<PAGE>   1
                                   EXHIBIT 13

                          ANNUAL REPORT TO STOCKHOLDERS

LETTER TO SHAREHOLDERS

Fellow Shareholders:

Net income totaled $2.2 million, or $0.50 per share for the year ended September
30, 1999, as compared to $1.9 million for 1998. The business plan and strategy
we developed in conjunction with our April 9, 1998, mutual-to-stock conversion
is clearly the blueprint for our financial performance and success in 1999. Our
goal to reposition the balance sheet to reflect lower-cost funding sources in
the form of demand deposits and higher interest margins in the form of increased
commercial and consumer loan outstandings is well underway. This is evidenced by
our growth in each of these areas.

During fiscal 1999, total deposits grew by $15.5 million, or 10.8%. Demand
deposits and statement savings, our focus areas, grew by $4.8 million, or 12.7%.
Our marketing campaign, combined with a sales incentive program, and a cultural
shift toward sales are primarily responsible for these accomplishments. We will
continue to place significant emphasis on these areas going forward.

On the asset side, our attention was centered on three primary goals:

1) Fully invest the capital raised in the 1998 stock conversion in quality
moderate-term loans.
2) Reduce the interest rate risk exposure of long-term fixed rate mortgage
loans.
3) Grow the higher-yielding more interest-sensitive commercial and consumer loan
portfolios.

We have achieved quite a bit of success in each of these areas. The capital
raised from our 1998 offering was fully invested in short- and moderate-term
residential loans with the strategy that we would reinvest the principal and
interest payments from these loans into higher-yielding and faster-repricing
commercial and consumer loans over the next several years as we develop those
business lines. I am pleased to report that we have made considerable progress
in developing the commercial and consumer loan portfolios during 1999. Our
commercial loans grew by $7.7 million, or 116.6%, to $14.4 million, while our
consumer portfolio grew by $2.5 million, or 28.5%, to $11.6 million outstanding
at September 30, 1999. Our ability to attract and hire quality experienced
commercial bankers and an experienced Chief Credit Officer has enabled us to
accomplish this.

We reduced our exposure to the effects of rising interest rates by selling $13.1
million of long-term (predominantly 30-year) fixed-rate mortgage loans during
1999. In total we have sold $22.7 million in fixed-rate mortgage loans since our
stock conversion. These proceeds were reinvested in shorter-term mortgages and
commercial and consumer loans.

The quality of our loan portfolio is of utmost importance and we are happy to
report that our credit quality remains very high with only 0.06% of loans as
nonperforming. This improved from an already favorable 0.91% in 1998.

During the coming years, we will continue to emphasize commercial and consumer
loan growth but will shift our residential mortgage emphasis to a mortgage
banking philosophy. This philosophy, which has now been implemented, will curb
lower margin residential mortgage outstandings. We will continue to nurture the
consumer banking relationships associated with mortgage lending while creating a
larger source of noninterest income from fees associated with mortgage banking.

Operating noninterest income has increased by $301,000, or 44.2%, in 1999. This
increase is attributable to a very successful year from our financial services
subsidiary, Gaston Financial Services, Inc., which contributed $92,000 in net
income to the Bank, as compared to $54,000 in 1998. Gaston Financial Services'
improvement is attributable to our shift to a sales culture along with a
significant amount of education and
<PAGE>   2
training of our staff on how and when our customers should be referred to an
investment professional. Additional success in noninterest income has been
derived through our growth in demand deposit accounts, which are traditional
sources of noninterest fee revenue.

We have made significant progress in capital management and capital leverage
during 1999. We repurchased 211,400 shares of our stock during 1999. This
reduced our total shares outstanding to 4,369,634. Our capital-to-assets ratio
at September 30, 1999, was 16.7%, as compared to 20.0%, at September 30, 1998.
Asset growth is the primary reason for this improvement. We are continuing to
pursue aggressively opportunities to grow through acquisitions or branch
purchases. However, to date we have not been afforded an opportunity which we
feel fits with our geographic and strategic growth plan. In lieu of this, we
have embarked on a de novo branching plan to accomplish our growth and leverage
goals. In this regard, in October 1999, we opened a loan production office in
Shelby, North Carolina; and, in Dallas, North Carolina, our fifth full-service
branch office is under construction and should be fully operational in March
2000. Additionally, we have identified a site for our sixth full-service banking
office, which we hope to announce in February 2000.

During the past year we have made substantial capital investments in
infrastructure, including the branch expansion previously discussed. In
addition, we have made significant investments in technology to ensure that our
computer systems are fully Year 2000 (Y2K) compliant. These Y2K measures
included investments in hardware and software, as well as investments of time,
training and energy. We have taken every precaution to retain our customers'
complete confidence in our ability to handle their financial matters securely in
the Year 2000 and beyond. We also have made investments in new technology for
telecommunications to enhance our Gaston Federal Bank Service 24 telephone
banking system and have purchased the technology necessary to reduce our
transaction processing time and, ultimately, to increase the speed with which we
deliver service to our customers. We have been engaged in the planning,
research, and interview process with providers of Internet Banking systems for
most of the last half of 1999. We expect to rollout an Internet Banking product
to our customers sometime in the Year 2000. While these infrastructure
investments are expensive, we are convinced they are necessary to provide the
service level and consumer "touch points" necessary to drive the growth of our
customer base.

While physical and technological assets are important to our continuing success,
both management and our board of directors believe that our employees are our
most valuable asset. Their ability to provide a high level of personalized
customer service is the most important ingredient for the success of our
organization. We have taken great measures to train and communicate this culture
throughout our organization in 1999. We have a very talented staff who clearly
understand and are dedicated to our mission. Both they and I pledge to continue
to strive for continuous improvement in our service levels and performance. We
welcome your comments and suggestions and hope that you will allow us to
demonstrate our commitment by serving your banking needs.

Sincerely,

/s/ David W. Hoyle                                            /s/ Kim S. Price
Chairman of the Board                                         President and CEO
<PAGE>   3
                 SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA

         The following tables set forth certain financial and other data of
Gaston Federal Bancorp, Inc. (the "Company"), or, prior to April 9, 1998, Gaston
Federal Bank (the "Bank") at the dates and for the periods indicated. For
additional information about the Company, reference is made to "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
the Consolidated Financial Statements of the Company and related notes included
elsewhere herein.

<TABLE>
<CAPTION>
                                                                                       At September 30,
                                                                          ---------------------------------------------
(In Thousands)                                                             1999         1998         1997         1996
-----------------------------------------------------------------------------------------------------------------------
<S>                                                                      <C>          <C>          <C>          <C>
SELECTED CONSOLIDATED FINANCIAL CONDITION DATA
Total assets ........................................................    $237,453     $208,003     $173,470     $171,953
Loans receivable, net ...............................................     168,044      136,501      134,491      130,862
Mortgage-backed and related securities ..............................      19,992       14,707       10,087       12,918
United States government and agency securities held to maturity .....      12,499       15,228       10,407       14,751
United States government and agency securities available for sale ...       9,159       15,203        2,009           --
Other investments available for sale ................................       6,618        5,716        6,239        5,515
Deposits ............................................................     159,425      143,900      145,444      145,975
Borrowed funds ......................................................      35,500       19,500        3,500        3,750
Total equity ........................................................      39,709       41,570       20,868       19,084
SELECTED CONSOLIDATED OPERATING DATA:

Interest income .....................................................    $ 15,238     $ 13,927     $ 12,936     $ 12,518
Interest expense ....................................................       7,888        7,126        6,952        7,381
                                                                         --------     --------     --------     --------
Net interest income .................................................       7,350        6,801        5,984        5,137
Provision for loan losses ...........................................         105          300          293           47
                                                                         --------     --------     --------     --------
Net interest income after provision for losses ......................       7,245        6,501        5,691        5,090
Noninterest income ..................................................       2,373          956          516          417
Noninterest expense (1) .............................................       6,259        4,567        3,956        4,646
                                                                         --------     --------     --------     --------
Income before income taxes ..........................................       3,359        2,890        2,251          861
Income tax expense ..................................................       1,198        1,004          819          351
                                                                         --------     --------     --------     --------
Net income ..........................................................    $  2,161     $  1,886     $  1,432     $    510
                                                                         ========     ========     ========     ========
PERFORMANCE RATIOS:
Return on average assets (net income divided by average total assets)        0.96%        0.98%        0.84%        0.30%
Return on average equity (net income divided by average equity) .....        5.19         6.47         7.38         2.76
Net interest rate spread ............................................        2.71         3.16         3.24         2.82
Net interest margin .................................................        3.27         3.54         3.50         3.03
Average interest-earning assets to average interest-bearing
 liabilities ........................................................      119.41       114.01       109.92       108.29
Noninterest expense to total assets .................................        2.64         2.20         2.28         2.70
Noninterest expense to average total assets .........................        2.78         2.38         2.31         2.74
ASSET QUALITY RATIOS:

Nonperforming assets to total assets ................................        0.15%        0.71%        0.75%        0.84%
Nonperforming loans to total loans ..................................        0.06         0.91         0.76         0.88
Nonperforming loans to total assets .................................        0.04         0.60         0.61         0.69
Allowance for loan losses to total loans at the end of period .......        0.86         0.98         0.80         0.61
Allowance for loan losses to nonperforming loans ....................    1,605.32       113.97       104.82        69.51
Net interest income after provision for loan losses to total
 noninterest expense ................................................      115.75       142.35       143.82       109.58
CAPITAL RATIOS:
Ratio of average equity to average total assets .....................       18.51%       15.16%       11.34%       10.92%
Equity to assets at period end ......................................       16.72        19.99        12.03        11.10
Dividend payout ratio  (2) ..........................................       43.40        23.90           --           --
OTHER DATA:
Number of real estate loans outstanding .............................       1,858        1,841        1,999        2,038
Number of deposit accounts ..........................................      14,419       13,432       13,760       13,795
Number of full service offices ......................................           4            4            4            4
</TABLE>

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

(1) Includes a nonrecurring expense of $867 for the year ended September 30,
    1996 for a one-time premium to recapitalize the Savings Association
    Insurance Fund.
(2) The Dividend payout ratio is not relevant for periods prior to the
    Reorganization in April 1998.
<PAGE>   4
                      MANAGEMENT'S DISCUSSION AND ANALYSIS
                OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

DESCRIPTION OF BUSINESS

         Gaston Federal Bancorp, Inc. was formed on March 18, 1998, for the
purpose of acting as the Holding Company for Gaston Federal Bank. The Company's
assets consist primarily of the outstanding capital stock of the Bank, deposits
held at the Bank, and investments. As of September 30, 1999, there were
1,986,489 shares of the Company's common stock held by the public and 2,383,145
shares held by Gaston Federal Holdings, MHC, the Company's parent mutual holding
company. The publicly held common stock of the Company currently trades on the
Nasdaq National Market System under the symbol GBNK. The Company's principal
business is overseeing and directing the business of the Bank and investing the
net stock offering proceeds retained by it.

         The Bank was organized in 1904 as a state-chartered building and loan
association. The Bank has since evolved into a community-oriented savings bank
engaged primarily in the business of offering FDIC-insured deposits to customers
through its branch offices and investing those deposits in residential,
commercial, and consumer loans and investment securities.

         All of the Bank's full service offices are located in the North
Carolina County of Gaston. The main office and two branches are located in the
City of Gastonia, and one branch is located in the City of Mount Holly. Gaston
County is located on the I-85 corridor in the Southern Piedmont region of North
Carolina, not far from Charlotte, North Carolina. Gaston County is bounded by
the North Carolina Counties of Mecklenburg, Lincoln, and Cleveland, and the
South Carolina County of York. The Bank considers Gaston and these contiguous
counties to be its primary market area.

FORWARD-LOOKING STATEMENTS

         In addition to historical information, this document contains
forward-looking statements. The forward looking statements contained in the
following sections are subject to certain risks and uncertainties that could
cause actual results to differ materially from those projected in the
forward-looking statements. Important factors that might cause such a difference
include, but are not limited to, those discussed. Readers should not place undue
reliance on these forward-looking statements, as they reflect management's
analysis as of the date of this report. The Company has no obligation to update
or revise these forward-looking statements to reflect events or circumstances
that occur after the date of this report. Readers should carefully review the
risk factors described in other documents the Company files from time to time
with the SEC, including quarterly reports on Form 10-QSB and current reports
filed on Form 8-K.

GENERAL

         The Company's results of operations are dependent primarily on net
interest income, which is the difference between the income earned on its loan
and securities portfolios and its cost of funds, consisting primarily of the
interest paid on deposits and borrowings. Results of operations are also
affected by the Company's provision for loan losses, securities sales, and
service charges on its deposit accounts. The Company's noninterest expense
primarily consists of salaries and employee benefits, occupancy expense, federal
deposit insurance premiums, advertising, and other expenses. Results of
operations are also significantly affected by general economic and competitive
conditions, particularly changes in interest rates and actions of regulatory and
governmental authorities.

MANAGEMENT OF MARKET RISK
<PAGE>   5
         Generally. The Company's most significant form of market risk is
interest-rate risk, as the majority of the Company's assets and liabilities are
sensitive to changes in interest rates. The principal objective of the Company's
interest rate risk management is to evaluate the interest rate risk inherent in
the Bank's assets and liabilities, determine the level of risk appropriate given
the Company's business strategy, operating environment, capital and liquidity
requirements, and performance objectives, and manage the risk consistent with
the guidelines approved by the Board of Directors. Through such management, the
Company seeks to reduce the vulnerability of its operations to changes in
interest rates. The Company's Asset/Liability Committee is comprised of the
Company's senior management and members of the Board of Directors. Senior
management is responsible for reviewing with the Board of Directors its
activities and strategies, the effect of those strategies on the Company's net
interest margin, the fair value of the portfolio, and the effect that changes in
interest rates will have on the Company's portfolio and the Company's exposure
limits.

