Exhibit 13





                             PIEDMONT BANCORP, INC.

                               1998 ANNUAL REPORT
<PAGE>
         "The evidence is clear that  well-managed  smaller banks can, and will,
exist side by side with larger  banks and other  financial  services  providers,
often  maintaining or increasing  local market share.  Technological  change has
facilitated this process by providing  smaller banks with low-cost access to new
products and  services.  In short,  the record shows that  well-managed  smaller
banks have little to fear from technology,  deregulation, or consolidation. Most
projections of the future United States banking structure call for a substantial
reduction  in the number of  American  banks.  But these same  projections  also
predict that thousands of banks will survive the consolidation trend, reflecting
both their individual  efficiencies and competitive skills, on the one hand, and
the preferences of the marketplace on the other. Such conclusions of the Federal
Reserve Board's staff and others  reinforce my own view that the franchise value
of the U.S. community bank--based on its intimate and personalized  knowledge of
local markets and customers, its organizational  flexibility,  and, most of all,
its management  skills--will remain high, assuring that community banks continue
to play a significant role in the U.S.  financial  system.  Technology can never
fully  displace  the  value of  personal  contact,  the  hallmark  of  community
banking."

Federal Reserve Chairman Alan Greenspan
At the Charlotte Chamber of Commerce, Charlotte, North Carolina
July 10, 1998

                                   WHO WE ARE

         Piedmont Bancorp,  Inc. is the holding company for Hillsborough Savings
Bank,  Inc. SSB ("HSB").  From its beginning in 1913 out of the small drug store
in  Hillsborough,  pictured  on the  cover,  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 and
Durham counties.  We like to think that HSB provides the best of the old and the
new. We are proud of our eighty-five  years of rich history in the historic town
of Hillsborough, North Carolina.

         We have been hard at work  during  the past year  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
www.hillsboroughbank.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 services offered is listed below:

Services for individuals:

     Checking and deposit products

          A complete range of checking account options designed with you in mind

          A money market account with competitive interest rates

          A complete line of savings, certificate of deposit and IRA products

          ATM card with access to thousands of ATM machines nationwide

          Banking by telephone with our Telebancing(TM) center
<PAGE>
     Loan products 

          Mortgage and consumer loans

          Home equity lines of credit

          Mastercard(TM) and Visa(TM) credit cards

     Investor services

          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

          A complete line of checking and savings accounts

          Loans

          Merchant card services

          Incoming and outgoing wiring of funds

          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.
<PAGE>
<TABLE>
<CAPTION>                                     
                                                       Piedmont Bancorp, Inc.
                                                       Selected Financial Data

                                                          1998           1997            1996           1995           1994
                                                        ---------      ---------       ---------      ---------      ---------
                                                                                 (dollars in thousands)
<S>                                                     <C>            <C>             <C>            <C>            <C>      
Summary of Operations:
Interest income ...................................     $  10,217      $   9,535       $   9,248      $   7,811      $   6,864
Interest expense ..................................         5,191          4,603           4,414          3,682          3,262
                                                        ---------      ---------       ---------      ---------      ---------
Net interest income ...............................         5,026          4,932           4,834          4,129          3,602
Provision for loan losses .........................            96            658              96            120             87
                                                        ---------      ---------       ---------      ---------      ---------

Net interest income after provision for loan losses         4,930          4,274           4,738          4,009          3,515
Other income ......................................           606            225             255            336            255
Other expenses ....................................         2,963          4,716           2,449          2,265          2,027
                                                        ---------      ---------       ---------      ---------      ---------
Income (loss) before income tax expense ...........         2,573           (217)          2,544          2,080          1,743
Income tax expense ................................           930            317             849            837            710
                                                        ---------      ---------       ---------      ---------      ---------
   Net income (loss) ..............................     $   1,643      $    (534)      $   1,695      $   1,243      $   1,033
                                                        =========      =========       =========      =========      =========
Net income (loss) per share - basic ...............     $    0.61      $   (0.20)      $    0.61            n/a            n/a
                                                        =========      =========       =========      =========      =========
Net income (loss) per share - diluted .............     $    0.61      $   (0.20)      $    0.61            n/a            n/a
                                                        =========      =========       =========      =========      =========
Selected Year-end Balances:
Total assets ......................................     $ 130,541      $ 122,761       $ 128,711      $ 104,013      $  97,368
Loans receivable, net .............................       106,500        100,173          91,187         84,713         81,733
Investments (1) ...................................        18,846         17,973          32,564         15,043         11,338
Deposits ..........................................        89,840         84,860          73,361         76,745         74,287
FHLB Advances .....................................        18,000         16,500          17,250         13,000         10,500
Stockholders' equity ..............................        21,606         20,416          37,050         13,646         12,195

Average Balance Sheet Data:
Total assets ......................................     $ 128,871      $ 123,896       $ 119,252      $ 100,359      $  97,827
Total earning assets ..............................       125,585        120,700         116,010         96,745         95,046
Loans receivable, net .............................       107,510         95,937          87,917         83,326         83,534
Investments (1) ...................................        17,013         23,869          27,297         12,633         10,733
Deposits ..........................................        86,648         78,720          77,221         75,110         73,137
Borrowings ........................................        20,119         16,481          13,248         10,628         11,603
Stockholders' equity ..............................        21,212         25,893          27,557         12,810         11,959

Selected Financial Ratios:
Return on average assets ..........................          1.27%         (0.43)%          1.42%          1.24%          1.06%
Return on average equity ..........................          7.75          (2.06)           6.15           9.70           8.64
Average equity to average assets ..................         16.46          20.90           23.11          12.76          12.22
Interest rate spread (tax equivalent basis) .......          3.26           3.13            3.16           3.72           3.32
Net interest margin (tax equivalent basis) ........          4.10           4.24            4.33           4.29           3.80
Dividend payout ratio .............................         68.85            n/a           48.89            n/a            n/a
Cash dividends declared per common share ..........     $    0.42      $    7.42            0.22            n/a            n/a

</TABLE>
         (1) Includes investment  securities,  mortgage-backed  securities,  and
interest-bearing deposits.
<PAGE>
                             Piedmont Bancorp, Inc.
              1998 Annual Report to Shareholders Table of Contents


President's Message..............................................   2

Management's Discussion and Analysis.............................   4

Independent Auditor's Report.....................................  20

Consolidated Financial Statements................................  21

Notes to Consolidated Financial Statements.......................  25

Directors, Officers and Office Location..........................  42

Corporate Information............................................. 42

Capital Stock....................................................  43


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

To Our Stockholders:

         The comment from Alan  Greenspan,  the Chairman of the Federal  Reserve
Bank, on the inside cover of this year's annual  report,  provides  insight into
Piedmont  Bancorp,  Inc.'s  (the  "Parent")  and  its  wholly-owned  subsidiary,
Hillsborough Savings Bank, Inc. SSB's (the "Bank") (collectively  referred to as
the  "Company"),  feelings about the future of community  banks in this country.
Since  1913  we  have  demonstrated  our  commitment  to  Hillsborough  and  the
surrounding  communities by evolving into a diversified,  full service community
bank  serving  the  needs  of  consumers,   small   businesses   and  charitable
organizations.

         For the year ended June 30, 1998, your Company reported a 4.7% increase
in consolidated net income to $1,643,000 or $0.61 basic and diluted earnings per
share,  compared  to  consolidated  net  income  before non  recurring  items of
$1,569,000 or $0.61 basic and diluted earnings per share for the year ended June
30, 1997.

         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.

         Total assets increased 6.3% to $130.5 million at June 30, 1998 compared
to $122.8 million at June 30, 1997. The primary contributor to the growth was an
increase of 6.3% in net loans receivable to $106.5 million at June 30, 1998 from
$100.2 million at June 30, 1997. Funding the majority of the loan growth was (1)
a $5.0 million or 5.9%  increase in deposits from June 30, 1997 to June 30, 1998
and (2) a $1.5 million or 9.1%  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  began and completed a number
of  significant  initiatives  as a result  of the  approval  and  adoption  of a
strategic plan by the Board of Directors in October of 1997. These are discussed
in more detail as follows:

         In November of 1997 the Bank made the  decision to convert our loan and
deposit  systems  to a new  vendor  that  is  better  able  to  respond  to  the
technological  opportunities  and  challenges  that face the financial  services
industry.  The actual conversion occurred in February of 1998, and thanks to the
hard work and effort of all employees I am happy to say that the conversion went
very well.

2
<PAGE>
         In conjunction with the conversion noted above, the Bank also installed
a  new  local  area  network  and  acquired   new  computer   workstations   for
substantially all employees.  We firmly believe that the investment in the local
area  network  and  computer  workstations  will  serve  us well in the  future,
especially with respect to our efforts in achieving Year 2000 compliance.

         Our new system comes with a relational  Microsoft  Access(TM)  database
designed to identify  cross sale  candidates  for  profitable  bank or fee based
investment  products  offered by the Bank.  The Bank  already  has done  several
direct mail campaigns and has surveyed its customer's  satisfaction  and product
needs since the system has been installed.

         In  March  of 1998 the Bank  introduced  a wide  range of new  checking
products that are designed for  customers at every stage of their lives.  If you
are a local  shareholder and not a customer we encourage you to come by and look
closely at our new checking products.

         Also in March of 1998, the Bank  established and  incorporated a wholly
owned subsidiary,  HSB Financial Services,  Inc., that provides a complete range
of investment and brokerage services to individuals and small businesses through
a partnership  with UVEST  Investment  Services,  Inc. Again, if you are a local
shareholder  and not a customer we encourage you to come by the Bank and see our
Investment Counselor, Dan Ferris.

         The Bank  developed  a web site in March of 1998 for current and future
use as another  delivery  channel  for  products  and  services  to current  and
potential customers. Our web address is www.hillsboroughbank.com  and we welcome
your comments and suggestions on changes we can make that will make our web site
accessible to shareholders and customers.

         Consistent with its financial strategy of increasing earnings per share
and return on equity to shareholders, the Parent's Board of Directors approved a
stock  repurchase  plan on June 30,  1998.  The plan will  enable  the Parent to
repurchase  stock  from  time to time in the open  market or  through  privately
negotiated  transactions.  Current market conditions make this an excellent time
to initiate this plan,  however,  the timing and extent of the stock repurchased
will depend upon financial market conditions.

         Also in June of 1998,  the  Parent's  Board of  Directors  approved  an
increase in the  quarterly  dividend  rate from $0.10 to $0.12 per common share.
The purpose of the  increase is twofold in that it is another tool to manage the
Parent's capital and increase the dividend yield to shareholders.

         As you can see, the last year was a very busy one for the  Company.  In
fiscal 1999,  we intend to focus on existing  and new  customers to continue our
solid  growth.   While  our  large   competitors   are  worrying  about  pending
acquisitions and exposure to faraway  countries we will continue to focus on our
niche as a strong, solid community bank serving Orange and Durham counties.

         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

                                                                               3
<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 employee
benefits,  federal deposit insurance premiums, data processing expenses,  office
occupancy costs, and income taxes.


Performance Overview


         The Company  ended  fiscal year 1998 with net income of  $1,643,000  or
$0.61 basic and diluted  earnings per share compared to consolidated  net income
before  nonrecurring items of $1,569,000 or $0.61 basic and diluted earnings per
share for the year ended  June 30,  1997.  For the year ended June 30,  1996 the
Company had net income of $1,695,000,  and basic and diluted  earnings per share
for the post  conversion  period from December 7, 1995 to June 30, 1996 of $0.45
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.
<PAGE>
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, 1998.

