<PAGE>
 
                                                                      Exhibit 13
 
                     1996 ANNUAL REPORT TO SECURITY HOLDERS
<TABLE> 
<CAPTION> 
 
SELECTED FINANCIAL DATA
-------------------------------------------------------------------------------------------------------------
                                                            1996        1995       1994       1993       1992
                                                            ----        ----       ----       ----       ----
                                                                       (dollars in thousands)
<S>                                                     <C>         <C>         <C>        <C>        <C> 
Summary of Operations:                                                 
Interest income                                         $  9,248    $  7,811    $ 6,864    $ 6,728    $ 7,397
Interest expense                                           4,414       3,682      3,262      3,506      4,425
                                                        --------    --------    -------    -------    -------
Net interest income                                        4,834       4,129      3,602      3,222      2,972
Provision for loan losses                                     96         120         87         60         48
                                                        --------    --------    -------    -------    -------
Net interest income after provision for loan losses        4,738       4,009      3,515      3,162      2,924
Other income                                                 255         336        255        683        297
Other expenses                                             2,449       2,265      2,027      1,832      1,702




                                                        --------    --------    -------    -------    -------
Income before income tax expense                           2,544       2,080      1,743      2,013      1,519
Income tax expense                                           849         837        710        803        538
                                                        --------    --------    -------    -------    -------
   Net income                                           $  1,695    $  1,243    $ 1,033    $ 1,210    $   981
                                                        ========    ========    =======    =======    =======
 
Selected Year-end Balances:
Total assets                                            $128,711    $104,013    $97,368    $95,094    $89,232
Loans receivable, net                                     91,187      84,713     81,733     80,937     75,892
Investments(1)                                            32,564      15,043     11,338      9,910      9,569
Deposits                                                  73,361      76,745     74,287     72,262     69,511
FHLB Advances                                             17,250      13,000     10,500     11,000      9,000
Stockholders' equity                                      37,050      13,646     12,195     11,347     10,138
 
Average Balance Sheet Data:
Total assets                                            $119,252    $100,359    $97,827    $90,876    $83,263
Total earning assets                                     116,010      96,745     95,046     87,265     80,875
Loans receivable, net                                     87,917      83,326     83,534     76,642     72,328
Investments(1)                                            27,297      12,633     10,733      9,976      7,978
Deposits                                                  77,221      75,110     73,137     71,505     68,032
FHLB Advances                                             13,248      10,628     11,603      7,074      4,421
Stockholders' equity                                      27,557      12,810     11,959     10,971      9,754
 
Selected Financial Ratios:
Return on average assets                                    1.42%       1.24%      1.06%      1.33%      1.18%
Return on average equity                                    6.15        9.70       8.64      11.03      10.20
Average equity to average assets                           23.11       12.76      12.22      12.07      11.55
Interest rate spread (tax equivalent basis)                 3.16        3.72       3.32       3.25       3.11
Net interest margin (tax equivalent basis)                  4.33        4.29       3.80       3.69       3.70
Dividend payout ratio                                      48.89         n/a        n/a        n/a        n/a
Cash dividends declared per common share                $   0.22         n/a        n/a        n/a        n/a
</TABLE>
(1) Includes investment securities, mortgage backed-securities, and interest-
    bearing deposits.

<PAGE>
 
                    MANAGEMENT'S DISCUSSION AND ANALYSIS OF
                 FINANCIAL CONDITION AND RESULTS OF OPERATIONS

       Management's discussion and analysis is intended to assist readers in the
understanding and evaluation of the financial condition and results of
operations of the Company.  It should be read in conjunction with the audited
consolidated financial statements and accompanying notes included in this report
and the supplemental financial data appearing throughout this discussion and
analysis.

ANALYSIS OF RESULTS OF OPERATIONS

       The Company's results of operations depend primarily on net interest
income, which is the difference between interest income from interest-earning
assets and interest expense on interest-bearing liabilities.  Operations are
also affected by non-interest income, such as income from customer service
charges, loan servicing fee income, gains and losses on the sale of loans and
investments, 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.

       The Company completed its first year as a public company with record
earnings.  Net income increased to $1.7 million for the year ended June 30, 1996
compared to $1.2 million in 1995 and $1.0 million in 1994.  Growth in net
interest income outpaced a decline in other income and an increase in other
expense to make 1996 the most profitable year in the Company's eighty-three year
history.
 
       Net Interest Income.  Net interest income, the Company's primary source
of earnings, continued its trend of growth.  Table 1 shows that tax-equivalent
net interest income increased by $902,000 or 21.6% in 1996 to $5.1 million from
$4.2 million in 1995.  Net interest income is analyzed on a tax-equivalent basis
to adjust for the nontaxable status of income earned on certain investments such
as municipal bonds.

       The increase in tax-equivalent interest income in 1996 as compared to
1995 was primarily the result of a $19.3 million or 19.9% increase in earning
assets.  Average loans increased by $4.6 million or 5.5% to $87.9 million.
Average investments increased by $11.8 million or 107% as stock Conversion
proceeds were invested primarily in both taxable and tax-exempt investment
securities.  The weighted average yield on interest-earning assets increased by
five basis points in 1996,  largely due to the upward adjustment of the
Company's portfolio of adjustable rate loans in the rising rate environment.  In
1995, tax-equivalent interest income rose 14.0% primarily due to increases in
the average yield which increased by 86 basis points.

       Interest expense rose by $732,000 or 19.9% during 1996.  Average
interest-bearing liabilities increased by $4.4 million or 5.2% in 1996 while the
average rate paid on those liabilities increased by 61 basis points.  The
increase in interest expense in 1996  was due primarily to increases in deposit
rates.  In 1995, interest expense rose 12.9% due to increases in deposit rates.

       Interest rate spread (on a tax equivalent basis) declined to 3.16% in
1996 from 3.72% in 1995 and 3.32% in 1994 as the increase in the cost of
interest-bearing liabilities outpaced the increase in the yield on interest-
earning assets.  Despite the decline in interest rate spread, net interest
margin (on a tax equivalent basis) increased to 4.33% in 1996 from 4.29% in
1995, and 3.80% in 1994.  While Conversion proceeds were invested at yields
somewhat less than the weighted average yield on total interest-earning assets,
those investments contributed to the increase in net interest margin.

       While primary reasons for increases have been discussed above, the total
increase in net interest income is attributable to both an increase in net
interest-earning assets and interest rate spread over the three-year period.
Table 2 shows the effect of variances in volume and rate on taxable-equivalent
interest income, interest expense, and net interest income.  The table shows
that increases in net interest income were primarily due to volume in 1996 while
such increases were primarily due to rate in 1995.
<PAGE>
 
Table 1:  NET INTEREST INCOME ANALYSIS - TAX EQUIVALENT
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
                                                       1996                          1995                          1994
                                                       ----                          ----                          ----  
                                                               Average                       Average                       Average
                                           Average              Yield/   Average              Yield/   Average              Yield/
                                           Balance   Interest    Rate    Balance   Interest    Rate    Balance   Interest    Rate
                                           -------   --------    ----    -------   --------    ----    -------   --------    ----  
                                                                            (dollars in thousands)
<S>                                        <C>       <C>       <C>       <C>       <C>       <C>       <C>       <C>       <C>
Assets: 
Interest-earning assets:
 Loans receivable                          $ 87,917   $ 7,591     8.63%  $ 83,326    $6,969     8.36%   $83,534    $6,186     7.41%
 Taxable investment securities               14,993     1,020     6.80     10,160       688     6.77      9,154       585     6.39
 Tax-exempt investment securities(1)          7,754       546     7.04        821        54     6.58        290        15     5.30
 Interest-bearing deposits                    4,550       226     4.97      1,652        64     3.87      1,289        43     3.34
 FHLB common stock                              796        58     7.29        786        55     7.00        779        41     5.26
                                            -------     -----             -------     -----              ------     -----
Total interest-earning assets               116,010     9,441     8.14     96,745     7,830     8.09     95,046     6,870     7.23
Non-interest-earning assets                   3,242                         3,614                         2,781
                                            -------                       -------                        ------
     TOTAL                                 $119,252                      $100,359                       $97,827
                                            =======                       =======                        ======
 
Liabilities and retained earnings:
Interest-bearing liabilities:
 Deposit accounts                          $ 75,365   $ 3,614     4.80%  $ 73,569    $3,101     4.21%   $71,755     2,761     3.85
 FHLB advances                               13,248       800     6.04     10,628       581     5.47     11,603       501     4.31
                                             ------     -----              ------     -----              ------     -----
Total interest-bearing liabilities           88,613     4,414     4.98     84,197     3,682     4.37     83,358     3,262     3.91
Non-interest-bearing liabilities              3,082                         3,352                         2,510
Stockholder's equity                         27,557                        12,810                        11,959
                                            -------                        ------                        ------
     TOTAL                                 $119,252                      $100,359                       $97,827
                                            =======                       =======                        ======
 
Net interest income and interest rate
 spread                                               $ 5,027     3.16%              $4,148     3.72%              $3,608     3.32%
                                                        =====                         =====                         =====
Net interest-earning assets
 and net interest margin                   $ 27,397               4.33%  $ 12,548               4.29%   $11,688               3.80%
                                             ======                        ======                         =====
Ratio of interest-earning assets
 to interest bearing liabilities                                130.92%                       114.90%                       114.02%
</TABLE>

(1) Interest earned on tax-exempt investment securities has been adjusted to a
tax-equivalent basis using the applicable combined federal and state rates of
34% and 7.75%, respectively,  and reduced by the nondeductible portion of
interest expense.


 
 
Table 2:  RATE/VOLUME ANALYSIS
--------------------------------------------------------------------------------


<TABLE> 
<CAPTION> 
                                                                1996                             1995
                                                                ----                             ----
                                                                     Rate/                           Rate/  
                                                  Volume     Rate    Volume   Net    Volume   Rate   Volume    Net 
                                                  ------     ----    ------   ---    ------   ----   ------    --- 
                                                                           (dollars in thousands)                  
<S>                                              <C>         <C>       <C>   <C>     <C>      <C>    <C>      <C>  
Interest income (tax-equivalent) on:                                                                               
  Loans                                           $  384    $ 225      $13  $  622    $(15)   $794     $ 4    $783 
  Taxable investment securities                      327        3        2     332      64      35       4     103 
  Tax-exempt investment securities                   455        4       33     492      28       4       7      39 
  Interest-bearing deposits                          112       18       32     162      12       7       2      21 
  FHLB common stock                                    1        2       --       3      --      14      --      14 
                                                   -----     ----      ---   -----     ---    ----    ----     --- 
     Total interest income                         1,279      252       80   1,611      89     854      17     960 
                                                   -----     ----      ---   -----     ---    ----    ----     --- 
  Deposit accounts                                    76      434        3     513      16     314      10     340 
  FHLB advances                                      143       61       15     219     (42)    135     (13)     80 
                                                   -----     ----      ---   -----     ---    ----    ----     --- 
     Total interest expense                          219      495       18     732     (26)    449      (3)    420 
                                                   -----     ----      ---   -----     ---    ----    ----     --- 
Increase (decrease) in net interest income        $1,060    $(243)     $62  $  879    $115    $405    $ 20    $540 
                                                   =====     ====      ===   =====     ===    ====    ====     === 
                                                       
</TABLE>

                                       2
<PAGE>
 
          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 cover loan losses based on existing loan levels and types
of loans outstanding, nonperforming loans, prior loan loss experience, industry
standards and general economic conditions.  Provisions for loan losses were
$96,000 in 1996 compared to $120,000 in 1995, and $87,000 in 1994.  During 1994
and 1995, the provision and resulting allowance for loan losses were increased
based on management's efforts to reflect industry practices regarding the
allowance for loan losses.  During 1996, the provision was lowered, largely as a
result of an improved level of the relationship of the allowance to outstanding
loans.

          Other Income.  Other income decreased from $337,000 in 1995 to
$255,000 in 1996, the same level as  1994.  Other income included losses
realized on the sale of investments and mortgage-backed securities of $47,000,
$100,000, and $81,000 in 1996, 1995, and 1994, respectively.  These net losses
were incurred as management, in response to higher prevailing market interest
rates, restructured the Company's investment portfolio to achieve higher yields
in future periods.  "Other" income includes lower-of-cost- or-market writedowns
on loans held-for-sale of $40,000 for 1996 resulting from the rising interest
rate environment while lower-of-cost-or-market recoveries of $19,000 were
recorded during 1995.

          In 1994, gains of $96,000 were recorded on mortgage loans sold as part
of management's efforts to improve its interest sensitivity and liquidity
positions.  Also in 1994, management wrote down excess servicing assets by
$111,000 as a result of a change in estimated prepayment speeds used in valuing
excess servicing which had risen to historical highs in response to mortgage
interest rates reaching historical lows.


          Other Expenses.  Other expenses increased by 8.1% in 1996 compared to
an increase of 11.7% in 1995.  As a percent of average assets, other expense for
1996 was at its lowest level of the last three years:  2.05% as compared to
2.26% in 1995 and 2.07% in 1994.

          Compensation and fringe benefits, consistently representing over 50%
of total other expenses, increased by $55,000 or 4.2% in 1996 compared to
$210,000 or 19.3% in 1995. Salaries increased by $57,000 and $72,000 in 1996 and
1995, respectively, while retirement expense increased by $120,000 and $6,000
for the same periods.  1996 retirement expense reflects the implementation of
the Bank's Employee Stock Ownership Plan ("ESOP") which provides a higher level
of retirement benefits to employees than the retirement plan which was in place
in previous years.  Directors' compensation declined by $113,000 to a more
normal level from 1995 when extra meetings associated with the Conversion were
held.

