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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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Form 10-KSB



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Annual Report Pursuant to Section 13
or 15(d) of the

Securities Exchange Act of 1934



For the fiscal year ended June 30, 2005



Commission File No.: 0-24479



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AF Financial Group

(Exact name of small business issuer as specified in its charter)



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|                       |  |                    
|---------------------- |  | -------------------
|Federally Chartered    |  | 56-2098545         
|State of Incorporation |  | IRS Employer Number



21 East Ashe Street

West Jefferson, North Carolina 28694-0026

(Address of Principal Executive Offices)



Issuers telephone, including area code: (336) 246-4344



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



Common Stock, par value $0.01 per share

Title of Class



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



Indicate by check mark if there is no disclosure of delinquent filers pursuant to Item 405 of Regulation S-B contained herein and no disclosure will be contained, to the best of registrants knowledge, in definitive proxy or
information statements incorporated by reference in part III of this Form 10-KSB, or any amendment to this Form 10-KSB. ̈



Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act.):    Yes ̈No  x



The revenues for the
issuers fiscal year ended June 30, 2005 are $15,960,626.



The issuer had 1,049,835 shares of common stock outstanding as of August 31, 2005. The aggregate value of the voting stock held by non-affiliates of the issuer, computed by reference to the price at which the common stock was sold on August
31, 2005 was $8,815,170.



Documents Incorporated by
Reference.



Portions of the Proxy Statement for the 2005
Annual Meeting of Stockholders are incorporated by reference into Part III of this Form 10-KSB.



Transitional Small Business Disclosure Format.    Yes ̈No  x



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##### Table of Contents

TABLE OF CONTENTS



|           |  |          |  |                                                                                                                 |  |      
|---------- |  | -------- |  | --------------------------------------------------------------------------------------------------------------- |  | -----
|PART I     |  |         
|           |  | Item 1.  |  | Description of Business                                                                                         |  | 1-26 
|           |  | Item 2.  |  | Properties                                                                                                      |  | 27   
|           |  | Item 3.  |  | Legal Proceedings                                                                                               |  | 28   
|           |  | Item 4.  |  | Submission of Matters to a Vote of Security Holders                                                             |  | 28   
|           | 
|PART II    |  |         
|           |  | Item 5.  |  | Market for Common Stock and Related Stockholder Matters                                                         |  | 28   
|           |  | Item 6.  |  | Managements Discussion and Analysis                                                                            |  | 29-40
|           |  | Item 7.  |  | Financial Statements                                                                                            |  | 41-72
|           |  | Item 8.  |  | Changes in and Disagreement with Accountants on Accounting and Financial Disclosure                             |  | 73   
|           |  | Item 8A. |  | Controls and Procedures                                                                                         |  | 73   
|           | 
|PART III   |  |         
|           |  | Item 9.  |  | Directors, Executive Officers, Promoters and Control Persons; Compliance with Section 16(a) of the Exchange Act |  | 73   
|           |  | Item 10. |  | Executive Compensation                                                                                          |  | 73   
|           |  | Item 11. |  | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters                  |  | 73-74
|           |  | Item 12. |  | Certain Relationships and Related Transactions                                                                  |  | 74   
|           |  | Item 13. |  | Exhibits                                                                                                        |  | 74-75
|           |  | Item 14. |  | Principal Accountant Fees and Services                                                                          |  | 75   
|           | 
|SIGNATURES |  | 76      



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PART I



ITEM 1. DESCRIPTION OF BUSINESS



General



AF Financial Group (the Company) is a federally chartered thrift holding company which owns 100% of the common stock of AF Bank (the Bank), AF Insurance Services, Inc. (an independent insurance
agency) and AF Capital Trust I (a Delaware business trust). The Company has no operations and conducts no business of its own other than ownership of its subsidiaries. The Bank is a federally chartered stock savings bank which was chartered in 1939
and the historical operations of AF Bank have been to provide fixed rate loans for the residents of Ashe County, North Carolina. Over the past several years, we have expanded our market area to include Alleghany, Caldwell, Surry, Watauga and Wilkes
counties and have diversified our product lines by engaging in non-residential mortgage and non-mortgage lending and offering insurance and uninsured investment products. In July 1997, we started offering traditional property and casualty, life and
health insurance products through AF Insurance Services, Inc., headquartered in West Jefferson, North Carolina and operating in Boone, Elkin, Jefferson, Lenoir, Sparta, West Jefferson and Wilkesboro, North Carolina.



During the fourth quarter of the 2005 fiscal year, AF Financial Group
dissolved the broker/dealer subsidiary, AF Brokerage, Inc. We continue to offer the same level of service through a third party relationship that AF Bank has entered into with LaSalle Street Securities. This new structure allows us to offer a full
array of investment products, including fixed-rate and variable annuities and mutual funds while reducing expenses associated with maintaining an independent broker/dealer registration. This new third party relationship operates as a division of AF
Bank under the name AF Investments.



At June 30, 2005, we had
total assets of $214.1 million, net loans of $181.2 million, deposits of $164.0 million and stockholders equity of $13.0 million. We realized net income of $648,777 for the year ended June 30, 2005 compared to a net loss of $308,254 for the
year ended June 30, 2004. The Companys operating results are primarily dependent upon net interest income, fees and charges and insurance commissions. Net interest income is the difference between interest earned on loans, investments and
interest-earning deposits at other financial institutions, and the cost of interest-bearing savings deposits and other borrowings. The primary interest-earning asset of the Company is its mortgage loan portfolio, representing 85.5% of total loans
with approximately 54.5% of portfolio mortgage loans at fixed rates as of June 30, 2005. The net interest income of the Company is affected by changes in economic conditions that influence market interest rates and to a large extent by the monetary
actions by the Federal Reserve Board (FRB). This exposure to changes in interest rates contributes to a moderate degree of interest rate risk because of the negative impact of changing rates to the Banks earnings and to the new
market value of its assets and liabilities. Historically, mortgage lenders have made loans and funded those loans with core and short-term deposits, exposing the lender to a higher level of interest rate risk in a rising rate scenario. We have
reduced our exposure to rising rates by limiting the term or the time to reprice of loans that we retain in our portfolio. Generally, the Bank sells mortgage loans with terms exceeding 15 years unless the loan documents permit us to re-price the
loan at an interval of ten years or less. Non-mortgage loans have rates that allow for adjustment as the prime rate changes, where possible, and where non-mortgage loans are made with fixed terms, the terms typically do not exceed five years.



We also offer consumer loans, including automobile and home
improvement loans. At June 30, 2005, consumer loans constituted approximately 5.8% of portfolio loans. In addition, we offer commercial loans to businesses in Ashe, Alleghany and Watauga counties and to areas adjacent to those counties. Commercial
loans generally have rates based on the prime rate of interest that more closely reflects prevailing market interest rates than do fixed rate products or other rate indices. Consumer and commercial loans also generally have shorter terms and greater
interest rate sensitivity than mortgage loans. Funding for loan originations has been provided by marketing savings and checking accounts, competitively pricing certificates of deposit, and borrowing from the Federal Home Loan Bank of Atlanta
(FHLB). Deposits increased $6.5 million as the result of normal business activities and FHLB advances decreased $5.0 million during the year ended June 30, 2005.



In addition to loans, the Bank invests in federal agency securities, certificates of deposit of insured banks, overnight
deposits with the FHLB, equity securities in the Federal Home Loan Mortgage Corporation (FHLMC), municipal bonds, and mortgage-backed securities issued by the Government National Mortgage Association



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(GNMA) and Federal National Mortgage Association (FNMA). We do not engage in the practice of trading securities. Rather,
the Banks investment portfolio consists primarily of securities designated as available for sale. We intend to maintain investment securities to meet liquidity needs, as a supplement to our lending activities, and as a means to reduce the
interest rate risk and credit risk of our asset base in exchange for lower rates of return than would typically be available with other lending activities.



The Company receives fee income primarily from loan origination fees; late loan payments fees; commissions from the sale of credit life; accident and
health insurance; deposit transaction fees; insurance commissions generated from AF Insurance Services, Inc.; commission income generated from AF Investments; and from payment for other services provided to customers by the Company.



Major non-interest costs to the Company include compensation and benefits;
occupancy and equipment; information technology costs; and provision for loan losses. Other external factors that affect the operating results of the Company include changes in government and accounting regulations and changes in the competitive
dynamics within the Companys market area.



Our executive
offices are located at 21 East Ashe Street, West Jefferson, North Carolina 28694-0026. Our telephone number is (336) 246-4344. We maintain a website at www.afgrp.com on which we will post all reports we file with the SEC under Section 13(a) and
Section 16 of the Securities Exchange Act of 1934. You can review these reports free of charge by clicking on About Us on the homepage of AF Financial Group, proceeding to Investor Information and then to reports filed
with the SEC. We also post on this site our key corporate governance documents, including our board committee charters and our code of ethics. Information on our website is not, however, a part of this report.



Market Area and Competition



Our market area for deposit gathering and lending is concentrated in
Alleghany, Ashe and Watauga Counties, North Carolina and to areas adjacent to those counties. Headquartered in West Jefferson, North Carolina, AF Insurance Services, Inc., has branches in Boone, Elkin, Jefferson, Lenoir, Sparta, West Jefferson, and
North Wilkesboro, North Carolina. AF Investments, a division of AF Bank, serves Ashe, Alleghany, Wilkes and Watauga counties in North Carolina.



The Company has substantial competition for each of the deposits it accepts, the loans it makes and for insurance and investment services. In the
Banks three county market area (Alleghany, Ashe and Watauga) there are fifteen banks and thrifts, including the four largest banks in North Carolina. AF Bank has the fourth largest deposit base in its combined three county market area with a
12.35% market share. In our home market of Ashe County, we believe that we have the second largest deposit base with market share of 27.95%, just slightly behind the leader. We compete for deposits by offering a variety of customer services and
deposit accounts at competitive interest rates. Insurance and investment sales are service oriented as well as price sensitive. We, like our competitors, are affected by general economic conditions, particularly changes in market interest rates,
real estate market values, government policies and regulatory authorities actions. Changes in the ratio of demand for loans relative to the availability of credit may attract additional competition from financial institutions which may have
greater resources than our Company, but which have not generally engaged in lending activities in our market area in the past and from credit unions that can expand into our market area and compete for customers without the level of taxation
experienced by the Company. Competition may also increase as a result of the lifting of restrictions on the interstate operations of financial institutions. SeeRegulation.



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Lending Activities



Loan Portfolio Composition. The Companys loan portfolio consists primarily of mortgage loans. The Company also makes consumer and commercial
loans.