         As shown in Table 1, net  interest  income,  on a fully  tax-equivalent
basis,  amounted to $5.2 million in 1998, $5.1 million in 1997, and $5.0 million
in 1996.  Total  interest  income  increased to $10.3  million in 1998 from $9.7
million in 1997 and $9.4 million in 1996, but the growth in interest  income was
almost matched by a comparable increase in interest expense over the same period
of time.  Total  interest  expense  increased  to $5.2 million in 1998 from $4.6
million in 1997 and $4.4 million in 1996.

         Growth in average loans  receivable of $11.6 million or 12.1% from 1997
to 1998 is  responsible  for the  majority  of the  increase  in total  interest
income. 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-


4
<PAGE>
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.

         Average taxable and tax exempt investment  securities declined $2.8 and
$3.3  million,  respectively,  from 1997 to 1998.  This  decline  was due to the
liquidation of investments in 1997 to facilitate payment of the special dividend
of $7.00 per share.

         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.

         Interest rate spread (on a tax-equivalent  basis) increased to 3.26% in
1998 from 3.13% in 1997 as the increase in the yield on interest-earning  assets
outpaced  the  increase  in the cost of  interest-bearing  liabilities.  The net
interest  margin (on a  tax-equivalent  basis)  decreased  to 4.10% in 1998 from
4.24% in 1997,  and 4.33% in 1996 due to increased  funding of  interest-earning
asset growth with  deposits and FHLB  advances in 1998 and 1997  compared to the
use of conversion  proceeds in 1996. Through the payment of the special dividend
in December 1996,  average  stockholder's  equity to assist in funding decreased
$1.7 million or 6.0% to $25.9 million in 1997 or 21.5% of total interest-earning
assets  compared to $27.6 million or 23.8% of total  interest-earning  assets in
1996. 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 1
NET INTEREST INCOME ANALYSIS - TAX EQUIVALENT
<TABLE>
<CAPTION>

                                                       1998                            1997                           1996
                                          -----------------------------   ----------------------------   ---------------------------
                                                                Average                        Average                      Average
                                           Average               Yield/    Average              Yield/    Average            Yield/
                                           Balance   Interest     Rate     Balance   Interest    Rate     Balance   Interest  Rate
                                          --------    -------     ----    ---------  -------     ----    ---------  -------    ---- 
Assets:                                                                      (dollars in thousands)
<S>                                       <C>         <C>         <C>     <C>        <C>         <C>     <C>        <C>        <C>  
Interest-earning assets:                  
   Loans receivable                       $107,510    $ 9,127     8.49%   $  95,937  $ 8,060     8.40%   $  87,917  $ 7,591    8.63%
   Taxable investment securities            11,469        747     6.51       14,271      959     6.72       14,993    1,020    6.80 
   Tax-exempt investment securities(1)       3,937        317     8.05        7,193      542     7.54        7,754      546    7.04 
   Interest-bearing deposits                 1,607         70     4.36        2,405       99     4.12        4,550      226    4.97 
   FHLB common stock                         1,062         78     7.34          894       65     7.27          796   
                                          --------    -------             ---------  -------             ---------  -------         
Total interest-earning assets              125,585     10,339     8.23      120,700    9,725     8.06      116,010    9,441    8.14 
Non-interest-earning assets                  3,286                            3,196                          3,242                  
                                          --------                        ---------                      ---------                  
                                          $128,871                        $ 123,896                      $ 119,252                  
         TOTAL                            ========                        =========                      =========                  
                                                                                      
Liabilities and retained earnings:                                                                                                  
Interest-bearing liabilities:              
   Deposit accounts                       $ 84,357    $ 3,991     4.73%   $  76,819  $ 3,615     4.71%    $ 75,365  $ 3,614    4.80%
   FHLB advances                            20,119      1,200     5.96       16,481      988     5.99       13,248      800    6.04 
                                          --------    -------             ---------  -------             ---------  -------         
Total interest-bearing liabilities         104,476      5,191     4.97       93,300    4,603     4.93       88,613    4,414    4.98 
Non-interest-bearing liabilities             3,183                            4,703                          3,082                  
Stockholder's equity                        21,212                           25,893                         27,557   
                                          --------                        ---------                       --------                  
         TOTAL                            $128,871                        $ 123,896                       $119,252                  
                                          ========                        =========                       ========                  
                                                                                                                                    
Net interest income and interest                      $ 5,148     3.26%              $ 5,122      3.13%              $ 5,027   3.16%
    rate spread                                       =======                        =======                         =======        
                                                                                                                                    
Net interest-earning assets                                                                                                         
   and net interest margin                $ 21,109               4.10%    $ 27,400               4.24%    $ 27,397             4.33%
                                          ========                        ========                        ========                  
Ratio of interest-earning assets                                                                                                    
   to interest-bearing liabilities                              120.2%                         129.37%                       130.92%
                                                                                                                                    
</TABLE>
(1) Interest earned on tax-exempt  investment  securities has been adjusted to a
tax-equivalent  basis using the applicable  combined  federal and state rates of
34.00% and 7.50%,  respectively,  and  reduced by the  nondeductible  portion of
interest expense.
<PAGE>
         In summary, the small increase in net interest income from 1997 to 1998
is  primarily   due  to  an  increase  in  the  average   yield/rate   on  total
interest-earning  assets mitigated by a decline in volume during the same period
of  time.  The  total  increase  in net  interest  income  from  1996 to 1997 is
primarily  attributable  to an increase in volume  mitigated by a decline in the
average yield/rate during the same period. Table 2 shows the effect of variances
in volume and rate on taxable-equivalent  interest income, interest expense, and
net interest income.  The table shows that increases in net interest income were
primarily due to rate in 1998 and volume in 1997.

                                                                               5
<PAGE>
TABLE 2
RATE / VOLUME ANALYSIS
<TABLE>
<CAPTION>
                                                              1998                                         1997
                                             ----------------------------------------    ---------------------------------------- 
                                                                     Rate/                                        Rate/
                                              Volume      Rate      Volume       Net      Volume       Rate     Volume       Net
                                              ------      ----      ------       ---      ------       ----     ------       ---
                                                                             (dollars in thousands)
<S>                                          <C>        <C>        <C>        <C>        <C>        <C>        <C>        <C>    
Interest income (tax-equivalent) on:
  Loans ..................................   $   972    $    85    $    10    $ 1,067    $   693    $  (205)   $   (19)   $   469
  Taxable investment securities ..........      (188)       (30)         6       (212)       (49)       (12)      --          (61)
  Tax-exempt investment securities .......      (245)        37        (17)      (225)       (40)        38         (2)        (4)
  Interest-bearing deposits ..............       (33)         6         (2)       (29)      (107)       (39)        19       (127)
  FHLB common stock ......................        12          1         --         13          7         --        --           7
                                             -------    -------    -------    -------    -------    -------    -------    -------
     Total interest income ...............       518         99         (3)       614        504       (218)        (2)       284
                                             -------    -------    -------    -------    -------    -------    -------    -------

  Deposit accounts .......................       355         19          2        376         70        (68)        (1)         1
  FHLB advances ..........................       218         (5)        (1)       212        195         (7)      --          188
                                             -------    -------    -------    -------    -------    -------    -------    -------
     Total interest expense ..............       573         14          1        588        265        (75)        (1)       189
                                             -------    -------    -------    -------    -------    -------    -------    -------

Increase (decrease) in net interest income   $   (55)   $    85    $    (4)   $    26    $   239    $  (143)   $    (1)   $    95
                                             =======    =======    =======    =======    =======    =======    =======    =======

</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, industry standards, and general
economic conditions. Provisions for loan losses totaled $96,000 in 1998 compared
to $658,000 in 1997,  and $96,000 in 1996.  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  $63,000 and $45,000 of recoveries
from this  single  borrower  during  the  years  ended  June 30,  1998 and 1997,
respectively.  In both 1998 and 1996, the provision for loan losses was recorded
based primarily on loan portfolio growth.
<PAGE>
Other Income

         Other income increased to $606,000 in 1998 compared to $225,000 in 1997
and  $255,000  in 1996.  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 1997 or 1996.  Other income  included gains realized on
the sale of  investments  and  mortgage-backed  securities of $6,000 in 1998 and
losses  realized on the sale of investments  and  mortgage-backed  securities of
$135,000 and $47,000 in 1997 and 1996, respectively.  The net losses on the sale
of   investments   and   mortgage-backed   securities  in  1997  were  primarily
attributable  to  partial   liquidation  of  invested   conversion  proceeds  to
facilitate  payment of the special  dividend in December  1996.  Net losses were
incurred in 1996 as management, in response to higher prevailing market interest
rates,  restructured the Company's investment portfolio to achieve higher yields
in  future   periods.   Other  income  also   includes   lower-of-cost-or-market
adjustments  on loans  held-for-sale.  In 1998  and  1997,  the Bank  recognized
$36,000  and  $4,000,   respectively,   in  lower-of-cost-or-market   recoveries
resulting from the falling interest rate environment  during the two years. This
compares to $40,000 of lower-of-cost-or-market writedowns in 1996. Mortgage loan
servicing  fees were  $63,000,  $87,000  and  $96,000 in 1998,  1997,  and 1996,
respectively.  The decline in mortgage loan servicing fees is  attributable to a
decline in the  Company's  average loan  servicing  portfolio  during this time.
Other income was positively affected by the growth in customer service and other
fees of $6,000 or 3.0% to $207,000 in 1998,  and $26,000 or 14.9% to $201,000 in
1997 from $175,000 in 1996.  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 July 1996.  "Other"  other income  increased to
$105,000 in 1998 from  $68,000 and $71,000 in 1997 and 1996,  respectively.  The
increase is primarily attributable to the Company's former branch facility being
leased for twelve months in 1998 compared to seven months in 1997.

6
<PAGE>
Other Expenses

         Other  expenses  totaled  $2,963,000 in 1998 compared to $4,716,000 and
$2,449,000 in 1997 and 1996, 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 from 1996 to 1997. 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, a $352,000 increase from 1996. Compensation and
fringe  benefits,  excluding  non-recurring  items,  increased  by  $371,000  to
$1,724,000 in 1997 compared to $1,353,000 in 1996, primarily related to the ESOP
and the  Company's  management  recognition  plan ("MRP").  The ESOP,  which was
established in conjunction with the Conversion in the middle of the prior fiscal
year,  provides a potentially  higher level of retirement  benefits to employees
than the  previous  retirement  plan.  The  recurring  portion  of  ESOP-related
compensation expense for 1997 totaled $274,000 compared to $179,000 recorded for
1996. Also contributing to the increase in compensation  expense was $237,000 of
amortization of deferred compensation associated with the MRP implemented August
29, 1996.

         Professional  fees increased to $185,000 in 1998 from $129,000 in 1997.
The increase 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  $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.  These  increased  expenses  are  mitigated  by  a  $18,000  decrease  in
FDIC-insurance  premiums  to $53,000  for 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.


Income Tax Expense


         The Company  recorded income tax expense of $930,000 in 1998,  compared
to $317,000  in 1997 and  $849,000 in 1996.  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.


