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

                                    FORM 10-K

(Mark One)

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

For the fiscal year ended         December 31, 1997
                         ------------------------------------------------------

                                       OR

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

For the transition period from                        to
                               ---------------------      ----------------------

Commission file number                        1-10506
                       --------------------------------------------------------

                               Essex Bancorp, Inc.
             (Exact name of registrant as specified in its charter)

              Delaware                                      54-1721085
       -----------------------                           ----------------
       (State of organization)                           (I.R.S. Employer
                                                        Identification No.)

          The Koger Center
        Building 9, Suite 200
          Norfolk, Virginia                                  23502
        ---------------------                             ----------
        (Address of principal                             (Zip Code)
         executive offices)

Registrant's telephone number, including area code (757) 893-1300

Securities registered pursuant to Section 12(b) of the Act:

Common Stock, Par Value $.01 Per Share              American Stock Exchange
--------------------------------------              -----------------------
          (Title of Class)                      (Exchange on Which Registered)

Securities registered pursuant to Section 12(g) of the Act:

                                      None
                                      ----
                                (Title of Class)

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

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

         The  aggregate  market  value of the  Registrant's  common stock on the
American  Stock  Exchange  on  March  25,  1998  held  by  nonaffiliates  of the
Registrant was $5,536,582.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Annual Report to  Stockholders  for the year ended  December 31,
1997 are incorporated by reference into Parts I and II hereof.

Portions  of the Proxy  Statement  for the Annual  Meeting to be held on May 28,
1998 are incorporated by reference into Part III hereof.


<PAGE>
                               Essex Bancorp, Inc.
                       Annual Report on Form 10-K for the
                          Year Ended December 31, 1997

                                Table of Contents


                                                                            Page
                                                                            ----
Part I

Item 1            Business................................................   3
Item 2            Properties..............................................  41
Item 3            Legal Proceedings.......................................  41
Item 4            Submission of Matters to a Vote
                      of Security Holders.................................  42


Part II

Item 5            Market for Registrant's Common Equity
                      and Related Stockholder Matters.....................  42
Item 6            Selected Financial Data.................................  43
Item 7            Management's Discussion and
                      Analysis of Financial Condition
                      and Results of Operations...........................  43
Item 8            Financial Statements and
                      Supplementary Data..................................  43
Item 9            Changes in and Disagreements with
                      Accountants on Accounting and
                      Financial Disclosure................................  43


Part III

Item 10           Directors and Executive Officers
                      of the Registrant...................................  44
Item 11           Executive Compensation..................................  45
Item 12           Security Ownership of Certain
                      Beneficial Owners and Management....................  45
Item 13           Certain Relationships and
                      Related Transactions................................  45


Part IV

Item 14           Exhibits, Financial Statement Schedules
                      and Reports on Form 8-K.............................  46




                                       2
<PAGE>

                                     PART I

Item 1.           Business

Organization and Background

         General. The following organizational chart depicts Essex Bancorp, Inc.
and its  subsidiaries  as of December 31, 1997. It is intended to facilitate the
readers' understanding of the companies discussed in this report.  Following the
chart is a glossary of terms which are used throughout this report.


                      Essex Bancorp, Inc. and Subsidiaries
                              Organizational Chart

<TABLE>
<S> <C>
                                                                 ---------------------
                                                                 |                   |
                                                                 |    The Company    |
                                                                 |                   |
                                                                 ---------------------
                                                                          |
                                                                          |
                                                                          |
                                                                          |
                                 ------------------------------------------------------------------------------------
                                 |                                        |                                         |
                       ---------------------                     ---------------------                     ---------------------
                       |                   |                     |                   |                     |                   |
                       |     The Bank      |                     |        EMC        |                     |        EAC        |
                       |                   |                     |                   |                     |                   |
                       ---------------------                     ---------------------                     ---------------------
                                 |                                        |
                                 |                                        |
            ---------------------------------------------------------------
            |                                  69%    |     31%
-----------------------                     ---------------------
|                     |                     |                   |
|    Essex First      |                     |         ECC       |
|                     |                     |                   |
-----------------------                     ---------------------
                                                      |
                                                      |
                                            ---------------------
                                            |                   |
                                            |    Essex Home     |
                                            |                   |
                                            ---------------------
                                                      |
                                                      |
                                            ---------------------
                                            |                   |
                                            |       EHADC       |
                                            |                   |
                                            ---------------------
</TABLE>

    Unless otherwise noted, each company is owned 100% by its parent entity.




                                       3
<PAGE>




Defined Term                                Formal Name
------------                                -----------

Company                    Essex  Bancorp,  Inc., successor  to  Essex Financial
                                    Partners, L.P. and Essex Bancorp.
Partnership                Essex Financial Partners, L.P.
Bancorp                    Essex Bancorp.
EAC                        Essex Acquisition Corporation
Bank                       Essex Savings Bank, F.S.B.
EMC                        Essex Mortgage Corporation
Essex First                Essex First Mortgage Corporation
ECC                        Essex Capital Corporation
Essex Home                 Essex Home Mortgage Servicing Corporation
EHADC                      E H Asset Disposition Corporation
TMS                        Thrift Management Services, Inc. - General Partner


         The Company is a Delaware  corporation  that is the holding company for
the Bank,  a  federally-chartered  savings  bank which  operates  four  branches
located in North  Carolina and Virginia.  The Company is the successor by merger
to the Partnership, a Delaware limited partnership,  which was formed in 1989 in
order to acquire an existing corporation that was the holding company for one of
the Bank's  predecessor  institutions.  The Partnership and Bancorp,  the Bank's
former  holding  company,  were  merged into the  Company in January  1995.  The
Company is engaged  primarily  in the  operation  of the Bank as a  wholly-owned
subsidiary.  The Company's  other  principal  operating  subsidiaries  are Essex
First,  a wholly-owned  subsidiary of the Bank that is engaged  primarily in the
origination and sale of residential  mortgage loans, and Essex Home, an indirect
subsidiary  of the  Company  and the  Bank  that  is  engaged  primarily  in the
servicing of mortgage loans owned by the Bank, various governmental agencies and
various  third party  investors.  At December  31,  1997,  the Company had total
assets of $195.1 million,  total liabilities of $180.3 million,  including total
deposits of $153.9 million, and total shareholders' equity of $14.8 million.

         In January 1995, following approval by the holders of the Partnership's
limited partnership units ("LPUs"), both the Partnership and Bancorp were merged
with and into the Company  (collectively,  the  "Merger"),  which  resulted in a
single holding company structure for the Bank and the other  subsidiaries of the
Company.  As a result of the  consummation  of the  Merger,  each holder of LPUs
received one share of Company common stock  ("Common  Stock") for every two LPUs
beneficially  owned, and the former corporate general partner of the Partnership
received 10,496 shares of Common Stock (which represented 1.0% of the issued and
outstanding  Common Stock) in exchange for its general partner's  interest.  The
Merger  was  undertaken,  among  other  reasons,  in order  (i) to  eliminate  a
cumbersome  business  structure that no longer provided the originally  intended
benefits to the Partnership's unitholders,  (ii) to expand the base of potential
investors in the Company by eliminating a complicated and nontraditional holding
company  structure,  and (iii) to provide the  Company  with  greater  access to
public and private equity capital  markets.  The Company had 1,049,687 shares of
Common Stock outstanding  immediately  following the Merger. As a consequence of
the Merger,  the Company  succeeded to all of the assets and  liabilities of the
Partnership and Bancorp. In this report,  unless the context otherwise requires,
the term  "Company"  refers to the  Partnership  prior to the Merger  and/or the
Company  subsequent  to the  Merger,  in each case  including  all  subsidiaries
thereof.





                                       4
<PAGE>

         Operations of the Partnership Prior to the Merger.  The Partnership was
the  predecessor  to the  Company  and was  formed in 1989 as a  publicly-traded
master limited partnership with the issuance of 2,078,382 LPUs priced at $20 per
LPU. The Partnership raised $41.6 million in partnership equity in order to fund
the acquisition of smaller,  predominantly  undercapitalized thrift institutions
located  in the  southeastern  United  States.  The  Partnership's  goal  was to
operationally link these thrift institutions  through common control by Bancorp,
a multi-state  thrift holding  company.  The bank branch network was little more
than a platform from which to raise deposits,  largely "mini-jumbo" certificates
of deposit in  denominations  of $25,000 to $80,000,  offering yields  typically
priced at the top of the deposit  market.  The funds  provided by these deposits
would be used to operate an active  secondary  marketing  function  which  would
acquire  mortgage loans,  principally  second  mortgage loans in  geographically
dispersed markets purchased at premiums, in the secondary market. Pools of loans
were then to be aggregated  and sold to or  participated  among  Bancorp's  bank
subsidiaries. The Partnership, however, made only three acquisitions.

         In January 1991 EMC, the Partnership's  non-bank  mortgage  subsidiary,
issued  $23.4  million in mortgage  servicing  backed  notes (the "Essex  11's")
through a private  placement.  Proceeds of these notes were used over a 17-month
period to acquire mortgage  servicing  rights for sale on the secondary  market.
Issuance of the Essex 11's coincided with the decline in interest rates to their
lowest  level  in 20  years  and,  not  unexpectedly,  the  Partnership  and its
subsidiaries suffered the adverse financial impact of impairment to the carrying
value of the Partnership's  purchased and originated servicing rights portfolios
and  loan  premiums.   Concurrently,  the  Partnership  also  suffered  dramatic
deterioration  in the quality of its loan portfolio,  necessitating  substantial
additional   loan  loss  reserves  and   provisions  for  losses  on  foreclosed
properties.

         By  mid-1992,  the  Partnership  was  (i)  operating  under  a  broadly
restrictive  supervisory  agreement  imposed  by its  regulators  after the 1990
examination of the Partnership and its subsidiaries, (ii) failing its regulatory
capital  requirements,  an event  which  required  the  submission  of a capital
restoration plan, (iii) in default on certain terms of the indenture under which
the Essex 11's were issued and (iv)  indefinitely  delaying payment of dividends
as a result  of a lack of  liquidity  at the  Partnership.  In  response  to the
serious deterioration in the financial condition of the Partnership, in May 1992
the Investment  Committee of the Partnership,  a body effectively  controlled by
members  employed  by the  Partnership's  investment  banker,  PaineWebber  Inc.
("PWI"),  acting  pursuant to certain  provisions  of the  Agreement  of Limited
Partnership, removed the Partnership's corporate general partner.

         The change of control of the  Partnership  was initiated on May 1, 1992
and was concluded on May 6, 1992 with the  installation of an interim  corporate
general partner of the Partnership.  Following  regulatory approval in 1993, TMS
was installed as the permanent corporate general partner of the Partnership. TMS
was  controlled  by Gene D. Ross,  the  present  president  and chief  executive
officer of the  Company,  who had also been the  president  and chief  executive
officer of the interim general partner since the 1992 change in control.

         The  Partnership's  new management  undertook four principal courses of
action.  First,  the  Company  replaced  certain  members of its  former  senior
management with individuals  with significant  experience in banking and problem
asset  rehabilitation.  Second, the Company  reorganized its risk management and
collections  department  in  order  to  focus  on the  early  identification  of
potential problem assets and the  administration,  rehabilitation or liquidation
of the Company's  nonperforming  assets. Third, the Partnership's three separate
savings bank subsidiaries were consolidated into Essex Savings Bank, F.S.B. (the
"Bank") in May 1993,  which  created  operating  efficiencies  and a  simplified
organizational  structure.  At the time of the  consolidation,  the Bank did not
comply  with its  minimum  regulatory  capital  requirements.  As a result,  the
Partnership  obtained a $3.0 million loan from PaineWebber Capital Inc. ("PWC"),
the  proceeds  of which  were  contributed  to the  Bank in  order to bring  the
institution  into  regulatory  capital  compliance.  This $3.0  million loan was


                                       5
<PAGE>

evidenced by a seven-year note (the  "Seven-Year  Note") from the Partnership to
PWC.  Fourth,  PWC  successfully  tendered for and repurchased at par all of the
outstanding Essex 11's. In exchange for the cancellation of substantially all of
the Essex 11's, the Partnership  delivered a ten-year note (the "Ten-Year Note")
in the original  principal  amount of $14.2 million to PWC in May 1993,  and PWC
received  the  proceeds of the sale of the balance of EMC's  mortgage  servicing
rights,  which was  consummated  in  mid-1993.  On October 24,  1994,  the total
outstanding  principal and interest owed with respect to the Seven- and Ten-Year
Notes and the remaining  Essex 11's held by PWC were forgiven in connection with
the settlement of the litigation discussed below.

         By the end of 1993, although the Bank had made significant  progress in
resolving many of its financial and operational  problems,  it again fell out of
compliance with its minimum regulatory capital  requirements.  Management of the
Bank had already  concluded  that in order to reposition  the Bank's  activities
along  the lines of a more  traditional  financial  institution  and in order to
focus the Bank's  lending and  deposit  gathering  activities  within the Bank's
primary market of North Carolina and Virginia, it would be necessary to sell the
Bank's  Florida  branches.  The sale of the Florida  branches to a third  party,
which was  consummated on June 30, 1994,  brought the Bank into  compliance with
its minimum regulatory capital requirements.

         In December 1993,  the  Partnership  also became a defendant,  together
with   PaineWebber  and  others,   in  certain  class  action   litigation  (the
"Litigation")  relating  to the  original  offering by the  Partnership  and the
management of the Partnership and its  subsidiaries  prior to the 1992 change in
control.  In September  1994,  the United States  District Court for the Eastern
District of Texas entered an order approving a proposed class action  settlement
(the "Settlement") of the Litigation.  The Settlement substantially improved the
financial condition of the Partnership and its subsidiaries by providing for the
forgiveness  by  PaineWebber,  effective  October 24,  1994,  of all of the debt
outstanding  under the Seven- and Ten-Year  Notes and the remaining  Essex 11's.
The aggregate amount of such debt totaled approximately $20.7 million at October
24, 1994.

         The  benefit of the debt  forgiveness  was offset to some extent by (i)
litigation   expenses  of   approximately   $90,000,   (ii)  the   Partnership's
contribution of $1.3 million to a settlement fund  established by the defendants
to pay the  plaintiffs'  attorneys'  fees and certain costs  associated with the
Settlement and to make certain payments to the named  plaintiffs,  and (iii) the
issuance by the Company to former  holders of LPUs of a total of $1.0 million in
preferred stock (the "Series A Preferred Stock"). As a result of the Settlement,
the Company also recognized  approximately $330,000 of alternative minimum taxes
("AMT") and the Company's net operating loss ("NOL")  carryforwards were reduced
by approximately $20.0 million, resulting in a NOL carryforward of $20.5 million
and a $330,000 AMT carryover at December 31, 1994.


Business Strategy of the Company and the Bank

         General. Since the change in management which occurred in May 1992, the
Company's new management achieved substantial progress in addressing its various
financial,  regulatory and operating  problems.  Such achievements  included the
consolidation  of the  Partnership's  three savings bank  subsidiaries  into the
Bank,  the  restructuring  of the Essex  11's,  the sale of the  Bank's  Florida
branches,   and  the  Settlement  of  the  Litigation  (which  resulted  in  the
forgiveness of approximately  $20.7 million of debt).  Nevertheless,  due to the
Bank's financial condition and continued losses from operations,  the Bank again
failed certain of its minimum  regulatory  capital  requirements at December 31,
1994.  Management had already  determined that the raising of additional capital
was critical to the Bank's  long-term  viability and the  accomplishment  of the
Bank's  business  objectives,  as well as the Bank's  compliance with applicable
regulatory capital requirements.



                                       6
<PAGE>

         Capital  Raising  Efforts.  On June 29,  1995,  the  Office  of  Thrift
Supervision  ("OTS"),  the Bank's primary regulator,  formally notified the Bank
that unless it raised  additional  capital by June 30,  1995,  the Bank would be
subject to the  appointment  of a  conservator  or a receiver,  as well as other
enforcement  actions.  The OTS  further  advised  that if the Bank was unable to
provide  written  evidence by June 30,  1995 that it had entered  into a binding
agreement  to  recapitalize  the Bank,  the OTS would  transfer  the Bank to the
Resolution  Trust Company ("RTC"),  an  instrumentality  of the U.S.  Government
which  had  the  authority  to  sell  and  liquidate  depository   institutions.
Therefore, it was imperative that the Bank raise capital in order to prevent its
imminent  seizure by the RTC. In the final analysis,  only one party was able to
step forward within the required  time-frame.  On June 30, 1995, the Company and
the Bank signed an Agreement and Plan of  Reorganization  (the "Agreement") with
Home Bancorp, Inc. ("Home Bancorp") and its wholly-owned subsidiary Home Savings
Bank, F.S.B. ("Home Savings"), a Norfolk, Virginia based savings institution. On
September  15, 1995,  the Company and the Bank merged with Home Bancorp and Home
Savings (the "Home Acquisition").  After this transaction, the Bank exceeded all
of the minimum regulatory capital requirements imposed by federal law.

         The Home  Acquisition  was accounted  for using the purchase  method of
accounting and the purchase price was allocated among the assets and liabilities
of Home  Bancorp and Home Savings at their fair value,  which was $60.1  million
and $52.6  million,  respectively,  as of September 15, 1995. The excess of cost
over net assets  acquired  ("goodwill")  recognized in connection  with the Home
Acquisition was approximately $8.6 million.

         In  exchange  for all of the  outstanding  stock of Home  Bancorp,  the
stockholders of Home Bancorp received  2,250,000  shares of nonvoting  perpetual
preferred  stock of the Company with an  aggregate  redemption  and  liquidation
value  of $15.0  million  and  warrants  to  purchase  7,949,000  shares  of the
Company's  common stock at a price of $0.9375 per share,  which was the price of
the  Company's  Common Stock as of June 30, 1995.  The warrants are  exercisable
beginning in September 1998 and expire in September  2005. The fair market value
of the preferred stock and the warrants was estimated in a third party valuation
to approximate $15.5 million at the time of the Home Acquisition.  Following the
completion of the transaction,  two  representatives  designated by Home Bancorp
joined the Boards of  Directors  of the Company and the Bank,  filling  existing
vacancies on those Boards.

         Development  of  Full-Service   Branches.   The  consolidation  of  the
Partnership's  three savings bank  subsidiaries in 1993, the sale of the Florida
branches in 1994, and the Home Acquisition in 1995, were important initial steps
in management's efforts to reposition the Bank's activities along the lines of a
more  traditional  savings  institution  while  allowing  the Bank to focus  its
lending and deposit gathering  activities within its primary markets of Virginia
and North Carolina.

         Not long  after  the Home  Acquisition  was  assimilated,  the Board of
Directors  of  the  Company  formed  a  Strategic   Evaluation   Committee  (the
"Committee") to explore the  possibility of further  expansion or contraction by
branch sales. It was concluded,  with assistance from an independent consultant,
that selling  non-strategic bank branches and effectively  shrinking the size of
the asset base by  approximately  50% was a strategy that ultimately would be in
the best  interests  of the common and  preferred  shareholders  of the Company.
Accordingly,  the Bank sold its branches in Charlotte,  Raleigh,  Greensboro and
Wilmington, North Carolina and in Norfolk, Portsmouth, Hampton, Newport News and
Grafton, Virginia (collectively,  the "Branches") in three separate transactions
over a  nine-month  period in 1996.  The  outcome of this  strategy  is that the
Company has retained the most strategic branches with the greatest potential for
significant  market share growth,  has approximately 7.9% tangible capital as of
December 31, 1997 and has largely removed  goodwill from its balance sheet.  See
Note 5 on pages 37 and 38 of the Notes to Consolidated  Financial  Statements of
the 1997 Annual Report to  Stockholders,  which is attached hereto as Exhibit 13
and incorporated herein by reference.



                                       7
<PAGE>

         During this  downsizing  period in 1996, the Bank continued its efforts
to position  the  remaining  strategic  branches  to more nearly  conform to the
activities of a traditional savings  institution.  To that end, the Bank and its
mortgage  banking  subsidiary  introduced a wider range of consumer and mortgage
loan products to attract new business and maximize the potential of its existing
customer  base.  In  addition,  in September  1996 the Bank  executed a purchase
agreement  on a parcel in  Suffolk,  Virginia  with the intent to  relocate  its
Suffolk branch from a leased facility  location to a location with potential for
significant  growth. This parcel was acquired in 1997 and construction has begun
on the new retail bank branch, which will be completed in April 1998.