The types of loans that the Company may originate are
subject to federal and state laws and regulations. Interest rates charged by the Bank on loans are affected by the demand for such loans, the supply of money available for lending purposes and the rates offered by competitors. These factors are in
turn affected by, among other things, economic conditions, monetary policies of the federal government, including the FRB, and legislative tax policies.



The following table sets forth the composition of the Companys mortgage and other loan portfolios in dollar amounts and percentages at the dates
indicated.



|                                              |  |                        |         |            |        |   |        |      |            |  |        |        |  |            |         |  |        |   |            |   |         |        |        |            |  |   |         |  |        |  
|--------------------------------------------- |  | ---------------------- | ------- | ---------- | ------ | - | ------ | ---- | ---------- |  | ------ | ------ |  | ---------- | ------- |  | ------ | - | ---------- | - | ------- | ------ | ------ | ---------- |  | - | ------- |  | ------ | -
|                                              |  | At June 30,            |        
|                                              |  | 2005                   |         |            | 2004   |   |        | 2003 |            |  | 2002   |        |  | 2001       |        
|                                              |  | Amount                 |         | % of Total |        |   | Amount |      | % of Total |  |        | Amount |  | % of Total |         |  | Amount |   | % of Total |   |         | Amount |        | % of Total | 
|                                              |  | (Dollars in thousands) |        
|Mortgage loans:                               |  |                        |         |            |        |   |        |      |            |  |        |        |  |            |         |  |        |   |            |   |         |        |        |            |  |   |         |  |        |  
|One-to four-family                            |  | $                      | 96,368  |            | 53.17  | % |        | $    | 94,691     |  | 52.56  | %      |  | $          | 88,725  |  | 56.78  | % |            | $ | 80,952  |        | 56.39  | %          |  | $ | 73,821  |  | 59.21  | %
|Multi-family                                  |  |                        | 4,171   |            | 2.30   | % |        |      | 5,728      |  | 3.18   | %      |  |            | 6,226   |  | 3.98   | % |            |   | 6,142   |        | 4.28   | %          |  |   | 3,507   |  | 2.81   | %
|Non-residential                               |  |                        | 27,154  |            | 14.98  | % |        |      | 28,958     |  | 16.07  | %      |  |            | 18,873  |  | 12.08  | % |            |   | 15,196  |        | 10.59  | %          |  |   | 8,525   |  | 6.84   | %
|Land                                          |  |                        | 17,155  |            | 9.47   | % |        |      | 13,906     |  | 7.72   | %      |  |            | 7,961   |  | 5.11   | % |            |   | 8,008   |        | 5.58   | %          |  |   | 8,298   |  | 6.66   | %
|Construction                                  |  |                        | 11,416  |            | 6.30   | % |        |      | 14,203     |  | 7.88   | %      |  |            | 9,383   |  | 6.00   | % |            |   | 10,329  |        | 7.20   | %          |  |   | 5,344   |  | 4.29   | %
|                                              |  |                        |         |            |        |   |        |      |            |  |        |        |  |            |         |  |        |   |            |   |         |        |        |            |  |   |         |  |        |  
|Total mortgage loans                          |  | $                      | 156,264 |            | 86.22  | % |        | $    | 157,486    |  | 87.41  | %      |  | $          | 131,168 |  | 83.95  | % |            | $ | 120,627 |        | 84.03  | %          |  | $ | 99,495  |  | 79.80  | %
|                                              |  |                        |         |            |        |   |        |      |            |  |        |        |  |            |         |  |        |   |            |   |         |        |        |            |  |   |         |  |        |  
|Other loans:                                  |  |                        |         |            |        |   |        |      |            |  |        |        |  |            |         |  |        |   |            |   |         |        |        |            |  |   |         |  |        |  
|Commercial                                    |  | $                      | 15,972  |            | 8.82   | % |        | $    | 12,626     |  | 7.01   | %      |  | $          | 15,186  |  | 9.72   | % |            | $ | 10,784  |        | 7.51   | %          |  | $ | 12,378  |  | 9.93   | %
|Consumer loans                                |  |                        | 10,611  |            | 5.85   | % |        |      | 11,512     |  | 6.39   | %      |  |            | 11,227  |  | 7.18   | % |            |   | 13,512  |        | 9.41   | %          |  |   | 14,051  |  | 11.27  | %
|                                              |  |                        |         |            |        |   |        |      |            |  |        |        |  |            |         |  |        |   |            |   |         |        |        |            |  |   |         |  |        |  
|Total other loans                             |  | $                      | 26,583  |            | 14.67  | % |        | $    | 24,138     |  | 13.40  | %      |  | $          | 26,413  |  | 16.90  | % |            |   | 24,296  |        | 16.92  | %          |  |   | 26,429  |  | 21.20  | %
|                                              |  |                        |         |            |        |   |        |      |            |  |        |        |  |            |         |  |        |   |            |   |         |        |        |            |  |   |         |  |        |  
|Gross loans                                   |  | $                      | 182,847 |            | 100.89 | % |        | $    | 181,624    |  | 100.81 | %      |  | $          | 157,581 |  | 100.85 | % |            | $ | 144,923 |        | 100.95 | %          |  | $ | 125,924 |  | 101.00 | %
|                                              |  |                        |         |            |        |   |        |      |            |  |        |        |  |            |         |  |        |   |            |   |         |        |        |            |  |   |         |  |        |  
|Less:                                         |  |                        |         |            |        |   |        |      |            |  |        |        |  |            |         |  |        |   |            |   |         |        |        |            |  |   |         |  |        |  
|Undisbursed loan funds                        |  |                        |        |            |       | % |        |      |           |  |       | %      |  |            |        |  |       | % |            |   |        |        |       | %          |  |   |        |  |       | %
|Unearned discounts and net deferred loan fees |  | $                      | 220     |            | 0.13   | % |        | $    | 223        |  | 0.12   | %      |  | $          | 212     |  | 0.14   | % |            | $ | 239     |        | 0.17   | %          |  | $ | 227     |  | 0.18   | %
|Allowance for loan losses                     |  |                        | 1,385   |            | 0.76   | % |        |      | 1,245      |  | 0.69   | %      |  |            | 1,111   |  | 0.71   | % |            |   | 1,131   |        | 0.79   | %          |  |   | 1,022   |  | 0.82   | %
|                                              |  |                        |         |            |        |   |        |      |            |  |        |        |  |            |         |  |        |   |            |   |         |        |        |            |  |   |         |  |        |  
|                                              |  |                        | 1,605   |            | 0.89   | % |        |      | 1,468      |  | 0.81   | %      |  |            | 1,323   |  | 0.85   | % |            |   | 1,370   |        | 0.95   | %          |  |   | 1,249   |  | 1.00   | %
|                                              |  |                        |         |            |        |   |        |      |            |  |        |        |  |            |         |  |        |   |            |   |         |        |        |            |  |   |         |  |        |  
|Loans, net                                    |  | $                      | 181,242 |            | 100.00 | % |        | $    | 180,156    |  | 100.00 | %      |  | $          | 156,258 |  | 100.00 | % |            | $ | 143,553 |        | 100.00 | %          |  | $ | 124,675 |  | 100.00 | %
|                                              |  |                        |         |            |        |   |        |      |            |  |        |        |  |            |         |  |        |   |            |   |         |        |        |            |  |   |         |  |        |  



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##### Table of Contents

Loan Maturity.The following table shows the maturity or period to repricing of the Companys
loan portfolio at June 30, 2005. Loans that have adjustable rates are shown using scheduled principal amortization. The table does not consider estimated prepayments of principal.



