,536               1,521              1,467
                                                 --------------    ---------------     ---------------     --------------
Net interest income                                       1,269              1,254               1,223              1,279
Provision for loan losses                                     5                  5                   5                  5
                                                 --------------    ---------------     ---------------     --------------
Net interest income after provision
    for loan losses                                       1,264              1,249               1,218              1,274
Other income (loss)                                         533             (1,103)             (1,093)               318
General and administrative expenses                         755                795                 802                895
                                                 --------------    ---------------     ---------------     --------------
Income before income taxes                                1,042               (649)               (677)               697
Income taxes (benefit)                                      407               (258)               (226)               232
                                                 --------------    ---------------     ---------------     --------------
Net income (loss)                              $            635               (391)               (451)               465
                                                 ==============    ===============     ===============     ==============
Net income (loss) per share  basic             $            .51               (.31)               (.36)               .37
                                                 ==============    ===============     ===============     ==============
Net income (loss) per share  diluted           $            .51               (.31)               (.36)               .37
                                                 ==============    ===============     ===============     ==============
</TABLE> 

<TABLE> 
<CAPTION>
                                                                                  1998
                                                 ------------------------------------------------------------------------
                                                                     (in thousands, except per share)
                                                      First              Second              Third              Fourth
                                                 --------------    ---------------     ---------------     --------------
<S>                                            <C>                 <C>                 <C>                 <C>
Interest income                                $          2,441              2,761               2,762              2,882
Interest expense                                          1,339              1,546               1,610              1,657
                                                 --------------    ---------------     ---------------     --------------
Net interest income                                       1,102              1,215               1,152              1,225
Provision for loan losses                                     5                  5                   5                  5
                                                 --------------    ---------------     ---------------     --------------
Net interest income after provision
    for loan losses                                       1,097              1,210               1,147              1,220
Other income                                                219                226                 851                130
General and administrative expenses                         812                781                 780                685
                                                 --------------    ---------------     ---------------     --------------
Income before income taxes                                  504                655               1,218                665
Income taxes                                                194                239                 391                342
                                                 --------------    ---------------     ---------------     --------------
Net income                                     $            310                416                 827                323
                                                 ==============    ===============     ===============     ==============
Net income per share  basic                    $            .26                .33                 .67                .26
                                                 ==============    ===============     ===============     ==============
Net income per share  diluted                  $            .26                .33                 .67                .26
                                                 ==============    ===============     ===============     ==============
</TABLE>

                                69                              (Continued)
<PAGE>
 
                    HAYWOOD BANCSHARES, INC. AND SUBSIDIARY

                  Notes to Consolidated Financial Statements

                       December 31, 1998, 1997 and 1996



(18) Haywood Bancshares, Inc. (Parent Company)

     The principal asset of the Parent Company is its investment in Haywood
     Savings, and its principal source of income is dividends from Haywood
     Savings. Certain regulatory and other requirements restrict the lending of
     funds by Haywood Savings to the Parent Company and the amount of dividends
     which can be paid to the Parent Company. In addition, certain regulatory
     agencies may prohibit the payment of dividends by Haywood Savings if it
     determines that such payment would constitute an unsafe or unsound
     practice. At December 31, 1998, Haywood Savings had no available undivided
     profits for payment of dividends without obtaining prior regulatory
     approval.

     The Parent Company's balance sheet data as of December 31, 1998 and 1997
     and related income and cash flow statement data for the three years ended
     December 31, 1998 are as follows:

<TABLE>
<CAPTION>
                                                    December 31,
      Balance sheet data                      1998                 1997
                                       ----------------     ----------------
<S>                                  <C>                     <C>   
Investment in subsidiaries           $       21,547,432           22,173,532
Receivable from subsidiaries                    200,057              187,554
                                       ----------------     ----------------
                                     $       21,747,489           22,361,086
                                       ================     ================
Accrued liabilities                  $          200,057              187,554
Shareholders' equity                         21,547,432           22,173,532
                                       ----------------     ----------------
                                     $       21,747,489           22,361,086
                                       ================     ================

</TABLE> 
                                70                              (Continued)
<PAGE>
 
                    HAYWOOD BANCSHARES, INC. AND SUBSIDIARY

                  Notes to Consolidated Financial Statements

                       December 31, 1998, 1997 and 1996

<TABLE> 
<CAPTION>  
 
                                                                                  Years ended December 31,
Income statement data                                                1998                 1997                 1996
                                                                ----------------     ----------------     ----------------
<S>                                                           <C>                    <C>                  <C>      
Dividends from subsidiaries                                   $          750,212              694,811              647,900
Equity (loss) in undistributed net income             
    of subsidiaries                                                     (491,914)           1,180,707              445,896
                                                      