          On August 29, 1996, 105,800 shares of Parent stock were awarded under
the Bank's Management Recognition Plan ("MRP") which has been approved by
stockholders and the board of directors.  Management estimates that pre-tax
expenses associated with the MRP will total approximately $315,000 per year for
a period of five years.

          Data and items processing expense increased by $31,000 and $16,000 in
1996 and 1995, respectively. Reasons for the increase include increased
transaction volume and investments in technology.  Professional fees increased
by $30,000 and $24,000 for the same periods as the Company obtained assistance
in making the transition from mutual to stock ownership.

          Management continues to look for ways to improve cost efficiency.
During the late fall of the coming year, the Company will be closing its branch,
which is located one mile from the home office, as part of the effort to operate
in the most cost efficient manner.  No losses will be incurred.

          Income Tax Expense.  Income tax expense increased 1.4% to $849,000 in
1996 from $837,000 in 1995.  The effective tax rate declined from 40.2% in 1995
to 33.4% in 1996, reflecting a higher level of tax-exempt income in 1996.
Income tax expense totaled $710,000 in 1994, and the effective tax rate was
40.7%.

                                       3
<PAGE>
 
ANALYSIS OF FINANCIAL CONDITION

          On December 7, 1995, the Bank completed its conversion from a mutual
to a stock savings bank through the sale of 2,645,000 shares of no par common
stock of the Parent.  Total proceeds of $26,450,000 were reduced by Conversion
expenses of $1,052,395.  The Parent retained 50% of the net conversion proceeds
after deducting the proceeds of a loan to the Bank's Employee Stock Ownership
Plan ("ESOP") and paid the balance to the Bank in exchange for the common stock
of the Bank issued in the Conversion.  The increase in assets from $104.0
million at June 30, 1995 to $128.7 million at June 30, 1996 is directly
attributable to proceeds of the Conversion which were invested in loans and
investment securities.

Loans

          The Company's primary source of revenue is interest and fee income
from lending activities, consisting primarily of one-to-four family residential
mortgage loans located in its primary market area.  The Company also makes loans
secured by improved nonresidential real estate, construction loans, loans
secured by undeveloped real estate, home equity loans, and consumer loans, both
secured and unsecured.

          At June 30, 1996, the loan portfolio totaled $91.2 million and
represented 70.8% of total assets.  During 1996, loans increased by $6.5 million
or 7.6%.  Loan originations increased from $9.8 million in 1995 to $21.2
million in 1996, largely in response to the Company's efforts to expand its loan
programs into adjacent counties.  The relative composition of the Company's loan
portfolio has remained consistent during recent years, with residential one-to-
four family loans comprising approximately 73% of the portfolio.  Table 3 sets
forth the composition of the loan portfolio at the dates indicated.
 
   Table 3:  TYPES OF LOANS
<TABLE> 
<CAPTION> 
------------------------------------------------------------------------------------------------------------------------------------

                                                                                June 30,
                              ------------------------------------------------------------------------------------------------------

                                       1996             1995                      1994               1993               1992
                                       ----             ----                      ----               ----               ---- 
Real estate loans:                                                      (dollars in thousands)
<S>                             <C>       <C>      <C>       <C>      <C>          <C>         <C>       <C>      <C>       <C>
   Residential 1-4 family        $67,095   73.58%   $62,379   73.63%      $59,842      73.22%   $58,500   72.28%   $55,036   72.52%
   Nonresidential real estate      8,818    9.67      8,623   10.18         7,574       9.27      7,242    8.95      8,677   11.43
   Home equity and other
      second mortgage             11,616   12.74     11,916   14.07        12,027      14.71     11,244   13.89      9,915   13.07
   Construction                    5,026    5.51      1,805    2.13         2,769       3.39      5,762    7.12      3,896    5.13
                                 -------  ------    -------  ------       -------     ------    -------  ------    -------  ------
        Total real estate loans   92,555  101.50     84,723  100.01        82,212     100.59     82,748  102.24     77,524  102.15
Other installment loans            1,719    1.89      1,635    1.93         1,635       2.00      1,460    1.80      1,498    1.97
Less:
   Unearned fees and
    discounts                        281    0.31        185    0.22           268       0.33        305    0.38        279    0.37
   Loans in process                2,198    2.41        945    1.11         1,442       1.76      2,649    3.27      2,574    3.39
   Allowance for loan losses         608    0.67        515    0.61           404       0.50        317    0.39        277    0.36
                                 -------  ------    -------  ------       -------     ------    -------  ------    -------  ------
   Total reductions                3,087    3.39      1,645    1.94         2,114       2.59      3,271    4.04      3,130    4.12
                                 -------  ------    -------  ------       -------     ------    -------  ------    -------  ------
        Total loans, net         $91,187  100.00    $84,713  100.00       $81,733     100.00    $80,937  100.00    $75,892  100.00
                                 =======  ======    =======  ======       =======     ======    =======  ======    =======  ======
</TABLE>

          In order to protect the Company's net interest margin, management has,
as part of its interest rate risk management program, placed an emphasis on
maintaining adjustable rate mortgage loans and home equity lines of credit in
its portfolio.  This strategy has resulted in more consistent net interest
income and lower interest sensitivity than experienced by most traditional
fixed-rate residential mortgage lenders.

          The following table sets forth the time to contractual maturity of the
Company's loan portfolio at June 30, 1996.  Loans which have adjustable rates
are shown as being due in the period during which rates are next subject to
change while fixed rate and other loans are shown as due in the period of
contractual maturity.  Demand loans, loans having no stated maturity and
overdrafts are reported as due in one year or less.  The table does not include
prepayments or scheduled principal repayments.   Amounts in the table are net of
loans in process and are net of unamortized loan fees.

                                       4
<PAGE>
 
<TABLE> 
<CAPTION> 
 
Table 4:  LOAN MATURITIES
---------------------------------------------------------------------------------------------
               .                                        June 30, 1996    
                                 ------------------------------------------------------------
                                             Over 1   Over 3    Over 5
                                 One Year   Year to  Years to  Years to  Over 10
                                  Or Less   3 Years  5 Years   10 Years   Years      Total
                                 ---------  -------  --------  --------  --------  ---------
                                                    (dollars in thousands)                  
<S>                              <C>        <C>      <C>       <C>       <C>       <C>
Mortgage loans:
  Fixed rate 1-4 family           $   166      $211      $471     3,200   $28,685   $32,733
  Adjustable rate 1-4 family       37,734       103       142        --        --    37,979
  Adjustable home equity           10,816        --        --        --        --    10,816
  Other fixed rate loans              100       167        --       304     1,112     1,683
  Other adjustable rate loans       6,857        --        --        --        --     6,857
Other loans                           960       458       129        80       100     1,727
Less:
  Allowance for loan losses          (608)       --        --        --        --      (608)
                                  -------      ----      ----    ------   -------   -------
     TOTAL LOANS                  $56,025      $939      $742    $3,584   $29,897   $91,187
                                  =======      ====      ====    ======   =======   =======
 
</TABLE>

Asset Quality and Allowance for Loan Losses

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

<TABLE> 
<CAPTION> 

Table 5:  SUMMARY OF NONPERFORMING AND PROBLEM ASSETS
-------------------------------------------------------------------------------------------------------------
                                                                             June 30,          
                                                        -----------------------------------------------------
                                                          1996       1995      1994      1993      1992
                                                        --------   --------   -------   -------   -------
                                                                      (dollars in thousands)           
<S>                                                     <C>        <C>        <C>       <C>       <C>
Total nonaccrual loans                                  $    758   $     30   $   139   $   158   $    76
Total restructured loans                                      --         --        --        --        --
                                                        --------   --------   -------   -------   -------
     Total nonperforming loans                               758         30       139       158        76
                                                        --------   --------   -------   -------   -------
Real estate owned                                             --         --       161       108       118
In-substance foreclosures                                     --         --        --        --        --
                                                        --------   --------   -------   -------   -------
     Total foreclosed property                                --         --       161       108       118
                                                        --------   --------   -------   -------   -------
Total nonperforming assets                              $    758   $     30   $   300   $   266   $   194

Accruing loans, delinquent 90 days or more              $    301   $    571        41   $   266   $   359

Nonperforming loans to total loans                          0.83%      0.04%     0.17%     0.20%     0.10%
Nonperforming assets to total assets                        0.59%      0.03%     0.31%     0.28%     0.22%
Total assets                                            $128,711   $104,013   $97,368   $95,094   $89,232
Total loans, net                                        $ 91,187   $ 84,713   $81,733   $80,937   $75,892
</TABLE>

Nonperforming assets increased to $758,000 at June 30, 1996 compared to $30,000
and $300,000 at June 30, 1995 and 1994, respectively. The increase in nonaccrual
loans is primarily attributable to one large credit totaling $457,000 secured by
commercial real estate and several smaller credits secured by residential real
estate.  Management has reviewed the collateral for nonaccrual loans and
believes that collateral values related to nonperforming loans exceed the loan
balances.  Management has included this review among the factors considered in
the evaluation of the allowance for possible loan losses as discussed below.
While the level of nonperforming assets is higher than in recent years, the
Company's asset quality remains strong as evidenced by security property,
charge-off activity, and comparison with peer asset quality measures.

                                       5
<PAGE>
 
          Effective July 1, 1995, the Company adopted the provisions of
Statement of Financial Accounting Standards No. 114, "Accounting by Creditors
for Impairment of a Loan", as amended by Statement of Financial Accounting
Standards No. 118, "Accounting by Creditors for Impairment of a Loan:  Income
Recognition" (collectively referred to hereafter as "SFAS No. 114").  At June
30, 1996, the recorded investment in loans that are considered to be impaired
under SFAS No. 114 was $826,000 and was comprised of two loans.  One of the
loans totaling $457,000 was in non-accrual status at June 30, 1996.  There was
no related allowance for credit losses associated with these loans as determined
in accordance with SFAS No. 114.  The average recorded investment in impaired
loans during 1996 was approximately $864,000.   No additions to the allowance
for loan losses were necessary due to the adoption of SFAS No. 114.

          The allowance for loan losses represents management's estimate of an
amount adequate to provide for potential losses inherent in the loan portfolio.
The adequacy of the allowance for loan losses and the related provision are
based upon management's evaluation of the risk characteristics of the loan
portfolio under current economic conditions with consideration to such factors
as financial condition of the 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.

          The provision for loan losses is calculated and charged to earnings to
maintain the total allowance for loan losses at a level considered adequate to
cover loan losses based on existing loan levels, types of loans outstanding,
nonperforming loans, prior loan loss experience, industry standards and general
economic conditions.  Provisions for loan losses were $96,000 in 1996 compared
to $120,000 in 1995, and $87,000 in 1994.  During 1994 and 1995, the provision
and resulting allowance for loan losses were increased based on management's
efforts to reflect industry practices regarding the allowance for loan losses.
During 1996, the provision was lowered, largely as a result of an improved level
of the relationship of the allowance to outstanding loans.

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


Table 6:  ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES
-------------------------------------------------------------------------------

<TABLE>
<CAPTION>
                                                   Year Ended June 30,
                                        ---------------------------------------
                                         1996    1995    1994    1993    1992
                                         ----    ----    ----    ----    ----  
                                                    (in thousands)
<S>                                     <C>     <C>     <C>     <C>     <C>
Balance, beginning of period            $ 515   $ 404   $ 317   $ 277    $ 250
Provision for loan losses                  96     120      87      60       49
Charge-offs                                 4      14       4      21       22
Recoveries                                  1       5       4       1       --
                                         ----    ----    ----    ----     ----
Balance, end of period                  $ 608   $ 515   $ 404   $ 317    $ 277
                                         ====    ====    ====    ====     ====
Allowance as a percentage of loans       0.66%   0.60%   0.49%   0.39%    0.36%
</TABLE>

                                       6
<PAGE>
 
Table 7:  ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------
                                                           June 30,
                                               ------------------------------------
                                                1996   1995   1994   1993   1992
                                                ----   ----   ----   ----   ----
<S>                                             <C>   <C>    <C>     <C>    <C>
                                                        (dollars in thousands)
Residential 1-4 family                         $ 256  $ 216  $ 170  $ 132  $ 116
Nonresidential real estate                       170    155    121     95     84
Home equity and other second mortgage             97     82     65     51     44
Construction                                      36     16     12     10      8
                                               -----  -----  -----  -----  -----
  Total real estate loans                        559    469    368    288    252
Other loans                                       49     46     36     29     25
                                               -----  -----  -----  -----  -----
  Total allowance for loan losses              $ 608  $ 515  $ 404  $ 317  $ 277
                                               =====  =====  =====  =====  =====
</TABLE>

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



Investment Securities

  Interest and dividend income from investment securities generally provides the
second largest source of income to the Company after interest on loans. The
Company's portfolio of investment securities includes U.S. government and agency
securities, mortgage-backed securities, and obligations of states and local
governments.  The mortgage-backed securities consist of mortgage-backed
securities issued by the FNMA and collateralized mortgage obligations issued by
the FNMA and FHLMC which are secured by mortgage-backed securities guaranteed by
the FNMA or FHLMC.
 
