WHO WE ARE

         Piedmont Bancorp,  Inc. is the holding company for Hillsborough Savings
Bank, Inc. SSB ("HSB").  From its beginning in 1913 out of a small drug store in
Hillsborough,  North Carolina,  HSB has grown into a full service community bank
that offers a complete line of banking and investment  services to  individuals,
small  businesses and  charitable  organizations  located in Orange,  Durham and
surrounding counties. We like to think that HSB provides the best of the old and
the new. We are proud of our  eighty-six  years of rich  history in the historic
town of Hillsborough, North Carolina.

         During  fiscal  year 1999 we added two new  financial  centers - one at
1406 E.  Franklin  Street in Chapel Hill and another at 3400  Westgate  Drive in
Durham.  Both of these locations offer the wide variety of products and services
offered at our location in Hillsborough.  In addition, both of the new locations
have full service 24 hour ATMs.

         We are  continuously  at work adding exciting new products and services
for our customers.  If you are  interested in a specific  product and would like
more information  please call us at (919) 732-2143 or just stop by. In addition,
you can  also  reach  us at our web  site at  http://www.HSBeBank.com,  email at
HSBBank@mindspring.com,  fax at (919) 732-6001 and 24 hour telephone  banking at
(800)  375-8017.  For your  convenience,  a  complete  list of our  banking  and
investment services offered is listed below:

Services for individuals:
     Checking and deposit products
     o   A complete range of checking  account options designed with you in mind
     o   A money market account with competitive interest rates
     o   A complete line of savings,  certificate  of deposit and IRA products
     o   ATM card with access to thousands of ATM machines nationwide
     o   Imaged checks and statements
     o   Visa or Mastercard Checkcard with access to millions of vendors nation
         and world wide.
     o   Banking by  telephone with our Telebancing(TM) center

     Loan products
     o   Mortgage and consumer loans
     o   Home equity lines of credit
     o   MasterCard(TM) and Visa(TM) credit cards

     Investor services
     o   We provide full and discount  securities  brokerage  services through a
         partnership  with UVEST  Investment  Services,  Inc. We also offer free
         financial  planning for retirement and college.  Turn to us for stocks,
         mutual funds, annuities, estate planning and life insurance.

Services for Small Businesses and Charitable Organizations
     o   A complete line of checking and savings accounts
     o   Working   capital,   equipment,   real   estate   and  Small   Business
         Administration loans
     o   Merchant card services
     o   Incoming and outgoing wiring of funds
<PAGE>
     o   Imaged checks and statements
     o   We offer full and discount  brokerage  services  through a  partnership
         with  UVEST  Investment  Services,  Inc.  Turn to us for all your small
         business investment needs.

Internet Banking and Investment Services (visit our new Web site at
http://www.HSBeBank.com)
     o   Online  Brokerage  Services through a partnership with UVEST Investment
         Services, Inc. - coming October of 1999.
     o   Internet  Banking  with Bill  Payment - coming  March of 2000.
     o   Online  Consumer  and  Equity  Line Loan  Applications
     o   Online  Check Reordering o Credit Reports
     o   Shareholder  information,  including a link to our  dedicated  AMEX Web
         site
     o   Links to many national and local sites of interest
     o   Special Offers for our online visitors
<PAGE>
<TABLE>
<CAPTION>
                                                    Piedmont Bancorp, Inc.
                                                   Selected Financial Data

                                                          1999           1998            1997           1996           1995
                                                        ---------      ---------       ---------      ---------      ---------
                                                                                (dollars in thousands)
<S>                                                     <C>            <C>            <C>             <C>            <C>
Summary of Operations:
Interest income                                         $  10,200      $  10,217      $   9,535       $   9,248      $   7,811
Interest expense                                            5,112          5,191          4,603           4,414          3,682
                                                        ---------      ---------       ---------      ---------      ---------
Net interest income                                         5,088          5,026          4,932           4,834          4,129
Provision for loan losses                                      33             96            658              96            120
                                                        ---------      ---------       ---------      ---------      ---------
Net interest income after provision for loan losses         5,055          4,930          4,274           4,738          4,009
Other income                                                  356            606            225             255            336
Other expenses                                              3,558          2,963          4,716           2,449          2,265
                                                        ---------      ---------       ---------      ---------      ---------
Income (loss) before income tax expense                     1,853          2,573           (217)          2,544          2,080
Income tax expense                                            653            930            317             849            837
                                                        ---------      ---------       ---------      ---------      ---------
   Net income (loss)                                    $   1,200      $   1,643       $   (534)      $   1,695      $   1,243
                                                        =========      =========       =========      =========      =========
Net income (loss) per share - basic                     $    0.48      $    0.61       $  (0.20)      $    0.45            n/a
                                                        =========      =========       =========      =========      =========
Net income (loss) per share - diluted                   $    0.46      $    0.61       $  (0.20)      $    0.45            n/a
                                                        =========      =========      =========       =========      =========
Selected Year-end Balances:
Total assets                                            $ 140,089      $ 130,541      $ 122,761       $ 128,711      $ 104,013
Loans receivable, net                                     100,717        106,500        100,173          91,187         84,713
Investments (1)                                            31,038         18,846         17,973          32,564         15,043
Deposits                                                   99,339         89,840         84,860          73,361         76,745
FHLB Advances                                              20,162         18,000         16,500          17,250         13,000
Stockholders' equity                                       19,561         21,606         20,416          37,050         13,646

Average Balance Sheet Data:
Total assets                                            $ 132,022      $ 128,871      $ 123,896       $ 119,252      $ 100,359
Total earning assets                                      127,467        125,585        120,700         116,010         96,745
Loans receivable, net                                     105,126        107,510         95,937          87,917         83,326
Investments (1)                                            21,180         17,013         23,869          27,297         12,633
Deposits                                                   92,013         86,648         78,720          77,221         75,110
Borrowings                                                 18,560         20,119         16,481          13,248         10,628
Stockholders' equity                                       20,805         21,212         25,893          27,557         12,810

Selected Financial Ratios:
Return on average assets                                     0.91%          1.27%          (0.43)%         1.42%          1.24%
Return on average equity                                     5.77           7.75           (2.06)          6.15           9.70
Average equity to average assets                            15.76          16.46           20.90          23.11          12.76
Interest rate spread (tax equivalent basis)                  3.34           3.26            3.13           3.16           3.72
Net interest margin (tax equivalent basis)                   4.09           4.10            4.24           4.33           4.29
Dividend payout ratio                                      104.35          68.85             n/a          48.89            n/a
Cash dividends declared per common share                 $   0.48      $    0.42      $     7.42           0.22            n/a
</TABLE>
         (1) Includes investment securities and interest-bearing deposits.

2
<PAGE>











<PAGE>
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                                                                               3
<PAGE>

                             Piedmont Bancorp, Inc.
              1999 Annual Report to Shareholders Table of Contents






President's Message..............................................            5

Management's Discussion and Analysis.............................            7

Independent Auditors' Report.....................................           23

Consolidated Financial Statements................................           24

Notes to Consolidated Financial Statements.......................           28

Directors, Officers and Office Location..........................           48

Corporate Information............................................           48

Capital Stock....................................................           49











4
<PAGE>
A Message from Your President and Chief Executive Officer:

To Our Stockholders:

         For the year ended June 30, 1999,  your Company  reported net income of
$1,200,000,  or $0.46 diluted  earnings per share,  compared to consolidated net
income of $1,643,000 or $0.61 diluted earnings per share for the year ended June
30, 1998.

         Total assets increased 7.3% to $140.1 million at June 30, 1999 compared
to $130.5 million at June 30, 1998. The primary contributor to the growth was an
increase of 71.3% in  investment  securities  to $29.2  million at June 30, 1999
from $17.0  million at June 30,  1998;  mitigated by a decrease of 5.4% in loans
receivable  to $100.7  million at June 30, 1999 from $106.5  million at June 30,
1998.  Funding the  majority of the asset growth was (1) a $9.5 million or 10.6%
increase in deposits  from June 30, 1998 to June 30, 1999 and (2) a $2.2 million
or 12.0%  increase in advances  from the Federal  Home Loan Bank during the same
period.

         Beyond the financial  results  discussed  above and in much more detail
after this letter, your Company and its employees continued  implementation of a
number of significant  initiatives as we continued to execute the strategic plan
adopted by the Board of Directors in October of 1997.

         In July of 1998 your Company  implemented  its stock  repurchase  plan.
From July of 1998 to August of 1999 we repurchased  248,100 shares of our stock.
The repurchase  plan was one of the primary  factors,  in  conjunction  with our
asset growth, of reducing our average equity to assets ratio from 16.46% for the
year ended June 30, 1998 to 15.76% for the year ended June 30, 1999.

         In December of 1998 the Bank purchased a long term  leasehold  interest
in a former bank branch  located at 3400 Westgate Drive in Durham that opened as
a full service branch in April of 1999. In February of 1999 the Bank purchased a
former bank branch building  located at 1406 East Franklin Street in Chapel Hill
that opened as a full service branch in June of 1999.

         In selecting  the new branch sites the  management  team and the Branch
Committee of the Board of Directors looked at over 30 different sites located in
and around our market area, and only locations that passed stringent demographic
and cost criteria were  selected.  In addition,  since both sites had previously
been full service  branches we were able to quickly  provide  community  banking
services to new customers in an area that has enjoyed  above  average  growth in
comparison  to most markets in the nation and in the  Southeast.  Both  branches
offer the full range of products  currently offered at our Hillsborough  office,
including  a wide  variety  of  checking,  savings  and  certificate  of deposit
accounts as well as mortgage and consumer  loans.  In  addition,  mutual  funds,
stocks and bonds, and financial advice are offered to our new customers  through
our wholly owned subsidiary, HSB Investment Services.

         Branching  within our contiguous  market area is a key component of our
strategic  plan,  and we are pleased to report that both  branches have exceeded
our expectations for both loans and deposits.  Staffing of the branches was done
with a  combination  of hand picked  internal  employees as well as  experienced
bankers from other banks.


                                                                               5
<PAGE>
         During fiscal year 1999 we spent a lot of time and effort getting ready
for the Year 2000,  and I am happy to report that our mission  critical  systems
are Y2K  ready.  By Y2K ready,  I mean the Bank has  inventoried  its  hardware,
software  and other  equipment  that could  possibly be  dependent  on dates for
proper  operation.  We have also  tested all of its defined  "mission  critical"
systems by entering  dates past  December 31, 1999 with no problems  noted,  and
developed  contingency  plans to allow key  services to customers to continue in
the event that any Year 2000 problems do occur.

         The Company also devoted a lot of time in planning our future  internet
activities.   We  now  have  a  new  Web   site   that   can  be   accessed   at
http://www.HSBeBank.com  that  offers  Online  Consumer  and  Equity  Line  Loan
Applications,  Online Check Reordering,  Credit reports, shareholder information
(including a link to our  dedicated  AMEX Web site),  links to many national and
local sites of interest, and special offers just for online visitors. In October
of 1999 we will begin offering online  brokerage  services through a partnership
with UVEST  Investment  Services,  Inc., a leading  provider of such services to
financial  institutions  throughout the Southeast.  Lastly,  in March of 2000 we
plan to offer  internet  banking  with bill  payment  to our  customers  and non
customers.  Please  visit  our Web  site  and  send us an  email  to  offer  any
recommendations on how we can improve our internet services.

         With the  increased  number of products  that the Bank now offers,  the
need for customer  relationship  management  skill has never been  greater,  and
senior  management  as well as any employees  with  customer  sales contact have
started an eight  week  customer  service  training  program.  We hope that this
training  program will help to reinforce  the already  strong  customer  service
reputation that the Bank enjoys in our marketplace.

         The  deployment  of  our  strategic  plan  is  primarily  aimed  at one
objective -  increasing  long-term  shareholder  value.  As a Company that was a
mutual  savings bank from 1913 to 1995,  and a public company from December 1995
to the present,  we understand that our primary focus is on improving our return
to you,  and we hope you will be  patient  while we deploy the  capital  and the
resources that you have entrusted to us.

         Lastly,  I would like to thank the board,  the management  team and the
employees  of the Bank that  worked  very hard during the past year as we opened
our branches in Durham and Chapel Hill.  While it was a team effort,  there were
many "superstars" that went the extra mile and worked long hours to make the two
branches as successful as they are.

         We thank you for your continued support of Piedmont  Bancorp,  Inc. and
will  continue to seek your  support and  suggestions  on how we can provide the
greatest value to both our shareholders and customers.

Sincerely,

/s/D. Tyson Clayton
-------------------
D. Tyson Clayton
President and Chief Executive Officer


6
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS


         The purpose of this  discussion  and  analysis is to provide the reader
with a description of the financial  conditions and changes  therein and results
of operations of Piedmont  Bancorp,  Inc.  (the  "Parent") and its  wholly-owned
subsidiary,  Hillsborough  Savings Bank,  Inc.,  SSB (the "Bank")  (collectively
referred  to as the  "Company").  This  discussion  and  analysis  of  financial
condition  and  results  of  operation  should be read in  conjunction  with the
audited  consolidated  financial  statements and accompanying  notes included in
this  report and the  supplemental  financial  data  appearing  throughout  this
discussion and analysis.


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 fringe
benefits,  data  processing  expenses,  occupancy  and  furniture  and equipment
expense, and income taxes.


Performance Overview

         The Company  ended  fiscal year 1999 with net income of  $1,200,000  or
$0.48  diluted  earnings  per  share  compared  to  consolidated  net  income of
$1,643,000 or $0.61 diluted earnings per share for the year ended June 30, 1998.
For the year ended June 30, 1997 the Company had net income before  nonrecurring
items of $1,569,000 or $0.61 basic and diluted  earnings per share.  In the year
ended June 30, 1997 the Company  recorded a net loss and basic and diluted  loss
per share after nonrecurring items of $534,000 and $0.20, respectively. Earnings
for the year  ended  June 30,  1997 were  adversely  impacted  by the  following
nonrecurring  items: (1) $1,496,000 of compensation  expense associated with the
release and  allocation of  approximately  126,000 shares of common stock of the
Company to participants of the  Hillsborough  Savings Bank, Inc.  Employee Stock
Ownership  Plan during the quarter ended  December 31, 1996, (2) a provision for
loan losses of $597,000 recorded during the quarter ended December 31, 1996 that
resulted  primarily from the charge off of  approximately  $510,000 in unsecured
loans to a single  borrower,  (3) losses of $106,000 on the sale of  investments
that were  sold in  December  of 1996 to fund the  special  dividend  of $7.00 a
share, and (4) a special $487,000 assessment paid in the first quarter of fiscal
1997 to the Federal Deposit  Insurance  Corporation to recapitalize  the Savings
Association Insurance Fund.


Net Interest Income

         Net  interest  income  is one of the  major  determining  factors  in a
financial  institution's  performance as it is its principal source of earnings.
Net interest income is impacted by a variety of elements: volume, yield/cost and
relative  mix  of  both   interest-earning   assets  and   interest-bearing  and
noninterest-bearing  sources of funds.  Table 1 presents  average balance sheets
and a net interest  income  analysis on a  tax-equivalent  basis for each of the
years in the three-year period ended June 30, 1999.
<PAGE>
         As shown in Table 1, net  interest  income,  on a fully  tax-equivalent
basis,  amounted to $5.2 million in 1999, $5.2 million in 1998, and $5.1 million
in 1997. Total interest income was $10.3 million in both 1999 and 1998, and $9.7
million in 1997.  Total interest expense  decreased  slightly to $5.1 million in
1999 from $5.2 million in 1998, and was $4.6 million in 1996.

                                                                               7
<PAGE>
         Although total interest income remained relatively  unchanged from 1998
to 1999, a shift in  interest-earning  assets from loans  receivable  to taxable
investment  securities caused a similar shift in interest income between the two
interest-earning  assets.  The weighted  average tax  equivalent  yield on total
interest-earning  assets  decreased  to 8.10% in 1999  from  8.23% in 1998.  The
decline  was  primarily  caused  by a  decline  in the  average  yield  on loans
receivable   and   taxable   investment   securities.   The   weighted   average
tax-equivalent yield increased from 8.06% in 1997 to 8.23% in 1998. The increase
was primarily caused by two factors. First, average loans accounted for 85.6% of
the  interest-earning  assets  of the  Company  in 1998  compared  to  79.5%  of
interest-earning  assets in 1997.  The shift in  interest-earning  assets toward
higher yielding loans accounts for part of the increase in the weighted  average
tax-equivalent  yield from 1997 to 1998.  The second factor that  contributed to
the increase was an increase in the average yield on loans receivable from 8.40%
in 1997 to 8.49% in 1998.

         The  decrease  in  interest  expense of  $79,000  from 1998 to 1999 was
caused by a  decline  in the  weighted  average  rate on total  interest-bearing
liabilities, mitigated by an increase in deposit accounts from 1998 to 1999. The
increase in interest  expense of $588,000 or 12.8% in 1998 was due  primarily to
the  increased  volume of both  deposits and FHLB  advances to fund loan growth.
Average interest-bearing liabilities increased by $11.2 million or 12.0% in 1998
while the average rate paid on those liabilities increased by four basis points.