                                Net income                    $          258,298            1,875,518            1,093,796
                                                                ================     ================     ================
Cash flow statement data                              
Cash flows from operating activities:                 
    Net income                                                $          258,298            1,875,518            1,093,796
    Increase in receivable from subsidiaries                             (12,503)             (18,873)              (1,322)
    Increase in accrued liabilities                                       12,503               18,873                1,322
    (Increase) decrease in investment in subsidiaries                    491,914           (1,180,707)            (445,896)
                                                                ----------------     ----------------     ----------------
        Net cash provided by operating activities                        750,212              694,811              647,900
                                                                ----------------     ----------------     ----------------
Cash flows from financing activities:                 
    Cash dividends paid                                                 (750,212)            (694,811)            (647,900)
                                                                ----------------     ----------------     ----------------
Net cash used by financing activities                                   (750,212)            (694,811)            (647,900)
                                                                 ----------------     ----------------     ----------------
Net increase (decrease) in cash                                               --                   --                   --
Cash at beginning of year                                                     --                   --                   --
Cash at end of year                                           $               --                   --                   --
                                                                ================     ================     ================
</TABLE>

                                71                              
<PAGE>
 
Item 9.  Changes in and Disagreements with Accountants on Accounting and
------------------------------------------------------------------------
Financial Disclosure
--------------------

     Not applicable.


                                    PART III

Item 10.  Directors and Executive Officers of the Registrant
------------------------------------------------------------

     (a)  Directors of the Registrant

     The information contained under the section captioned "Proposal I --
Election of Directors" in the Company's proxy statement for its 1999 Annual 
Meeting of Stockholders (the "Proxy Statement") is incorporated herein by
reference.

     (b) Executive Officers of the Registrant

     The information contained under the section captioned "Item 1. Business --
Executive Officers of the Registrant" is incorporated herein by reference.


Item 11.  Executive Compensation
--------------------------------

     The information contained under the section captioned "Proposal I --
Election of Directors -- Executive Compensation" and "-- Director Compensation"
in the Proxy Statement is incorporated herein by reference.


Item 12.  Security Ownership of Certain Beneficial Owners and Management
------------------------------------------------------------------------

     (a) Security Ownership of Certain Beneficial Owners

         Information required by this item is incorporated herein by reference
         to the section captioned "Voting Securities and Principal Holders
         Thereof" in the Proxy Statement.

     (b) Security Ownership of Management

         Information required by this item is incorporated herein by reference
         to the sections captioned "Proposal I -- Election of Directors" in the
         Proxy Statement.

     (c) Changes in Control

         Management of the Company knows of no arrangements, including any
         pledge by any person of securities of the Company, the operation of
         which may at a subsequent date result in a change in control of the
         Company.


Item 13.  Certain Relationships and Related Transactions
--------------------------------------------------------

     The information required by this item is incorporated herein by reference
to the section captioned "Certain Transactions" in the Proxy Statement.

                                       72
<PAGE>
 
                                 PART IV

Item 14.  Exhibits, Financial Statement Schedules, and Reports on Form 8-K
--------------------------------------------------------------------------

     (a) Contents.  The following documents are filed as part of this Annual
         --------                                                           
Report on Form 10-K.

     (1) Consolidated Financial Statements

          Independent Auditors' Report
          Consolidated Statements of Financial Condition as of December 31, 1998
           and 1997
          Consolidated Statements of Income for the years ended December 31,
           1998, 1997 and 1996
          Consolidated Statements of Stockholders' Equity and Comprehensive
          Income for the years ended
             December 31, 1998, 1997 and 1996
          Consolidated Statements of Cash Flows for the years ended December 31,
           1998, 1997 and 1996
          Notes to Consolidated Financial Statements for the years ended
           December 31, 1998, 1997 and 1996

     (2)  Financial Statement Schedules.  All schedules for which provision is
made in the applicable accounting regulations of the Securities and Exchange
Commission are omitted because of the absence of conditions under which they are
required or because the required information is included in the consolidated
financial statements and related notes thereto.

     (3) Exhibits.  The following is a list of exhibits filed as part of this
         --------                                                            
Annual Report on Form 10-K and is also the Exhibit Index.