                                                                               7
<PAGE>
ANALYSIS OF FINANCIAL CONDITION

         Total assets increased 6.3% to $130.5 million at June 30, 1998 compared
to $122.8 million at June 30, 1997. The primary contributor to the growth was an
increase of 6.3% in net loans receivable to $106.5 million at June 30, 1998 from
$100.2 million at June 30, 1997. Funding the majority of the loan growth was (1)
a $5.0 million or 5.9%  increase in deposits from June 30, 1997 to June 30, 1998
and (2) a $1.5 million or 9.1%  increase in advances  from the Federal Home Loan
Bank during the same period.


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,  1998,  the  loan  portfolio  totaled  $106.5  million  and
represented  81.6% of total  assets.  As  mentioned  above,  during  1998  loans
increased by $6.3 million or 6.3% . Loan originations increased to $50.0 million
in 1998 from  $33.2  million  in 1997,  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 1998 from prior years.  One-to-four family
loans  increased as a percentage  of the portfolio in the current year to 84.67%
from  77.48% in 1997 and 73.58% in 1996.  All other loan  types  decreased  as a
percentage of the portfolio from 1997 to 1998. The shift in the loan mix towards
one-to-four  family loans is attributable to the growth in the  Hillsborough and
surrounding  market  areas.  Table 3 sets  forth  the  composition  of the  loan
portfolio at the dates indicated.

<PAGE>
TABLE 3
TYPES OF LOANS
<TABLE>
<CAPTION>
                                                                                      June 30,
                                 --------------------------------------------------------------------------------------------------
                                          1998                   1997                  1996               1995             1994
                                 -------------------    -------------------    ------------------  ---------------  ---------------
Real estate loans:                                                      (dollars in thousands)
<S>                              <C>         <C>      <C>          <C>       <C>         <C>     <C>      <C>    <C>       <C>   
   Residential 1-4 family        $  90,175    84.67%  $  77,621     77.48%   $ 67,095     73.58% $ 62,379  73.63% $ 59,842  73.22%
   Nonresidential real estate        6,795     6.38       6,649      6.64       8,818      9.67     8,623  10.18     7,574   9.27
   Home equity and other
      second mortgage               10,588     9.94      10,997     10.98      11,616     12.74    11,916  14.07    12,027  14.71
Construction                         7,552     7.09       9,638      9.62       5,026      5.51     1,805   2.13   2,769     3.39
                                 ---------    -----   ---------     -----    --------     -----  --------  -----  --------  ----- 
       Total real estate loans     115,110   108.08     104,905    104.72      92,555    101.50    84,723 100.01    82,212 100.59
Other installment loans                850     0.80       1,061      1.06       1,719      1.89     1,635   1.93     1,635   2.00
Less:
    Unearned fees and discounts        412     0.39         348      0.35         281      0.31       185   0.22       268   0.33
    Loans in process                 8,097     7.60       4,649      4.64       2,198      2.41       945   1.11     1,442   1.76
    Allowance for loan losses          951     0.89         796      0.79         608      0.67       515   0.61       404   0.50
                                 ---------    -----   ---------     -----    --------     -----  --------  -----  --------  ----- 
   Total reductions                  9,460     8.88       5,793      5.78       3,087      3.39     1,645   1.94     2,114   2.59
                                 ---------  --------   --------    ------    --------     -----  --------  -----  --------  ----- 
                                    
       Total loans, net          $ 106,500   100.00    $100,173    100.00    $ 91,187    100.00  $ 84,713 100.00  $ 81,733 100.00
                                 =========  =======    ========    ======    ========    ======  ======== ======    ====== ======

</TABLE>

         In order to protect the Company's net interest margin,  management has,
as part of its  interest  rate risk  management  program,  placed an emphasis on
maintaining  adjustable  rate mortgage  loans and home equity lines of credit in
its portfolio. This strategy has resulted in more consistent net interest income
and lower net interest income  sensitivity  than experienced by most traditional
fixed-rate  residential mortgage lenders. In 1998 the Company sold approximately
$10.0 million in fixed rate mortgage loans in the secondary  market. In 1997 and
1996,  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.

8
<PAGE>
         The following table sets forth the time to contractual  maturity of the
Company's loan portfolio at June 30, 1998.  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, 1998
                                    -------------------------------------------------------------------------- 
                                                     Over 1       Over 3      Over 5
                                     One Year        Year to     Years to    Years to      Over 10
                                      Or Less        3 Years      5 Years    10 Years       Years        Total
                                    ---------    ----------    ---------    ---------    ---------    --------- 
Real estate loans:                                             (dollars in thousands)
  Residential 1-4 family
<S>                                 <C>           <C>          <C>          <C>          <C>          <C>      
     Fixed .....................    $      12     $      97    $     264    $   3,097    $  51,287    $  54,757
     Floating ..................          100           161          547        4,106       26,950       31,864
  Nonresidential real estate
     Fixed .....................            1          --             14          423        1,215        1,653
     Floating ..................          200           249          735        1,944        2,274        5,402
  Home equity and other second
    mortgage
     Fixed .....................           59             6         --           --           --             65
     Floating ..................           89           577        2,858        6,302           11        9,837
  Construction
     Fixed .....................         --            --           --           --           --           --
     Floating ..................        1,958          --            286         --            773        3,017
                                    ---------     ---------    ---------    ---------    ---------    ---------        
         Total real estate loans        2,419         1,090        4,704       15,872       82,510      106,595

Other installment loans:
     Fixed .....................          219           346          169           53           69          856
     Floating ..................         --            --           --           --           --           --

Less:
  Allowance for loan losses ....         (951)         --           --           --           --           (951)
                                    ---------     ---------    ---------    ---------    ---------    ---------

       Total loans, net ........    $   1,687     $   1,436    $   4,873    $  15,925    $  82,579    $ 106,500
                                    =========     =========    =========    =========    =========    ========= 

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

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

TABLE 5
SUMMARY OF NONPERFORMING AND RISK ASSETS
<TABLE>
<CAPTION>
                                                                                       June 30,
                                                            ----------------------------------------------------------------
                                                              1998          1997          1996          1995          1994
                                                            --------      --------      --------      --------      --------
                                                                                (dollars in thousands)
<S>                                                         <C>           <C>           <C>           <C>           <C>     
Total nonaccrual loans                                      $    928      $    803      $    758      $     30      $    139
Total restructured loans                                        --            --            --            --            --
                                                            --------      --------      --------      --------      --------
      Total nonperforming loans                                  928           803           758            30           139
                                                            --------      --------      --------      --------      -------- 
Real estate owned                                               --            --            --            --             161
                                                            --------      --------      --------      --------      --------
       Total nonperforming assets                           $    928      $    803      $    758      $     30      $    300
 Accruing loans, delinquent 90 days or more                     --             244           301           571            41
                                                            --------      --------      --------      --------      --------
      Total risk assets                                     $    928      $  1,047      $  1,059      $    601      $    341
                                                            ========      ========      ========      ========      ========


Nonperforming loans to total loans, net                         0.87%         0.80%         0.83%         0.04%         0.17%
Nonperforming assets to total assets
                                                                0.71          0.65          0.59          0.03          0.31
Risk assets to total assets
                                                                0.71          0.85          0.82          0.58          0.35
Allowance for loan losses to:
    Total nonperforming assets                                  1.02x         0.99x         0.80x        17.17x         1.35x  
                                                     
    Total risk assets                                           1.02x         0.76x         0.57x         0.86x         1.18x   
                                                                                   
Total assets                                                $130,541      $122,761      $128,711      $104,013      $ 97,368
Total loans, net                                             106,500       100,173        91,187        84,713        81,733
Allowance for loan losses                                        951           796           608           515           404
</TABLE>

         Nonperforming assets increased to $928,000 at June 30, 1998 compared to
$803,000 and $758,000 at June 30, 1997 and 1996, respectively. Nonperforming and
risk assets at June 30, 1998 are  primarily  composed of small loans  secured by
residential real estate totaling  $858,000.  The remainder of nonperforming  and
risk assets are composed of smaller  installment  and line of credit  loans.  At
June 30, 1997,  nonperforming  assets are comprised of one large credit totaling
$461,000  secured by commercial  real estate and several smaller credits secured
by  residential  real  estate  where the  borrowers  have  declared  Chapter  13
bankruptcy.  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.
<PAGE>
         At June 30, 1998 and 1997,  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
$118,000 and $119,000, respectively. There were no impaired loans in non-accrual
status at June 30,  1998 and 1997.  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, 1998 and 1997 was  approximately  $118,500  and  $121,000.  The Company
recognized  interest  income on the impaired loans of  approximately  $9,500 and
$9,700 during the year ended June 30, 1998 and 1997, 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  anticipated   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.

10
<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 potential loan losses 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
$96,000  in 1998,  compared  to  $658,000  in 1997,  and  $96,000  in 1996.  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 $63,000 and $45,000 of recoveries
from this single borrower during 1998 and 1997,  respectively.  In both 1998 and
1996,  the  provision  for loan  losses was  recorded  based  primarily  on loan
portfolio  growth.  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 6
ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES
<TABLE>
<CAPTION>
                                                                 Year Ended June 30,
                                               -----------------------------------------------------
                                                1998        1997        1996        1995        1994
                                                ----        ----        ----        ----        ----
                                                                (dollars in thousands)

<S>                                              <C>       <C>         <C>         <C>         <C>  
Balance, beginning of period                     796       $ 608       $ 515       $ 404       $ 317
Provision for loan losses                         96         658          96         120          87
Charge-offs                                       (8)       (519)         (4)        (14)         (4)
Recoveries                                        67          49           1           5           4
                                               -----       -----       -----       -----       -----
Balance, end of period                         $ 951       $ 796       $ 608       $ 515       $ 404
                                               =====       =====       =====       =====       =====
Allowance as a percentage of loans              0.89%       0.79%       0.66%       0.60%       0.49%

</TABLE>
<PAGE>
TABLE 7
ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
<TABLE>
<CAPTION>
                                                     Year Ended June 30,
                                          -----------------------------------------
                                          1998     1997     1996     1995      1994
                                          ----     ----     ----     ----      ----
                                                   (dollars in thousands)
<S>                                       <C>      <C>      <C>      <C>      <C>  
Residential 1-4 family                    $533     $382     $256     $216     $170
Nonresidential real estate                 124      233      170      155      121
Home equity and other second mortgage      142       83       97       82       65
Construction                                95       54       36       16       12
                                          ----     ----     ----     ----     ----
     Total real estate loans               894      752      559      469      368
Other installment loans                     57       44       49       46       36
                                          ----     ----     ----     ----     ----
     Total allowance for loan losses      $951     $796     $608     $515     $404

</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.


                                                                              11
<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, and obligations of states and
local  governments.  The  mortgage-backed  securities consist of mortgage-backed
securities issued by the Federal National Mortgage Association ("FNMA").

         Investment  securities  increased $2.8 million to $17.0 million at June
30, 1998 from $14.2 million at June 30, 1997.  This increase is  attributable to
normal  growth to meet the Company's  liquidity and growth needs.  Approximately
81% 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,
1998,  net  unrealized  gains of $126,000 were included in the carrying value of
securities  classified  available-for-sale  compared to net unrealized losses of
$138,000 on such  securities at June 30, 1997.  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, 1998 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, 1998 and 1997 is  presented in Note 2 of the notes to
the consolidated financial statements.