         The net interest margin (on a tax-equivalent  basis) decreased to 4.09%
in 1999  from  4.10% in 1998,  and  4.24% in 1997 due to  increased  funding  of
interest-earning  asset growth with  deposits and FHLB advances in 1999 and 1998
compared to 1997.  The  payment of the special  dividend in December of 1996 had
the effect of decreasing average  stockholder's  equity $4.7 million or 18.1% to
$21.2 million in 1998 or 16.9% of total interest-earning assets in 1998.
<PAGE>
<TABLE>
<CAPTION>
TABLE 1
NET INTEREST INCOME ANALYSIS - TAX EQUIVALENT

                                                    1999                            1998                            1997
                                      ------------------------------    ---------------------------     ----------------------------
                                                             Average                        Average                          Average
                                      Average                 Yield/    Average              Yield/     Average               Yield/
                                      Balance     Interest     Rate     Balance   Interest    Rate      Balance    Interest    Rate
                                      --------    --------     ----   --------    -------     ----    ---------    -------     ----
<S>                                   <C>         <C>          <C>    <C>         <C>         <C>     <C>          <C>         <C>
Assets:                                                                    (dollars in thousands)
Interest-earning assets:
   Loans receivable (1)               $105,126    $  8,835     8.40%  $107,510    $ 9,127     8.49%   $  95,937    $ 8,060     8.40%
   Taxable investment securities        15,855         996     6.28     11,469        747     6.51       14,271        959     6.72
Tax-exempt investment securities(2)      4,033         325     8.06      3,937        317     8.05        7,193        542     7.54
Interest-bearing deposits                1,292          82     6.35      1,607         70     4.36        2,405         99     4.12
FHLB common stock                        1,161          87     7.49      1,062         78     7.34          894         65     7.27
                                      --------    --------     ----   --------    -------     ----    ---------    -------     ----
Total interest-earning assets          127,467      10,325     8.10    125,585     10,339     8.23      120,700      9,725     8.06
Non-interest-earning assets              4,555                           3,286                            3,196
                                      --------                        --------                         --------
TOTAL                                 $132,022                        $128,871                         $123,896
                                      ========                        ========                         ========

Liabilities and retained earnings:
Interest-bearing liabilities:
   Deposit accounts                  $  88,850       4,056     4.56%  $ 84,357    $ 3,991     4.73%    $ 76,819    $ 3,615     4.71%
   FHLB advances                        18,560       1,056     5.69     20,119      1,200     5.96       16,481        988     5.99
                                      --------    --------     ----   --------    -------     ----    ---------    -------     ----
Total interest-bearing liabilities     107,410       5,112     4.76    104,476      5,191     4.97       93,300      4,603     4.93
Non-interest-bearing liabilities         3,807                           3,183                            4,703
Stockholder's equity                    20,805                          21,212                           25,893
                                     ---------                        --------                         --------
         TOTAL                       $ 132,022                        $128,871                         $123,896
                                     =========                        ========                         ========

Net interest income and
   interest rate spread                            $ 5,213     3.34%              $ 5,148     3.26%               $ 5,122      3.13%
                                                   =======                        =======                         =======

Net interest-earning assets
   and net interest margin           $  20,057                 4.09%  $ 21,109                4.10%    $ 27,400                4.24%
                                     =========                        ========                         ========
Ratio of interest-earning assets
   to interest-bearing liabilities                           118.67%                        120.20%                          129.37%
</TABLE>

(1) Nonaccrual loans are excluded from the average balance of loans  receivable.
(2) Interest earned on tax-exempt  investment  securities has been adjusted to a
tax-equivalent  basis using the applicable  combined  federal and state rates of
34.00% and 7.50%,  respectively,  and  reduced by the  nondeductible  portion of
interest expense.
<PAGE>
         In summary, the small increase in net interest income from 1998 to 1999
is  primarily  due to a decrease in the average  rate on total  interest-bearing
liabilities  mitigated  by a increase in volume  during the same period of time.
The small increase in net interest  income from 1997 to 1998 is primarily due to
an increase in the  average  yield on  interest-earning  assets  mitigated  by a
decline in volume  during the same  period of time.  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 rate in both 1999 and 1998.

8
<PAGE>
<TABLE>
<CAPTION>
TABLE 2
RATE / VOLUME ANALYSIS
                                                                 1999                                          1998
                                                                 ----                                          ----
                                                                     Rate/                                        Rate/
                                              Volume       Rate      Volume        Net      Volume      Rate      Volume      Net
                                              -------    -------    -------     -------    -------    -------    -------    -------
                                                                           (dollars in thousands)
Interest income (tax-equivalent) on:
<S>                                           <C>        <C>        <C>         <C>        <C>        <C>        <C>        <C>
  Loans                                       $  (202)   $   (97)   $     7     $  (292)   $   972    $    85    $    10    $ 1,067
  Taxable investment securities                   286        (26)       (11)        249       (188)       (30)         6       (212)
  Tax-exempt investment securities                  8       --         --             8       (245)        37        (17)      (225)
  Interest-bearing deposits                       (14)        32         (6)         12        (33)         6         (2)       (29)
  FHLB common stock                                 7          2       --             9         12          1       --           13
                                              -------    -------    -------     -------    -------    -------    -------    -------
     Total interest income                         85        (89)       (10)        (14)       518         99         (3)       614
                                              -------    -------    -------     -------    -------    -------    -------    -------
  Deposit accounts                                213       (143)        (5)         65        355         19          2        376
  FHLB advances                                   (93)       (54)         3        (144)       218         (5)        (1)       212
                                              -------    -------    -------     -------    -------    -------    -------    -------
     Total interest expense                       120       (197)        (2)        (79)       573         14          1        588
                                              -------    -------    -------     -------    -------    -------    -------    -------
Increase (decrease) in net interest income    $   (35)   $   108    $    (8)    $    65    $   (55)   $    85    $    (4)   $    26
                                              =======    =======    =======     =======    =======    =======    =======    =======

</TABLE>

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,   and  general  economic
conditions.  Provisions  for loan  losses  totaled  $33,000 in 1999  compared to
$96,000 in 1998,  and $658,000 in 1997.  The  unusually  high  provision in 1997
resulted  primarily from the  reprovision of the allowance for loan losses after
charge offs of approximately  $510,000 of loans to a single borrower in December
of 1996. The Company  received  approximately  $85,000 and $63,000 of recoveries
from this  single  borrower  during  the  years  ended  June 30,  1999 and 1998,
respectively.


Other Income

         Other income decreased to $356,000 in 1999 compared to $606,000 in 1998
and  $225,000  in 1997.  In 1998  other  income  included a gain on sale of real
estate owned and gains on sale of loans of $114,000  and $75,000,  respectively,
that were not present in 1999 or 1997.  Other income  included gains realized on
the sale of investments of $5,000 and $6,000 in 1999 and 1998, respectively, and
losses  realized on the sale of investment  securities of $135,000 in 1997.  The
net losses on the sale of  investment  in 1997 were  primarily  attributable  to
partial liquidation of invested conversion proceeds to facilitate payment of the
special    dividend   in   December    1996.    Other   income   also   includes
lower-of-cost-or-market adjustments on loans held-for-sale. In 1999, the Company
recorded  $73,000  in  lower-of-cost-or-market  write-downs  resulting  from the
rising interest rate  environment  during the last quarter of that year. In 1998
and 1997,  the Bank  recognized  $36,000  and  $4,000,  respectively,  in
<PAGE>
lower-of-cost-or-market  recoveries  resulting  from the falling  interest  rate
environment  during the two years. The rising interest rate  environment  during
the last quarter of 1999 also was the primary  reason for the loss of $20,000 on
sale of loans compared to the gain of $75,000 on sale of loans in 1998. Mortgage
loan servicing fees were $42,000,  $63,000 and $87,000 in 1999,  1998, and 1997,
respectively.  The decline in mortgage loan servicing fees from 1997 and 1998 is
attributable  to a decline in the  Company's  average loan  servicing  portfolio
during this time.  The decline in mortgage loan servicing fees from 1998 to 1999
was due to the  general  decline  in  market  interest  rates up until  the last
quarter of 1999. Other income was positively  affected by the growth in customer
service  and other fees of $16,000 or 7.7% to  $223,000  in 1999,  and $6,000 or
3.0% to $207,000 in 1998 from $201,000 in 1997. This increase is attributable to
increases in the volume of deposit accounts with the Bank and the implementation
of a new  deposit-related fee schedule in February of 1998. "Other" other income
increased  to  $105,000  in 1999  from  $98,000  and  $68,000  in 1998 and 1997,
respectively.  The increase is primarily  attributable  to the Company's  former
branch  facility  being  leased for twelve  months in 1999 and 1998  compared to
seven months in 1997.

Other Expenses

         Other  expenses  totaled  $3,558,000 in 1999 compared to $2,963,000 and
$4,716,000 in 1998 and 1997, respectively. Two large non-recurring expenses that
occurred  in the first and second  quarters of fiscal year 1997 were the primary
reason for the  significant  increase  in other  expenses in 1997 as compared to
1998 and 1999.  First, in 1997, the Company recorded  $1,702,000 of compensation
expense  related  to the  Company's  employee  stock  ownership  plan  ("ESOP"),
primarily  associated with the release and allocation of  approximately  126,000
shares of common  stock of the  Parent to  participants  of the ESOP  during the
second  quarter of 1997.  The special  dividend  paid on the  Parent's  stock on
December 6, 1996 and management's  decision to use the special dividends paid on
the unallocated  shares of the Parent's common stock held by the ESOP to pre-pay
the ESOP loan from the Parent to the ESOP resulted in a  significant  portion of
that share release,  approximately  103,000 shares.  As a result,  approximately
$1,428,000  of  the   ESOP-related   compensation   expense  was  deemed  to  be
non-recurring in nature.

         The  second  non-recurring  other  expense  in 1997  was  the  $487,000
one-time  FDIC special  assessment  for the  recapitalization  of the SAIF.  The
assessment was levied on all depository  institutions with SAIF-insured deposits
and amounted to 65.7 basis points on  assessable  deposits as of March 31, 1995.
The Company's quarterly FDIC premiums have decreased since the  recapitalization
of the SAIF.

         Without  the  effect  of the  non-recurring  SAIF  assessment  and  the
non-recurring portion of ESOP-related compensation expense, other expenses would
have totaled  $2,801,000 in 1997.  Compensation and fringe  benefits,  excluding
non-recurring  items,  decreased by $11,000 to 1,713,000 in 1998 from $1,724,000
in 1997.  From 1998 to 1999,  compensation  and  fringe  benefits  increased  to
$1,989,000. This increase was primarily attributable to the addition of staff in
the third and fourth  quarters of 1999 for two new branches  that were opened in
March and June of 1999.  The  recurring  portion  of  ESOP-related  compensation
expense for 1997 totaled $274,000 compared to $209,000 and $165,000 recorded for
1998 and 1999, respectively.
<PAGE>
         Data and items processing  expenses  increased to $396,000 in 1999 from
$256,000 in 1998. The increase was due to the conversion to a new data processor
in February of 1998. The Bank's new processor provides a higher level of service
and technology compared to the Bank's previous processor.

         FDIC-insurance  premiums  declined  to  $53,000  in 1999 and 1998  from
$71,000 for 1997. Deposit insurance premiums decreased starting with the quarter
ended  December  31,  1996.  The  reduced  level of  FDIC-insurance  premiums is
anticipated to continue into the future.

         Occupancy  expense  increased to $145,000 in 1999 from $114,000 in 1998
due to the  opening  of two new  branches  during  the  fourth  quarter of 1999.
Furniture and equipment  expense  increased to $214,000 in 1999 from $113,000 in
1998  due to  higher  depreciation  expense  associated  with the  purchase  and
depreciation  of computer  equipment  at the end of the third  quarter of fiscal
1998 and the opening of the two new branches in the last quarter of fiscal 1999.

         Professional  fees decreased to $117,000 in 1999 from $185,000 in 1998.
The decrease is primarily attributable to fees paid for assistance in developing
a strategic plan and branch feasibility studies for the Company in 1998.

         Other  "other"  expenses  increased  $115,000  to $644,000 in 1999 from
$529,000  in 1998 due to  increases  in  marketing  expenses,  office  supplies,
postage and forms associated with the two new branches that were opened in 1999.
Other "other" expenses  increased  $121,000 to $529,000 in 1998 from $408,000 in
1997 due to increases in marketing expenses,  employee education associated with
the conversion to a new data center, and office supplies and forms.


Income Tax Expense


         The Company  recorded income tax expense of $653,000 in 1999,  compared
to $930,000 in 1998 and $317,000 in 1996. This resulted in an effective tax rate
of 35.2% and 36.1% in 1999 and 1998, respectively. The 1997 tax expense reflects
the pre-tax  loss and the fact that a  significant  portion of the  ESOP-related
compensation expense is not tax-deductible.

10
<PAGE>
ANALYSIS OF FINANCIAL CONDITION

         Total assets increased 7.3% to $140.1 million at June 30, 1999 compared
to $130.5 million at June 30, 1998. The primary contributor to the growth was an
increase of 87% in investment securities  available-for-sale to $25.8 million at
June 30, 1999 from $13.8  million at June 30,  1998,  mitigated  by a decline of
5.4% in loans  receivable to $100.7 million at June 30, 1999 from $106.5 million
at June 30, 1998.  Funding the majority of the investment  securities growth was
(1) a $9.5 million or 10.6%  increase in deposits from June 30, 1998 to June 30,
1999 and (2) a $2.2 million or 12.0%  increase in advances from the Federal Home
Loan Bank during the same period.
<PAGE>
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,  1999,  the  loan  portfolio  totaled  $100.7  million  and
represented  71.9% of total  assets.  As  mentioned  above,  during  1999  loans
decreased by $5.8 million or 5.4%. Loan originations  increased to $55.4 million
in 1999 from  $50.0  million  in 1998,  largely  in  response  to the  Company's
continued  efforts to expand its loan programs into  adjacent  counties  through
increased  marketing.  As presented in Table 3, the relative  composition of the
loan portfolio continued to change in 1999 from prior years.  One-to-four family
loans  decreased as a percentage  of the portfolio in the current year to 78.20%
from  84.67% in 1998.  All other loan types  increased  as a  percentage  of the
portfolio  from 1998 to 1999.  The  shift in the loan mix away from  one-to-four
family loans is attributable to the Company's strategy of selling all conforming
one-to-four family 30 year loans in the secondary market. Table 3 sets forth the
composition of the loan portfolio at the dates indicated.

<TABLE>
<CAPTION>
TABLE 3
TYPES OF LOANS
                                                                                June 30,
                                 ---------------------------------------------------------------------------------------------------
                                          1999                 1998               1997                1996                1995
Real estate loans:                                                       (dollars in thousands)
<S>                              <C>          <C>     <C>          <C>     <C>        <C>     <C>          <C>     <C>        <C>
   Residential 1-4 family        $ 78,767     78.20%  $ 90,175     84.67%  $ 77,621   77.48%  $ 67,095     73.58%  $ 62,379   73.63%
   Nonresidential real estate       8,647      8.59      6,795      6.38      6,649    6.64      8,818      9.67      8,623   10.18
   Home equity and other
      second mortgage              10,854     10.78     10,588      9.94     10,997   10.98     11,616     12.74     11,916   14.07
Construction                        8,741      8.68      7,552      7.09      9,638    9.62      5,026      5.51      1,805    2.13
                                 --------    ------   --------    ------   --------  ------   --------    ------   --------  ------
       Total real estate loans    107,009    106.25    115,110    108.08    104,905  104.72     92,555    101.50     84,723  100.01
Other installment loans             1,314      1.30        850      0.80      1,061    1.06      1,719      1.89      1,635    1.93
Less:
    Unearned fees and discounts       386      0.38        412      0.39        348    0.35        281      0.31        185    0.22
    Loans in process                6,166      6.12      8,097      7.60      4,649    4.64      2,198      2.41        945    1.11
    Allowance for loan losses       1,054      1.05        951      0.89        796    0.79        608      0.67        515    0.61
                                 --------    ------   --------    ------   --------  ------   --------    ------   --------  ------
   Total reductions                 7,606      7.55      9,460      8.88      5,793    5.78      3,087      3.39      1,645    1.94
                                 --------    ------   --------    ------   --------  ------   --------    ------   --------  ------
       Total loans, net          $100,717    100.00   $106,500    100.00   $100,173  100.00   $ 91,187    100.00   $ 84,713  100.00
                                 ========    ======   ========    ======   ========  ======   ========    ======   ========  ======
</TABLE>
<PAGE>
         In order to protect the Company's net interest margin,  management has,
as part of its  interest  rate risk  management  program,  placed an emphasis on
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 net interest income  sensitivity  than experienced by most traditional
fixed-rate  residential  mortgage  lenders.  In 1999 and 1998 the  Company  sold
approximately  $24.0  million  and $10.0  million,  respectively,  in fixed rate
mortgage loans in the secondary  market. In 1997 the Company did not sell any of
its mortgage loan production into the secondary  market as sufficient  liquidity
and interest rate  protection was provided  through the investment of conversion
proceeds in shorter term investments.  In the future the Company expects to sell
selected  current loan  production to both provide for sufficient  liquidity and
protection of the net interest margin.