|                                      |  |                       |            |              |   |                  |  |       |            |              |   |                  |  |               |            |        |   |            |  |   |            |  |   |             |  |        |  
|------------------------------------- |  | --------------------- | ---------- | ------------ | - | ---------------- |  | ----- | ---------- | ------------ | - | ---------------- |  | ------------- | ---------- | ------ | - | ---------- |  | - | ---------- |  | - | ----------- |  | ------ | -
|                                      |  | At June 30, 2005      |            |              |  
|                                      |  | Mortgage Loans        |            |              |   |                  |  | Total |           
|                                      |  | One-  to Four- Family |            | Multi-Family |   | Non- Residential |  | Land  |            | Construction |   | Commercial Loans |  | ConsumerLoans |            | Amount |   | %          | 
|Fixed rate loans:                     |  |                       |            |              |   |                  |  |       |            |              |   |                  |  |               |            |        |   |            |  |   |            |  |   |             |  |        |  
|                                      |  |                       |            |              |   |                  |  |       |           
|Amount due or repricing:              |  |                       |            |              |   |                  |  |       |            |              |   |                  |  |               |            |        |   |            |  |   |            |  |   |             |  |        |  
|One year or less                      |  | $                     | 2,064,593  |              |   |                 |  |       |           |              |   | 574,899          |  |               | 1,869,994  |        |   | 276,660    |  |   | 1,029,711  |  | $ | 5,815,857   |  | 3.18   | %
|                                      |  |                       |            |              |   |                  |  |       |            |              |   |                  |  |               |            |        |   |            |  |   |            |  |   |             |  |        |  
|One to three years                    |  |                       | 14,021,573 |              |   | 106,284          |  |       | 3,273,523  |              |   | 1,304,503        |  |               |           |        |   | 187,141    |  |   | 3,100,586  |  |   | 21,993,609  |  | 12.03  | %
|More than three years to five years   |  |                       | 15,734,605 |              |   | 559,421          |  |       | 5,953,453  |              |   | 2,029,695        |  |               | 146,296    |        |   | 2,833,281  |  |   | 3,154,895  |  |   | 30,411,646  |  | 16.63  | %
|More than five years to fifteen years |  |                       | 25,654,061 |              |   | 196,146          |  |       | 3,090,070  |              |   | 5,592,041        |  |               | 734,509    |        |   | 966,616    |  |   | 895,918    |  |   | 37,129,362  |  | 20.31  | %
|Over fifteen years                    |  |                       | 2,256,146  |              |   |                 |  |       |           |              |   |                 |  |               |           |        |   |           |  |   | 77,989     |  |   | 2,334,134   |  | 1.28   | %
|                                      |  |                       |            |              |   |                  |  |       |            |              |   |                  |  |               |            |        |   |            |  |   |            |  |   |             |  |        |  
|Total due or repricing after one year |  |                       | 57,666,385 |              |   | 861,852          |  |       | 12,317,045 |              |   | 8,926,239        |  |               | 880,805    |        |   | 3,987,038  |  |   | 7,229,387  |  |   | 91,868,752  |  | 50.24  | %
|                                      |  |                       |            |              |   |                  |  |       |            |              |   |                  |  |               |            |        |   |            |  |   |            |  |   |             |  |        |  
|Total amounts due or repricing, gross |  | $                     | 59,730,978 |              | $ | 861,852          |  | $     | 12,317,045 |              | $ | 9,501,138        |  | $             | 2,750,799  |        | $ | 4,263,698  |  | $ | 8,259,098  |  | $ | 97,684,608  |  | 53.42  | %
|                                      |  |                       |            |              |   |                  |  |       |            |              |   |                  |  |               |            |        |   |            |  |   |            |  |   |             |  |        |  
|Variable rate loans:                  |  |                       |            |              |   |                  |  |       |            |              |   |                  |  |               |            |        |   |            |  |   |            |  |   |             |  |        |  
|                                      |  |                       |            |              |   |                  |  |       |           
|Amount due or repricing:              |  |                       |            |              |   |                  |  |       |            |              |   |                  |  |               |            |        |   |            |  |   |            |  |   |             |  |        |  
|One year or less                      |  | $                     | 32,264,195 |              |   | 3,309,330        |  |       | 14,432,402 |              |   | 7,617,429        |  |               | 8,665,555  |        |   | 11,707,995 |  |   | 2,351,460  |  | $ | 80,348,367  |  | 43.94  | %
|                                      |  |                       |            |              |   |                  |  |       |            |              |   |                  |  |               |            |        |   |            |  |   |            |  |   |             |  |        |  
|One to three years                    |  |                       | 4,374,441  |              |   |                 |  |       |           |              |   | 36,105           |  |               |           |        |   |           |  |   |           |  |   | 4,410,546   |  | 2.41   | %
|More than three years to five years   |  |                       |           |              |   |                 |  |       | 404,557    |              |   |                 |  |               |           |        |   |           |  |   |           |  |   | 404,557     |  | 0.22   | %
|More than five years to fifteen years |  |                       |           |              |   |                 |  |       |           |              |   |                 |  |               |           |        |   |           |  |   |           |  |   |            |  | 0.00   | %
|Over fifteen years                    |  |                       |           |              |   |                 |  |       |           |              |   |                 |  |               |           |        |   |           |  |   |           |  |   |            |  | 0.00   | %
|                                      |  |                       |            |              |   |                  |  |       |            |              |   |                  |  |               |            |        |   |            |  |   |            |  |   |             |  |        |  
|Total due or repricing after one year |  |                       | 4,374,441  |              |   |                 |  |       | 404,557    |              |   | 36,105           |  |               |           |        |   |           |  |   |           |  |   | 4,815,103   |  | 2.63   | %
|                                      |  |                       |            |              |   |                  |  |       |            |              |   |                  |  |               |            |        |   |            |  |   |            |  |   |             |  |        |  
|Total amounts due or repricing, gross |  | $                     | 36,638,637 |              | $ | 3,309,330        |  | $     | 14,836,959 |              | $ | 7,653,534        |  | $             | 8,665,555  |        | $ | 11,707,995 |  | $ | 2,351,460  |  | $ | 85,163,470  |  | 46.58  | %
|                                      |  |                       |            |              |   |                  |  |       |            |              |   |                  |  |               |            |        |   |            |  |   |            |  |   |             |  |        |  
|Total loans:                          |  |                       |            |              |   |                  |  |       |            |              |   |                  |  |               |            |        |   |            |  |   |            |  |   |             |  |        |  
|                                      |  |                       |            |              |   |                  |  |       |           
|Amount due or repricing:              |  |                       |            |              |   |                  |  |       |            |              |   |                  |  |               |            |        |   |            |  |   |            |  |   |             |  |        |  
|One year or less                      |  | $                     | 34,328,789 |              | $ | 3,309,330        |  | $     | 14,432,402 |              | $ | 8,192,328        |  | $             | 10,535,549 |        | $ | 11,984,655 |  | $ | 3,381,171  |  | $ | 86,164,223  |  | 47.12  | %
|                                      |  |                       |            |              |   |                  |  |       |            |              |   |                  |  |               |            |        |   |            |  |   |            |  |   |             |  |        |  
|One to three years                    |  |                       | 18,396,014 |              |   | 106,284          |  |       | 3,273,523  |              |   | 1,340,608        |  |               |           |        |   | 187,141    |  |   | 3,100,586  |  |   | 26,404,155  |  | 14.44  | %
|More than three years to five years   |  |                       | 15,734,605 |              |   | 559,421          |  |       | 6,358,010  |              |   | 2,029,695        |  |               | 146,296    |        |   | 2,833,281  |  |   | 3,154,895  |  |   | 30,816,203  |  | 16.85  | %
|More than five years to fifteen years |  |                       | 25,654,061 |              |   | 196,146          |  |       | 3,090,070  |              |   | 5,592,041        |  |               | 734,509    |        |   | 966,616    |  |   | 895,918    |  |   | 37,129,362  |  | 20.31  | %
|Over fifteen years                    |  |                       | 2,256,146  |              |   |                 |  |       |           |              |   |                 |  |               |           |        |   |           |  |   | 77,989     |  |   | 2,334,134   |  | 1.28   | %
|                                      |  |                       |            |              |   |                  |  |       |            |              |   |                  |  |               |            |        |   |            |  |   |            |  |   |             |  |        |  
|Total due or repricing after one year |  |                       | 62,040,826 |              |   | 861,852          |  |       | 12,721,602 |              |   | 8,962,344        |  |               | 880,805    |        |   | 3,987,038  |  |   | 7,229,387  |  |   | 96,683,855  |  | 52.88  | %
|                                      |  |                       |            |              |   |                  |  |       |            |              |   |                  |  |               |            |        |   |            |  |   |            |  |   |             |  |        |  
|Total amounts due or repricing, gross |  | $                     | 96,369,615 |              | $ | 4,171,182        |  | $     | 27,154,005 |              | $ | 17,154,672       |  | $             | 11,416,354 |        | $ | 15,971,693 |  | $ | 10,610,558 |  | $ | 182,848,078 |  | 100.00 | %
|                                      |  |                       |            |              |   |                  |  |       |            |              |   |                  |  |               |            |        |   |            |  |   |            |  |   |             |  |        |  



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##### Table of Contents

Origination, Purchase, Sale and Servicing of Loans. The Banks lending activities are
conducted through its branches in Ashe, Alleghany and Watauga counties, North Carolina. The Bank originates both adjustable-rate loans and fixed-rate mortgage loans for portfolio and for sale in the secondary market. The Bank retains in its
portfolio adjustable-rate mortgage loans and fixed-rate mortgage loans that carry maximum maturities of 30 years and 15 years, respectively. Fixed-rate loans originated for sale in the secondary market have maximum maturities of 30 years. The Bank
sells qualified fixed-rate loans to FNMA, but retains the servicing rights. The determination to sell loans is based upon managements efforts to reduce interest rate risk. At June 30, 2005, the Bank serviced approximately $63.6 million of
loans for FNMA.



One- to Four-Family Mortgage Lending.
The Bank offers both fixed-rate and adjustable-rate mortgage loans, with maturities up to 30 years, which are secured by one- to four-family residences, which generally are owner-occupied. Fixed-rate loans held in the Banks portfolio generally
have higher interest rates and shorter terms than those loans sold to FNMA. Most are secured by property located in Ashe, Alleghany and Watauga counties, North Carolina. Loan originations are generally obtained from existing or past customers and
members of the local communities.



The Bank offers three to
five year call loans, which are either called or modified based on the Banks interest rates currently in effect at the call date. These loans are similar to adjustable rate loans in that the loans generally amortize over terms of up to 30
years but are not indexed to any widely recognized rate, such as the one year U.S. Treasury securities rate, and do not have interest rate caps or floors. Instead, the majority of such loans are modified at the call date and the rate is adjusted to
the Banks current rate offered for similar loans being originated on such dates. For purposes of the tabular presentations included throughout this document, such loans are considered to be adjustable.



In view of its operating strategy, the Bank adheres to its Board-approved
underwriting guidelines for loan originations, which, though prudent in approach to credit risk and evaluation of collateral, allow management flexibility with respect to documentation of certain matters, such as loan amount and certain credit
requirements. The Banks loans are typically originated under terms, conditions and documentation which permit them to be sold to U.S. government sponsored agencies such as FNMA. The Banks policy is to originate one- to four-family
residential mortgage loans in amounts up to 80% of the lower of the appraised value or the selling price of the property securing the loan. The Bank offers products with a higher loan-to-value ratio in conjunction with private mortgage insurance.
Mortgage loans originated by the Bank generally include due-on-sale clauses which provide the Bank with the contractual right to deem the loan immediately due and payable in the event the borrower transfers ownership of the property without the
Banks consent. Due-on-sale clauses are an important means of adjusting the rates on the Banks fixed-rate mortgage loan portfolio and the Bank has generally exercised its rights under these clauses.



Construction Lending. The Bank originates construction loans primarily
to finance construction of one- to four-family homes to the individuals who will be the owners and occupants upon completion of construction, in the Banks market area. At June 30, 2005, the Banks portfolio contained construction loans
with balances of approximately $11.4 million, or 6.2%, of total loans. The Banks policy is to disburse loan proceeds as construction progresses and as periodic inspections warrant. These loans are made primarily to the individuals who will
ultimately occupy the home, and are structured to guarantee the permanent financing to the Bank. Thus construction loans typically roll into permanent financing. Construction loans are normally made for a maximum of 12 months, by which
time permanent financing generally is obtained. From time to time the Bank makes construction loans to a select group of builders for speculative purposes. The Bank imposes limits on the number of speculative units that each builder has unsold at
any time. The Bank is restrictive on the builders that qualify for speculative construction loans.



Construction lending is generally considered to involve a higher degree of credit risk than long-term financing of residential properties. The Banks
risk of loss on a construction loan is dependent largely upon the accuracy of the initial estimate of the propertys value at completion of construction or development and the estimated cost of construction. If the estimated construction cost
proves to be inaccurate, the Bank may be compelled to advance additional funds to complete construction.





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##### Table of Contents

Non-Residential Mortgage Lending. The Bank originates real estate mortgage loans that are
generally secured by various properties used for business purposes and retail facilities, such as small office buildings and church loans. The Banks underwriting procedures provide that non-residential mortgage loans may be made based on debt
service coverage and in amounts up to the lesser of (i) 80% of the lesser of the appraised value or purchase price of the property or (ii) the Banks current loans-to-one-borrower limit. These loans are generally originated as three to five
year call loans with amortization periods of up to 15 years. The Bank considers factors such as the borrowers expertise, credit history, profitability, cash flow and the value of the collateral while underwriting these loans. At June 30, 2005
the Banks non-residential mortgage loan portfolio was $27.2 million, or 14.9% of total loans outstanding. The largest non-residential mortgage loan in the Banks portfolio at June 30, 2005 was approximately $1.5 million and is secured by
a commercial property.