  Investment securities totaled $30.6 million at June 30, 1996, an increase of
$17.9 million from $12.7 million at June 30, 1995.  This growth is attributable
to management placing Conversion proceeds in investment securities until such
time as those funds are needed for other purposes, primarily to fund loans in
the Company's community.  Accordingly, most of the securities purchased were
classified as available-for-sale under Statement of Financial Accounting
Standards No. 115 ("SFAS 115").  At June 30, 1996, net unrealized losses of
$951,000 were included in the carrying value of securities classified available-
for-sale compared to net unrealized gains of $37,000 on such securities at June
30, 1995. Net unrealized losses were caused by fluctuations in market interest
rates rather than by concerns about the issuer's ability to meet their
obligations.

  Table 8 shows maturities of investment securities held by the Company at June
30, 1996 and the weighted average tax-equivalent yields for each type of
security and maturity.  Further information about the Company's investment
securities as of June 30, 1996 and 1995 is presented in Note 2 of the notes to
the consolidated financial statements.

                                       7
<PAGE>
 
<TABLE> 
<CAPTION> 

Table 8:  INVESTMENT SECURITIES -  MATURITY/YIELD SCHEDULE
-------------------------------------------------------------------------------------------------
                                                          More than              More than
                                 One year or Less    1 Year to 5  Years     5 years to 10 years   
                                ------------------  ---------------------  ---------------------- 
                                          Weighted              Weighted                Weighted  
                                Carrying  Average    Carrying    Average    Carrying     Average  
                                 Value     Yield      Value       Yield       Value       Yield   
                                --------  --------  ----------  ---------  -----------  --------- 
<S>                             <C>       <C>       <C>         <C>        <C>          <C>       
Available-for-sale:         
U.S. government and agency      $      -         -      $  503      8.37%      $ 8,859      6.79%   
State and local government(1)          -         -         857      6.82         2,947      7.38      
Mortgage-backed securities(2)          -         -       2,419      5.73         3,715      6.25      
                                --------  --------      ------      ----       -------      ----     
   Total available-for-sale     $      -         -      $3,779      6.33       $15,521      6.77     
                                --------  --------      ------      ----       -------      ----      
 
Held-to-maturity:
U.S. government and agency      $      -         -      $    -         -       $     -         -      
State and local government(3)         76      4.93       1,215      6.51         1,285      8.20        
Mortgage-backed securities             -         -           -         -             -         -        
                                --------  --------      ------      ----       -------      ----     
   Total held-to-maturity       $     76      4.93      $1,215      6.51       $ 1,285      8.20     
                                --------  --------      ------      ----       -------      ----    
Total investments,        
    at carrying value           $     76                $4,994                 $16,806                                
                                ========                ======                 =======                               
<CAPTION>                                            
                                     Over 10 Years              Total
                                     -------------              -----
                                             Weighted                 Weighted
                                  Carrying    Average     Carrying     Average
                                    Value      Yield       Value        Yield
                                  ---------  ---------  ------------  ---------
<S>                               <C>        <C>        <C>           <C>
Available-for-sale:
U.S. government and agency         $  947      7.42%       $10,309      6.93%
State and local government(1)       6,039      8.28          9,843      7.88
Mortgage-backed securities(2)         812      7.13          6,946      6.17
                                   ------      ----        -------      ----
   Total available-for-sale        $7,798      8.06        $27,098      7.08
                                   ------      ----        -------      ----
 
Held-to-maturity:
U.S. government and agency         $    -         -        $     -         -
State and local government(3)         943       8.19         3,519      7.54
Mortgage-backed securities              -         -              -         -
                                   ------      ----        -------      ----
   Total held-to-maturity          $  943      8.19        $ 3,519      7.54
                                   ------      ----        -------      ----
Total investments,
    at carrying value              $8,741                  $30,617
                                   ======                  =======
</TABLE>

(1)  Yields are stated on a taxable equivalent basis assuming statutory tax
     rates of 34% for federal and 7.75% for state purposes.  Book yields
     without regard to tax-equivalent adjustments are:  one to five years,
     4.15%; six to ten years, 4.56%; over ten years, 4.87%; total 4.71%.
(2)  Mortgage-backed securities are shown at their weighted average expected
     life obtained from an outside evaluation of the average remaining life of
     each security based on historic prepayment speeds of the underlying
     mortgages at June 30, 1996.
(3)  Yields are stated on a taxable equivalent basis assuming statutory tax 
     rates of 34% for federal and 7.75% for state purposes.  Book yields without
     regard to tax-equivalent adjustments are: one year or less, 3.30%; one to 
     five years, 5.03%; six to ten years, 4.68%, over ten years, 5.28%;
     total, 5.04%.

In addition to the investment securities discussed above, the Company also earns
interest on its correspondent bank account at the Federal Home Loan Bank
("FHLB") of Atlanta and dividends on its FHLB stock.  The Bank is required to
maintain, as a condition of membership, an investment in stock of the FHLB of
Atlanta equal to the greater of 1% of outstanding home loans or 5% of its
outstanding advances.  No ready market exists for such stock, which is carried
at cost.  As of June 30, 1996, the Company's investment in stock of the FHLB of
Atlanta was $863,000.


Funding Sources

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

          Deposits.   Deposits totaled $73.4 million at June 30, 1996 compared
to $76.7 million at June 30, 1995.  The decrease reflects approximately $5
million of deposits which customers used to purchase the Parent's stock in the
Conversion. The following table sets forth certain information regarding the
Company's average savings deposits for the last three years.

                                       8
<PAGE>
 
Table 9:  AVERAGE DEPOSITS
<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------------
                                             1996                1995                1994
                                           --------            --------            --------
                                       Average   Average   Average   Average   Average   Average
                                        Amount     Rate     Amount     Rate     Amount     Rate
                                       --------  --------  --------  --------  --------  --------
                                                        (Dollars in Thousands)
<S>                                   <C>       <C>       <C>       <C>       <C>       <C>
Interest bearing checking accounts     $ 6,412     1.84%   $ 5,305     2.32%     4,698     2.16%
Savings and money market deposits       18,980     3.22     17,592     2.72     18,537     2.71
Certificates of deposit                 49,973     5.78     50,672     4.91     48,520     4.45
                                       -------     ----    -------     ----    -------     ----
   Total interest-bearing deposits      75,365     4.80     73,569     4.20     71,755     3.85
Non-interest-bearing deposits            1,856       --      1,541       --      1,382       --
                                       -------     ----    -------     ----    -------     ----
     TOTAL DEPOSITS                    $77,221     4.68    $75,110     4.11    $73,137     3.78
                                       =======     ====    =======     ====    =======     ====
</TABLE>

          As of June 30, 1996, the Company held $6,072,000 in time certificates
of deposit of $100,000 or more. Maturities of certificates of deposits of
$100,000 or more at June 30, 1996 were as follows:  three months or less,
$2,361,000; over three months through six months, $1,488,000; over six months
through twelve months, $719,000; over twelve months through twenty-four months,
$1,249,000; and over twenty-four months, $255,000.

          Borrowings.   The Company's principal source of long-term borrowings
are advances from the FHLB of Atlanta.  As a requirement for membership, the
Bank is required to own capital stock in the FHLB of Atlanta and is authorized
to apply for advances on the security of that stock and a floating lien on its
1-4 family residential mortgage loans.  Each credit program has its own interest
rate and range of maturities.  At June 30, 1996, FHLB advances totaled $17.25
million compared to $13 million at June 30, 1995.  Additional information on
borrowings is provided in Note 6 of the notes to the consolidated financial
statements.


Liquidity and Interest Rate Risk Management

          Liquidity is the ability to raise funds or convert assets to cash in
order to meet customer and operating needs. The Company's primary sources of
liquidity are its portfolio of investment securities available-for-sale,
principal and interest payments on loans and mortgage-backed securities,
interest income from investment securities, maturities of investment securities
held-to-maturity, increases in deposits, and advances from the FHLB of Atlanta.
At June 30, 1996, the Bank had $7,750,000 of credit available from the FHLB
which would be collateralized by a blanket lien on qualifying loans secured by
first mortgages on 1-4 family residences.  Additional amounts may be made
available under this blanket floating lien or by using investment  securities as
collateral.  Management believes that it will have sufficient funds available to
meet its anticipated future loan commitments as well as other liquidity needs.

          Interest rate risk is the sensitivity of interest income and interest
expense to changes in interest rates.  Management has structured its assets and
liabilities in an attempt to protect net interest income from large fluctuations
associated with changes in interest rates.  Table 10 shows the amount of
interest-earning assets and interest-bearing liabilities outstanding at June 30,
1996 which are projected to reprice or mature in each of the future time periods
shown.  At June 30, 1996, the Company had a cumulative one year asset-sensitive
gap position of $3.7 million or 2.95% of interest-earning assets. This generally
indicates that net interest income would increase in a rising rate environment
and would experience downward pressure in a declining rate environment.

          It should be noted that this table reflects the interest-sensitivity
of the balance sheet as of a specific date and is not necessarily indicative of
future results.  Because of this and other limitations, management also monitors
interest rate sensitivity through the use of a model which estimates the change
in net portfolio value and net interest income in response to a range of assumed
changes in market interest rates.  Based on interest sensitivity measures as of
June 30, 1996, management believes that its interest rate risk is at an
acceptable level.

                                       9
<PAGE>
 
<TABLE>
<CAPTION>
 
 

Table 10:  INTEREST SENSITIVITY
--------------------------------------------------------------------------------------------------------------
                                                                     June 30, 1996
                                          --------------------------------------------------------------------
                                                                More than    More than
                                          3 Months   4 to 12    1 Year to    3 Years to     Over
                                          Or Less     Months     3 Years      5 Years     5 Years     Total
                                          --------   --------   ----------   ----------   --------   --------
                                                                (dollars in thousands)
<S>                                       <C>        <C>        <C>          <C>          <C>        <C>
Interest-earning assets  
 Mortgage loans:
  Fixed rate residential 1-4 family        $ 1,405    $ 3,458      $ 7,277      $ 4,069    $16,524   $ 32,733
  Adjustable rate residential 1-4 family    10,137     27,635          117           90         --     37,979
  Adjustable home equity                    10,816         --           --           --         --     10,816
  Other fixed rate loans                        15         49          145          172      1,302      1,683
  Other adjustable rate loans                1,028      5,829           --           --         --      6,857
                                           -------    -------      -------      -------    -------   --------
   Total mortgage loans                     23,401     36,971        7,539        4,331     17,826     90,068
  Other loans                                  818        444          465           --         --      1,727
                                           -------    -------      -------      -------    -------   --------
   Total loans                              24,219     37,415        8,004        4,331     17,826     91,795
 Interest-bearing deposits                   1,947         --           --           --         --      1,947
 Investment securities(1)                       --         76        2,236        2,758     25,547     30,617
 FHLB common stock                              --         --           --           --        863        863
                                           -------    -------      -------      -------    -------   --------
   Total interest-earning assets           $26,166    $37,491      $10,240      $ 7,089    $44,236   $125,222
                                           =======    =======      =======      =======    =======   ========
 
Interest-bearing liabilities
 Deposits:
  Fixed maturity deposits                  $18,195    $16,935      $11,556      $ 1,730         --   $ 48,416
  NOW accounts                                 594      1,420        1,899          493      1,092      5,498
  Savings and money market accounts          1,947      3,618        3,990        2,522      5,727     17,804
                                           -------    -------      -------      -------    -------   --------
   Total deposits                           20,736     21,973       17,445        4,745      6,819     71,718
 FHLB advances                               8,250      9,000           --           --         --     17,250
                                           -------    -------      -------      -------    -------   --------
   Total interest-bearing liabilities      $28,986    $30,973      $17,445      $ 4,745    $ 6,819   $ 88,968
                                           =======    =======      =======      =======    =======   ========
 
Interest sensitivity gap per period        $(2,820)   $ 6,518      $(7,205)     $ 2,344    $37,417   $ 36,254
Cumulative interest sensitivity gap         (2,820)     3,698       (3,507)      (1,163)    36,254     36,254
Cumulative gap as a percentage of
 total interest-earning assets              (2.25)%      2.95%      (2.80)%      (0.93)%     28.95%     28.95%
Cumulative interest-earning assets as a
 percentage of interest-bearing              90.27%    106.17%       95.47%       98.58%    140.75%    140.75%
  liabilities
</TABLE>
 
(1) Includes investment and mortgage-backed securities

This table was prepared using the assumptions regarding loan prepayment rates,
loan repricing and deposit decay rates which are used by the FHLB of Atlanta in
making its gap computations.  These assumptions should not be regarded as
indicative of the actual prepayments and withdrawals that may be experienced by
the Company.  However, management believes that these assumptions approximate
actual experience and considers them appropriate and reasonable.



Capital Resources

     Stockholders' equity increased from $13,646,000 at June 30, 1995 to
$37,050,000 at June 30, 1996, largely as a result of the Conversion.

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

                                      10
<PAGE>
 
     The Bank must comply with the capital requirements of the FDIC and the
Administrator.  The FDIC requires the Bank to maintain minimum ratios of Tier I
capital to total risk-weighted assets and total capital to risk-weighted assets
of 4% and 8%, respectively.  Tier I capital consists of total stockholders'
equity calculated in accordance with generally accepted accounting principles
less intangible assets, and total capital is comprised of Tier I capital plus
certain adjustments, the only one of which applicable to the Bank is the
allowance for loan losses.  Risk-weighted assets reflect the Bank's on- and off-
balance sheet exposures after such exposures have been adjusted for their
relative risk levels using formulas set forth in FDIC regulations.  The Bank is
also subject to a leverage capital requirement, which calls for a minimum ratio
of Tier I capital (as defined above) to quarterly average total assets of 3% to
5%, depending on the institution's composite ratings as determined by its
regulators. The Administrator requires a net worth equal to at least 5% of
assets.