                                                                              11
<PAGE>
         The following table sets forth the time to contractual  maturity of the
Company's loan portfolio at June 30, 1999.  All loans,  fixed and floating,  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.

<TABLE>
<CAPTION>
TABLE 4
LOAN MATURITIES

                                                                      June 30, 1999
                                     --------------------------------------------------------------------------------
                                                      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
                                     ---------      ---------     ---------     ---------     ---------     ---------
Real estate loans:                                                (dollars in thousands)
<S>                                  <C>            <C>           <C>           <C>           <C>          <C>
  Residential 1-4 family
     Fixed                           $       3      $     103     $     157     $   2,969     $  52,399     $  55,631
     Floating                                6            166           419         2,895        19,219        22,705
  Nonresidential real estate
     Fixed                                --              161           169           480         2,459         3,269
     Floating                               88              8           392         2,584         2,280         5,352
  Home equity and other second
    mortgage
     Fixed                                  76             97           225           265           133           796
     Floating                              237          1,529         2,323         5,969          --          10,058
  Construction
     Fixed                                --             --            --            --            --            --
     Floating                            2,421             39           186          --            --           2,646
                                     ---------      ---------     ---------     ---------     ---------     ---------

         Total real estate loans         2,831          2,103         3,871        15,162        76,490       100,457
Other installment loans:
     Fixed                                 301            549           150            29            87         1,126
     Floating                              188           --            --            --            --             188

Less:
  Allowance for loan losses             (1,054)          --            --            --            --          (1,054)
                                     ---------      ---------     ---------     ---------     ---------     ---------

       Total loans, net              $   2,266      $   2,653     $   4,020     $  15,191     $  76,587     $ 100,717
                                     =========      =========     =========     =========     =========     =========
</TABLE>
12
<PAGE>
Asset Quality and Allowance for Loan Losses

         The   following   table  sets  forth   information   with   respect  to
nonperforming assets, including nonaccrual loans and real estate owned, and risk
assets at the dates indicated.
<TABLE>
<CAPTION>
TABLE 5
SUMMARY OF NONPERFORMING AND RISK ASSETS

                                                                                 June 30,
                                                     ----------------------------------------------------------------
                                                       1999          1998          1997          1996          1995
                                                     --------      --------      --------      --------      --------
                                                                        (dollars in thousands)
<S>                                                  <C>           <C>           <C>           <C>           <C>
Total nonaccrual loans                               $    973      $    928      $    803      $    758      $     30
Total restructured loans                                 --            --            --            --            --
                                                     --------      --------      --------      --------      --------
      Total nonperforming loans                           973           928           803           758            30
Real estate owned                                        --            --            --            --            --
                                                     --------      --------      --------      --------      --------
       Total nonperforming assets                    $    973      $    928      $    803      $    758      $     30
 Accruing loans, delinquent 90 days or more              --            --             244           301           571
                                                     --------      --------      --------      --------      --------
      Total risk assets                              $    973      $    928      $  1,047      $  1,059      $    601

Nonperforming loans to total loans, net                  0.97%         0.87%         0.80%         0.83%         0.04%
Nonperforming assets to total assets                     0.69          0.71          0.65          0.59          0.03
Risk assets to total assets                              0.69          0.71          0.85          0.82          0.58
Allowance for loan losses to:
    Total nonperforming assets                           1.08x         1.02x         0.99x         0.80x        17.17x
    Total risk assets                                    1.08x         1.02x         0.99x         0.80x        17.17x
Total assets                                         $140,089      $130,541      $122,761      $128,711      $104,013
Total loans, net                                      100,717       106,500       100,173        91,187        84,713
Allowance for loan losses                               1,054           951           796           608           515

</TABLE>

         Nonperforming assets increased to $973,000 at June 30, 1999 compared to
$928,000 and $803,000 at June 30, 1998 and 1997, respectively. Nonperforming and
risk  assets at June 30,  1999 and 1998 are  primarily  composed  of small loans
secured by residential real estate totaling $832,000 and $858,000, respectively.
The  remainder  of  nonperforming  and risk assets at June 30, 1999 and 1998 are
composed  of  smaller  installment  and line of  credit  loans.  Management  has
reviewed the collateral for nonaccrual loans and believes that collateral values
related to the  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.

         At June 30, 1999 and 1998,  the recorded  investment  in loans that are
considered to be impaired under Statement of Financial  Accounting Standards No.
114,  "Accounting  by Creditors  for  Impairment of a Loan" ("SFAS No. 114") was
$117,000 and $118,000, respectively. There were no impaired loans in non-accrual
<PAGE>
status at June 30,  1999 and 1998.  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, 1999 and 1998 was  approximately  $118,000  and  $118,500.  The Company
recognized  interest  income on the impaired loans of  approximately  $9,400 and
$9,500 during the years ended June 30, 1999 and 1998, respectively.

         The allowance for loan losses  represents  management's  estimate of an
amount adequate to provide for potential  losses inherent in the loan portfolio.
The  adequacy of the  allowance  for loan losses and the related  provision  are
based  upon  management's  evaluation  of the risk  characteristics  of the loan
portfolio under current economic  conditions.  Among the factors determining the
level of the allowance are loan growth,  projected net charge offs,  delinquency
trends, the financial  condition of borrowers,  collateral values, the amount of
nonperforming  and  past  due  loans,  and  current  and  economic   conditions.
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.

                                                                              13
<PAGE>
         The provision for loan losses is calculated  and charged to earnings to
maintain the total allowance for loan losses at a level  considered  adequate to
cover  probable loan losses  inherent in the  portfolio  based on an analysis of
existing loan levels,  types of loans  outstanding,  nonperforming  loans, prior
loan loss  experience,  industry  standards  and  general  economic  conditions.
Provisions  for loan losses were  $33,000 in 1999,  compared to $96,000 in 1998,
and $658,000 in 1997. The unusually  high  provision in 1997 resulted  primarily
from the charge off of  approximately  $510,000 of loans to a single borrower in
December  1996. No further charge offs related to this borrower have occurred or
are  anticipated at this time. The Company  received  approximately  $85,000 and
$63,000  of  recoveries   from  this  single  borrower  during  1999  and  1998,
respectively.  At this time,  management is unaware of any significant potential
problem loans except as noted above or any other  concentrations  of credit risk
which may exist in the portfolio.

         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>
<CAPTION>
TABLE 6
ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES





                                                              Year Ended June 30,
                                       ---------------------------------------------------------------
                                         1999          1998          1997          1996          1995
                                       -------       -------       -------       -------       -------
                                                              (dollars in thousands)
<S>                                    <C>               <C>       <C>           <C>           <C>
Balance, beginning of period           $   951           796       $   608       $   515       $   404
Provision for loan losses                   33            96           658            96           120
Charge-offs                                (17)           (8)         (519)           (4)          (14)
Recoveries                                  87            67            49             1             5
                                       -------       -------       -------       -------       -------
Balance, end of period                 $ 1,054       $   951       $   796       $   608       $   515
                                       =======       =======       =======       =======       =======
Allowance as a percentage of loans        1.04%         0.89%         0.79%         0.66%         0.60%

</TABLE>
<PAGE>
<TABLE>
<CAPTION>
TABLE 7
ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES

                                                               June 30,
                                          --------------------------------------------------
                                           1999       1998       1997       1996       1995
                                          ------     ------     ------     ------     ------
                                                         (dollars in thousands)
<S>                                       <C>        <C>        <C>        <C>        <C>
Residential 1-4 family                    $  548     $  533     $  382     $  256     $  216
Nonresidential real estate                   116        124        233        170        155
Home equity and other second mortgage        126        142         83         97         82
Construction                                 200         95         54         36         16
                                          ------     ------     ------     ------     ------
     Total real estate loans                 990        894        752        559        469
Other installment loans                       64         57         44         49         46
                                          ------     ------     ------     ------     ------
     Total allowance for loan losses      $1,054     $  951     $  796     $  608     $  515
                                          ======     ======     ======     ======     ======

</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.



14
<PAGE>
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  issued by the Federal Home
Loan Mortgage  Corporation  (FHLMC),  the Federal National Mortgage  Association
(FNMA) and the Government National Mortgage  Association (GNMA),  collateralized
mortgage  obligations  issued  by  FNMA  and  GNMA  secured  by  mortgage-backed
securities  guaranteed  by FNMA and GNMA,  and  obligations  of states and local
governments.

         Investment  securities increased $12.2 million to $29.2 million at June
30, 1999 from $17.0 million at June 30, 1998.  This increase is  attributable to
the  reinvestment  in  investment  securities of a portion of the $24 million in
proceeds  received  during  1999  from the  sale of  one-to-four  family  loans.
Approximately  88%  of the  Company's  investment  portfolio  is  classified  as
available-for-sale  in order to provide  flexibility  to meet  liquidity  needs.
Generally   securities   issued  by  the  state  of  North  Carolina  and  local
municipalities  in North Carolina are the only ones classified by the Company as
held-to-maturity.  At June 30,  1999,  net  unrealized  losses of $596,000  were
included  in the  carrying  value of  securities  classified  available-for-sale
compared to net  unrealized  gains of $126,000  on such  securities  at June 30,
1998.  These net unrealized  gains and losses are the result of  fluctuations in
market  interest rates rather than concerns  about the issuers'  ability to meet
their obligations.

         Table 8 shows  maturities of investment  securities held by the Company
at June 30, 1999 and the weighted average tax-equivalent yields for each type of
security and maturity.  Additional  information  about the Company's  investment
securities  as of June 30, 1999 and 1998 is  presented in Note 2 of the notes to
the  consolidated  financial  statements.
<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       Over 10 Years
                                 --------------------    ----------------------- --------------------  -------------------
                                             Weighted                  Weighted              Weighted             Weighted
                                 Carrying    Average     Carrying      Average   Carrying    Average   Carrying   Average
                                   Value      Yield        Value        Yield      Value      Yield      Value      Yield
                                   -----      -----        -----        -----      -----      -----      -----      -----
Available-for-sale:                                           (dollars in thousands)
<S>                               <C>                    <C>            <C>      <C>          <C>      <C>
U.S. government and agency        $    --       -- %     $ 6,122        6.23%    $ 5,264      6.18%    $    --         - %
State and local government (1)         --       --            --          --         783      6.23       1,035      8.52
Mortgage-backed securities (2)         --       --         5,257        6.21       2,355      6.26       4,994      6.43
                                  -------     ----       -------        ----     -------      ----     -------      ----
   Total available-for-sale       $    --       --       $11,379        6.22     $ 8,402      6.21     $ 6,029      6.79
                                  -------     ----       -------        ----     -------      ----     -------      ----
Held-to-maturity:
U.S. government and agency        $    --       -- %     $    --          -- %   $    --        -- %   $    --        -- %
State and local  government (3)     1,166     6.46           597        6.78         862      8.04         737      7.29
Mortgage-backed securities             --       --            --          --          --        --          --        --
                                  -------     ----       -------        ----     -------      ----     -------      ----
   Total held-to-maturity         $ 1,166     6.46       $   597        6.78     $   862      8.04 $       737      7.29
                                  -------     ----       -------        ----     -------      ----     -------      ----
Total investments,
    at carrying value             $ 1,166                $11,976                 $ 9,264               $ 6,766
                                  =======                =======                 =======               =======
<CAPTION>
                                             Total
                                    ----------------------
                                                  Weighted
                                    Carrying       Average
                                      Value         Yield
                                     -------        ----
<S>                                  <C>            <C>
Available-for-sale:
U.S. government and agency           $11,386        6.21 %
State and local government (1)         1,818        7.53
Mortgage-backed securities (2)        12,606        6.31
                                     -------        ----
   Total available-for-sale$         $25,810        6.34
                                     -------        ----

Held-to-maturity:
U.S. government and agency$          $    --          -- %
State and local  government (3)        3,362        7.10
Mortgage-backed securities                --          --
                                     -------        ----
   Total held-to-maturity            $ 3,362        7.10
                                     -------        ----
Total investments,
    at carrying value                $29,172
                                     =======
</TABLE>
<PAGE>
(1)  Yields are stated on a taxable  equivalent  basis  assuming  statutory  tax
     rates of 34% for federal and 7.50% for state purposes.  Book yields without
     regard to tax-equivalent  adjustments are: six to ten years, 4.68%;over ten
     years, 5.63%; total 5.20%.
(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, 1999.
(3)  Yields are stated on a taxable  equivalent  basis  assuming  statutory  tax
     rates of 34% for federal and 7.50% for state purposes.  Book yields without
     regard to tax- equivalent  adjustments are: one year or less, 4.76%; one to
     five years,  4.64%; six to ten years,  4.89%, over ten years, 5.30%; total,
     4.89%.


         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 its  outstanding  home loan balances or 5%
of its  outstanding  advances.  No ready market exists for such stock,  which is
carried at cost. As of June 30, 1999,  the Company's  investment in stock of the
FHLB of Atlanta was $1,036,000.



                                                                              15
<PAGE>
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.  General  interest rates,
economic conditions,  and competitive market conditions  significantly influence
deposit  inflows and outflows.  As  competition  for deposits has increased both
from larger financial  institutions in the Company's local market place and from
mutual  funds and other  investments,  borrowings  have  provided an  additional
source of funding.  Borrowed  funds provide  liquidity and assist the Company in
matching  interest rates on its assets and liabilities as interest rates on most
borrowed  funds are  fixed  and  therefore  more  predictable  than the rates on
deposits,  which are subject to change  based upon market  conditions  and other
factors.


Deposits

         Deposits  totaled  $99.3  million at June 30,  1999  compared  to $89.8
million at June 30,  1998,  and $84.9  million at June 30, 1997.  The  following
table sets forth certain  information  regarding the Company's  average  savings
deposits for the last three years.
<TABLE>
<CAPTION>
TABLE 9
AVERAGE DEPOSITS

                                                 1999                    1998                      1997
                                        --------------------     --------------------     --------------------
                                        Average      Average     Average      Average     Average      Average
                                        Amount        Rate       Amount        Rate        Amount        Rate
                                        ------        ----       ------        ----        ------        ----
<S>                                    <C>            <C>       <C>            <C>        <C>            <C>
Interest-bearing checking accounts     $ 7,815        0.92%     $ 6,930        1.04%      $ 6,011        1.48%
Savings and money market deposits       27,511        3.87       23,610        3.68        20,050        3.36
Certificates of deposit                 53,524        5.46       53,817        5.67        50,758        5.62
                                       -------        ----      -------        ----       -------        ----
   Total interest-bearing deposits      88,850        4.56       84,357        4.73        76,819        4.71
Non-interest-bearing deposits            3,163          --         2,291         --         1,901          --
                                       -------        ----      -------        ----       -------        ----

     Total deposits                    $92,013        4.41      $86,648        4.61       $78,720        4.59
                                       =======        ====      =======        ====       =======        ====
</TABLE>
         As of June 30, 1999, the Company held $12,237,000 in time  certificates
of deposit of  $100,000  or more.  Maturities  of  certificates  of  deposits of
$100,000  or more at June  30,  1999  were as  follows:  three  months  or less,
$1,907,000;  over three months through six months,  $5,635,000;  over six months
through  twelve  months,  $2,461,000;  over twelve  months  through  twenty-four
months, $1,715,000; and over twenty-four months, $519,000.
<PAGE>


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, 1999, FHLB of Atlanta  advances  totaled $20.2
million  compared to $18.0 million at June 30, 1998.  Additional  information on
borrowings  is  provided  in Note 7 of the notes to the  consolidated  financial
statements.



16
<PAGE>
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, 1999, the Bank had  $9,838,000 of credit  available from the FHLB of
Atlanta  that 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,
1999 which are projected to reprice or mature in each of the future time periods
shown.   At  June  30,   1999,   the   Company   had  a   cumulative   one  year
liability-sensitive  gap position of $5.9  million or 4.44% of  interest-earning
assets.  This  generally  indicates  that net interest  income would  experience
downward pressure in a rising rate environment and would increase in a declining
rate  environment,  as  interest-sensitive  liabilities  would generally reprice
faster than interest-sensitive assets.