Mortgage loans secured by
non-residential properties can be larger and therefore may involve a greater degree of credit risk than one- to four-family residential mortgage loans. This risk is attributable to the uncertain realization of projected income-producing cash flows
which are affected by vacancy rates, the ability to maintain rent levels against competitively-priced properties and the ability to collect rent from tenants on a timely basis. Because payments on loans secured by non-residential properties are
often dependent on the successful operation or management of the properties, repayment of such loans may be subject to a greater extent to adverse conditions in the real estate market or the economy. The Bank seeks to minimize these risks through
its underwriting standards, which require such loans to be qualified on the basis of the propertys income and debt service ratio.



Other Mortgage Lending. The Bank also offers loans secured by land and multi-family residences. Land loans generally consist of residential
building lots for which the borrower intends to ultimately construct residential properties, but may also include tracts purchased for agricultural use and a minor amount purchased for speculative purposes. Multi-family loans generally consist of
residential properties with more than four units, typically small apartment complexes. At June 30, 2005, the Banks total land loan portfolio was $17.2 million or 9.4% of total loans and its multi-family loan portfolio was $4.2 million or 2.3%
of total loans.



The Bank originates multi-family residential
loans with both fixed and adjustable interest rates which vary as to maturity. Such loans are typically income-producing investment loans. Loan to value ratios on the Banks multi-family residential loans are generally limited to 80%. As part
of the criteria for underwriting these loans, the Banks general policy is to require principals of corporate borrowers to become co-borrowers or to obtain personal guarantees from the principals of corporate borrowers.



Multi-family residential lending generally entails significant additional
risks as compared with single-family residential property lending. Such loans typically involve large loan balances to single borrowers or groups of related borrowers. The payment experience on such loans is typically dependent on the successful
operation of the real estate project. The success of such projects is sensitive to changes in supply and demand, conditions in the market for multi-family residential properties as well as to regional and economic conditions.



Appraisals for most mortgage loans are performed by independent appraisers
designated by the Bank. The appraisals of such properties are then reviewed by the Banks management. The independent appraisers used by the Bank are reviewed annually by management and the Board of Directors. Experienced loan officers may rely
on tax records for smaller mortgage loans where the loan to value ratios are high, such as home equity or second mortgages, especially where the Bank holds the first mortgage.



Consumer Loans. Subject to the restrictions contained in federal laws and regulations, the Bank is also authorized to
make loans for a wide variety of personal or consumer purposes. As of June 30, 2005, $10.6 million, or 5.8%, of the Banks total loan portfolio consisted of consumer loans. The primary component of the Banks consumer loan portfolio was
$5.5 million of auto loans. Consumer loans are available at fixed or variable interest rates.



The Bank also offers loans secured by savings accounts at the Bank. Interest rates charged on such loans are tied to the prime rate and are available in amounts up to 90% of the value of the account. Savings account
loans are reviewed and approved in conformity with standards approved by the Banks Board of Directors. At June 30, 2005, the Banks savings account loan portfolio totaled $914,151.





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Consumer loans generally involve more credit risk than mortgage loans because of the type and nature of
the collateral. In addition, consumer lending collections are dependent on the borrowers continuing financial stability, and thus are more likely to be adversely affected by job loss, divorce, illness, and personal bankruptcy. In some cases,
any repossessed collateral resulting from a defaulted consumer loan will not provide an adequate source of repayment of the outstanding loan balance because of depreciation and improper repair and maintenance of the underlying security.



As of June 30, 2005, the Bank did not have any non-performing consumer
loans (loans 90 days or more delinquent). Charge-offs for consumer loans totaled $117,600 and $112,000 for the years ended June 30, 2005 and 2004, respectively.



Commercial Business Loans. The Bank offers commercial business loans that are generally provided to various types of closely held businesses
located in the Banks primary market area. Commercial business loans generally have terms of five years or less and interest rates which float in accordance with the prime rate although the Bank occasionally originates commercial business loans
with fixed rates of interest. The Bank performs a cash flow analysis in underwriting these loans. The Banks commercial loans generally are secured by equipment, machinery or other corporate assets including receivables. The Bank requires
principals of corporate borrowers to become co-borrowers or obtains personal guarantees from the principals of the borrowers with respect to all commercial business loans.



Commercial business lending generally entails greater credit risk than mortgage lending. The repayment of commercial
business loans typically is dependent on the successful operations and income of the borrower. Such risks can be significantly affected by economic conditions. In addition, commercial business lending generally requires substantially greater
oversight efforts compared to residential real estate lending.



As of June 30,
2005, the Bank had no non-performing commercial business loans. We did not charge off any commercial business loans during the year ended June 30, 2005 and charge-offs for commercial business loans totaled $399,000 for the year ended June 30, 2004.



Loan Approval Procedures and Authority. The Board of
Directors establishes the lending policies of the Bank. The Board of Directors has established the following lending authority: the Banks Chief Executive Officer, Chief Lending Officer, Chief Credit Officer and Retail Bank Executive may
individually combine with any lending officer to approve lending relationships up to $750,000. In addition, the Bank Loan Committee comprised of three voting members which may include the Chief Executive Officer, Chief Lending Officer, Chief Credit
Officer or the Retail Bank Executive can approve lending relationships up to $1,500,000. The Executive Committee of the Board of Directors may approve loans up to the Banks legal lending limit. The foregoing lending limits are reviewed
annually and, as needed, revised by the Board of Directors. The Board ratifies all loans on a monthly basis.



For all loans originated by the Bank, upon receipt of a completed loan application from a prospective borrower, a credit report is obtained and certain
other information supporting the borrowers ability to repay is required. An appraisal performed by a Bank approved independent appraiser is generally required for all real property intended to secure a proposed loan when the amount of the loan
proceeds will exceed $100,000. The Board annually approves the independent appraisers used by the Bank and approves the Banks appraisal policy. It is the Banks policy to obtain title insurance on all real estate loans of $25,000 or more
and hazard insurance on all improved real estate loans. In connection with a borrowers request for a renewal of a mortgage loan, the Bank evaluates both the borrowers ability to service the renewed loan applying an interest rate that
reflects prevailing market conditions and the customers payment history, as well as the value of the underlying collateral property.



Asset Quality



Non-Performing Loans. Loans are considered non-performing if they are in foreclosure or are 90 or more days delinquent. The Banks level of
non-performing loans decreased to $185,000, or 0.09% of total assets, at June 30, 2005 compared to $518,801, or 0.25% of total assets, at June 30, 2004. We stop accruing interest on loans when they are classified as non-performing. The Bank
established reserves for uncollectible interest, or interest accrued prior to the non-performing classification, totaling $2,161 and $3,538 at June 30, 2005 and 2004, respectively. The effect of nor recognizing interest income on non-performing
loans in accordance with original terms totaled approximately $11,630 and $13,978 during the years ended June 30, 2005 and 2004, respectively. Management and



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##### Table of Contents

the Board of Directors perform a monthly review of all delinquent loans. The actions taken by the Bank with respect to
delinquencies vary depending on the nature of the loan and period of delinquency. The Banks policies generally provide that delinquent mortgage loans be reviewed and that a written late charge notice be mailed no later than the 17th day of
delinquency. The Banks policies provide that telephone contact and further written notification will be attempted to ascertain the reasons for delinquency and the prospects of repayment. When contact is made with the borrower at any time prior
to foreclosure, the Bank attempts to obtain full payment or work out a repayment schedule with the borrower to avoid foreclosure. It is the Banks general policy to reserve all accrued interest due on all loans that are 90 days or more past
due.



Real Estate Owned. Property acquired by the Bank
as a result of foreclosure on a mortgage loan is classified as real estate owned (REO). At June 30, 2005, the Bank did not hold any REO, while non-performing loans, defined as loans that are 90 days or more delinquent, totaled $185,000.
The Banks REO is initially recorded at the fair value of the related assets at the date of foreclosure. Thereafter, if there is a further deterioration in value, the Bank provides an REO valuation allowance and charges operations for the
diminution in value less cost to sell. It is the policy of the Bank to obtain an appraisal on all real estate acquired through foreclosure as soon as practicable after it determines that foreclosure is imminent. The Bank generally reassesses the
value of REO at least annually thereafter. The policy for loans is to establish loss reserves in accordance with the Banks asset classification process, based on Generally Accepted Accounting Principles (GAAP).



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Non-performing Assets. The following table sets forth information regarding the Banks
non-performing assets at the dates indicated.