         Expansion of Residential Construction and Consumer Lending. Since 1992,
the Company  has  increased  its  emphasis on the  origination  and  purchase of
residential  construction and consumer loans because of the shorter-term  nature
of such loans and the higher yields available thereon when compared to permanent
residential  mortgage  lending.  However,  construction  and consumer lending is
generally  considered  to  involve  a  higher  level  of  risk  as  compared  to
single-family  residential lending.  Notwithstanding the higher risk aspect, the
portfolio  of  residential  construction  loans has grown  steadily  since  1992
without  a  loss.  For  additional  information,  see "-  Lending  Activities  -
Construction Loans" and "- Consumer Loans."

         Reduction in Operating Expenses.  Historically, the Company's operating
expenses  have been high  relative  to those of other  savings  institutions  of
similar asset size.  This has been  primarily due to the presence of duplicative
operating procedures and personnel,  a high level of professional fees resulting
from the  various  financial  and  operating  problems  of the  Partnership,  an
increase in expenses  relating to the  allocation of resources to the collection
and work-out of  nonperforming  assets,  high levels of provisions for losses on
foreclosed  properties  and high levels of  impairment  adjustments  relating to
purchased  and  originated   mortgage   servicing   rights  and  loan  premiums.
Significant  reductions have been made in operating expenses since the change in
management  which occurred in May 1992.  Nevertheless,  management  continues to
evaluate  the Bank's  personnel  needs and  operating  requirements  in order to
identify areas where  additional  measures may be taken to reduce costs.  During
1997, the Company  implemented  additional  cost reductions so that the on-going
expense  structure is compatible with institutions the Company's size and nature
of  business.  Although  the Bank is  committed  to  achieving  a lower level of
operating expenses relative to the Bank's operations, management recognizes that
operating  expenses will remain higher than much of the Bank's peer group due to
the relatively low level of assets of Essex Home.

         Reduction  of  Nonperforming  Assets.  As  previously  discussed,   the
Company's new management  reorganized the Bank's risk management and collections
department  and  revised  its  loan  underwriting,   collection  and  monitoring
procedures  in an effort  to reduce  the  level of  nonperforming  assets.  As a
result,  nonperforming assets have declined from $24.8 million or 5.92% of total
assets at December 31, 1992 to $3.3 million or 1.69% of total assets at December
31, 1997. Such results for 1997 are over a significantly smaller asset base than
the results for 1992. In addition,  loans delinquent 30 to 89 days have declined
from $7.0  million or 2.66% of total loans held for  investment  at December 31,
1992 to  $940,000  or 0.6% of total loans held for  investment  at December  31,
1997.  Reduced  provisions  for loan losses  contributed  to improved  operating
results during the year ended December 31, 1997.

         Expansion of  Subservicing  Activities.  In its efforts to generate fee
income,  the Bank  continues  to pursue  profitable  residential  mortgage  loan
servicing  and  subservicing.  Essex  Home is a service  corporation  subsidiary
licensed  by the Federal  National  Mortgage  Association  ("Fannie  Mae"),  the
Federal  Home Loan  Mortgage  Corporation  ("Freddie  Mac")  and the  Government
National  Mortgage  Association  ("Ginnie  Mae").  Essex Home also  services and
subservices loans for approximately 50 other private investors.



                                       8
<PAGE>

         Through various  networking and referral  opportunities and advertising
efforts,  Essex Home has attracted  other  financial  institutions  and mortgage
banking firms interested in  subcontracting  their loan servicing  function.  By
subservicing  loans for others,  the Bank will be able to utilize more fully its
available  resources in a cost  efficient and  profitable  manner.  However,  on
February 28, 1997, the Company was notified by its largest  subservicing  client
of its  intention  not to renew its  contract  beyond  June 1, 1997.  Because no
assurances  could  be made  that  this  significant  servicing  volume  could be
replaced in its  entirety in the near term,  Essex Home  implemented  a plan for
operating expense reductions.  Notwithstanding the impact of the cancellation of
this  subservicing  contract,  Essex Home  offset some of the  reduction  in its
servicing  portfolio in 1997 by acquiring  servicing rights and by entering into
18 new subservicing  contracts  consisting of approximately  2,100 loans with an
aggregate principal balance of $201.4 million as of December 31, 1997.

         Strengthening of Loan Policies.  Since May 1992, the loan  underwriting
policies of the Bank have been  substantially  revised and strengthened with the
objective  of  reducing  the risk  profile  of the  Bank's  loan  portfolio.  In
addition, the Company's loan portfolio has been restructured in order to improve
its asset quality,  reduce the  risk-weighting of the Bank's assets and minimize
the  Company's  exposure to interest  rate risk.  Specifically,  the Company has
significantly  reduced its portfolio of second mortgage loans while  emphasizing
the   origination  of  both   construction   and  permanent   loans  secured  by
single-family residential real estate. Efforts were made to effect these changes
while  continuing to be responsive to the borrowing needs in the Bank's markets.
In addition to strengthening  the Bank's  underwriting  policies and procedures,
other  measures  were taken to improve the Bank's asset  quality,  including the
formation of a loan  committee,  further  strengthening  of the Bank's  internal
audit and quality control functions and enhanced loan origination  standards and
practices.  During 1997,  underwriting policies were further expanded to include
an assessment of the Year 2000 readiness of potential commercial borrowers.

         Interest Rate Risk Management.  Deposit accounts  typically adjust more
quickly to changes in market  interest  rates than mortgage loans because of the
shorter maturities of deposits.  As a result,  significant increases in interest
rates  may  adversely  affect  the  Bank's  earnings.  To reduce  the  potential
volatility of the Bank's  earnings,  management  has sought to improve the match
between  asset  and  liability   maturities  and  rates,  while  maintaining  an
acceptable  interest rate spread.  Pursuant to this  strategy,  the Bank has (i)
emphasized  investment in  adjustable-rate  single-family  residential  loans or
shorter-term (seven years or less), fixed-rate single-family  residential loans;
(ii) sold longer-term (over seven years),  fixed-rate single-family  residential
loans in the secondary market; (iii) purchased  adjustable-rate  mortgage-backed
securities;  (iv) maintained higher liquidity by holding short-term  investments
and cash  equivalents;  and (v)  increased  the  average  maturity of the Bank's
interest-bearing  liabilities by utilizing  long-term advances and attempting to
attract longer-term retail deposits.

         The interest rate sensitivity gap is defined as the difference  between
interest-earning  assets and interest-bearing  liabilities maturing or repricing
with a given time period.  The Bank's  one-year  interest rate  sensitivity  gap
amounted to a negative 14.9% at December 31, 1997,  which reflects the impact of
shortening  deposit  maturities as the Bank's deposit customers are reluctant to
enter into extended maturities in the current low interest rate environment. The
negative gap also reflects near-term maturities of higher-rate Federal Home Loan
Bank  advances.  The Company  will benefit from the lower cost of funds as these
borrowings mature and may consider extended  maturities in order to mitigate the
impact of an  increase  in  interest  rates in the  future.  While  the  Company
continues to emphasize investment in adjustable-rate  loan portfolios,  customer


                                       9
<PAGE>

demand for such loans is  lessening  as  borrowers  demand for lower  fixed-rate
loans is increasing.  Within the spectrum of loan products  offered by the Bank,
the percentage of balloon payment and adjustable-rate  loans with longer initial
adjustment  terms has increased.  See  "Management's  Discussion and Analysis of
Financial Condition and Results of Operations - Market Risk Management" on pages
16 through  19 of the 1997  Annual  Report to  Stockholders,  which is  attached
hereto as Exhibit 13 and incorporated herein by reference.

General

         The Company,  as a  registered  savings and loan  holding  company,  is
subject  to  examination  and  regulation  by the OTS and is  subject to various
reporting and other requirements of the Securities and Exchange  Commission (the
"Commission").  The Bank, as a federally  chartered  savings bank, is subject to
comprehensive regulation and examination by the OTS, as its chartering authority
and  primary  regulator,  and  by  the  Federal  Deposit  Insurance  Corporation
("FDIC"),  which  administers the Savings  Association  Insurance Fund ("SAIF"),
which insures the Bank's  deposits to the maximum  extent  permitted by law. The
Bank is a member of the Federal Home Loan Bank of Atlanta ("FHLB"), which is one
of 12 regional banks  comprising the Federal Home Loan Bank System.  The Bank is
further  subject to regulations of the Board of Governors of the Federal Reserve
System ("Federal  Reserve Board")  governing  reserves required to be maintained
against deposits and certain other matters.

         The Company's principal focus is currently on the origination  (through
Essex First) of both construction and permanent single-family  residential loans
(of which  substantially  all fixed-rate  single-family  residential  loans with
terms to  maturity in excess of seven years are being sold by Essex First in the
secondary market). Moreover, in order to provide a full range of services to its
customers and in accordance  with the Company's  asset and liability  management
policies,  the Company recently has increased its emphasis of the origination of
various types of consumer loans. In addition,  the Company  generates fee income
by  providing  to  third  parties   residential   mortgage  loan  servicing  and
subservicing   through  Essex  Home.   Furthermore,   the  Company   invests  in
mortgage-backed   securities  which  are  insured  or  guaranteed  by  the  U.S.
Government  and  agencies  thereof and other  similar  investments  permitted by
applicable laws and regulations.

Lending Activities

         General.  At  December  31,  1997,  the  Company's  net loan  portfolio
(excluding   loans   classified  as  held  for  sale)  totaled  $167.4  million,
representing  approximately  85.8% of its $195.1 million of total assets at that
date.  The  principal  categories  of  loans  in  the  Company's  portfolio  are
residential real estate loans,  which are secured by single-family  (one-to-four
units)  residences;  loans for the  construction  of  single-family  properties;
commercial  real  estate  loans,  which are secured by  multi-family  (over five
units)  residential and commercial real estate;  commercial  business loans; and
consumer  loans.  Substantially  all of the Company's  mortgage  loan  portfolio
consists  of  conventional  mortgage  loans,  which are loans  that are  neither
insured by the Federal Housing  Administration  ("FHA") nor partially guaranteed
by the Veterans Administration ("VA").

         As a  federally  chartered  savings  institution,  the Bank has general
authority  to  originate  and  purchase  loans  secured by real  estate  located
throughout the United States. The Company currently originates substantially all
of its loans  within  Virginia  and North  Carolina.  Nevertheless,  the Company
continues  to purchase  from time to time loans  secured by  properties  located
outside  of its  market  area and  continues  to hold a  relatively  diversified
portfolio.

         Federal  regulations  permit the Bank to invest  without  limitation in
residential  mortgage loans and up to four times its capital in loans secured by
non-residential  or commercial real estate. The Bank is also permitted to invest
in secured and  unsecured  consumer  loans in an amount not exceeding 35% of the
Bank's total assets;  however,  such 35% limit may be exceeded for certain types
of consumer  loans,  such as home equity,  property  improvement  and  education
loans.  In  addition,  the Bank is  permitted  to  invest up to 20% of its total


                                       10
<PAGE>

assets  in  secured  (by  other  than  real  estate)  and  unsecured  loans  for
commercial,  corporate,  business or  agricultural  purposes,  provided that any
investments which in the aggregate total 10% may only be used for small business
loans.

         Since the enactment of the Financial Institutions Reform,  Recovery and
Enforcement Act of 1989 ("FIRREA"), a savings institution generally may not make
loans to one borrower and related entities in an amount which exceeds 15% of its
unimpaired  capital  and  surplus,  although  loans  in an  amount  equal  to an
additional  10% of  unimpaired  capital and surplus may be made to a borrower if
the loans are fully secured by readily marketable securities.  See "Regulation -
Regulation  of the Bank - General." At December  31,  1997,  the Bank's limit on
loans-to-one borrower was $2.5 million. The loans-to-one borrower limitation may
restrict the Bank's ability to do business with certain existing customers.

         At December 31, 1997, the Bank's five largest  commercial  loans-to-one
borrower and their  related  entities  amounted to $1.4  million,  $1.2 million,
$565,000,  $515,000  and  $448,000.  In addition,  as of December 31, 1997,  the
Bank's largest lines of credit with unaffiliated home builders  consisted of one
in the amount of $2.0 million (of which  $716,000 had been drawn upon as of such
date),  another in the amount of $1.5 million (of which  $959,000 had been drawn
upon as of such date),  another in the amount of $1.5 million (of which $214,000
had been drawn upon as of such date),  another in the amount of $1.5 million (of
which $185,000 had been drawn upon as of such date) and another in the amount of
$1.3 million (of which $29,000 had been drawn upon as of such date). At December
31, 1997, the $1.4 million loan was classified  based on a rating system adopted
by the Company.  Refer to "-Asset Quality - Classified Assets" for a description
of the classifications for problem assets.

         The $1.4  million  group of loans  consists  of (i) a  commercial  real
estate loan of $955,000 as of December 31, 1997, which was originated in October
1987  in  the  amount  of  $1.0  million  for  the  purpose  of   refinancing  a
mini-storage/office facility (76 mini-storage units and 38 office units) located
in Virginia Beach, Virginia, and (ii) a line of credit in the amount of $600,000
with an  outstanding  balance of $440,000 as of December 31,  1997.  The Company
occupies  approximately  12,000  square feet of the office  facility.  The lease
payments  largely service the principal and interest on the two loans.  The term
of the lease  coincides  with the maturity of the loans,  which are scheduled to
mature on December 31, 2001. In addition,  as of December 31, 1997, the Bank and
its  subsidiaries  leased ten of the  mini-storage  units. The property was most
recently  appraised in November 1992 for $915,000.  As of December 31, 1997, the
Bank had established a $300,000  specific  reserve with respect to the loans and
the remaining $1.1 million was classified as substandard.





                                       11
<PAGE>

         Loan Portfolio Composition.  The following table sets forth information
concerning the Company's loan portfolio  (excluding loans held for sale) by type
of loan at the dates indicated:
<TABLE>
<CAPTION>
<S> <C>
                                                                            December 31,
                                             ------------------------------------------------------------------
                                                      1997                    1996                    1995
                                                      ----                    ----                    ----
                                                  $        %               $       %               $       %
                                                  -        -               -       -               -       -
                                                                       (dollars in thousands)
Real estate:
   Single-family residential:
     First mortgages................           $130,486     76.8%       $103,643    70.0%       $223,531    82.1%
     Second mortgages...............              8,699      5.1          12,384     8.3          13,398     4.9
   Construction and development.....             16,583      9.8          17,190    11.6          15,078     5.5
   Commercial real estate...........              5,970      3.5           6,313     4.3          10,611     3.9
                                               --------     ----        --------    ----        --------    ----
     Total real estate loans........            161,738     95.2         139,530    94.2         262,618    96.4

Commercial business loans...........              1,883      1.1           1,915     1.3           2,171      .8

Consumer loans:
   Other............................              5,426      3.2           5,828     3.9           6,488     2.4
   Secured by deposits..............                805       .5             842      .6             994       .
                                               --------     ----        --------    ----        --------    ----
     Total consumer loans...........              6,231      3.7           6,670     4.5           7,482     2.8
                                               --------     ----        --------    ----        --------    ----

           Total Loans..............            169,852    100.0%        148,115   100.0%        272,271   100.0%
                                                           =====                   =====                   =====
Less:
   Unearned loan fees and discounts.                 29                        8                     388
   Allowance for loan losses........              2,382                    2,556                   5,251
                                              ---------                ---------               ---------
                                                  2,411                    2,564                   5,639
                                              ---------                ---------               ---------

           Net Loans................           $167,441                 $145,551                $266,632
                                                =======                  =======                 =======

<CAPTION>


                                                        1994                    1993
                                                        ----                    ----
                                                    $         %             $         %
                                                    -         -             -         -
Real estate:
   Single-family residential:
     First mortgages................           $187,607     77.7%       $159,398    75.8%
     Second mortgages...............             18,717      7.8          24,851    11.8
   Construction and development.....             15,501      6.4           9,137     4.4
   Commercial real estate...........             11,499      4.8          10,781     5.1
                                               --------     ----        --------    ----
     Total real estate loans........            233,324     96.7         204,167    97.1

Commercial business loans...........              1,824       .8           1,946      .9

Consumer loans:
   Other............................              5,320      2.2           2,884     1.4
   Secured by deposits..............                835       .3           1,263      .6
                                               --------     ----        --------    ----
     Total consumer loans...........              6,155      2.5           4,147     2.0
                                               --------     ----        --------    ----

           Total Loans..............            241,303    100.0%        210,260   100.0%
                                                           =====                   =====
Less:
   Unearned loan fees and discounts.                482                      440
   Allowance for loan losses........              3,429                    3,039
                                              ---------                ---------
                                                  3,911                    3,479
                                              ---------                ---------

           Net Loans................           $237,392                 $206,781
                                                =======                  =======

</TABLE>


                                       12
<PAGE>

         Total loans  decreased by an  aggregate of $40.5  million or 19.3% from
December 31, 1993 to December 31, 1997 primarily due to sales of second mortgage
loans,  the sale of  loans in  connection  with the sale of the  Bank's  Florida
branches  in 1994  and the  sale of  loans  in  connection  with the sale of the
Branches in 1996.  The  acquisition  of $22.2 million of  adjustable  rate first
mortgage loans in 1997 partially  offsets the decline and reflects the Company's
strategy of investing proceeds from the maturities of investment  securities and
funds provided by the growth in deposits into higher yielding loans. Since 1992,
the Company has placed increased emphasis on single-family first mortgage loans,
which,  together with  construction  loans secured by single-family  residences,
increased  from 80.2% of total loans held for investment at December 31, 1993 to
86.6% of total loans held for  investment  at December 31,  1997.  Single-family
second mortgage loans declined  substantially from 11.8% of total loans held for
investment  at December 31, 1993 to 5.1% of total loans held for  investment  at
December 31, 1997. The decline in second mortgage loans resulted from loan sales
undertaken  to reduce the  regulatory  risk-weighting  of the Bank's assets and,
thus,  improve its  risk-based  capital  ratio,  while at the same time reducing
earnings  volatility  associated with the amortization of deferred  premiums and
the increased credit risk associated with second mortgage loans. Commercial real
estate loans  decreased from 5.1% of total loans held for investment at December
31, 1993 to 3.5% of total loans held for investment at December 31, 1997,  while
commercial  business loans  increased  slightly from .9% of total loans held for
investment  at December 31, 1993 to 1.1% of total loans held for  investment  at
December 31, 1997.  Consumer  loans  increased from 2.0% of total loans held for
investment  at December 31, 1993 to 3.7% of total loans held for  investment  at
December 31, 1997.  The Company  increased its emphasis  during 1997 and 1996 on
the   origination   and  purchase  of  various  types  of  consumer  loans  and,
consequently, expects the balance of such loans to increase.

         The following  table  presents the maturity  distribution  and interest
sensitivity  of selected loan  categories  (excluding  residential  mortgage and
consumer loans) at December 31, 1997.  Maturities are presented on a contractual
basis.  Loans having no stated schedule of repayments and no stated maturity are
reported as due in one year or less. Scheduled  contractual principal repayments
do not reflect the actual maturities of loans.
<TABLE>
<CAPTION>
<S> <C>
                                                             Commercial        Commercial
                                         Construction        Real Estate        Business           Total
                                         ------------        -----------        --------           -----
                                                                (dollars in thousands)
Amounts due:
    One year or less                       $15,876             $   268           $1,102            $17,246
    After one year through
      five years                               157               3,773              781              4,711
    Beyond five years                          550               1,929                -              2,479
                                          --------               -----         --------            -------
        Total                              $16,583              $5,970           $1,883            $24,436

Interest rate terms on
    amounts due after one
    year:
      Fixed                               $    339              $1,418           $  678           $  2,435
                                           =======               =====            =====            =======
      Adjustable                          $    368              $4,284           $  103           $  4,755
                                           =======               =====            =====            =======
</TABLE>

         Origination,  Purchase and Sale of Loans.  In earlier  years,  the Bank
operated  as  a  wholesale  financial  institution  and  conducted  its  deposit
gathering  activities  through a network of limited  service  branches that were
designed to primarily accumulate large  non-transactional  deposit accounts. The
Bank's  lending  activities  were not  generally  conducted  through  its branch
offices.  Instead,  substantially  all of the Company's  loan product was either
originated by Essex First or purchased in the secondary market.