     At June 30, 1996 and 1995, the Bank was in compliance with all of the
aforementioned capital requirements as summarized in Table 11.  Refer to
"Supervision and Regulation" under "Business" and note 7 to the consolidated
financial statements for a discussion of other matters that may affect the
Company's capital resources.

Table 11:  REGULATORY CAPITAL
<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------
                                                                                    At June 30,
                                                                                    -----------
                                                                                 1996          1995
                                                                                 ----          ----    
Risk-Based and Leverage Capital                                                (dollars in thousands)
<S>                                                                         <C>           <C>
Tier I Capital:                                      
 Common stockholders' equity                                                $     23,429  $     13,646
 Unrealized holding loss (gain) on securities available-for-sale                     441           (22)
                                                                            ------------  ------------
     Total Tier I leverage capital                                                23,870        13,624
Tier II Capital:                                     
 Qualifying allowance for loan losses                                                608           515
     Tier II capital additions                                                       608           515
                                                                            ------------  ------------
Total risk-based capital                                                    $     24,478  $     14,139
                                                     
Risk-weighted assets                                                              66,500        58,972
Fourth quarter average assets                                                    122,491       102,858
                                                     
Risk-based capital ratios:                           
 Tier I capital as a percent of risk-weighted assets                               35.89%        23.10%
 Minimum Required Tier I capital                                                    4.00%         4.00%
 Total risk-based capital as a percent of risk-weighed assets                      36.81%        23.98%
 Minimum required total risk-based capital                                          8.00%         8.00%
Leverage capital ratios:                             
 Tier I leverage capital as a percent of fourth quarter average assets             19.49%        13.25%
 Minimum required Tier I leverage capital                                    3.00 - 5.00%  3.00 - 5.00%
North Carolina regulatory capital:                   
 Total risk-based capital as a percent of fourth quarter average assets            19.98%        13.75%
 Minimum required North Carolina capital                                            5.00%         5.00%
</TABLE>

Impact of Inflation and Changing Prices

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

                                      11
<PAGE>
 
Regulatory Issues

  Various proposals are currently being considered by committees of the United
States Congress concerning a possible merger of the FDIC's Savings Association
Insurance Fund ("SAIF") and the Bank Insurance Fund ("BIF").  One of the
principal issues under discussion is the amount of additional funds needed to
capitalize the SAIF prior to such merger.  Substantially all of the proposals
under consideration include a special assessment of 85 basis points to be levied
on SAIF-insured deposits.  As a SAIF-insured institution, the Bank may be
subject to a special assessment on its deposits under the proposals which have
been published.  Based upon the Bank's deposits as of June 30, 1996, the
approximate proposed one-time fee would be $671,000.

  Financial institutions such as the Bank which are members of the SAIF, are
required to pay higher deposit insurance premiums than financial institutions
which are members of the BIF (primarily commercial banks) because the BIF has
higher reserves than the SAIF and has been responsible for fewer troubled
institutions.  The FDIC Board of Directors has approved a risk-based premium
schedule that will maintain assessment rates for SAIF-insured financial
institutions at current levels which will increase the disparity between SAIF
and BIF assessments.  In announcing this rule, the FDIC noted that the premium
differential may have adverse consequences for SAIF members, including reduced
earnings and an impaired ability to raise funds in the capital markets.  This
premium differential could continue to exist for a long period of time.  In
addition, SAIF members, such as the  Bank, could be placed at a substantial
competitive disadvantage to BIF members, with respect to pricing of loans and
deposits and the ability to achieve lower operating costs.  Several alternatives
to mitigate the effect of the BIF/SAIF premium disparity have been suggested by
federal banking regulators, by members of the United States Congress, and by
industry groups.

  The Bank incurred deposit insurance premium expense of $176,000, $172,000 and
$166,000 in fiscal 1996, 1995 and 1994, respectively.  A significant increase in
SAIF insurance premiums or a significant one-time fee to recapitalize the SAIF
would likely have an adverse effect on the operating expenses and results of
operations of the Bank.

Accounting Issues

  The Company prepares its consolidated financial statements and related
disclosures in conformity with standards established by, among others, the
Financial Accounting Standards Board (the "FASB").  Because the information
needed by users of financial reports is dynamic, the FASB frequently has new
rules and proposed new rules for companies to apply in reporting their
activities.  The following discussion addresses such changes as of June 30, 1996
that will affect the Company's future reporting.

  The FASB has issued Statement of Financial Accounting Standards ("SFAS") No.
121 , "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed Of."  SFAS 121 requires that long-lived assets and certain
identifiable intangibles to be held and used by an entity be reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable.  In evaluating
recoverability, if estimated future cash flows, undiscounted and without
interest charges, are less than the carrying amount of the asset, an impairment
loss is recognized.  SFAS 121 also requires that certain long-lived assets and
certain identifiable intangibles to be disposed of be reported at the lower of
carrying amount or fair value less cost to sell.  SFAS 121 applies prospectively
for fiscal years beginning after December 15, 1995.  Management does not expect
that adoption of SFAS 121 will have a material impact on the Company's
consolidated financial statements.

  The FASB has also issued SFAS No. 122, "Accounting for Mortgage Servicing
Rights, an amendment of FASB Statement No. 65," which provides guidance for the
capitalization of originated as well as purchased mortgage servicing rights and
the measurement of impairment of those rights.  SFAS 122 requires that an entity
recognize as separate assets the rights to service mortgage loans for others,
however those servicing rights are acquired.  SFAS 122 also requires that an
entity assess its capitalized mortgage servicing rights for impairment based on
the fair value of those rights.  It should stratify its mortgage servicing
rights based on one or more 

                                      12
<PAGE>
 
predominant risk characteristics of the underlying loans, and recognize
impairment through a valuation allowance for each impaired stratum. SFAS 122
applies prospectively for fiscal years beginning after December 15, 1995.
Management does not expect that adoption of SFAS 122 will have a material impact
on the Company's consolidated financial statements.

  In October 1995, the FASB issued SFAS No. 123, "Accounting for Stock-Based
Compensation".  The statement defines a fair value method of accounting for an
employee stock option or similar equity instrument and encourages all entities
to adopt that method of accounting for all of their employee stock compensation
plans.  It also allows an entity to continue to measure compensation cost for
those plans using the intrinsic value based method of accounting prescribed in
Accounting Principles Board Opinion Number 25 ("APB No. 25"), "Accounting for
Stock Issued to Employees".  SFAS No. 123 requires that an employers' financial
statements include certain disclosures about stock-based compensation
arrangements regardless of the method used to account for them.  Entities
electing to remain with the accounting in APB No. 25 must make pro forma
disclosures of net income and, if presented, earnings per share, as if the fair
value based method of accounting defined in SFAS No. 123 had been applied.  The
disclosure requirements of the statement are effective for financial statements
for fiscal years beginning after December 15, 1995, or for an earlier fiscal
year for which this statement is initially adopted for recognizing compensation
cost.  Pro forma disclosures required for entities that elect to continue to
measure compensation cost using APB No. 25 must include the effects of all
awards granted in fiscal years that begin after December 15, 1994.  Management
anticipates that the adoption of the statement should have no material impact on
its consolidated financial statements.

  SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities" was issued in June 1996.  This statement
provides accounting and reporting standards for transfers and servicing of
financial assets and extinguishments of liabilities based on consistent
application of a financial-components approach that focuses on control.  It
distinguishes transfers of financial assets that are sales from transfers that
are secured borrowings.  Under the financial-components approach, after a
transfer of financial assets, an entity recognizes all financial and servicing
assets it controls and liabilities it has incurred and derecognizes financial
assets it no longer controls and liabilities that have been extinguished.  The
financial-components approach focuses on the assets and liabilities that exist
after the transfer.  If a transfer does not meet the criteria for a sale, the
transfer is accounted for as a secured borrowing with pledge of collateral.
This statement is effective for transfer and servicing of financial assets and
extinguishments of liabilities occurring after December 31, 1996, and is to be
applied prospectively.  Management anticipates that the adoption of the
statement should have no material impact on its consolidated financial
statements.

                                      13
<PAGE>
 
                          INDEPENDENT AUDITORS' REPORT


The Board of Directors and Stockholders
Piedmont Bancorp, Inc.:


We have audited the accompanying consolidated balance sheets of Piedmont Bancorp
Inc. and subsidiary as of June 30, 1996 and 1995, and the related consolidated
statements of income, stockholders' equity and cash flows for each of the years
in the three-year period ended June 30, 1996.  These consolidated financial
statements are the responsibility of the Company's management.  Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.

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

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Piedmont Bancorp,
Inc. and subsidiary as of June 30, 1996 and 1995, and the results of their
operations and their cash flows for each of the years in the three-year period
ended June 30, 1996, in conformity with generally accepted accounting
principles.

As discussed in notes 2 and 8, respectively, to the consolidated financial
statements, on July 1, 1993, the Company adopted the provisions of the Financial
Accounting Standards Board's Statement of Financial Accounting Standards No.
115, "Accounting for Certain Investments in Debt and Equity Securities," and the
provisions of the Financial Accounting Standards Board's Statement of Financial
Accounting Standards No. 109, "Accounting for Income Taxes".


                                                KPMG Peat Marwick LLP

                                                /s/ KPMG Peat Marwick LLP

Raleigh, North Carolina
July 19, 1996



                                      -1-
<PAGE>
 
                     PIEDMONT BANCORP, INC. AND SUBSIDIARY
                          Consolidated Balance Sheets
                            June 30, 1996 and 1995

<TABLE>
<CAPTION>


                                                                            1996           1995     
                                                                            ----           ----
                                                                               (in thousands)

ASSETS

<S>                                                                       <C>          <C>     
Cash                                                                      $     723    $    778
Interest-bearing deposits in other financial institutions                     1,947       2,358
Investment securities (note 2):
     Available-for-sale (cost:  $28,049 in 1996 and
       $10,850 in 1995)                                                      27,098      10,887
     Held-to-maturity (market value: $3,477 in 1996
       and $1,813 in 1995)                                                    3,519       1,798
Loans receivable (net of allowance for loan losses of
     $608 in 1996 and $515 in 1995) (note 3)                                 91,187      84,713
Federal Home Loan Bank stock, at cost                                           863         786
Premises and equipment (note 4)                                               1,324       1,339
Prepaid expenses and other assets (note 8)                                    2,050       1,354
                                                                          ---------    --------
           Total assets                                                   $ 128,711    $104,013
                                                                          =========    ========

LIABILITIES AND STOCKHOLDERS' EQUITY

Deposits (note 5):
     Demand, non-interest bearing                                             1,643       1,672
     Savings, NOW and MMDA                                                   23,302      21,954
     Certificates of deposit                                                 48,416      53,119
                                                                          ---------    --------
                                                                             73,361      76,745

Advances from the Federal Home Loan Bank (note 6)                            17,250      13,000
Accrued expenses and other liabilities                                        1,050         622
                                                                          ---------    --------
           Total liabilities                                                 91,661      90,367
                                                                          ---------    --------

Stockholders' Equity:
Common stock, no par value, 20,000,000 shares authorized;
   2,654,000 shares issued and outstanding (note 1)                          25,398        --
Unearned ESOP shares                                                         (2,552)       --
Retained earnings, substantially restricted (notes 7 and 8)                  14,783      13,624
Unrealized holding gains (losses) on available-for-sale securities, net        (579)         22
                                                                          ---------    --------
           Total stockholders' equity                                        37,050      13,646
                                                                          ---------    --------

Commitments and contingencies (notes 3 and 9)
                      Total liabilities and stockholders' equity

                                                                          $ 128,711    $104,013
                                                                          =========    ========
</TABLE> 


See accompanying notes to consolidated financial statements.

                                      -2-
<PAGE>
 
                     PIEDMONT BANCORP, INC. AND SUBSIDIARY
                        Consolidated Statements of Income
                For the years ended June 30, 1996, 1995 and 1994
<TABLE>
<CAPTION>
 
                                                          1996             1995         1994
                                                          ----             ----         ----
                                                         (in thousands except per share data)
<S>                                                   <C>              <C>           <C> 
Interest income:
 Interest on loans                                     $ 7,591          $ 6,969       $ 6,186
 Interest on deposits in other financial
  institutions                                             226               64            42
 Interest and dividends on investment securities:
    Taxable                                              1,078              743           626
    Non-taxable                                            353               35            10
                                                        ------           ------        ------
      Total interest income                              9,248            7,811         6,864
                                                        ======           ======        ======
Interest expense:
 Interest on deposits (note 5)                           3,614            3,101         2,761
 Interest on borrowings                                    800              581           501
                                                        ------           ------        ------
      Total interest expense                             4,414            3,682         3,262
                                                        ------           ------        ------
 
Net interest income                                      4,834            4,129         3,602
Provision for loan losses (note 3)                          96              120            87
                                                        ------           ------        ------
      Net interest income after provision for
        loan losses                                      4,738            4,009         3,515
                                                        ------           ------        ------
 
Other income:
 Customer service and other fees                           175              178           196
 Mortgage loan servicing fees                               96              115            91   
 Gain on sale of loans                                       -                -            96
 Excess servicing writedown                                  -                -          (111)
 Other                                                      31              144            64
                                                        ------           ------        ------    
       Total other income                                  255              337           255
                                                        ------           ------        ------
 
Other expenses:
 Compensation and fringe benefits                        1,353            1,298         1,088
 Data and items processing                                 239              208           192
 Deposit insurance premiums                                176              172           166
 Occupancy expense                                         123              113           111
 Furniture and equipment expense                           100              108            90
 Professional fees                                         120               90            66
 Other                                                     338              276           314
                                                        ------           ------        ------
       Total other expenses                              2,449            2,265         2,027
                                                        ======           ======        ======
       Income before income tax expense                  2,544            2,081         1,743
 
Income tax expense (note 8)                                849              837           710
                                                        ------           ------        ------
      Net income                                        $1,695           $1,244        $1,033
                                                        ======           ======        ======
 
Net income per share (note 1)                           $ 0.45              N/A           N/A
                                                        ======

</TABLE>
See accompanying notes to consolidated financial statements.