|                                                                                          |  |                        |      |   |      |   |      |      |  |   |      |   |  |      |      |   |  |   |      |  
|----------------------------------------------------------------------------------------- |  | ---------------------- | ---- | - | ---- | - | ---- | ---- |  | - | ---- | - |  | ---- | ---- | - |  | - | ---- | -
|                                                                                          |  | At June 30,            |     
|                                                                                          |  | 2005                   |      |   | 2004 |   |      | 2003 |  |   | 2002 |   |  | 2001 |     
|                                                                                          |  | (Dollars in thousands) |     
|Non-accrual mortgage loans:                                                               |  |                        |      |   |      |   |      |      |  |   |      |   |  |      |      |   |  |   |      |  
|One-to four-family                                                                        |  | $                      | 185  |   |      | $ | 232  |      |  | $ | 321  |   |  | $    | 305  |   |  | $ |     |  
|Multi-family                                                                              |  |                        |     |   |      |   |     |      |  |   |     |   |  |      |     |   |  |   |     |  
|Non-residential                                                                           |  |                        |     |   |      |   |     |      |  |   |     |   |  |      |     |   |  |   |     |  
|Land                                                                                      |  |                        |     |   |      |   |     |      |  |   | 22   |   |  |      |     |   |  |   |     |  
|Construction                                                                              |  |                        |     |   |      |   | 249  |      |  |   |     |   |  |      |     |   |  |   |     |  
|                                                                                          |  |                        |      |   |      |   |      |      |  |   |      |   |  |      |      |   |  |   |      |  
|Total mortgage loans                                                                      |  |                        | 185  |   |      |   | 481  |      |  |   | 343  |   |  |      | 305  |   |  |   |     |  
|                                                                                          |  |                        |      |   |      |   |      |      |  |   |      |   |  |      |      |   |  |   |      |  
|Commercial                                                                                |  |                        |     |   |      |   |     |      |  |   | 33   |   |  |      |     |   |  |   |     |  
|Consumer Loans                                                                            |  |                        |     |   |      |   | 38   |      |  |   | 67   |   |  |      | 155  |   |  |   |     |  
|                                                                                          |  |                        |      |   |      |   |      |      |  |   |      |   |  |      |      |   |  |   |      |  
|Total non-accruing loans                                                                  |  | $                      | 185  |   |      | $ | 519  |      |  | $ | 443  |   |  | $    | 460  |   |  | $ |     |  
|                                                                                          |  |                        |      |   |      |   |      |      |  |   |      |   |  |      |      |   |  |   |      |  
|Loans delinquent 90 or more days for which interest is fully reserved and still accruing: |  |                        |      |   |      |   |      |      |  |   |      |   |  |      |      |   |  |   |      |  
|One-to four-family                                                                        |  | $                      |     |   |      | $ |     |      |  | $ |     |   |  | $    |     |   |  | $ | 383  |  
|Multi-family                                                                              |  |                        |     |   |      |   |     |      |  |   |     |   |  |      |     |   |  |   | 28   |  
|Non-residential                                                                           |  |                        |     |   |      |   |     |      |  |   |     |   |  |      |     |   |  |   |     |  
|Land                                                                                      |  |                        |     |   |      |   |     |      |  |   |     |   |  |      |     |   |  |   |     |  
|Construction                                                                              |  |                        |     |   |      |   |     |      |  |   |     |   |  |      |     |   |  |   |     |  
|                                                                                          |  |                        |      |   |      |   |      |      |  |   |      |   |  |      |      |   |  |   |      |  
|Total mortgage loans                                                                      |  |                        |     |   |      |   |     |      |  |   |     |   |  |      |     |   |  |   | 411  |  
|                                                                                          |  |                        |      |   |      |   |      |      |  |   |      |   |  |      |      |   |  |   |      |  
|Commercial                                                                                |  |                        |     |   |      |   |     |      |  |   |     |   |  |      |     |   |  |   |     |  
|Consumer Loans                                                                            |  |                        |     |   |      |   |     |      |  |   |     |   |  |      |     |   |  |   | 68   |  
|                                                                                          |  |                        |      |   |      |   |      |      |  |   |      |   |  |      |      |   |  |   |      |  
|Total loans delinquent 90 or more days for which interest has been fully reserved         |  |                        |     |   |      |   |     |      |  |   |     |   |  |      |     |   |  |   |     |  
|                                                                                          |  |                        |      |   |      |   |      |      |  |   |      |   |  |      |      |   |  |   |      |  
|Total non-performing loans                                                                |  | $                      | 185  |   |      | $ | 519  |      |  | $ | 443  |   |  | $    | 460  |   |  | $ | 479  |  
|                                                                                          |  |                        |      |   |      |   |      |      |  |   |      |   |  |      |      |   |  |   |      |  
|Total real estate owned                                                                   |  |                        |     |   |      |   |     |      |  |   | 43   |   |  |      | 263  |   |  |   | 248  |  
|                                                                                          |  |                        |      |   |      |   |      |      |  |   |      |   |  |      |      |   |  |   |      |  
|Total non-performing assets                                                               |  | $                      | 185  |   |      | $ | 519  |      |  | $ | 486  |   |  | $    | 723  |   |  | $ | 727  |  
|                                                                                          |  |                        |      |   |      |   |      |      |  |   |      |   |  |      |      |   |  |   |      |  
|Total non-performing loans to loans, gross                                                |  |                        | 0.10 | % |      |   | 0.29 | %    |  |   | 0.28 | % |  |      | 0.32 | % |  |   | 0.36 | %
|Total non-performing assets to total assets                                               |  |                        | 0.09 | % |      |   | 0.25 | %    |  |   | 0.25 | % |  |      | 0.41 | % |  |   | 0.47 | %



Classified
Assets. Federal regulations and the Banks Classification of Assets Policy require the Bank to use an internal asset classification system as a means of reporting problem and potential problem assets. The Bank has incorporated the Office of
Thrift Supervisions (OTS) internal asset classifications as a part of its credit monitoring system. The Bank currently classifies problem and potential problem assets as Special Mention, Substandard,
Doubtful or Loss assets. Additionally, the Bank places assets on an internal Watch List when those assets demonstrate characteristics that if not corrected or that if deteriorated further would lead to a more
severe classification. An asset is considered Substandard if it is inadequately protected by the current equity and paying capacity of the obligor or of the collateral pledged, if any. Substandard assets include those
characterized by the distinct possibility that the insured institution will sustain some loss if the deficiencies are not corrected. Assets classified as Doubtful have all of the weaknesses inherent in those
classified Substandard with the added characteristic that the weaknesses present make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and
improbable. Assets classified as Loss are those considered uncollectible and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted. Assets which do
not currently expose the insured institution to sufficient risk to warrant classification in one of the aforementioned categories but possess weaknesses are required to be designated Special Mention.



The Banks management reviews and classifies the Banks assets and
reports the results to the Banks Board of Directors on a monthly basis. The Bank classifies assets in accordance with the management guidelines described above. At June 30, 2005, the Bank had $185,000 of assets classified as Substandard, $2.8
million of assets designated as Special Mention, no assets classified as Loss and no assets classified as Doubtful.





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##### Table of Contents

Allowance for Loan Losses. The Allowance for Loan Losses (ALL) is established through
a provision for loan losses based on managements evaluation of the risks inherent in the Banks loan portfolio, prior loss history and the general economy. The ALL is maintained at an amount we consider adequate to cover loan losses which
are deemed probable and estimable. The allowance is based upon a number of factors, including asset classifications, economic trends, industry experience and trends, industry and geographic concentrations, estimated collateral values, our assessment
of the credit risk inherent in the portfolio, historical loan loss experience, and the Banks underwriting policies. At June 30, 2005, the Banks ALL was $1.4 million, or 0.76% of total loans, as compared to $1.2 million or 0.69% of total
loans at June 30, 2004. The Bank had non-performing loans of $185,000 and $519,000 at June 30, 2005 and June 30, 2004, respectively. Allowance for loan losses to total non-performing assets at the end of the period increased to 748.9% at June 30,
2005 compared to 239.9% at June 30, 2004. This increase is primarily the result of the decrease of non-performing loans, mentioned above. The Bank will continue to monitor and modify its ALL as conditions dictate. While the Bank believes it has
established its existing allowances for loan losses in accordance with GAAP, various regulatory agencies, as an integral part of their examination processes, periodically review the Banks ALL. These agencies may require the Bank to establish
additional valuation allowances, based on their judgments of the information available at the time of the examination, and thereby negatively affect the Banks financial condition and earnings. In addition, there can be no assurance that
increases in the Banks allowance for loan losses will not occur in the future.



The following table sets forth activity in the Banks ALL at or for the dates indicated.



|                                                                                      |  |                                   |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|------------------------------------------------------------------------------------- |  | --------------------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | - |  | ---- | ------- | - |  | - | ------- | -
|                                                                                      |  | At or For the Year Ended June 30, |        
|                                                                                      |  | 2005                              |         |   | 2004 |   |         | 2003 |  |   | 2002    |   |  | 2001 |        
|                                                                                      |  | (Dollars in thousands)            |        
|Balance at beginning of year                                                          |  | $                                 | 1,245   |   |      | $ | 1,111   |      |  | $ | 1,131   |   |  | $    | 1,022   |   |  | $ | 979     |  
|                                                                                      |  |                                   |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Provision for loan losses                                                             |  |                                   | (79     | ) |      |   | 668     |      |  |   | 243     |   |  |      | 420     |   |  |   | 225     |  
|                                                                                      |  |                                   |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Charge-offs:                                                                          |  |                                   |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|One-  to four-family residential                                                      |  |                                   | (97     | ) |      |   | (73     | )    |  |   | (39     | ) |  |      | (123    | ) |  |   |        |  
|Multi-family residential                                                              |  |                                   |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Non-residential and land                                                              |  |                                   |        |   |      |   | (19     | )    |  |   | (3      | ) |  |      | (11     | ) |  |   | (5      | )
|Construction                                                                          |  |                                   |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Commercial                                                                            |  |                                   |        |   |      |   | (399    | )    |  |   | (69     | ) |  |      | (11     | ) |  |   | (172    | )
|Consumer loans                                                                        |  |                                   | (117    | ) |      |   | (112    | )    |  |   | (306    | ) |  |      | (282    | ) |  |   | (126    | )
|                                                                                      |  |                                   |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Total charge-offs                                                                     |  |                                   | (214    | ) |      |   | (603    | )    |  |   | (417    | ) |  |      | (427    | ) |  |   | (303    | )
|                                                                                      |  |                                   |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Recoveries                                                                            |  |                                   | 433     |   |      |   | 69      |      |  |   | 154     |   |  |      | 116     |   |  |   | 121     |  
|                                                                                      |  |                                   |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Balance at end of year                                                                |  | $                                 | 1,385   |   |      | $ | 1,245   |      |  | $ | 1,111   |   |  | $    | 1,131   |   |  | $ | 1,022   |  
|                                                                                      |  |                                   |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Total loans outstanding at end of period                                              |  | $                                 | 182,847 |   |      | $ | 181,624 |      |  | $ | 157,581 |   |  | $    | 144,923 |   |  | $ | 125,924 |  
|                                                                                      |  |                                   |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Average total loans outstanding                                                       |  | $                                 | 185,623 |   |      | $ | 169,549 |      |  | $ | 154,586 |   |  | $    | 136,621 |   |  | $ | 119,965 |  
|                                                                                      |  |                                   |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Allowance for loan losses to total loans at end of period                             |  |                                   | 0.76    | % |      |   | 0.69    | %    |  |   | 0.71    | % |  |      | 0.78    | % |  |   | 0.81    | %
|                                                                                      |  |                                   |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Allowance for loan losses to total non-performing assets at end of period             |  |                                   | 748.87  | % |      |   | 239.98  | %    |  |   | 228.60  | % |  |      | 156.43  | % |  |   | 140.58  | %
|                                                                                      |  |                                   |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Allowance for loan losses to total non-performing loans at end of period              |  |                                   | 748.87  | % |      |   | 239.98  | %    |  |   | 250.79  | % |  |      | 245.87  | % |  |   | 213.36  | %
|                                                                                      |  |                                   |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Ratio of net charge-offs during the period to average loans outstanding during period |  |                                   | 0.12    | % |      |   | 0.31    | %    |  |   | 0.17    | % |  |      | 0.23    | % |  |   | 0.15    | %
|                                                                                      |  |                                   |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  