         As part of  management's  efforts to reposition  the Bank's  activities
along the lines of a more traditional financial institution,  the Bank converted
its existing  branch  offices into  full-service  retail  facilities,  which has


                                       13
<PAGE>

enabled the Bank to,  among  other  things,  increase  its  origination  of both
consumer and mortgage loans directly  through its branch network.  Nevertheless,
substantially all of the Company's mortgage loan product is expected to continue
to be either originated by Essex First or purchased in the secondary market.

         Mortgage Banking Activities.  Since 1992, Essex First has significantly
expanded  its  mortgage  banking  operations  in order to,  among other  things,
increase the Company's level of loan  originations  that generate fee income. At
December 31, 1997,  Essex First  conducted its  operations  out of four offices,
which are located in Norfolk,  Richmond,  and Chester,  Virginia,  and Elizabeth
City, North Carolina.  Essex First also currently accepts  applications  through
the Bank's branch office in Emporia,  Virginia.  During the years ended December
31, 1997, 1996, and 1995,  Essex First originated $65.6 million,  $104.2 million
and  $101.8  million  of  loans  (consisting  primarily  of both  permanent  and
construction  loans secured by single-family  residential  real estate).  During
such  periods,  $25.9  million,  $29.3  million and $26.3 million of such loans,
respectively,  were sold by Essex First to the Bank,  with the  remainder  being
sold by Essex  First  primarily  to other  private  investors  in the  secondary
market.

         Although   the  majority  of  the  Bank's  loan  product  is  currently
originated by Essex First, Essex First was established primarily to increase the
volume of loans being originated for sale to private  investors in the secondary
market.  Such loan sales  generate fee income,  while avoiding the interest rate
and credit risk associated with holding long-term  fixed-rate  mortgage loans in
its portfolio.  Loans originated by Essex First for sale in the secondary market
are originated in accordance with terms, conditions and documentation prescribed
by the Freddie  Mac,  Fannie Mae and Ginnie Mae.  However,  Essex First does not
generally sell mortgage loans to such government  agencies and,  instead,  sells
loans  to  private  investors  in  the  secondary  market.  Consequently,  loans
originated by Essex First for sale in the secondary market must also comply with
any  particular  requirements  of such  private  investors.  Upon  approval of a
particular loan,  Essex First provides an independent  title company or attorney
instructions  to close the loan.  Loan  proceeds are disbursed and funded at the
closing by Essex  First.  The loan  documents  are  generally  delivered  to the
private investor within 10 days of the closing and the price paid by the private
investor for  purchasing the loan is generally  remitted  within five to 10 days
after such delivery.  Although Essex First  currently  sells  substantially  all
conventional  loans  without  recourse  (so that losses  incurred as a result of
nonperformance  with  respect  to the  loan  become  the  responsibility  of the
purchaser  of the loan as of the date of the  closing),  Essex  First has in the
past occasionally sold conventional loans in the secondary market with recourse,
and may continue to sell certain conventional loans in the secondary market with
recourse. However, as of December 31, 1997 there were no loans outstanding which
were previously  originated and sold by Essex First in the secondary market with
recourse.

         A majority of all residential  mortgage loans originated by Essex First
for sale in the secondary market are sold with servicing released to third party
investors. Substantially all of the loans originated by Essex First and not sold
with  servicing  released to third party  investors are sold to the Bank,  which
enables the Company to retain the servicing.  When loans are sold with servicing
rights released to the buyer, the Company recognizes current income from receipt
of servicing  release fees.  Alternatively,  when loans are sold with  servicing
retained,  the Company  recognizes  additional gains based on the estimated fair
value  of the  servicing  retained.  For  additional  information,  see "-  Loan
Servicing" and "- Loan Fee Income."

         Management  of the Bank and Essex First believe that  "pipeline  risk,"
which is created by offering loan  applicants  agreed-upon  interest rates for a
future closing, is currently being minimized because Essex First's loan officers
are  compensated in accordance  with pricing  guidelines  which are based on the
purchase  price  received from the third party  investors  purchasing the loans.
Therefore,  in most cases,  the loan officer will lock-in a purchase  price with
the third party investor  simultaneously  with making the rate commitment to the
borrower and  therefore  eliminate  any interest  rate risk.  If the loan is not


                                       14
<PAGE>

locked-in  simultaneously  with  the  commitment  to the  borrower,  any  market
movement that occurs prior to the third party  investor  locking-in the purchase
price is reflected in the loan officer's  compensation and not absorbed by Essex
First or the Bank.

         Loan  Purchases  and  Sales.   The  Bank  purchases  from  Essex  First
single-family  mortgage loans which generally have adjustable rates or a term to
maturity of seven years or less.  In  addition,  the Bank  continues to purchase
first  mortgage  loans  secured by  single-family  residential  properties  from
selected financial  institutions and mortgage banking companies in the secondary
market.  Such loans generally  consist of ARMs or fixed-rate loans with terms of
five, seven, or to a lesser extent, 15 years. Such loan purchases are secured by
properties  located both within and outside the Bank's primary  markets.  During
the years ended December 31, 1997 and 1995, the Bank purchased $22.2 million and
$50.7 million of loans,  respectively,  from various financial  institutions and
mortgage  banking  companies  (other than Essex First) in the secondary  market.
However,   the  amount  of  loans  purchased   during  1995  was   predominantly
attributable to the Home  Acquisition.  The Company purchased less than $600,000
of loans in the  secondary  market  during 1996  because of its emphasis on loan
sales to accommodate the sale of the Branches.

         At December 31, 1997,  1996, and 1995,  loans classified by the Company
as held for sale  amounted  to $2.2  million,  $2.5  million  and $3.3  million,
respectively.  Except for loans  originated for sale in the secondary  market by
Essex First,  it is generally  management's  intention  to hold  originated  and
purchased  loans for  investment.  Under  certain  circumstances,  however,  the
Company may sell loans  originally  acquired for  investment in order to address
needs  regarding  liquidity,  regulatory  capital,  interest rate risk, or other
objectives.  During 1996, the Bank sold first  mortgage  loans  totaling  $118.3
million in order to provide  funds for the sale of the  Branches.  See Note 5 on
pages 37 and 38 of the Notes to  Consolidated  Financial  Statements of the 1997
Annual  Report to  Stockholders,  which is  attached  hereto as  Exhibit  13 and
incorporated herein by reference.

         Loan  Underwriting.  Applications for all types of loans offered by the
Bank are taken at all of the Bank's branch offices. Applications for residential
mortgage loans are taken at all of Essex First's offices.  Residential  mortgage
loan  applications  are  generally  attributable  to referrals  from real estate
brokers  and  builders,  existing  customers  and, to a lesser  extent,  walk-in
customers.  Essex First also obtains applications for residential mortgage loans
through  several loan officers who solicit and refer mortgage loan  applications
to Essex  First.  These loan  officers are  compensated  in part on a commission
basis and provide convenient  origination services during banking and nonbanking
hours.  During 1996, Essex First established a wholesale lending program,  which
consists primarily of  construction/permanent  ("C/P") lending. Approved brokers
are  responsible for originating and processing C/P loans and submitting them to
the Bank for underwriting approval.

         Loans  purchased  by the Bank  from  Essex  First  or  other  financial
institutions  and  mortgage  banking  companies  in  the  secondary  market  are
underwritten  by the Bank in accordance  with its  underwriting  guidelines  and
procedures  (which  generally  follow Freddie Mac and Fannie Mae guidelines) and
may be  approved  by various  lending  officers  of the Bank  within  designated
limits,  which are  established  and  modified  from time to time to  reflect an
individual's  expertise and  experience.  All loans in excess of an individual's
designated  limits are  referred  to an officer  with the  requisite  authority.
Specifically,  when acting  individually,  the Chief  Executive  Officer and the
Senior Underwriter are authorized to approve secured loans of up to $250,000 and
unsecured loans of up to $25,000. When the Senior Underwriter acts together with
the Chief Executive Officer,  they are authorized to approve secured loans of up
to $500,000 and unsecured loans of up to $50,000. All secured loans greater than
$500,000  but  not  exceeding  $750,000  require  approval  by the  Bank's  loan
committee, which consists of the aforementioned officers and the Chief Executive
Officer  of Essex  First.  All  secured  loans  greater  than  $750,000  and all
unsecured  loans  greater  than  $50,000  must be  approved  by the Bank's  loan
committee  and the  Board of  Directors  of the  Bank.  In  addition,  all loans


                                       15
<PAGE>

committed or approved by the Bank's loan  committee are reported to the Board of
Directors  on a  monthly  basis.  Management  of  the  Bank  believes  that  its
relatively  centralized  approach to approving loan applications  ensures strict
adherence to the Bank's underwriting guidelines while still allowing the Bank to
approve loan applications on a timely basis.

         Loan  Servicing.  Essex Home services or subservices  residential  real
estate loans owned by the Bank as well as for other private mortgage  investors.
Loan servicing includes  collecting and remitting loan payments,  accounting for
principal and interest,  making advances to cover  delinquent  payments,  making
inspections as required of mortgaged premises, contacting delinquent mortgagors,
supervising  foreclosures  and property  dispositions in the event of unremedied
defaults and generally administering the loans. Funds that have been escrowed by
borrowers for the payment of mortgage related  expenses,  such as property taxes
and   hazard   and   mortgage    insurance    premiums,    are   maintained   in
noninterest-bearing  accounts  at  the  Bank  or at  nonaffiliated  banks  if so
required by the mortgage investors.

         Essex Home  receives fees for servicing  and/or  subservicing  mortgage
loans.  Such fees serve to compensate Essex Home for the costs of performing the
servicing/subservicing  function.  Other  sources  of  loan  servicing  revenues
include late charges and other ancillary fees.  Servicing and subservicing  fees
are  collected  by  Essex  Home out of the  monthly  mortgage  payments  made by
borrowers.  For additional  information  concerning Essex Home and its servicing
and subservicing portfolio, see "- Loan Fee Income."

         Real Estate Lending Standards.  Effective March 19, 1993, all financial
institutions  were  required to adopt and  maintain  comprehensive  written real
estate  lending  policies  that  are  consistent  with  safe and  sound  banking
practices.  These lending policies must reflect consideration of the Interagency
Guidelines  for Real Estate  Lending  Policies  adopted by the  federal  banking
agencies,  including  the OTS,  in December  1992  ("Lending  Guidelines").  The
Lending  Guidelines set forth,  pursuant to the mandates of the Federal  Deposit
Insurance  Corporation  Improvement Act of 1991 ("FDICIA"),  uniform regulations
prescribing standards for real estate lending. Real estate lending is defined as
extensions  of credit  secured by liens on  interests in real estate or made for
the purpose of financing the construction of a building or other improvements to
real estate, regardless of whether a lien has been taken on the property.

         The policies must address certain lending  considerations  set forth in
the Lending Guidelines, including supervisory loan-to-value ("LTV") limits, loan
portfolio management, loan administration procedures and underwriting standards.
These policies must also be appropriate to the size of the  institution  and the
nature and scope of its  operations,  and must be reviewed  and  approved by the
institution's board of directors at least annually.  The LTV ratio, which is the
total  amount of credit to be  extended  divided by the  appraised  value of the
property  at the time the credit is  originated,  must be  established  for each
category of real estate loans.  If not a first lien, the lender must include all
senior liens when calculating this ratio.  The Lending  Guidelines,  among other
things,  establish the following  supervisory LTV limits:  raw land (65%);  land
development (75%);  construction  (commercial,  multi-family and nonresidential)
(80%);  improved  property (85%);  and  one-to-four  family  residential  (owner
occupied)  (no  maximum  ratio;  however  any LTV ratio in excess of 90%  should
require  appropriate  mortgage insurance or readily marketable  collateral).  In
most cases,  the  Company's  loan  underwriting  guidelines  with respect to LTV
ratios are more stringent than the Lending Guidelines set forth above.

         Single-Family  Residential  Real Estate Loans.  As part of management's
efforts  to  reposition  the Bank along the lines of a more  traditional  thrift
institution, the Bank has increased its emphasis on loans secured by first liens
on single-family  residential real estate.  At December 31, 1997, $130.4 million
or 76.8% of the  Company's  total loans held for  investment  consisted  of such
loans.



                                       16
<PAGE>

         In recent  years,  the Company has been  emphasizing  for its portfolio
single-family  residential  mortgage  adjustable-rate  loans  which  provide for
periodic  adjustments to the interest rate. These loans have up to 30-year terms
and interest rates which adjust annually in accordance  with a designated  index
after a specified period has elapsed.  Depending on the loan product selected by
the borrower, this period can range from one year to seven years. In order to be
competitive and generate production, the ARMs offered by the Company provide for
initial  rates of interest  below the rates which would  prevail  when the index
used for repricing is applied.  However,  the Company  underwrites certain loans
(i.e.,  ARMs  with  95%  LTV) on a basis  that is no  less  stringent  than  the
underwriting  guidelines  of the Fannie Mae.  The Company has not engaged in the
practice of using a cap on the  payments  that could  allow the loan  balance to
increase rather than decrease, resulting in negative amortization. Approximately
56.4% of the permanent  single-family  residential  loans in the Company's  loan
portfolio  held for  investment  at December  31, 1997 had  adjustable  interest
rates.

         The demand for  adjustable-rate  loans in the Company's  primary market
area has been a function  of several  factors,  including  the level of interest
rates,  the  expectations  of  changes  in the level of  interest  rates and the
difference between the interest rates and loan fees offered for fixed-rate loans
and adjustable-rate loans. The relative amount of fixed-rate and adjustable-rate
residential  loans that can be originated  at any time is largely  determined by
the demand for each in a competitive environment.

         Adjustable-rate  loans  decrease the risks  associated  with changes in
interest rates but involve other risks, primarily because as interest rates rise
and the loan rates  adjust  upward,  the  payment by the  borrower  rises to the
extent permitted by the terms of the loan,  thereby increasing the potential for
default.  At the same time, the marketability of the underlying  property may be
adversely  affected by higher  interest rates.  The Company  believes that these
risks,  which have not had a  material  adverse  effect on the  Company to date,
generally are less than the risks associated with holding fixed-rate loans in an
increasing interest rate environment. In addition,  depending on the LTV and the
initial  repricing  frequency of the ARMs,  the Company  underwrites  certain of
these loans based on a  borrower's  qualification  at a  fully-indexed  interest
rate.

         The Company continues to originate long-term, fixed-rate loans in order
to provide a full range of products to its  customers,  but generally only under
terms,  conditions  and  documentation  which  permit  the sale  thereof  in the
secondary market.  Currently,  fixed-rate  single-family  residential loans with
terms to maturity of seven years or less are generally retained in the Company's
portfolio  while  fixed-rate  single-family  residential  loans  with  terms  to
maturity  of over seven  years are  generally  sold in the  secondary  market as
market  conditions  permit.  At December  31, 1997,  approximately  43.6% of the
permanent  single-family  residential  loans held by the Company for  investment
consisted  of loans which  provide for fixed rates of interest.  Although  these
loans provide for repayments of principal over a fixed period of up to 30 years,
it is  the  Company's  experience  that  such  loans  remain  outstanding  for a
substantially shorter period of time.

         The Company is generally  permitted to lend up to 100% of the appraised
value of the real property  securing a residential  loan (referred to as the LTV
ratio);  however,  if the amount of a residential  loan originated or refinanced
exceeds  90%  of the  appraised  value,  the  Company  is  required  by  federal
regulations  to  obtain  appropriate  credit  enhancement  in the form of either
mortgage  insurance or readily marketable  collateral.  Pursuant to underwriting
guidelines adopted by the Board of Directors, the Company will lend up to 95% of
the appraised  value of the property  securing an  owner-occupied  single-family
residential  loan, and generally  requires  borrowers to obtain private mortgage
insurance  on loans  which  have a  principal  amount  that  exceeds  80% of the
appraised  value of the security  property.  The extent of coverage is dependent
upon the LTV ratio at the time of origination.



                                       17
<PAGE>

         The Company generally requires title insurance insuring the priority of
its mortgage lien, as well as fire and extended coverage  casualty  insurance in
order to protect the  properties  securing its  residential  and other  mortgage
loans.  Borrowers may be required to advance funds, with each monthly payment of
principal  and interest,  to a loan escrow  account from which the Company makes
disbursements for items such as real estate taxes, hazard insurance premiums and
mortgage  insurance  premiums  as  they  become  due.  Substantially  all of the
properties  securing all of the Company's mortgage loans originated or closed by
the Bank and/or Essex First are appraised by independent appraisers that conform
to  guidelines  established  pursuant  to  FIRREA  and  regulations  promulgated
thereunder.

         Home  equity  line of credit  loans have a maximum  commitment  of five
years,  which may be extended  within the sole  discretion of the Bank,  and the
interest  rate is set at the Bank's  prime rate plus a margin.  The Company will
lend  up to a 90%  LTV  ratio  and the  loan  can be  secured  by a  primary  or
subordinate  mortgage on the property.  The Company will originate the loan even
if another  institution  holds the first  mortgage.  At December 31, 1997,  home
equity lines of credit totaled $417,000  ($248,000 of which had been utilized by
borrowers as of such date).

         Construction  Loans. In recent years, the Company has been increasingly
active in originating  loans to construct  primarily  single-family  residences.
These  construction  lending  activities  generally are limited to the Company's
primary  market,  with  particular  emphasis in the greater  Richmond,  Virginia
market,  the  Tidewater,  Virginia  area  and  counties  in  northeastern  North
Carolina. At December 31, 1997,  construction loans amounted to $16.6 million or
9.8% of the  Company's  total loans held for  investment.  As of such date,  the
Company's  entire  portfolio of  construction  loans  consisted of loans for the
construction of single-family residences.

         The Company offers  construction loans to individual  borrowers as well
as to local real estate builders,  contractors and developers for the purpose of
constructing  single-family  residences.  Substantially  all  of  the  Company's
construction  lending to individuals is originated on a C/P mortgage loan basis.
C/P loan  originations  are made by Essex  First loan  officers  or through  the
wholesale C/P lending program,  which is a network of 68 approved  brokers.  C/P
loans  are made to  individuals  who hold a  contract  with a  licensed  general
contractor to construct their personal residence.  The construction phase of the
loan  currently  provides  for monthly  payments on an interest  only basis at a
designated  prime  rate  (plus  100 basis  points)  for up to six  months.  Upon
completion of  construction,  the loan converts to a permanent loan at either an
adjustable or fixed interest rate,  consistent with the Company's  policies with
respect to residential real estate  financing.  Essex First's  construction loan
department approves the proposed contractors and administers the loan during the
construction  phase.  The Company's C/P loan program has been  successful due to
its  ability to offer  borrowers a single  closing  and,  consequently,  reduced
costs.  At December 31, 1997, the Company's C/P portfolio  included 60 C/P loans
with an aggregate  principal  balance of $7.1 million (and an  additional  $10.9
million was subject to legally binding  commitments but had not been advanced as
of such date).

         The Company  also offers  construction  loans to real estate  builders,
contractors and developers for the construction of  single-family  residences on
both a presold and speculative  basis.  Construction loans to builders generally
have a three-year note with annual  renewals  throughout the term, with payments
being made  monthly on an interest  only basis (at 100 basis points to 200 basis
points over a  designated  prime  rate).  Upon  application,  credit  review and
analysis of personal and corporate financial statements,  the Company will grant
builders  lines of credit up to designated  amounts.  The Company will generally
limit  the  number  of homes  that may be built  by any  individual  builder  or
developer on a speculative basis depending on the builder's  financial  strength


                                       18
<PAGE>

and total exposure to other lenders.  Although at December 31, 1997, the Company
did not have any real estate acquisition and development loans in its portfolio,
the Company may in the future, on a case-by-case  basis,  grant a limited amount
of real estate  acquisition  and  development  loans.  At December 31, 1997, the
Company's  construction  loan  portfolio  included  101  loans  to 39  different
builders with an aggregate  principal balance of $8.5 million (and an additional
$26.3  million  was  subject to  legally  binding  commitments  but had not been
advanced as of such date). Of this $8.5 million of builder loans,  approximately
$6.8 million  consisted of construction  loans for which there were no contracts
for sale at the time of origination.