         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,  1999,  management  believes  that  its  interest  rate  risk is at an
acceptable level.
<PAGE>
<TABLE>
<CAPTION>
TABLE 10
INTEREST SENSITIVITY

                                                                                    June 30, 1999
                                                  ---------------------------------------------------------------------------------
                                                                              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
                                                  --------      --------       --------       --------       --------      --------
Interest-earning assets:                                                       (dollars in thousands)
<S>                                               <C>           <C>            <C>            <C>            <C>           <C>
   Loans receivable                               $ 28,306      $ 25,267       $ 21,203       $ 14,338       $ 12,657      $101,771
   Interest-bearing deposits                         1,866          --             --             --             --           1,866
   Investment securities (1)                         2,469         2,126          3,289          8,341         12,947        29,172
   FHLB common stock                                  --            --             --             --            1,036         1,036
                                                  --------      --------       --------       --------       --------      --------
       Total interest-earning assets              $ 32,641      $ 27,393       $ 24,492       $ 22,679       $ 26,640      $133,845
                                                  ========      ========       ========       ========       ========      ========

Interest-bearing liabilities
   Deposits:
     Fixed maturity deposits                      $  9,331      $ 29,437       $ 16,782      $     484       $     --      $ 56,034
     Savings and money market accounts               3,494        14,717         14,716          3,494          3,494        39,915
                                                  --------      --------       --------       --------       --------      --------
       Total deposits                               12,825        44,154         31,498          3,978          3,494        95,949
   FHLB advances                                     5,305         2,000          3,000          9,000            857        20,162
                                                  --------      --------       --------       --------       --------      --------
       Total interest-bearing liabilities         $ 18,130      $ 46,154       $ 34,498       $ 12,978       $  4,351      $116,111
                                                  ========      ========       ========       ========       ========      ========

Interest sensitivity gap per period               $ 14,511      $(18,761)      $(10,006)      $  9,701       $ 22,289      $ 17,734
Cumulative interest sensitivity gap                 14,511        (4,250)       (14,256)        (4,555)        17,734          --
Cumulative gap as a percentage of
   total interest-earning assets                     10.84%        (3.18)%       (10.65)%        (3.40)%       13.25%        13.25%
Cumulative interest-earning assets as a
   percentage of interest-bearing liabilities       180.04%        93.39%         85.57%         95.92%       115.27%       115.27%
</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 Company 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.


                                                                              17
<PAGE>
Market Risk

         Market risk reflects the risk of economic loss  resulting  from adverse
changes in market price and interest  rates.  This risk of loss can be reflected
in diminished current market values and/or reduced potential net interest income
in future periods.

         The  Company's  market risk arises  primarily  from  interest rate risk
inherent in its lending and  deposit-taking  activities.  The  structure  of the
Company's  loan and deposit  portfolios  is such that a  significant  decline in
interest rates may adversely  impact net market values and net interest  income.
The Company  does not maintain a trading  account nor is the Company  subject to
currency exchange risk or commodity price risk.  Interest rate risk is monitored
as part of the Company's asset/liability management function, which is discussed
in "Liquidity and Interest Rate Risk Management" above.

         Table 11 presents information about the contractual maturities, average
interest  rates and estimated  fair values of financial  instruments  considered
market risk sensitive at June 30, 1999.
<TABLE>
<CAPTION>
TABLE 11
MARKET RISK ANALYSIS OF FINANCIAL INSTRUMENTS

                                        Contractual Maturities at June 30, 1999
                              --------------------------------------------------------------------
                                                                                          Beyond                Average   Estimated
                                                                                           Five                 Interest    Fair
                                2000         2001        2002        2003       2004       Years        Total   Rate (1)    Value
                              --------     --------    --------    --------   --------    --------    --------  --------   --------
<S>                           <C>          <C>         <C>         <C>        <C>         <C>         <C>         <C>      <C>
Financial Assets
  Debt securities (2)         $  2,310     $  2,324    $  1,954    $  1,199   $  7,494    $ 14,487    $ 29,768    6.64%    $ 29,198
                              --------     --------    --------    --------   --------    --------    --------             --------
  Loans (3):
    Fixed rate                     378          323         466         244        330      51,880      53,621    8.20       52,767
    Variable rate                2,772          479       1,265       2,026      1,289      40,705      48,536    8.61       49,483
                              --------     --------    --------    --------   --------    ------      --------             --------
          Total               $  5,460     $  3,126    $  3,685    $  3,469   $  9,113    $107,072    $131,925    8.01     $131,448
                              ========     ========    ========    ========   ========    ========    ========             ========

Financial Liabilities
  Savings, NOW and MMDA       $ 39,915     $   --      $   --      $   --     $   --      $   --      $ 39,915    3.30     $ 40,986
  Fixed rate certificates
       of deposit               38,768       14,093       2,689         484       --          --        56,034    5.46       56,783
  Advances from the Federal
       Home Loan Bank            7,305        2,000       1,000       9,000        857        --        20,162    5.69       20,027
                              --------     --------    --------    --------   --------    --------    --------    ----     --------
          Total               $ 85,988     $ 16,093    $  3,689    $  9,484   $    857    $   --      $116,111    4.76     $117,796
                              ========     ========    ========    ========   ========    ========    ========             ========
</TABLE>
<PAGE>
(1)  The average  interest rate related to debt  securities is stated on a fully
     taxable basis,  assuming a 34% federal income tax rate and applicable state
     income tax rate, reduced by the nondeductible portion of interest expense.
(2)  Debt securities are reported on the basis of amortized cost.
(3)  Nonaccrual  loans are included in the balance of loans.  The  allowance for
     loan loss and unearned fees and discounts are excluded.

18
<PAGE>
Capital Resources


         Stockholders'  equity  decreased  from  $21,606,000 at June 30, 1998 to
$19,561,000  at June 30,  1999.  Under a stock  repurchase  plan  adopted by the
Company's  Board of  Directors  in July of 1998,  the  Company  repurchased  and
retired  218,800 shares of its common stock during the year ended June 30, 1999.
The average cost of the shares  repurchased was $9.32 per share for a total cost
of  $2,040,000.  The  implementation  of the  share  repurchase  plan  and  cash
dividends  declared  were the  primary  factors  contributing  to the decline in
stockholders'  equity  during  the  year  ended  June  30,  1999.  Another  item
contributing to the decrease in stockholders'  equity from June 30, 1998 to June
30, 1999 was an unrealized  loss on  securities  available for sale of $440,000.
Mitigating  these  decreases was net income of  $1,200,000,  and release of ESOP
shares and  amortization  of unearned  compensation  of $165,000  and  $272,000,
respectively.

         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  FDIC  and  the  Savings
Institutions Division, North Carolina Department of Commerce ("the
Administrator").

         The Bank must comply with the capital  requirements of the FDIC and the
Administrator.  The FDIC requires the Bank to maintain  minimum ratios of Tier I
capital to total risk-weighted  assets and total capital to risk-weighted assets
of 4% and 8%, respectively.  To be "well-capitalized",  the FDIC requires ratios
of  Tier  I  capital  to  total  risk-weighted   assets  and  total  capital  to
risk-weighted  assets of 6% and 10%,  respectively.  Tier I capital  consists of
total  stockholders'  equity  calculated in accordance  with generally  accepted
accounting  principles less intangible assets, and total capital is comprised of
Tier I capital plus certain adjustments, the only one of which 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% and a  ratio  of 5% to be  "well-capitalized".  The  Administrator
requires a net worth equal to at least 5% of assets.

         At June 30, 1999 and 1998,  the Bank was in compliance  with all of the
aforementioned  capital  requirements of both the FDIC and the Administrator and
is  deemed  to be  "well-capitalized".  Refer  to  note  9 to  the  consolidated
financial statements for additional discussion of the Bank's capital resources.


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 of 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.
<PAGE>

Regulatory Matters

         Management is not presently aware of any current  recommendation to the
Company by regulatory authorities, which, if they were implemented, would have a
material effect on the Company's liquidity, capital resources, or operations.



                                                                              19
<PAGE>
Year 2000 Issue


         The  Company  recognizes  and  is  addressing  the  potentially  severe
implications  of the "Year 2000  Issue." The "Year 2000 Issue" is a general term
used to  describe  the  various  problems  that may  result  from  the  improper
processing of dates and date-sensitive calculations as the Year 2000 approaches.
This  issue is caused by the fact that  many of the  world's  existing  computer
programs  use only  two  digits  to  identify  the  year in the date  field of a
program.  These  programs were designed and developed  without  considering  the
impact of the  upcoming  change in the  century  and  could  experience  serious
malfunctions  when the last two digits of the year change to "00" as a result of
identifying a year  designated  "00" as the year 1900 rather than the Year 2000.
This  misidentification  could  prevent the Company from being able to engage in
normal  business  operations,  including,  among  other  things,  miscalculating
interest accruals and the inability to process customer transactions. Because of
the potentially  serious  ramifications  of the Year 2000 Issue,  the Company is
taking  the Year 2000  Issue  very  seriously.  The  Company  formed a Year 2000
Committee,  which is comprised of the Company's  management team, in November of
1997.  Other employees are actively  involved in the Company's Year 2000 efforts
on an as needed basis.  The Committee is leading the Company's Year 2000 efforts
to ensure that the Company is properly prepared for the Year 2000. The Company's
Board of Directors has approved a plan submitted by the Year 2000 Committee that
was developed in accordance with  guidelines set forth by the Federal  Financial
Institutions  Examination  Council.  This plan,  which is  described  in further
detail below, has five primary phases related to internal Year 2000 compliance:


1.   Awareness - this phase is ongoing  and is designed to inform the  Company's
     Board of Directors (the "Board") and Executive  management  ("Management"),
     employees,  customers  and  vendors of the  impact of the Year 2000  Issue.
     Since December of 1997 the Board has been apprised of the Company's efforts
     at their regular monthly meetings.  Employees are informed of the Company's
     Year 2000 efforts through scheduled  employee  meetings.  In addition,  all
     customers  were  updated with  respect to the  Company's  Year 2000 efforts
     through  mailings  sent in June of 1998 and April of 1999.  The Company has
     also  placed Year 2000  information  on the Bank's  World Wide Web site.  A
     final Year 2000  mailing  will be sent to all  customers  of the Bank as of
     September 30, 1999.

2.   Assessment  - during this phase an  inventory  was  conducted  of all known
     Company  processes that could  reasonably be expected to be impacted by the
     Year 2000 Issue and their related vendors, if applicable. This inventory of
     processes and vendors included not only typical computer  processes such as
     the Company's  transaction  applications  systems,  but all known processes
     that could be impacted by  micro-chip  malfunctions.  These include but are
     not limited to the Company's  alarm system,  phone system,  check  ordering
     process,  and ATM network.  The Company  inventoried all the systems listed
     above in December of 1997 and performed an initial  assessment of potential
     risks from either under or nonperformance arising from incorrect processing
     and usage of dates after  December 31,  1999.  At this time the Company had
     already  made the decision to convert in February of 1998 to a new computer
     service  provider  for  processing  all loan,  deposit and  general  ledger
     transactions. In conjunction with the conversion, the Company purchased and
<PAGE>
     installed new computers,  printers and related software in January of 1998.
     New hardware and software for a local area network was also  purchased  and
     installed  in January of 1998.  The total cost of the hardware and software
     purchased  by  the  Company  in  fiscal  1998  totaled   $296,000  and  was
     capitalized.  Most of the hardware  and  software  purchased by the Company
     either  is Year  2000  compliant  or will be with  minor  modifications  or
     upgrades.  The  assessment  phase  is  complete,  although  it  is  updated
     periodically as necessary.

3.   Renovation  and/or  replacement  - this  phase  includes  programming  code
     enhancements,  hardware and software upgrades, system replacements,  vendor
     certification  and  any  other  changes  necessary  to make  any  hardware,
     software  and other  equipment  Year 2000  compliant.  The Company does not
     perform in-house programming,  and thus is dependent on external vendors to
     ensure and modify, if needed,  the hardware,  software or other services it
     provides  to the  Company  for Year  2000  compliance.  As a result  of the
     assessment  performed above, the Company contacted all third party vendors,
     requested  documentation  regarding their Year 2000 compliance efforts, and
     analyzed their responses.  The responses from third party vendors generally
     include an overview of renovation efforts to their systems that the Company
     utilizes. In addition,  some third party software vendors have notified the
     Company  that  upgrades  of their  software  will be  necessary  to  ensure
     reliable and accurate Year 2000 processing. One third party computer vendor
     (the "primary service provider") processes,  either directly, or indirectly
     through  other  computer  vendors,  all loan,  deposit and  general  ledger
     transactions.  The primary  service  provider has notified the Company that
     the  renovation  and  replacement of their systems is complete and has been
     tested for Year 2000 compliance.


20
<PAGE>
4.   Testing - The next phase for the  Company  under the plan is to  complete a
     comprehensive  testing of all known  processes.  As noted in the renovation
     and/or  replacement phase above, the Company's primary service provider has
     already tested their system for Year 2000 compliance.  The next step, which
     is currently in process,  is to test the Company's network and core service
     provider software  applications and hardware. A first test of the company's
     core service provider  software  applications and hardware was performed on
     September 20, 1998 using a future date of January 3, 2000.  The Company has
     reviewed  the  results of this test,  and this  review  indicated  that the
     system  performed  reliably  and  accurately  when using the future date of
     January  3,  2000.  The  Company  performed  follow up tests  with its core
     service provider during the third quarter of fiscal 1999 using future dates
     of February  29,  2000 and March 1, 2000.  The  Company  has  reviewed  the
     results of this test, and this review  indicated that the system  performed
     reliably  and  accurately  when using the future dates of February 29, 2000
     and March 1, 2000. The testing of the remainder of the Company's  processes
     was  substantially  complete as of June 30, 1999, with follow up testing to
     be performed as needed in the remainder of calendar year 1999.

5.   Implementation - this phase occurred when the Company's  vendors  certified
     their  present  systems  as Year 2000  compliant.  All of the  systems  the
     Company is presently  using have been  certified as Year 2000  compliant by
     the  respective  vendors.  On some  applications  the  Company  is  already
     entering dates greater than December 31, 1999 into their systems.  In these
     situations no adverse  events have been noted.  The Company has developed a
     Business  Resumption  Contingency plan for critical  processes in the event
     they do not process information  reliably and accurately after December 31,
     1999.  This plan was  approved by the Bank's Board of Directors in late May
     of 1999 and tested by the Company in July of 1999.

The Company has also assessed the year 2000 readiness of  significant  borrowers
and  depositors.  In the second  quarter of 1999 the Company  prepared a list of
significant  borrowers and depositors.  After verbal and/or written inquiries of
these  customers,  any that  the  Company  had Year  2000  concerns  about  were
counseled on the Year 2000 issue and urged to take corrective action. Since most
of the  Company's  loans are to  individuals  and  secured by one to four family
residences this step did not require a significant amount of time or resources.

Excluding the hardware and software  purchases noted above, the Company expensed
$24,000  and  $2,000 on Year 2000 costs for the years  ended  June 30,  1999 and
1998,  respectively.  The  Year  2000  costs  do not  include  the  time of Bank
personnel  related to the Year 2000 issue.  Based on an  analysis  of  projected
expenses  performed in the second  quarter of fiscal 1999, the total cost of the
Year 2000  project is currently  estimated at $28,000.  Funding of the Year 2000
project  costs  has come from  normal  operating  cash  flow,  and the  expenses
associated  with the Year 2000  Issue  has and will  directly  reduce  otherwise
reported net income for the Company.

Management of the Company  believes that the potential  effects on the Company's
internal  operations of the Year 2000 Issue has been addressed prior to the Year
2000.  However,  notwithstanding  the time and  effort  expended  to date by the
Company and its vendors,  if required  modifications or conversions are not made
or are not  completed  on a timely  basis prior to the Year 2000,  the Year 2000
Issue could disrupt normal business operations. The most reasonably likely worst
case Year 2000  scenarios  foreseeable  at this time would  include  the Company
temporarily  not being able to process,  in some  combination,  various types of
<PAGE>
customer  transactions.  This could  affect the ability of the Company to, among
other things, originate new loans, post loan payments,  accept deposits or allow
immediate  withdrawals,  and,  depending  on the  amount of time such a scenario
lasted,  could have a material  adverse  effect on the  Company.  Because of the
serious  implications of these scenarios,  the primary emphasis of the Company's
Year 2000 efforts has been to correct any systems or  processes  whose Year 2000
test results are not satisfactory prior to the Year 2000.  Nevertheless,  should
one of the most  reasonably  likely worst case scenarios occur in the Year 2000,
the Company,  as noted above, has formalized a contingency plan that would allow
for  limited  transactions,  including  the  ability  to  make  certain  deposit
withdrawals,  until the Year 2000 problems are fixed. The costs of the Year 2000
project and the date on which the Company plans to complete Year 2000 compliance
are based on  management's  best  estimates,  which were derived using  numerous
assumptions  of future  events  such as the  availability  of certain  resources
(including internal and external resources),  third party vendor plans and other
factors.  However,  there  can be no  guarantee  that  these  estimates  will be
achieved at the cost  disclosed or within the  timeframe  indicated,  and actual
results could differ materially from these plans.  Factors that might affect the
timely and efficient  completion of the Company's Year 2000 project include, but
are not limited to, vendors' abilities to adequately correct or convert software
and the effect on the Company's  ability to test its systems,  the  availability
and cost of personnel trained in the Year 2000 area, the ability to identify and
correct all relevant computer programs and similar uncertainties.


                                                                              21
<PAGE>
Accounting Pronouncements

         The Company prepares its consolidated  financial statements and related
disclosures  in conformity  with  standards  established  by, among others,  the
Financial  Accounting  Standards  Board (the  "FASB").  Because the  information
needed by users of financial  reports is dynamic,  the FASB  frequently  has new
rules  and  proposed  new  rules  for  companies  to  apply in  reporting  their
activities.  The following discussion addresses such changes as of June 30, 1999
that will affect the Company's future reporting.