- 10 -



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##### Table of Contents

The following table sets forth the Banks ALL allocated by loan category and the percent of loans in
each category to total loans at the dates indicated.



|                         |  |                        |       |                                         |        |   |                                                  |        |   |                  |   |                                        |  |        |                                                  |  |        |                  |  |                                        |       |  |                                                  |   |  |        |  
|------------------------ |  | ---------------------- | ----- | --------------------------------------- | ------ | - | ------------------------------------------------ | ------ | - | ---------------- | - | -------------------------------------- |  | ------ | ------------------------------------------------ |  | ------ | ---------------- |  | -------------------------------------- | ----- |  | ------------------------------------------------ | - |  | ------ | -
|                         |  | At June 30,            |      
|                         |  | 2005                   |       |                                         | 2004   |   |                                                  | 2003   |  
|                         |  | Allowance Amount       |       | Percent of Allowance to Total Allowance |        |   | Percent of Loans in Each Category to Total Loans |        |   | Allowance Amount |   | Percent of Allowance to TotalAllowance |  |        | Percent of Loans in Each Category to Total Loans |  |        | Allowance Amount |  | Percent of Allowance to TotalAllowance |       |  | Percent of Loans in Each Category to Total Loans |  
|                         |  | (Dollars in thousands) |      
|Mortgage Loans:          |  |                        |       |                                         |        |   |                                                  |        |   |                  |   |                                        |  |        |                                                  |  |        |                  |  |                                        |       |  |                                                  |   |  |        |  
|One-to four family       |  | $                      | 685   |                                         | 49.46  | % |                                                  | 52.70  | % |                  | $ | 651                                    |  | 52.29  | %                                                |  | 52.14  | %                |  | $                                      | 646   |  | 58.15                                            | % |  | 56.30  | %
|Multi-family             |  |                        | 24    |                                         | 1.73   | % |                                                  | 2.28   | % |                  |   | 20                                     |  | 1.61   | %                                                |  | 3.15   | %                |  |                                        | 20    |  | 1.80                                             | % |  | 3.95   | %
|Non-residential and land |  |                        | 148   |                                         | 10.69  | % |                                                  | 24.24  | % |                  |   | 93                                     |  | 7.47   | %                                                |  | 23.60  | %                |  |                                        | 80    |  | 7.20                                             | % |  | 17.03  | %
|Construction             |  |                        | 78    |                                         | 5.63   | % |                                                  | 6.24   | % |                  |   | 45                                     |  | 3.61   | %                                                |  | 7.82   | %                |  |                                        | 25    |  | 2.25                                             | % |  | 5.95   | %
|Other:                   |  |                        |       |                                         |        |   |                                                  |        |   |                  |   |                                        |  |        |                                                  |  |        |                  |  |                                        |       |  |                                                  |   |  |        |  
|Consumer                 |  |                        | 170   |                                         | 12.27  | % |                                                  | 5.80   | % |                  |   | 160                                    |  | 12.85  | %                                                |  | 6.34   | %                |  |                                        | 150   |  | 13.50                                            | % |  | 9.64   | %
|Commercial               |  |                        | 280   |                                         | 20.22  | % |                                                  | 8.74   | % |                  |   | 276                                    |  | 22.17  | %                                                |  | 6.95   | %                |  |                                        | 190   |  | 17.10                                            | % |  | 7.13   | %
|                         |  |                        |       |                                         |        |   |                                                  |        |   |                  |   |                                        |  |        |                                                  |  |        |                  |  |                                        |       |  |                                                  |   |  |        |  
|Total                    |  | $                      | 1,385 |                                         | 100.00 | % |                                                  | 100.00 | % |                  | $ | 1,245                                  |  | 100.00 | %                                                |  | 100.00 | %                |  | $                                      | 1,111 |  | 100.00                                           | % |  | 100.00 | %
|                         |  |                        |       |                                         |        |   |                                                  |        |   |                  |   |                                        |  |        |                                                  |  |        |                  |  |                                        |       |  |                                                  |   |  |        |  



|                         |  |                        |       |                                         |        |   |                                               |        |   |                 |   |                                       |  |        |                                               |  |        |  
|------------------------ |  | ---------------------- | ----- | --------------------------------------- | ------ | - | --------------------------------------------- | ------ | - | --------------- | - | ------------------------------------- |  | ------ | --------------------------------------------- |  | ------ | -
|                         | 
|                         |  | At June 30,            |      
|                         |  | 2002                   |       |                                         | 2001   |  
|                         |  | AllowanceAmount        |       | Percent of Allowance to Total Allowance |        |   | Percent ofLoans inEachCategory to Total Loans |        |   | AllowanceAmount |   | Percent ofAllowance to TotalAllowance |  |        | Percent ofLoans inEachCategory to Total Loans | 
|                         |  | (Dollars in thousands) |      
|Mortgage Loans:          |  |                        |       |                                         |        |   |                                               |        |   |                 |   |                                       |  |        |                                               |  |        |  
|One-to four family       |  | $                      | 606   |                                         | 53.58  | % |                                               | 55.92  | % |                 | $ | 572                                   |  | 55.96  | %                                             |  | 60.47  | %
|Multi-family             |  |                        | 20    |                                         | 1.77   | % |                                               | 4.23   | % |                 |   | 15                                    |  | 1.47   | %                                             |  | 2.67   | %
|Non-residential and land |  |                        | 75    |                                         | 6.63   | % |                                               | 16.03  | % |                 |   | 61                                    |  | 5.97   | %                                             |  | 12.68  | %
|Construction             |  |                        | 25    |                                         | 2.21   | % |                                               | 7.11   | % |                 |   | 15                                    |  | 1.47   | %                                             |  | 4.07   | %
|Other:                   |  |                        |       |                                         |        |   |                                               |        |   |                 |   |                                       |  |        |                                               |  |        |  
|Consumer                 |  |                        | 310   |                                         | 27.41  | % |                                               | 9.29   | % |                 |   | 284                                   |  | 27.79  | %                                             |  | 10.69  | %
|Commercial               |  |                        | 95    |                                         | 8.40   | % |                                               | 7.42   | % |                 |   | 75                                    |  | 7.34   | %                                             |  | 9.42   | %
|                         |  |                        |       |                                         |        |   |                                               |        |   |                 |   |                                       |  |        |                                               |  |        |  
|Total                    |  | $                      | 1,131 |                                         | 100.00 | % |                                               | 100.00 | % |                 | $ | 1,022                                 |  | 100.00 | %                                             |  | 100.00 | %
|                         |  |                        |       |                                         |        |   |                                               |        |   |                 |   |                                       |  |        |                                               |  |        |  





- 11 -



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##### Table of Contents

Investment Activities



The Banks investment policy permits it to invest in U.S. government obligations, certain securities of various government-sponsored agencies and
municipal obligations, including mortgage-backed securities issued/guaranteed by FNMA, FHLMC and GNMA, certificates of deposit of insured banks, federal funds and mutual funds. At June 30, 2005, the Company held $5.8 million in investment
securities.



The following table sets forth activity in the
Companys investment securities portfolio for the periods indicated:



|                                                   |  |                            |       |   |      |   |        |      |  |   |        |  
|-------------------------------------------------- |  | -------------------------- | ----- | - | ---- | - | ------ | ---- |  | - | ------ | -
|                                                   |  | For the Year Ended June 30 |      
|                                                   |  | 2005                       |       |   | 2004 |   |        | 2003 | 
|                                                   |  | (In thousands)             |      
|Amortized cost at beginning of period              |  | $                          | 6,484 |   |      | $ | 8,658  |      |  | $ | 11,359 |  
|Proceeds, net                                      |  |                            | (227  | ) |      |   | (907   | )    |  |   | (1,782 | )
|Principal payments from mortgage backed securities |  |                            | (556  | ) |      |   | (1,221 | )    |  |   | (913   | )
|Premium and discount amortization, net             |  |                            | (17   | ) |      |   | (46    | )    |  |   | (13    | )
|                                                   |  |                            |       |   |      |   |        |      |  |   |        |  
|Amortized cost at end of period                    |  |                            | 5,684 |   |      |   | 6,484  |      |  |   | 8,658  |  
|Net unrealized gain (1)                            |  |                            | 66    |   |      |   | 17     |      |  |   | 96     |  
|                                                   |  |                            |       |   |      |   |        |      |  |   |        |  
|Total securities, net                              |  | $                          | 5,750 |   |      | $ | 6,501  |      |  | $ | 8,754  |  
|                                                   |  |                            |       |   |      |   |        |      |  |   |        |  

---

|(1) | The net unrealized gain at June 30, 2005, 2004 and 2003 relates to available for sale securities in accordance with Statement of Financial Accounting Standards (SFAS)
No. 115. The net unrealized gain is presented in order to reconcile the Amortized Cost of the Companys securities portfolio to the Carrying Cost, as reflected in the Statements of Financial Condition.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



The following table sets forth the amortized
cost and fair value of the Companys securities at the dates indicated.



|                            |  |                |       |            |   |               |  |           |       |               |   |           |  |   |       |  |   |      
|--------------------------- |  | -------------- | ----- | ---------- | - | ------------- |  | --------- | ----- | ------------- | - | --------- |  | - | ----- |  | - | -----
|                            |  | At June 30,   
|                            |  | 2005           |       | 2004       |   | 2003         
|                            |  | AmortizedCost  |       | Fair Value |   | AmortizedCost |  | FairValue |       | AmortizedCost |   | FairValue
|                            |  | (In thousands)
|Mortgage-backed securities: |  |                |       |            |   |               |  |           |       |               |   |           |  |   |       |  |   |      
|Fannie Mae and GNMA         |  | $              | 1,137 |            | $ | 1,149         |  | $         | 1,711 |               | $ | 1,706     |  | $ | 2,979 |  | $ | 3,002
|                            |  |                |       |            |   |               |  |           |       |               |   |           |  |   |       |  |   |      
|Other debt securities:      |  |                |       |            |   |               |  |           |       |               |   |           |  |   |       |  |   |      
|U.S. Treasury and Agency    |  |                | 1,400 |            |   | 1,391         |  |           | 1,400 |               |   | 1,400     |  |   | 3,335 |  |   | 3,370
|Other                       |  |                | 287   |            |   | 304           |  |           | 286   |               |   | 300       |  |   | 286   |  |   | 308  
|                            |  |                |       |            |   |               |  |           |       |               |   |           |  |   |       |  |   |      
|Total debt securities       |  |                | 1,687 |            |   | 1,695         |  |           | 1,686 |               |   | 1,700     |  |   | 3,621 |  |   | 3,678
|                            |  |                |       |            |   |               |  |           |       |               |   |           |  |   |       |  |   |      
|Equity securities(1)        |  |                | 1,001 |            |   | 1,047         |  |           | 1,001 |               |   | 1,009     |  |   | 1,001 |  |   | 1,017
|FHLB Stock                  |  |                | 1,705 |            |   | 1,705         |  |           | 1,657 |               |   | 1,657     |  |   | 1,057 |  |   | 1,057
|Certificates of Deposit     |  |                | 154   |            |   | 154           |  |           | 429   |               |   | 429       |  |   |      |  |   |     
|Net unrealized gain (2)     |  |                | 66    |            |   |              |  |           | 17    |               |   |          |  |   | 96    |  |   |     
|                            |  |                |       |            |   |               |  |           |       |               |   |           |  |   |       |  |   |      
|Total securities, net       |  | $              | 5,750 |            | $ | 5,750         |  | $         | 6,501 |               | $ | 6,501     |  | $ | 8,754 |  | $ | 8,754
|                            |  |                |       |            |   |               |  |           |       |               |   |           |  |   |       |  |   |      