         The  Company  intends  to  continue  to  increase  its  involvement  in
construction  lending. Such loans afford the Company the opportunity to increase
the interest rate  sensitivity of its loan  portfolio.  Construction  lending is
generally  considered  to  involve  a  higher  level  of  risk  as  compared  to
single-family  residential  lending,  due to the concentration of principal in a
limited  number of loans and  borrowers  and the  effects  of  general  economic
conditions on real estate developers and managers. Moreover, a construction loan
can involve  additional  risks because of the inherent  difficulty in estimating
both a property's  value at  completion  of the project and the  estimated  cost
(including interest) of the project. The nature of these loans is such that they
are generally more difficult to evaluate and monitor.  In addition,  speculative
construction  loans to a builder are not  necessarily  pre-sold  and thus pose a
greater potential risk to the Company than construction  loans to individuals on
their personal residences.

         The Company has taken steps to minimize the  foregoing  risks by, among
other  things,  limiting  its  construction  lending  primarily  to  residential
properties.  In addition, the Company has adopted underwriting  guidelines which
impose  stringent  LTV (80%  during  the  construction  phase  with  respect  to
single-family  residential real estate), debt service and other requirements for
loans which are believed to involve higher  elements of credit risk, by limiting
the  geographic  area in which the Company  will do business and by working with
builders with whom it has established relationships or knowledge thereof.

         Commercial Real Estate Loans. The Company has also originated  mortgage
loans  secured by  multi-family  residential  and  commercial  real  estate.  At
December 31, 1997,  $6.0 million or 3.5% of the  Company's  total loans held for
investment consisted of such loans.

         Commercial  real estate loans  originated  by the Company are primarily
secured by office  buildings,  retail  stores,  warehouses  and general  purpose
industrial  space.  Commercial  real  estate  loans  also  include  multi-family
residential  loans,  substantially  all of which are secured by small  apartment
buildings.  At December 31, 1997,  $1.3 million or 21.7% of the Company's  total
commercial real estate loans were comprised of multi-family residential loans.

         Although  terms  vary,  commercial  real  estate  loans  generally  are
amortized over a period of up to 20 years and mature in seven years or less. The
Company  will  originate  these loans either with fixed  interest  rates or with
interest  rates  which  adjust in  accordance  with a  designated  index,  which
generally is negotiated at the time of origination.  LTV ratios on the Company's
commercial  real estate loans are currently  limited to 80% or lower. As part of
the  criteria  for  underwriting  commercial  real  estate  loans,  the  Company
generally  imposes a specified  debt coverage  ratio (the ratio of net cash from
operations  before  payment  of debt  service to debt  service).  It is also the
Company's  general  policy  to  seek  additional   protection  to  mitigate  any
weaknesses  identified in the underwriting  process.  Additional strength may be
provided via mortgage insurance, secondary collateral and/or personal guarantees
from the principals of the borrower.

         Commercial real estate lending entails  different and significant risks
when compared to single-family  residential lending because such loans typically
involve  large  loan  balances  to single  borrowers  and  because  the  payment
experience on such loans is typically  dependent on the successful  operation of
the project or the borrower's  business.  These risks can also be  significantly
affected by supply and demand  conditions  in the local  market for  apartments,


                                       19
<PAGE>

offices,  warehouses or other commercial space. The Company attempts to minimize
its risk exposure by limiting the extent of its commercial lending. In addition,
the Company imposes  stringent LTV ratios,  requires  conservative debt coverage
ratios,  and  continually  monitors the operation and physical  condition of the
collateral.

         Commercial  Business  Loans.  From time to time, and in connection with
its community bank activities,  the Company has originated  secured or unsecured
loans for commercial, corporate, business and agricultural purposes. At December
31, 1997,  $1.9 million or 1.1% of the Company's total loans held for investment
consisted of commercial business loans. The Company's  commercial business loans
consist  primarily  of loans and lines of credit  secured by various  equipment,
machinery and other corporate assets.

         Consumer Loans. Subject to restrictions contained in applicable federal
laws and regulations, the Company is authorized to make loans for a wide variety
of personal or consumer  purposes.  The Company has recently  begun to emphasize
the  origination and purchase of consumer loans in order to provide a full range
of financial  services to its  customers and because such loans  generally  have
shorter terms and higher  interest  rates than mortgage  loans.  At December 31,
1997,  $6.2  million or 3.7% of the  Company's  total loans held for  investment
consisted of consumer  loans.  The consumer loans offered by the Company include
automobile loans, boat and recreational  vehicle loans, mobile home loans, loans
secured by deposit accounts and unsecured personal loans.

         The Company currently offers loans secured by deposit  accounts,  which
amounted to $805,000 at December 31, 1997.  Such loans are  originated for up to
90% of the account  balance,  with a hold placed on the account  restricting the
withdrawal of the account  balance.  At December 31, 1997,  the  Company's  loan
portfolio  also included $1.5 million of  automobile  loans,  $384,000 of mobile
home loans and $41,000 of boat and recreational vehicle loans.

         Consumer loans  generally have shorter terms and higher  interest rates
than mortgage  loans and generally  involve more credit risk than mortgage loans
because of the type and nature of the  collateral  and,  in certain  cases,  the
absence of collateral.  In addition,  consumer lending collections are dependent
on the borrower's continuing financial stability, and thus are more likely to be
adversely effected by job loss,  divorce,  illness and personal  bankruptcy.  In
many cases,  any repossessed  collateral for a defaulted  consumer loan will not
provide an adequate source of repayment of the outstanding  loan balance because
of improper  repair and  maintenance of the underlying  security.  The remaining
deficiency may not warrant further  substantial  collection  efforts against the
borrower.

         Loan Fee Income.  In addition to interest earned on loans,  the Company
receives income through servicing of loans,  unamortized loan fees in connection
with loan sales and fees in connection with loan  modifications,  late payments,
prepayments and miscellaneous  services related to its loans.  Income from these
activities  varies from period to period with the volume and types of loans made
and competitive conditions.

         In connection with its loan origination  activities,  the Company often
charges loan  origination fees that are calculated as a percentage of the amount
borrowed.  The Company generally charges a borrower on a single-family home loan
a loan  origination  fee based on the  principal  amount  of the loan,  with the
actual amount being  dependent upon,  among other things,  the interest rate and
market  conditions at the time the loan application is taken.  These fees are in
addition to appraisal  and other fees paid by the borrower to the Company at the
time of the  application.  The Company's policy is to defer all loan origination


                                       20
<PAGE>

fees  net  of  direct  origination  costs  and  amortize  those  fees  over  the
contractual lives of the related loans. Amortization of loan fees is included in
interest income.  Nevertheless,  the predominant  portion of the Company's loans
are  originated  for  resale  and,  consequently,  related  net  loan  fees  are
recognized as mortgage banking income upon consummation of the loan sales.

         When loans are sold with servicing  rights  released to the buyer,  the
Company also recognizes current income from receipt of servicing release fees in
addition  to  receiving a premium or  deducting  a discount  based on the market
value of the loan,  which is dependent  upon,  among other things,  the interest
rate and market  conditions  at the time the sales price is  locked-in  with the
buyer. Sales prices for loans originated for resale are generally locked-in with
a buyer at the time of origination  in order to minimize the Company's  interest
rate risk. When loans are sold with servicing  retained,  the Company recognizes
additional  gains based on the estimated  fair value of the servicing  retained.
Recognition of such gains creates originated mortgage servicing rights ("OMSRs")
for the Company,  which are capitalized and amortized in proportion to, and over
the  period  of,  the  estimated  future  net  servicing  income  stream  of the
underlying  mortgage  loans.  OMSRs amounted to $782,000,  $1.1 million and $1.6
million at  December  31,  1997,  1996 and 1995,  respectively.  For  additional
information regarding the Company's servicing assets, see Note 2 of the Notes to
Consolidated  Financial  Statements  on pages 32 through  35 of the 1997  Annual
Report to Stockholders,  which is attached hereto as Exhibit 13 and incorporated
herein by reference.

         Through Essex Home,  the Company  services  loans that are owned by the
Bank and other investors.  At December 31, 1997,  approximately 8,400 loans with
principal  balances of $482.7 million were serviced or subserviced by Essex Home
as  compared  to  approximately  13,300  loans with  principal  balances of $1.1
billion as of December 31, 1996. On February 28, 1997,  the Company was notified
by its largest  subservicing  client (with  approximately  7,000 loans  totaling
$858.9  million  as of  December  31,  1996) of its  intention  not to renew its
contract beyond June 1, 1997. As a result,  during 1997 the Company's management
intensified  its  marketing  efforts and initiated  cost  reductions in order to
minimize the impact of this loss on the earnings  performance  of Essex Home and
the Company.  Essex Home has replaced a portion of the lost servicing  volume by
entering into 18 new subservicing  contracts  consisting of approximately  2,100
loans with an aggregate  principal  balance of $201.4 million as of December 31,
1997 and, to a lesser extent, by acquiring mortgage  servicing rights.  However,
no assurances can be made that the lost servicing  volume can be replaced in its
entirety in the near term.

Asset Quality

         Delinquent Loans. When a borrower fails to make a required payment on a
loan, the Company attempts to cure the deficiency by contacting the borrower and
seeking payment.  Contacts are generally made on the 15th day after a payment is
due and a late charge is assessed at such time. In most cases,  deficiencies are
cured  promptly.  If a delinquency  extends beyond 30 days, the loan and payment
history is carefully  reviewed,  additional notices are sent to the borrower and
additional  efforts  are made to collect the loan.  While the Company  generally
prefers  to work with  borrowers  to resolve  such  problems,  when the  account
becomes  90  days  delinquent,  the  Company  institutes  foreclosure  or  other
proceedings, as necessary, to minimize any potential loss.





                                       21
<PAGE>




         The following  table sets forth  information  concerning  the principal
balances and percent of the total loan portfolio held for investment represented
by delinquent loans at the dates indicated:
<TABLE>
<CAPTION>
<S> <C>
                                                                     December 31,
                                          -----------------------------------------------------------------
                                                  1997                   1996                   1995
                                          -------------------    -------------------   --------------------
                                            Amount   Percent       Amount    Percent      Amount    Percent
                                                                (dollars in thousands)
         30-59 days (1).................   $   645    .38%         $1,156     .78%        $2,222     .82%
         60-89 days (1).................       295    .17             335     .23            942     .34
         90 or more days (1), (2).......     1,577    .93           2,938    1.98          6,258    2.30
                                             -----  -----           -----   -----          -----    ----
                                            $2,517   1.48%         $4,429    2.99%        $9,422    3.46%
                                             =====  =====           =====   =====         ======    ====
</TABLE>

         (1)  Includes at December 31, 1997,  $217,000,  $16,000 and $305,000 of
              loans  delinquent  30-59  days,  60-89  days  and 90 days or more,
              respectively,  which were  acquired  in  connection  with the Home
              Acquisition.  Includes at December 31, 1996, $185,000, $70,000 and
              $611,000 of loans delinquent 30-59 days, 60-89 days and 90 days or
              more,  respectively,  which were acquired in  connection  with the
              Home  Acquisition.   Includes  at  December  31,  1995,  $977,000,
              $381,000 and $1.2 million of loans  delinquent  30-59 days,  60-89
              days and 90 days or more,  respectively,  which were  acquired  in
              connection with the Home Acquisition.

         (2)  Includes $21,000, $30,000 and $177,000 of loans that were accruing
              interest at December 31, 1997, 1996, and 1995, respectively.

         Nonperforming Assets. All loans are reviewed on a regular basis and are
placed  in  nonaccrual  status  based  on  the  loan's  delinquency  status,  an
evaluation of the related  collateral,  and the borrower's  ability to repay the
loan.  Generally,  loans  past due more than 90 days are  placed  in  nonaccrual
status;  however, in instances where the borrower has demonstrated an ability to
make  timely  payments,  loans  past due more  than 90 days are  returned  to an
accruing status.  Such loans may be returned to accruing status, even though the
loans have not been brought  fully  current,  provided two criteria are met: (i)
all principal and interest amounts contractually due (including  arrearages) are
reasonably  assured of repayment within a reasonable period, and (ii) there is a
sustained period of repayment performance (generally a minimum of six months) by
the borrower.  Consumer  loans  generally are  charged-off or fully reserved for
when  the  loan  becomes  over 120 days  delinquent.  When a loan is  placed  in
nonaccrual status,  interest accruals cease and uncollected  accrued interest is
reversed and charged against current income.  Additional interest income on such
loans is recognized only when received.

         In certain circumstances, for reasons related to a borrower's financial
difficulties,  the Company may grant a concession  to the borrower that it would
not  otherwise  consider.  Such  restructuring  of  troubled  debt may include a
modification of loan terms and/or a transfer of assets (or equity interest) from
the borrower to the Company.

         If a foreclosure action is instituted with respect to a particular loan
and the loan is not reinstated, paid in full or refinanced, the property is sold
at a foreclosure  sale in which the Company may participate as a bidder.  If the
Company is the  successful  bidder,  the  acquired  property  is  classified  as
foreclosed property until it is sold. Properties acquired in settlement of loans
are initially  recorded at fair value less estimated  costs to sell.  Valuations
are  periodically  performed  by  management,  and an  allowance  for  losses is
established  by a charge  to  operations  if the  carrying  value of a  property
exceeds its fair market value less the estimated  costs to sell.  Costs incurred
in  connection  with  ownership of the  property,  including  interest on senior


                                       22
<PAGE>

indebtedness,  are  expensed  to  the  extent  not  previously  allowed  for  in
calculating  fair value less  estimated  costs to sell.  Costs  relating  to the
development or  improvement of the property are  capitalized to the extent these
costs  increase  fair value less  estimated  costs to sell.  Sales of foreclosed
properties  are  recorded  under the accrual  method of  accounting.  Under this
method,  a sale is not  recognized  unless the buyer has  assumed  the risks and
rewards  of  ownership,  including  an  adequate  cash down  payment.  Until the
contract qualifies as a sale, all collections are recorded as deposits.

         The  following  table sets forth  information  regarding  nonperforming
assets held by the Company at the dates indicated (dollars in thousands):
<TABLE>
<CAPTION>
<S> <C>
                                                                           December 31,
                                                 -----------------------------------------------------------------
                                                        1997                   1996                     1995
                                                        ----                   ----                     ----
                                                             % of                    % of                    % of
                                                             Total                   Total                   Total
                                                 Amount      Loans       Amount      Loans       Amount      Loans
                                                 ------      -----       ------      -----       ------      -----
Nonaccrual loans, net:
   Single-family residential................     $1,203       .71%        $2,513     1.70%      $  2,959      1.09%
   Construction.............................        133       .08            220      .15            378       .14
   Commercial...............................        132       .08             22      .01          2,636       .97
   Consumer.................................         88       .05            153      .10            108       .04
                                                  -----     -----          -----     ----        -------      ----
     Total nonaccrual loans.................      1,556       .92          2,908     1.96          6,081      2.24

Accruing loans 90 days or more past due.....         21       .01             30      .02            177       .06

Troubled debt restructurings................        209       .12            223      .15            143       .05
                                                  -----     -----          -----     ----        -------      ----
     Total nonperforming loans..............      1,786      1.05          3,161     2.13          6,401      2.35

Foreclosed properties, net..................      1,512       .89          2,054     1.39          4,856      1.78
                                                  -----     -----          -----     ----        -------      ----

     Total nonperforming assets.............     $3,298      1.94%        $5,215     3.52%       $11,257      4.13%
                                                  =====     ====           =====    ====          ======     ====

Nonperforming loans to total loans..........                 1.05%                    2.13%                   2.35%
Nonperforming assets to total assets........                 1.69                     2.99                    3.32
Allowance for loan losses to total loans....                 1.40                     1.73                    1.93
Allowance for loan losses to nonaccrual
   loans....................................               153.09                    87.90                   86.35
Allowance for loan losses to nonperforming
   loans....................................               133.37                    80.86                   82.03
<CAPTION>

                                                        1994                   1993
                                                        ----                   ----
                                                             % of                    % of
                                                             Total                   Total
                                                 Amount      Loans       Amount      Loans
Nonaccrual loans, net:                           ------      -----       ------      -----
   Single-family residential................   $  3,158       1.31%     $  4,801      2.28%
   Construction.............................      1,253        .52            17       .01
   Commercial...............................      2,306        .96           513       .25
   Consumer.................................         57        .02            93       .04
                                                -------       ----       -------      ----
     Total nonaccrual loans.................      6,774       2.81         5,424      2.58

Accruing loans 90 days or more past due.....        539        .22         1,136       .54

Troubled debt restructurings................      1,049        .44         2,948      1.40
                                                -------       ----       -------      ----
     Total nonperforming loans..............      8,362       3.47         9,508      4.52

Foreclosed properties, net..................      5,290       2.19         8,582      4.08
                                                -------       ----       -------      ----

     Total nonperforming assets.............    $13,652       5.66%      $18,090      8.60%
                                                 ======       ====        ======      ====

Nonperforming loans to total loans..........                  3.47%                   4.52%
Nonperforming assets to total assets........                  4.61                    4.63
Allowance for loan losses to total loans....                  1.42                    1.45
Allowance for loan losses to nonaccrual
   loans....................................                 50.62                   56.03
Allowance for loan losses to nonperforming
   loans....................................                 41.01                   31.96

</TABLE>


                                       23
<PAGE>

         Gross  interest  income that would have been recorded  during the years
ended December 31, 1997, 1996, and 1995 if the Company's nonaccrual loans at the
end of such periods had been  performing in  accordance  with their terms during
such periods was $171,000, $291,000 and $678,000, respectively.

         The $1.6 million of nonaccrual  loans at December 31, 1997 consisted of
$1.2 million of loans secured by single-family residential property, $133,000 of
construction  loans (which were secured by  residential  property),  $132,000 of
loans secured by commercial  property and $88,000 of consumer loans. The $21,000
of accruing loans 90 days or more past due at December 31, 1997 consisted of one
loan secured by  single-family  residential  property.  The $209,000 of troubled
debt  restructurings  at December 31, 1997  consisted of three loans  secured by
single-family   residential  property,  one  secured  commercial  loan  and  one
unsecured loan.

         The  Company's  decrease  in  nonaccrual  loans  during  1997  occurred
primarily in loans  secured by  single-family  residential  property.  This $1.4
million  decrease  was  attributable  to the  improvement  in asset  quality  as
evidenced by the decline in delinquencies.

         The  $1.5  million  of  foreclosed  properties  at  December  31,  1997
consisted of $1.3 of single-family  residential properties and $257,000 of land.
The  Company's  decrease in  foreclosed  properties  reflected the impact of the
decline in  nonperforming  and delinquent  loans during 1997 and prior years. In
addition, during 1997 the Company completed the sale of residential lots located
in the Outer Banks of North Carolina,  which had a carrying value of $164,000 at
December 31, 1996.

         For additional  information about the Company's  nonperforming  assets,
see "Management's  Discussion and Analysis of Financial Condition and Results of
Operations - Financial  Condition -  Nonperforming  Assets" on pages 6 and 7 and
Notes 8 and 9 of the  Notes to  Consolidated  Financial  Statements  on pages 39
through 41 of the 1997 Annual Report to  Stockholders,  which is attached hereto
as Exhibit 13 and incorporated herein by reference.

         Classified  Assets.  Federal  regulations  require  that  each  insured
savings  institution  classify its assets on a regular  basis.  In addition,  in
connection with  examinations of insured  institutions,  federal  examiners have
authority to identify  problem assets and, if appropriate,  classify them. There
are three  classifications  for problem  assets:  "substandard,"  "doubtful" and
"loss."  Substandard  assets  have  one  or  more  defined  weaknesses  and  are
characterized  by the distinct  possibility  that the insured  institution  will
sustain some loss if the  deficiencies  are not corrected.  Doubtful assets have
the weaknesses of substandard assets with the additional characteristic that the
weaknesses  make  collection  or  liquidation  in full on the basis of currently
existing  facts,  conditions  and  values  questionable,  and  there  is a  high
possibility of loss. An asset classified as loss is considered uncollectible and
of such little  value that  continuance  as an asset of the  institution  is not
warranted.   Another  category   designated   "special  mention"  also  must  be
established  and maintained for assets which do not currently  expose an insured
institution  to a  sufficient  degree  of  risk  to  warrant  classification  as
substandard,  doubtful or loss.  Assets  classified as  substandard  or doubtful
require the institution to establish  general  allowances for loan losses. If an
asset or portion  thereof is classified as loss,  the insured  institution  must
either  establish  specific  allowances for loan losses in the amount of 100% of
the portion of the asset  classified  loss, or charge-off  such amount.  General
loss  allowances   established  to  cover  possible  losses  related  to  assets
classified   substandard   or  doubtful  may  be  included  in   determining  an
institution's  risk-based capital,  while specific valuation allowances for loan
losses do not qualify as regulatory capital. Federal examiners may disagree with
an insured institution's classifications and amounts reserved.