         In June  1998,  the  FASB  issued  Statement  of  Financial  Accounting
Standards No. 133 ("SFAS No. 133"),  "Accounting for Derivative  Instruments and
Hedging Activities". SFAS No. 133 establishes accounting and reporting standards
for derivative  instruments and for hedging  activities.  Statement of Financial
Accounting Standards No. 137, "Accounting for Derivative Instruments and Hedging
Activities  - Deferral of the  Effective  Date of FASB  Statement  No. 133 - and
amendment of FASB No. 133" delayed the effective  date of this statement for one
year.  This  Statement  is  effective  for all fiscal  quarters of fiscal  years
beginning  after June 15,  2000.  The Company  plans to adopt SFAS 133 in fiscal
year 2001 without any impact on its  consolidated  financial  statements  as the
Company does not have any derivative  financial  instruments and is not involved
in any hedging activities.

         In October  1998,  the FASB issued  Statement of  Financial  Accounting
Standards No. 134, "Accounting for Mortgage-Backed Securities Retained after the
Securitization   of  Mortgage  Loans  Held  for  Sale  by  a  Mortgage   Banking
Enterprise," establishes accounting and reporting standards for certain mortgage
banking  activities.  It also conforms the subsequent  accounting for securities
retained after the  securitization  of other types of assets.  This statement is
effective for financial statements for fiscal years beginning after December 15,
1998. The Company adopted SFAS 134 in fiscal year 1999 without any impact on its
consolidated financial statements.


Forward Looking Statements

         The foregoing  discussion may contain  statements  that could be deemed
forward-looking  statements  within the meaning of Section 21E of the Securities
Exchange Act of 1934 and the Private  Securities  Litigation  Reform Act,  which
statements are inherently  subject to risks and  uncertainties.  Forward-looking
statements are statements that include projections, predictions, expectations or
beliefs  about  future  events or results or  otherwise  are not  statements  of
historical  fact.  Such  statements  are  often  characterized  by  the  use  of
qualifying  words  (and  their   derivatives)   such  as  "expect,"   "believe,"
"estimate,"  "plan,"  "project,"  or other  statements  concerning  opinions  or
judgment of the Company and its  management  about future  events.  Factors that
could influence the accuracy of such forward-looking statements include, but are
not limited to, the  financial  success or changing  strategies of the Company's
customers, actions of government regulators, the level of market interest rates,
and general economic conditions.

22
<PAGE>

                          INDEPENDENT AUDITORS' REPORT









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


We have audited the accompanying consolidated balance sheets of Piedmont Bancor,
Inc. and subsidiary as of June 30, 1999 and 1998,  and the related  consolidated
statements of income,  stockholders'  equity and  comprehensive  income and cash
flows for each of the years in the three-year  period ended June 30, 1999. 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,  1999 and 1998,  and the  results of their
operations and their cash flows for each of the years in the  three-year  period
ended  June  30,  1999,  in  conformity  with  generally   accepted   accounting
principles.



                                    /s/KPMG LLP
                                    -----------
                                    KPMG LLP


Raleigh, North Carolina
July 19, 1999

                                                                              23
<PAGE>
<TABLE>
<CAPTION>
                                     CONSOLIDATED BALANCE SHEETS
                                       June 30, 1999 and 1998

                                                                               1999           1998
                                                                            ---------      ---------
                                                                             (dollars in thousands)
<S>                                                                         <C>            <C>
ASSETS

Cash                                                                        $   1,706      $     823
Interest-bearing deposits in other financial institutions                       1,866          1,821
Investment securities (note 2):
   Available-for-sale (cost:  $26,406 in 1999 and
       $13,649 in 1998)                                                        25,810         13,775
   Held-to-maturity (market value: $3,388 in 1999
       and $3,331 in 1998)                                                      3,362          3,250
Loans receivable (net of allowance for loan losses of
     $1,054 in 1999 and $951 in 1998) (note 3)                                100,717        106,500
Federal Home Loan Bank stock, at cost                                           1,036          1,152
Premises and equipment (note 4)                                                 3,213          1,414
Prepaid expenses and other assets (note 10)                                     2,379          1,806
                                                                            ---------      ---------
                                    Total assets                            $ 140,089      $ 130,541
                                                                            =========      =========


LIABILITIES AND STOCKHOLDERS' EQUITY

Deposits (note 6):
     Demand, non-interest bearing                                               3,390          2,844
     Savings, NOW and MMDA                                                     39,915         32,800
Certificates of deposit                                                        56,034         54,196
                                                                            ---------      ---------
                                                                               99,339         89,840

Advances from the Federal Home Loan Bank (note 7)                              20,162         18,000
Accrued expenses and other liabilities                                          1,027          1,095
                                                                            ---------      ---------
                                       Total liabilities                      120,528        108,935
                                                                            ---------      ---------
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
<S>                                                                         <C>            <C>
Stockholders' Equity (note 9):
Preferred stock, no par value, 5,000,000 shares authorized;
   none issued                                                                   --             --
Common stock, no par value, 20,000,000 shares authorized;
   2,532,000 and 2,750,800 shares issued and outstanding as of June 30,
   1999 and 1998, respectively                                                  7,035          9,121
Unearned ESOP shares                                                             (450)          (679)
Unamortized deferred compensation                                                (655)          (953)
Unallocated restricted stock                                                      (87)           (61)
Retained earnings, substantially restricted (note 10)                          14,081         14,101
Accumulated other comprehensive income, net                                      (363)            77
                                                                            ---------      ---------
                      Total stockholders' equity                               19,561         21,606
                                                                            ---------      ---------

Commitments and contingencies (note 3)
                       Total liabilities and stockholders' equity           $ 140,089      $ 130,541
                                                                            =========      =========
</TABLE>

See accompanying notes to consolidated financial statements.


24
<PAGE>
<TABLE>
<CAPTION>
                                   CONSOLIDATED STATEMENTS OF INCOME
                                Years ended June 30, 1999, 1998 and 1997


                                                                     1999          1998         1997
                                                                   --------     --------      --------
                                                              (dollars in thousands, except per share data)
Interest income:
<S>                                                                <C>           <C>          <C>
Interest on loans                                                  $  8,835      $  9,127     $  8,060
Interest on deposits in other financial institutions                     82            70           99
Interest and dividends on investment securities:
         Taxable                                                      1,083           825        1,024
         Non-taxable                                                    200           195          352
                                                                   --------      --------     --------
                           Total interest income                     10,200        10,217        9,535
                                                                   --------      --------     --------

Interest expense:
     Interest on deposits (note 6)                                    4,056         3,991        3,615
     Interest on borrowings                                           1,056         1,200          988
                                                                   --------      --------     --------
         Total interest expense                                       5,112         5,191        4,603
                                                                   --------      --------     --------

Net interest income                                                   5,088         5,026        4,932
Provision for loan losses (note 3)                                       33            96          658
                                                                   --------      --------     --------
         Net interest income after provision for loan losses          5,055         4,930        4,274
                                                                   --------      --------     --------

Other income:
     Customer service and other fees                                    223           207          201
     Mortgage loan servicing fees                                        42            63           87
     Gains (losses) on sales of investment securities                     5             6         (135)
     Lower-of-cost or market adjustment on loans held-for-sale          (73)           36            4
     Gain on sale of real estate owned                                   --           114           --
     Gain (loss) on sale of loans                                       (20)           75           --
     Stock and mutual fund commissions                                   74             7           --
     Other                                                              105            98           68
                                                                   --------      --------     --------

         Total other income                                             356           606          225
                                                                   --------      --------     --------
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
<S>                                                                <C>           <C>          <C>
Other expenses:
     Compensation and fringe benefits (note 8)                        1,989         1,713        3,152
     SAIF recapitalization assessment (note 6)                           --            --          487
     Data and items processing                                          396           256          241
     Deposit insurance premiums                                          53            53           71
     Occupancy expense                                                  145           114          113
     Furniture and equipment expense                                    214           113          115
     Professional fees                                                  117           185          129
     Other                                                              644           529          408
                                                                   --------      --------     --------

         Total other expenses                                         3,558         2,963        4,716
                                                                   --------      --------     --------

         Income (loss) before income tax expense                      1,853         2,573         (217)

Income tax expense (note 10)                                            653           930          317
                                                                   --------      --------     --------


                       Net income (loss)                           $  1,200      $  1,643     $   (534)
                                                                   ========      ========     ========


Net income (loss) per share - basic (note 8)                       $   0.48      $   0.61     $  (0.20)
                                                                   ========      ========     ========

Net income (loss) per share - diluted (note 8)                     $   0.46      $   0.61     $  (0.20)
                                                                   ========      ========     ========

</TABLE>

See accompanying notes to consolidated financial statements.


                                                                              25
<PAGE>
<TABLE>
<CAPTION>
                              CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME
                                          For the years ended June 30, 1999, 1998 and 1997




                                                                                   Unearned    Unamortized      Unallocated
                                                     Shares         Common           ESOP        Deferred       Restricted
                                                  Outstanding        Stock          Shares     Compensation        Stock
                                                   ---------      ----------      ----------      ---------       --------
                                                                                    (dollars in thousands)
<S>                                               <C>            <C>             <C>             <C>             <C>
Balance at June 30, 1996                          2,645,000      $   25,398      $   (2,552)     $     --        $     --

Comprehensive loss:
     Net loss                                          --              --              --              --              --
     Other comprehensive income-unreal-
       ized gain on securities available for
       sale net of income taxes of $318                --              --              --              --              --
        Total comprehensive loss
     Issuance of restricted stock                   105,800           1,587            --            (1,587)           --
      Release of ESOP shares                           --                83           1,619            --              --
     Amortization of unearned
       compensation                                    --              --              --               237            --
     Forfeiture of restricted stock
      and  related dividends                           --               107            --               224            (224)
     Allocation of restricted stock                    --               (60)           --              (143)            203
     Tax benefit of dividends on
       restricted stock                                --               261            --              --              --
     Cash dividends ($7.42 per share)**                --           (18,233)           --              --              --
                                                  ---------      ----------      ----------       ---------        --------
Balance at June 30, 1997                          2,750,800           9,143            (933)         (1,269)            (21)
Comprehensive income:
     Net income                                        --              --              --              --              --
     Other comprehensive income-unreal-
       ized gain on securities available for
       sale net of income taxes of $104                --              --              --              --              --
     Total comprehensive income
     Release of ESOP shares                            --               (45)            254            --              --
     Amortization of unearned
          compensation                                 --              --              --               265            --
     Forfeiture of  restricted stock                   --              --              --               146            (146)
     Allocation of restricted stock                    --               (11)           --               (95)            106
     Tax benefit of dividends on
       restricted  stock                               --                (2)           --              --              --
     Cash dividends declared, net of
     forfeited dividends on
       restricted stock
       ($0.42 per share)                               --                36            --              --              --
                                                 ---------       ----------      ----------       ---------        --------

Balance at June 30, 1998                         2,750,800            9,121            (679)           (953)            (61)
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
                                                                  Accumulated
                                                                    other           Total
                                                  Retained      comprehensive   Stockholders'
                                                  Earnings          income          Equity
                                                 ----------      ----------      ----------

<S>                                              <C>             <C>             <C>
Balance at June 30, 1996                         $   14,783      $     (579)     $   37,050

Comprehensive loss:
     Net loss                                          (534)           --              (534)
     Other comprehensive income-unreal-
       ized gain on securities available for
       sale net of income taxes of $318                --               495             495
                                                                                 ----------
        Total comprehensive loss                                                        (39)
     Issuance of restricted stock                      --              --              --
      Release of ESOP shares                           --              --             1,702
     Amortization of unearned
       compensation                                    --              --               237
     Forfeiture of restricted stock
      and  related dividends                           --              --               107
     Allocation of restricted stock                    --              --              --
     Tax benefit of dividends on
       restricted stock                                --              --               261
     Cash dividends ($7.42 per share)**                (669)           --           (18,902)
                                                 ----------      ----------      ----------
Balance at June 30, 1997                             13,580             (84)         20,416
Comprehensive income:
     Net income                                       1,643            --             1,643
     Other comprehensive income-unreal-
       ized gain on securities available for
       sale net of income taxes of $104                --                 161           161
                                                                                 ----------
     Total comprehensive income                                                       1,804
     Release of ESOP shares                            --              --               209
     Amortization of unearned
          compensation                                 --              --               265
     Forfeiture of  restricted stock                   --              --              --
     Allocation of restricted stock                    --              --              --
     Tax benefit of dividends on
       restricted  stock                               --              --                (2)
     Cash dividends declared, net of
     forfeited dividends on
       restricted stock
       ($0.42 per share)                             (1,122)           --            (1,086)
                                                 ----------      ----------      ----------
Balance at June 30, 1998                             14,101              77          21,606
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
                                                                                   Unearned       Unamortized       Unallocated
                                                     Shares         Common           ESOP           Deferred        Restricted
                                                  Outstanding        Stock          Shares        Compensation         Stock
                                                   ---------      ----------      ----------       ---------         --------
                                                                             (dollars in thousands)
<S>                                                 <C>            <C>             <C>             <C>             <C>
 Balance at June 30, 1998                           2,750,800           9,121            (679)           (953)            (61)
 Comprehensive income:
     Net income                                          --              --              --              --              --
     Other comprehensive income-unreal-
      ized loss on  securities available for
        sale net of income tax benefit of $282           --              --              --              --              --
        Total comprehensive  income
     Purchase and  retirement of common  stock       (218,800)         (2,040)           --              --              --
     Release of ESOP shares                              --               (64)            229            --              --
     Amortization of unearned
           compensation                                  --              --              --               272            --
     Forfeiture of  restricted stock                     --              --              --                26             (26)
     Tax benefit of dividends on                            6
          restricted stock                               --              --              --              --              --
     Cash dividends declared, net of
     forfeited dividends on
     restricted stock
     ($0.48 per share)                                   --                12            --              --              --
                                                   ----------      ----------      ----------      ----------      ----------
Balance at June 30, 1999                            2,532,000      $    7,035      $     (450)     $     (655)     $      (87)
                                                   ==========      ==========      ==========      ==========      ==========

</TABLE>
<PAGE>
<TABLE>
<CAPTION>

                                                                 Accumulated
                                                                    other           Total
                                                  Retained      comprehensive   Stockholders'
                                                  Earnings          income          Equity
                                                 ----------      ----------      ----------
<S>                                                 <C>             <C>             <C>
 Balance at June 30, 1998                               14,101              77          21,606
 Comprehensive income:
     Net income                                          1,200            --             1,200
     Other comprehensive income-unreal-
      ized loss on  securities available for
        sale net of income tax benefit of $282            --              (440)           (440)
                                                                                    ----------
        Total comprehensive  income                                                        760
     Purchase and  retirement of common  stock            --              --            (2,040)
     Release of ESOP shares                               --              --               165
     Amortization of unearned
           compensation                                   --
     Forfeiture of  restricted stock                      --              --              --
      Tax benefit of dividends on
          restricted stock                                --              --                 6
     Cash dividends declared, net of
     forfeited dividends on
     restricted stock
     ($0.48 per share)                                  (1,220)           --            (1,208)
                                                    ----------      ----------      ----------
Balance at June 30, 1999                            $   14,081      $     (363)     $   19,561
                                                    ==========      ==========      ==========

</TABLE>
**  includes $7.00 special dividend paid on December 6, 1996.

          See accompanying notes to consolidated financial statements.