                                      -3-
<PAGE>
 
                     PIEDMONT BANCORP, INC. AND SUBSIDIARY
                Consolidated Statements of Stockholders' Equity
                For the years ended June 30, 1996, 1995 and 1994

<TABLE>
<CAPTION>

                                                                           Unearned                Unrealized        Total
                                                      Shares      Common     ESOP     Retained      holding      Stockholders'
                                                    Outstanding   Stock     Shares    Earnings   Gains/(Losses)      Equity
                                                    -----------   -----     ------    --------   --------------      ------   
<S>                                                 <C>          <C>       <C>        <C>        <C>             <C>
                                                                  (in thousands, except shares outstanding)
Balance at June 30, 1993                                      -   $     -   $     -   $ 11,347       $   -            $ 11,347
    Net income                                                -         -         -      1,033           -               1,033
    Adjustment to beginning balance for change in  
     accounting method, net of income taxes of $128           -         -         -          -         184                 184
    Change in unrealized holding gains (losses),   
     net of income taxes of $256                              -         -         -          -         (369)              (369)
                                                    -----------   -------   -------   --------        -----           --------
Balance at June 30, 1994                                      -         -         -     12,380         (185)            12,195
    Net income                                                -         -         -      1,244            -              1,244
    Change in unrealized holding gains (losses),                                                                
     net of income taxes of $144                              -         -         -          -          207                207
                                                    -----------   -------   -------   --------        -----           --------
Balance at June 30, 1995                                      -         -         -     13,624           22             13,646
    Net income                                                -         -         -      1,695            -              1,695
    Net proceeds from issuance of                                                                               
     no par common stock                              2,645,000    25,398         -          -            -             25,398
    Common stock acquired by ESOP                             -         -    (2,731)         -            -             (2,731)
    Release of ESOP shares                                    -         -       179          -            -                179
    Cash dividends declared ($0.22 per share)                 -         -         -       (536)           -               (536)
    Change in unrealized holding gains (losses),
     net of income taxes of $387                              -         -         -          -         (601)              (601)
                                                    -----------   -------   -------   --------        -----           --------
Balance at June 30, 1996                              2,645,000   $25,398   $(2,552)  $ 14,783        $(579)          $ 37,050
                                                    ===========   =======   =======   ========        =====           ======== 
</TABLE>



See accompanying notes to consolidated financial statements.

                                      -4-
<PAGE>
 
                      PIEDMONT BANCORP, INC. AND SUBSIDIARY
                      Consolidated Statements of Cash Flows
                For the years ended June 30, 1996, 1995, and 1994
<TABLE>
<CAPTION>

                                                                                           1996        1995        1994
                                                                                         --------    --------    --------
   Operating activities:                                                                         (in thousands)
<S>                                                                                      <C>         <C>         <C>    
      Net income                                                                         $  1,695    $  1,244    $ 1,033
      Adjustments to reconcile net income to net cash provided by operating
        activities:
           Depreciation                                                                        90          88         78
           Net amortization (accretion)                                                       154         (48)       161
           Provision for loan losses                                                           96         120         87
           Deferred income taxes                                                              (56)        (60)       (45)
           Gain on sale of loans                                                             --          --          (96)
           Net loss on sale of investment and mortgage-backed securities                       47         100         80
           Release of ESOP shares                                                             179        --         --
           Net decrease (increase) in morgage loans held for sale                          (1,667)       (232)       249
           Federal Home Loan Bank stock dividends                                            --          --          (31)
           Increase in other assets                                                          (291)       (109)       (83)
           Increase (decrease) in other liabilities                                           136         236        (36)
                                                                                         --------    --------    -------
                     Net cash provided by operating activities                                383       1,339      1,397
                                                                                         --------    --------    -------

Investing activities:
      Net increase in loans held for investment                                            (4,995)     (2,776)    (1,095)
      Principal collected on mortgage-backed securities                                       753         149        754
      Purchases of investment securities classified as available-for-sale                 (23,968)       (485)    (9,529)
      Purchases of investment securities classified as held-to-maturity                    (1,815)     (1,416)      (465)
      Purchases of mortgage-backed securities classified as available-for-sale             (1,482)     (1,990)      --
      Proceeds of sales of investment securities classified as available-for-sale           2,946         466      7,965
      Proceeds from maturities of investment securities                                        75          75       --
      Proceeds from investment securities called by issuer                                  4,500        --         --
      Proceeds of sales of mortgage-backed securities classified as available-for-sale       --           942       --
      Purchases of FHLB Stock                                                                 (77)       --         --
      Purchases of premises and equipment                                                     (75)        (70)       (50)
                                                                                         --------    --------    -------
                     Net cash used by investing activities                                (24,138)     (5,105)    (2,420)
                                                                                         --------    --------    -------

Financing activities:

      Net increase (decrease) in time deposits                                             (4,703)      3,971      1,054
      Net increase (decrease) in other deposits                                             1,319      (1,513)       971
      Proceeds from borrowings                                                             12,750      13,000      6,000
      Repayments of borrowings                                                             (8,500)    (10,500)    (6,500)
      Proceeds from issuance of no par common stock                                        25,398        --         --
      Purchase of common stock for ESOP                                                    (2,731)       --         --
      Cash dividends paid to shareholders                                                    (244)       --         --
                                                                                         --------    --------    -------
               Net cash provided by financing activities                                   23,289       4,958      1,525
                                                                                         --------    --------    -------
                   Increase (decrease) in cash and cash equivalents                          (466)      1,192        502
Cash and cash equivalents at beginning of period                                            3,136       1,944      1,442
                                                                                         --------    --------    -------
Cash and cash equivalents at end of period                                               $  2,670    $  3,136    $ 1,944
                                                                                        ========    ========    =======
Supplemental disclosure of cash flow information: 
  Cash paid during the period for:

      Interest                                                                           $  4,448    $  3,615    $ 3,271
                                                                                         ========    ========    =======
      Income taxes                                                                       $    828    $    775    $   817
                                                                                         ========    ========    =======
Supplemental disclosure of noncash transactions:
   Unrealized gains (losses) on available-for-sale securities, net of deferred
      taxes (benefit) of $387 for 1996, $144 for 1995 and $(128) for 1994                $   (601)   $    207    $  (185)
                                                                                         ========    ========    =======
   Dividends declared but unpaid                                                         $   (292)   $   --      $  --
                                                                                         ========    ========    =======

</TABLE>

See accompanying notes to consolidated financial statements.

                                      -5-

<PAGE>
 
                     PIEDMONT BANCORP, INC. AND SUBSIDIARY
                   Notes to Consolidated Financial Statements
                For the years ended June 30, 1996, 1995 and 1994



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

   (a) Organization and Operations
       ---------------------------

   In December 1995, pursuant to a Plan of Conversion approved by its members
   and regulators, Hillsborough Savings Bank, Inc., SSB (the "Bank") amended and
   restated its charter to effect its conversion from a North Carolina chartered
   mutual savings bank to a North Carolina chartered stock savings bank (the
   "Conversion"), and became a wholly-owned subsidiary of Piedmont Bancorp, Inc.
   (the "Parent"), a holding company formed in connection with the Conversion.
   The Bank is primarily engaged in the business of obtaining savings deposits
   and providing loans to the general public.  The principal activity of the
   Parent is ownership of the Bank.

   (b) Basis of Presentation
       ---------------------

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

   (c) Investment and Mortgage-Backed Securities
       -----------------------------------------

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

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

                                       6
<PAGE>
 
                     PIEDMONT BANCORP, INC. AND SUBSIDIARY
             Notes to Consolidated Financial Statements, Continued

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

   (d) Loan Sales
       ----------

   At the time of origination, when specific loans or groups of loans are
   identified for sale, the Company classifies such loans as held for sale and
   values these at the lower of aggregate cost or market value as determined by
   the current investor yield requirements calculated on an aggregate loan
   basis.  The Company recognizes gains and losses at the time of sale if loans
   selected for sale have an average interest rate, adjusted for servicing
   costs, which differs substantially from the actual yield to the purchaser.
   Any resulting discount or premium is amortized using a level-yield method
   over the actual life of such loans.  Normal servicing fees are recognized as
   income in the period earned.  Prepayment assumptions are reviewed in view of
   actual rates of prepayment of loans sold and amortization of the excess
   servicing on loans sold is adjusted accordingly.  Due to changes in
   prepayment assumptions, the Company wrote down its excess servicing asset by
   $111,000 during the year ended June 30, 1994.

   (e) Loans Receivable
       ----------------

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

   Interest on loans is recorded as borrowers' monthly payments become due.
   Accrual of interest income on loans is suspended when, in management's
   judgment, doubts exist as to the collectibility of principal and interest.
   Loans are returned to accrual status when management determines, based on an
   evaluation of the underlying collateral together with the borrower's payment
   record and financial condition, that the borrower has the capability and
   intent to meet the contractual obligations of the loan agreement.

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

   (f) Allowance for Loan Losses
       -------------------------

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

   At June 30, 1996, substantially all of the Company's loans were
   collateralized by real estate in Orange and adjacent counties. The collateral
   is predominately owner-occupied residential real estate in which the borrower
   does not rely on underlying cash flows from the property to satisfy debt
   service. The ultimate collectibility of a substantial portion of the loan
   portfolio is susceptible to changes in market conditions in the Company's
   market area. While management uses available information to recognize losses
   on loans, future additions to the allowance may be necessary based on changes
   in economic conditions.  Various regulatory agencies, as an integral part of
   their examination processes, periodically review the Company's allowance for
   loan losses.  Such agencies may require the Company to recognize additions to
   the allowance based on their judgments about information available to them at
   the time of their examinations.

                                       7
<PAGE>
 
                     PIEDMONT BANCORP, INC. AND SUBSIDIARY
             Notes to Consolidated Financial Statements, Continued


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

   Effective July 1, 1995, as required, the Company adopted the provisions of
   Statement of Financial Accounting Standards No. 114, "Accounting by Creditors
   for Impariment of a Loan," as amended by Statement of Financial Accounting
   Standards No. 118, "Accounting by Creditors for Impairment of a Loan:  Income
   Recognition" (collectively referred to hereafter as "SFAS No. 114").  The
   adoption of SFAS No. 114 did not have a material effect on the Company's
   financial condition or results of operations.  Under the provisions of SFAS
   No. 114, the 1996 provision for loan losses releated to loans that are
   identified for impairment in accordance with SFAS No. 114 is based on
   discounted cash flows using the loans' initial interest rate or the fair
   value of the collateral if the loan is collateral dependent.  Large groups of
   smaller balance homogenous loans that are collectively evaluated for
   impairment (such as residential mortgage and consumer installment loans) are
   excluded from this impairment evaluation in accordance with SFAS No. 114, and
   their allowance for loan losses is calculated in accordance with the
   allowance for loan losses policy described above.

   (g) Investment in Federal Home Loan Bank Stock
       ------------------------------------------

   As a requirement for membership, the Bank invests in stock of the Federal
   Home Loan Bank of Atlanta (FHLB) in the amount of 1% of its outstanding
   residential loans or 5% of its outstanding advances from the FHLB, whichever
   is greater. At June 30, 1996, the Bank owned 8,625 shares of the FHLB's $100
   par value capital stock.

   (h) Premises and Equipment
       ----------------------

   Premises and equipment are stated at cost. Provisions for depreciation are
   computed principally using the straight-line method and charged to operations
   over the estimated useful lives of the assets which range from 5 to 40 years
   for office buildings and 3 to 10 years for furniture, fixtures, and equipment
   and other improvements.

   (i) Income Taxes
       ------------

   In February of 1992, the Financial Accounting Standards Board (FASB) issued
   Statement of Financial Accounting Standards (SFAS) No. 109, "Accounting for
   Income Taxes".  Statement 109 requires a change from the deferred method of
   accounting for income taxes of APB Opinion 11 to the asset and liability
   method of accounting for income taxes.  Under the asset and liability method
   of Statement 109, deferred tax assets and liabilities are recognized for the
   future tax consequences attributable to differences between the financial
   statement carrying amounts of existing assets and liabilities and their
   respective tax bases.  Deferred tax assets and liabilities are measured using
   enacted tax rates expected to apply to taxable income in the years in which
   those temporary differences are expected to be recovered or settled.  Under
   Statement 109, the effect on deferred tax assets and liabilities of a change
   in tax rates is recognized in income in the period that includes the
   enactment date.  Effective July 1, 1993, the Company adopted Statement 109
   with no cumulative effect of that change in the method of accounting for
   income taxes on the June 30, 1994 statement of income.