                                       24
<PAGE>

         In addition to the  nonperforming  assets  discussed above, at December
31, 1997, the Company had  classified  for  regulatory and internal  purposes an
additional  $2.1  million of  assets,  $1.6  million  of which  were  classified
substandard,  $149,000 of which were  classified  doubtful and $350,000 of which
were classified loss.

         Allowance for Losses on Loans and Foreclosed  Properties.  An allowance
for loan losses is maintained at a level that management  considers  adequate to
provide for potential  losses based upon an evaluation of the inherent  risks in
the loan portfolio.  Management's determination of the adequacy of the allowance
is based on an  evaluation  of the  portfolio,  past  loss  experience,  current
economic conditions,  volume, growth and composition of the portfolio, and other
relevant factors. The allowance is increased by provisions for loan losses which
are charged against income. While management uses the best information available
to make such evaluations,  future  adjustments to the allowance may be necessary
if economic conditions differ  substantially from the assumptions used in making
the evaluations.  For additional information,  see Notes 8 and 9 of the Notes to
Consolidated  Financial  Statements  on pages 39 through  41 of the 1997  Annual
Report to Stockholders,  which is attached hereto as Exhibit 13 and incorporated
herein by reference.

         The following table sets forth  information  concerning the activity in
the Company's allowance for loan losses during the years indicated:
<TABLE>
<CAPTION>
<S> <C>
                                                                        Year Ended December 31,
                                                 -------------------------------------------------------------
                                                     1997         1996           1995        1994        1993
                                                     ----         ----           ----        ----        ----
                                                                       (dollars in thousands)
Loans, net of unearned fees and discounts:
     Year-end..................................     $169,823     $148,107      $271,883    $240,821    $209,820
     Average outstanding during period.........      156,217      216,803       251,108     218,806     267,143

Allowance for loan losses:
     Balance, beginning of year................       $2,556       $5,251    $    3,429  $    3,039  $    4,489
     Allowance transferred in connection
         with the Home Acquisition.............            -            -           500           -           -
     Provision for loan losses.................          113        1,411         2,477       1,604       1,085
                                                      ------        -----     ---------   ---------   ---------
                                                       2,669        6,662         6,406       4,643       5,574
     Charge-offs, net of recoveries (1):
         Commercial (2)........................         (366)       2,892           644           -          82
         Real estate - mortgage................          535          894           494       1,255       2,248
         Consumer .......................                118          320            17         (41)        205
                                                      ------        -----     ---------   ---------   ---------
              Total (2)........................          287        4,106         1,155       1,214       2,535
                                                      ------        -----     ---------   ---------   ---------
     Balance, end of year......................       $2,382       $2,556    $    5,251  $    3,429  $    3,039
                                                       =====        =====     =========   =========   =========

Ratio of net charge-offs to average
  outstanding loans (2)........................          .18%        1.89%          .46%        .55%        .95%
Allowance for loan losses to year-end
  total nonperforming loans....................       133.37%       80.86%        82.03%      41.01%      31.96%
Allowance for loan losses to year-end
  loans, net of unearned fees and discounts....         1.40%        1.73%         1.93%       1.42%       1.45%
</TABLE>

     (1)   Except as noted in (2) below,  recoveries  of prior loan  charge-offs
           were not significant for the periods presented.

     (2)   Charge-offs  during  1997  include  a  $329,000  recovery  on a  loan
           guarantee  associated with the Richmond Apartments loan and a $39,000
           recovery  associated  with  claims  against  the estate of a deceased
           borrower.  Excluding the impact of these recoveries, the ratio of net
           charge-offs  to  average   outstanding   loans  for  1997  was  .42%.
           Charge-offs  during 1996  include the $2.8  million  write-off of the
           Richmond  Apartments  loan.  Excluding the impact of this charge-off,
           the ratio of net  charge-offs to average  outstanding  loans for 1996
           was .59%.





                                       25
<PAGE>

         The following table sets forth information concerning the allocation of
the  Company's  allowance  for  loan  losses  by loan  categories  at the  dates
indicated.
<TABLE>
<CAPTION>
<S> <C>
                                                                     December 31,
                        ----------------------------------------------------------------------------------------------
                             1997                1996                 1995               1994               1993
                        ----------------    ----------------    ----------------    ----------------  ----------------
                        Amount   Percent    Amount   Percent    Amount   Percent    Amount   Percent  Amount   Percent
                        -------  -------    -------  -------    ------   -------    ------   -------  ------   -------
                                                            (dollars in thousands)

Residential mortgage   $1,139      91.7%    $1,636     89.9%    $2,607     92.5%     2,068     91.9%  $2,080     92.0%
Commercial (1)            545       4.6        505      5.6      1,530      4.7        861      5.6      387      6.0
Consumer                  254       3.7        299      4.5        323      2.8        467      2.5      424      2.0
Unallocated               444         -        116        -        791        -         33        -      148        -
                       ------      ----     ------     ----     ------     ----      -----     ----   ------     ----
                       $2,382     100.0%    $2,556    100.0%    $5,251    100.0%    $3,429    100.0%  $3,039    100.0%
                       ======     =====     ======    =====     ======    =====     ======    =====   ======    =====

(1) Includes commercial real estate and commercial business loans.

         The  Company  also  maintains  an  allowance  for losses on  foreclosed
properties.  The following table sets forth information  concerning the activity
in the  Company's  allowance  for  losses on  foreclosed  properties  during the
periods indicated:
<CAPTION>

                                                                            Year Ended December 31,
                                                                   ----------------------------------------
                                                                    1997             1996              1995
                                                                    ----             ----              ----
                                                                            (dollars in thousands)
         Balance at beginning of year.....................         $ 179              $199             $ 418
         Provision for losses on
           foreclosed properties..........................           159               (21)               79
                                                                    ----              ----             -----
                                                                     338               178               497
         Charge-offs, net of recoveries...................          (183)                1              (298)
                                                                    ----             -----              ----
         Balance at end of year...........................         $ 155              $179             $ 199
                                                                    ====               ===              ====
</TABLE>
Investment Activities

         Mortgage-Backed Securities.  Mortgage-backed securities (which also are
known as  mortgage  participation  certificates  or  pass-through  certificates)
represent a participation  interest in a pool of  single-family  or multi-family
mortgages,  the  principal  and  interest  payments on which are passed from the
mortgage originators, through intermediaries (generally U.S. Government agencies
and government sponsored  enterprises) that pool and repackage the participation
interests in the form of securities, to investors such as the Company. Such U.S.
Government agencies and government  sponsored  enterprises,  which guarantee the
payment of principal and interest to investors,  primarily  include Freddie Mac,
Fannie Mae and Ginnie Mae.

         Freddie Mac is a public  corporation  chartered by the U.S.  Government
and  owned by the 12  Federal  Home  Loan  Banks  and  federally-insured  member
institutions  of  the  Federal  Home  Loan  Bank  system.   Freddie  Mac  issues
participation  certificates  backed principally by conventional  mortgage loans.
Freddie Mac guarantees the timely payment of interest and the ultimate return of
principal.  Fannie Mae is a private  corporation  chartered by the U.S. Congress
with a mandate to establish a secondary market for conventional  mortgage loans.
Fannie Mae guarantees the timely payment of principal and interest on Fannie Mae
securities.  Freddie  Mac and Fannie Mae  securities  are not backed by the full
faith and credit of the United  States,  but because  Freddie Mac and Fannie Mae
are quasi-Government and U.S.  Government-sponsored  enterprises,  respectively,
these securities are considered to be among the highest quality investments with
minimal credit risks. Ginnie Mae is a government agency within the Department of
Housing   and   Urban   Development   which   is   intended   to  help   finance
government-assisted  housing  programs.  Ginnie  Mae  securities  are  backed by


                                       26
<PAGE>

FHA-insured  and  VA-guaranteed  loans,  and the timely payment of principal and
interest on Ginnie Mae securities are guaranteed by Ginnie Mae and backed by the
full faith and credit of the U.S.  Government.  Because  Freddie Mac, Fannie Mae
and Ginnie Mae were  established to provide  support for low- and  middle-income
housing,  there are limits to the maximum  size of loans that  qualify for these
programs. To accommodate  larger-sized loans, and loans that, for other reasons,
do not conform to the agency  programs,  a number of independent  companies have
established their own home-loan origination and securitization programs.

         Mortgage-backed  securities  typically are issued with stated principal
amounts,  and the  securities  are backed by pools of mortgages  that have loans
with  interest  rates that are within a range and have varying  maturities.  The
characteristics  of the  underlying  pool  of  mortgages,  i.e.,  fixed-rate  or
adjustable-rate,  as well as prepayment  risk, are passed on to the  certificate
holder.  The life of a mortgage-backed  pass-through  security thus approximates
the life of the underlying mortgages.

         The  Company's   mortgage-backed   securities  include   collateralized
mortgage obligations ("CMOs"), which include securities issued by entities which
have  qualified  under the  Internal  Revenue  Code (the  "Code") as Real Estate
Mortgage Investment Conduits ("REMICs").  CMOs and REMICs  (collectively,  CMOs)
have been developed in response to investor  concerns  regarding the uncertainty
of cash flows associated with the prepayment option of the underlying  mortgagor
and  are  typically  issued  by  government   agencies,   government   sponsored
enterprises  and  special  purpose  entities,  such as trusts,  corporations  or
partnerships,   established   by  financial   institutions   or  other   similar
institutions.  A CMO can be  collateralized  by loans or  securities  which  are
insured or guaranteed  by Fannie Mae,  Freddie Mac or Ginnie Mae. In contrast to
pass-through mortgage-backed securities, in which cash flow is received pro rata
by all security  holders,  the cash flow from the mortgages  underlying a CMO is
segmented  and paid in  accordance  with a  predetermined  priority to investors
holding various CMO classes. By allocating the principal and interest cash flows
from the underlying collateral among the separate CMO classes, different classes
of bonds are created, each with its own stated maturity, estimated average life,
coupon rate and prepayment characteristics.

         Mortgage-backed  securities  generally  increase  the  quality  of  the
Company's  assets by virtue of the insurance or guarantees  that back them,  are
more  liquid than  individual  mortgage  loans and may be used to  collateralize
borrowings or other obligations of the Company.

         The   following   table  sets  forth  the  activity  in  the  Company's
mortgage-backed securities portfolio during the periods indicated:
<TABLE>
<CAPTION>
<S> <C>
                                                           At or For the Year Ended December 31,
                                                         ---------------------------------------
                                                         1997              1996             1995
                                                         ----              ----             ----
                                                                  (dollars in thousands)
         Balance at beginning of year............       $1,905            $15,650         $18,223
         Sales...................................            -             (9,915) (1)          -
         Repayments..............................            -             (3,668) (2)     (2,724)
         Amortization............................            -                 (8)             (3)
         Valuation adjustments...................            -               (154)            154
                                                      --------            -------        --------
         Balance at end of year..................       $1,905            $ 1,905         $15,650 (3)
                                                        ======            =======         =======

         Weighted average coupon at end
            of year..............................         6.65%              6.40%           7.25%
                                                        ======            =======         =======
</TABLE>

         (1)  Represents sale of  mortgage-backed  securities in connection with
              the sale of branches during 1996.
         (2)  Includes the termination and  reclassification of a Company-issued
              second  mortgage REMIC totaling $2.7 million from  mortgage-backed
              securities to loans.
         (3)  Includes $13.7 million of mortgage-backed securities classified as
              available for sale at December 31, 1995.

         The Company's investment in mortgage-backed  securities at December 31,
1997 consists  solely of a $1.9 million  Fannie Mae guaranteed  adjustable  rate
REMIC.  The Company does not currently own and does not anticipate  investing in


                                       27
<PAGE>

mortgage-backed  securities that would be deemed "high risk" securities pursuant
to OTS Thrift Bulletin 52. The Company's mortgage-backed  securities are carried
in accordance with generally accepted accounting  principles.  See Note 7 of the
Notes to Consolidated  Financial Statements on page 39 of the 1997 Annual Report
to Stockholders,  which is attached hereto as Exhibit 13 and incorporated herein
by reference.

         Investment  Securities.  Federally-chartered  savings institutions have
authority to invest in various types of liquid assets,  including  United States
Treasury  obligations,  securities of various Federal  agencies and of state and
municipal  governments,  certificates of deposit at federally-insured  banks and
savings and loan associations,  certain bankers'  acceptances and Federal funds.
Subject to various  restrictions,  federally-chartered  savings institutions may
also  invest a portion  of their  assets in  commercial  paper,  corporate  debt
securities and mutual funds, the assets of which conform to the investments that
federally-chartered  savings  institutions  are  otherwise  authorized  to  make
directly.

         The Bank's investment  securities portfolio is managed by the Treasurer
of the Bank in accordance with a comprehensive investment policy which addresses
strategies,  types and levels of allowable investments and which is reviewed and
approved  by the  Board of  Directors  on an  annual  basis and by the Asset and
Liability  Management  Committee as  circumstances  warrant.  The Bank currently
emphasizes lending activities in order to increase the weighted average yield on
the Bank's interest-earning assets. The Bank's investment securities are carried
in accordance with generally accepted accounting  principles.  See Note 6 of the
Notes to Consolidated  Financial Statements on page 38 of the 1997 Annual Report
to Stockholders,  which is attached hereto as Exhibit 13 and incorporated herein
by reference.

         The  following  table sets forth  certain  information  relating to the
Company's investment securities held for investment at the dates indicated:
<TABLE>
<CAPTION>
<S> <C>
                                                                      December 31,
                                                1997                      1996                       1995
                                      -----------------------   -----------------------   -----------------------
                                       Carrying      Market       Carrying      Market      Carrying      Market
                                         Value        Value         Value        Value        Value        Value
                                         -----        -----         -----        -----        -----        -----
                                                                 (dollars in thousands)
     U.S. Government securities......    $    -       $    -       $1,003       $1,003     $  1,000     $    999
     U.S. Government agency
        securities (1)...............     2,299        2,217        5,000        4,887        6,998        6,841
     FHLB stock......................     1,431        1,431        2,540        2,540        3,603        3,603
                                          -----        -----        -----        -----      -------      -------
         Total (2)...................    $3,730       $3,648       $8,543       $8,430      $11,601      $11,443
                                          =====        =====        =====        =====       ======       ======
</TABLE>

     (1) Of the $2.3  million  of U.S.  Government  agency  securities  held for
         investment  at December  31,  1997,  $2.0  million  consisted of a note
         issued by the FHLB and  $299,000  consisted  of a note issued by Fannie
         Mae.  The $2.0 million  FHLB note  adjusts  semi-annually  based on the
         yield of three-year  constant  maturity  treasury  notes.  The $299,000
         Fannie Mae note earns interest at a fixed rate.

     (2) Does not include investment securities classified as available for sale
         which consisted of a $17,000,  $9,000 and $1.5 million  investment in a
         money  market  mutual  fund  at  December  31,  1997,  1996  and  1995,
         respectively.





                                       28
<PAGE>

         Information regarding the carrying values,  contractual  maturities and
weighted  average  yield  of  the  Company's  investment   securities  held  for
investment  (excluding FHLB stock) at December 31, 1997 is presented below. FHLB
stock  is  neither  a debt nor an  equity  security  because  its  ownership  is
restricted and it lacks a market.  FHLB stock can be sold at its par of $100 per
share only to the FHLBs or to another member institution.
<TABLE>
<CAPTION>
<S> <C>
                                                  One Year     After One to    After Five to   Over 10
                                                   or Less      Five Years       10 Years       Years      Total
                                                                          (dollars in thousands)
     U.S. Government agency securities......       $     -        $2,299         $     -     $      -     $2,299
                                                   =======        ======         =======     ========     ======

     Weighted average yield.................             -%         4.98%              -%           -%      4.98%
                                                   =======        ======         =======     ========     ======
</TABLE>

Sources of Funds

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

         Deposits.  Deposits obtained through bank branch offices of the Company
have  traditionally  been the principal source of the Company's funds for use in
lending and for other general business  purposes.  The Company's current deposit
products include regular  passbook and statement  savings  accounts,  negotiable
order  of  withdrawal  ("NOW")  accounts,  money  market  accounts,  fixed-rate,
fixed-maturity  retail  certificates of deposit ranging in terms from 90 days to
60 months,  mini-jumbo  (generally $25,000 - $99,999) and jumbo (generally equal
to or greater than $100,000)  certificates of deposit and individual  retirement
accounts.

         The Bank's deposits are currently  obtained primarily from residents in
its primary market area. The principal  methods currently used by the Company to
attract  deposit  accounts  include  offering  a wide  variety of  services  and
accounts  and  competitive  interest  rates.  The Company  utilizes  traditional
marketing methods to attract new customers and savings deposits, including print
media advertising. Currently, the Company does not advertise for retail deposits
outside of its local  market  area or utilize the  services of deposit  brokers.
Management  estimates that as of December 31, 1997,  deposit  accounts  totaling
$4.1 million or 2.7% of the Bank's total deposits were held by  nonresidents  of
Virginia  or  North  Carolina.   These  out-of-market   deposits  include  jumbo
certificates of deposits owned largely by financial  institutions  which totaled
$1.9  million at December  31,  1997,  and  represented  a decline from the $2.8
million of such  certificates at December 31, 1996. These jumbo  certificates of
deposit  were  obtained  through  the  posting  of  deposit  rates  on  national
computerized  bulletin  boards at no cost to the Company  and were not  obtained
through deposit brokers.





                                       29
<PAGE>


         The  following  table sets forth the average  balances and rates of the
Company's deposits for the periods indicated:
<TABLE>
<CAPTION>
<S> <C>

                                                                   Year Ended December 31,
                                          ---------------------------------------------------------------------
                                                   1997                         1996                    1995
                                          -------------------        ------------------      ------------------
                                          Average                    Average                 Average
                                          Balance       Rate         Balance       Rate      Balance       Rate
                                          -------       ----         -------       ----      -------       ----
                                                                   (dollars in thousands)

     Noninterest-bearing deposits...        $3,143          -%     $    1,433         -%   $    1,285         -%
     Passbook savings...............         3,839       3.48           6,782      3.33         5,465      3.33
     NOW accounts...................         4,344       2.83           5,332      2.80         4,859      2.85
     Money market accounts..........        21,401       4.87          21,104      4.50        21,760      4.14
     Certificates of deposit:
         Consumer...................        53,256       5.78          92,771      5.83        95,363      5.99
         Mini-jumbo.................        44,932       5.65          71,269      5.69        90,216      5.60
         Jumbo......................        13,206       5.78          19,670      5.86        28,026      5.46
                                          --------                   --------                --------
                                          $144,121                   $218,361                $246,974
                                           =======                    =======                 =======

         The following  table shows the interest  rate and maturity  information
for the Company's time deposits at December 31, 1997:
<CAPTION>

                                                                      Maturity Date
                                    --------------------------------------------------------------------------
                                    One Year                                               Over
                                     or Less          1-2 Years          2-3 Years        3 Years        Total
                                     -------          ---------          ---------        -------        -----
                                                                  (dollars in thousands)
4.01% to 5.00%.............         $  1,125       $         2       $         -      $        -       $  1,127
5.01% to 6.00%.............           67,575            12,574             3,179           2,923         86,251
6.01% to 7.00%.............            7,388             5,477             6,035           5,187         24,087
7.01% to 8.00%.............              600               251             2,906               -          3,757
8.01% to 9.00%.............               32                 -                 6               -             38
                                   ---------       -----------        ----------       ---------     ----------
                                     $76,720           $18,304           $12,126          $8,110       $115,260
                                      ======            ======            ======           =====        =======

         The  following  table shows the  Company's  certificates  of deposit of
$100,000 or more outstanding at the dates indicated:
<CAPTION>

                                                                             December 31,
                                                        --------------------------------------------------
                                                            1997                 1996               1995
                                                            ----                 ----               ----
                                                                        (dollars in thousands)

         3 months or less........................         $  4,624            $  2,709            $  6,638
         Over 3 through 6 months.................            4,785               3,505              11,270
         Over 6 through 12 months................            3,747               2,625              12,834
         Over 12 months .........................            5,365               5,919              10,489
                                                          --------            --------            --------
                  Total..........................         $ 18,521            $ 14,758            $ 41,231
                                                          ========            ========            ========
</TABLE>

         The  ability of the Company to attract and  maintain  deposits  and the
Company's  cost of funds on these deposit  accounts have been, and will continue
to be, significantly affected by economic and competitive conditions.