26
<PAGE>
<TABLE>
<CAPTION>
                                            CONSOLIDATED STATEMENTS OF CASH FLOWS For the
                                              years ended June 30, 1999, 1998, and 1997

                                                                                            1999          1998          1997
                                                                                          --------      --------      --------
Operating activities:                                                                             (dollars in thousands)
<S>                                                                                       <C>           <C>           <C>
     Net income (loss)                                                                    $  1,200      $  1,643      $   (534)
     Adjustments to reconcile netincome (loss) to net cash
           provided by operating activities:
         Depreciation                                                                          172            94            93
         Net amortization (accretion)                                                           94           119            98
         Provision for loan losses                                                              33            96           658
         Deferred income taxes                                                                --              (5)         (163)
         Gain on sale of fixed assets                                                         --              (2)         --
         Net (gain) loss on sale of investment and mortgage-backed securities                   (5)           (6)          135
         Gain on sale of real estate owned                                                    --            (114)         --
         Loss (gain) on sale of loans                                                           20           (75)         --
         Release of ESOP shares                                                                165           209         1,702
         Compensation earned under MRP                                                         272           265           237
         Net decrease in mortgage loans held for sale                                          513           264           519
         Decrease (increase) in other assets                                                  (356)         (328)          585
         Increase (decrease) in other liabilities                                              (48)           53           (40)
                                                                                          --------      --------      --------
              Net cash provided by operating activities                                      2,060         2,213         3,290
                                                                                          --------      --------      --------

Investing activities:
     Net decrease (increase) in loans held for investment                                    5,243        (7,198)      (10,230)
     Principal collected on mortgage-backed securities                                       1,427           620           628
     Purchases of investment securities classified as available-for-sale                    (8,748)       (2,254)         (504)
     Purchases of investment securities classified as held-to-maturity                        (300)         (307)         --
     Purchases of mortgage-backed securities classified as available-for-sale               (7,677)       (2,517)       (1,658)
     Purchases of collateralized mortgage obligations                                       (2,524)         --            --
     Proceeds of sales of investment securities classified as available-for-sale              --            --          13,601
     Proceeds from maturities of investment securities                                        --            --              78
     Proceeds from investment securities called by issuer                                    4,420           380         1,085
     Proceeds of sales of mortgage-backed securities classified as available-for-sale          501         1,508         3,847
     Redemptions (purchases) of FHLB Stock                                                     116          (232)          (57)
     Purchases of premises and equipment                                                    (1,971)         (318)          (34)
     Proceeds from sale of real estate owned                                                  --             636          --
     Proceeds from sale of fixed assets                                                       --              17
                                                                                          --------      --------      --------
                                  Net cash provided (used) by investing activities          (9,513)       (9,665)        6,756
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
<S>                                                                                       <C>           <C>           <C>
Financing activities:
     Net increase in time deposits                                                           1,838             4         5,776
     Net increase in other deposits                                                          7,661         4,976         5,723
     Proceeds from borrowings                                                                7,305        18,000        14,000
     Repayments of borrowings                                                               (5,143)      (16,500)      (14,750)
     Repurchase of no par common stock                                                       2,040            --            --
     Cash dividends paid to shareholders                                                     1,240        (1,029)      (18,820)
                                                                                          --------      --------      --------
         Net cash provided (used) by financing activities                                    8,381         5,451        (8,071)
                                                                                          --------      --------      --------

                  Increase (decrease) in cash and cash equivalents                             928        (2,001)        1,975
Cash and cash equivalents at beginning of period                                             2,644         4,645         2,670
                                                                                          --------      --------      --------
Cash and cash equivalents at end of period                                                $  3,572      $  2,644      $  4,645
                                                                                          ========      ========      ========
Supplemental  disclosure of cash flow  information:
   Cash paid during the period for:
     Interest                                                                             $  4,048      $  5,217      $  4,592
                                                                                          ========      ========      ========
     Income taxes                                                                         $    680      $    977      $    342
                                                                                          ========      ========      ========

Supplemental disclosure of noncash transactions:
   Unrealized gains (losses) on available-for-sale securities, net of deferred
     taxes of $282 for 1999, $104 for 1998 and $318 for 1997                              $   (440)     $    161      $    495
                                                                                          ========      ========      ========
   Dividends declared but unpaid                                                          $   (304)     $   (324)     $   (267)
                                                                                          ========      ========      ========
   Transfer of bank premises no longer in use from fixed assets to other
      assets at net book value                                                            $   --        $     --      $     60
                                                                                          ========      ========      ========

Transfer from loans receivable to real estate owned
      assets at net book value                                                            $   --        $    522      $   --
                                                                                          ========      ========      ========

</TABLE>

See accompanying notes to consolidated financial statements.

                                                                              27
<PAGE>
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

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

Piedmont  Bancorp,  Inc.,  ("the Parent") is a bank holding  company,  formed in
December 1995,  that owns all of the  outstanding  common stock of  Hillsborough
Savings Bank,  Inc. SSB ("the Bank").  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  in  December  1995  ("the
Conversion").  The  Bank is  primarily  engaged  in the  business  of  obtaining
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 Securities
         ---------------------

Management determines the appropriate classification of investment securities at
the time of purchase.  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.
<PAGE>
(d)      Mortgage Servicing Rights
         -------------------------

Mortgage  servicing  rights ("MSR") are the rights to service mortgage loans for
others which are capitalized and included in "other assets" on the  Consolidated
Balance Sheets at the lower of their carrying value or fair value.  The carrying
value of  mortgage  loans  originated  or  purchased  is  allocated  between the
carrying  value  of the  loans  and the  MSR.  Capitalization  of the  allocated
carrying value of MSR occurs when the underlying  loans are sold or securitized.
MSR's  are  amortized  over the  estimated  period of and in  proportion  to net
servicing revenues.  MSR for loans originated by the Bank prior to 1997 were not
capitalized in accordance with the then current accounting standards.

The Company  periodically  evaluates MSR for  impairment by estimating  the fair
value based on a discounted cash flow  methodology.  This analysis  incorporates
current market assumptions, including discount, prepayment and delinquency rates
with net cash  flows.  The  predominant  characteristics  used as the  basis for
stratifying  MSR are  investor  type,  product type and  interest  rate.  If the
carrying  value of the MSR's  exceed  the  estimated  fair  value,  a  valuation
allowance is established. Changes to the valuation allowance are charged against
or credited to mortgage  servicing  income and fees up to the original  carrying
value of the MSR.

(d)      Loans Held for Sale
         -------------------

         Loans  held for sale are  carried at the lower of cost or fair value in
the aggregate as determined by outstanding commitments from investors or current
investor yield requirements. Gains and losses on loan sales are determined by
the  difference  between the selling  price and the carrying  value of the loans
sold.

28
<PAGE>
(1)      Significant Accounting Policies, Continued
         ------------------------------------------

(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  (including  impaired  loans) is suspended when, in
management's  judgment,  doubts exist as to the  collectibility of principal and
interest.  Interest  received on  nonaccrual  and  impaired  loans is  generally
applied  against  principal or may be reported as interest  income  depending on
management's judgment as to the collectibility of principal.  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 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, 1999,  substantially all of the Company's loans were  collateralized
by real estate in Orange  County,  North  Carolina  and adjacent  counties.  The
collateral is predominately  owner-occupied residential real estate in which the
borrower  does not rely on  underlying  cash flows from the  property to satisfy
debt service.  The ultimate  collectibility of a substantial portion of the loan
portfolio is susceptible to changes in market conditions in the Company's market
area. While management uses available  information to recognize losses on loans,
future  additions to the allowance may be necessary based on changes in economic
conditions.   Various  regulatory  agencies,   as  an  integral  part  of  their
examination  processes,  periodically  review the  Company's  allowance for loan
losses.  Such  agencies  may require the Company to  recognize  additions to the
allowance based on their judgments  about  information  available to them at the
time of their examinations.

For all specifically  reviewed loans for which it is probable that the Bank will
be  unable  to  collect  all  amounts  due  according  to the  terms of the loan
agreement,  the Bank determines fair value either based on discounted cash flows
using the loans'  initial  interest rate or the fair value of the  collateral if

<PAGE>
the loan is collateral  dependent.  Large groups of smaller  balance  homogenous
loans  that are  collectively  evaluated  for  impairment  (such as  residential
mortgage  and  consumer   installment   loans)  are  excluded  from   impairment
evaluation, and their allowance for loan losses is calculated in accordance with
the allowance for loan losses policy described above.

(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, 1999, the Bank owned 10,360 shares of the FHLB's $100 par value capital
stock. No ready market exists for such stock, which is carried at cost.

(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.


                                                                              29
<PAGE>
(1)      Significant Accounting Policies, Continued
         ------------------------------------------

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

The  provision  for income  taxes is based on income and  expense  reported  for
financial statement purposes after adjustment for permanent  differences such as
tax exempt interest  income.  Deferred income taxes are provided when there is a
difference  between the  periods  items are  reported  for  financial  statement
purposes  and when they are  reported  for tax  purposes and are recorded at the
enacted tax rates  expected  to apply to taxable  income in years in which these
temporary  differences  are  expected to be  recovered  or  settled.  Subsequent
changes in tax rates will require adjustment to these assets and liabilities.

(j)      Retirement Plans
         ----------------

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.  The Company  records  compensation
expense for shares released to employees,  as a result of  contributions  by the
Company or dividends paid on unreleased  shares in the employee stock  ownership
plan, equal to the fair value of the shares released.

The Bank also has 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.

(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 (Loss) Per Share
         -------------------------

In 1998, the Company adopted the provisions of Statement of Financial Accounting
Standards (SFAS) No. 128, "Earnings Per Share", which establishes  standards for
computing and presenting  earnings per share (EPS) data. SFAS No. 128 simplifies
the standards for computing EPS previously found in APB Opinion No. 15 "Earnings
Per Share", and makes them comparable to international EPS standards. Under SFAS
No. 128, basic EPS replaces the former presentation of primary EPS. Also, a dual
presentation  of of basic and  diluted EPS is required on the face of the income
statement for all entities with complex capital structures, and a reconciliation
must be provided of the numerator and  denominator of the basic EPS  computation
to the numerator and denominator of the diluted EPS  computation.  In accordance
with SFAS No. 128, all prior period EPS data has been restated.

30
<PAGE>
(1)       Significant Accounting Policies, Continued
          ------------------------------------------

(m)       Comprehensive Income
          --------------------

On July 1, 1999,  the Company  adopted  SFAS No. 130,  "Reporting  Comprehensive
Income".  SFAS No. 130 establishes  standards for reporting and  presentation of
comprehensive  income and its components in a full set of financial  statements.
Comprehensive income consists of net income and net unrealized gains (losses) on
securities  and is  presented  in the  statements  of  stockholders'  equity and
comprehensive income. The Statement requires only additional  disclosures in the
consolidated  financial  statements;  it does not affect the Company's financial
position or results of  operations.  Prior year financial  statements  have been
reclassified to conform to the requirements of SFAS No. 130.

The Company's other comprehensive income for the years ended June 30, 1999, 1998
and 1997 and accumulated other comprehensive income as of June 30, 1999 and 1998
are comprised  solely of unrealized  gains and losses on certain  investments in
debt securities.  Other comprehensive income (loss) for the years ended June 30,
1999, 1998 and 1997 follows:
<TABLE>
<CAPTION>
                                                                                 1999            1998           1997
                                                                             ----------      ---------      ---------
<S>                                                                          <C>             <C>            <C>
Unrealized holding gains (losses) arising during period                      $     (437)     $     165      $     414
Less: reclassification adjustment for realized gains (losses), net of tax             3              4            (81)
                                                                             ----------      ---------      ---------
Unrealized gains (losses) on securities, net of applicable income taxes      $     (440)     $     161      $     495
                                                                             ==========      =========      =========
</TABLE>

(n)       Disclosures Regarding Segments
          ------------------------------

The Company adopted SFAS No. 131,  "Disclosures  about Segments of an Enterprise
and Related Information" in 1999. SFAS No. 131 establishes standards for the way
that public  businesses report  information  about operating  segments in annual
financial  statements  and  requires  that  those  enterprises  report  selected
information  about  operating  segments in interim  financial  reports issued to
shareholders.  It also  establishes  standards  for  related  disclosures  about
products  and  services,  geographic  areas,  and major  customers.  The Company
adopted  SFAS  No.  131  without  any  impact  on their  consolidated  financial
statements  as the  chief  operating  decision  maker  reviews  the  results  of
operations of the Company and its subsidiaries as a single enterprise.

(o)      Reclassifications
         -----------------

Certain  reclassifications  have been made for 1998 and 1997 to conform with the
1999 presentation.  The  reclassifications  had no effect on previously reported
net income or stockholders' equity.



                                                                              31


<PAGE>
(2)      Investment Securities
         ---------------------

The  following is a summary of the  investment  securities  portfolios  by major
classification:
<TABLE>
<CAPTION>

                                                              June 30, 1999
                                             -----------------------------------------------
                                                         (dollars 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       $11,696     $  --       $   310     $11,386
     Mortgage-backed securities (1)             12,923           7         324      12,606
     State and local governments                 1,787          57          26       1,818
                                               -------     -------     -------     -------
       Total securities available-for-sale     $26,406     $    64     $   660     $25,810
                                               =======     =======     =======     =======
Securities held-to-maturity:
         State and local governments           $ 3,362     $    57     $    31     $ 3,388
                                               =======     =======     =======     =======
<CAPTION>
                                                              June 30, 1998
                                             -----------------------------------------------
                                                         (dollars 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       $ 8,005     $    26     $     3     $ 8,028
     Mortgage-backed securities                  4,668          32           5       4,695
     State and local governments                   976          76        --         1,052
                                               -------     -------     -------     -------

       Total securities available-for-sale     $13,649     $   134     $     8     $13,775
                                               =======     =======     =======     =======
Securities held-to-maturity:
     State and local governments               $ 3,250     $    85     $     4     $ 3,331
                                               =======     =======     =======     =======
</TABLE>
(1) At June 30, 1999 and 1998,  the  Company  owned  mortgage-backed  securities
issued by the  Federal  Home Loan  Mortgage  Corporation  (FHLMC),  the  Federal
National  Mortgage  Association  (FNMA)  and the  Government  National  Mortgage
Association  (GNMA)  with  an  aggregate   amortized  cost  of  $10,405,000  and
$4,668,000,  respectively,  and a market value of $10,162,000 and $4,695,000. In
addition,   at  June  30,  1999,  the  Company  owned  collateralized   mortgage
obligations  issued  by FNMA  and GNMA  secured  by  mortgage-backed  securities
guaranteed by FNMA and GNMA with an amortized  cost of  $2,518,000  and a market
value of $2,444,000. The Bank owned no collateralized mortgage obligations as of
June 30, 1998.

32
<PAGE>
(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, 1999,
by remaining contractual maturity are as follows:
<TABLE>
<CAPTION>

                                            Securities available-for-sale      Securities held-to-maturity
                                                                 (dollars 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 in 1 year through 5 years               6,206       6,122                 --          --
       Due after 5 through 10 years                5,490       5,264                 --          --
Obligations of states and local governments:
       Due in 1 year or less                        --          --                  1,166       1,175
       Due 1 year through 5 years                   --          --                    597         604
       Due after 5 through 10 years                  811         783                  862         890
       Due after 10 years                            976       1,035                  737         719
Mortgage-backed  securities                       12,923      12,606                 --          --
                                                 -------     -------              -------     -------
       Total securities                          $26,406     $25,810              $ 3,362     $ 3,388
                                                 =======     =======              =======     =======

</TABLE>
At June 30, 1999 and 1998,  investment securities with book values of $7,310,000
and $8,311,000, respectively, were pledged as collateral for public deposits.

Summarized below is the sales activity in investment securities:
<TABLE>
<CAPTION>

                                                                   Year ended June 30,
                                                                   -------------------
                                                           1999           1998           1997
                                                         --------      --------      --------
                                                                (dollars in thousands)
<S>                                                      <C>           <C>           <C>
Proceeds from sales of available-for-sale securities     $    506      $  1,508      $ 17,448
Realized gains                                                 (5)           (6)          (55)
Realized losses                                                --            --           190
                                                         --------      --------      --------
Cost of available-for-sale securities sold               $    501      $  1,502      $ 17,583
                                                         ========      ========      ========

</TABLE>

                                                                              33
<PAGE>
(3)   Loans Receivable
      ----------------
<TABLE>
<CAPTION>
                                                                                    June 30,
                                                                          ------------------------
Loans receivable consist of the following:                                   1999             1998
                                                                             ----             ----
                                                                            (dollars in thousands)
<S>                                                                       <C>            <C>
Loans secured by first mortgages on real estate:
     Mortgage loans held for sale                                         $   2,264      $   2,797
     Mortgage loans held for investment, primarily one-to-four family        76,503         87,378
     Construction loans                                                       8,741          7,552
     Commercial and agricultural loans                                        8,228          6,472
     Participation loans purchased                                              419            323
                                                                          ---------      ---------
                                                                             96,155        104,522
Home equity lines of credit                                                  10,113          9,879
Other second mortgage loans                                                     741            709
Other installment loans                                                       1,314            850
                                                                          ---------      ---------
                                                                            108,323        115,960
Undisbursed proceeds on loans in process                                     (6,166)        (8,097)
Deferred loan fees                                                             (386)          (412)
Allowance for loan losses                                                    (1,054)          (951)
                                                                          ---------      ---------
                                                                          $ 100,717      $ 106,500
                                                                          =========      =========
</TABLE>

An analysis of the allowance for loan losses follows:
<TABLE>
<CAPTION>
                                               1999          1998           1997
                                               ----          ----           ----
                                                   (dollars in thousands)
<S>                                         <C>           <C>           <C>
Balance at beginning of period              $   951       $   796       $   608
Provision for loan losses                        33            96           658
Loans charged off                               (17)           (8)         (519)
Recoveries                                       87            67            49
                                            -------       -------       -------
Balance at end of period                    $ 1,054       $   951       $   796
                                            =======       =======       =======
</TABLE>

At June 30, 1999 and 1998, the Company had loans totaling approximately $973,000
and $928,000, respectively, which were in nonaccrual status. There were no loans
that were  contractually  delinquent  for 90 days or more and still  accruing at
June 30, 1999 and 1998.

Additional interest income that would have been recorded on nonaccrual loans for
the years ended June 30, 1999,  1998 and 1997 had they  performed in  accordance
with  their  original  terms   throughout  each  of  the  periods   amounted  to
approximately $76,000, $46,000 and $61,000, respectively.
<PAGE>
At June  30,  1999,  the  Company  had  fixed  rate  mortgage  loan  commitments
outstanding  of  $1,764,000.  Preapproved  but  unused  lines of credit  totaled
$11,164,000, and standby letters of credit totaled $21,434 at June 30, 1999. The
Company's exposure to credit losses 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.

34
<PAGE>
 (3)     Loans Receivable, Continued
         ---------------------------

At June 30, 1999 and 1998, the recorded  investment in loans that are considered
to be impaired under SFAS No. 114 was $117,000 and $118,000, respectively. There
were no impaired  loans in non-accrual  status at June 30, 1999 and 1998.  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 years ended June 30, 1999 and 1998 was  approximately
$118,000 and $118,500.  The Company  recognized  interest income on the impaired
loans of  approximately  $9,400 and $9,500  during the years ended June 30, 1999
and 1998, respectively.