         In recent years, the Company has utilized the following strategies to
manage interest rate risk: (1) emphasize the origination and retention of one-
to four-family residential, adjustable-rate mortgage loans ("ARMs") and
fixed-rate loans with maturities of 15 years or less, (2) emphasize the
origination and retention of shorter-term commercial business loans, (3)
emphasize the origination of adjustable-rate home equity lines of credit, and
(4) invest in shorter-term investment securities.

         Net Portfolio Value. The Office of Thrift Supervision ("OTS") requires
the computation of amounts by which the net present value of an institution's
cash flow from assets, liabilities, and off balance sheet items (the Bank's net
portfolio value or "NPV") would change in the event of a range of assumed
changes in market interest rates. These computations estimate the effect on an
institution's NPV from instantaneous and permanent 1% to 3% (100 to 300 basis
points) increases and decreases in market interest rates.

         The following table presents the Bank's NPV at September 30, 1999, as
calculated by the OTS, which is based upon quarterly information that is
voluntarily provided to the OTS.

<TABLE>
<CAPTION>
                                        PERCENTAGE CHANGE IN NET PORTFOLIO VALUE

                                 Changes                                            Board
                                in Market                  Projected               Policy
                             Interest Rates                Change (1)              Limit (2)
                             --------------                ----------              ---------
                             (basis points)
<S>                                                          <C>                    <C>
                                  + 300                      -35.00%                -40.00%
                                  + 200                      -24.00%                -30.00%
                                  + 100                      -12.00%                -15.00%
                                      0                        0.00%                  0.00%
                                   -100                       10.00%                -15.00%
                                   -200                       20.00%                -30.00%
                                   -300                       29.00%                -40.00%
</TABLE>

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

(1) Calculated as the amount of change in the estimated NPV divided by the
    estimated NPV assuming no change in interest rates.
(2) Limits are established by the Bank's Board of Directors.

         Certain shortcomings are inherent in the methodology used in the above
interest rate risk measurement. Modeling changes in NPV require the making of
certain assumptions, which may or may not reflect the manner in which actual
yields and costs respond to changes in market interest rates. Accordingly,
although the NPV table provides an indication of the Bank's interest rate risk
exposure at a particular point
<PAGE>   6
in time, such measurements are not intended to and do not provide a precise
forecast of the effect of changes in market interest rates on the Bank's net
interest income and will differ from actual results.

COMPARISON OF FINANCIAL CONDITION

         Assets. Total assets for the fiscal year ended September 30, 1999,
increased by $29.5 million, or 14.2% from $208.0 million to $237.5 million. The
change in assets was primarily due to a $31.5 million increase in net loans
outstanding. Mortgage loans secured by one-to-four family dwellings increased by
$23.8 million, or 22.6%, while nonmortgage loans increased by $10.3 million, or
66.2%. Cash and cash equivalents, investment securities, and mortgage-backed and
related securities decreased by $3.8 million, or 6.2%, due to the increased loan
demand, normal maturities and principal payments, calls, and prepayments.
Management plans to continue to grow its asset base with an increased emphasis
on higher-yielding nonmortgage loans and adjustable-rate mortgage loans.

         Total assets for the fiscal year ended September 30, 1998, increased by
$34.5 million, or 19.9%, from $173.5 million to $208.0 million. This increase in
assets was primarily due to the $18.5 million in net proceeds received from the
Company's stock offering completed April 9, 1998, as part of the Bank's mutual
holding company reorganization (the "Reorganization") and a $16.0 million
increase in investment and mortgage-backed securities that were funded by
Federal Home Loan Bank ("FHLB") advances. In addition to the increase in assets,
there were also material changes in the Company's asset portfolio mix. Cash and
cash equivalents increased $9.2 million, or 198.3%, from $4.6 million to $13.8
million. This increase was primarily due to the receipt of $9.7 million from the
sale of long-term fixed-rate loans in August 1998. Also, nonmortgage loans
increased by $2.4 million, or 18.5%, from $13.0 million to $15.4 million, while
the mortgage loan portfolio remained stable at $121.1 million.

         Liabilities. Total liabilities for the fiscal year ended September 30,
1999, increased by $31.3 million, or 18.8%, from $166.4 million to $197.7
million. The change in liabilities was primarily due to a $16.0 million increase
in borrowed money and a $15.5 million increase in total deposits. Borrowed money
increased from $19.5 million to $35.5 million, or 82.1%, while deposits
increased from $143.9 million to $159.4 million, or 10.8%. Funds generated from
borrowed money and deposits were used to fund the purchase and origination of
loans and to engage in various wholesale leverage strategies. Management plans
to continue to aggressively market its retail deposit products to the local
community and to continue pursuing attractive opportunities to leverage the
Company's capital.

         Total liabilities for the fiscal year ended September 30, 1998,
increased $13.8 million, or 9.0% , from $152.6 million to $166.4 million. This
change in liabilities was primarily due to a $16.0 million increase in borrowed
money from $3.5 million to $19.5 million. The borrowed money was used to
purchase investment and mortgage backed securities. Also, as part of the
Reorganization, depositors withdrew approximately $8.4 million in existing Bank
deposits to purchase stock in the Company. While a significant portion of these
deposits was replaced as a result of aggressive marketing, total deposits
decreased by $1.5 million, or 1.1%, from $145.4 million to $143.9 million.

         Equity. Total equity for the fiscal year ended September 30, 1999,
decreased from $41.6 million to $39.7 million, or 4.5%. This decrease was due,
in part, to a $2.9 million repurchase of common stock, the payment of $938,000
in cash dividends, and a $1.4 million reduction of accumulated unrealized gains
on available for sale securities. These reductions in capital were offset by
$2.2 million in net income for the year. Management plans to continue to
repurchase its publicly traded common stock at prices that are considered by
management to be attractive.

         Total equity for the fiscal year ended September 30, 1998, increased by
$20.7 million, or 99.2%,
<PAGE>   7
from $20.9 million to $41.6 million. The primary reasons for the increase in
equity are the receipt of $18.5 million in net proceeds from the Reorganization
and the $1.9 million in net income for the fiscal year.

ANALYSIS OF RESULTS OF OPERATIONS

         Net Interest Income. Net interest income represents the difference
between income on interest-earning assets and expense on interest-bearing
liabilities. Net interest income also depends on the relative amounts of
interest-earning assets and interest-bearing liabilities and the interest rate
earned or paid on them, respectively. The following table sets forth certain
information relating to the Company for the years ended September 30, 1999,
1998, and 1997. For the periods indicated, the total dollar amount of interest
income from average interest-earning assets and the resultant yields, as well as
the interest expense on average interest-bearing liabilities, is expressed both
in dollars and rates. No tax equivalent adjustments were made.

<TABLE>
<CAPTION>
                                                                      For The Years Ended September 30,
                                                      1999                                1998
                                  --------------------------------------------------------------------------------------
                                    AVERAGE        INTEREST                 AVERAGE     INTEREST              AVERAGE
                                  OUTSTANDING       EARNED/        YIELD/  OUTSTANDING   EARNED/    YIELD/   OUTSTANDING
(DOLLARS IN THOUSANDS)              BALANCE          PAID           RATE     BALANCE      PAID      RATE      BALANCE
------------------------------------------------------------------------------------------------------------------------
Interest-earning assets:
<S>                                 <C>            <C>              <C>     <C>        <C>          <C>      <C>
  Loans receivable (1).....         $158,534       $ 11,999         7.57%   $136,491   $ 11,020     8.07%    $132,529
  Investment securities....           32,010          1,833         5.73      24,058      1,471     6.11       18,226
  Interest-earning deposits            3,500            226         6.46      13,376        802     6.00        1,049
  Mortgage-backed securities          20,750          1,181         5.69       9,692        634     6.54       11,612
                                      ------          -----         ----       -----        ---     ----       ------

Total interest-earning assets       $214,794        $15,239         7.09     183,617   $ 13,927     7.58      163,416
Noninterest-earning assets.           10,126                                   8,608   ========                 7,751
                                      ------                                   -----                            -----

Total assets...............         $224,920                                           $192,225
                                    ========                                           ========


Interest-bearing liabilities,:
  Demand deposit accounts..         $ 17,413        $   194         1.11%   $ 16,214   $    281     1.73%      12,905
  Money market demand account         13,152            397         3.02      20,974        580     2.77       14,296
  Savings accounts.........           22,624            717         3.17      19,607        663     3.38       14,037
  Certificates of deposit..           98,030          5,099         5.20      96,400      5,170     5.36      105,119
  Borrowed funds...........           28,658          1,481         5.17       7,852        432     5.50        2,309
                                      ------          -----         ----       -----        ---     ----        -----

Total interest-bearing liabilities  $179,877        $ 7,888         4.39     161,047      7,126     4.42%     148,666
                                                    -------                            ========
Noninterest-bearing liabilities        3,420                                   2,032                            3,098
                                       -----                                   -----                            -----

Total liabilities..........         183,297                                  163,079                          151,764

Total equity...............          41,623                                   29,146                           19,403
                                     ------                                   ------                           ------

Total liabilities and
  retained earnings........        $224,920                                 $192,225                         $171,167
                                   ========                                 ========                         ========

Net interest income........                         $ 7,351                             $ 6,801
                                                    =======                             =======

Interest rate spread (2)...                                         2.71%                           3.16%
                                                                    ====                            ====


Net yield on interest-earning
  assets (3)...............                                         3.42%                           3.70%
                                                                    ====                            ====

Ratio of average interest-earning
  assets to interest-bearing
  liabilities..............                                       119.41%                         114.01%
                                                                  ======                          ======
</TABLE>

<TABLE>
<CAPTION>
                                           1997
                                   ------------------
                                    INTEREST
                                     EARNED/  YIELD/
                                      PAID      RATE
                                   ------------------
Interest-earning assets:
<S>                               <C>          <C>
  Loans receivable (1).....        $ 10,826     8.17%
  Investment securities....           1,232     6.76
  Interest-earning deposits              89     8.48
  Mortgage-backed securities            789     6.79
                                        ---     ----

Total interest-earning assets        12,936     7.92
Noninterest-earning assets.

Total assets...............        $171,167
                                   ========


Interest-bearing liabilities,:
  Demand deposit accounts..             243     1.88%
  Money market demand account           429     3.00
  Savings accounts.........             387     2.76
  Certificates of deposit..           5,746     5.47
  Borrowed funds...........             147     6.37
                                        ---     ----

Total interest-bearing liabilities    6,952     4.68%
                                      -----

Noninterest-bearing liabilities

Total liabilities..........

Total equity...............

Total liabilities and
  retained earnings........

Net interest income........        $  5,984
                                   ========

Interest rate spread (2)...                     3.24%
                                                ====


Net yield on interest-earning
  assets (3)...............                     3.66%
                                                ====

Ratio of average interest-earning
  assets to interest-bearing
  liabilities..............                   109.92%
                                              ======
</TABLE>

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

(1)      Average balances include nonaccrual loans.
(2)      Interest rate spread represents the difference between the average
         yield on interest-earning assets and the average cost of
         interest-bearing liabilities.
(3)      Net yield on interest-earning assets represents net interest income as
         a percentage of average interest-earning assets.
<PAGE>   8
         The table below sets forth information regarding changes in our
interest income and interest expense for the periods indicated. For each
category of our interest-earning assets and interest-bearing liabilities,
information is provided on changes attributable to (i) changes in volume
(changes in volume multiplied by old rate); (ii) changes in rate (changes in
rate multiplied by old volume); (iii) changes in rate-volume (changes in rate
multiplied by the change in volume).

<TABLE>
<CAPTION>
                                                   FOR THE YEAR ENDED                           FOR THE YEAR ENDED
                                        SEPTEMBER 30, 1999 VS SEPTEMBER 30, 1998       SEPTEMBER 30, 1998 TO SEPTEMBER 30, 1997
                                                   INCREASE (DECREASE)                          INCREASE (DECREASE)
                                                         DUE TO                                       DUE TO
                                                         ------                                       ------
                                                                   RATE/                                   RATE/
(IN THOUSANDS)                                 VOLUME     RATE    VOLUME     TOTAL    VOLUME      RATE    VOLUME   TOTAL
----------------------------------------------------------------------------------------------------------------------------
Interest income:
<S>                                            <C>      <C>        <C>    <C>         <C>       <C>       <C>      <C>
Securities and other interest-earning assets   $(106)   $ (32)     $(76)  $   (214)   $1,245    $(145)    $(137)   $963
Mortgage-backed and related securities           723      (82)      (94)       547      (130)     (43)        7    (166)
Loan portfolio........................         1,780     (689)     (112)       979       324      (126)      (4)    194
                                               -----     ----      ----        ---       ---      ----       --     ---

    Total interest income.............         2,397     (803)     (282)     1,312     1,438      (313)     (133)   991
                                               -----     ----      ----      -----     -----      ----      ----    ---

Interest expense:
Deposits..............................            (6)    (245)      (36)      (287)      318      (410)      (19)  (111)
Borrowed funds........................         1,145      (26)      (69)     1,049       353       (20)      (48)   285
                                               -----      ---       ---      -----       ---       ---       ---    ---
  Total interest expense..............         1,139     (270)     (107)       762       671      (429)      (68)   174
                                               -----     ----      ----        ---       ---      ----       ---    ---

Net interest income...................       $ 1,259    $(534)   $ (175)   $   550     $ 767     $ 115     $ (65)  $817
                                             =======    =====    ======    =======     =====     =====     =====   ====
</TABLE>

RESULTS OF OPERATIONS

         General. The earnings of the Company depend primarily on its level of
net interest income, which is the difference between interest earned on the
Company's interest-earning assets, consisting primarily of real estate loans,
commercial business loans, consumer loans, investment securities and
mortgage-backed securities, and the interest paid on interest-bearing
liabilities, consisting primarily of deposits and borrowed funds. Net interest
income is a function of the Company's interest rate spread, which is the
difference between the average yield earned on interest-earning assets and the
average rate paid on interest-bearing liabilities, as well as a function of the
average balance of interest-earning assets as compared to interest-bearing
liabilities. The Company's earnings also are affected by its level of service
charges and gains on sale of assets, as well as its level of noninterest
expenses, including salaries and benefits, occupancy, deposit insurance,
advertising, professional services and other noninterest expenses.