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

                                                                   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>            <C>         <C>  
U.S. government and agency        $  755      6.69%          $ 2,756      6.44%         $ 4,517     6.70%          $     -        -%
State and local government (1)         -         -                 -         -                -        -             1,052     8.52 
Mortgage-backed securities (2)         -         -             3,013      6.44            1,165     7.09               517     6.55 
                                  ------      ----           -------      ----          -------     ----           -------     ---- 
   Total available-for-sale       $  755      6.69           $ 5,769       6.44         $ 5,682     6.78           $ 1,569     7.86 
                                  ------      ----           -------      ----          -------     ----           -------     ---- 
                                                                                                                                    
Held-to-maturity:                                                                                                                   
U.S. government and agency        $    -         - %         $     -          -%        $     -       - %          $     -        -%
State and local  government (3)       76      5.53             1,773       6.58             709     7.88               692     7.78 
Mortgage-backed securities                       -                 -          -               -        -                 -        - 
                                       -         -                 -          -               -        -                 -        - 
                                  ------      ----           -------      ----          -------     ----           -------     ---- 
   Total held-to-maturity         $   76      5.53           $ 1,773       6.58         $   709     7.88           $   692     7.78 
                                  ------      ----           -------      ----          -------     ----           -------     ---- 
                                                                                                                                    
Total investments,                                                                                                               
    at carrying value             $  831                     $ 7,542                    $ 6,391                    $ 2,261          
                                  ======                     =======                    =======                    =======          
</TABLE>
<PAGE>
<TABLE>                                                      
<CAPTION>
                                                 Total          
                                          ------------------                    
                                                    Weighted     
                                          Carrying   Average     
                                            Value      Yield   
                                          ---------    -----  
<S>                                        <C>          <C>                                                                  
Available-for-sale:                     
                                
U.S. government and agency                 $  8,028     6.61%  
State and local government (1)                1,052     8.52   
Mortgage-backed securities (2)                4,695     6.61   
                                           --------     ----                   
    Total available-for-sale               $ 13,775     6.75   
                                           --------     ----                   
                                                               
Held-to-maturity:                                              
U.S. government and agency                 $      -        -%  
State and local  government (3)               3,250     7.10   
Mortgage-backed securities                        -        -                   
                                           --------     ----       
   Total held-to-maturity                  $  3,250     7.10   
                                           --------     ----                                  
Total investments,                                             
    at carrying value                      $ 17,025            
                                           ========            
</TABLE>
(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: over ten years,  5.63%;  total
     5.63%.
(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, 1998.
(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, 3.65%; one to
     five years,  4.79%; six to ten years,  5.20%, over ten years, 5.13%; total,
     4.92%.


         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, 1998,  the Company's  investment in stock of the
FHLB of Atlanta was $1,152,000.

12
<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  $89.8  million at June 30,  1998  compared  to $84.9
million at June 30,  1997,  and $73.4  million at June 30, 1996.  The  following
table sets forth certain  information  regarding the Company's  average  savings
deposits for the last three years.

TABLE 9
AVERAGE DEPOSITS
<TABLE>
<CAPTION>
                                                     1998                          1997                        1996
                                           ----------------------        ----------------------        ---------------------
                                              Average    Average           Average      Average        Average       Average
                                              Amount       Rate            Amount         Rate          Amount         Rate
                                              ------       ----            ------         ----          ------         ----
                                                                          (dollars in thousands)
<S>                                        <C>              <C>          <C>              <C>          <C>             <C>  
Interest-bearing checking accounts         $    6,930       1.04%        $   6,011        1.48%        $  6,412        1.84%
Savings and money market deposits              23,610       3.68            20,050        3.36           18,980        3.22
Certificates of deposit                        53,817       5.67            50,758        5.62           49,973        5.78
                                           ----------       ----         ---------        ----         --------        ----  
   Total interest-bearing deposits             84,357       4.73            76,819        4.71           75,365        4.80
Non-interest-bearing deposits                   2,291          -             1,901           -            1,856           -
                                           ----------       ----         ---------        ----         --------        ---- 
     Total deposits                        $   86,648       4.61         $  78,720        4.59         $ 77,221        4.68
                                           ----------       ----         ---------        ----         --------        ----
                                             
</TABLE>
         As of June 30, 1998, the Company held  $9,556,000 in time  certificates
of deposit of  $100,000  or more.  Maturities  of  certificates  of  deposits of
$100,000  or more at June  30,  1998  were as  follows:  three  months  or less,
$1,663,000;  over three months through six months,  $3,976,000;  over six months
through  twelve  months,  $1,925,000;  over twelve  months  through  twenty-four
months, $1,655,000; and over twenty-four months, $337,000.
<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, 1998, FHLB of Atlanta  advances  totaled $18.0
million  compared to $16.5 million at June 30, 1997.  Additional  information on
borrowings  is  provided  in Note 6 of the notes to the  consolidated  financial
statements.


Liquidity and Interest Rate Risk Management

         Liquidity  is the ability to raise  funds or convert  assets to cash in
order to meet customer and operating  needs.  The Company's  primary  sources of
liquidity  are  its  portfolio  of  investment  securities   available-for-sale,
principal  and  interest  payments  on  loans  and  mortgage-backed  securities,
interest income from investment securities,  maturities of investment securities
held-to-maturity,  increases in deposits, and advances from the FHLB of Atlanta.
At June 30, 1998, the Bank had $12,000,000 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.

                                                                              13
<PAGE>

         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,
1998 which are projected to reprice or mature in each of the future time periods
shown.   At  June  30,   1998,   the   Company   had  a   cumulative   one  year
liability-sensitive  gap position of $9.0  million or 7.09% 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,  1998,  management  believes  that  its  interest  rate  risk is at an
acceptable level.
<PAGE>
TABLE 10
INTEREST SENSITIVITY
<TABLE>
<CAPTION>
                                                                                   June 30, 1998
                                                 ---------------------------------------------------------------------------------
                                                                              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                               $ 16,087      $ 29,666       $ 28,378       $ 12,456      $ 20,864      $107,451
   Interest-bearing deposits                         1,821            --             --             --            --         1,821
   Investment securities (1)                           402         3,435          1,559          1,795         9,834        17,025
   FHLB common stock                                    --            --
                                                        --            --             --             --         1,152         1,152
                                                  --------      --------       --------       --------      --------      --------
       Total interest-earning assets              $ 18,310      $ 33,101       $ 29,937       $ 14,251      $ 31,850      $127,449
                                                  ========       ========       ========      ========      ========      ========

Interest-bearing liabilities
   Deposits:
     Fixed maturity deposits                      $  9,445      $ 32,634       $ 10,885       $  1,232      $     --      $ 54,196
     Savings and money market accounts               4,058        10,312         10,312          4,058         4,060        32,800
                                                  --------      --------       --------       --------      --------      --------
       Total deposits                               13,503        42,946         21,197          5,290         4,060        86,996
   FHLB advances                                     2,000         2,000          1,000          1,000        12,000        18,000
                                                  --------      --------       --------       --------      --------      --------
       Total interest-bearing liabilities         $ 15,503      $ 44,946       $ 22,197       $  6,290      $ 16,060      $104,996
                                                  ========      ========       ========       ========      ========      ========

Interest sensitivity gap per period               $  2,807      $(11,845)      $  7,740       $  7,961      $ 15,790      $ 22,453
Cumulative interest sensitivity gap                  2,807        (9,038)        (1,298)         6,663        22,453        22,453
Cumulative gap as a percentage of
   total interest-earning assets                      2.20%        (7.09)%        (1.02)%         5.23%        17.62%        17.62%
Cumulative interest-earning assets as a
   percentage of interest-bearing liabilities       118.11%        85.05%         98.43%       111.19%       121.38%       121.38%
</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.

14
<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, 1998.

TABLE 11
MARKET RISK ANALYSIS OF FINANCIAL INSRUMENTS
<TABLE>
<CAPTION>
                                       Contractual Maturities at June 30, 1998
                              -------------------------------------------------------------------
                                                                                           Beyond                 Average  Estimated
                                                                                            Five                 Interest     Fair
                                 1999        2000        2001        2002        2003       Years       Total      Rate       Value
                              --------    --------    --------    --------    --------    --------    --------     ----    --------
<S>                           <C>         <C>         <C>         <C>         <C>         <C>         <C>          <C>     <C>      
Financial Assets
  Debt securities (2)         $    828    $    815    $    306    $    616    $  5,808    $  8,652    $ 17,025     6.90%   $ 17,106
   Loans (3):
    Fixed rate                     213         196         389         262         332      52,221      53,613     8.28      55,713
    Variable rate                2,299         237         613       1,425       3,156      46,520      54,250     8.70      51,270
                              --------    --------    --------    --------    --------    --------    --------     ----    --------
          Total               $  3,340    $  1,248    $  1,308    $  2,303    $  9,296    $107,393    $124,888     8.27    $124,089
                              ========    ========    ========    ========    ========    ========    ========     ====    ========

Financial Liabilities
  Savings, NOW and MMDA       $ 32,800    $     --    $     --    $     --    $     --    $     --    $ 32,800     3.18    $ 31,734
  Fixed rate certificates       42,107       9,719       1,139       1,231          --          --      54,196     5.67      54,570
       of deposit
  Advances from the Federal
       Home Loan Bank            5,000       2,000          --       1,000       9,000       1,000      18,000     5.96      17,940
                              --------    --------    --------    --------    --------    --------    --------     ----    --------
          Total               $ 79,907    $ 11,719    $  1,139    $  2,231    $  9,000    $  1,000    $104,996     4.97    $104,244
                              ========    ========    ========    ========    ========    ========    ========     ====    ========
</TABLE>

(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.  

15
<PAGE>
Capital Resources


         Stockholders'  equity  increased  from  $20,416,000 at June 30, 1997 to
$21,606,000 at June 30, 1998.

         As a state savings bank holding company, the Parent is regulated by the
Board of  Governors  of the  Federal  Reserve  Board  ("FRB")  and is subject to
securities  registration and public reporting  regulations of the Securities and
Exchange  Commission.  The  Bank  is  regulated  by the  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, 1998 and 1997,  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  8 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.


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.
<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 a cross-section of the Company's employees, in
November of 1997.  This  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 on the following  page,  has five primary phases related to internal Year
2000 compliance:


16
<PAGE>
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. The
     awareness  phase is an ongoing  one that is  designed  to  provide  ongoing
     information   about  the  Year  2000  issue  to  the  Board  of  Directors,
     Management,  employees and customers.  Since December of 1997 the Board has
     been  apprised  of the  Company's  efforts at their  regular  meetings.  In
     addition,  all customers  were updated with respect to the  Company's  Year
     2000 efforts through a mailing sent in June of 1998.

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
     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.
<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 scheduled  for the first and second  quarters of fiscal 1999, is to test
     the Company's network and core service provider  software  applications and
     hardware.  The  Company has  performed  Year 2000  testing of all  employee
     computer  work  stations,  and all but one are  Year  2000  compliant.  The
     testing of the  remainder  of the  Company's  processes  is  expected to be
     substantially complete by the end of the second quarter of fiscal 1999.

5.   Implementation - this phase will occur when Year 2000 processing commences.
     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  significant  part of the  implementation  phase will
     occur after  December 31, 1999. The Company is in the process of developing
     contingency  plans for processes that do not process  information  reliably
     and  accurately  after  December 31, 1999.  The  contingency  plans for all
     systems should be  substantially  complete by the end of the second quarter
     of fiscal 1999.