---

|(1) | Equity securities consist of FHLMC common stock and mutual fund securities.
|--- | ---------------------------------------------------------------------------

|(2) | The net unrealized gain at June 30, 2005, 2004 and 2003 relates to available for sale securities in accordance with SFAS No. 115. The net unrealized gain is presented in order to
reconcile the Amortized Cost of the Companys securities portfolio in the Carrying Cost, as reflected in the Statements of Financial Condition.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



- 12 -



---

##### Table of Contents

The following table sets forth the amortized cost and fair value of the Companys securities, by
accounting classification and by type of security, at the dates indicated.



|                           |  |                |       |           |   |               |  |           |       |               |   |           |  |   |       |  |   |      
|-------------------------- |  | -------------- | ----- | --------- | - | ------------- |  | --------- | ----- | ------------- | - | --------- |  | - | ----- |  | - | -----
|                           |  | At June 30,   
|                           |  | 2005           |       | 2004      |   | 2003         
|                           |  | AmortizedCost  |       | FairValue |   | AmortizedCost |  | FairValue |       | AmortizedCost |   | FairValue
|                           |  | (In thousands)
|Held-to-Maturity           |  |                |       |           |   |               |  |           |       |               |   |           |  |   |       |  |   |      
|Other debt securities      |  | $              |      |           | $ |              |  | $         | 100   |               | $ | 100       |  | $ | 100   |  | $ | 100  
|Certificates of deposit    |  |                | 154   |           |   | 154           |  |           | 429   |               |   | 429       |  |   |      |  |   |     
|                           |  |                |       |           |   |               |  |           |       |               |   |           |  |   |       |  |   |      
|Total held-to-maturity     |  |                | 154   |           |   | 154           |  |           | 529   |               |   | 519       |  |   | 100   |  |   | 100  
|                           |  |                |       |           |   |               |  |           |       |               |   |           |  |   |       |  |   |      
|Available-for-Sale:        |  |                |       |           |   |               |  |           |       |               |   |           |  |   |       |  |   |      
|Mortgage-backed securities |  |                | 1,137 |           |   | 1,149         |  |           | 1,711 |               |   | 1,706     |  |   | 2,979 |  |   | 3,002
|Other debt securities      |  |                | 1,687 |           |   | 1,695         |  |           | 1,586 |               |   | 1,600     |  |   | 3,521 |  |   | 3,578
|Equity securities:         |  |                | 1,001 |           |   | 1,047         |  |           | 1,001 |               |   | 1,009     |  |   | 1,001 |  |   | 1,017
|Net unrealized gain (1)    |  |                | 66    |           |   |              |  |           | 17    |               |   |          |  |   | 96    |  |   |     
|                           |  |                |       |           |   |               |  |           |       |               |   |           |  |   |       |  |   |      
|Total available-for-sale   |  |                | 3,891 |           |   | 3,891         |  |           | 4,315 |               |   | 4,315     |  |   | 7,597 |  |   | 7,597
|                           |  |                |       |           |   |               |  |           |       |               |   |           |  |   |       |  |   |      
|FHLB Stock                 |  |                | 1,705 |           |   | 1,705         |  |           | 1,657 |               |   | 1,657     |  |   | 1,057 |  |   | 1,057
|                           |  |                |       |           |   |               |  |           |       |               |   |           |  |   |       |  |   |      
|Total securities, net      |  | $              | 5,750 |           | $ | 5,750         |  | $         | 6,501 |               | $ | 6,501     |  | $ | 8,754 |  | $ | 8,754
|                           |  |                |       |           |   |               |  |           |       |               |   |           |  |   |       |  |   |      

---

|(1) | The net unrealized gains at June 30, 2005, 2004 and 2003 relate to available for sale securities in accordance with SFAS No. 115. The net unrealized gain is presented in order to
reconcile the Amortized Cost of the Companys securities portfolio to the Carrying Cost, as reflected in the Statements of Financial Condition.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------





- 13 -



---

##### Table of Contents

The following table sets forth certain information regarding the amortized cost, fair value and weighted
average yield of the Companys investment securities at June 30, 2005, by remaining period to contractual maturity. With respect to mortgage-backed securities, the entire amount is reflected in the maturity period that includes the final
security payment date and, accordingly, no effect has been given to periodic repayments or possible prepayments. The weighted average yields on investments available-for-sale are based on amortized cost.



|                                      |  |                        |     |            |                    |                      |  |      |               |  |           |       |                      |   |       |  |      |  
|------------------------------------- |  | ---------------------- | --- | ---------- | ------------------ | -------------------- |  | ---- | ------------- |  | --------- | ----- | -------------------- | - | ----- |  | ---- | -
|                                      |  | At June 30, 2005       |    
|                                      |  | Held-to-Maturity       |     |            | Available-for-Sale |                     
|                                      |  | AmortizedCost          |     | Fair Value |                    | WeightedAverageYield |  |      | AmortizedCost |  | FairValue |       | WeightedAverageYield |  
|                                      |  | (Dollars in thousands) |    
|Debt Securities                       |  |                        |     |            |                    |                      |  |      |               |  |           |       |                      |   |       |  |      |  
|Mortgaged-backed securities:          |  |                        |     |            |                    |                      |  |      |               |  |           |       |                      |   |       |  |      |  
|Due within 1 year                     |  | $                      |    |            | $                  |                     |  |     | %             |  | $         |      |                      | $ |      |  |     | %
|Due after 1 year but within 5 years   |  |                        |    |            |                    |                     |  |     |               |  |           |      |                      |   |      |  |     |  
|Due after 5 years but within 10 years |  |                        |    |            |                    |                     |  |     |               |  |           | 394   |                      |   | 393   |  | 4.80 |  
|Due after 10 years                    |  |                        |    |            |                    |                     |  |     |               |  |           | 743   |                      |   | 756   |  | 4.59 |  
|                                      |  |                        |     |            |                    |                      |  |      |               |  |           |       |                      |   |       |  |      |  
|Total                                 |  |                        |    |            |                    |                     |  |     |               |  |           | 1,137 |                      |   | 1,149 |  | 4.66 |  
|                                      |  |                        |     |            |                    |                      |  |      |               |  |           |       |                      |   |       |  |      |  
|U.S. Treasury and Agency:             |  |                        |     |            |                    |                      |  |      |               |  |           |       |                      |   |       |  |      |  
|Due within 1 year                     |  |                        |    |            |                    |                     |  |     |               |  |           |      |                      |   |      |  |     |  
|Due after 1 year but within 5 years   |  |                        |    |            |                    |                     |  |     |               |  |           | 800   |                      |   | 794   |  | 3.25 |  
|Due after 5 years but within 10 years |  |                        |    |            |                    |                     |  |     |               |  |           | 600   |                      |   | 597   |  | 3.50 |  
|Due after 10 years                    |  |                        |    |            |                    |                     |  |     |               |  |           |      |                      |   |      |  |     |  
|                                      |  |                        |     |            |                    |                      |  |      |               |  |           |       |                      |   |       |  |      |  
|Total                                 |  |                        |    |            |                    |                     |  |     |               |  |           | 1,400 |                      |   | 1,391 |  | 3.36 |  
|                                      |  |                        |     |            |                    |                      |  |      |               |  |           |       |                      |   |       |  |      |  
|Corporate & Other:                    |  |                        |     |            |                    |                      |  |      |               |  |           |       |                      |   |       |  |      |  
|Due within 1 year                     |  |                        |    |            |                    |                     |  |     |               |  |           |      |                      |   |      |  |     |  
|Due after 1 year but within 5 years   |  |                        |    |            |                    |                     |  |     |               |  |           |      |                      |   |      |  |     |  
|Due after 5 years but within 10 years |  |                        |    |            |                    |                     |  |     |               |  |           |      |                      |   |      |  |     |  
|Due after 10 years                    |  |                        |    |            |                    |                     |  |     |               |  |           | 287   |                      |   | 304   |  | 4.81 |  
|                                      |  |                        |     |            |                    |                      |  |      |               |  |           |       |                      |   |       |  |      |  
|Total                                 |  |                        |    |            |                    |                     |  |     |               |  |           | 287   |                      |   | 304   |  | 4.81 |  
|                                      |  |                        |     |            |                    |                      |  |      |               |  |           |       |                      |   |       |  |      |  
|Equity Securities:                    |  |                        |    |            |                    |                     |  |     |               |  |           | 1,001 |                      |   | 1,047 |  |     |  
|                                      |  |                        |     |            |                    |                      |  |      |               |  |           |       |                      |   |       |  |      |  
|Certificates of Deposit:              |  |                        |     |            |                    |                      |  |      |               |  |           |       |                      |   |       |  |      |  
|Due within 1 year                     |  |                        | 154 |            |                    | 154                  |  | 2.75 |               |  |           |      |                      |   |      |  |     |  
|Due after 1 year but within 5 years   |  |                        |    |            |                    |                     |  |     |               |  |           |      |                      |   |      |  |     |  
|Due after 5 years but within 10 years |  |                        |    |            |                    |                     |  |     |               |  |           |      |                      |   |      |  |     |  
|Due after 10 years                    |  |                        |    |            |                    |                     |  |     |               |  |           |      |                      |   |      |  |     |  
|                                      |  |                        |     |            |                    |                      |  |      |               |  |           |       |                      |   |       |  |      |  
|Total                                 |  |                        | 154 |            |                    | 154                  |  | 2.75 |               |  |           |      |                      |   |      |  |     |  
|                                      |  |                        |     |            |                    |                      |  |      |               |  |           |       |                      |   |       |  |      |  
|Total:                                |  |                        |     |            |                    |                      |  |      |               |  |           |       |                      |   |       |  |      |  
|Due within 1 year                     |  |                        | 154 |            |                    | 154                  |  | 2.75 |               |  |           |      |                      |   |      |  |     |  
|Due after 1 year but within 5 years   |  |                        |    |            |                    |                     |  |     |               |  |           | 800   |                      |   | 794   |  | 3.25 |  
|Due after 5 years but within 10 years |  |                        |    |            |                    |                     |  |     |               |  |           | 994   |                      |   | 990   |  | 4.02 |  
|Due after 10 years                    |  |                        |    |            |                    |                     |  |     |               |  |           | 1,030 |                      |   | 1,060 |  | 4.65 |  
|Equity Securities                     |  |                        |    |            |                    |                     |  |     |               |  |           | 1,001 |                      |   | 1,047 |  |     |  
|                                      |  |                        |     |            |                    |                      |  |      |               |  |           |       |                      |   |       |  |      |  
|Total                                 |  | $                      | 154 |            | $                  | 154                  |  | 2.75 | %             |  | $         | 3,825 |                      | $ | 3,891 |  | 4.03 | %
|                                      |  |                        |     |            |                    |                      |  |      |               |  |           |       |                      |   |       |  |      |  







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##### Table of Contents

Sources of Funds



General. Deposits, loan and security repayments and prepayments, proceeds of refinanced loans sold to FNMA and cash flows generated from operations
are the primary sources of the Banks funds for use in lending and for other general purposes.