         Net Income. Net income for the fiscal year ended September 30, 1999,
increased by $275,000, or 14.6%, to $2.2 million. This change was primarily due
to a $549,000 increase in net interest income, a $1.1 million increase in the
gain on sale of assets, and a $301,000 increase in operating noninterest income.
These increases were offset, in part, by a $1.7 million increase in noninterest
expenses.

          Net income for the fiscal year ended September 30, 1998, increased by
$454,000, or 30.3%, from $1.4 million to $1.9 million. The increase was
primarily due to a $866,000 increase in net interest income and an increase of
$391,000 in noninterest income. The effects of these increases were partially
offset by a $610,000 increase in noninterest expenses.

         Interest Income. Interest income for the fiscal year ended September
30, 1999, increased by $1.3 million, or 9.4%, to $15.2 million. This change was
primarily due to a $1.0 million, or 8.9%, increase in interest earned on loans
outstanding. This increase was primarily attributable to a $22.0 million, or
16.1% increase in average loans outstanding from $136.5 million to $158.5
million, the effects of which were offset by a 50 basis point reduction in the
yield from 8.07% to 7.57%. The decrease in yield was primarily due to the lower
interest rate environment that resulted in the refinancing of many existing
higher-yielding loans and the origination of new loans at lower interest rates.
Management plans to continue to prudently grow the
<PAGE>   9
Company's loan portfolio with an emphasis on higher-yielding nonmortgage loans
and adjustable-rate mortgage loans.

         Interest earned on mortgage-backed and related securities increased by
$547,000, or 86.3%, due to an $11.1 million, or 114.1%, increase in the average
outstanding balance from $9.7 million to $20.8 million, the effects of which
were offset by a 74 basis point decrease in yield from 6.43% to 5.69%.
Mortgage-backed securities increased during the year primarily due to the
execution of leverage strategies, which were funded by FHLB advances. Interest
earned on investment securities and interest-earning deposits decreased by
$214,000, or 9.4%, due to a $1.9 million, or 5.1%, decrease in the average
outstanding balance from $37.4 million to $35.5 million and a 30 basis point
decrease in yield from 6.10% to 5.80%. The decrease in yield was primarily
caused by a lower interest rate environment which resulted in faster prepayments
on higher-yielding securities, downward adjustments on adjustable-rate
securities, and the reinvestment of matured and called securities at lower
interest rates.

         Interest income for the fiscal year ended September 30, 1998, increased
by $1.0 million, or 7.8%, from $12.9 million to $13.9 million. This increase was
due to a $963,000 increase in income from investment securities and a $243,000
increase in income from loans, the effects of which were partially offset by a
$166,000 decrease in income from mortgage-backed securities. The increase in
income from investment securities was primarily attributable to an $18.1
million, or 93.8%, increase in the average balance of investment securities from
$19.3 million to $37.4 million, the effects of which were offset by a 75 basis
point decrease in the average yield from 6.85% to 6.10%. The increase in the
Company's investment portfolio was due, in part, to the purchase of $26.2
million in investment securities using proceeds received from the stock
conversion and FHLB advances. The sale and maturity of $8.1 million in
investment securities offset this increase. The decrease in the yield on
investments was primarily due to the fact that many higher-yielding investments
have either matured or were called, while additional securities were purchased
in a lower interest rate environment. The decrease in income from
mortgage-backed securities was attributable to a $1.9 million, or 16.4%,
decrease in the average balance of mortgage backed securities from $11.6 million
to $9.7 million. The decrease in the average balance of mortgage-backed
securities was primarily the result of faster prepayments due to falling
interest rates. The decrease in market rates also resulted in a 36 basis point
decrease in the yield on mortgage-backed securities from 6.79% to 6.43%.
Interest income from the Company's loan portfolio increased by $243,000, or
2.2%, from $10.8 million to $11.0 million. This increase was primarily due to a
$4.0 million, or 3.0%, increase in the average balance of loans from $132.5
million to $136.5 million, the effects of which were partially offset by a 10
basis point reduction in the yield to 8.07% from 8.17%. The decrease in yield
was primarily due to the lower interest rate environment.

         Interest Expense. For the fiscal year ended September 30, 1999,
interest expense increased by $761,000, or 10.7% from $7.1 million to $7.9
million. This change was due to a $1.0 million increase in interest expense on
borrowed money, the effects of which were offset by a $287,000 decrease in
interest paid on deposits. The increase in interest expense on borrowed money
was due to a $20.8 million increase in the average balance from $7.9 million to
$28.7 million, the effects of which were offset by a 33 basis point decrease in
the interest rate paid on borrowed funds. Interest paid on deposits decreased as
a result of a $2.0 million reduction in the average outstanding balance from
$153.2 million to $151.2 million and 13 basis point reduction in the rate paid
from 4.37% to 4.24%. The average outstanding balance of deposits in 1998
included the effects of approximately $113 million in deposits held in escrow in
connection with the mutual holding company reorganization completed in April
1998.

         Interest expense increased by $174,000, or 2.5%, to $7.1 million for
the fiscal year ended September 30, 1998, from $6.9 million for the prior fiscal
year. This increase was due to the net effect of a $285,000 increase in interest
expense on borrowings and a $111,000 decrease in interest expense on deposits.
The increased expense on borrowed money was primarily due a $5.4 million
increase in the average balance of borrowings from $2.3 million to $7.9 million,
the effects of which were offset by an 87 basis point reduction in the rate paid
on borrowings from 6.37% to 5.50%. Interest expense on deposits decreased as a
result of a 28 basis point decrease in the rate paid on deposits from 4.65% to
4.37%. The benefit of the lower cost of deposits was offset by a $6.8 million
increase in the average balance of deposit accounts.
<PAGE>   10
         Provision for Loan Losses. The Company establishes provisions for loan
losses, which are charged to operations, in order to maintain the allowance for
loan losses at a level which is deemed appropriate to absorb future charge-offs
of loans deemed uncollectible. In determining the appropriate level of the
allowance for loan losses, management considers past and anticipated loss
experience, evaluations of real estate collateral, current and anticipated
economic conditions, volume and type of lending and the levels of nonperforming
and other classified loans. The amount of the allowance is based on estimates
and the ultimate losses may vary from such estimates. Management of the Company
assesses the allowance for loan losses on a quarterly basis and makes provisions
for loan losses monthly in order to maintain the adequacy of the allowance.

         The Company provided $105,000 and $300,000 in loan loss provisions for
the fiscal years ended September 30, 1999 and 1998, respectively. The reduction
in the provision for loan losses was primarily the result of the decrease in
nonperforming loans from $1.2 million to $94,000. The Company's allowance for
loan losses was $1.5 million and $1.4 million, or 1,605% and 114% of
nonperforming assets, for the fiscal years ended September 30, 1999 and 1998,
respectively. Management will make future loan loss provisions based on
available information including changes in economic conditions, changes in the
loan portfolio mix and performance, and regulatory requirements.

          The Company provided $300,000 and $293,000 in loan loss provisions
during the fiscal years ended September 30, 1998 and 1997, respectively. The
increase was primarily due to the strong loan volume during the year. At
September 30, 1998 and 1997, the Company's allowance for loan losses was $1.4
million and $1.1 million, respectively, and the Company's nonperforming loans
were $1.2 million and $1.1 million, respectively. The Company's allowance for
loan losses as a percentage of total nonperforming loans at September 30, 1998
and 1997, was 114.0% and 104.8%, respectively.

         Noninterest Income. Noninterest income is composed of service charges
on deposit accounts, gains on sale of assets, and other income. For the fiscal
year ended September 30, 1999, noninterest income increased by $1.4 million, or
148.3%, from $956,000 to $2.4 million. The primary reasons for the change were a
$1.1 million increase in gain on sale of assets, a $108,000 increase in service
charges on deposit accounts, and a $193,000 increase in other income. The gain
on sale of assets included a $90,000 gain on sale of $13.1 million in long-term
fixed-rate mortgage loans and a $1.3 million gain on sale of $6.4 million in
investments. The increase in service charges on deposit accounts resulted from
an aggressive marketing program to increase fee generating demand deposit
accounts. Other income increased due to fees generated as a result of strong
loan demand and increased commissions generated on the sale of uninsured
investment products by the Bank's wholly-owned subsidiary.

         Noninterest income increased by $440,000, or 85.3%, to $956,000 for the
fiscal year ended September 30, 1998, from $516,000 for the prior fiscal year.
The primary reasons for the increase were a $114,000 increase in the gain on
sale of assets, a $52,000 increase in service charges on deposit accounts, and a
$274,000 increase in other income. The increase in deposit fees resulted, in
part, from management's emphasis on fee generating demand deposit accounts. The
increase in the gain on sale of assets was primarily due to the sale of $9.7
million of long-term fixed rate loans at a gain of $80,000 in order to reduce
the Bank's interest rate risk. Other income increased due to a higher level of
loan demand due to falling interest rates and increased commissions on the sale
of uninsured securities products.

         Noninterest Expenses. Noninterest expense is composed of salaries and
benefits, office occupancy, deposit insurance, data processing, advertising,
professional services, and other expenses. For the fiscal year ended September
30, 1999, noninterest expense increased $1.7 million, or 37.1%, from $4.6
million to $6.3 million. The primary reason for the change was a $1.5 million
increase in salary and benefits. There were also modest increases in
professional services, data processing, and other noninterest expenses, the
effects of which were partially offset by small decreases in office occupancy,
deposit insurance, and advertising. The increase in salary and benefits was
primarily due to a $1.0 million nonrecurring expense associated with the award
of common stock in accordance with the Gaston Federal Bank 1999 Recognition and
Retention Plan approved by the shareholders in April 1999. Also, there was an
increase in the number of employees
<PAGE>   11
resulting, in part, from the preparation of the opening of the Shelby Loan
Production Office and the implementation of extended drive-thru hours at each of
the branch office locations. Professional services increased as a result of the
additional expenses associated with operating a publicly traded company and data
processing expenses increased due to the purchase of updated software and
hardware and the added expense of preparing and testing for Year 2000 readiness.

         Noninterest expenses increased by $600,000, or 15.0%, to $4.6 million
for the fiscal year ended September 30, 1998, from $4.0 million for the prior
fiscal year. The increase was primarily due to a $248,000 increase in
compensation and benefits and a $324,000 increase in other noninterest expenses.
The increase in compensation and benefits was primarily due to an increase in
the number of personnel in order to operate the Company more like a commercial
bank. Other noninterest expenses increased, in part, due to the addition of
three automated teller machines, the implementation of a debit card program,
branch office improvements, and increased expenditures for computers and
technology.

         Provision for Income Taxes. The Company's provision for income taxes
was $1.2 million and $1.0 million for the fiscal years ended September 30, 1999,
and 1998, respectively. The change was due to a $470,000 increase in income
before taxes and a slight increase in the effective tax rate from 34.7% to
35.7%.

         The Company's provision for income taxes was $1.0 million and $819,000
for the fiscal years ended September 30, 1998 and 1997. The increase was due to
a $600,000 increase in income before taxes and a reduction in the effective tax
rate from 36.4% to 34.7%. The effective tax rate decreased due to the increase
in state tax-exempt investments and bank-qualified tax-exempt municipal
securities.

CAPITAL RESOURCES AND LIQUIDITY

         The Company's liquidity management objective is to ensure the
availability of sufficient cash flows to meet all financial commitments and to
capitalize on opportunities for expansion. Liquidity management addresses the
ability to meet deposit withdrawals on demand or at contractual maturity, to
repay borrowings as they mature, and to fund new loans and investments as
opportunities arise. The Company's primary sources of internally generated funds
are principal and interest payments on loans receivable, cash flows generated
from operations, and cash flows generated by investments. External sources of
funds include increases in deposits and FHLB advances.

         The Company is required under applicable federal regulations to
maintain specified levels of "liquid" investments in qualifying types of United
States Government, federal agency and other investments having maturities of
five years of less. Current OTS regulations require that a savings association
maintain liquid assets of not less than 4% of its average daily balance of net
withdrawable deposit accounts and borrowings payable in one year or less.
Monetary penalties may be imposed for failure to meet applicable liquidity
requirements. At September 30, 1999, the Company's liquidity, as measured for
regulatory purposes, was in excess of the minimum OTS requirement.