         The Company is also in the process of assessing the year 2000 readiness
of  significant  borrowers  and  depositors.  In the second  quarter of 1999 the
Company  plans  on  making  a list  of  significant  borrowers  and  depositors.
Customers who the Company has Year 2000 concerns  about will be counseled on the
Year 2000 issue and urged to take corrective  action.  Since the majority of the
Company's loans are to individuals and secured by one to four family  residences
this step is not expected to require a significant amount of time or resources.

                                                                              17
<PAGE>
         Excluding the hardware and software  purchases noted above, the Company
expensed  $2,000 on Year 2000  costs in fiscal  1998.  Based on an  analysis  of
projected  expenses performed in the last quarter of fiscal 1998, the total cost
of the Year 2000 project is currently estimated at $50,000.  Funding of the Year
2000  project  costs will come from  normal  operating  cash flow,  however  the
expenses  associated  with the Year 2000 Issue 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 can and will be addressed
prior to the Year 2000.  However,  if required  modifications or conversions are
not made or are not completed on a timely basis prior to the Year 2000, the Year
2000 Issue could disrupt normal business operations.  The most reasonably likely
worst  case Year 2000  scenarios  foreseeable  at this time  would  include  the
Company  temporarily  not being able to process,  in some  combination,  various
types of customer transactions. This could affect the ability of the Company to,
among other things, originate new loans, post loan payments,  accept deposits or
allow  immediate  withdrawals,  and,  depending  on the  amount  of time  such a
scenario lasted, could have a material adverse effect on the Company. Because of
the  serious  implications  of these  scenarios,  the  primary  emphasis  of the
Company's  Year  2000  efforts  is to  correct,  with  complete  replacement  if
necessary,  any  systems  or  processes  whose  Year 2000 test  results  are not
satisfactory  prior  to the  Year  2000.  Nevertheless,  should  one of the most
reasonably  likely worst case scenarios occur in the Year 2000, the Company,  as
noted above,  is in the process of  formalizing  a  contingency  plan that would
allow for limited  transactions,  including the ability to make certain  deposit
withdrawals,  until the Year 2000 problems are fixed. The costs of the Year 2000
project and the date on which the Company plans to complete Year 2000 compliance
are based on  management's  best  estimates,  which were derived using  numerous
assumptions  of future  events  such as the  availability  of certain  resources
(including internal and external resources),  third party vendor plans and other
factors.  However,  there  can be no  guarantee  that  these  estimates  will be
achieved at the cost  disclosed or within the  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.

Accounting Issues

         The Company prepares its consolidated  financial statements and related
disclosures  in conformity  with  standards  established  by, among others,  the
Financial  Accounting  Standards  Board (the  "FASB").  Because the  information
needed by users of financial  reports is dynamic,  the FASB  frequently  has new
rules  and  proposed  new  rules  for  companies  to  apply in  reporting  their
activities.  The following discussion addresses such changes as of June 30, 1998
that will affect the Company's future reporting.
<PAGE>
         In February  1997,  the FASB issued  Statement of Financial  Accounting
Standards  No. 128 ("SFAS  128"),  "Earnings  per Share".  SFAS 128  establishes
standards of computing  and  presenting  earnings per share (EPS) and applies to
entities  with  publicly  held common  stock or  potential  common  stock.  This
statement  simplifies the standards for computing  earnings per share previously
found in APB Opinion No. 15, "Earnings per Share",  and makes them comparable to
international EPS standards.  It replaces the presentation of primary EPS with a
presentation  of basic EPS.  It also  requires  dual  presentation  of basic and
diluted EPS on the face of the income  statement  for all entities  with complex
capital   structures  and  requires  a  reconciliation   of  the  numerator  and
denominator of the basic EPS computation to the numerator and denominator of the
diluted EPS computation.  SFAS 128 is effective for financial  statements issued
for periods ending after December 15, 1997 and requires restatement of all prior
period EPS data presented.  The Company adopted SFAS 128 in fiscal year and made
the required disclosures.

         In February  1997,  the FASB issued  Statement of Financial  Accounting
Standards  No.  129 ("SFAS  129"),  "Disclosure  of  Information  about  Capital
Structure".  SFAS 129 establishes standards for disclosing  information about an
entity's  capital  structure and is  applicable to all entities.  It contains no
change in disclosure  requirements for entities that were previously  subject to
the  requirements of APB Opinion No. 10, "Omnibus  Opinion - 1966",  APB Opinion
No. 15, "Earnings Per Share",  and Statement of Financial  Accounting  Standards
No.  47,  "Disclosure  of  Long-Term  Obligations".  SFAS 129 is  effective  for
financial  statements  for periods  ending after  December 15, 1997. The Company
adopted  SFAS 129 in fiscal  year 1998  without  any impact on its  consolidated
financial statements.

                                                                              18
<PAGE>
         In June  1997,  the  FASB  issued  Statement  of  Financial  Accounting
Standards  No. 130 ("SFAS  130"),  "Reporting  Comprehensive  Income".  SFAS 130
establishes standards for reporting and displaying  comprehensive income and its
components   (revenues,   expenses,   gains,  and  losses)  in  a  full  set  of
general-purpose financial statements. This Statement requires that an enterprise
(a)  classify  items of  other  comprehensive  income  by  their  nature  in the
financial   statement  and  (b)  display  the   accumulated   balance  of  other
comprehensive   income   separately   from  retained   earnings  and  additional
paid-in-capital in the equity section of a statement of financial position. SFAS
130  is  effective  for  fiscal  years   beginning   after  December  15,  1997.
Reclassification  of  financial  statements  for earlier  periods  provided  for
comparative  purposes is  required.  The Company  plans to adopt the SFAS 130 in
fiscal year 1999 and has not determined the impact on its consolidated financial
statements.

         In June  1997,  the  FASB  issued  Statement  of  Financial  Accounting
Standards No. 131 ("SFAS 131"), "Disclosures about Segments of an Enterprise and
Related  Information".  SFAS 131  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. This Statement is effective for financial
statements for periods beginning after December 15, 1997 and in the initial year
of application, comparative information for earlier years is to be restated. The
Company  plans to adopt SFAS 131 in fiscal  year 1999  without  any  significant
impact on its consolidated financial statements as it operates as one segment.

         In February  1998,  the FASB issued  Statement of Financial  Accounting
Standards No. 132 ("SFAS 132"),  "Employers Disclosures about Pensions and Other
Postretirement   Benefits".   This   statement   standardizes   the   disclosure
requirements of pensions and other postretirement  benefits. This statement does
not  change  any  measurement  or  recognition  provisions,  and  thus  will not
materially  impact the Company.  This  statement  is effective  for fiscal years
beginning after December 15, 1997. The Company plans to adopt SFAS 132 in fiscal
year  1999  without  any  significant  impact  on  its  consolidated   financial
statements.

         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. SFAS No. 133 is effective
for all fiscal  quarters of fiscal  years  beginning  after June 15,  1999.  The
Company  plans to adopt SFAS 133 in fiscal  year 2000  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.

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
<PAGE>
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.

                                                                              19
<PAGE>


                          INDEPENDENT AUDITORS' REPORT









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


We have audited the accompanying consolidated balance sheets of Piedmont Bancorp
Inc. and subsidiary as of June 30, 1998 and 1997,  and the related  consolidated
statements of income,  stockholders' equity and cash flows for each of the years
in the  three-year  period ended June 30,  1998.  These  consolidated  financial
statements   are  the   responsibility   of  the   Company's   management.   Our
responsibility  is  to  express  an  opinion  on  these  consolidated  financial
statements based on our audits.

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

In our opinion, the consolidated  financial statements referred to above present
fairly, in all material  respects,  the financial  position of Piedmont Bancorp,
Inc.  and  subsidiary  as of June 30,  1998 and 1997,  and the  results of their
operations and their cash flows for each of the years in the  three-year  period
ended  June  30,  1998,  in  conformity  with  generally   accepted   accounting
principles.



                                                        /s/KPMG Peat Marwick LLP
                                                        ------------------------
                                                           KPMG Peat Marwick LLP




Raleigh, North Carolina
July 21, 1998

20
<PAGE>
<TABLE>
<CAPTION>
                                    CONSOLIDATED BALANCE SHEETS
                                       June 30, 1998 and 1997

                                                                             1998          1997
                                                                           ---------     ---------
                                                                            (dollars in thousands)
<S>                                                                        <C>           <C>   
ASSETS

Cash                                                                       $     823     $     879
Interest-bearing deposits in other financial institutions                      1,821         3,766
Investment securities (note 2):
   Available-for-sale (cost:  $13,649 in 1998 and
       $11,004 in 1997)                                                       13,775        10,866
   Held-to-maturity (market value: $3,331 in 1998
       and $3,395 in 1997)                                                     3,250         3,341
Loans receivable (net of allowance for loan losses of
     $951 in 1998 and $796 in 1997) (note 3)                                 106,500       100,173
Federal Home Loan Bank stock, at cost                                          1,152           920
Premises and equipment (note 4)                                                1,414         1,205
Prepaid expenses and other assets (note 9)                                     1,806         1,611
                                                                           ---------     ---------
                Total assets                                               $ 130,541     $ 122,761
                                                                           =========     =========
LIABILITIES AND STOCKHOLDERS' EQUITY

Deposits (note 5):
     Demand, non-interest bearing                                              2,844         2,074
     Savings, NOW and MMDA                                                    32,800        28,594
Certificates of deposit                                                       54,196        54,192
                                                                           ---------     ---------
                                                                                           
                                                                              84,840        84,860
Advances from the Federal Home Loan Bank (note 6)                             18,000        16,500
Accrued expenses and other liabilities                                         1,095           985
                                                                           ---------     ---------
                Total liabilities                                            108,935       102,345
                                                                           ---------     ---------
Stockholders' Equity (note 8):
Preferred stock, no par value, 5,000,000 shares authorized;
   none issued                                                                  --            --
Common stock, no par value, 20,000,000 shares authorized;
   2,750,800 shares issued and outstanding as of June 30,
   1998 and 1997                                                               9,121         9,143
Unearned ESOP shares                                                            (679)         (933)
Unamortized deferred compensation                                               (953)       (1,269)
Unallocated restricted stock                                                     (61)          (21)
Retained earnings, substantially restricted (note 9)                          14,101        13,580
Unrealized holding gains (losses) on available-for-sale securities, net           77           (84)
                                                                           ---------     ---------
                Total stockholders' equity                                    21,606        20,416
                                                                           ---------     ---------

Commitments and contingencies (note 3)
                 Total liabilities and stockholders' equity                $ 130,541     $ 122,761
                                                                           =========     =========
</TABLE>
See accompanying notes to consolidated financial statements.
                                                                              23
<PAGE>
<TABLE>
<CAPTION>
                                  CONSOLIDATED STATEMENTS OF INCOME
                              Years ended June 30, 1998, 1997 and 1996


                                                                   1998        1997        1996
                                                                  -------     -------     -------
                                                                        (dollars in thousands, 
                                                                      except per share data)
<S>                                                               <C>        <C>         <C>    
Interest income:
     Interest on loans                                            $ 9,127    $ 8,060     $ 7,591
     Interest on deposits in other financial institutions              70         99         226
     Interest and dividends on investment securities:
         Taxable                                                      825      1,024       1,078
         Non-taxable                                                  195        352         353
                                                                  -------     -------     -------
              Total interest income                                10,217      9,535       9,248