The Company serviced loans for others of approximately $37,870,000, $18,256,000,
and $10,913,000 at June 30, 1999, 1998 and 1997, respectively. The June 30, 1999
balance  of loans  sold  with  recourse  was  approximately  $285,000.  Mortgage
servicing rights were not material for any of the periods presented.

Certain of the Company's  mortgage  loans are pledged as collateral for advances
from the Federal Home Loan Bank (see note 7).

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, 1999:

                                                 (dollars in thousands)
         Balance at June 30, 1998                     $  458
         New loans                                       121
         Repayments                                      (32)
                                                      ------
         Balance at June 30, 1999                     $  547
                                                      ======


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

Premises and equipment consist of the following:
<TABLE>
<CAPTION>
                                               June 30, 1999                   June 30, 1998
                                       ------------------------------   -------------------------------
                                               Accumulated   Net book           Accumulated    Net book
                                        Cost   depreciation   value      Cost   depreciation    value
                                        ----   ------------   -----      ----   ------------    -----
                                                           (dollars in thousands)
<S>                                    <C>        <C>        <C>        <C>        <C>        <C>
Land and land improvements             $1,424     $   68     $1,356     $  407     $   63     $  344
Office buildings and improvements       1,443        271      1,172        891        246        645
Furniture, fixtures, and equipment      1,441        756        685      1,042        617        425
                                       ------     ------     ------     ------     ------     ------
                                       $4,308     $1,095     $3,213     $2,340     $  926     $1,414
                                       ======     ======     ======     ======     ======     ======
</TABLE>
<PAGE>
(5)      Leases
         ------

The Company leases one of its branches  under a  noncancelable  operating  lease
expiring through 2017. The total expense  associated with this lease was $21,000
in 1999.  Future minimum lease payments on noncancelable  operating leases as of
June 30, 1999, consist of the following:

                                      Lease payments
                                      --------------
2000                                    $  39,680
2001                                       39,680
2002                                       39,680
2003                                       43,151
2004                                       45,630
                                         --------
                                        $ 207,821
                                        =========


                                                                              35
<PAGE>
(6)      Deposits
         --------

Contractual maturities of time deposits are as follows:

                                                               Total
               Year Ending June 30                           Maturities
               -------------------                           ----------
                                                        (dollars in thousands)
               1999                                         $  38,768
               2000                                            14,093
               2001                                             2,689
               2002                                               484
               2003 and thereafter
                                                            ---------
                     Total time deposits                    $  56,034
                                                            =========

Time deposits of $100,000 or more totaled $12,237,000 and $9,556,000 at June 30,
1999 and 1998, respectively.

Interest expense on deposits includes $545,000,  $563,000,  and $406,000 for the
years ended June 30, 1999,  1998,  and 1997,  respectively,  on time deposits of
$100,000 or more.

On September 30, 1996,  President  Clinton signed into law the Deposit Insurance
Funds Act allowing a special assessment to be levied by the FDIC to recapitalize
the SAIF.  The  special  assessment  was based on the level of SAIF  deposits  a
financial  institution  had as of March 31, 1995 subject to a 20%  reduction for
certain  qualifying  deposits.  The Bank's  special  assessment  in 1997 totaled
$487,000.  On December 11, 1996,  the FDIC approved a final rule  retroactive to
October 1, 1996 which lowered rates on assessments paid to the SAIF.


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

Advances  from the Federal  Home Loan Bank of  Atlanta,  with  weighted  average
interest rates, are as follows:
<TABLE>
<CAPTION>
                                                                     June 30,
                                                                       1999
                                                                     -------
(dollars in thousands)
<S>                                                                  <C>
5.29% due on or before June 30, 2000                                 $ 7,305
5.15% due on or before June 30, 2001                                   2,000
5.86% due on or before June 30, 2002                                   1,000
5.91% due on or before June 30, 2003                                   9,000
5.68% July 1, 2003 and thereafter                                        857
                                                                     -------
                                                                     $20,162
                                                                     =======
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
                                                                      June 30,
                                                                       1998
(dollars in thousands)
<S>                                                                  <C>
5.91% due on or before June 30, 1999                                 $ 5,000
6.14% due on or before June 30, 2000                                   2,000
5.86% due on or before June 30, 2002                                   1,000
5.88% July 1, 2003 and thereafter                                     10,000
                                                                     -------
                                                                    $ 18,000
                                                                    ========
</TABLE>


At June 30, 1999, the Bank had additional  credit  availability from the Federal
Home Loan Bank of $9,838,000.

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


36
<PAGE>
(8)      Employee and Director Benefit Plans
         -----------------------------------

401(k) Plan
The Bank  sponsors 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.  Matching  contributions are funded when accrued.
Matching expense totalled  approximately  $17,000 in 1999,  $15,000 in 1998, and
$18,000 in 1997.

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  under the ESOP vest in full upon five  years of  service  with  credit
given for years of service prior to the conversion.

The ESOP was funded by a $40,000 cash  contribution made by 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. 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.

On December  31,  1996,  the Bank made a  $1,710,000  contribution  to the ESOP,
representing the normal  principal  payment due for the year and the application
of dividends on unallocated  shares to the principal  balance of the loan.  This
contribution resulted in the release of 128,919 shares to individual participant
accounts.  On December 31, 1997,  the Bank made a $212,000  contribution  to the
ESOP,  representing  the  normal  principal  payment  due for the  year  and the
application of dividends on unallocated  shares to the principal  balance of the
loan. This  contribution  resulted in the release of 19,918 shares to individual
participant   accounts.   On  December  31,  1998,  the  Bank  made  a  $207,000
contribution to the ESOP,  representing the normal principal payment due for the
year and the  application  of dividends on  unallocated  shares to the principal
balance of the loan. This contribution  resulted in the release of 18,448 shares
to individual  participant accounts. At June 30, 1999, a total of 167,285 shares
have been  released  and  allocated to  participants  and 44,315  shares  remain
unallocated, of which 16,660 shares are committed to be released on December 31,
1999.

Total compensation expense associated with the ESOP for the years ended June 30,
1999, 1998 and 1997 was $165,000,  $209,000,  and $1,702,000,  respectively.  At
June 30, 1999, there were 44,315 unallocated ESOP shares with a total fair value
of approximately $382,217.
<PAGE>
Management Recognition Plan ("MRP")
The Bank's MRP was  approved by  stockholders  of the Parent and by the Parent's
and the Bank's Boards of Directors  during fiscal year 1997. The MRP serves as a
means  of  providing  existing  directors  and  employees  of the  Bank  with an
ownership interest in the Company.  Shares of the Company's common stock awarded
under the MRP vest equally over a five year period. Compensation expense related
to those shares is recognized on a straight-line  basis  corresponding  with the
vesting period. Prior to vesting,  each participant granted shares under the MRP
may direct the voting of the shares  allocated  to the  participant  and will be
entitled to receive any dividends or other distributions paid on such shares. On
August 29, 1996,  105,800 shares were awarded but unearned to participants under
the MRP. During fiscal year 1997, 14,914 shares were forfeited under the MRP. Of
those shares forfeited, 13,500 were subsequently reallocated to new participants
under  the MRP in 1997.  During  fiscal  year  1998,  19,417  shares  vested  to
participants in the MRP and 11,645 shares were forfeited under the MRP. Of those
shares forfeited,  9,000 were subsequently reallocated to new participants under
the MRP in 1998.  During fiscal year 1999,  20,111 shares vested to participants
in the MRP and 1,719  shares were  forfeited  under the MRP.  None of the shares
forfeited were  reallocated  to new  participants  under the MRP in 1999.  Total
compensation  expense  associated with the MRP for the years ended June 30, 1999
and 1998 was $272,000 and $265,000, respectively.

                                                                              37
<PAGE>
(8)      Employee and Director Benefit Plans, Continued
         ----------------------------------------------

Stock Option Plan
The  Company  adopted a Stock  Option  Plan which has also been  approved by the
stockholders  of the  Parent  and by the  Parent's  and  the  Bank's  Boards  of
Directors.  The Stock Option Plan makes  available  options to purchase  264,500
shares,  or  10%  of the  shares  issued  in the  conversion  to  employees  and
directors.  Options granted under the Stock Option Plan have a vesting  schedule
which  provides that 20% of the options  granted vest in the first year, and 20%
will  vest  on each  subsequent  anniversary  date,  so that  options  would  be
completely vested within five years from the date of grant.  Options become 100%
vested upon death or disability,  if earlier.  Unexercised options expire within
ten years from the date of grant.

The Company has elected to follow APB Opinion No. 25 ("APB 25"), "Accounting for
Stock Issued to Employees"  and related  interpretations  in accounting  for its
stock  options as permitted  under SFAS No. 123 ("SFAS  123"),  "Accounting  for
Stock-Based  Compensation".  In accordance with APB 25, no compensation  cost is
recognized  by the Company when stock  options are granted  because the exercise
price of the Company's  stock options  equals the market price of the underlying
common  stock on the date of grant.  As  required by SFAS 123,  disclosures  are
presented  below for the effect on the net income  (loss) and net income  (loss)
per share  that would  result  from the use of the fair  value  based  method to
measure  compensation  cost  related  to stock  option  grants.  The  effects of
applying the  provisions  of SFAS 123 are not  necessarily  indicative of future
effects.
<TABLE>
<CAPTION>

Net income                             1999             1998             1997
                                       ----             ----             ----
<S>                             <C>               <C>               <C>
   As reported                  $   1,200,000     $   1,643,000     $  (534,000)
   Pro forma                        1,117,000         1,563,000        (569,000)

Net income per share
   As reported - basic          $        0.48     $        0.61     $     (0.20)
   Pro forma - basic                     0.48              0.58           (0.21)

   As reported - diluted                 0.46              0.61           (0.20)
   Pro forma - diluted                   0.43              0.58           (0.21)

</TABLE>
38
<PAGE>
(8)      Employee and Director Benefit Plans, Continued
         ----------------------------------------------

The  weighted-average  fair value per share of options  granted in 1998 and 1997
amounted  to $2.45 and $2.74,  respectively.  There  were no options  granted in
1999.  Fair values were  estimated on the date of grant using the  Black-Scholes
option-pricing model with the following weighted average assumptions:

                                                         1998        1997
                                                         ----        ----

                    Risk-free interest rate              5.77%        6.75%
                    Dividend yield                       4.83         3.90
                    Volatility                          30.00        30.00
                    Expected life                      7 years      7 years

A summary of the Company's stock option activity and related information for the
years ended June 30, 1999 and 1998 follows:
<TABLE>
<CAPTION>
                                      Outstanding                 Exercisable
                                      -----------                 -----------
                                                 Weighted                   Weighted
                                                  Average                    Average
                                  Option         Exercise     Option        Exercise
                                  Shares          Price       Shares         Price
                                  ------          -----       ------         -----
<S>                               <C>           <C>           <C>          <C>
At June 30, 1997                  262,354       $    9.52        --         $   --
Granted                            27,172           10.38        --             --
Became exercisable                   --               --      46,268           9.43
Exercised                            --               --         --             --
Forfeited                         (32,102)          10.15       (226)          9.25
                                  -------           -----       ----           ----
At June 30, 1998                  257,424            9.52     46,042           9.43
Granted                              --               --         --             --
Became exercisable                   --               --      50,658           9.53
Exercised                            --               --         --             --
Forfeited                          (4,090)           9.25       (818)          9.25
                                  -------           -----       ----           ----
At June 30, 1999                  253,334       $    9.53     95,882       $   9.48
                                  =======       =========     ======       ========
</TABLE>

Directors' Deferred Compensation Plan
The Bank has in place two deferred  compensation plans for its directors.  Under
the first plan  directors are to 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  under both
plans. Total expense related to these plans was approximately  $66,000 for 1999,
$84,000 for 1998, and $73,000 for 1997.
<PAGE>
Employment Agreements
The Bank has entered into employment  agreements with five 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.
These employement agreements are considered contingent liabilities which are not
reflected in the consolidated financial statements.

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. This severance plan is considered a contingent liability which is
not reflected in the consolidated financial statements.


                                                                              39
<PAGE>
(9)      Stockholders' Equity
         --------------------

Earnings Per Share (EPS)
Basic net income per share,  or basic EPS, is computed by dividing net income by
the weighted  average number of common shares  outstanding for the period.  ESOP
shares  that  are  unallocated  and are not  committed  to be  released  are not
included in weighted  average  shares  outstanding.  Diluted  EPS  reflects  the
potential dilution that could occur if the Company's dilutive stock options were
exercised.  The  numerator  of the  basic  EPS  computation  is the  same as the
numerator  of  the  diluted  EPS  computation  for  all  periods  presented.   A
reconciliation  of the denominators of the basic and diluted EPS computations is
as follows:
<TABLE>
<CAPTION>

                                                                            1999           1998         1997
                                                                         ---------     ---------     ---------
<S>                                                                      <C>           <C>           <C>
Basic EPS denominator-Weighted average number of common
         shares outstanding                                              2,515,939     2,686,537     2,665,277
Dilutive share effect arising from stock options and restricted shares      69,624         24,182          --
                                                                         ---------     ---------     ---------
Diluted EPS denominator                                                  2,585,563     2,710,719     2,665,277
                                                                         =========     =========     =========
</TABLE>

Common Stock
The Company is authorized to issue 20,000,000 shares of common stock. The common
stock has no par value.  As of June 30, 1999 and 1998,  there were 2,532,000 and
2,750,800 shares of common stock issued and outstanding, respectively.

Preferred Stock
The Company is authorized to issue up to 5,000,000 shares of preferred stock. No
shares of preferred stock have been issued or were  outstanding at June 30, 1999
or 1998.  Such  preferred  stock may be issued in one or more  series  with such
rights,  preferences,  and  designations as the Board of Directors of the Parent
may from time to time determine  subject to applicable law and  regulations.  If
and when such  shares  are  issued,  holders  of such  shares  may have  certain
preferences,  powers,  and rights (including voting rights) senior to the rights
of the holders of the common stock of the Company. The Board of Directors of the
Parent can (without stockholder  approval) issue preferred stock with voting and
conversion rights which could,  among other things,  adversely affect the voting
power of the holders of the common stock of the Company and assist management in
impeding an  unfriendly  takeover or attempted  change in control of the Company
that some  stockholders  may consider to be in their best  interest but to which
management  is  opposed.  The Company  has no current  plans to issue  preferred
stock.

Capital Adequacy
The Parent is regulated by the Board of Governors of the Federal  Reserve System
("FRB")  and  is  subject  to  securities   registration  and  public  reporting
regulations of the Securities and Exchange Commission.  The Bank is regulated by
the FDIC and the Administrator,  Savings Institutions  Division,  North Carolina
Department of Commerce (the "Administrator").
<PAGE>
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 4% and a ratio of 5% to
be "well-capitalized".  The Administrator requires a net worth equal to at least
5% of total assets.

As summarized  below, at June 30, 1999 and 1998, the Bank was in compliance with
all of the aforementioned capital requirements.

As of June 30, 1999, the FDIC categorized the Bank as  "well-capitalized"  under
the  regulatory  framework for prompt  corrective  action.  To be categorized as
well-capitalized,  the Bank must meet minimum ratios for total  risk-based,  and
Tier I leverage (the ratio of Tier I capital to average  assets) as set forth in
the following  table.  There are no events or conditions since the June 30, 1999
that management believes have changed the Bank's category.

40
<PAGE>
(9)      Stockholders' Equity (continued)
         --------------------------------

<TABLE>
<CAPTION>
                                                                                              Minimum Ratios
                                                                                              --------------
                                                                                          For         To Be Well
                                               Capital Amount            Ratio          Capital    Capitalized Under
                                              ---------------       --------------      Adequacy   Prompt Corrective
                                              1999       1998       1999      1998      Purposes   Action Provisions
                                              ----       ----       ----      ----      --------   -----------------
                                                                       (dollars in thousands)
<S>                                            <C>         <C>            <C>        <C>         <C>       <C>
As of June 30:
 Tier I Capital (to risk-weighted assets):     $18,332     $19,949        23.78%     27.12%      4.00%     6.00%

 Total Capital - Tier II capital (to risk-
    weighted assets):                           19,386      20,900        25.15      28.41      10.00
                                                                                                           8.00
 Leverage - Tier I capital (to average
    assets):                                    18,332      19,949        13.21      14.87       4.00      5.00

</TABLE>

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 the  Conversion.  Only in the
event of a complete  liquidation  will each eligible  deposit  account holder be
entitled to receive a liquidation  distribtuion 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 to stockholders of the
Parent's common stock. Dividends cannot be paid from this liquidation account.