         At September 30, 1999, the Company had loan commitments (excluding
undisbursed portions of interim construction loans of $6.2 million) of $704,000
and unused lines of credit of $19.3 million. The Company believes that it has
adequate resources to fund loan commitments as they arise. If the Company
requires funds beyond its internal funding capabilities, additional advances
from the FHLB are available. At September 30, 1999, approximately $85.2 million
of time deposits were scheduled to mature within a year, and the Company expects
that a portion of these time deposits will not be renewed upon maturity.
<PAGE>   12
IMPACT OF INFLATION AND CHANGING PRICES

         The Consolidated Financial Statements and related Notes have been
prepared in accordance with generally accepted accounting principles ("GAAP"),
which generally require the measurement of financial position and operating
results in terms of historical dollars without considering the change in the
relative purchasing power of money over time due to inflation. The impact of
inflation is reflected in the increased cost of the Company's operations. Nearly
all the assets and liabilities of the Company are financial, unlike most
industrial companies. As a result, the Company's performance is directly
impacted by changes in interest rates, which are indirectly influenced by
inflationary expectations. The Company's ability to match the interest
sensitivity of its financial assets to the interest sensitivity of it financial
liabilities in its asset/liability management may tend to minimize the effect of
changes in interest rates on the Company's performance. Changes in interest
rates do not necessarily move to the same extent as changes in the price of
goods and services. In the current interest rate environment, liquidity and the
maturity structure of the Company's assets and liabilities are critical to the
maintenance of acceptable performance levels.

IMPACT OF NEW ACCOUNTING STANDARDS

         In June, 1998, the Financial Accounting Standards Board issued SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities," which,
establishes accounting and reporting requirements for derivative instruments,
including derivative instruments imbedded other contracts. The provisions of the
Statement are effective for fiscal years beginning after June 15, 2000. The
Company expect that adopting the provisions of SFAS No. 133 will not have a
material impact on the consolidated financial statements of the Company.

YEAR 2000 CONSIDERATIONS

         Like many financial institutions, the Bank relies upon computers for
conducting its daily operations. There is concern among industry experts that on
January 1, 2000, computers will be unable to "read" the new year and, as a
consequence, there may be widespread computer malfunctions. Since the Bank
processes all of its loan, deposit, and accounting operations on an internal
data processing system, the Year 2000 issue could have a material adverse effect
on the operations of the Bank if proper modifications and conversions are not
made in a timely manner. As a result, Management has successfully completed a
comprehensive review of its computer systems to identify items that could be
affected by the Year 2000, developed and implemented a Year 2000 Plan to modify
or replace the affected systems, and tested all systems for Year 2000 readiness.

         While the Bank has completed its Year 2000 Plan, there can be no
assurance that the mission critical systems of the Bank or other companies and
vendors on which the Bank's systems may rely will be fully operational. The
failure of outside entities to adequately address the Year 2000 issue could have
an adverse effect on the Bank's ability to conduct its business. In an effort to
reduce the potential adverse effects in such a scenario, workaround procedures
have been developed for all third party vendors and are detailed in the
Company's Year 2000 Business Resumption Contingency Plan.

STOCK REPURCHASE PLANS

         In October 1998, the Company was authorized to repurchase up to 105,668
shares, or 5.0% of the publicly held common stock as part of its capital
management strategy. The repurchase was completed in May 1999 at a weighted
average price of $13.45 per share.

         In April 1999, the Company was authorized to repurchase up to 84,534
shares of the publicly held common stock in accordance with the Gaston Federal
Bank 1999 Recognition and Retention Plan. The repurchase was completed in July
1999 at a weighted average price of $13.78 per share.

         In April 1999, the Company was authorized to repurchase up to 211,335
shares of the publicly held common stock in accordance with the Gaston Federal
Bank 1999 Stock Option Plan. As of December 6, 1999, the Company has repurchased
68,398 shares of its common stock at a weighted average price of $12.81 per
share.
<PAGE>   13
CONSOLIDATED STATEMENTS OF CONDITION

<TABLE>
<CAPTION>
                                                                                                         September 30,
                                                                                                 1999                   1998
                                                                                                 ----                   ----
ASSETS
<S>                                                                                          <C>                  <C>
Cash and due from banks                                                                      $   4,206,884        $   2,697,028
Interest-earning bank balances                                                                   8,375,733           11,100,936
                                                                                             -------------        -------------
      Cash and cash equivalents                                                                 12,582,617           13,797,964
Investment securities
         Available-for-sale                                                                     15,777,462           20,919,033
         Held-to-maturity (fair value of  $12,367,959 in 1999 and $15,967,677 in 1998)          12,865,176           15,588,173
Mortgage-backed and related securities
         Available-for-sale                                                                     16,166,636            8,350,179
         Held-to-maturity (fair value of $3,804,134 in 1999 and $6,448,878 in 1998)              3,825,092            6,357,370
Loans, net                                                                                     168,044,032          136,500,519
Premises and equipment                                                                           2,503,082            2,247,437
Accrued interest receivable                                                                      1,244,381            1,238,225
Federal Home Loan Bank stock                                                                     1,775,000            1,300,121
Deferred income taxes                                                                              709,795                   --
Other assets                                                                                     1,959,932            1,704,466
                                                                                             -------------        -------------
         Total assets                                                                        $ 237,453,205        $ 208,003,487
                                                                                             =============        =============

LIABILITIES AND EQUITY
Deposits                                                                                     $ 159,424,778        $ 143,900,772
Advances from borrowers for taxes and insurance                                                    760,857              728,061
Accrued interest payable                                                                           549,783              428,868
Advances from Federal Home Loan Bank                                                            35,500,000           19,500,000
Deferred income taxes                                                                                   --              415,589
Other liabilities                                                                                1,509,197            1,460,068
                                                                                             -------------        -------------
         Total liabilities                                                                     197,744,615          166,433,358
Commitments and contingencies
Stockholders' Equity
         Preferred stock, 10,000,000 shares authorized, none issued                                     --                   --
      Common stock, $1.00 par value, 20,000,000 shares authorized,
         issued and outstanding 4,581,034 in 1999 and 4,496,500 in 1998                          4,581,034            4,496,500
      Additional paid-in-capital                                                                16,650,944           15,721,070
      Unallocated common stock held by Employee Stock Ownership Plan                            (1,493,434)          (1,615,539)
      Retained earnings, substantially restricted                                               22,653,309           21,430,004
      Accumulated unrealized gain on securities available-for-sale, net of tax                     176,226            1,538,094
      Treasury stock of 211,400 shares at cost                                                  (2,859,489)                  --
                                                                                             -------------        -------------
            Total equity                                                                        39,708,590           41,570,129
                                                                                             -------------        -------------

            Total liabilities and equity                                                     $ 237,453,205        $ 208,003,487
                                                                                             =============        =============
</TABLE>

See notes to consolidated financial statements.
<PAGE>   14
CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
                                                            Year Ended September 30,
                                                             1999               1998
                                                             ----               ----
INTEREST INCOME
<S>                                                       <C>               <C>
    Loans                                                 $11,998,766       $11,019,814
    Investment securities                                   2,059,379         2,273,839
    Mortgage-backed and related securities                  1,180,512           633,789
                                                          -----------       -----------
         Total interest income                             15,238,657        13,927,442
INTEREST EXPENSE
    Deposits                                                6,407,099         6,694,335
    Borrowed funds                                          1,481,231           432,240
                                                          -----------       -----------
         Total interest expense                             7,888,330         7,126,575
                                                          -----------       -----------

         Net interest income                                7,350,327         6,800,867

PROVISION FOR LOAN LOSSES                                     105,000           300,000
                                                          -----------       -----------

Net interest income after provision for loan losses         7,245,327         6,500,867

NONINTEREST INCOME
     Service charges on deposit accounts                      368,076           260,543
     Gain on sale of securities                             1,272,356           184,213
     Gain on sale of other assets                             116,706            88,006
     Other income                                             616,371           423,035
                                                          -----------       -----------
         Total noninterest income                           2,373,509           955,797

NONINTEREST EXPENSE
     Salaries and benefits                                  4,011,564         2,476,633
     Occupancy                                                457,878           500,232
     Deposit insurance                                         90,720           109,360
     Data processing                                          207,105           122,817
     Advertising                                              230,988           255,223
     Professional services                                    290,143           197,209
     Other                                                    970,646           905,406
                                                          -----------       -----------
         Total noninterest expense                          6,259,044         4,566,880
                                                          -----------       -----------

INCOME BEFORE INCOME TAXES                                  3,359,792         2,889,784
PROVISION FOR INCOME TAXES                                  1,198,430         1,004,000
                                                          -----------       -----------

NET INCOME                                                $ 2,161,362       $ 1,885,784
                                                          ===========       ===========

EARNINGS PER SHARE
     Basic earnings per share                             $      0.50                NA
     Diluted earnings per share                           $      0.50                NA
</TABLE>




See notes to consolidated financial statements.
<PAGE>   15
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

<TABLE>
<CAPTION>
                                                                                      Year Ended September 30,
                                                                                       1999                1998
                                                                                       ----                ----
<S>                                                                                <C>                <C>
Net income                                                                         $ 2,161,362        $ 1,885,784

Other comprehensive income, net of tax:
     Unrealized gains (losses) on securities
         Unrealized holding gains (losses) arising during period, net of tax
              effect of $308,003 in 1999 and $(313,334) in 1998                       (547,560)           557,039
         Reclassification adjustment for gains included in net income,
              net of tax effect of $458,048 in 1999 and $66,317 in 1998               (814,308)          (117,896)
                                                                                   -----------        -----------
     Other comprehensive income                                                     (1,361,868)           439,143

Comprehensive income                                                               $   799,494        $ 2,324,927
                                                                                   ===========        ===========
</TABLE>


See notes to consolidated financial statements.
<PAGE>   16
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY

<TABLE>
<CAPTION>
                                                                                               Unallocated
                                                                               Retained          Common        Accumulated
                                                            Additional         Earnings          Stock          Unrealized
                                  Preferred     Common       Paid-In         Substantially       Held By      Gains (Losses)
                                    Stock        Stock       Capital           Restricted         ESOP          net of tax
---------------------------------------------------------------------------------------------------------------------------

<S>                               <C>         <C>             <C>              <C>              <C>              <C>
BALANCE, SEPTEMBER 30, 1997          $--      $         --    $         --     $ 19,769,045     $         --     $  1,098,951
Comprehensive results:
Net income                            --                --              --        1,885,784               --               --
Other comprehensive results,
     net of tax                       --                --              --               --               --          439,143
Issuance of 2,113,355 shares
     of $1.00 par value common
     stock in the initial public
     offering at $10.00 per share     --         2,113,355      18,104,215               --               --               --
Issuance of 2,383,145 shares of
     $1.00 par value common
     stock to Gaston Federal
     Holdings, MHC                    --         2,383,145      (2,383,145)              --               --               --
Loan to ESOP for purchase
     of common stock                  --                --              --               --       (1,690,680)              --
Allocation from shares
     purchased with loan to ESOP      --                --              --               --           75,141               --
Cash dividends declared on
     common stock                     --                --              --         (224,825)              --               --

-----------------------------------------------------------------------------------------------------------------------------
BALANCE, SEPTEMBER 30, 1998           --         4,496,500      15,721,070       21,430,004       (1,615,539)       1,538,094
Comprehensive results:
     Net income                       --                --              --        2,161,362               --               --
     Other comprehensive
         results, net of tax                                            --               --               --       (1,361,868)
Issuance of 84,534 shares of
     $1.00 par value common
     stock for employee
     benefit plans                    --            84,534         929,874               --               --               --
Allocation from shares
     purchased with loan to ESOP      --                --              --               --          122,105               --
Cash dividends declared on
     common stock                     --                --              --         (938,057)              --               --
Repurchase of common stock            --                --              --               --               --               --

-----------------------------------------------------------------------------------------------------------------------------
BALANCE, SEPTEMBER 30, 1999        $  --      $  4,581,034     $ 16,650,944     $ 22,653,309     $ (1,493,434)       $176,226
=============================================================================================================================
</TABLE>


<TABLE>
<CAPTION>
                                          Treasury                       Total
                                            Stock                       Equity
------------------------------------------------------------------------------

<S>                                <C>                         <C>
BALANCE, SEPTEMBER 30, 1997        $         --                $ 20,867,996
Comprehensive results:
Net income                                   --                   1,885,784
Other comprehensive results,
     net of tax                              --                     439,143
Issuance of 2,113,355 shares
     of $1.00 par value common
     stock in the initial public
     offering at $10.00 per share            --                  20,217,570
Issuance of 2,383,145 shares of
     $1.00 par value common
     stock to Gaston Federal
     Holdings, MHC                           --                          --
Loan to ESOP for purchase
     of common stock                         --                  (1,690,680)
Allocation from shares
     purchased with loan to ESOP             --                      75,141
Cash dividends declared on
     common stock                            --                    (224,825)

------------------------------------------------------------------------------
BALANCE, SEPTEMBER 30, 1998                  --                  41,570,129
Comprehensive results:
     Net income                              --                   2,161,362
     Other comprehensive
         results, net of tax                  --                 (1,361,868
Issuance of 84,534 shares of
     $1.00 par value common
     stock for employee
     benefit plans                           --                   1,014,408
Allocation from shares
     purchased with loan to ESOP             --                     122,105
Cash dividends declared on
     common stock                            --                    (938,057)
Repurchase of common stock           (2,859,489)                 (2,859,489)

---------------------------------------------------------------------------
BALANCE, SEPTEMBER 30, 1999         $(2,859,489)               $ 39,708,590
===========================================================================
</TABLE>


See notes to consolidated financial statements.