                                       8
<PAGE>
 
                     PIEDMONT BANCORP, INC. AND SUBSIDIARY
             Notes to Consolidated Financial Statements, Continued


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

   (j) Retirement Plan
       ---------------

   The Bank has an employee stock ownership plan which covers substantially all
   of its employees.  Contributions to the plan are determined annually by the
   Board of Directors based on employee compensation.  Prior to establishment of
   the employee stock ownership plan, the Company had a self-administered,
   defined contribution retirement plan that covered all eligible employees.
   This plan was terminated as of July 31, 1995 in conjunction with the
   Conversion. The Bank also has a 401(k) plan that covers all eligible
   employees.  The Bank matches voluntary contributions by participating
   employees.

   (k) Cash and Cash Equivalents
       -------------------------

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

   (l) Earnings Per Share
       ------------------

   Earnings per share has been computed based on net income and the weighted
   average number of shares outstanding solely for the post Conversion period,
   or 2,446,832 shares for the year ended June 30, 1996.  For purposes of this
   computation, the number of shares purchased by the Bank's employee stock
   ownership plan which have not been allocated to participant accounts are not
   assumed to be outstanding.

   (m) New Accounting Pronouncements
       -----------------------------

   The FASB has issued SFAS No. 121, "Accounting for the Impairment of Long-
   Lived Assets and for Long-Lived Assets to be Disposed Of".  SFAS 121 requires
   that long-lived assets and certain identifiable intangibles to be held and
   used by an entity be reviewed for impairment whenever events or changes in
   circumstances indicate that the carrying amount of an asset may not be
   recoverable.  In evaluating recoverability, if estimated future cash flows,
   undiscounted and without interest charges, are less than the carrying amount
   of the asset, an impairment loss is recognized.  SFAS 121 also requires that
   certain long-lived assets and certain identifiable intangibles to be disposed
   of be reported at the lower of carrying amount or fair value less cost to
   sell.  SFAS 121 applies prospectively for fiscal years beginning after
   December 15, 1995.  Management does not expect that adoption of SFAS 121 will
   have a material impact on the Company's consolidated financial statements.

   The FASB has also issued SFAS No. 122, "Accounting for Mortgage Servicing
   Rights, an amendment of FASB Statement No. 65," which provides guidance for
   the capitalization of originated as well as purchased mortgage servicing
   rights and the measurement of impairment of those rights.  SFAS 122 requires
   that an entity recognize as separate assets the rights to service mortgage
   loans for others, however those servicing rights are acquired.  SFAS 122 also
   requires that an entity assess its capitalized mortgage servicing rights for
   impairment based on the fair value of those rights.  It should stratify its
   mortgage servicing rights based on one or more predominant risk
   characteristics of the underlying loans, and recognize impairment through a
   valuation allowance for each impaired stratum. SFAS 122 applies prospectively
   for fiscal years beginning after December 15, 1995. Management does not
   expect that adoption of SFAS 122 will have a material impact on the Company's
   consolidated financial statements.

                                       9
<PAGE>
 
                     PIEDMONT BANCORP, INC. AND SUBSIDIARY
             Notes to Consolidated Financial Statements, Continued

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

    In October 1995, the FASB issued SFAS No. 123, "Accounting for Stock-Based
    Compensation". The statement defines a fair value method of accounting for
    an employee stock option or similar equity instrument and encourages all
    entities to adopt that method of accounting for all of their employee stock
    compensation plans. It also allows an entity to continue to measure
    compensation cost for those plans using the intrinsic value based method of
    accounting prescribed in Accounting Principles Board Opinion Number 25 ("APB
    No. 25"), "Accounting for Stock Issued to Employees". SFAS No. 123 requires
    that an employers' financial statements include certain disclosures about
    stock-based compensation arrangements regardless of the method used to
    account for them. Entities electing to remain with the accounting in APB No.
    25 must make pro forma disclosures of net income and, if presented, earnings
    per share, as if the fair value based method of accounting defined in SFAS
    No. 123 had been applied. The disclosure requirements of the statement are
    effective for financial statements for fiscal years beginning after December
    15, 1995, or for an earlier fiscal year for which this statement is
    initially adopted for recognizing compensation cost. Pro forma disclosures
    required for entitites that elect to continue to measure compensation cost
    using APB No. 25 must include the effects of all awards granted in fiscal
    years that begin after December 15, 1994. Management anticipates that the
    adoption of the statement should have no material impact on its consolidated
    financial statements.

    SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets
    and Extinguishments of Liabilities" was issued in June 1996. This statement
    provides accounting and reporting standards for transfers and servicing of
    financial assets and extinguishments of liabilities based on consistent
    application of a financial-components approach that focuses on control. It
    distinguishes transfers of financial assets that are sales from transfers
    that are secured borrowings. Under the financial-components approach, after
    a transfer of financial assets, an entity recognizes all financial and
    servicing assets it controls and liabilities it has incurred and
    derecognizes financial assets it no longer controls and liabilities that
    have been extinguished. The financial-components approach focuses on the
    assets and liabilities that exist after the transfer. If a transfer does not
    meet the criteria for a sale, the transfer is accounted for as a secured
    borrowing with pledge of collateral. This statement is effective for
    transfers and servicing of financial assets and extinguishments of
    liabilities occurring after December 31, 1996, and is to be applied
    prospectively. Management anticipates that the adoption of the statement
    should have no material impact on its consolidated financial statements.

    (n) Reclassifications
        -----------------

    Certain reclassifications have been made for 1995 and 1994 to conform with
    the 1996 presentation. The reclassifications had no effect on previously
    reported net income or stockholders' equity.

                                      10
<PAGE>
 
                     PIEDMONT BANCORP, INC. AND SUBSIDIARY
             Notes to Consolidated Financial Statements, Continued

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

   The Financial Accounting Standards Board has issued Statement of Financial
   Accounting Standards No. 115 (SFAS 115), "Accounting for Certain Investments
   in Debt and Equity Securities".  This statement addresses the accounting and
   reporting for investments in equity securities that have readily determinable
   fair values and for all investments in debt securities.  These investments
   are to be classified in three categories and accounted for as follows:  (1)
   debt securities that the entity has the positive intent and ability to hold
   to maturity are classified as held-to-maturity and reported at amortized
   cost;  (2) debt and equity securities that are bought and held principally
   for the purpose of selling them in the near term are classified as trading
   securities and reported at fair value, with net unrealized gains and losses
   included in earnings; and (3) debt and equity securities not classified as
   either held-to-maturity  or trading securities  are classified as securities
   available-for-sale and reported at fair value, with unrealized gains and
   losses excluded from earnings and reported as a separate component of equity.
   The Company adopted SFAS 115 on July 1, 1993.  The adoption affected only the
   held-to-maturity and available-for-sale classifications, with the net
   unrealized securities gains on the securities available-for-sale of $184,000
   net of related deferred taxes of $128,000, reported as a separate component
   of equity.  The Company has no trading securities.

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

<TABLE>
<CAPTION>
                                                                                       June 30, 1996
                                                         -----------------------------------------------------------------------
                                                                                       (in thousands)
                                                                                                                       Estimated
                                                            Amortized            Unrealized           Unrealized        market
                                                              cost                 gains                losses          value
                                                              ----                 -----                ------          -----
<S>                                                         <C>                  <C>                  <C>              <C>
Securities available for sale:
 US government and agency securities                        $10,695                 $ 14                  $  400         $10,309
 Mortgage-backed securities (1)                               7,086                   37                     177           6,946
 State and local governments                                 10,268                    -                     425           9,843
                                                            -------                 ----                  ------         -------
  Total securities available-for-sale                        28,049                   51                   1,002          27,098
                                                            =======                 ====                  ======         =======    
Securities held-to-maturity:
 State and local governments                                $ 3,519                   17                      59         $ 3,477
                                                            =======                 ====                  ======         =======    

<CAPTION> 

                                                                                       June 30, 1995
                                                         -----------------------------------------------------------------------
                                                                                       (in thousands)
                                                                                                                       Estimated
                                                            Amortized            Unrealized           Unrealized        market
                                                              cost                 gains                losses          value
                                                              ----                 -----                ------          -----
<S>                                                        <C>                   <C>                  <C>              <C>
Securities available for sale:
 US government and agency securities                       $  4,493                   62                       1           4,555
 Mortgage-backed securities (1)                               6,357                   38                      62           6,333
                                                           --------                 ----                  ------         -------
   Total securities available-for-sale                     $ 10,850                  100                      63          10,887
                                                           ========                 ====                  ======         =======    
Securities held-to-maturity:
 State and local governments                               $  1,798                   25                      10           1,813
                                                           ========                 ====                  ======         =======    
</TABLE>

   (1) At June 30, 1996 and 1995, the Company owned mortgage-backed securities
       issued by the Federal National Mortgage Association (FNMA) and the
       Federal Home Loan Mortgage Corporation (FHLMC) with an aggregate
       amortized cost of $4,595,000 and $3,869,000 respectively, and a market
       value of $4,527,000 and $3,902,000.  In addition, the Bank owned
       collateralized mortgage obligations issued by FNMA and FHLMC secured by
       mortgage-backed securities guaranteed by FNMA and FHLMC, respectively.
       The securities had an amortized cost of $2,491,000 and $2,488,000 at
       June 30, 1996 and 1995, respectively, and a market value of $2,419,000
       and $2,431,000.

                                      11
<PAGE>
 
                     PIEDMONT BANCORP, INC. AND SUBSIDIARY
             Notes to Consolidated Financial Statements, Continued

(2) Investment Securities, Continued
    --------------------------------

   The aggregate amortized cost and approximate market value of the available-
   for-sale and held-to-maturity securities portfolios at June 30, 1996, by
   remaining contractual maturity are as follows:

<TABLE>
<CAPTION>
 
                                                       Securities                 Securities         
                                                   available-for-sale          held-to-maturity      
                                                -------------------------  ------------------------  
                                                                  (in thousands)                     
                                                               Estimated                 Estimated   
                                                 Amortized      market      Amortized     market     
                                                    cost         value        cost         value     
                                                ------------  -----------  -----------  -----------  
<S>                                             <C>           <C>          <C>          <C>          
   US government and agency securities:                                                                               
      Due in 1 year or less                      $     -       $     -      $    -       $      -     
      Due after 1 year through 5 years               489           503           -              -  
      Due after 5 through 10 years                 9,209         8,859           -              -  
      Due after 10 years                             997           947           -              -  
   Obligations of states local governments:                                                                               
      Due in 1 year or less                            -             -          76             75  
      Due after 1 year through 5 years               860           857       1,215          1,197  
      Due after 5 through 10 years                 3,088         2,947       1,285          1,282  
      Due after 10 years                           6,320         6,039         943            923  
   Mortgage-backed securities                      7,086         6,946           -              -  
                                                 -------       -------      ------         ------  
      Total securities                           $28,049       $27,098      $3,519         $3,477  
                                                 =======       =======      ======         ======
</TABLE>

   At June 30, 1996 and 1995, investment securities with book values of
   $1,925,000 and $1,999,000, respectively, were pledged as collateral for
   public deposits.


   Summarized below is the sales activity in investment securities:
<TABLE>
<CAPTION>
                                                                   Year ended June 30,    
                                                               ---------------------------
                                                                 1996     1995      1994  
                                                               --------  -------  --------
                                                                     (in thousands)       
<S>                                                            <C>       <C>      <C>     
Proceeds from sales of available-for-sale securities            $2,946    $1,408   $7,965 
Realized gains                                                      (7)        -      (73)
Realized losses                                                     54       100      154 
                                                                ------    ------   ------ 
Cost of available-for-sale securities sold                      $2,993    $1,508   $8,046 
                                                                ======    ======   ======
</TABLE>

                                      12
<PAGE>
 
                     PIEDMONT BANCORP, INC. AND SUBSIDIARY
             Notes to Consolidated Financial Statements, Continued


<TABLE>
<CAPTION>
 

(3) Loans Receivable
    ----------------
                                                                       June 30,          
                                                               -----------------------   
 Loans receivable consist of the                                                         
  following:                                                    1996            1995     
                                                                ----            ----     
                                                                   (in thousands)  
<S>                                                            <C>             <C>             
 Loans secured by first mortgages on real estate:                                                                        
  Mortgage loans held for sale                                $  3,505        $  1,838   
  Mortgage loans held for investment, primarily                                                                 
   one-to-four family                                           63,590          60,541   
  Construction loans                                             5,026           1,805   
  Commercial and agricultural loans                              8,600           8,534   
  Participation loans purchased                                    218              89   
                                                               -------         -------   
                                                                80,939          72,807                   
 Home equity lines of credit                                    10,816          11,082   
 Other second mortgage loans                                       800             834   
 Other installment loans                                         1,719           1,635   
                                                               -------         -------   
                                                                94,274          86,358                   
 Undisbursed proceeds on loans in process                       (2,198)           (945)  
 Deferred loan fees                                               (281)           (185)  
 Allowance for loan losses                                        (608)           (515)  
                                                               -------         -------   
                                                              $ 91,187        $ 84,713                   
                                                               =======         =======

<CAPTION>  
 An analysis of the allowance for loan losses follows:

                                                 1996           1995      1994
                                                 ----           ----      ----
                                                           (in thousands)
<S>                                            <C>             <C>        <C> 
 Balance at beginning of period                $   515         $   404    $   317
 Provision for loan losses                          96             120         87
 Loans charged off                                  (4)            (14)        (4)
 Recoveries                                          1               5          4
                                               -------         -------     ------
       Balance at end of period                $   608         $   515    $   404
                                               =======         =======     ======
</TABLE>

   At June 30, 1996 and 1995, the Company had loans totaling approximately
   $758,000 and $30,000, respectively, which were in nonaccrual status and
   $301,000 and $571,000, respectively, which were contractually delinquent for
   90 days or more and still accruing.