         Borrowings.  The Bank is a member of the FHLB System, which consists of
12 regional FHLBs subject to supervision  and regulation by the Federal  Housing
Finance Board. The FHLBs provide a central credit facility  primarily for member
institutions.  The Bank, as a member of the FHLB of Atlanta, is required to hold
shares  of common  stock in that  FHLB in an amount at least  equal to 1% of the
aggregate  principal  amount  of  its  unpaid  residential  mortgage  loans  and
mortgage-backed  securities,  3/10  of 1% of  total  assets  at  the  end of the


                                       30
<PAGE>

calendar year, or 5% of its advances  (borrowings)  from the FHLB,  whichever is
greater. The Bank had a $1.4 million investment in stock of the FHLB at December
31, 1997, which was in compliance with this  requirement.  At December 31, 1997,
the Bank had $23.5 million of advances outstanding from the FHLB.

         The  following  table  presents  certain   information   regarding  the
Company's FHLB advances at the dates and for the periods indicated:
<TABLE>
<CAPTION>
<S> <C>

                                                                At or For the Year Ended December 31,
                                                         -------------------------------------------------
                                                          1997                  1996                 1995
                                                          ----                  ----                 ----
                                                                       (dollars in thousands)
         Balance at end of period..................      $23,547               $25,690             $29,833
         Weighted average interest rate
              at end of period.....................         5.75%                 6.14%               6.00%
         Maximum amount outstanding
              at any month's end...................      $28,118               $29,833             $59,952
         Average amount outstanding
              during the period....................      $24,885               $27,137             $46,617
         Weighted average interest rate
              during the period....................         5.92%                 5.99%               6.00%
</TABLE>

         The  outstanding  FHLB  advances at December 31, 1997 mature as follows
(in thousands):

                  1998....................................      $21,139
                  1999....................................        1,808
                  2000....................................          600
                                                               --------
                                                                $23,547

         The Company's notes payable  amounted to $72,000,  $96,000 and $120,000
at December 31, 1997, 1996, and 1995, respectively. Notes payable on these dates
consisted  solely of a note payable to the former  president of Home Bancorp and
Home Savings.  The note accrues  interest at 9.50% per annum. The note is due in
five equal annual  installments,  plus accrued  interest  thereon.  However,  in
conjunction with a severance  settlement with the former  employee,  the Company
repaid  this  note in its  entirety  in  February  1998.  See  "Item  3. - Legal
Proceedings."

         During  1989 and  1990,  the Bank  sold $3.3  million  of  subordinated
capital  notes  with a  ten-year  maturity.  The notes  were  issued in  minimum
denominations  of $2,500 at interest rates ranging  between 11.5% and 12.0%.  In
July 1993, the Bank redeemed $2.8 million of the subordinated capital notes. The
Company's  subordinated capital notes amounted to $628,000 at December 31, 1995.
In August 1996,  the Bank redeemed the remaining  subordinated  capital notes at
par in their entirety

         Other  Liabilities.  As of December 31, 1997, other  liabilities of the
Company included a $703,000  obligation to the Company's Chief Executive Officer
resulting from the exercise of his stock appreciation rights in November 1997. A
determination  has not yet been  made as to the date and  method of  payment  to
satisfy  this  obligation.  See Note 19 of the Notes to  Consolidated  Financial
Statements on pages 47 and 48 of the 1997 Annual Report to  Stockholders,  which
is attached hereto as Exhibit 13 and incorporated herein by reference.

Year 2000 Costs

         For information  about the Company's Year 2000 readiness and associated
costs,  see  "Management's  Discussion  and Analysis of Financial  Condition and
Results of Operations - Year 2000 Costs" on page 21 of the 1997 Annual Report to
Stockholders,  which is attached hereto as Exhibit 13 and incorporated herein by
reference.





                                       31
<PAGE>

Competition

         The Company faces strong  competition  both in attracting  deposits and
making real estate and other loans. Its most direct competition for deposits has
historically come from other savings institutions,  credit unions and commercial
banks located in Virginia and North  Carolina,  including  many large  financial
institutions which have greater financial and marketing  resources  available to
them. In addition, the Company has faced additional significant  competition for
investors' funds from short-term money market securities and other corporate and
government securities.  The ability of the Company to attract and retain savings
deposits depends on its ability to generally provide a rate of return, liquidity
and risk comparable to that offered by competing investment opportunities.

         The Company  experiences  strong  competition for real estate and other
loans principally from other savings  institutions,  commercial banks,  mortgage
banking companies,  insurance  companies and other  institutional  lenders.  The
Company competes for loans principally  through the interest rates and loan fees
it charges and the  efficiency  and  quality of services it provides  borrowers.
Competition may increase as a result of the continuing reduction of restrictions
on the interstate operations of financial institutions.

Employees

         As of December 31, 1997,  the Company  employed 99 full-time  employees
and 12 part-time employees.

Regulation of the Company

         General.  The Company is a savings and loan holding  company within the
meaning of the Home Owners' Loan Act ("HOLA").  As such,  the Company is subject
to OTS regulations,  examinations,  supervision and reporting requirements. As a
subsidiary of a savings and loan holding company, the Bank is subject to certain
restrictions in its dealings with the Company and affiliates thereof.

         Activities  Restrictions.  There are generally no  restrictions  on the
activities of a savings and loan holding company which holds only one subsidiary
savings  association.  However, if the Director of the OTS determines that there
is  reasonable  cause to believe  that the  continuation  by a savings  and loan
holding  company of an  activity  constitutes  a serious  risk to the  financial
safety,  soundness or  stability  of its  subsidiary  savings  association,  the
Director may impose such  restrictions as deemed necessary to address such risk,
including  limiting (i) payment of dividends  by the savings  association;  (ii)
transactions  between the savings association and its affiliates;  and (iii) any
activities of the savings  association that might create a serious risk that the
liabilities  of the  holding  company and its  affiliates  may be imposed on the
savings association.  Notwithstanding the above rules as to permissible business
activities  of  unitary  savings  and loan  holding  companies,  if the  savings
association  subsidiary  of such a  holding  company  fails to meet a  qualified
thrift lender ("QTL") test,  then such unitary holding company also shall become
subject to the activities  restrictions  applicable to multiple savings and loan
holding  companies  and,  unless the savings  association  requalifies  as a QTL
within one year  thereafter,  shall  register  as, and  become  subject  to, the
restrictions  applicable  to, a bank holding  company.  See "- Regulation of the
Bank - Qualified Thrift Lender Test."

         Limitations  on  Transactions  with  Affiliates.  Transactions  between
savings  associations  and any affiliate are governed by Sections 23A and 23B of
the Federal Reserve Act. An affiliate of a savings association is any company or
entity which  controls,  is  controlled  by or is under common  control with the
savings association. In a holding company context, the parent holding company of
a  savings  association  (such  as the  Company)  and any  companies  which  are


                                       32
<PAGE>

controlled  by  such  parent  holding  company  are  affiliates  of the  savings
association.  Generally,  Sections 23A and 23B (i) limit the extent to which the
savings  association or its  subsidiaries  may engage in "covered  transactions"
with any one affiliate to an amount equal to 10% of such  association's  capital
stock and surplus,  and contain an aggregate limit on all such transactions with
all  affiliates  to an amount equal to 20% of such capital stock and surplus and
(ii) require that all such  transactions be on terms  substantially the same, or
at least as favorable,  to the  association or subsidiary as those provided to a
non-affiliate.  The term  "covered  transaction"  includes  the making of loans,
purchase  of  assets,  issuance  of a  guarantee  and  similar  other  types  of
transactions.  In addition to the restrictions  imposed by Sections 23A and 23B,
no savings  association may (i) loan or otherwise extend credit to an affiliate,
except for any affiliate which engages only in activities  which are permissible
for bank holding  companies,  or (ii)  purchase or invest in any stocks,  bonds,
debentures, notes or similar obligations of any affiliate, except for affiliates
which are subsidiaries of the savings association.

         In addition,  Sections  22(h) and (g) of the Federal  Reserve Act place
restrictions   on  loans  to  executive   officers,   directors   and  principal
stockholders. Under Section 22(h), loans to a director, an executive officer and
to a  greater  than  10%  stockholder  of a  savings  association,  and  certain
affiliated  interests  of  either,  may not  exceed,  together  with  all  other
outstanding  loans to such person and affiliated  interests,  the  association's
loans  to one  borrower  limit  (generally  equal  to  15% of the  institution's
unimpaired  capital and  surplus).  Section  22(h) also  requires  that loans to
directors,  executive  officers  and  principal  stockholders  be made on  terms
substantially  the same as offered in comparable  transactions  to other persons
and also  requires  prior board  approval for certain  loans.  In addition,  the
aggregate  amount  of  extensions  of credit  by a  savings  association  to all
insiders  cannot  exceed  the  association's  unimpaired  capital  and  surplus.
Furthermore,  Section 22(g) places additional restrictions on loans to executive
officers.  At  December  31,  1997,  the Bank was in  compliance  with the above
restrictions.

         Restrictions  on  Acquisitions.  Except  under  limited  circumstances,
savings and loan holding companies are prohibited from acquiring,  without prior
approval  of  the  Director  of the  OTS,  (i)  control  of  any  other  savings
association or savings and loan holding company or substantially  all the assets
thereof or (ii) more than 5% of the voting  shares of a savings  association  or
holding  company  thereof  which is not a  subsidiary.  Except  with  the  prior
approval  of the  Director  of the OTS,  no director or officer of a savings and
loan holding  company or person owning or controlling by proxy or otherwise more
than  25%  of  such  company's   stock,  may  acquire  control  of  any  savings
association,  other  than a  subsidiary  savings  association,  or of any  other
savings and loan holding company.

Regulation of the Bank

         General. The OTS has extensive authority over the operations of savings
associations.  As part of this authority,  savings  associations are required to
file periodic  reports with the OTS and are subject to periodic  examinations by
the  OTS  and  the  FDIC.  The  investment  and  lending  authority  of  savings
associations  are  prescribed  by  federal  laws  and  regulations  and they are
prohibited  from  engaging  in any  activities  not  permitted  by such laws and
regulations.  Those  laws  and  regulations  generally  are  applicable  to  all
federally  chartered savings  associations and may also apply to state-chartered
savings associations.  Such regulation and supervision is primarily intended for
the protection of depositors.

         FIRREA  imposed  limitations  on the  aggregate  amount of loans that a
savings association could make to any one borrower,  including related entities.
See "- Lending Activities - General" for a discussion of such limitations.



                                       33
<PAGE>

         The OTS's enforcement authority over all savings associations and their
holding  companies  was  substantially  enhanced  by  FIRREA.  This  enforcement
authority  includes,  among  other  things,  the  ability to assess  civil money
penalties,  to  issue  cease  and  desist  or  removal  orders  and to  initiate
injunctive actions.  In general,  these enforcement actions may be initiated for
violations  of laws and  regulations  and  unsafe or  unsound  practices.  Other
actions or inactions  may provide the basis for  enforcement  action,  including
misleading  or  untimely  reports  filed  with  the  OTS.  FIRREA  significantly
increased the amount of and grounds for civil money penalties.  FIRREA requires,
except under  certain  circumstances,  public  disclosure  of final  enforcement
actions by the OTS.

         Insurance  of  Accounts.  The  deposits  of the Bank are  insured up to
$100,000  per  insured  member (as  defined by law and  regulation)  by the SAIF
administered  by the FDIC and are  backed by the full  faith  and  credit of the
United  States  Government.  As  insurer,  the  FDIC is  authorized  to  conduct
examinations of, and to require reporting by, FDIC-insured institutions. It also
may prohibit any FDIC-insured institution from engaging in any activity the FDIC
determines by regulation or order to pose a serious threat to the FDIC. The FDIC
also  has  the  authority  to  initiate   enforcement  actions  against  savings
associations, after giving the OTS an opportunity to take such action.

         The FDIC may terminate the deposit insurance of any insured  depository
institution,  including  the Bank,  if it  determines  after a hearing  that the
institution has engaged or is engaging in unsafe or unsound practices,  is in an
unsafe  or  unsound  condition  to  continue  operations,  or has  violated  any
applicable law, regulation,  order or any condition imposed by an agreement with
the FDIC. It also may suspend deposit insurance  temporarily  during the hearing
process for the permanent  termination of insurance,  if the  institution has no
tangible  capital.  If insurance of accounts is terminated,  the accounts at the
institution at the time of the termination,  less subsequent withdrawals,  shall
continue to be insured for a period of six months to two years, as determined by
the FDIC. Management is aware of no existing circumstances which could result in
termination of the Bank's deposit insurance.

         Under  FDIC  regulations,  institutions  are  assigned  to one of three
capital groups for insurance premium purposes - "well capitalized,"  "adequately
capitalized"  and  "undercapitalized"  - which are defined in the same manner as
the regulations  establishing the prompt  corrective action system under Section
38 of the Federal  Deposit  Insurance Act ("FDIA"),  as discussed under "-Prompt
Corrective  Action"  below.  These three groups are then divided into  subgroups
which are based on supervisory  evaluations by the institution's primary federal
regulator,  resulting in nine assessment  classifications.  Effective January 1,
1998, assessment rates for SAIF-insured  institutions range (except as described
below) from 0 basis points of insured deposits for well-capitalized institutions
with minor  supervisory  concerns  to 27 basis  points of insured  deposits  for
undercapitalized   institutions  with  substantial   supervisory   concerns.  In
addition,  an additional  assessment  approximating 6.4 basis points is added to
the regular  SAIF-assessment until December 31, 1999 in order to cover Financing
Corporation ("FICO") debt service payments.

         Both  the  SAIF  and the  Bank  Insurance  Fund  ("BIF"),  the  deposit
insurance  fund that covers  most  commercial  bank  deposits,  are  statutorily
required to be  recapitalized  to a ratio of 1.25% of insured reserve  deposits.
The BIF previously  achieved the required  reserve ratio,  and as a result,  the
FDIC reduced the average deposit  insurance premium paid by BIF-insured banks to
a level  substantially  below the average premium paid by savings  institutions.
Banking  legislation  was enacted on September 30, 1996 to eliminate the premium
differential between SAIF-insured institutions and BIF-insured institutions. The
legislation   provided   that   all   insured   depository   institutions   with
SAIF-assessable  deposits as of March 31, 1995 pay a special one-time assessment


                                       34
<PAGE>

to recapitalize the SAIF.  Pursuant to this legislation,  the FDIC promulgated a
rule that established the special assessment  necessary to recapitalize the SAIF
at 65.7 basis points of SAIF-assessable  deposits held by affected  institutions
as of March 31, 1995. However, as a result of the Bank's financial condition, on
November 8, 1996,  the Bank was  notified by the FDIC that its  application  for
exemption had been  approved.  As a result,  the Bank was exempt from paying the
special  one-time  assessment  (which  would  have  amounted  to $1.8  million).
Instead,  the Bank is continuing to pay future  assessments  through 1999 at the
assessment  rate  schedule  in  effect  as of June 30,  1995.  Therefore,  as of
December 31, 1997,  the Bank's annual  assessment  for deposit  insurance was 26
basis  points of insured  deposits as opposed to three  basis  points of insured
deposits (the assessment rate otherwise  charged to "well  capitalized"  savings
institutions such as the Bank).

         Another  component of the SAIF  recapitalization  plan provides for the
merger  of the  SAIF  and  the BIF on  January  1,  1999,  provided  no  insured
depository  institution is a savings association on that date. If legislation is
enacted which required the Bank to convert to a bank charter,  the Company would
become a bank holding  company subject to the more  restrictive  activity limits
imposed on bank holding  companies  unless  special  grandfather  provisions are
included in the  legislation.  The Company does not believe that its  activities
would be materially  affected in the event that it was required to become a bank
holding company.

         Regulatory Capital Requirements. Federally insured savings associations
are  required to maintain  minimum  levels of  regulatory  capital.  The OTS has
established  capital  standards  applicable to all savings  associations.  These
standards generally must be as stringent as the comparable capital  requirements
imposed  on  national  banks.  The OTS  also is  authorized  to  impose  capital
requirements  in excess  of these  standards  on  individual  associations  on a
case-by-case basis.

         Current OTS capital standards  require savings  associations to satisfy
three  different   capital   requirements.   Under  these   standards,   savings
associations must maintain "tangible" capital equal to at least 1.5% of adjusted
total assets,  "core"  capital equal to at least 3% of adjusted total assets and
"total" capital (a combination of core and "supplementary"  capital) equal to at
least 8.0% of  "risk-weighted"  assets.  For  purposes of the  regulation,  core
capital generally consists of common  stockholders'  equity (including  retained
earnings), noncumulative perpetual preferred stock and related surplus, minority
interests in the equity  accounts of fully  consolidated  subsidiaries,  certain
nonwithdrawable  accounts  and  pledged  deposits  and  "qualifying  supervisory
goodwill."  Tangible  capital is given the same  definition  as core capital but
does not include qualifying supervisory goodwill and is reduced by the amount of
all the savings  association's  intangible assets, with only a limited exception
for  mortgage  servicing  rights.  Both core and  tangible  capital  are further
reduced  by  an  amount  equal  to  a  savings  association's  debt  and  equity
investments in  subsidiaries  engaged in activities not  permissible to national
banks (other than  subsidiaries  engaged in  activities  undertaken as agent for
customers  or  in  mortgage   banking   activities  and  subsidiary   depository
institutions or their holding  companies).  A savings  association is allowed to
include both core capital and  supplementary  capital in the  calculation of its
total capital for purposes of the risk-based capital requirement,  provided that
the amount of  supplementary  capital does not exceed the savings  association's
core  capital.  Supplementary  capital  generally  consists  of  hybrid  capital
instruments;  perpetual  preferred stock which is not eligible to be included as
core capital;  subordinated  debt and  intermediate-term  preferred stock;  and,
subject to limitations,  general allowances for loan losses. Assets are adjusted
under  the   risk-based   guidelines  to  take  into  account   different   risk
characteristics,  with the  categories  ranging from 0% (requiring no additional
capital)  for assets such as cash to 100% for  repossessed  assets or loans more
than 90 days past due. Single-family  residential first mortgage loans which are
not  past-due  or  non-performing  and which have been made in  accordance  with
prudent  underwriting  standards are assigned a 50% level in the  risk-weighting
system, as are certain privately-issued  mortgage-backed securities representing
indirect  ownership of such loans.  Off-balance sheet items also are adjusted to
take into account certain risk characteristics.



                                       35
<PAGE>

         An association which is not in capital compliance or which is otherwise
deemed to require more than normal supervision is subject to restrictions on its
ability to grow  pursuant  to OTS  Regulatory  Bulletin  3a-1.  In  addition,  a
provision of the HOLA generally  provides that,  among other  restrictions,  the
Director of OTS must  restrict the asset growth of savings  institutions  not in
regulatory  capital  compliance,  subject to a limited  exception for growth not
exceeding interest credited.

         Any savings  association that fails any of the capital  requirements is
subject to possible  enforcement  actions by the OTS or the FDIC.  Such  actions
could  include a  capital  directive,  a cease and  desist  order,  civil  money
penalties,  the  establishment of restrictions on an  association's  operations,
termination of federal deposit insurance and the appointment of a conservator or
receiver.  The OTS's capital  regulation  provides  that such  actions,  through
enforcement proceedings or otherwise,  could require one or more of a variety of
corrective  actions.  For  additional  information,  see  "-  Prompt  Corrective
Action."

         In  August  1993,  the  OTS  adopted  a  final  rule  incorporating  an
interest-rate risk component into the risk-based capital  regulation.  Under the
rule, an  institution  with a greater than "normal"  level of interest rate risk
will be subject to a deduction of its interest  rate risk  component  from total
capital for purposes of calculating  its risk-based  capital  requirement.  As a
result,  such an institution will be required to maintain  additional capital in
order to comply  with the  risk-based  capital  requirement.  The final rule was
effective  January  1,  1994.  However,  the date  that  institutions  are first
required  to  deduct  the  interest  rate  risk  component  has  been  postponed
indefinitely  until a final rule is published by the OTS.  Pursuant to the rule,
the Bank would have not been subject to the interest  rate risk  component as of
December 31, 1997.