<PAGE>   17
CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                                                                      Year Ended September 30,
                                                                                                    1999                   1998
                                                                                                ------------           ------------
<S>                                                                                             <C>                    <C>
OPERATING ACTIVITIES
   Net income                                                                                   $  2,161,362           $  1,885,784
      Adjustments to reconcile net income to net cash provided by operating activities
      Provision for loan losses                                                                      105,000                300,000
      Depreciation                                                                                   334,533                401,789
      Deferred income tax (benefit)                                                                 (146,000)              (213,000)
      Gain on sale of investments available-for-sale                                              (1,272,356)              (184,213)
      Gain on sale of loans                                                                          (89,725)               (80,148)
      Gain on sale of premises and equipment                                                         (26,981)                     -
      Deferred loan origination fees                                                                (115,690)               (20,050)
      Issuance of shares for the Recognition and Retention Plan                                    1,014,408                      -
      Allocation of shares to the ESOP                                                               122,105                 75,141
      (Increase) in interest receivable                                                               (6,156)              (281,033)
         Increase (decrease) in interest payable                                                    (101,504)                16,634
      (Increase) in other operating assets                                                          (186,048)              (882,324)
                                                                                                ------------           ------------
           Net cash provided by operating activities                                               1,792,948              1,018,580

INVESTING ACTIVITIES
Net (increase) in loans made to customers                                                        (44,578,609)           (11,809,490)
Proceeds from the sale of loans                                                                   13,135,511              9,600,226
Proceeds from the sale of premises and equipment                                                      49,250                      -
Proceeds from the sale of investments available-for-sale                                           5,881,780              2,628,000
Proceeds from the sale of mortgage-backed and related securities                                     492,304                      -
Maturities and prepayments of investments available-for-sale                                       5,275,277                      -
Maturities and prepayments of investments held-to-maturity                                         2,722,997              6,700,000
Maturities and prepayments of mortgage-backed and related securities                               5,723,340              4,414,063
Purchases of investments available-for-sale                                                       (6,515,000)           (14,420,877)
Purchases of investments held-to-maturity                                                                  -            (11,881,144)
Purchases of mortgage-backed and related securities                                              (11,867,075)            (9,012,318)
Purchases of FHLB stock                                                                             (474,879)                     -
Purchases of premises and equipment                                                                 (612,447)              (509,729)
                                                                                                ------------           ------------
           Net cash used for investing activities                                                (30,767,551)           (24,291,269)

FINANCING ACTIVITIES
Net increase (decrease) in  deposits                                                              15,524,006             (1,542,728)
Dividends to stockholders                                                                           (938,057)              (224,825)
Repurchase of common stock                                                                        (2,859,489)                     -
Proceeds from common stock issuance                                                                        -             18,526,890
Advances from FHLB                                                                                18,000,000             16,000,000
Repayments of advances from FHLB                                                                  (2,000,000)                     -
Increase (decrease) in advances from borrowers for insurance and taxes                                32,796               (314,299)
                                                                                                ------------           ------------
           Net cash provided by financing activities                                              27,759,256             32,445,038

Net increase (decrease) in cash and cash equivalents                                              (1,215,347)             9,172,349
Cash and cash equivalents at the beginning of the year                                            13,797,964              4,625,615
                                                                                                ------------           ------------
Cash and cash equivalents at the end of the year                                                $ 12,582,617           $ 13,797,964
                                                                                                ============           ============
</TABLE>


See notes to consolidated financial statements.
<PAGE>   18
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Gaston Federal Bancorp, Inc. is a stock holding company whose activities are
primarily limited to holding the stock of Gaston Federal Bank. The Bank is a
community-oriented Federal stock savings bank engaged primarily in the business
of offering deposits to customers through its branch offices and investing those
deposits, together with funds generated from operations and borrowings, in
residential, commercial and consumer loans. The Bank's wholly-owned subsidiary,
Gaston Financial Services, Inc. (doing business as Gaston Federal Investment
Services) acts as an independent agent selling various financial products.

The accounting and reporting policies of Gaston Federal Bancorp, Inc. and its
subsidiaries follow generally accepted accounting principles and policies within
the financial services industry. The following is a summary of the more
significant policies.

Principles of Consolidation - The consolidated financial statements include the
accounts of Gaston Federal Bancorp, Inc., its wholly-owned subsidiary, Gaston
Federal Bank, and the Bank's wholly-owned subsidiary, Gaston Financial Services,
Inc. All significant intercompany accounts and transactions have been
eliminated.

Use of Estimates - The financial statements are prepared in accordance with
generally accepted accounting principles which require management to make
estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates.

Cash and Cash Equivalents - The Company considers cash on hand, cash due from
banks, which are maintained in financial institutions, and interest-earning
deposits, which are maintained with the Federal Home Loan Bank, as cash and cash
equivalents.

Securities - Management determines the appropriate classification of securities
at the time of purchase. Securities are classified as held-to-maturity when the
Company has the positive intent and ability to hold the securities to maturity.
Held-to-maturity securities are stated at amortized cost.

Securities classified as available-for-sale are carried at fair value. Such
securities are used to execute asset/liability management strategies and to
manage liquidity. Adjustments for unrealized gains or losses, net of related
income tax effect, are recorded as an addition or deduction from equity in the
form of other comprehensive results.

The Company has no trading portfolio.

Amortization of premiums and accretion of discounts are included in interest
income over the life of the related security, or in the case of mortgage-backed
and related securities, the estimated life of the security. Gains or losses on
the sale of securities are recognized on a specific identification, trade date
basis.

Loans and Allowance for Loan Losses - Loans are carried at their principal
amount outstanding. Income on loans is accrued based upon the outstanding
principal balance. Generally, loans are classified as nonaccrual, and the
accrual of interest is discontinued, when the contractual payment of principal
and interest has become 90 days past due or when, in management's judgment,
principal or interest is not collectible in accordance with the terms of the
obligation. Cash receipts on nonaccrual loans are applied to principal. The
accrual of interest resumes when the loan returns to performing status.

The allowance for loan losses is maintained at a level believed by management to
be adequate to absorb losses inherent in the portfolio. Management's
determination of the adequacy of the allowance is based on an evaluation of the
portfolio, past loan loss experience, current economic conditions, volume,
growth, and
<PAGE>   19
composition of the loan portfolio, and other risks inherent in the portfolio.
Loans are charged to the allowance at the time they are determined to be losses.
Subsequent recoveries are credited to the allowance.

Concentrations of Credit Risk - The Company makes loans to individuals and small
businesses primarily in Gaston County, North Carolina and surrounding counties.
The Company has a diversified loan portfolio, and the borrowers' ability to
repay their loans is not dependent upon any specific economic segment.

Premises and Equipment - Premises and equipment are stated at cost less
accumulated depreciation and amortization. Depreciation and amortization are
computed over the estimated useful lives of the assets (from 3 to 30 years)
primarily by the straight-line method. Leasehold improvements are amortized on a
straight-line basis over the shorter of the estimated useful life of the
improvement or the lease term.

Other Real Estate Owned - Other real estate owned, included in other assets, is
comprised of real estate properties acquired in partial or total satisfaction of
problem loans. The properties are recorded at the lower of cost or fair value
less estimated costs to sell at the date acquired. Losses arising at the time of
acquisition of such properties are charged against the allowance for loan
losses. Subsequent write-downs that may be required to the carrying value of
these properties are charged to noninterest expenses. Gains and losses realized
from the sale of other real estate owned are included in noninterest income.

Loan Origination Fees - Origination fees received and direct costs incurred are
amortized to interest income over the contractual lives of the loans, using the
level yield method.

Income Taxes - Deferred income taxes reflect the net tax effects of temporary
differences between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes. Amounts
provided for deferred income taxes relate primarily to differences between tax
and financial reporting for unrealized gains and losses on securities
available-for-sale, allowances for loan losses, depreciation, and deferred
compensation.

Advertising - Advertising costs are expensed as incurred.

Reclassifications - Certain of the prior year amounts have been reclassified to
conform to current year presentation; such reclassifications are immaterial to
the financial statements.

Comprehensive Income - During the year ended September 30, 1999, the Company
adopted SFAS No. 130, Reporting Comprehensive Income. SFAS No. 130 established
standards for the reporting and display of comprehensive income and its
components in financial statements. SFAS No. 130 defines comprehensive income as
net income, as currently reported, as well as unrealized gains and losses on
assets available for sale and certain other items not currently included in the
income statement. The disclosure requirements of SFAS No. 130 have been included
in the Consolidated Statements of Comprehensive Income.

Operating Segments - The FASB issued in June 1997, SFAS No. 131, Disclosures
about Segments of an Enterprise and Related Information, which established
standards for the way public business enterprises report information about
operating segments. This statement also established standards for related
disclosures about products, services, geographic areas and major customers. In
adopting SFAS No. 131, the Company has determined that, using the definitions
contained in the statement, all of its activities constitute only one reportable
operating segment.

Impact of Recently Issued Accounting Standards - SFAS No. 133, Accounting for
Derivative Instruments and Hedging Activities, issued in June 1998, establishes
accounting and reporting requirements for derivative instruments, including
derivative instruments embedded in other contracts. The provisions of the
Statement
<PAGE>   20
are effective for fiscal years beginning after June 15, 2000. The Company
intends to adopt this statement effective October 1, 2000. The Company expects
that adopting the provisions of this statement will not have a material impact
on the consolidated financial statements of the Company.

NOTE 2 - CONVERSION TO STOCK FORM OF OWNERSHIP

On July 14, 1997, the Board of Directors of Gaston Federal Savings and Loan
Association (now known as "Gaston Federal Bank") adopted the Gaston Federal
Savings and Loan Association Plan of Reorganization from Mutual Savings
Association to Mutual Holding Company and Stock Issuance Plan (the "Plan of
Reorganization"). Pursuant to the Plan of Reorganization, on April 9, 1998, the
Bank converted from a federally chartered mutual savings and loan association to
a federally chartered stock savings bank and became the wholly-owned subsidiary
of Gaston Federal Bancorp, Inc., a Federal corporation (the "Reorganization").
The Company was incorporated on March 18, 1998, to serve as the Bank's holding
company, and prior to April 9, 1998, had no operations and insignificant assets
and liabilities. In addition, pursuant to the Plan of Reorganization, the
Company sold 2,113,355 shares of its common stock to the Bank's customers for
$10.00 per share (the "Offering"), and issued 2,383,145 shares of its common
stock to Gaston Federal Holdings, MHC (the "Mutual Holding Company"), a federal
mutual holding company formed as part of the Reorganization. At the conclusion
of the Offering, the Mutual Holding Company owned 53.0% of the Company's
outstanding shares of common stock and purchasers in the Offering owned 47.0%.
Gross proceeds of the Offering totaled $21,133,550, expenses totaled
approximately $916,000, and purchases by the Bank's employee stock ownership
plan formed in connection with the Offering, funded with a loan from the
Company, totaled $1,690,680 for net proceeds of approximately $18,527,000.

Subsequent to the Conversion, the Bank may not declare or pay cash dividends on
or repurchase any of its shares of common stock if the effect thereof would
cause stockholder's equity to be reduced below applicable regulatory capital
maintenance requirements or if such declaration and payment would otherwise
violate regulatory requirements. The Company, unlike the Bank, is not subject to
the same restrictions regarding the declaration or payment of dividends to its
shareholders, although the source of the Company's dividends may depend upon the
Bank's ability to pay dividends.

<PAGE>   21

NOTE 3 - INVESTMENT SECURITIES

The aggregate book and fair values, as well as gross unrealized gains and
losses, of investment securities as of September 30 were as follows:

<TABLE>
<CAPTION>
                                                                              September 30, 1999
                                                           -------------------------------------------------------
                                                                Book      Unrealized    Unrealized        Fair
                                                               Value         Gains        Losses          Value
                                                           -------------------------------------------------------
<S>                                                         <C>           <C>           <C>            <C>
Available-for-Sale
U.S. Treasury and other agencies                            $ 9,256,466   $     5,545   $  (102,730)   $ 9,159,281
Municipals                                                    5,736,978          --        (372,773)     5,364,205
FHLMC stock                                                      25,404     1,135,662          --        1,161,066
Other equity securities                                          92,910          --            --           92,910
                                                            -----------   -----------   ------------   -----------
Total available-for-sale                                    $15,111,758   $ 1,141,207   $  (475,503)   $15,777,462
                                                            ===========   ===========   ===========    ===========

Mortgage-backed and related securities Available-for-Sale
FNMA                                                          2,485,393          --         (72,275)     2,413,118
GNMA                                                          8,014,443          --        (232,728)     7,781,715
SBA's                                                         6,043,041          --         (71,238)     5,971,803
                                                            -----------   -----------   ------------   -----------
    Total mortgage-backed and
        related securities                                  $16,542,877   $      --     $  (376,241)   $16,166,636
                                                            ===========   ===========   ===========    ===========

Held-to-Maturity
U.S. Treasury and other agencies                            $12,498,539   $      --     $  (497,298)   $12,001,241
Municipals                                                      366,637            81          --          366,718
                                                            -----------   -----------   ------------   -----------
    Total held-to-maturity                                   12,865,176            81      (497,298)    12,367,959
                                                            ===========   ===========   ===========    ===========

Mortgage-backed and related securities Held-to-Maturity

FHLMC                                                       $ 1,645,951   $     7,171   $   (20,502)   $ 1,632,620
FNMA                                                          1,415,532         4,414       (18,743)     1,401,203
GNMA                                                            763,609        11,850        (5,148)       770,311
                                                            -----------   -----------   ------------   -----------
    Total mortgage-backed and
        related securities                                  $ 3,825,092   $    23,435   $   (44,393)   $ 3,804,134
                                                            ===========   ===========   ===========    ===========