Interest expense:
     Interest on deposits (note 5)                                  3,991      3,615       3,614
     Interest on borrowings                                         1,200        988         800
                                                                  -------     -------     -------
         Total interest expense                                     5,191      4,603       4,414
                                                                  -------     -------     -------

Net interest income                                                 5,026      4,932       4,834
Provision for loan losses (note 3)                                     96        658          96
                                                                  -------     -------     -------
         Net interest income after provision for loan losses        4,930      4,274       4,738
                                                                  -------     -------     -------

Other income:
     Customer service and other fees                                  207        201         175
     Mortgage loan servicing fees                                      63         87          96
     Gains (losses) on sales of investment securities                   6       (135)        (47)
     Lower-of-cost or market adjustment on loans held-for-sale         36          4         (40)
     Gain on sale of real estate owned                                114       --          --
     Gain on sale of loans                                             75       --          --
     Other                                                            105         68          71
                                                                  -------     -------     -------
         Total other income                                           606        225         255
                                                                  -------     -------     -------
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
<S>                                                               <C>        <C>         <C>    
Other expenses:
     Compensation and fringe benefits (note 7)                      1,713      3,152       1,353
SAIF recapitalization assessment (note 5)                            --          487        --
     Data and items processing                                        256        241         239
     Deposit insurance premiums                                        53         71         176
     Occupancy expense                                                114        113         123
     Furniture and equipment expense                                  113        115         100
     Professional fees                                                185        129         120
     Other                                                            529        408         338
                                                                  -------     -------     -------
         Total other expenses                                       2,963      4,716       2,449
                                                                  -------     -------     -------

         Income (loss) before income tax expense                    2,573       (217)      2,544

Income tax expense (note 9)                                           930        317         849
                                                                  -------     -------     -------
               Net income (loss)                                  $ 1,643     $ (534)     $ 1,695
                                                                  =======     =======     =======
Net income (loss) per share - basic (note 7)                      $  0.61     $ (0.20)    $  0.45
                                                                  =======     =======     =======

Net income (loss) per share - diluted (note 7)                    $  0.61     $ (0.20)    $  0.45
                                                                  =======     =======     =======

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

24
<PAGE>
<TABLE>
<CAPTION>
                                        CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                                       For the years ended June 30, 1998, 1997 and 1996



                                                                                                                                 
                                                                                   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, 1995                                --        $     --        $     --        $     --        $     --   
     Net income                                         --              --              --              --              --   
     Net proceeds from
        issuance of no par
        common stock                               2,645,000          25,398            --              --              --   
     Common stock acquired by ESOP                      --              --            (2,731)           --              --   
     Release of ESOP shares                             --              --               179            --              --   
     Cash dividends ($0.22 per share)                   --              --              --              --              --   
     Change in unrealized holding gains
        (losses), net of income taxes of $387           --              --              --              --              --   
                                                   ---------           -----            ----          ------             --- 
Balance at June 30, 1996                           2,645,000          25,398          (2,552)           --              --   

     Net 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)           --              --              --   
     Change in unrealized holding gains
        (losses), net of                                --              --              --              --              --   
                                                   ---------           -----            ----          ------             --- 
Balance at June 30, 1997                           2,750,800           9,143            (933)         (1,269)            (21)

     Net 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            --              --              --   
     Change in unrealized
         holding gains
        (losses), net of income
        taxes of $104                                   --              --              --              --              --   
                                                   ---------           -----            ----          ------             --- 
Balance at June 30, 1998                           2,750,800      $    9,121      $     (679)     $     (953)     $      (61)
                                                  ==========      ==========      ==========      ==========      ==========
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
                                                   Unrealized                           
                                                     holding         Total            
                                                    Retained        gains        Stockholders'  
                                                    Earnings       (losses)         Equity     
                                                    --------       --------         ------     
<S>                                                <C>            <C>             <C>          
Balance at June 30, 1995                          $   13,624      $       22      $   13,646
     Net income                                        1,695            --             1,695
     Net proceeds from
        issuance of no par
        common stock                                    --              --            25,398
     Common stock acquired by ESOP                      --              --            (2.731)
     Release of ESOP shares                             --              --               179
     Cash dividends ($0.22 per share)                   (536)           --              (536)
     Change in unrealized holding gains      
        (losses), net of income taxes of $387           --              (601)           (601)
                                                  ----------      ----------      ----------
Balance at June 30, 1996                              14,783            (579)         37,050

     Net loss                                           (534)           --              (534)
     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)
     Change in unrealized holding gains
        (losses), net of                                --               495             495
                                                  ----------      ----------      ----------
Balance at June 30, 1997                              13,580             (84)         20,416

     Net income                                        1,643            --             1,643
     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)
     Change in unrealized
         holding gains
        (losses), net of income
        taxes of $104                                   --               161             161
                                                  ----------      ----------      ----------
Balance at June 30, 1998                          $   14,101      $       77      $   21,606
                                                  ==========      ==========      ==========
</TABLE>
**  includes $7.00 special dividend paid on December 6, 1996.
See accompanying notes to consolidated financial statements.
                                                                              25
<PAGE>
<TABLE>
<CAPTION>
                                                CONSOLIDATED STATEMENTS OF CASH FLOWS
                                          For the years ended June 30, 1998, 1997, and 1996


                                                                                            1998          1997          1996
                                                                                          --------      --------      --------
Operating activities:                                                                              (dollars in thousands)
<S>                                                                                       <C>           <C>           <C>     
     Net income (loss)                                                                    $  1,643      $   (534)     $  1,695
     Adjustments  to  reconcile  net  income  (loss)  to net
       cash  provided  by operating activities:
         Depreciation                                                                           94            93            90
         Net amortization (accretion)                                                          119            98           154
         Provision for loan losses                                                              96           658            96
         Deferred income taxes                                                                  (5)         (163)          (56)
         Gain on sale of fixed assets                                                           (2)         --            --
         Net (gain) loss on sale of investment and mortgage-backed securities                   (6)          135            47
         Gain on sale of real estate owned                                                    (114)         --            --
         Gain on sale of loans                                                                 (75)         --            --
         Release of ESOP shares                                                                209         1,702           179
         Compensation earned under MRP                                                         265           237          --
         Net decrease (increase) in mortgage loans held for sale                               264           519        (1,667)
         Decrease (increase) in other assets                                                  (328)          585          (291)
         Increase (decrease) in other liabilities                                               53           (40)          136
                                                                                          --------      --------      --------
              Net cash provided by operating activities                                      2,213         3,290           383
                                                                                          --------      --------      --------

Investing activities:
     Net increase in loans held for investment                                              (7,198)      (10,230)       (4,995)
     Principal collected on mortgage-backed securities                                         620           628           753
     Purchases of investment securities classified as available-for-sale                    (2,254)         (504)      (23,968)
     Purchases of investment securities classified as held-to-maturity                        (307)         --          (1,815)
     Purchases of mortgage-backed securities classified as available-for-sale               (2,517)       (1,658)       (1,482)
     Proceeds of sales of investment securities classified as available-for-sale -          13,601         2,946
     Proceeds from maturities of investment securities                                        --              78            75
     Proceeds from investment securities called by issuer                                      380         1,085         4,500
     Proceeds of sales of mortgage-backed securities classified as available-for-sale        1,508         3,847          --
     Purchases of FHLB Stock                                                                  (232)          (57)          (77)
     Purchases of premises and equipment                                                      (318)          (34)          (75)
     Proceeds from sale of real estate owned                                                   636          --            --
     Proceeds from sale of fixed assets                                                         17          --            --
                                                                                          --------      --------      --------
              Net cash provided (used) by investing activities                              (9,665)        6,756       (24,138)
                                                                                          --------      --------      --------

</TABLE>
<PAGE>
<TABLE>
<CAPTION>
<S>                                                                                       <C>           <C>           <C>     
Financing activities:
     Net increase (decrease) in time deposits                                                    4         5,776        (4,703)
     Net increase (decrease) in other deposits                                               4,976         5,723         1,319
     Proceeds from borrowings                                                               18,000        14,000        12,750
     Repayments of borrowings                                                              (16,500)      (14,750)       (8,500)
     Proceeds from issuance of no par common stock                                            --            --          25,398
     Purchase of common stock for ESOP                                                        --            --          (2,731)
     Cash dividends paid to shareholders                                                    (1,029)      (18,820)         (244)
                                                                                          --------      --------      --------
         Net cash provided (used)  by financing activities                                   5,451        (8,071)       23,289
                                                                                          --------      --------      --------

                  Increase (decrease) in cash and cash equivalents                          (2,001)        1,975          (466)
Cash and cash equivalents at beginning of period                                             4,645         2,670         3,136
                                                                                          --------      --------      --------
Cash and cash equivalents at end of period                                                $  2,644      $  4,645      $  2,670
                                                                                          ========      ========      ========
Supplemental  disclosure of cash flow  information:
Cash paid during the period for:
     Interest                                                                             $  5,217      $  4,592      $  4,448
                                                                                          ========      ========      ========
     Income taxes                                                                         $    977      $    342      $    828
                                                                                          ========      ========      ========

Supplemental disclosure of noncash transactions:
   Unrealized gains (losses) on available-for-sale securities, net of deferred
     taxes of $104 for 1998, $318 for 1997 and $387 for 1996                              $    161      $    495      $   (601)
                                                                                          ========      ========      ========
   Dividends declared but unpaid                                                          $   (324)     $   (267)     $   (292)
                                                                                          ========      ========      ========
   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>
                                                                              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 and Mortgage-Backed Securities

Management   determines  the  appropriate   classification   of  investment  and
mortgage-backed 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.

(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
<PAGE>
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.

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, 1998,  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
the loan is collateral  dependent.  Large groups of smaller  balance  homogenous
<PAGE>
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, 1998, the Bank owned 11,520 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. Prior to establishment of the employee
stock ownership plan, the Company had a self-administered,  defined contribution
retirement plan that covered all eligible employees. This plan was terminated as
of July 31, 1995 in conjunction with the Conversion.  The Bank also has a 401(k)
plan  that  covers  all  eligible   employees.   The  Bank   matches   voluntary
contributions by participating employees.

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.

(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.

(m)      Reclassifications

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


30
<PAGE>
(2)               Investment Securities


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

                                                                    June 30, 1997
                                                 -------------------------------------------------
                                                               (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         $ 5,754       $  --         $   101       $ 5,653
     Mortgage-backed securities                    4,275            10            88         4,197
     State and local governments                     975            41          --           1,016
                                                 -------       -------       -------       -------
       Total securities available-for-sale       $11,004       $    51       $   189       $10,866
                                                 =======       =======       =======       =======
Securities held-to-maturity:
     State and local governments $               $ 3,341       $    58       $     4       $ 3,395
                                                 =======       =======       =======       =======
</TABLE>
                                                                              31

<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, 1998,
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                       $   752       $   755            $  --         $  --           
       Due in 1 year through 5 years                 2,753         2,756               --            --           
       Due after 5 through 10 years                  4,500         4,517               --            --           
Obligations of states and local governments:                                                                      
       Due in 1 year or less                          --            --                   76            75         
       Due 1 year through 5 years                     --            --                1,773         1,791         
       Due after 5 through 10 years                   --            --                  709           745         
       Due after 10 years                              976         1,052                692           720         
Mortgage-backed  securities                          4,668         4,695               --            --           
   Total securities                                $13,649       $13,775            $ 3,250       $ 3,331         
                                                   =======       =======            =======       =======         
                                                                                
</TABLE>

At June 30, 1998 and 1997,  investment securities with book values of $8,311,000
and $4,825,000, respectively, were pledged as collateral for public deposits.