   Additional interest income that would have been recorded on nonaccrual loans
   for the years ended June 30, 1996, 1995 and 1994 had they performed in
   accordance with their original terms throughout each of the periods amounted
   to approximately $57,000, $2,000 and $8,000, respectively.

   At June 30, 1996, the Company had mortgage loan commitments outstanding of
   $2,220,000.  Preapproved but unused lines of credit totaled $7,831,000, and
   standby letters of credit totaled $221,000 at June 30, 1996.  The Company's
   exposure to credit loss for commitments to extend credit and standby letters
   of credit is the contractual amount of those financial instruments.  The
   Company uses the same credit policies for making commitments and issuing
   standby letters of credit as it does for on-balance sheet financial
   instruments.  Each customer's creditworthiness is evaluated on an individual
   basis.  The amount and type of collateral, if deemed necessary by management,
   is based upon this evaluation of creditworthiness.  Collateral obtained
   varies but may include marketable securities, deposits, real estate,
   investment assets, and property and equipment.  In management's opinion,
   these commitments, and undisbursed proceeds on loans in process reflected
   above, represent no more than normal lending risk to the Company and will be
   funded from normal sources of liquidity.

                                      13
<PAGE>
 
                     PIEDMONT BANCORP, INC. AND SUBSIDIARY
             Notes to Consolidated Financial Statements, Continued

(3)  Loans Receivable, Continued
     ---------------------------

     At June 30, 1996, the recorded investment in loans that are considered to
     be impaired under SFAS No. 114 was $826,000, comprised of two loans. One of
     the loans totaling $457,000 was in non-accrual status at June 30, 1996.
     There was no related allowance for credit losses associated with these
     loans as determined in accordance with SFAS No. 114. The average recorded
     investment in impaired loans during the year ended June 30, 1996 was
     approximately $864,000. The Company recognized interest income on the
     impaired loans of approximately $65,000 during the year ended June 30,
     1996, all of which was collected by June 30, 1996.

     The Company serviced loans for others of approximately $12,719,000,
     $15,413,000, and $16,733,000 at June 30, 1996, 1995 and 1994, respectively.
     The June 30, 1996 balance of loans sold with recourse was approximately
     $226,000.

     Certain of the Company's mortgage loans are pledged as collateral for
     advances from the Federal Home Loan Bank (see note 6).

     The Bank makes loans to executive officers and directors of the Company and
     to their associates. It is management's opinion that such loans are made on
     substantially the same terms, including interest rates and collateral, as
     those prevailing at the time for comparable transactions with unrelated
     persons and do not involve more than the normal risk of collectibility.
     Following is a reconciliation of loans outstanding to executive officers,
     directors, and their associates for the year ending June 30, 1996:


              Balance at June 30, 1995    $ 776,000
              New loans                      17,000
              Repayments                   (123,000)
                                          ---------
              Balance at June 30, 1996    $ 670,000
                                          =========

(4)  Premises and Equipment
     ----------------------

     Premises and equipment consist of the following:

<TABLE>
<CAPTION>
                                                        June 30, 1996                                   June 30, 1995
                                         -------------------------------------------  ------------------------------------------- 
                                                        Accumulated      Net book                       Accumulated      Net book
                                             Cost       depreciation      value              Cost       depreciation       value
                                             ----       -------------     -----              ----       -------------      -----
                                                                               (in thousands)
<S>                                      <C>            <C>              <C>                 <C>        <C>              <C>
   Land and land improvements                  443              53          390                 443              47           396
   Office buildings and improvements         1,013             295          718               1,013             268           745
   Furniture, fixtures, and equipment          735             519          216                 699             501           198
                                            ------            ----       ------              ------            ----        ------
                                           $ 2,191           $ 867      $ 1,324             $ 2,155           $ 816       $ 1,339
                                            =======           ====       ======              ======            ====        ======
</TABLE>

(5)  Deposits
     --------

     Time deposits of $100,000 or more totaled $6,072,000 and $7,048,000 at June
     30, 1996 and 1995, respectively.

     Interest expense on deposits includes $312,000, $326,000, and $306,000 for
     the years ended June 30, 1996, 1995, and 1994, respectively, on time
     deposits of $100,000 or more.

                                      14
<PAGE>
 
                     PIEDMONT BANCORP, INC. AND SUBSIDIARY
             Notes to Consolidated Financial Statements, Continued

(6)  Advances from the Federal Home Loan Bank
     ----------------------------------------

   Advances from the Federal Home Loan Bank of Atlanta, with weighted average
   interest rates, are as follows:

                                                   June 30,
                                           -----------------------
                                               1996         1995
                                               ----         ----
                                               (in thousands)

   6.03% due on or before June 30, 1996          $     -   $ 8,000
   5.78% due on or before June 30, 1997           15,250         -
   6.02% due on or before June 30, 1997                -     3,000
   6.16% due on or before June 30, 1998            2,000     2,000
                                                 -------   -------
                                                 $17,250   $13,000
                                                 =======   =======
 
   At June 30, 1996, the Bank had additional credit availability from the
   Federal Home Loan Bank of $7,750,000.

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

(7) Regulatory Restrictions
    -----------------------

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

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

   At June 30, 1996, the Bank was in compliance with all of the aforementioned
   capital requirements.

   LIQUIDATION ACCOUNT:  At the time of Conversion, the Bank established a
   liquidation account in an amount equal to its net worth at June 30, 1995.
   The liquidation account will be maintained for the benefit of eligible
   deposit account holders who continue to maintain their deposit accounts in
   the Bank after conversion.  Only in the event of a complete liquidation will
   each eligible deposit account holder be entitled to receive a liquidation
   distribution from the liquidation account in the amount of the then current
   adjusted subaccount balance for deposit accounts then held before any
   liquidation distribution may be made with respect to the Parent's common
   stock.  Dividends cannot be paid from this liquidation account.

                                      15
<PAGE>
 
                     PIEDMONT BANCORP, INC. AND SUBSIDIARY
             Notes to Consolidated Financial Statements, Continued


(7) Regulatory Restrictions, continued
    ----------------------------------

   DIVIDENDS:  Subject to applicable law, the Boards of Directors of the Bank
   and the Parent may each provide for the payment of dividends.  Future
   declarations of cash dividends, if any, by the Parent may depend upon
   dividend payments by the Bank to the Parent.  Subject to regulations of the
   Administrator, the Bank may not declare or pay a cash dividend on or
   repurchase any of its common stock if its stockholders' equity would thereby
   be reduced below either the aggregate amount then required for the
   liquidation account or the minimum regulary capital requirements imposed by
   federal and state regulations.  In addition, for a period of five years after
   the Conversion, the Bank will be required, under existing North Carolina
   regulations, to obtain prior written approval of the Administrator before it
   can declare and pay a cash dividend on its capital stock in an amount in
   excess of one-half of the greater of (i) its net income for the most recent
   fiscal year, or (ii) the average of its net income after dividends for the
   most recent fiscal year and not more than two of the immediately preceding
   fiscal years, if applicable.   As a result of this limitation,  the Bank
   cannot pay a dividend in excess of $700,000 without the approval of the
   Administrator.


(8) Income Taxes
    ------------

   As discussed in note 1, effective July 1, 1993, the Company adopted Statement
   of Financial Accounting Standards No. 109 (SFAS 109), "Accounting for Income
   Taxes".  There was no cumulative effect of the change in accounting for
   income taxes.  Prior year's financial statements have not been restated to
   apply the provisions of FAS 109.

   The components of income tax expense (benefit) were as follows:

<TABLE> 
 <CAPTION> 
                                 Year ended June 30,
                         ------------------------------------
                                       (in thousands)
                          1996         1995          1994
                          ----         ----          ----
<S>                      <C>          <C>            <C> 
   Currently payable:
      Federal            $ 782         $ 760          $ 626
      State                123           137            129
                         -----         -----          -----
                           905           897            755
                         -----         -----          -----
   Deferred:                                       
      Federal              (45)          (48)           (36)
      State                (11)          (12)            (9)
                         -----         -----       
                           (56)          (60)           (45)
                         -----         -----          -----
                         $ 849         $ 837          $ 710
                         =====         =====          ===== 
</TABLE> 
                                      16
<PAGE>
 
                     PIEDMONT BANCORP, INC. AND SUBSIDIARY
             Notes to Consolidated Financial Statements, Continued

(8) Income Taxes, Continued
    -----------------------

    The tax effects of temporary differences that give rise to significant
    portions of the deferred tax assets and deferred tax liabilities are shown
    below:
<TABLE>
<CAPTION>
                                                                                         June 30          
                                                                                 ---------------------         
                                                                                      1996      1995 
                                                                                      ----      ----
                                                                                      (in thousands)        
<S>                                                                              <C>       <C>    
    Allowance for loan losses (net)                                                  $ 108     $  70
    Unrealized holding losses on securities available-for-sale                         372         -
    Deferred compensation accruals                                                     152       140
    Deferred loan origination fees, net of deferred costs                                -        17
    Excess servicing                                                                    23        30
                                                                                     -----     -----
        Gross deferred tax assets                                                      655       257
    Valuation allowance                                                                  -         -
                                                                                     -----     -----
        Net deferred tax assets                                                        655       257
                                                                                     -----     -----
                                                                                                  
    Accelerated depreciation                                                           (46)      (34)
    FHLB stock dividends                                                              (106)     (106)
    Loan liquidation spread                                                              -       (37)
    Deferred loan origination fees, net of deferred costs                               (6)        -
    Unrealized holding gains on securities available-for-sale                            -       (16)
    Other temporary differences creating deferred tax liabilities                      (23)      (34)
                                                                                     -----     -----
        Gross deferred tax liabilities                                                (181)     (227)
                                                                                     -----     -----
                                                                                                
        Net deferred tax asset                                                       $ 474     $  30
                                                                                     =====     ===== 
</TABLE>

    The Company has no valuation allowance at June 30, 1996 or 1995 because
    it has sufficient taxable   income in the carryback period to support the
    realizability of the net deferred tax asset.


    The reconciliation of income taxes at statutory tax rates to income tax
    expense reported in the statements of income follows:
<TABLE>
<CAPTION>
                                                                      June 30,
                                                        ---------------------------------
                                                            1996       1995       1994
                                                            ----       ----       ----
                                                                 (in thousands)
<S>                                                     <C>        <C>        <C>
    Income taxes at the statutory federal tax rate          $ 865      $ 707      $ 593
    State income taxes less federal benefit                    74         83         79
    Tax exempt interest                                      (107)         9          3
    Other                                                      17         38         35
                                                            -----      -----      -----
        Total tax expense                                   $ 849      $ 837      $ 710
                                                            =====      =====      =====
</TABLE>

   Retained earnings at June 30, 1996 includes approximately $2,777,000 for
   which no provision for federal income tax has been made.  This amount
   represents allocations of income to bad debt deductions for tax purposes
   only.  Reduction of such amount for purposes other than tax bad debt losses
   will create income for tax purposes only, which will be subject to the then
   current corporate income tax rate.

                                      17
<PAGE>
 
                     PIEDMONT BANCORP, INC. AND SUBSIDIARY
             Notes to Consolidated Financial Statements, Continued

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

   DEFINED CONTRIBUTION RETIREMENT PLAN:  The Bank has had a self-administered,
   defined contribution retirement plan that covered all eligible employees.
   The Bank's policy has been to fund retirement costs accrued.  Under the plan,
   the Bank contributed an amount equivalent to 10% of the eligible employees'
   annual salaries.  In conjunction with the Conversion, the defined
   contribution retirement plan was terminated as of July 31, 1995.  Funds were
   distributed in October 1995.  There was no gain or loss upon the termination
   of the defined contribution retirement plan.  Retirement expense of this plan
   totaled approximately $9,000 in 1996, $79,000 in 1995, and $77,000 in 1994.

   401(k) PLAN:  During 1993, the Bank implemented a 401(k) plan that covers all
   eligible employees.  The Bank matches 50% of employee contributions, with the
   Bank's contribution limited to 3% of each employee's salary.  401(k) matching
   contributions are funded when accrued.  Matching expense totalled
   approximately $16,000 in 1996, $17,000 in 1995, and $14,000  in 1994.

   EMPLOYEE STOCK OWNERSHIP PLAN ("ESOP"):  The Bank has an ESOP whereby an
   aggregate number of shares amounting to 211,600 were purchased for future
   allocation to employees.  Contributions to the ESOP are made by the Bank on a
   discretionary basis, and are allocated among ESOP participants on the basis
   of relative compensation in the year of allocation.  Benefits will vest in
   full upon five years of service with credit given for years of service prior
   to the conversion.

   The ESOP has been funded by a $40,000 cash contribution from the Bank in
   December 1995 and a loan from the Parent in the amount of $2,690,677.  The
   loan is secured by shares of stock purchased by the ESOP and is not
   guaranteed by the Bank.  Principal and interest payments on this loan are
   funded primarily from discretionary contributions by the Bank.  Dividends, if
   any, paid on shares held by the ESOP may also be used to reduce the loan.
   The $40,000 cash contribution was used to release 3,100 shares to ESOP
   participants in December 1995.  During the six months ended June 30, 1996,
   21,566 shares were considered committed to be released to ESOP partipants,
   and compensation expense of $139,000 associated with those shares was
   recorded.  Total compensation expense associated with the ESOP for the year
   ended June 30, 1996 was $179,000.  At June 30, 1996, there remain 186,934
   unearned ESOP shares with a total fair value of approximately $2,454,000.