</TABLE>
<PAGE>   22
<TABLE>
<CAPTION>
                                                                               September 30, 1998
                                                           -------------------------------------------------------
                                                               Book       Unrealized    Unrealized        Fair
                                                               Value        Gains        Losses           Value
                                                           -------------------------------------------------------
<S>                                                         <C>           <C>           <C>            <C>
Available-for-Sale
Federated U.S. Government Fund                              $ 1,162,998   $   134,735   $       --     $ 1,297,733
Asset Management Fund                                         1,459,188        36,803           --       1,495,991
FHLMC Stock                                                      43,967     2,184,170           --       2,228,137
U.S. Treasury and other agencies                             15,046,698       156,003           --      15,202,701
Municipals                                                      680,000        14,471           --         694,471
                                                            -----------   -----------   ------------   -----------
    Total available-for-sale                                $18,392,851   $ 2,526,182   $       --     $20,919,033
                                                            ===========   ===========   ============   ===========


Mortgage-backed and related securities Available-for-Sale
FNMA                                                        $ 1,482,570   $      --     $     (1,276)  $ 1,481,294
GNMA                                                          4,866,382          --          (12,078)    4,854,304
SBA's                                                         2,009,810         4,771           --       2,014,581
                                                            -----------   -----------   ------------   -----------
   Total mortgage-backed and
      related securities                                    $ 8,358,762   $     4,771   $    (13,354)  $ 8,350,179
                                                            ===========   ===========   ============   ===========

Held-to-Maturity

U.S. Treasury and other agencies                            $15,228,173   $   371,223   $       --     $15,599,396
Municipals                                                      360,000         8,281           --         368,281
                                                            -----------   -----------   ------------   -----------
    Total held-to-maturity                                   15,588,173       379,504           --      15,967,677
                                                            ===========   ===========   ============   ===========


Mortgage-backed and related securities Held-to-Maturity
FHLMC                                                       $ 3,038,585   $    22,103   $       --     $ 3,060,688
FNMA                                                          2,352,782        26,879           --       2,379,661
GNMA                                                            966,003        42,526           --       1,008,529
                                                            -----------   -----------   ------------   -----------
   Total mortgage-backed and
      related securities                                    $ 6,357,370   $    91,508   $       --     $ 6,448,878
                                                            ===========   ===========   ============   ===========
</TABLE>
<PAGE>   23
 The book value and estimated fair value of debt securities at September 30,
1999, by contractual maturity, are shown below. Expected maturities will differ
from contractual maturities because borrowers may have the right to call or
prepay obligations with or without call or prepayment penalties.

<TABLE>
<CAPTION>
                                                 September 30, 1999
                                            ----------------------------
                                               Book             Fair
                                               Value            Value
                                            ----------------------------
<S>                                         <C>              <C>
Available-for-Sale
Due in one year or less                     $ 1,500,673      $ 1,504,814
Due after one year through five years         8,609,885        8,488,474
Due after five years through ten years        2,269,337        2,153,771
Due after ten years                           2,613,549        2,376,427
Equities                                        118,314        1,253,976
                                            -----------      -----------
                                            $15,111,758      $15,777,462
                                            ===========      ===========

Mortgage-backed and related securities      $16,542,877      $16,166,636
                                            ===========      ===========

Held-to-maturity
Due in one year or less                     $      --        $      --
Due after one year through five years           866,637          868,030
Due after five years through ten years       11,998,539       11,499,929
Due after ten years                                --               --
                                            -----------      -----------
                                            $12,865,176      $12,367,959
                                            ===========      ===========

Mortgage-backed and related securities      $ 3,825,092      $ 3,804,134
                                            ===========      ===========
</TABLE>

Gross realized gains on the sale of securities available for sale were
$1,282,044 and $184,213 in 1999 and 1998, respectively. Gross realized losses on
the sale of securities available for sale were $9,688 and $0 in 1999 and 1998,
respectively. After-tax net gains on the sale of securities were $814,308 and
$117,896 in 1998 and 1998, respectively.

Investment securities having a carrying amount of approximately $1,000,000 have
been pledged as collateral to secure public deposits at September 30, 1999.

NOTE 4 - LOANS AND ALLOWANCE FOR LOAN LOSSES

The following is a summary of loans outstanding by category at September 30:
<PAGE>   24
<TABLE>
<CAPTION>
                                            1999              1998
                                        ------------      ------------
<S>                                     <C>               <C>
Real estate:
    One-to-four family residential      $129,332,817      $105,526,044
    Multi-family residential               2,413,821         3,771,000
    Commercial mortgage                    7,265,832         8,076,000
    Construction                          11,175,675        10,572,620
Commercial                                14,355,922         6,629,452
Consumer                                  11,599,049         8,988,997
                                        ------------      ------------
Gross loans                              176,143,116       143,564,113
Less:
    Loans in process                       6,204,788         5,151,824
    Deferred loan fees, net                  384,831           500,521
    Allowance for loan losses              1,509,465         1,411,249
                                        ------------      ------------
Net loans                               $168,044,032      $136,500,519
                                        ============      ============
</TABLE>


The Company evaluates impairment of its residential mortgage and consumer loans
on a collective basis. Commercial loans individually evaluated and considered
impaired under SFAS No. 114 at September 30, 1999 and 1998 were immaterial.

<PAGE>   25
Changes in the allowance for loan losses for the two years ended September 30,
1999 were as follows:

<TABLE>
<CAPTION>
                                                        1999            1998
                                                    -----------     -----------
<S>                                                 <C>             <C>
Balance at beginning of year                        $ 1,411,249     $ 1,110,000
Provision for loan losses                               105,000         300,000
Recoveries on loans previously charged off                1,666           6,453
Loans charged off                                        (8,450)         (5,204)
                                                    -----------     -----------
Balance at end of year                              $ 1,509,465     $ 1,411,249
                                                    ===========     ===========
</TABLE>

Directors, executive officers, and associates of such persons were customers of
and had transactions with the Bank in the ordinary course of business. Included
in such transactions are outstanding loans and commitments, all of which were
made under normal credit terms and did not involve more than normal risk of
collection. The aggregate amount of these loans was $2,409,544 and $1,988,197 at
September 30, 1999 and 1998, respectively. During 1999, new loans of $1,022,119
were made and payments totaled $589,485. During 1998, new loans of $1,444,735
were made and payments totaled $216,666.

During 1999, the Bank sold groups of loans with a book value of $13,045,786 at a
net gain of $89,725. During 1998, the Bank sold groups of loans with a book
value of $9,588,145 at a gain of $80,148. The Bank held no loans for sale at
September 30, 1999 or 1998.


NOTE 5 - PREMISES AND EQUIPMENT

Premises and equipment at September 30 are summarized as follows:

<TABLE>
<CAPTION>
                                                       1999              1998
                                                    ----------        ----------
<S>                                                 <C>               <C>
Land                                                $  694,289        $  604,704
Buildings                                            1,799,033         1,725,332
Land Improvements                                      101,720           103,071
Furniture and equipment                              2,140,454         2,067,050
                                                    ----------        ----------
                                                     4,735,496         4,500,157

Less: accumulated depreciation                       2,232,414         2,252,720
                                                    ----------        ----------
                                                    $2,503,082        $2,247,437
                                                    ==========        ==========
</TABLE>
<PAGE>   26
NOTE 6 - DEPOSITS

Deposit balances and interest expense and average rates paid for the years ended
September 30 are summarized as follows:

<TABLE>
<CAPTION>
                                              1999                                     1998
                            --------------------------------------   --------------------------------------
                                Actual       Interest      Average      Actual        Interest      Average
                               Balance        Expense        Rate       Balance        Expense        Rate
                               -------       --------      -------      -------       --------      -------
<S>                         <C>            <C>             <C>       <C>            <C>             <C>
Noninterest bearing         $  6,481,000   $       --        --      $  5,878,000   $       --        --
Interest bearing checking     11,916,000        195,000      1.6%      10,913,000        281,000      2.4%
Money market demand           13,709,000        396,000      2.1%      11,929,000        580,000      2.4%
Passbook savings              23,869,000        717,000      3.2%      20,557,000        664,000      3.4%
Savings certificates         103,450,000      5,100,000      5.2%      94,623,000      5,169,000      5.4%
                            ------------   ------------      ---     ------------   ------------      ---
                            $159,425,000   $  6,408,000      4.1%    $143,900,000   $  6,694,000      4.3%
                            ============   ============      ===     ============   ============      ===
</TABLE>

Contractual maturities of savings certificates as of September 30, 1999 are as
follows:

<TABLE>
<S>                                                                 <C>
Under 1 year                                                        $ 85,165,011
1 to 2 years                                                          13,015,613
2 to 3 years                                                           5,269,028
                                                                    ------------
                                                                    $103,449,652
                                                                    ============
</TABLE>

Certificates of deposit in excess of $100,000 totaled $17,727,853 and
$17,908,000 at September 30,1999 and 1998, respectively, and are not federally
insured. Interest paid on deposits and other borrowings was $7,786,826 and
$7,126,575 for the years ended September 30, 1999 and 1998, respectively.

Directors, executive officers, and associates of such persons were customers of
and had transactions with the Bank in the ordinary course of business. Included
in such transactions are deposit accounts, all of which were made under normal
terms. The aggregate amount of these deposit accounts was $2,512,000 and
$1,520,000 at September 30, 1999 and 1998, respectively.

The deposits of the Bank are insured by the Savings Association Insurance Fund
(SAIF), one of two funds administered by the FDIC. The Bank's annual SAIF
premium rates were $.0648 per $100 of deposits in 1999 and 1998.

NOTE 7 - ADVANCES FROM THE FEDERAL HOME LOAN BANK

Advances from the Federal Home Loan Bank of Atlanta are pursuant to lines of
credit and are collateralized by a lien on qualifying first mortgage loans in an
amount necessary to satisfy outstanding indebtedness plus accrued interest.
Advances had interest rates ranging from 4.69% to 5.75% at September 30, 1999
and 4.97% to 5.75% at September 30, 1998. The unused portion of the line of
credit available to the Company at September 30, 1999 was $9,500,000.
<PAGE>   27
Maturities of advances at September 30 are as follows:

<TABLE>
<CAPTION>
                                                     1999                1998
                                                 -----------         -----------
<S>                                              <C>                 <C>
Advances from FHLB due:
    Less than 1 year                             $      --           $      --
    1 to 2 years                                        --                  --
    2 to 3 years                                        --                  --
    3 to 4 years                                   1,500,000           2,000,000
    4 to 5 years                                   7,000,000           1,500,000
    5 to 10 years                                 27,000,000          16,000,000
    After 10 years                                      --                  --
                                                 -----------         -----------
                                                 $35,500,000         $19,500,000
                                                 ===========         ===========
</TABLE>

Interest rates on certain advances may be reset at the option of the Federal
Home Loan Bank of Atlanta. At September 30, 1999, interest rates on $10 million
may be converted to a variable rate of interest on a quarterly basis starting in
December 1999, interest rates on $7 million may be reset in 2001, interest rates
on $8 million may be reset in 2003 and in 2004.

NOTE 8 - INCOME TAXES

The provision for income taxes is summarized below:

<TABLE>
<CAPTION>
                                                   1999                 1998
                                               -----------          -----------
<S>                                            <C>                  <C>
Currently payable
    Federal                                    $ 1,218,430          $ 1,123,000
    State                                          126,000               94,000
                                               -----------          -----------
                                                 1,344,430            1,217,000
Deferred
    Federal                                       (105,000)            (172,000)
    State                                          (41,000)             (41,000)
                                               -----------          -----------
                                                  (146,000)            (213,000)
                                               -----------          -----------
    Total income taxes                         $ 1,198,430          $ 1,004,000
                                               ===========          ===========
</TABLE>

The reasons for the difference between consolidated income tax expense and the
amount computed by applying the statutory federal income tax rate of 34% to
income before income taxes were as follows:
<PAGE>   28
<TABLE>
<CAPTION>
                                                       1999            1998
                                                   -----------     -----------
<S>                                                <C>             <C>
Federal income taxes at statutory rate             $ 1,142,000     $   973,000
State income taxes, net of federal benefit              56,000          35,000
Other                                                      430          (4,000)
                                                   -----------     -----------
                                                   $ 1,198,430     $ 1,004,000
                                                   ===========     ===========
Effective tax rate                                        35.7%           34.7%
                                                   ===========     ===========
</TABLE>

Income taxes recoverable (payable) are included in other assets (liabilities)
and were $(78,000) and $65,000, at September 30, 1999 and 1998, respectively.
Income taxes paid for the years ended September 30, 1999 and 1998 were
$1,315,000 and $1,693,000, respectively.
<PAGE>   29
The tax effects of temporary differences that give rise to significant portions
of deferred tax assets and liabilities at September 30 are as follows:

<TABLE>
<CAPTION>
                                                          1999          1998
                                                      -----------   -----------
<S>                                                   <C>           <C>
Deferred tax assets
    Deferred compensation                             $   278,824   $   207,823
    Deferred loan fees                                    150,546       195,804
    Allowance for loan losses                             314,623       184,242
    Other                                                  80,693        70,150
                                                      -----------   -----------
             Gross deferred tax assets                    824,686       658,019
Deferred tax liabilities
    Unrealized gain on securities
       available-for-sale                                 114,891       985,990
    Other                                                    --          87,618
                                                      -----------   -----------
             Gross deferred tax liabilities               114,891     1,073,608
                                                      -----------   -----------
             Net deferred tax asset (liability)       $   709,795   $  (415,589)
                                                      ===========   ===========
</TABLE>

The Company, in accordance with SFAS No. 109, did not record a deferred tax
liability of approximately $1,870,000 as of September 30, 1999 related to the
cumulative special bad debt deduction for savings and loan associations
recognized for income tax reporting prior to September 30, 1988, Gaston
Federal's base year.