Summarized below is the sales activity in investment securities:
<TABLE>
<CAPTION>
                                                                      Year ended June 30,
                                                            ------------------------------------
                                                               1998         1997          1996
                                                            --------      --------      --------
                                                                  (dollars in thousands)
<S>                                                         <C>           <C>           <C>     
   Proceeds from sales of available-for-sale securities     $  1,508      $ 17,448      $  2,946
   Realized gains                                                 (6)          (55)           (7)
   Realized losses                                              --             190            54
                                                            --------      --------      --------
Cost of available-for-sale securities sold                  $  1,502      $ 17,583      $  2,993
                                                            ========      ========      ========

</TABLE>
32
<PAGE>
(3)   Loans Receivable

<TABLE>
<CAPTION>
                                                                                  June 30,
                                                                          ------------------------
Loans receivable consist of the following:                                   1998           1997
                                                                             ----           ----
                                                                           (dollars in thousands)
<S>                                                                       <C>            <C>      
Loans secured by first mortgages on real estate:
     Mortgage loans held for sale                                         $   2,797      $   2,986
     Mortgage loans held for investment, primarily one-to-four family        87,378         74,635
     Construction loans                                                       7,552          9,638
     Commercial and agricultural loans                                        6,472          6,379
     Participation loans purchased                                              323            270
                                                                          ---------      ---------
                                                                            104,522         93,908
Home equity lines of credit                                                   9,879         10,423
Other second mortgage loans                                                     709            574
Other installment loans                                                         850          1,061
                                                                          ---------      ---------
                                                                            115,960        105,966
Undisbursed proceeds on loans in process                                     (8,097)        (4,649)
Deferred loan fees                                                             (412)          (348)
Allowance for loan losses                                                      (951)          (796)
                                                                          ---------      ---------
                                                                          $ 106,500      $ 100,173
                                                                          =========      =========
</TABLE>
An analysis of the allowance for loan losses follows:
<TABLE>
<CAPTION>
                                              1998           1997          1996
                                              ----           ----          ----
                                                     (dollars in thousands)
<S>                                           <C>           <C>           <C>  
Balance at beginning of period                $ 796         $ 608         $ 515
Provision for loan losses                        96           658            96
Loans charged off                                (8)         (519)           (4)
Recoveries                                       67            49             1
                                              -----         -----         -----
Balance at end of period                      $ 951         $ 796         $ 608
                                              =====         =====         =====
</TABLE>

At June 30, 1998 and 1997, the Company had loans totaling approximately $928,000
and $803,000,  respectively,  which were in nonaccrual status and $244,000 which
were contractually delinquent for 90 days or more and still accruing at June 30,
1997. There were no loans that were contractually delinquent for 90 days or more
and still accruing at June 30, 1998.
<PAGE>
Additional interest income that would have been recorded on nonaccrual loans for
the years ended June 30, 1998,  1997 and 1996 had they  performed in  accordance
with  their  original  terms   throughout  each  of  the  periods   amounted  to
approximately $46,000, $61,000 and $57,000, respectively.

At June  30,  1998,  the  Company  had  fixed  rate  mortgage  loan  commitments
outstanding  of  $1,781,000.  Preapproved  but  unused  lines of credit  totaled
$10,027,000, and standby letters of credit totaled $14,650 at June 30, 1998. 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.

                                                                              33
<PAGE>
 (3)     Loans Receivable, Continued

At June 30, 1998 and 1997, the recorded  investment in loans that are considered
to be impaired under SFAS No. 114 was $118,000 and $119,000, respectively. There
were no impaired  loans in non-accrual  status at June 30, 1998 and 1997.  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, 1998 and 1997 was  approximately
$118,500 and $121,000.  The Company  recognized  interest income on the impaired
loans of approximately $9,500 and $9,700 during the year ended June 30, 1998 and
1997, respectively.

The Company serviced loans for others of approximately $18,256,000, $10,913,000,
and $12,719,000 at June 30, 1998, 1997 and 1996, respectively. The June 30, 1998
balance of loans sold with recourse was approximately $433,000.

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

The Bank makes loans to executive  officers and  directors of the Company and to
their  associates.  It is  management's  opinion  that  such  loans  are made on
substantially the same terms, including interest rates and collateral,  as those
prevailing at the time for comparable transactions with unrelated persons and do
not  involve  more  than  the  normal  risk of  collectibility.  Following  is a
reconciliation of loans outstanding to executive officers,  directors, and their
associates for the year ending June 30, 1998:

         Balance at June 30, 1997                  $  394,000
         New loans                                    81,000
         Repayments                                   (17,000)
                                                      -------
         Balance at June 30, 1998                  $  458,000
                                                      =======


(4)               Premises and Equipment

Premises and equipment consist of the following:
<TABLE>
<CAPTION>
                                                   June 30, 1998                             June 30, 1997
                                          -----------------------------------       ----------------------------------
                                                     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                $  407        $   63        $  344        $  407        $   57        $  350
Office buildings and improvements            891           246           645           891           222           669
Furniture, fixtures, and equipment         1,042           617           425           752           566           186
                                          ------        ------        ------        ------        ------        ------
                                          $2,340        $  926        $1,414        $2,050        $  845        $1,205
                                          ======        ======        ======        ======        ======        ======
</TABLE>
<PAGE>
(5)               Deposits

Contractual maturities of time deposits are as follows:

                                                             Total
               Year Ending June 30                         Maturities
               -------------------                         ----------
                                                       (dollars in thousands)

               1998                                        $  42,107
               1999                                            9,719
               2000                                            1,139
               2001                                            1,231
               2002 and thereafter
                                                           ---------
                     Total time deposits                   $  54,196
                                                           =========

34
<PAGE>
(5)               Deposits, Continued

Time deposits of $100,000 or more totaled  $9,556,000 and $9,636,000 at June 30,
1998 and 1997, respectively.

Interest expense on deposits includes $563,000,  $406,000,  and $312,000 for the
years ended June 30, 1998,  1997,  and 1996,  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.


(6)               Advances from the Federal Home Loan Bank

Advances  from the Federal  Home Loan Bank of  Atlanta,  with  weighted  average
interest rates, are as follows:
 
                                                                June 30,
                                                    ----------------------------
                                                         1998            1997
                                                         ----            ----
                                                         (dollars in thousands)
5.96% due on or before June 30, 1998                $       -           $ 16,500
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           $ 16,500
                                                       ======             ======

At June 30, 1998, the Bank had additional  credit  availability from the Federal
Home Loan Bank of $12,000,000.

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.


(7)               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  $15,000 in 1998,  $18,000 in 1997, and
$16,000 in 1996.
<PAGE>
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.

36
<PAGE>
(7)       Employee and Director Benefit Plans, Continued

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 125,819 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.  At June 30,  1998,  a total of 148,837  shares have been
released and allocated to participants and 62,763 shares remain unallocated,  of
which 18,430 shares are committed to be released on December 31, 1998.

Total compensation expense associated with the ESOP for the years ended June 30,
1998 and 1997 was $209,000 and $1,702,000, respectively. At June 30, 1998, there
were 62,763  unallocated  ESOP  shares with a total fair value of  approximately
$624,000.

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.  Total  compensation  expense  associated  with the MRP for the
years ended June 30, 1998 and 1997 was $265,000 and $237,000, respectively.

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
<PAGE>
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.


      Net income (loss)                              1998           1997
                                                     ----           ----
         As reported                             $ 1,643,000    $ (534,000)
         Pro forma                                 1,563,000      (569,000)

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

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

                                                                              37
<PAGE>
(7)               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.  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
year ended June 30, 1998 and 1997 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, 1996                                --         $      --           --            $    --
Granted                                      262,354              9.52         --                 --
Exercised                                       --                --           --                 --
Forfeited                                       --                --           --                 --
                                             -------       -----------       ------         --------
At June 30, 1997                             262,354              9.52         --                 --
Granted                                       27,172             10.38         --                 --
Became exercisable                              --                 --        39,856             9.45
Exercised                                       --                 --           --                --
Forfeited                                    (32,102)            10.15         (226)            9.25
                                             -------       -----------       ------         --------
At June 30, 1998                             257,424       $      9.52       39,630         $   9.46
                                            ========       ===========     ========         ========   
</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  $84,000 for 1998,
$73,000 for 1997, and $89,000 for 1996.
<PAGE>
Employment Agreements
The Bank has entered into employment  agreements with four 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>
(8)               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>
                                                                         1998            1997           1996
                                                                         ----            ----           ----
<S>                                                                    <C>            <C>            <C>      
Basic EPS denominator-Weighted average number of common
         shares outstanding                                            2,686,537      2,665,277      2,446,832
Dilutive share effect arising from assumed exercise of stock options      24,182              -              -
                                                                       ---------      ---------      ---------
Diluted EPS denominator                                                2,710,719      2,665,277      2,446,382
                                                                       =========      =========      =========
</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,  1998 and 1997,  there  were  2,750,800
shares of common stock issued and outstanding.

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, 1998
or 1997.  Such  preferred  stock may be issued in one or more  series  with such
rights,  preferences,  and  designations as the Board of Directors of the Parent
may from time to time determine  subject to applicable law and  regulations.  If
and when such  shares  are  issued,  holders  of such  shares  may have  certain
preferences,  powers,  and rights (including voting rights) senior to the rights
of the holders of the common stock of the Company. The Board of Directors of the
Parent can (without stockholder  approval) issue preferred stock with voting and
conversion rights which could,  among other things,  adversely affect the voting
power of the holders of the common stock of the Company and assist management in
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.


40
<PAGE>
(8)                Stockholders' Equity (continued)

As summarized  below, at June 30, 1998 and 1997, the Bank was in compliance with
all of the aforementioned capital requirements.