         At December 31, 1997,  the Bank's actual capital ratios and the minimum
requirements under FIRREA were as follows (dollars in thousands):

                                                 Minimum
                             Actual            Requirement             Excess
                             ------            -----------             ------
Tangible capital         $15,298  7.86%        $2,921  1.5%           $12,377
Core capital              15,298  7.86         7,790   4.0              7,508
Risk-based capital        16,762 14.33         9,354   8.0              7,408

         For further information  regarding the Bank's actual capital ratios and
minimum  requirements  under  FDICIA,  see Note 21 of the Notes to  Consolidated
Financial  Statements  on  pages  50  and  51  of  the  1997  Annual  Report  to
Stockholders,  which is attached hereto as Exhibit 13 and incorporated herein by
reference.  At  December  31,  1997,  the Bank  exceeded  its core  capital  and
risk-based capital requirements under FDICIA.

         Prompt Corrective Action. Under Section 38 of the FDIA, as added by the
FDICIA,  each federal banking agency is required to implement a system of prompt
corrective  action for  institutions  which it  regulates.  The federal  banking
agencies,  including  the OTS,  adopted  substantially  similar  regulations  to
implement  Section 38 of the FDIA,  effective as of December 19, 1992. Under the
regulations,  an  institution is deemed to be (i) "well  capitalized"  if it has
total risk-based capital of 10.0% or more, has a Tier I risk-based capital ratio
of 6.0% or more, has a Tier I leverage  capital ratio of 5.0% or more and is not
subject to any order or final capital  directive to meet and maintain a specific
capital level for any capital measure, (ii) "adequately capitalized" if it has a
total  risk-based  capital  ratio of 8.0% or more, a Tier I  risk-based  capital
ratio of 4.0% or more and a Tier I leverage  capital ratio of 4.0% or more (3.0%
under  certain  circumstances)  and  does  not  meet  the  definition  of  "well
capitalized,"  (iii)  "undercapitalized"  if it has a total  risk-based  capital
ratio that is less than 8.0%,  a Tier I  risk-based  capital  ratio that is less
than 4.0% or a Tier I leverage  capital ratio that is less than 4.0% (3.0% under


                                       36
<PAGE>

certain circumstances),  (iv) "significantly undercapitalized" if it has a total
risk-based  capital  ratio that is less than 6.0%, a Tier I  risk-based  capital
ratio  that is less than 3.0% or a Tier I  leverage  capital  ratio that is less
than 3.0% and does not meet the definition of "critically undercapitalized," and
(v) "critically  undercapitalized" if it has a ratio of tangible equity to total
assets  that is  equal  to or less  than  2.0%.  Section  38 of the FDIA and the
regulations  promulgated  thereunder  also specify  circumstances  under which a
federal  banking  agency  may  reclassify  a  well  capitalized  institution  as
adequately capitalized and may require an adequately capitalized  institution or
an undercapitalized institution to comply with supervisory actions as if it were
in the  next  lower  category  (except  that  the  FDIC  may  not  reclassify  a
significantly  undercapitalized institution as critically undercapitalized).  At
December 31, 1997,  the Bank was  considered  a "well  capitalized"  institution
under the prompt correction action provisions of FDIA.

         Liquidity  Requirements.  All  savings  associations  are  required  to
maintain an average daily balance of liquid assets (including cash, certain time
deposits  and  savings  accounts,   bankers'  acceptances,   certain  government
obligations and certain other  investments) equal to a certain percentage of the
sum of its  average  daily  balance of net  withdrawable  deposit  accounts  and
borrowings payable in one year or less. The liquidity  requirement may vary from
time to time (between 4% and 10%) depending upon economic conditions and savings
flows of all savings  associations.  At the present time,  the required  minimum
liquid asset ratio is 4%. The Bank has  consistently  exceeded  such  regulatory
liquidity requirement and, at December 31, 1997, had a liquidity ratio of 8.72%.

         Qualified Thrift Lender Test. All savings  associations are required to
meet a QTL test set forth in Section  10(m) of HOLA and  regulations  of the OTS
thereunder in order to avoid certain restrictions on their operations. A savings
association  that  does  not  meet  the QTL  test  set  forth  in the  HOLA  and
implementing  regulations  must either  convert to a bank charter or comply with
the following restrictions on its operations: (i) the association may not engage
in any new activity or make any new investment,  directly or indirectly,  unless
such  activity  or  investment  is  permissible  for a national  bank;  (ii) the
branching  powers of the association  shall be restricted to those of a national
bank;  (iii) the  association  shall not be eligible to obtain any advances from
its FHLB; and (iv) payment of dividends by the  association  shall be subject to
the rules regarding payment of dividends by a national bank. Upon the expiration
of three years from the date the  association  ceases to be a QTL, it must cease
any activity and not retain any investment not  permissible  for a national bank
and  immediately  repay any  outstanding  FHLB  advances  (subject to safety and
soundness considerations).

         Under applicable  regulations,  any savings institution is a QTL if (i)
it  qualifies  as  a  domestic  building  and  loan  association  under  Section
7701(a)(19)  of the Code  (which  generally  requires  that at least  60% of the
institution's assets constitute  housing-related and other qualifying assets) or
(ii) at least 65% of the institution's  "portfolio  assets" (as defined) consist
of certain housing and consumer-related  assets on a monthly average basis in at
least nine out of every 12 months.  At December 1997, the Bank was in compliance
with the QTL test.

         Restrictions on Capital  Distributions.  OTS regulations govern capital
distributions  by savings  associations,  which  include cash  dividends,  stock
redemptions  or  repurchases,  cash-out  mergers,  interest  payments on certain
convertible  debt and other  transactions  charged to the  capital  account of a
savings  association to make capital  distributions.  Generally,  the regulation
creates a safe  harbor  for  specified  levels  of  capital  distributions  from
associations  meeting at least their minimum  capital  requirements,  so long as
such  associations  notify the OTS and receive no objection to the  distribution
from the OTS. Savings institutions and distributions that do not qualify for the
safe harbor are required to obtain prior OTS approval  before making any capital
distributions.

         Generally,  savings  associations  that  before and after the  proposed
distribution meet or exceed their fully phased-in capital requirements,  or Tier
1 associations, may make capital distributions during any calendar year equal to
the higher of (i) 100% of net income for the calendar  year-to-date  plus 50% of
its "surplus capital ratio" at the beginning of the calendar year or (ii) 75% of
net income over the most recent four-quarter period. The "surplus capital ratio"


                                       37
<PAGE>

is  defined to mean the  percentage  by which the  association's  ratio of total
risk-based  capital to assets exceeds the ratio of its fully  phased-in  capital
requirement to assets.  "Fully phased-in capital requirement" is defined to mean
an  association's   capital  requirement  under  the  statutory  and  regulatory
standards applicable on December 31, 1994, as modified to reflect any applicable
individual minimum capital requirement imposed upon the association.

         Tier 2 associations  (such as the Bank),  which are  associations  that
before and after the proposed  distribution meet or exceed their minimum capital
requirements,  may make capital distributions during any calendar year up to 75%
of net income over the most recent four-quarter period.

         In order to make  distributions  under these safe  harbors,  Tier 1 and
Tier 2  associations  must  submit  written  notice to the OTS 30 days  prior to
making the  distribution.  The OTS may object to the  distribution  during  that
30-day  period based on safety and  soundness  concerns.  In addition,  a Tier 1
association  deemed to be in need of more than normal supervision by the OTS may
be  downgraded  to a  Tier  2 or  Tier  3  association  as a  result  of  such a
determination.

         Tier 3 associations,  which are  associations  that do not meet current
minimum  regulatory  capital  requirements,  or that have  capital  in excess of
either their fully phased-in capital  requirement or minimum capital requirement
but which  have been  notified  by the OTS that they will be  treated  as Tier 3
associations  because they are in need of more than normal  supervision,  cannot
make any capital  distribution  without  obtaining OTS approval  prior to making
such distributions.

         The OTS has proposed to amend its capital  distribution  regulation  to
bring such  regulations  into greater  conformity with the other bank regulatory
agencies. Under the proposed regulation,  certain savings associations would not
be required to file with the OTS. Specifically, savings associations that remain
at least  adequately  capitalized  following a capital  distribution,  under the
proposed  regulation,  would not be  subject  to any  requirement  for notice or
application unless the total amount of all capital distributions,  including any
proposed capital distribution,  for the applicable calendar year would exceed an
amount equal to the savings  association's net income for that year to date plus
the savings association's retained net income for the preceding two years.

         Federal  Home  Loan  Bank  System.  The Bank is a member of the FHLB of
Atlanta,  which is one of 12 regional FHLBs that  administers the home financing
credit  function  of  savings  associations.  Each FHLB  serves as a reserve  or
central bank for its members within its assigned region.  It is funded primarily
from  proceeds  derived from the sale of  consolidated  obligations  of the FHLB
System.  It makes loans to members (i.e.,  advances) in accordance with policies
and procedures established by the Board of Directors of the FHLB.

         As a member, the Bank is required to purchase and maintain stock in the
FHLB in an  amount  equal  to at least 1% of its  aggregate  unpaid  residential
mortgage loans, home purchase contracts or similar  obligations at the beginning
of each year.  At December  31,  1997,  the Bank had $1.4 million in FHLB stock,
which was in compliance with this requirement.

         Federal Reserve System. The FRB requires all depository institutions to
maintain  reserves against their transaction  accounts  (primarily NOW and Super
NOW checking accounts) and non-personal time deposits. At December 31, 1997, the
Bank was in compliance with applicable  requirements.  However, because required


                                       38
<PAGE>

reserves must be  maintained in the form of vault cash or a  noninterest-bearing
account at a Federal Reserve Bank, the effect of this reserve  requirement is to
reduce an institution's earning assets.

         Safety and Soundness.  Effective  August 9, 1995,  the federal  banking
regulatory  agencies jointly  implemented  Interagency  Guidelines  Establishing
Standards for Safety and  Soundness  ("Guidelines")  for all insured  depository
institutions  relating to internal  controls,  information  systems and internal
audit  systems,  loan  documentation,  credit  underwriting,  interest rate risk
exposure,  asset  growth,  compensation,   fees  and  benefits,  and  employment
contracts and other compensation arrangements of executive officers,  employees,
directors and principal  stockholders of insured  depository  institutions  that
would prohibit  compensation and benefits and arrangements that are excessive or
that could lead to a material  financial loss for the institution.  In addition,
the federal  banking  regulatory  agencies  adopted  asset  quality and earnings
standards,  which became  effective  October 1, 1996.  If an insured  depository
institution fails to meet any of its prescribed standards as described above, it
may be required to submit to the appropriate federal banking agency a compliance
plan specifying the steps that will be taken to cure the deficiency and the time
within  which these steps will be taken.  If an  institution  fails to submit an
acceptable plan or fails to implement the plan, the appropriate  federal banking
agency will require the institution or holding company to correct the deficiency
and until  corrected,  may impose  restrictions  on the  institution  or holding
company,   including  any  of  the  restrictions  applicable  under  the  prompt
corrective  action  provisions of FDICIA.  At December 31, 1997, the Bank was in
compliance with the Guidelines.

Taxation

         Federal Taxation. The Company and its subsidiaries are subject to those
rules of federal income taxation generally  applicable to corporations under the
Code.  The  Company and its  principal  subsidiary,  the Bank,  as members of an
affiliated group of corporations within the meaning of Section 1504 of the Code,
file a  consolidated  federal  income  tax  return,  which  has  the  effect  of
eliminating or deferring the tax  consequences of intercompany  transactions and
distributions,  including dividends,  in the computation of consolidated taxable
income.

         In addition to regular  corporate income tax,  corporations are subject
to an  alternative  minimum tax which  generally is equal to 20% of  alternative
minimum  taxable  income  (taxable  income,  increased by certain tax preference
items and  determined  with  adjustments  to certain  regular  tax  items).  The
adjustments  which  are  generally  applicable  include  an  amount  equal  to a
percentage  of the amount by which a financial  institution's  adjusted  current
earnings  (generally  alternative minimum taxable income computed without regard
to this  adjustment  and prior to reduction  for  alternative  tax net operating
losses)  exceeds its  alternative  minimum taxable income without regard to this
adjustment. Alternative minimum tax paid can be credited against regular tax due
in later years. See Note 14 of the Notes to Consolidated Financial Statements on
pages 44 and 45 of the 1997  Annual  Report to  Stockholders,  which is attached
hereto as Exhibit 13 and incorporated herein by reference.

         State Taxation.  The Commonwealth of Virginia imposes a tax at the rate
of 6.0% on the  combined  "Virginia  taxable  income"  of the Bank,  EMC and its
subsidiaries.  Virginia  taxable income is equal to federal  taxable income with
certain  adjustments.  Significant  modifications  include the subtraction  from
federal  taxable income of interest or dividends on obligations or securities of
the United States that are exempt from state income taxes,  and a  recomputation
of the bad debt reserve deduction on reduced modified taxable income.





                                       39
<PAGE>

         Because  consolidated  or  combined  income tax returns are not allowed
under North Carolina law, the Bank and its subsidiaries that conduct business in
North Carolina are separately subject to an annual corporate income tax of 7.75%
of their federal  taxable income as computed under the Code,  subject to certain
prescribed adjustments.  In addition to the state corporate income tax, the Bank
and its  subsidiaries  are subject to an annual state  franchise  tax,  which is
imposed at a rate of .15% applied to the greater of the Company's and the Bank's
respective (i) capital stock,  surplus, and undivided profits,  (ii) investments
in tangible property in North Carolina; or (iii) appraised valuation of property
in North Carolina.

         Furthermore,  the Company is separately  subject to income taxes and an
annual state franchise tax in Delaware.










                              [intentionally blank]




                                       40
<PAGE>


Item 2.           Properties

         The following table sets forth  information  with respect to offices of
the Company and its subsidiaries as of December 31, 1997.
<TABLE>
<CAPTION>
<S> <C>

                                                       Lease           Date           Total         Net Book
                                   Owned/         Expiration Date     Acquired/      Office         Value at
Location                           Leased         Including Options    Leased     Square Ft. (1)   12/31/97 (2)
--------                           ------         -----------------    ------     --------------   ------------

The Company
Executive Office:
The Koger Center                   Leased              01/31/02         10/96         7,328     $  26,121
Building 9, Suite 200
Norfolk, VA  23502

The Bank
Main Office:
400 W. Ehringhaus Street            Owned                  -            11/78         3,805       201,750
Elizabeth City, NC  27906

Branch Offices:
520 South Main Street               Owned                 -             05/86         6,517       685,326
Emporia, VA  23847

1401 Gaskins Road                  Leased             09/07/98          05/95         5,876        11,184
Richmond, VA  23233

1455 N. Main Street               Leased (3)          12/31/99          09/95         1,200             -
Suffolk, VA  23434

Essex First
The Koger Center                   Leased             01/31/02          10/96         5,554             -
Building 9, Suite 200
Norfolk, VA  23502

1401 Gaskins Road                 Leased (4)          09/07/98          05/95         3,078             -
Richmond, VA  23233

2430 Southland Drive, 3rd Floor    Leased             05/31/98          06/93         2,000             -
Chester, VA  23831

400 W. Ehringhaus Street          Leased (4)               -            07/94           750             -
Elizabeth City, NC  27906

Essex Home
2420 Virginia Beach Blvd.          Leased              12/31/01         12/91        11,950         8,780
Virginia Beach, VA  23454
</TABLE>


(1)   Total office square feet excludes leased common area.
(2)   Consists  of the net  book  value  of land  and  buildings  if  owned,  or
      leasehold improvements if leased.
(3)   The  Company  has  begun  construction  of a retail  bank  branch at a new
      Suffolk,  Virginia  location.  As of  December  31,  1997,  the land had a
      carrying  value of $215,000  and  building  construction-in-process  had a
      carrying value of $83,000.  The Company has recognized an estimated  lease
      termination  penalty of $28,000  during the year ended  December 31, 1997.
      The Company anticipates completion of construction in April 1998.
(4)   Leased or subleased from the Bank.


Item 3.           Legal Proceedings

         The  Company  and  its  subsidiaries  are  involved  in  routine  legal
proceedings  occurring in the ordinary course of business which in the aggregate
are believed by management  to be  immaterial to the financial  condition of the
Company.





                                       41
<PAGE>

         As of December  31,  1997,  the  Company  and the Bank were  parties to
litigation  pending in the Circuit Court of the City of Norfolk,  Virginia under
the style of Roger E. Early v. Essex Bancorp,  Inc., Essex Savings Bank, F.S.B.,
Home  Bancorp,  Inc. and Home  Savings,  F.S.B.  (the "Early  Litigation").  The
plaintiff in this action,  Roger E. Early,  was the former  President  and Chief
Executive   Officer  of  Home  Bancorp  and  Home  Savings  prior  to  the  Home
Acquisition.  Immediately prior to the Home  Acquisition,  Home Bancorp and Home
Savings terminated Mr. Early's Employment Agreement.  Mr. Early claimed that the
Company and the Bank became  liable for  severance  payments by operation of law
upon consummation of the Home Acquisition.

         On February 13, 1998, all parties to the Early Litigation  entered into
a Settlement and Agreement and Mutual Release  whereby the Company agreed to pay
$136,500 to Mr. Early.  This amount was recognized as an expense during the year
ended  December  31,  1997.  In  addition,  the  Company  agreed to pay its note
obligation to Mr. Early totaling  $72,102 as of December 31, 1997,  plus accrued
interest thereon, in its entirety in February 1998.


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

         No matters were submitted to a vote of the  stockholders of the Company
through the solicitation of proxies, or otherwise,  during the fourth quarter of
the year ended December 31, 1997.


                                     PART II


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

         The Common Stock is currently  traded on the  American  Stock  Exchange
("AMEX")  under the symbol  "ESX." The  information  contained on page 56 of the
1997 Annual  Report to  Stockholders,  which is  attached  hereto as Exhibit 13,
under  the  caption  "Stock  Price   Information,"  is  incorporated  herein  by
reference.  As a company  listed on the AMEX, the Company is subject to the AMEX
rules regarding  continued  listing,  and does not fully satisfy those continued
listing guidelines.  Accordingly,  there can be no assurance that the listing of
the Common Stock on the AMEX will be  continued.  In this regard,  however,  the
Company  believes that its recently  improved  operating  results will favorably
impact the AMEX's evaluation.

         As of March 25,  1998,  there  were  1,058,136  shares of Common  Stock
outstanding,  which  were held by  approximately  2,100  persons.  The number of
persons  holding  shares of Common  Stock  reflects an estimate of the number of
persons or entities  holding  their stock in nominee or  "street"  name  through
various brokerage firms or other entities.

Dividends

         Neither the Company nor its predecessor (the  Partnership) has declared
any capital distributions since the fourth quarter of 1991. The Company does not
anticipate  the  payment of  dividends  on the Common  Stock in the  foreseeable
future.

         The Company's  ability to pay dividends on the Common Stock will depend
primarily on the receipt of dividends  from the Bank.  While the Company and the
Bank are no longer  operating  under any supervisory  agreements,  the Bank must
seek a letter of nonobjection  from the OTS prior to making dividend payments to
the Company.



                                       42
<PAGE>

         In connection with the Home  Acquisition,  the Company issued 2,250,000
shares of nonvoting perpetual  preferred stock with an aggregate  redemption and
liquidation  value of $15.0 million in exchange for all of the outstanding stock
of Home Bancorp. The preferred stock is redeemable at the option of the Company.
The  2,125,000  shares of Series B  preferred  stock  bear a  cumulative  annual
dividend  rate of 9.5% (based on  redemption  value) and the  125,000  shares of
Series C preferred  stock bear a cumulative  annual dividend rate of 8.0% (based
on  redemption  value).  The  Series C  preferred  stock is  senior  to Series B
preferred stock with respect to the payment of dividends, and the holders of the
Series C preferred stock may, in their discretion, from time to time in whole or
in part,  elect to convert  such shares of Series C preferred  stock into a like
amount of Series B preferred stock. At December 31, 1997,  dividends and accrued
interest  thereon in arrears on the Series B and Series C  preferred  stock were
$3,289,386 and $160,992, respectively.

         Also in connection with the Home Acquisition,  the stockholders of Home
Bancorp  received  warrants to purchase  7,949,000  shares of Common  Stock at a
price of $0.9375 per share,  which was the price of the Common  Stock as of June
30, 1995. The warrants are exercisable beginning in September 1998 and expire in
September 2005.


Item 6.  Selected Financial Data

         The selected financial data for the five years ended December 31, 1997,
which  appears  on page 3 of the 1997  Annual  Report to  Stockholders  attached
hereto as Exhibit  13, is  incorporated  by  reference  in this Form 10-K Annual
Report.