Management believes that the Company will fully realize deferred tax assets
based on future taxable temporary differences, refundable income taxes from
carryback years, and current levels of operating income.
<PAGE>   30
NOTE 9 - COMMITMENTS TO EXTEND CREDIT

Commitments to extend credit are agreements to lend as long as there is no
violation of any condition established in the contract. Commitments generally
have fixed expiration dates or other termination clauses and may require payment
of a fee. Since commitments may expire without being drawn upon, the total
commitment amounts do not necessarily represent future cash requirements.
Commitments to extend credit as of September 30 are as follows:

<TABLE>
<CAPTION>
                                                     1999                1998
                                                 -----------         -----------
<S>                                              <C>                 <C>
Loan commitments                                 $   703,700         $   889,995
Unused lines of credit
    Commercial                                     6,099,144           6,654,000
    Consumer                                      13,192,106           8,389,000
</TABLE>

All loan commitments at September 30, 1999 are at fixed rates ranging from 7.4%
to 8.5%. Commitment periods are typically 60 days.

NOTE 10 - REGULATORY CAPITAL REQUIREMENTS

The Bank is subject to various regulatory capital requirements administered by
the federal banking agencies. Under the capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Bank must meet specific
capital guidelines that involve quantitative measures of assets, liabilities,
and certain commitments as calculated under regulatory accounting practices. The
capital amounts and classification are also subject to qualitative judgments by
the regulators about components, risk weightings and other factors. Failure to
meet minimum capital requirements can initiate certain mandatory, and possibly
discretionary, actions by regulators that, if undertaken, could have a direct
material effect on the Bank's financial statements.

The Bank is required to maintain: tangible capital of at least 1.5% of adjusted
total assets; core capital of at least 4.0% of adjusted total assets; and total
capital of at least 8.0% of risk weighted assets. At September 30, 1999, the
Bank's tangible capital and core capital were both $33,813,000 or 14.28% of
tangible assets, and total capital was $35,208,000 or 27.57% of risk-weighted
assets. The Company's primary regulator, the Office of Thrift Supervision,
informed the Bank that it was in the well-capitalized category as of the most
recent regulatory examination, and management is not aware of any events that
have occurred since that would have changed its classification.
<PAGE>   31
<TABLE>
<CAPTION>
                                                                                               To Be Well
                                                                                            Capitalized Under
                                                                     For Capital            Prompt Corrective
                                              Actual              Adequacy Purposes         Action Provisions
                                      ----------------------   ----------------------    ----------------------
                                       Amount        Ratio        Amount      Ratio        Amount      Ratio
                                       ------        -----        ------      -----        ------      -----
                                      (dollars in thousands)   (dollars in thousands)    (dollars in thousands)
<S>                                   <C>            <C>       <C>            <C>         <C>          <C>
As of September 30, 1999
     Total Risk-Based Capital
         (to Risk-Weighted Assets)    $35,208        27.57%    $10,217        8.00%       $12,772      10.00%
     Tier 1 Capital
         (to Risk-Weighted Assets)     33,813        26.48%      5,109        4.00%         7,663       6.00%
     Tier 1 Capital
         (to Adjusted Total Assets)    33,813        14.28%      9,474        4.00%        11,842       5.00%
     Tangible Capital
         to Adjusted Total Assets)     33,813        14.28%      3,553        1.50%         7,105       3.00%
As of September 30, 1998
     Total Risk-Based Capital
         (to Risk-Weighted Assets)     34,142        31.53%      8,663        8.00%        10,829      10.00%
     Tier 1 Capital
         (to Risk-Weighted Assets)     31,671        29.25%      4,332        4.00%         6,498       6.00%
     Tier 1 Capital
         (to Adjusted Total Assets)    31,671        15.44%      8,207        4.00%        10,256       5.00%
     Tangible Capital
         (to Adjusted Total Assets)    31,671        15.44%      3,078        1.50%         6,155       3.00%
</TABLE>

NOTE 11 - EMPLOYEE BENEFIT PLANS

The Bank contributes to the Financial Institutions Retirement Fund, a
multiemployer, qualified, noncontributory defined benefit pension plan that
covers substantially all employees of the Bank meeting age and service
requirements. The plan provides pension benefits based on the employee's length
of credited service and final average compensation as defined in the plan. The
plan requires employers to fund amounts necessary to meet ERISA minimum funding
requirements. Total expense relating to this plan was $3,810 in 1999 and $3,338
in 1998. Separate company information relating to the Bank is not available.

The Bank also provides supplemental benefits to substantially all employees
through a 401(k) savings plan. Eligible participants may contribute up to 15% of
base salary, with the Bank providing matching contributions of 50% of employee
contributions up to 6% of compensation. The plan also provides for discretionary
employer contributions. Total expense relating to this plan was $47,765 in 1999
and $90,961 in 1998.

The Bank also maintains nonqualified deferred compensation and supplemental
retirement plans for its directors. Total expense for the plans was $141,845 in
1999 and $67,623 in 1998.

1999 Recognition and Retention Plan - On April 12, 1999, the Company's
shareholders, among other actions,
<PAGE>   32
approved the Gaston Federal Bank 1999 Recognition and Retention Plan.
Subsequently, 84,534 shares of common stock were awarded under the plan to
directors and management. All such awards vested during the year ended September
30, 1999. The Company recognized compensation expense of $1.0 million in
connection with these stock awards.

1999 Stock Option Plan - On April 12, 1999, the Company's shareholders also
approved the Gaston Federal Bank 1999 Stock Option Plan that provided the
issuance of 211,335 options for directors and officers to purchase the Company's
common stock. As of September 30, 1999, 200,069 shares had been awarded under
the plan at exercise prices ranging from $12.00 to $13.00 per share with a
weighted average exercise price of $12.05 and a weighted average contractual
life of 115 months. The exercise price of each option equals the fair market
value of the Company's common stock at the date of the grants. There were
109,628 options fully vested as of September 30, 1999. No options were
exercised, forfeited, or expired during the year ended September 30, 1999. The
Company applies the provisions of Accounting Principles Board Opinion No. 25 in
accounting for the plan and accordingly, no compensation expense has been
recognized in connection with the granting of the stock options. In accordance
with SFAS No. 123, Accounting for Stock-Based Compensation, the Company adopted
the disclosure - only option and elected to apply the provisions of APB No. 25
for financial statement purposes.

Had the compensation cost for the Company's stock option plan been determined in
accordance with the fair-value accounting provisions of SFAS No. 123, net
income, basic earnings per share, and diluted earnings per share for the year
ended September 30, 1999, would have been as follows:

<TABLE>
<CAPTION>
                                                                        1999
                                                                   -------------
<S>                                                                <C>
Net income:
     As reported                                                   $   2,161,362
     Pro forma                                                     $   1,749,131
Basic earnings per share:
     As reported                                                   $        0.50
     Pro forma                                                     $        0.41
Diluted earnings per share:
     As reported                                                   $        0.50
     Pro forma                                                     $        0.41
</TABLE>

The weighted average fair value of options granted during the year ended
September 30, 1999 was $4.27 per share. The fair value of the stock options was
determined by using the Black-Scholes option pricing model. This model requires
the use of assumptions, which can materially affect fair value estimates.
Therefore, this model does not necessarily provide a reliable single measure of
the fair value of the Company's stock options. The fair value of stock options
granted was estimated on the date of the grant using the following assumptions:
(1) expected dividend yield of 1.62%; (2) risk free interest rate of 5.20%; (3)
expected volatility of 30%; and (4) expected lives of options of seven years.

Employee Stock Ownership Plan - In connection with the Conversion, the Bank
established an ESOP. The ESOP is a tax-qualified retirement plan designed to
invest primarily in the Company's common stock. All full-time employees of the
Bank who have completed one year of service with the Bank will be eligible to
participate in the ESOP. The ESOP utilized funds borrowed from the Company
totaling $1,690,680, to purchase approximately 8%, or 169,068 shares of the
Company's common stock issued in the Conversion. The loan to the ESOP will be
primarily repaid with contributions from the Bank to the ESOP over a period not
to exceed 15 years. Under the terms of the ESOP, the Bank makes contributions to
the ESOP sufficient to cover all payments of principal and
<PAGE>   33
interest as they become due. At September 30, 1999, the loan had an outstanding
balance of $1,493,434 and an interest rate equal to the Bank's prime rate (8.25%
as of September 30, 1999).

Shares purchased with the loan proceeds are held in a suspense account by the
trustee of the plan for future allocation among participants as the loan is
repaid. Contributions to the ESOP and shares released from the suspense account
are allocated among participants on the basis of compensation as described in
the plan. The number of shares released to participants will be determined based
upon the percentage of principal and interest payments made during the year
divided by the total remaining principal and interest payments including the
current year's payment. Participants will vest in the shares allocated to their
respective accounts over a period not to exceed 5 years. Any forfeited shares
are allocated to the then remaining participants in the same proportion as
contributions. At September 30, 1999, 11,271 shares have been allocated to
participants and 157,797 shares remain unallocated. The fair value of the
unallocated shares was $1,972,463 at September 30, 1999. The Company recognizes
compensation expense attributable to the ESOP ratably over the fiscal year based
upon the estimated number of ESOP shares to be allocated each December 31st. The
Company recognized $128,000 and $75,000 as compensation expense in 1999 and
1998, respectively.

The trustee for the ESOP must vote all allocated shares held in the ESOP trust
in accordance with the instructions of the participants. Unallocated shares held
by the ESOP trust are voted by the trustee in a manner calculated to most
accurately reflect the results of the allocated ESOP shares voted, subject to
the requirements of the Employee Retirement Income Security Act of 1974, as
amended (ERISA).

NOTE 12 - FAIR VALUE OF FINANCIAL INSTRUMENTS

The following methods and assumptions were used by the Company in estimating its
fair value disclosures for financial instruments. In cases where quoted market
prices are not available, fair values are based on estimates using present value
or other valuation techniques. The estimates are significantly affected by the
assumptions used, including discount rates and estimates of future cash flows.
These estimates may differ substantially from amounts that could be realized in
an immediate sale or settlement of the instrument.

Fair value approximates book value for the following financial instruments due
to their short-term nature: cash and due from banks, interest-earning bank
balances, and advances from customers for taxes and insurance.

Fair value for investment securities and mortgage-backed and related securities
are based on quoted market prices. If a quoted market price is not available,
fair value is estimated using market prices for similar securities.

Fair value for variable rate loans that reprice frequently is based on the
carrying value reduced by an estimate of credit losses inherent in the
portfolio. Fair value for all other loans is estimated by discounting their
future cash flows using interest rates currently being offered for loans of
comparable terms and credit quality.

Fair value for demand deposit accounts and interest-bearing accounts with no
fixed maturity is equal to the carrying value. Certificate of deposit fair
values are estimated by discounting cash flows from expected maturities using
interest rates currently being offered for similar instruments.

Fair value for the advances from the Federal Home Loan Bank Board is based on
discounted cash flows using current interest rates.

At September 30, 1999 and 1998, The Company had outstanding unfunded commitments
to extend credit offered in the normal course of business. Fair values of these
commitments are based on fees currently charged
<PAGE>   34
for similar instruments. At September 30, 1999 and 1998, the carrying amounts
and fair values of these off-balance sheet financial instruments were
immaterial.

The Company has used management's best estimates of fair values of financial
instruments based on the above assumptions. This presentation does not include
certain financial instruments, nonfinancial instruments or certain intangible
assets such as customer relationships, deposit base intangibles, or goodwill.
Accordingly, the aggregate fair value amounts presented do not represent the
underlying value of the Company. The estimated fair values of financial
instruments as of September 30 were as follows:

<TABLE>
<CAPTION>
                                                   1999                              1998
                                      ------------------------------    -------------------------------
                                         Carrying     Estimated Fair       Carrying     Estimated Fair
                                          Amount          Value             Amount          Value
                                      ------------     ------------     ------------     ------------
<S>                                   <C>              <C>              <C>              <C>
Financial assets
   Cash and due from banks            $  4,206,884     $  4,206,884     $  2,697,028     $  2,697,028
   Interest-earning bank balances        8,375,733        8,375,733       11,100,936       11,100,936
   Investment and mortgage-
      backed securities                 48,634,366       48,116,191       51,214,755       51,685,767
   Loans                               168,044,032      164,032,000      136,500,519      138,444,000

Financial liabilities
   Deposits                            159,424,778      154,810,000      143,900,772      144,324,000
   Advances from FHLB                   35,500,000       34,014,000       19,500,000       19,677,000
</TABLE>

NOTE 13 - EARNINGS PER SHARE

Earnings per share has been determined under the provisions of SFAS No. 128,
Earnings Per Share. Basic earnings per share is computed by dividing net income
applicable to common stock by the weighted average number of common shares
outstanding during the period, without considering any dilutive items. Diluted
earnings per share is computed by dividing net income applicable to common stock
by the weighted average number of common shares and common stock equivalents for
items that are dilutive, net of shares assumed to be repurchased using the
treasury stock method. Common stock equivalents arise from the assumed
conversion of outstanding stock options. Earnings per share data for the year
ended September 30, 1998 is not presented because such data would not be
meaningful given the short period during which common stock was outstanding
during that period.