   Dividends on unallocated shares are used by the ESOP to repay the debt to the
   Parent and are not reported as dividends in the consolidated financial
   statements.  Dividends on allocated shares are credited to the accounts of
   the participants and reported as dividends in the consolidated financial
   statements.

   MANAGEMENT RECOGNITION PLAN:  The Bank's Management Recognition Plan ("MRP")
   has been approved by stockholders of the Parent and by the Parent's and the
   Bank's Boards of Directors.  The MRP serves as a means of providing existing
   directors and employees of the Bank with an ownership interest in the
   Company. On August 29, 1996, 105,800 shares were awarded under the plan.  No
   amounts were charged to expense in 1996, 1995 or 1994 in connection with this
   plan.

   STOCK OPTION  PLAN:  The Company plans to adopt a Stock Option Plan which has
   also been approved by the stockholders of the Parent and by the Parent's and
   the Bank's Boards of Directors.  The Stock Option Plan is to provide for the
   granting of options to purchase 264,500 shares, or 10% of the shares issued
   in the conversion to employees and directors.  No amounts have been charged
   to expense in 1996, 1995, or 1994 in connection with this plan.

                                      18
<PAGE>
 
                     PIEDMONT BANCORP, INC. AND SUBSIDIARY
             Notes to Consolidated Financial Statements, Continued

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

    DIRECTORS' DEFERRED COMPENSATION PLAN: The Bank has a deferred compensation
    plan for its directors under which the directors would be paid specified
    amounts during the ten year period following the latter of the date that the
    director becomes 65 years of age, or five years from adoption of the plan.
    During 1995, the Bank established another deferred compensation plan for
    certain of its directors under which the directors would be paid specified
    amounts during the ten year period following the latter of the date that the
    director meets a specified age requirement, or five years from adoption of
    the plan. The Bank has purchased life insurance policies with the Bank named
    as beneficiary to fund the benefits. Total expense related to these plans
    was approximately $89,000 for 1996, $162,000 for 1995, and $51,000 for 1994.

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

    SEVERANCE PLAN: In connection with the Conversion, the Bank adopted a
    Severance Plan for the benefit of its employees. The Plan provides for
    severance pay benefits in the event of a change in control which results in
    the termination of such employees or diminished compensation, duties, or
    benefits within two years of a change in control. The employees covered
    would be entitled to a severance benefit of the greater of (a) the amount
    equal to two weeks' salary at the existing salary rate multiplied by the
    employee's number of complete years of service or (b) the amount of one
    month's salary at the employee's salary rate at the time of termination,
    subject to a maximum payment equal to two times the employee's annual
    salary.
 
                                      19
<PAGE>
 
                     PIEDMONT BANCORP, INC. AND SUBSIDIARY
             Notes to Consolidated Financial Statements, Continued

(10) Quarterly Financial Data (Unaudited)
     ------------------------------------
   Summarized unaudited quarterly financial data for the year ended June 30,
   1996 is as follows:

<TABLE>
<CAPTION>
                                First       Second       Third        Fourth
                               Quarter     Quarter      Quarter      Quarter
                             -----------  ----------  -----------  ------------

                                  (in thousands except per share amounts)
<S>                          <C>          <C>         <C>          <C>
Operating Summary:
  Interest income               $  2,137    $  2,378    $  2,363      $  2,370
  Interest expense                 1,124       1,191       1,033         1,066
                                --------    --------    --------      --------
  Net interest income              1,013       1,187       1,330         1,304
  Provision for loan losses           30          24          21            21
                                --------    --------    --------      --------
  Net interest income
   after provision for
   loan losses                       983       1,163       1,309         1,283
  Other income                        84          82          79            10
  Other expenses                     573         622         642           612
                                --------    --------    --------      --------
  Income before income tax
   expense                           494         623         746           681
  Income taxes                       187         219         243           200
                                --------    --------    --------      --------
  Net income                    $    307    $    404    $    503      $    481
                                ========    ========    ========      ========
  Per Share Data:
  Earnings                           n/a        0.05        0.20          0.20
  Cash dividends declared            n/a           -        0.10          0.12
  Dividend payout                    n/a           -          50%           60%
  Book value per share               n/a       14.05       14.05         14.01
  Selected Average
   Balances:
  Assets                        $104,824    $121,715    $123,372      $127,095
  Investment securities           13,100      18,307      28,390        31,191
  Loans                           86,107      87,648      87,818        90,096
  Interest-bearing deposits       74,833      84,623      70,387        71,617
  Advances                        12,893      13,082      11,912        15,105
  Stockholders' equity            13,860      21,846      37,351        37,173

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

  Summarized unaudited quarterly financial data for the year ended June 30, 
  1995 is as follows:

<CAPTION> 
                                First       Second       Third        Fourth
                               Quarter     Quarter      Quarter      Quarter
                             -----------  ----------  -----------  ------------

                                  (in thousands except per share amounts)
<S>                          <C>          <C>         <C>          <C>
  Operating Summary:
  Interest income               $  1,822    $  1,898    $  1,982      $  2,109
  Interest expense                   826         872         934         1,050
                                --------    --------    --------      --------
  Net interest income                996       1,026       1,048         1,059
  Provision for loan losses           30          30          30            30
                                --------    --------    --------      --------
  Net interest income
   after provision for
   loan losses                       966         996       1,018         1,029
  Other income                        97          77         116            47
  Other expenses                     522         584         576           583
                                --------    --------    --------      --------
  Income before income tax
   expense                           541         489         558           493
 Income taxes                        218         203         234           182
                                --------    --------    --------      --------
  Net income                    $    323    $    286    $    324      $    311
                                ========    ========    ========      ========
  Per Share Data:
  Earnings                           n/a         n/a         n/a           n/a
  Cash dividends declared            n/a         n/a         n/a           n/a
  Dividend payout                    n/a         n/a         n/a           n/a
  Book value per share               n/a         n/a         n/a           n/a
  Selected Average
   Balances:
  Assets                        $ 98,587    $ 98,581    $100,299      $103,969
  Investment securities           10,951      10,687      11,332        10,954
  Loans                           82,580      83,240      83,175        84,309
  Interest-bearing deposits       73,008      73,578      73,223        74,467
  Advances                        10,032       9,698      11,063        11,719
  Stockholders' equity            12,398      12,651      12,961        13,230
</TABLE> 

                                      20
<PAGE>
 
                     PIEDMONT BANCORP, INC. AND SUBSIDIARY
             Notes to Consolidated Financial Statements, Continued

(11) Parent Company Financial Data
     -----------------------------
 
     Condensed financial information for Piedmont Bancorp, Inc. (Parent Company)
     is as follows:

<TABLE> 
<CAPTION> 
 
                                                                   June 30, 1996
                                                                   -------------
                                                                  (in thousands)
                                          
<S>                                                                   <C> 
Condensed Balance Sheet                   
  Assets:
   Cash on deposit with bank subsidiary                                $  5,615
   Investment securities available for sale at market value:
      Obligations of states and local governments, cost $5,624,000        5,398
   Investment in bank subsidiary                                         26,120
   Other assets                                                             322
                                                                        -------
      Total assets                                                     $ 37,455
                                                                        =======
  Liabilities and stockholders' equity:
   Accrued taxes, expenses and other liabilities                       $    405
   Stockholders' equity                                                  37,050
                                                                        -------
      Total liabilities and stockholders' equity                       $ 37,455
                                                                        =======

<CAPTION>  
                                                                   Year Ended
                                                                  June 30, 1996
                                                                  -------------
                                                                  (in thousands)
<S>                                                                <C> 
  Condensed Statement of Income                                   
   Interest income from bank subsidiary                              $  200
   Interest on loan from bank subsidiary ESOP                           148
   Interest on investment securities                                    115
                                                                      -----
      Total income                                                      463
   Operating expenses                                                    50
                                                                      -----
      Income before income taxes                                        413
   Income tax expense                                                   117
                                                                      -----
   Income before equity in undistributed net income of subsidiary       296
   Equity in undistributed net income of bank subsidiary              1,399  
                                                                      -----
        Net income                                                   $1,695
                                                                      =====
</TABLE>

                                      21
<PAGE>
 
                     PIEDMONT BANCORP, INC. AND SUBSIDIARY
             Notes to Consolidated Financial Statements, Continued

<TABLE>
<CAPTION>
(11) Parent Company Financial Data, Continued
     ---------------------------------------- 
                                                                   Year Ended
                                                                 June 30, 1996
                                                                 --------------
                                                                 (in thousands)

<S>                                                              <C>
Condensed Statement of Cash Flows                                
  Cash flows from operating activities:
   Net income                                                        $  1,695
   Adjustments to reconcile net income to
    net cash provided by operating activites:
   Undistributed earnings of bank susidiary                            (1,399)
   Increase in other assets                                              (238)
   Increase in other liabilities                                          113
                                                                     --------
        Net cash provided by operating activities                         171
                                                                     --------
  Cash flows from investing activities:
   Purchases of available for sale securities                          (5,626)
                                                                     --------
        Net cash used by investing activities                          (5,626)
                                                                     --------
  Cash flows from financing activities:
   Proceeds of issuance of no par common stock                         25,398
   Purchase of common stock for ESOP                                   (2,731)
   Capital contribution to Hillsborough Savings Bank                  (11,353)
   Cash dividends paid to stockholders                                   (244)
                                                                     --------
        Net cash provided by financing activities                      11,070
                                                                     --------
           Net increase in cash and cash equivalents                    5,615
  Cash and cash equivalents at beginning of year                            -
                                                                     --------
  Cash and cash equivalents at end of year                           $  5,615
                                                                     ========
  Supplemental disclosure of cash flow information:
   Cash paid during the year for income taxes                        $     29
                                                                     ========
  Supplemental disclosure of noncash transactions:
   Unrealized gains (losses) on securities available for sale
    net of deferred tax benefit of $88                               $    138
                                                                     ========
   Unrealized gains (losses) on subsidiary's securities available
    for sale net of deferred tax benefit of $299                     $    463
                                                                     ========
   Dividends declared but unpaid                                     $   (292)
                                                                     ========
</TABLE>

                                      22
<PAGE>
 
                     PIEDMONT BANCORP, INC. AND SUBSIDIARY
             Notes to Consolidated Financial Statements, Continued

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

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

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

     The following table presents the carrying values and estimated fair values
     of the Company's financial instruments at June 30, 1996:
<TABLE>
<CAPTION>
                                            Carrying        Estimated
                                             value          fair value
                                            --------        ----------
<S>                                         <C>             <C>
     Financial assets:                               
      Cash and interest-bearing deposits     $ 2,670           $ 2,670
      Investment securities:                         
        Available-for-sale                    27,098            27,098
        Held-to-maturity                       3,519             3,477
      Net loans                               91,187            90,775
      Federal Home Loan Bank stock               863               863
                                                     
     Financial liabilities:                          
      Deposits                                73,361            73,475
      Federal Home Loan Bank advances         17,250            17,242
</TABLE>

     The estimated fair values of net loans and deposits are based on cash flows
     discounted at market interest rates. The carrying values of other financial
     instruments, including various receivables and payables, approximate fair
     value.

     At June 30, 1996, the Company had outstanding standby letters of credit and
     commitments to extend credit. These off-balance sheet financial instruments
     are generally exercisable at the market rate prevailing at the date the
     underlying transaction will be complete, and, therefore, they are deemed to
     have no current fair market value. Refer to note 3.

                                      23
<PAGE>
 
16

                                 CAPITAL STOCK

     The Parent's common stock is traded on the American Stock Exchange under
the symbol "PDB". As of June 30, 1996, there were 2,645,000 shares outstanding
and 641 shareholders of record, not including the number of persons or entities
whose stock is held in nominee or street name through various brokerage firms or
banks. Payment of dividends by the Bank subsidiary to the Parent is subject to
various restrictions. Under applicable banking regulations, the Bank may no
declare a cash dividend if the effect thereof would be to reduce its net worth
to an amount less than the minimum required by federal and state banking
regulations. In addition, for a period of five years after the consummation of
the Bank's stock conversion, which occurred on December 7, 1995, the Bank will
be required to obtain prior written approval from the Administrator of the
Savings Institutions Division, North Carolina Department of Commerce, before it
can declare a cash dividend in an amount in excess of one-half the greater of
(I) its net income for the most recent fiscal year or (ii) the average of its
net income after dividends for the most recent fiscal year and not more than two
of the immediately preceding fiscal years, as applicable.

            Quarterly Common Stock Performance and Dividends Declared
                        For the Year Ended June 30, 1996

<TABLE> 
<CAPTION> 

                                                     Stock Price           Dividends Declared, Per Share
                                                  ----------------         -----------------------------
                                                  High         Low     
                                                  ----         ---     
<S>                                               <C>          <C>                 <C> 
Second quarter ended December 31*                 $13          $12 3/8             $    -
Third quarter ended March 31                       13 3/8       12                   0.10
Fourth quarter ended June 30                       13 5/8       12 3/8               0.12
</TABLE> 

---------------------------------------------------------
* The Parent's common stock did not begin trading until December 8, 1995