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

                                                                              41
<PAGE>
(10)     Income Taxes
         ------------

The components of income tax expense (benefit) were as follows:
<TABLE>
<CAPTION>
                                                    Year ended June 30,
                                          -------------------------------------
                                                  (dollars in thousands)
                                           1999            1998            1997
                                           ----            ----            ----
<S>                                       <C>             <C>             <C>
Currently payable:
       Federal                            $ 559           $ 805           $ 419
       State                                 53             130              61
                                          -----           -----           -----
                                            612             935             480
                                          -----           -----           -----
Deferred:
       Federal                               32              (4)           (136)
       State                                  9              (1)            (27)
                                          -----           -----           -----
                                             41              (5)           (163)
                                          -----           -----           -----
                                          $ 653           $ 930           $ 317
                                          =====           =====           =====

</TABLE>
The tax effects of temporary  differences that give rise to significant portions
of the deferred tax (liabilities) are shown below:
<TABLE>
<CAPTION>
                                                                    June 30
                                                               ----------------
                                                               1999        1998
                                                            (dollars in thousands)
<S>                                                            <C>        <C>
Allowance for loan losses                                      $ 175      $ 219
Unrealized holding losses on securities available-for-sale       233         --

Deferred compensation                                            199        184
Management recognition plan                                      151        115
Capital loss carryforward                                         --          4
Other                                                             48         20
                                                               -----      -----
         Gross deferred tax assets                               806        542

Accelerated depreciation                                         (63)       (47)
FHLB stock dividends                                             (57)       (79)
Deferred loan origination fees                                   (88)       (43)
Unrealized holding gains on securities available-for-sale         --        (49)
Mortgage servicing rights                                        (63)       (24)
Other                                                             (1)        (8)
                                                               -----      -----
         Gross deferred tax liabilities                         (272)      (250)
                                                               -----      -----

         Net deferred tax asset                                $ 534      $ 292
                                                               =====      =====
</TABLE>
<PAGE>

The Company has no  valuation  allowance at June 30, 1999 or 1998 because it has
sufficient  taxable income in the carry back period to support the realizability
of the net deferred tax asset.



42
<PAGE>
(10)     Income Taxes (continued)
         ------------------------

The  reconciliation  of income taxes  (benefit) at statutory tax rates to income
tax expense reported in the statements of income follows:
<TABLE>
<CAPTION>
                                                              June 30,
                                                     --------------------------
                                                     1999       1998       1997
                                                     ----       ----       ----
                                                        (dollars in thousands)
<S>                                                 <C>        <C>        <C>
Income taxes at the statutory federal tax rate      $ 630      $ 875      $ (74)
State income taxes less federal benefit                41         85         23
Nondeductible ESOP compensation                      --         --          518
Tax exempt interest                                   (57)       (55)      (104)
Other                                                  39         25        (46)
                                                    -----      -----      -----
Total tax expense                                   $ 653      $ 930      $ 317
                                                    =====      =====      =====

</TABLE>

Retained earnings at June 30, 1999 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  could  create  taxable
income in certain  remote  instances,  which will be subject to the then current
corporate income tax rate. Payment of dividends by the Bank out of this bad debt
allocation  would  create  taxable  income  equal to  approximately  164% of the
dividend for the Bank.


                                                                              43
<PAGE>
(11)     Quarterly Financial Data (Unaudited)
         ------------------------------------

Summarized  unaudited  quarterly financial data for the year ended June 30, 1999
is as follows:
<TABLE>
<CAPTION>
                                                          First         Second          Third          Fourth
                                                         Quarter        Quarter        Quarter         Quarter
                                                        ---------      ---------      ---------      ---------
Operating Summary:                                           (dollars in thousands, except per share amounts)
<S>                                                     <C>            <C>            <C>            <C>
Interest income                                         $   2,602      $   2,481      $   2,541      $   2,576
Interest expense                                            1,313          1,259          1,255          1,285
                                                        ---------      ---------      ---------      ---------
Net interest income                                         1,289          1,222          1,286          1,291
Provision for loan losses                                      24              3              3              3
                                                        ---------      ---------      ---------      ---------
Net interest income after provision for loan losses         1,265          1,219          1,283          1,288
Other income                                                  151            128             90            (13)
Other expenses                                                783            829            859          1,087
                                                        ---------      ---------      ---------      ---------
Income before income tax expense                              633            518            514            188
Income taxes                                                  219            181            178             75
                                                        ---------      ---------      ---------      ---------
Net income                                              $     414      $     337      $     336      $     113
                                                        =========      =========      =========      =========
Per Share Data:
Earnings-basic                                               0.15           0.14           0.14           0.05
Earnings-diluted                                             0.15           0.13           0.13           0.05
Cash dividends declared                                      0.12           0.12           0.12           0.12
Dividend payout                                                80%            92%            92%           240%
Book value per share                                         7.90           7.91           7.92           7.73
Selected Average Balances:
Assets                                                  $ 130,943      $ 127,928      $ 132,111      $ 137,107
Investment securities                                      19,116         19,509         21,406         29,324
Loans                                                     108,196        104,521        105,822        101,964
Interest-bearing deposits                                  83,167         84,992         88,695         92,626
FHLB advances                                              19,022         15,459         19,571         20,188
Stockholders' equity                                       21,645         20,995         20,556         20,017


</TABLE>
<PAGE>
Summarized  unaudited  quarterly financial data for the year ended June 30, 1998
is as follows:
<TABLE>
<CAPTION>

                                                          First         Second          Third          Fourth
                                                         Quarter        Quarter        Quarter         Quarter
                                                         --------      --------      --------      --------
Operating Summary:                                           (dollars in thousands, except per share amounts)
<S>                                                      <C>           <C>           <C>           <C>
Interest income                                          $  2,454      $  2,515      $  2,599      $  2,649
Interest expense                                            1,259         1,293         1,302         1,337
                                                         --------      --------      --------      --------
Net interest income                                         1,195         1,222         1,297         1,312
Provision for loan losses                                      24            24            24            24
                                                         --------      --------      --------      --------
Net interest income after provision for loan losses         1,171         1,198         1,273         1,288
Other income                                                  137            97           207           165
Other expenses                                                671           730           786           776
                                                         --------      --------      --------      --------
Income before income tax expense                              637           565           694           677
Income taxes                                                  223           202           247           258
                                                         --------      --------      --------      --------
Net income                                               $    414      $    363      $    447      $    419
                                                         ========      ========      ========      ========
Per Share Data:
Earnings-basic                                               0.15          0.13          0.17          0.16
Earnings-diluted                                             0.15          0.13          0.16          0.15
Cash dividends declared                                      0.10          0.10          0.10          0.12
Dividend payout                                                67%           77%           63%           80%
Book value per share                                         7.56          7.66          7.77          7.85
Selected Average Balances:
Assets                                                   $123,947      $128,122      $130,796      $132,621
Investment securities                                      17,836        18,208        18,141        18,111
Loans                                                     102,242       106,595       109,161       111,220
Interest-bearing deposits                                  82,229        83,562        85,330        85,780
Advances                                                   17,574        20,326        21,126        21,451
Stockholders' equity                                       20,777        21,045        21,370        21,657

</TABLE>
44
<PAGE>
(12)     Parent Company Financial Data
         -----------------------------

Condensed financial  information for Piedmont Bancorp,  Inc. (Parent Company) is
as follows:
<TABLE>
<CAPTION>
                                                                  June 30,
                                                                  --------
                                                             1999          1998
                                                            -------      -------
Condensed Balance Sheet                                   (dollars in thousands)
Assets:
<S>                                                         <C>          <C>
  Cash on deposit with bank subsidiary                      $   988      $   750
  Investment in bank subsidiary                              18,531       20,794
  Other                                                         346          393
                                                            -------      -------
      Total assets                                          $19,865      $21,937
                                                            =======      =======

Liabilities and stockholders' equity:
  Accrued taxes, expenses and other liabilities                 304          331
  Stockholders' equity                                       19,561       21,606
                                                            -------      -------
      Total liabilities and stockholders' equity            $19,865      $21,937
                                                            =======      =======
<CAPTION>


                                                                                   June 30,
                                                                                   --------
                                                                        1999        1998        1997
                                                                      -------      -------     -------
Condensed Statement of Income                                                    (dollars in thousands)
<S>                                                                   <C>          <C>         <C>
   Dividends from bank subsidiary                                     $ 1,243      $ 1,155     $ 8,050
   Interest income from bank subsidiary                                    39           27         153
   Interest on loan from bank subsidiary ESOP                              62           79         172
    Interest on investment securities                                    --           --            88
                                                                      -------      -------     -------
     Total income                                                       1,344        1,261       8,463
   Interest on short-term borrowing                                      --           --            41
   Loss on sale of investment securities                                 --           --            81
   Operating expenses                                                      80           70          84
                                                                      -------      -------     -------
     Income before income taxes                                         1,264        1,191       8,257
   Income tax expense                                                       8           15          47
                                                                      -------      -------     -------
   Income before equity in undistributed net income of subsidiary       1,256        1,176       8,210
Equity in undistributed net income (loss) of bank subsidiary              (56)         467      (8,744)
                                                                      -------      -------     -------
         Net income (loss)                                            $ 1,200      $ 1,643     $  (534)
                                                                      =======      =======     =======
</TABLE>
                                                                              45


<PAGE>
(12)     Parent Company Financial Data, Continued
         ----------------------------------------
<TABLE>
<CAPTION>
                                                                                   Year Ended June 30,
                                                                             1999          1998          1997
                                                                             ----          ----          ----
Condensed  Statement  of Cash  Flows  (dollars  in  thousands)            <C>           <C>           <C>
<S>
Cash  flows from operating activities:                                    $  1,200      $  1,643      $   (534)
    Net income (loss)
    Adjustments to reconcile net income (loss) to
       net cash provided by operating activities:
          Undistributed loss (earnings) of bank subsidiary                      56          (467)        8,744
          Loss on sale of available-for-sale securities                         --            --            81
          Payments on ESOP loan receivable from bank subsidiary                207           213         1,709
          Increase in other assets                                              47           (27)         (132)
                                                                                (7)           (2)         (105)
          Decrease in other liabilities                                   --------      --------      --------
               Net cash provided by operating activities                     1,503         1,360         9,763
                                                                          --------      --------      --------

Cash flows from investing activities:                                           --            --         5,543
    Proceeds from sale of available-for-sale securities                   --------      --------      --------
                                                                                --            --         5,543
              Net cash provided by investing activities                   --------      --------      --------

Cash flows from financing activities:                                       (1,265)       (1,096)     (20,435)
    Cash dividends paid to stockholders                                   --------      --------      --------
                                                                            (1,265)       (1,096)     (20,435)
              Net cash used by financing activities                       --------      --------      --------

              Net increase (decrease) in cash and cash equivalents             238           264        (5,129)
                                                                               750           486         5,615
Cash and cash equivalents at beginning of year                            --------      --------      --------
                                                                          $    988      $    750      $    486
Cash and cash equivalents at end of year                                  ========      ========      ========

Supplemental disclosure of cash flow information:
   Cash paid during the year for income taxes                                    1            24           160
                                                                          ========      ========      ========
Supplemental disclosure of noncash transactions:
   Unrealized gains (losses) on securities available for sale             $   --        $   --        $    138
       net of deferred taxes of $88 in 1997                               ========      ========      ========

   Unrealized gains on bank subsidiary's securities available-for-sale
       net of  deferred  taxes  of $282 in  1999,  $104 in 1998           $   (440)     $    161      $    357
       and $230 in 1997                                                   ========      ========      ========
                                                                          $   (304)     $   (324)     $   (267)
   Dividends declared but unpaid                                          ========      ========      ========

</TABLE>
<PAGE>
(13)     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.


                                                                              46

<PAGE>
(13)     Fair Value of Financial Instruments, Continued
         ----------------------------------------------

The following  table  presents the carrying  values and estimated fair values of
the Company's financial instruments at June 30, 1999 and 1998:
<TABLE>
<CAPTION>
                                                          1999                             1998
                                                          ----                              ----
                                                Carrying   Estimated Fair          Carrying  Estimated Fair
                                                  Value        Value                 Value      Value
                                                  -----        -----                 -----      -----
                                                                 (dollars in thousands)
<S>                                             <C>          <C>                 <C>          <C>
Financial assets:
         Cash and interest bearing deposits     $  3,572     $  3,572            $  2,644     $  2,644
         Investment securities:
             Available-for-sale                   25,810       25,810              13,775       13,775
             Held-to-maturity                      3,362        3,388               3,250        3,331
        Net loans                                100,717      102,250             106,500      105,840
        Federal Home Loan Bank Stock               1,036        1,036               1,152        1,152


Financial liabilities:
      Deposits                                    99,339      101,159              89,840       88,937
      Federal Home Loan Bank advances             20,162       20,027              18,000       17,940


</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,  1999,  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.

                                                                              47
<PAGE>
                               BOARD OF DIRECTORS
                     M. Marion Clark, Chairman of the Board
             Retired President, Hillsborough Savings Bank, Inc., SSB

 Robert B. Nichols, Jr.                                         D. Tyson Clayton
 Vice Chairman of the Board                President and Chief Executive Officer
 Retired Farmer                                              of Company and Bank

 Peggy S. Walker                                                    James P. Ray
 Secretary of Company                                         Owner and Operator
 Executive Vice President of Bank                    Occoneechee Golf Club, Inc.

 William L. Rogers                                                Donald W. Pope
 Farmer                                               Owner, Pope's Tire Service

 Alfred L. Carr                                               Everett H. Kennedy
 Retired Merchant                                               Retired Realtor

                               EXECUTIVE OFFICERS

 D. Tyson Clayton                                                Peggy S. Walker
 President and Chief Executive Officer                      Secretary of Company
 of Company and Bank                            Executive Vice President of Bank


 Thomas W. Wayne                                                     Ted R. Laws
 Treasurer of Company                                          Vice President of
 Vice President and Chief Financial Officer of Bank             Company and Bank


 Danny C. Lloyd
 Vice President of Company and Bank

--------------------------------------------------------------------------------
<PAGE>

CORPORATE OFFICE                        INDEPENDENT CERTIFIED
PIEDMONT BANCORP, INC.                  PUBLIC ACCOUNTANTS
260 South Churton Street                KPMG LLP
Hillsborough, NC 27278-2507             Suite 1200, 150 Fayetteville Street Mall
Phone: (919) 732-2143                   Raleigh, NC  27601
Fax:     (919) 732-6001
web address: http://www.HSBeBank.com
Email: HSBBank@mindspring.com

                                        FORM 10-K
                                        A copy of the the Company's annual
STOCK TRANSFER AGENT                    report on Form 10-K  including the
Registrar and Transfer Company          financial statements and financial
Commerce Drive                          statement schedules as filed with the

Cranford, New Jersey 07016-3572         Securities and Exchange Commis-
Phone: (800) 346-6084 Press "1"         sion pursuant to Rule 13a-1 of the
                                        Securities and Exchange Act of
                                        1933 will be furnished without
                                        charge to stockholders upon
SPECIAL LEGAL COUNSEL                   written request to:
Brooks, Pierce, McLendon, Humphrey
   and Leonard, LLP                         D. Tyson Clayton
Post Office Box 26000                       260 South Churton Street
Greensboro, North Carolina 27420            Hillsborough, NC  27278-2507



                                 ANNUAL MEETING

The 1999 Annual Meeting of stockholders of Piedmont  Bancorp,  Inc. will be held
at 6:30 p.m. on November 18, 1999 at the  Corporate  Office,  260 South  Churton
Street, Hillsborough North Carolina.
<PAGE>
                                  CAPITAL STOCK

The Parent's  common stock is traded on the American  Stock  Exchange  under the
symbol "PDB". As of June 30, 1999, there were 2,532,000  shares  outstanding and
667  shareholders  of record,  not  including  the number of persons or entities
whose stock is held in nominee or street name through various brokerage firms or
banks.  Payment of dividends by the Bank  subsidiary to the Parent is subject to
various  restrictions.  Under applicable banking  regulations,  the Bank may not
declare a cash  dividend if the effect  thereof would be to reduce its net worth
to an  amount  less than the  minimum  required  by  federal  and state  banking
regulations.  In addition,  for a period of five years after the consummation of
the Bank's stock  conversion,  which occurred on 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.  As a result of this
limitation,  the  Bank  cannot  pay a  dividend  without  the  approval  of  the
Administrator.  The Bank has  obtained  the  Administrator's  approval  for each
dividend paid by the Bank to the Parent.

<TABLE>
<CAPTION>

                         Quarterly Common Stock Performance and Dividends Declared
                                      For the Year Ended June 30, 1999

                                                       Stock Price           Dividends Declared, Per Share
                                                    --------------------     -----------------------------
                                                    High          Low
                                                    ----          ---
<S>                                                 <C>           <C>                      <C>
First quarter ended September 30                    10 1/8        9 1/4                    $ 0.12
Second quarter ended December 31                     9 3/4        8 7/8                      0.12
Third quarter ended March 31                         9 1/4        8 1/2                      0.12
Fourth quarter ended June 30                             9        8 1/16                     0.12
<CAPTION>

                         Quarterly Common Stock Performance and Dividends Declared
                                      For the Year Ended June 30, 1998

                                                       Stock Price           Dividends Declared, Per Share
                                                    --------------------     -----------------------------
                                                    High          Low
                                                    ----          ---
<S>                                                 <C>           <C>                      <C>

First quarter ended September 30                    11 1/8       10 1/8                    $ 0.10
Second quarter ended December 31                    11 5/8       10 3/8                      0.10
Third quarter ended March 31                        11 3/8       10 5/8                      0.10
Fourth quarter ended June 30                       10 9/16        9 1/2                      0.12



                                                                              49
</TABLE>