The only potential stock of the Company as defined in SFAS No. 128, is stock
options granted to various directors and officers of the Bank. The following is
a summary of the computation of basic and diluted earnings per share:


<TABLE>
<CAPTION>
                                                                    Year Ended
                                                               September 30, 1999
                                                               ------------------
<S>                                                            <C>
Net income                                                         $2,161,362

Weighted average outstanding shares                                 4,293,516

Basic earnings per share                                           $     0.50
</TABLE>
<PAGE>   35
<TABLE>
<S>                                                                <C>
Weighted average outstanding shares                                 4,293,516
Dilutive effect of stock options                                       13,773
                                                                   ----------

Weighted average diluted shares                                     4,307,289

Diluted earnings per share                                         $     0.50
</TABLE>

Options to purchase 10,000 shares of common stock at $13 per share were
outstanding since May 1999 but were not included in the computation of diluted
earnings per share because the options' exercise price was greater than the
average market price of the common shares. These options, which will expire May
2009, were outstanding at September 30, 1999.

On October 9, 1998, the Company's Board of Directors announced the authorization
to repurchase up to 105,668 shares of outstanding common stock under the 1998
Stock Repurchase Plan. On April 19, 1999, the Company's Board of Directors
announced the authorization to repurchase 295,869 shares of outstanding common
stock for the 1999 Stock Option Plan and the 1999 Recognition and Retention
Plan.

As of September 30, 1999, 211,400 shares have been repurchased under these plans
at an average price of $13.53 per share.

NOTE 14 - PARENT-ONLY FINANCIAL INFORMATION

The earnings of the Bank are recognized by Gaston Federal Bancorp, Inc. using
the equity method of accounting. Accordingly, undistributed earnings of the Bank
are recorded as increases in the Company's investment in the Bank. The following
are the condensed financial statements of the Company as of and for the year
ended September 30, 1999.

Condensed Statements of Financial Condition

<TABLE>
<CAPTION>
                                                         1999            1998
                                                     -----------     -----------
<S>                                                  <C>             <C>
Assets
Cash and cash equivalents                            $ 5,199,471     $ 6,874,046
Investment in securities available-for-sale              495,648       1,514,219
Investment in subsidiary                              33,992,158      33,200,213
Other assets                                              21,313          33,300
                                                     -----------     -----------
Total assets                                         $39,708,590     $41,621,778
                                                     ===========     ===========

Liabilities and Stockholders' Equity
Liabilities                                          $      --       $    51,649
Stockholders' Equity                                  39,708,590      41,570,129
                                                     -----------     -----------
Total liabilities and stockholders' equity           $39,708,590     $41,621,778
                                                     ===========     ===========
</TABLE>
<PAGE>   36
Condensed Statements of Operations

<TABLE>
<CAPTION>
                                                       Year Ended September 30,
                                                         1999             1998
                                                     -----------      -----------
<S>                                                  <C>              <C>
Interest income                                      $   226,347      $   467,092
Interest expense                                            --           (227,282)
Other operating expenses                                (136,687)        (108,126)
                                                     -----------      -----------
Income before income taxes and undistributed
earnings from subsidiaries                                89,660          131,684
Income taxes                                             (70,148)         (51,397)
                                                     -----------      -----------

Income before undistributed earnings
from subsidiaries                                         19,512           80,287
Equity in undistributed earnings of subsidiaries       2,141,850        1,805,497
                                                     -----------      -----------

Net income                                           $ 2,161,362      $ 1,885,784
                                                     ===========      ===========
</TABLE>

Condensed Statements of Cash Flows

<TABLE>
<CAPTION>
                                                                     Year Ended September 30,
                                                                      1999              1998
                                                                 ------------      ------------
<S>                                                              <C>               <C>
Operating activities
     Net income                                                  $  2,161,362      $  1,885,784
     Adjustments to reconcile net income to net
     Cash provided by operating activities
     Equity in undistributed earnings of subsidiaries              (2,141,850)       (1,805,497)
     Issuance of stock for Recognition and Retention Plan           1,014,408              --
     Allocation of shares to ESOP                                     122,105              --
     Decrease (increase) in other operating assets                     11,987           (33,300)
     (Decrease) increase in other operating liabilities               (45,041)           46,562
                                                                 ------------      ------------

         Net cash (used in) provided by operating activities        1,122,971            93,549

Investing activities
     Purchase of investments available-for-sale                          --          (1,500,000)
     Maturities and prepayments of investment securities            1,000,000              --
     Investment in subsidiary                                            --         (10,096,709)
                                                                 ------------      ------------

         Net cash provided by (paid in)investing activities         1,000,000       (11,596,709)

Financing activities
     Repurchase of common stock                                    (2,859,489)             --
     Proceeds from common stock issuance                                 --          18,602,031
     Dividends to stockholders                                       (938,057)         (224,825)
                                                                 ------------      ------------

         Net cash (paid in) provided by financing activities       (3,797,546)       18,377,206

Net (decrease) increase in cash and cash equivalents               (1,674,575)        6,874,046
Cash and cash equivalents, beginning of period                      6,874,046              --
                                                                 ------------      ------------
Cash and cash equivalents, end of period                         $  5,199,471      $  6,874,046
                                                                 ============      ============
</TABLE>
<PAGE>   37
REPORT OF INDEPENDENT AUDITORS


The Board of Directors
Gaston Federal Bancorp, Inc.


        We have audited the accompanying consolidated statements of condition of
Gaston Federal Bancorp, Inc. and subsidiaries as of September 30, 1999 and 1998
and the related consolidated statements of operations, comprehensive income,
changes in equity and cash flows for the years then ended. These financial
statements are the responsibility of management. Our responsibility is to
express an opinion on these financial statements based on our audits.

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

        In our opinion, the financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Gaston
Federal Bancorp, Inc. and subsidiaries as of September 30, 1999 and 1998 and the
results of their operations and their cash flows for the years then ended, in
conformity with generally accepted accounting principles.




/s/ Cherry, Bekaert & Holland, L.L.P.


Gastonia, North Carolina
October 26, 1999
<PAGE>   38
                  SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)

         A summary of selected financial data for the years ended September 30,
1999 and 1998 is as follows:

<TABLE>
<CAPTION>
                                          FIRST          SECOND        THIRD        FOURTH
(In Thousands Except Per Share Data)     QUARTER        QUARTER       QUARTER       QUARTER
------------------------------------     -------        -------       -------       -------
<S>                                      <C>            <C>           <C>           <C>
FISCAL 1999:
Interest income ....................      $3,708         $3,770        $3,886        $3,875
Net interest income ................       1,821          1,859         1,886         1,784
Provision for losses ...............          15             50            25            15
Income before provision for
  income taxes .....................         826            838           954           742
Net income .........................         526            537           616           482
Earnings per common share ..........      $ 0.12         $ 0.12        $ 0.14        $ 0.12

Fiscal 1998:
Interest income ....................      $3,277         $3,410        $3,655        $3,585
Net interest income ................       1,540          1,573         1,937         1,751
Provision for losses ...............          75             75            90            60
Income before provision
  for income taxes .................         597            660           921           712
Net income .........................         378            428           609           471
Earnings per common share ..........         n/a            n/a        $ 0.14        $ 0.10
</TABLE>


                        COMMON STOCK AND RELATED MATTERS

         The Company's common stock is listed on the Nasdaq National Market
under the symbol "GBNK." As of November 30, 1999, the Company had six registered
market makers, 1,041 stockholders of record (excluding the number of persons or
entities holding stock in street name through various brokerage firms), and
4,328,634 shares outstanding. As of such date, Gaston Federal Holdings, MHC (the
"Mutual Company"), the Company's mutual holding company, held 2,383,145 shares
of common stock and stockholders other than the Mutual Company held 1,945,489
shares.

         The following table sets forth market price and dividend information
for the Common Stock since the completion of the Bank's reorganization into the
two-tier mutual holding company structure, which was completed on April 9, 1998.

<TABLE>
<CAPTION>
FISCAL YEAR ENDED                                                       CASH DIVIDENDS
SEPTEMBER 30, 1999            HIGH                   LOW                   DECLARED
<S>                          <C>                   <C>                  <C>
First quarter                $14 7/8               $10 1/8               $0.050/share
Second quarter               $13 1/2               $11 1/2                0.055/share
Third quarter                $13 7/8               $11 1/2                0.055/share
Fourth quarter               $14 1/4               $12 7/16               0.055/share
</TABLE>

<TABLE>
<CAPTION>
Fiscal Year Ended                                                       Cash Dividends
September 30, 1998            High                   Low                   Declared
<S>                          <C>                   <C>                  <C>
Third quarter                $20                   $10                   $0.050/share
Fourth quarter               $15 1/2               $10 5/8                0.050/share
</TABLE>

         Payment of dividends on the Company's common stock is subject to
determination and declaration by the Board of Directors and depends upon a
number of factors, including capital requirements, regulatory
<PAGE>   39
limitations on the payment of dividends, the Company's results of operations and
financial condition, tax considerations and general economic conditions. No
assurance can be given that dividends will be declared or, if declared, what the
amount of dividends will be, or whether such dividends, once declared, will
continue.

         OTS regulations impose limitations upon all "capital distributions" by
savings institutions, including cash dividends, payments by a savings
institution to repurchase or otherwise acquire its stock, payments to
stockholders of another savings institution in a cash-out merger, and other
distributions charged against capital. The regulations establish a three-tiered
system of regulation, with the greatest flexibility being afforded to
well-capitalized or Tier 1 savings associations. As of the date hereof, the Bank
was a Tier 1 institution. Accordingly, under the OTS capital distribution
regulations, the Bank would be permitted to pay dividends during any calendar
year up to 100 percent of its net income during that calendar year, plus the
amount that would reduce by one-half its surplus capital ratio at the beginning
of the calendar year.

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

         The Mutual Company has accepted all dividends paid by the Company. OTS
regulations require the Mutual Company to notify the OTS of any proposed waiver
of the right to receive dividends. It is the OTS' recent practice to review
dividend waiver notices on a case-by case-basis, and, in general, not object to
any such waiver if: (i) the mutual holding company's board of directors
determines that such a waiver is consistent with such directors' fiduciary
duties to the mutual holding company's members; (ii) for as long as the savings
association subsidiary is controlled by the mutual holding company, the dollar
amount of dividends waived by the mutual holding company are considered as a
restriction on the retained earnings of the savings association as a note to the
financial statements; (iii) the amount of any dividend waived by the mutual
holding company is available for declaration as a dividend solely to the mutual
holding company, and, in accordance with SFAS 5, where the savings association
determines that the payment of such dividend to the mutual holding company is
probable, an appropriate dollar amount is recorded as a liability; (iv) the
amount of any waived dividend is considered as having been paid by the savings
association (and the savings association's capital ratios adjusted accordingly)
in evaluating any proposed dividend under OTS capital distribution regulations;
and (v) in the event the mutual holding company converts to stock form, the
appraisal submitted to the OTS in connection with the conversion application
takes into account the aggregate amount of the dividends waived by the mutual
holding company.
<PAGE>   40
                             STOCKHOLDER INFORMATION

DIRECTORS
Senator David W. Hoyle, Chairman of the Board
Ben R. Rudisill, II, Vice Chairman of the Board
Kim S. Price, President, CEO, and Director
Martha Barnett Beal, Director
James J. Fuller, Director
William H. Keith, Director
Charles D. Massey, Director
Eugene R. Matthews, II, Director
Robert W. Williams, Sr., Director

DIRECTORS EMERITI
Henry L. Fowler, Sr.
Thomas M. Holland
B. Frank Matthews, II

EXECUTIVE OFFICERS
Kim S. Price, President and Chief Executive Officer
Paul L. Teem, Jr., Executive Vice President, Secretary, and Chief Operations
Officer
Gary F. Hoskins, Senior Vice President, Treasurer, and Chief Financial Officer
Michael R. Maguire, Senior Vice President and Chief Credit Officer

ANNUAL MEETING
The Annual Meeting of Stockholders will be held at 10:30 A.M. on Thursday,
February 17, 2000, at the Gaston County Public Library at 1555 East Garrison
Boulevard, Gastonia, North Carolina, 28054-5175.

STOCK LISTING
The Company's Common Stock trades over-the-counter on the Nasdaq National Market
under the symbol "GBNK."

COUNSEL
Stott, Hollowell, Palmer, and Windham, L.L.P.
110 West Main Avenue, Third Floor
Post Office Box 995
Gastonia, NC 28053-0995

SPECIAL COUNSEL
Luse Lehman Gorman Pomerenk & Schick, P.C.
5335 Wisconsin Avenue, N.W., Suite 400
Washington, D.C.  20015

INDEPENDENT AUDITORs
Cherry, Bekaert & Holland, L.L.P.
2020 Remount Road
Post Office Box 1064
Gastonia, North Carolina  28053-1064

TRANSFER AGENT AND REGISTRAR
ChaseMellon Shareholder Services, L.L.C.
85 Challenger Road, Overpeck Centre
Ridgefield Park, New Jersey 07660
Phone (800) 370-1163
<PAGE>   41
ANNUAL REPORT ON FORM 10-KSB
A copy of the Company's Form 10-KSB for the fiscal year ended September 30,
1999, will be furnished without charge to stockholders as of December 27, 1999,
upon written request to the Secretary, Gaston Federal Bancorp, Inc., 245 West
Main Avenue, P.O. Box 2249, Gastonia, North Carolina 28053-2249.