<TABLE>
<CAPTION>
 
          No.  Description
         ----- -----------
<S>      <C>
*         3.1  Articles of Incorporation of Haywood Bancshares, Inc.
*         3.2  Bylaws of Haywood Bancshares, Inc.
++       10.1  Employment Agreement of Larry R. Ammons
++       10.2  Employment Agreement of Jack T. Nichols
++**     10.3  Haywood Bancshares, Inc., 1988 Stock Option and Incentive Plan
++       10.4  Retirement Payment Agreements between Larry R. Ammons and the 
               Bank, as amended
         10.5  Retirement Payment Agreements between Philip S. Dooly and the
               Bank 
         10.6  Retirement Payment Agreement between G.D. Stovall, Jr. and the 
               Bank
         10.7  Retirement Payment Agreement between R. Neal Ensley and the Bank
         10.8  Retirement Payment Agreement between R. Bruce Norman and the 
               Bank     
         10.9  Retirement Payment Agreements, between Joseph E. Taylor, Jr. and 
               the Bank
        10.10  Retirement Payment Agreements between C. Leon Turner and the Bank
++*     10.11  Supplemental Income Agreement between Larry R. Ammons and the 
               Bank, dated October 1, 1989, as amended
++*     10.12  Supplemental Income Agreement between Jack T. Nichols and the
               Bank, dated October 1, 1989, as amended
++*     10.13  Haywood Savings Bank, Inc., SSB Retirement Plan for 
               Non-Employee Directors, as amended
*       10.14  Capital Maintenance Agreement
         21    Subsidiaries of the Registrant
         23    Consent of KPMG LLP
         27    Financial Data Schedule (EDGAR Only)
-------------------------
</TABLE>

*    Incorporated by reference to similarly numbered exhibits to the Company's
     Registration Statement on Form S-4 (File No. 33-90186).
**   Incorporated by reference to Exhibit 99.1 to the Company's Post-Effective
     Amendment No. 1 on Form S-8 to Registration Statement on Form S-4 
     (File No. 33-90186).       
***  Incorporated by reference to similarly numbered exhibits to the Company's
     Annual Report on Form 10-K for the year ended December 31, 1995.          
++   Management contract or compensatory plan or arrangement required to be 
     filed as an exhibit pursuant to Item 14(c) of Form 10-K.

                                       73
<PAGE>
 
     (b) Reports on Form 8-K.  The Registrant did not file any Current Reports
         -------------------                                                  
on Form 8-K during the last quarter of the fiscal year ending December 31, 1998.

     (c) Exhibits.  The exhibits required by Item 601 of Regulation S-K are
         --------                                                          
either filed as part of this Annual Report on Form 10-K or incorporated by
reference herein.

     (d) Financial Statements and Schedules Excluded from Annual Report.  There
         --------------------------------------------------------------        
are no other financial statements and financial statement schedules which were
excluded from the Annual Report to Stockholders pursuant to Rule 14a-3(b)(1)
which are required to be included herein.

                                       74
<PAGE>
 
                                   SIGNATURES

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

                              HAYWOOD BANCSHARES, INC.


Date:  March 22, 1999         By: /s/ Larry R. Ammons
                                  -------------------
                                   Larry R. Ammons
                                   President

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


By: /s/ Larry R. Ammons                      By: /s/ R. Bruce Norman
    -------------------                          -------------------
    Larry R. Ammons                              R. Bruce Norman
    President and a Director                     Director
    (Principal Executive Officer)

Date: March 22, 1999                         Date: March 22, 1999
 
By: /s/ Jack T. Nichols                      By: /s/ C. Jeff Reece, Jr.
    -------------------                          ----------------------
Jack T. Nichols                                  C. Jeff Reece, Jr.
Chief Financial Officer                          Director
(Principal Financial and Accounting Officer
 
Date: March 22, 1999                                 Date: March 22, 1999
 
By: /s/ Glenn W. Brown                       By: /s/ G. D. Stovall, Jr.
    ------------------                           ----------------------
    Glenn W. Brown                               G. D. Stovall, Jr.
    Director                                     Director
 
Date: March 22, 1999                         Date: March 22, 1999
 
By: /s/ William P. Burgin                    By: /s/ Joseph E. Taylor, Jr.
    ---------------------                        -------------------------
    William P. Burgin                            Joseph E. Taylor, Jr.    
    Director                                     Director             
                                                 
Date: March 22, 1999                         Date: March 22, 1999

By: /s/ Philip S. Dooly                      By: /s/ C. Leon Turner
    -------------------                          ------------------
    Philip S. Dooly                              C. Leon Turner
    Director                                     Director

Date: March 22, 1999                         Date: March 22, 1999

By: /s/ R. Neal Ensley
    ------------------
    R. Neal Ensley
    Director

Date: March 22, 1999

                                       75