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


         The  information  contained  on pages 4 through  22 of the 1997  Annual
Report to  Stockholders,  which is  attached  hereto as  Exhibit  13,  under the
caption "Management's Discussion and Analysis of Financial Condition and Results
of Operations" is incorporated herein by reference.


Item 8.  Financial Statements and Supplementary Data

         The consolidated  balance sheets of the Company as of December 31, 1997
and 1996 and the related  consolidated  statements of operations,  shareholders'
equity  and cash  flows for each of the  years in the  three-year  period  ended
December  31,  1997,  along with the  related  notes to  consolidated  financial
statements and the report of Price Waterhouse LLP, independent accountants,  are
incorporated  herein by reference from pages 23 through 55 of the Company's 1997
Annual Report to Stockholders, which is attached hereto as Exhibit 13.


Item 9.  Changes  in  and  Disagreements  with  Accountants  on  Accounting  and
         Financial Disclosure

         Not applicable.






                                       43
<PAGE>

                                    PART III


Item 10. Directors and Executive Officers of the Registrant

         Information  regarding  the directors of the Company is included in the
Company's  Proxy  Statement  for the Annual  Meeting to be held on May 28,  1998
under the heading  "Information  with Respect to Continuing  Directors," and the
information included therein is incorporated herein by reference.

         Set forth below is information  with respect to the executive  officers
of the  Company  and its  subsidiaries  who do not  serve  as  directors  of the
Company.
<TABLE>
<CAPTION>
<S> <C>

             Name                   Age                              Title
             ----                   ---                              -----
   Earl C. McPherson                44            President and Chief Executive Officer of
                                                  Essex First and Executive Vice President
                                                  of Loan Production and Secondary
                                                  Marketing of the Bank

   Roy H. Rechkemmer, Jr.           35            Senior Vice President of Finance and Treasurer
                                                  of the Company and the Bank

   Mary-Jo Rawson                   44            Vice President and Chief Accounting
                                                  Officer of the Company and the Bank
</TABLE>

         Earl C. McPherson. Mr. McPherson presently serves as a director as well
as President and Chief  Executive  Officer of Essex First and as Executive  Vice
President of Loan Production and Secondary  Marketing of the Bank. Mr. McPherson
served as President of Essex  Industrial  Loan  Association/Virginia  Beach from
January 1992 through May 1992.  From January  1990 through  December  1991,  Mr.
McPherson served as President of Mortgage Centers,  Inc.  ("MCI").  Prior to his
employment with MCI, Mr. McPherson served as Divisional,  Regional, and Training
Director for Security  Pacific  Financial  Services,  Inc. Mr.  McPherson  has a
Bachelor of Arts from the  University of Richmond.  Mr.  McPherson also attended
the American Financial Services Association Management program at the University
of North Carolina at Chapel Hill.

         Roy H. Rechkemmer,  Jr. Mr. Rechkemmer  presently serves as Senior Vice
President of Finance and Treasurer of the Company and the Bank.  Mr.  Rechkemmer
also serves as chairman of the Bank's Asset and Liability Management  Committee,
manager of the  Bank's  investment  portfolio  and  administrator  of the Bank's
branches.  Mr. Rechkemmer  received a Bachelor of Science Degree in Finance from
the University of Wisconsin-La  Crosse in 1985. He has been employed by the Bank
and subsidiaries since 1987.

         Mary-Jo Rawson. Ms. Rawson presently serves as Vice President and Chief
Accounting Officer of the Company and the Bank. Prior to her employment with the
Company,   Ms.  Rawson  served  in  various   accounting  officer  positions  at
NationsBank Corporation and its predecessor institution C&S/Sovran. Ms. Rawson's
primary responsibilities emphasized regulatory reporting and accounting policies
and  procedures.  At the time of her departure  from  NationsBank  in 1992,  Ms.
Rawson was a Senior Vice President and the controller of the Bankcard  Division.
Ms. Rawson received a Bachelor of Science Degree in Business Administration from
Old Dominion University in 1976.

         Information  regarding  compliance with Section 16(a) of the Securities
Exchange Act is included in the Company's Proxy Statement for the Annual Meeting


                                       44
<PAGE>

to be held on May 28, 1998 under the heading  "Compliance  with Section 16(a) of
the Exchange Act," and the information  included therein is incorporated  herein
by reference.


Item 11. Executive Compensation

         Information regarding  compensation of executive officers and directors
is  incorporated  herein by reference to the Company's  Proxy  Statement for the
Annual  Meeting to be held on May 28, 1998 under the headings  "Directors  Fees"
and "Executive Compensation."


Item 12. Security Ownership of Certain Beneficial Owners and Management

         Information  regarding  security ownership of certain beneficial owners
and  management  is included in the  Company's  Proxy  Statement  for the Annual
Meeting to be held on May 28, 1998 under the headings  "Securities  Ownership of
Certain   Beneficial   Owners"  and  "Information  with  Respect  to  Continuing
Directors,"  and the  information  included  therein is  incorporated  herein by
reference.


Item 13. Certain Relationships and Related Transactions

         Information regarding certain relationships and related transactions is
included in the Company's  Proxy  Statement for the Annual Meeting to be held on
May 28, 1998 under the heading  "Transactions with Certain Related Persons," and
the information included therein is incorporated herein by reference.





                                       45
<PAGE>

                                     PART IV


Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
<TABLE>
<CAPTION>
<S> <C>

(a)       1.     Financial Statements:
                                                                                             Page in
                                                                                             Annual
                                                                                             Report*
                                                                                             -------
                 The  following  documents  are  filed as part of this report:

                 Report of Independent Accountants  .................................           23

                 Consolidated Balance Sheets at December 31, 1997
                    and 1996.........................................................           24

                 Consolidated Statements of Operations for the three
                    years ended December 31, 1997....................................           26

                 Consolidated Statements of Shareholders' Equity for
                    the three years ended December 31, 1997..........................           28

                 Consolidated Statements of Cash Flows for the three
                    years ended December 31, 1997....................................           29

                 Notes to Consolidated Financial Statements..........................           32
</TABLE>

                *Incorporated  by reference from the indicated pages of the 1997
                 Annual Report to Stockholders.

                 The financial  statements,  together with the report thereon of
                 Price  Waterhouse  LLP dated  February 18,  1998,  appearing on
                 pages 23 through 55 of the  accompanying  1997 Annual Report to
                 Stockholders  are  incorporated  by reference in this Form 10-K
                 Annual  Report.   With  the  exception  of  the  aforementioned
                 information and the  information  incorporated in Items 1, 6, 7
                 and 8, the 1997  Annual  Report  to  Stockholders  is not to be
                 deemed filed as part of this Form 10-K Annual Report.

          2.     Financial Statement Schedules:

                 All schedules are omitted  because they are not required or are
                 not  applicable  or the  required  information  is shown in the
                 consolidated financial statements or notes thereto.




                                       46
<PAGE>

                  3.     Exhibits:

                           The  following  exhibits  are either filed as part of
                           this Part IV or are incorporated herein by reference:
<TABLE>
<CAPTION>
<S> <C>

            Exhibit No.             Description
            -----------             -----------

               3.1*           Certificate  of  Incorporation  of Essex  Bancorp,
                              Inc., dated June 21, 1994. Filed as Exhibit 3.1 to
                              the Registrant's  Form S-4 Registration  Statement
                              under  the  Securities  Act of  1933 as  filed  on
                              August 15, 1994.

               3.2*           Certificate of Amendment of Essex  Bancorp,  Inc.,
                              dated August 10, 1994. Filed as Exhibit 3.2 to the
                              Registrant's Form S-4 Registration Statement under
                              the  Securities Act of 1933 as filed on August 15,
                              1994.

               3.3*           Bylaws of Essex Bancorp,  Inc., effective July 25,
                              1994.  Filed as  Exhibit  3.3 to the  Registrant's
                              Form  S-4   Registration   Statement   under   the
                              Securities  Act of 1933 as  filed  on  August  15,
                              1994.

               4.1*           Certificate   of   Designation  of  the  Series  A
                              Preferred  Stock of Essex  Bancorp,  Inc. Filed as
                              Exhibit 4.1 to the  Registrant's  Annual Report on
                              Form 10-K for the year ended December 31, 1995.

               4.2*           Certificate   of    Designations   of   Cumulative
                              Perpetual  Preferred  Stock,  Series  B  of  Essex
                              Bancorp,   Inc.   Filed  as  Exhibit  4.1  to  the
                              Registrant's Quarterly Report on Form 10-Q for the
                              quarter ended September 30, 1995.

               4.3*           Certificate   of    Designations   of   Cumulative
                              Perpetual  Preferred  Stock,  Series  C  of  Essex
                              Bancorp,   Inc.   Filed  as  Exhibit  4.2  to  the
                              Registrant's Quarterly Report on Form 10-Q for the
                              quarter ended September 30, 1995.

               4.4*           Form of Common Stock Purchase Warrant Certificate.
                              Filed as Exhibit 4.3 to the Registrant's Quarterly
                              Report  on  Form  10-Q  for  the   quarter   ended
                              September 30, 1995.

               4.5*           Specimen   Common  Stock   Certificate   of  Essex
                              Bancorp,   Inc.   Filed  as  Exhibit  4.1  to  the
                              Registrant's Pre-Effective Amendment No. 1 to Form
                              S-4  Registration  Statement  under the Securities
                              Act of 1933, as filed on October 12, 1994.


*    Not filed herewith. In accordance with Rule 12b-32 of the General Rules and
     Regulations under the Securities Exchange Act of 1934, reference is made to
     the document previously filed with the Commission.



                                       47
<PAGE>

               4.6*           Specimen Series B 9.5% Cumulative  Preferred Stock
                              Certificate  of  Essex  Bancorp,   Inc.  Filed  as
                              Exhibit 4.6 to the  Registrant's  Annual Report on
                              Form 10-K for the year ended December 31, 1995.

               4.7*           Specimen  Series C 8% Cumulative  Preferred  Stock
                              Certificate  of  Essex  Bancorp,   Inc.  Filed  as
                              Exhibit 4.7 to the  Registrant's  Annual Report on
                              Form 10-K for the year ended December 31, 1995.

               10.1           Essex Savings Bank, F.S.B.  Supplemental Executive
                              Retirement Plan dated August 26, 1993. Filed as an
                              exhibit to this report.

               10.2           First Amendment to the Essex Savings Bank,  F.S.B.
                              Supplemental  Executive Retirement Plan dated June
                              5, 1997. Filed as an exhibit to this report.

               10.3           Second Amendment to the Essex Savings Bank, F.S.B.
                              Supplemental   Executive   Retirement  Plan  dated
                              November  1,  1997.  Filed as an  exhibit  to this
                              report.

               10.4*          Fannie Mae/Freddie  Mac/Private  Investor Mortgage
                              Servicing  Purchase  and  Sale  Agreement  by  and
                              between Essex Mortgage  Corporation and Chase Home
                              Mortgage  Corporation dated June 8, 1993. Filed as
                              Exhibit 10.19 to Essex Financial Partners,  L.P.'s
                              Annual  Report on the Second  Amended and Restated
                              Form 10-K for the year ended December 31, 1992.

               10.5*          Essex Bancorp, Inc.  Non-Employee  Directors Stock
                              Option  Plan.   Filed  as  Exhibit  10.18  to  the
                              Registrant's Form 10-K for the year ended December
                              31, 1994.

               10.6*          First   Amendment  to  the  Essex  Bancorp,   Inc.
                              Non-Employee  Directors  Stock  Option  Plan dated
                              July  29,  1995.  Filed  as  Exhibit  10.6  to the
                              Registrant's  Annual  Report  on Form 10-K for the
                              year ended December 31, 1995.

               10.7*          Essex Bancorp,  Inc.  Stock Option Plan.  Filed as
                              Exhibit  10.19 to the  Registrant's  Form 10-K for
                              the year ended December 31, 1994.

               10.8*          First  Amendment to the Essex Bancorp,  Inc. Stock
                              Option Plan dated June 29, 1995.  Filed as Exhibit
                              10.8 to the  Registrant's  Annual  Report  on Form
                              10-K for the year ended December 31, 1995.


*    Not filed herewith. In accordance with Rule 12b-32 of the General Rules and
     Regulations under the Securities Exchange Act of 1934, reference is made to
     the document previously filed with the Commission.



                                       48
<PAGE>

               10.9*          Second Amendment to the Essex Bancorp,  Inc. Stock
                              Option Plan dated May 23,  1996.  Filed as Exhibit
                              10.6 to the  Registrant's  Annual  Report  on Form
                              10-K for the year ended December 31, 1996.

               10.10*         Essex Bancorp,  Inc. Employee Stock Purchase Plan.
                              Filed as Exhibit  10.20 to the  Registrant's  Form
                              10-K for the year ended December 31, 1994.

               10.11*         First   Amendment  to  the  Essex  Bancorp,   Inc.
                              Employee  Stock Purchase Plan dated June 29, 1995.
                              Filed as Exhibit 10.10 to the Registrant's  Annual
                              Report  on Form 10-K for the year  ended  December
                              31, 1995.

               10.12          Restated  Employment  Agreement  dated  January 1,
                              1998  by and  among  Essex  Bancorp,  Inc.,  Essex
                              Savings Bank, F.S.B.,  Essex Mortgage  Corporation
                              and  Gene D.  Ross.  Filed as an  exhibit  to this
                              report.

               10.13          Restated   Executive   Services   Agreement  dated
                              January 1, 1998 by and among Essex  Savings  Bank,
                              F.S.B.,  Essex First Mortgage Corporation and Earl
                              C. McPherson. Filed as an exhibit to this report.

               10.14*         Branch Purchase and Deposit  Assumption  Agreement
                              between  Essex Savings  Bank,  F.S.B.  and Centura
                              Bank dated as of April 11, 1996.  Filed as Exhibit
                              10.1 to the Registrant's  Quarterly Report on Form
                              10-Q for the quarter ended March 31, 1996.

               10.15*         Branch Purchase and Deposit  Assumption  Agreement
                              between Essex Savings Bank, F.S.B. and CENIT Bank,
                              FSB  dated as of July 2,  1996.  Filed as  Exhibit
                              10.1 to the  Registrant's  Current  Report on Form
                              8-K dated July 3, 1996.

               13             The 1997 Annual  Report is attached as Exhibit 13.
                              Portions   of   the   1997   Annual   Report   are
                              incorporated by reference into this Form 10-K.

               21*            Subsidiaries of the  Registrant.  Filed as Exhibit
                              21 to the Registrant's  Annual Report on Form 10-K
                              for the year ended December 31, 1995.

               27             Financial Data Schedule.

*    Not filed herewith. In accordance with Rule 12b-32 of the General Rules and
     Regulations under the Securities Exchange Act of 1934, reference is made to
     the document previously filed with the Commission.


</TABLE>


                                       49
<PAGE>



(b)               Reports on Form 8-K Filed in the Fourth Quarter of 1997

                  Not applicable.

(c)               Exhibits

                  See Exhibit Index contained herein.

(d)               Financial   Statements   Excluded   from   Annual   Report  to
                  Shareholders Pursuant to Rule 14a3(b)

                  Not applicable.









                              [intentionally blank]




                                       50
<PAGE>

                                   SIGNATURES


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

                                      Essex Bancorp, Inc.


                                      By:   /s/ Gene D. Ross
                                         --------------------------
                                            Gene D. Ross
                                            Chairman, President,
                                            and Chief Executive
                                            Officer

                                                March 31, 1998
                                                --------------
                                                    (Date)

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


By: /s/ Gene D. Ross                                              March 31, 1998
--------------------                                              --------------
       Gene D. Ross                                                    (Date)
       Chairman, President, Chief
       Executive Officer and
       Principal Financial Officer


By: /s/ Mary-Jo Rawson                                            March 31, 1998
----------------------                                            --------------
       Mary-Jo Rawson                                                  (Date)
       Chief Accounting Officer


By: /s/ Roscoe D. Lacy, Jr.                                       March 31, 1998
---------------------------                                       --------------
       Roscoe D. Lacy, Jr.                                             (Date)
       Director


By: /s/ Harry F. Radcliffe                                        March 31, 1998
--------------------------                                        --------------
       Harry F. Radcliffe                                              (Date)
       Director




                                       51
<PAGE>

                                  Exhibit Index
<TABLE>
<CAPTION>
<S> <C>

             Exhibit No.             Description
             -----------             -----------

               3.1*           Certificate  of  Incorporation  of Essex  Bancorp,
                              Inc., dated June 21, 1994.

               3.2*           Certificate of Amendment of Essex  Bancorp,  Inc.,
                              dated August 10, 1994.

               3.3*           Bylaws of Essex Bancorp,  Inc., effective July 25,
                              1994.

               4.1*           Certificate   of   Designation  of  the  Series  A
                              Preferred Stock of Essex Bancorp, Inc.

               4.2*           Certificate   of    Designations   of   Cumulative
                              Perpetual  Preferred  Stock,  Series  B  of  Essex
                              Bancorp, Inc.

               4.3*           Certificate   of    Designations   of   Cumulative
                              Perpetual  Preferred  Stock,  Series  C  of  Essex
                              Bancorp, Inc.

               4.4*           Form of Common Stock Purchase Warrant Certificate

               4.5*           Specimen   Common  Stock   Certificate   of  Essex
                              Bancorp, Inc.

               4.6*           Specimen Series B 9.5% Cumulative  Preferred Stock
                              Certificate of Essex Bancorp, Inc.

               4.7*           Specimen  Series C 8% Cumulative  Preferred  Stock
                              Certificate of Essex Bancorp, Inc.

               10.1           Essex Savings Bank, F.S.B  Supplemental  Executive
                              Retirement Plan.

               10.2           First   Amendment  to  the  Savings  Bank,   F.S.B
                              Supplemental Executive Retirement Plan.

               10.3           Second   Amendment  to  the  Savings  Bank,  F.S.B
                              Supplemental Executive Retirement Plan.

               10.4*          Fannie Mae/Freddie  Mac/Private  Investor Mortgage
                              Servicing  Purchase  and  Sale  Agreement  by  and
                              between Essex Mortgage  Corporation and Chase Home
                              Mortgage Corporation dated June 8, 1993.

*    For exhibit  reference see Item 14(c) for statement of location of exhibits
     incorporated by reference.




                                       E-1
<PAGE>

               10.5*          Essex Bancorp, Inc.  Non-Employee  Directors Stock
                              Option Plan.

               10.6*          First   Amendment  to  the  Essex  Bancorp,   Inc.
                              Non-Employee  Directors  Stock  Option  Plan dated
                              July 29, 1995.

               10.7*          Essex Bancorp, Inc. Stock Option Plan.

               10.8*          First  Amendment to the Essex Bancorp,  Inc. Stock
                              Option Plan dated June 29, 1995.

               10.9*          Second Amendment to the Essex Bancorp,  Inc. Stock
                              Option Plan dated May 23, 1996.

               10.10*         Essex Bancorp, Inc. Employee Stock Purchase Plan.

               10.11*         First   Amendment  to  the  Essex  Bancorp,   Inc.
                              Employee Stock Purchase Plan dated June 29, 1995.

               10.12          Restated  Employment  Agreement  dated  January 1,
                              1998  by  an  among  Essex  Bancorp,  Inc.,  Essex
                              Savings Bank, F.S.B.,  Essex Mortgage  Corporation
                              and Gene D. Ross.

               10.13          Restated   Executive   Services   Agreement  dated
                              January 1, 1998 by and among Essex  Savings  Bank,
                              F.S.B.,  Essex First Mortgage Corporation and Earl
                              C. McPherson.

               10.14*         Branch Purchase and Deposit  Assumption  Agreement
                              between  Essex Savings  Bank,  F.S.B.  and Centura
                              Bank dated as of April 11, 1996.

               10.15*         Branch Purchase and Deposit  Assumption  Agreement
                              between Essex Savings Bank, F.S.B. and CENIT Bank,
                              FSB dated as of July 2, 1996.

               13             The 1997 Annual  Report is attached as Exhibit 13.
                              Portions   of   the   1997   Annual   Report   are
                              incorporated by reference into this Form 10-K.

               21*            Subsidiaries of the Registrant, as updated.

               27             Financial Data Schedule

*    For exhibit  reference see Item 14(c) for statement of location of exhibits
     incorporated by reference.
</TABLE>


                                      E-2