As of June 30, 1998, 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 notification
that management believes have changed the Bank's category.
<TABLE>
<CAPTION>
                                                                                                    Minimum Ratios
                                                                                           -----------------------------
                                                                                              For         To Be Well
                                               Capital Amount            Ratio             Capital     Capitalized Under
                                              ----------------       ----------------     Adequacy    Prompt Corrective
                                               1998       1997       1998        1997      Purposes     Action Provisions
                                               ----       ----       ----        ----      --------   -----------------
                                                                    (dollars in thousands)
<S>                                          <C>        <C>         <C>         <C>            <C>               <C>  
As of June 30:
 Tier I Capital (to risk-weighted assets):   $ 19,949   $ 18,942    27.12%      27.66%         4.00%             6.00%

 Total Capital - Tier II capital (to risk-
    weighted assets):                          20,900     19,738    28.41       28.82          8.00             10.00
                                                                                        

 Leverage - Tier I capital (to average
    assets):                                   19,949     18,942    14.87       15.67          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
<PAGE>
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>
(9)               Income Taxes

The components of income tax expense (benefit) were as follows:
<TABLE>
<CAPTION>
                                                    Year ended June 30,
                                          -------------------------------------
                                                  (dollars in thousands)
                                           1998            1997            1996
                                           ----            ----            ----
<S>                                       <C>             <C>             <C>  
Currently payable:
       Federal                            $ 805           $ 419           $ 782
       State                                130              61             123
                                          -----           -----           -----
                                            935             480             905
                                          -----           -----           -----
Deferred:
       Federal                               (4)           (136)            (45)
       State                                 (1)            (27)            (11)
                                          -----           -----           -----
                                             (5)           (163)            (56)
                                          -----           -----           -----
                                          $ 930           $ 317           $ 849
                                          =====           =====           =====
</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
                                                              ------------------ 
                                                               1998        1997
                                                               ----        ----
                                                           (dollars in thousands)
<S>                                                            <C>        <C>  
Allowance for loan losses                                      $ 219      $ 198
Unrealized holding losses on securities available-for-sale      --           54
Deferred compensation                                            183        165
Management recognition plan                                      115         92
Capital loss carryforward                                          4         28
Excess servicing                                                  19         23
Other                                                             18         26
                                                               -----      -----
         Gross deferred tax assets                               558        586
Valuation allowance                                             --         --
                                                               -----      -----
         Net deferred tax assets                                 558        586
                                                               -----      -----

Accelerated depreciation                                         (47)       (52)
FHLB stock dividends                                             (79)      (106)
Deferred loan origination fees                                   (99)       (46)
Unrealized holding gains on securities available-for-sale        (49)      --
Other                                                             (8)        (8)
                                                               -----      -----
         Gross deferred tax liabilities                         (282)      (212)
                                                               -----      -----

         Net deferred tax asset                                $ 276      $ 374
                                                               =====      =====
</TABLE>
<PAGE>
The Company has no  valuation  allowance at June 30, 1998 or 1997 because it has
sufficient  taxable income in the carry back period to support the realizability
of the net deferred tax asset.

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,
                                                                ----------------------------------------
                                                                 1998             1997              1996
                                                                 ----             ----              ----
                                                                         (dollars in thousands)
<S>                                                             <C>             <C>                <C>  
Income taxes at the statutory federal tax rate                  $ 875           $ (74)             $ 865
State income taxes less federal benefit                            85               23                74
Nondeductible ESOP compensation                                     -              518                 -
Tax exempt interest                                               (55)            (104)             (107)
Other                                                              25              (46)               17
                                                                  ---              ---              ----
Total tax expense                                               $ 930            $ 317             $ 849
                                                                  ===              ===               ===

</TABLE>
                                                                              43
<PAGE>
 (9)              Income Taxes (continued)

Retained earnings at June 30, 1998 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.

(10)     Quarterly Financial Data (Unaudited)

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>
<PAGE>
Summarized  unaudited  quarterly financial data for the year ended June 30, 1997
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                                         $   2,463      $   2,430      $   2,298      $   2,344
Interest expense                                            1,111          1,148          1,158          1,186
                                                        ---------      ---------      ---------      ---------
Net interest income                                         1,352          1,282          1,140          1,158
Provision for loan losses                                      21            597             20             20
                                                        ---------      ---------      ---------      ---------
Net interest income after provision for loan losses         1,331            685          1,120
                                                                                                         1,138
Other income (expense)                                        102            (19)            70             72
Other expenses                                              1,214          2,261            617            624
                                                        ---------      ---------      ---------      ---------
Income (loss) before income tax expense                       219         (1,595)           573            586
Income taxes (benefit)                                         36           (164)           201            244
                                                        ---------      ---------      ---------      ---------
Net income (loss)                                       $     183      $  (1,431)     $     372      $     342
                                                        =========      =========      =========      =========
Per Share Data:
Earnings - basic                                             0.07          (0.54)          0.14           0.13
Earnings - diluted                                           0.07          (0.54)          0.14           0.13
Cash dividends declared                                      0.12           7.10           0.10           0.10
Dividend payout                                               171%           n/a             71%            77%
Book value per share                                        13.54           7.14           7.31           7.42
Selected Average Balances:
Assets                                                  $ 129,823      $ 128,579      $ 118,974      $ 119,454
Investment securities                                      30,897         27,202         16,116         15,335
Loans                                                      93,110         94,422         96,657         98,087
Interest-bearing deposits                                  72,231         73,953         79,217         80,171
Advances                                                   16,889         16,731         16,713         15,752
Stockholders' equity                                       37,462         31,644         19,928         20,358
</TABLE>
<PAGE>
(11)    Parent Company Financial Data

Condensed financial  information for Piedmont Bancorp,  Inc. (Parent Company) is
as follows:
<TABLE>
<CAPTION>
                                                                    June 30,
                                                            --------------------
                                                             1998           1997
                                                             ----           ----
Condensed Balance Sheet                                    (dollars in thousands)
<S>                                                         <C>          <C>    
Assets:
  Cash on deposit with bank subsidiary                      $   750      $   486
  Investment in bank subsidiary                              20,794       19,839
  Other                                                         393          366
                                                            -------      -------
      Total assets                                           21,937       20,691
                                                            =======      =======

Liabilities and stockholders' equity:
  Accrued taxes, expenses and other liabilities                 330          275
  Stockholders' equity                                       21,607       20,416
                                                            -------      -------
      Total liabilities and stockholders' equity            $21,937      $20,691
                                                            =======      =======
<CAPTION>
                                                                                June 30,
                                                                      --------------------------
                                                                       1998                1997
                                                                       ----                ----
Condensed Statement of Income                                           (dollars in thousands)
   Dividends from bank subsidiary                                     $ 1,155            $ 8,050
   Interest income from bank subsidiary                                    27                153
   Interest on loan from bank subsidiary ESOP                              79                172
   Interest on investment securities                                     --                   88
                                                                      -------            -------
     Total income                                                       1,261              8,463
Interest on short-term borrowing                                         --                   41
   Loss on sale of investment securities                                 --                   81
   Operating expenses                                                      70                 84
                                                                      -------            -------
     Income before income taxes                                         1,191              8,257
   Income tax expense                                                      15                 47
                                                                      -------            -------
   Income before equity in undistributed net income of subsidiary       1,176              8,210
   Equity in undistributed net income (loss) of bank subsidiary           467             (8,744)
                                                                      -------            -------
         Net income (loss)                                            $ 1,643            $  (534)
                                                                      =======            =======

</TABLE>
                                                                              45
<PAGE>
(11)    Parent Company Financial Data, Continued
<TABLE>
<CAPTION>
                                                                            Year Ended June 30,
                                                                             1998        1997
                                                                             ----        ----
Condensed Statement of Cash Flows                                         (dollars in  thousands)
<S>                                                                       <C>           <C>   
Cash flows from operating activities:
    Net income (loss)                                                     $  1,643      $   (534)
    Adjustments to reconcile net income (loss) to
       net cash provided by operating activities:
          Undistributed loss (earnings) of bank subsidiary                    (467)        8,744
          Loss on sale of available-for-sale securities                       --              81
          Payments on ESOP loan receivable from bank subsidiary                213         1,709
          Increase in other assets                                             (27)         (132)
          Decrease in other liabilities                                         (2)         (105)
                                                                          --------      --------
              Net cash provided by operating activities
                                                                             1,360         9,763
                                                                          --------      --------

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

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

              Net increase (decrease) in cash and cash equivalents             264        (5,129)
Cash and cash equivalents at beginning of year                                 486         5,615
                                                                          --------      --------
Cash and cash equivalents at end of year                                  $    750      $    486
                                                                          ========      ========
                                                                                           
Supplemental disclosure of cash flow information:
   Cash paid during the year for income taxes                             $     24      $    160
                                                                          ========      ========

Supplemental disclosure of noncash transactions:
   Unrealized gains (losses) on securities available for sale
       net of deferred taxes of $88 in 1997                               $   --        $    138
                                                                          ========      ========
   Unrealized gains on bank subsidiary's securities available-
      for-sale net of deferred taxes of $104 in 1998 and $230 in 1997     $    161      $    357
                                                                          ========      ========
   Dividends declared but unpaid                                          $   (324)     $   (267)
                                                                          ========      ========

</TABLE>
<PAGE>
(12)     Fair Value of Financial Instruments

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

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


46
<PAGE>
(12)     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, 1998 and 1997:
<TABLE>
<CAPTION>
                                                             1998                        1997
                                                             ----                        ----
                                                   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          2,644          2,644          4,645          4,645
         Investment securities:
             Available-for-sale
                                                    13,775         13,775         10,866         10,866
             Held-to-maturity
                                                     3,250          3,331          3,341          3,395
        Net loans                                  105,840
                                                                  106,500        100,173        100,949
        Federal Home Loan Bank Stock
                                                     1,152          1,152            920            920

Financial liabilities:
      Deposits                                      89,840         88,937         84,860         82,579 
      Federal Home Loan Bank advances               18,000         17,940         16,500         16,510 
                                                                   
</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,  1998,  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.                                
         Vice Chairman of the Board                             
         Retired Farmer                                         

         Peggy S. Walker                                        
         Secretary of Company                                   
         Executive Vice President of Bank                       

         William L. Rogers                                      
         Farmer                                                 

         Alfred L. Carr                                         
         Retired Merchant                                       

                                                              D. Tyson Clayton  
                                        President and Chief Executive Officer   
                                                          of Company and Bank   
                                                                                
                                                                 James P. Ray   
                                                           Owner and Operator   
                                                  Occoneechee Golf Club, Inc.   
                                                                                
                                                               Donald W. Pope   
                                                   Owner, Pope's Tire Service   
                                                                                
                                                           Everett H. Kennedy   
                                                              Retired Realtor   
                                                                                
--------------------------------------------------------------------------------

                               EXECUTIVE OFFICERS

         D. Tyson Clayton                                        
         President and Chief Executive Officer                   
         of Company and Bank                                     


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


                                                                 Peggy S. Walker
                                                            Secretary of Company
                                                Executive Vice President of Bank
                                                                                
                                                                                
                                                                     Ted R. Laws
                                                       Vice President of Company
                                                                        and Bank
                                        
<PAGE>
 

 

CORPORATE OFFICE                       INDEPENDENT CERTIFIED
PIEDMONT BANCORP, INC.                 PUBLIC ACCOUNTANTS
260 South Churton Street               KPMG Peat Marwick LLP
Hillsborough, NC 27278-2507            Suite 1200, 150 Fayetteville Street Mall
Phone: (919) 732-2143                  Raleigh, NC  27601
Fax:     (919) 732-6001
web address: www.hillsboroughbank.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 1998 Annual Meeting of stockholders of Piedmont  Bancorp,  Inc. will be held
at 6:30 p.m. on November 19, 1998 at the  Corporate  Office,  260 South  Churton
Street, Hillsborough North Carolina.


48
<PAGE>
                                  CAPITAL STOCK

The Parent's  common stock is traded on the American  Stock  Exchange  under the
symbol "PDB". As of June 30, 1998, there were 2,750,800  shares  outstanding and
703  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.



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

<TABLE>
<CAPTION>
                                                        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
<CAPTION>

            Quarterly Common Stock Performance and Dividends Declared
                        For the Year Ended June 30, 1997

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

                                                    High          Low
                                                    ----          ---

<S>                                                <C>           <C>                   <C>   
First quarter ended September 30                    8 3/4         5                        $ 0.12
Second quarter ended December 31                   11 5/8        10 3/8                 **   7.10
Third quarter ended March 31                       11 1/8         9 1/4                      0.10
Fourth quarter ended June 30                       11            10 1/8                      0.10

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

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