Deposits. The Bank offers a variety of deposit accounts with a range of interest rates and terms. The Banks deposits consist of savings
accounts, checking accounts, money market deposit accounts, IRAs and certificates of deposit. At June 30, 2005, the Banks core deposits (which the Bank considers to consist of checking accounts and savings accounts) constituted 50.3% of total
deposits. The flow of deposits is influenced significantly by general economic conditions, changes in money market rates, prevailing interest rates and competition. The Banks deposits are obtained predominantly from Ashe, Alleghany and Watauga
counties. The Bank relies primarily on customer service and long-standing relationships with customers to attract and retain these deposits; however, market interest rates and rates offered by competing financial institutions significantly affect
the Banks ability to attract and retain deposits.



The
following table presents the deposit activity of the Bank for the periods indicated.



|                                                                  |  |                             |         |      |   |         |  |   |        
|----------------------------------------------------------------- |  | --------------------------- | ------- | ---- | - | ------- |  | - | -------
|                                                                  |  | For the Year Ended June 30,
|                                                                  |  | 2005                        |         | 2004 |   | 2003   
|                                                                  |  | (In thousands)             
|Total deposits at beginning of period, including accrued interest |  | $                           | 157,434 |      | $ | 149,571 |  | $ | 136,769
|Net increase before interest credited                             |  |                             | 3,668   |      |   | 5,156   |  |   | 9,510  
|Interest credited                                                 |  |                             | 2,875   |      |   | 2,707   |  |   | 3,292  
|                                                                  |  |                             |         |      |   |         |  |   |        
|Total deposits at end of period                                   |  | $                           | 163,977 |      | $ | 157,434 |  | $ | 149,571
|                                                                  |  |                             |         |      |   |         |  |   |        



At June 30, 2005, the
Bank had approximately $23.5 million in jumbo certificates of deposit (accounts in amounts over $100,000) maturing as follows:



|                                  |  |                |        |                       |      |  
|--------------------------------- |  | -------------- | ------ | --------------------- | ---- | -
|                                  |  | Amount         |        | Weighted Average Rate |     
|                                  |  | (In thousands) |       
|Maturity Period                   |  |                |        |                       |      |  
|Within three months               |  | $              | 6,240  |                       | 3.79 | %
|After three but within six months |  |                | 5,478  |                       | 2.97 | %
|After six but within 12 months    |  |                | 4,497  |                       | 3.06 | %
|After 12 months                   |  |                | 7,279  |                       | 3.84 | %
|                                  |  |                |        |                       |      |  
|Total                             |  | $              | 23,494 |                       | 3.48 | %
|                                  |  |                |        |                       |      |  





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##### Table of Contents

The following table sets forth the distribution of the Banks deposit accounts and the related
weighted average interest rates at the dates indicated.



|                                      |  |             |                        |                          |        |   |                     |      |   |        |   |                         |  |        |                     |  |      |        |  |                         |         |  |                     |   |  |      |  
|------------------------------------- |  | ----------- | ---------------------- | ------------------------ | ------ | - | ------------------- | ---- | - | ------ | - | ----------------------- |  | ------ | ------------------- |  | ---- | ------ |  | ----------------------- | ------- |  | ------------------- | - |  | ---- | -
|                                      |  | At June 30, |                       
|                                      |  | 2005        |                        |                          | 2004   |   |                     | 2003 |  
|                                      |  | Amount      |                        | Percent of TotalDeposits |        |   | WeightedAverageRate |      |   | Amount |   | Percent ofTotalDeposits |  |        | WeightedAverageRate |  |      | Amount |  | Percent ofTotalDeposits |         |  | WeightedAverageRate |  
|                                      |  |             | (Dollars in thousands) |                         
|Noninterest bearing checking accounts |  | $           | 18,007                 |                          | 10.98  | % |                     | 0.00 | % |        | $ | 13,793                  |  | 8.76   | %                   |  | 0.00 | %      |  | $                       | 12,772  |  | 8.54                | % |  | 0.00 | %
|Interest bearing checking accounts    |  |             | 23,771                 |                          | 14.50  | % |                     | 0.65 | % |        |   | 22,724                  |  | 14.43  | %                   |  | 0.49 | %      |  |                         | 18,893  |  | 12.63               | % |  | 0.59 | %
|Money Market accounts                 |  |             | 1,017                  |                          | 0.62   | % |                     | 0.49 | % |        |   | 1,646                   |  | 1.05   | %                   |  | 0.48 | %      |  |                         | 1,305   |  | 0.87                | % |  | 0.82 | %
|Savings                               |  |             | 39,499                 |                          | 24.08  | % |                     | 1.43 | % |        |   | 42,495                  |  | 26.99  | %                   |  | 1.12 | %      |  |                         | 43,474  |  | 29.07               | % |  | 1.64 | %
|Certificates of deposit               |  |             | 81,427                 |                          | 49.66  | % |                     | 3.05 | % |        |   | 76,436                  |  | 48.55  | %                   |  | 2.55 | %      |  |                         | 72,782  |  | 48.66               | % |  | 3.13 | %
|Accrued interest                      |  |             | 256                    |                          | 0.16   | % |                     | 0.00 | % |        |   | 340                     |  | 0.22   | %                   |  | 0.00 | %      |  |                         | 345     |  | 0.23                | % |  | 0.00 | %
|                                      |  |             |                        |                          |        |   |                     |      |   |        |   |                         |  |        |                     |  |      |        |  |                         |         |  |                     |   |  |      |  
|Totals                                |  | $           | 163,977                |                          | 100.00 | % |                     | 1.95 | % |        | $ | 157,434                 |  | 100.00 | %                   |  | 1.62 | %      |  | $                       | 149,571 |  | 100.00              | % |  | 2.09 | %
|                                      |  |             |                        |                          |        |   |                     |      |   |        |   |                         |  |        |                     |  |      |        |  |                         |         |  |                     |   |  |      |  



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##### Table of Contents

The following table presents, by interest rate ranges and the period to maturity, the amount of
certificate of deposit accounts outstanding at June 30, 2005.



|                    |  |                                     |        |                    |   |                     |  |       |       |  |   |       
|------------------- |  | ----------------------------------- | ------ | ------------------ | - | ------------------- |  | ----- | ----- |  | - | ------
|                    |  | Period to Maturity at June 30, 2005
|Interest Rate Range |  | Less than One Year                  |        | One to Three years |   | Four Yearsand After |  | Total
|                    |  | (In thousands)                     
|0.40% to 5.99%      |  | $                                   | 56,939 |                    | $ | 20,236              |  | $     | 2,653 |  | $ | 79,828
|6.00% to 7.50%      |  |                                     | 1,599  |                    |   |                    |  |       |      |  |   | 1,599 
|                    |  |                                     |        |                    |   |                     |  |       |       |  |   |       
|Total               |  | $                                   | 58,538 |                    | $ | 20,236              |  | $     | 2,653 |  | $ | 81,427
|                    |  |                                     |        |                    |   |                     |  |       |       |  |   |       



In addition to
traditional savings deposits, AF Bank has an agreement with Promontory Interfinancial Network which allows us to provide FDIC insurance coverage beyond the normal limits by using its network. The agreement allows us to maintain large deposit
relationships when the customer desires FDIC coverage on all deposit balances. As of June 30, 2005, we had $2.3 million placed in the Promontory Interfinancial Network.



Borrowings. The Bank may obtain advances from the FHLB as an alternative to retail deposit funds and may do so in the
future as part of its operating strategy. These advances would be collateralized primarily by certain of the Banks mortgage loans and secondarily by the Banks investment in capital stock of the FHLB. See RegulationRegulation
of Federal Savings BanksFederal Home Loan Bank System. Such advances may be made pursuant to several different credit programs, each of which has its own interest rate and range of maturities. The maximum amount that the FHLB will
advance to member institutions, including the Bank, fluctuates from time to time in accordance with the policies of the OTS and the FHLB. The Bank had advances of $28.1 million at June 30, 2005 from the FHLB. Interest is payable at rates ranging
from 2.51% to 6.87%. These advances are listed on the balance sheet as either short-term or long-term borrowings depending on the remaining maturity of the advance as of the balance sheet date. FHLB advances consist of the following:



|                                                             |  |             |  |             |  |            
|------------------------------------------------------------ |  | ----------- |  | ----------- |  | -----------
|                                                             |  | 2005        |  | 2004        |  | 2003       
|Balance outstanding                                          |  | $28,141,664 |  | $33,143,754 |  | $21,145,669
|Interest rate range                                          |  | 2.51%-6.87% |  | 1.03%-6.87% |  | 3.50%-6.87%
|Weighted average interest rate at June 30                    |  | 4.50%       |  | 3.76%       |  | 5.00%      
|Maximum amount outstanding at any month end                  |  | 42,143,248  |  | 33,143,754  |  | 25,146,999 
|Average amount outstanding                                   |  | 35,059,129  |  | 23,345,330  |  | 21,440,089 
|Interest expense                                             |  | 1,367,744   |  | 1,129,778   |  | 1,053,315  
|Weighted average interest rate during the year ended June 30 |  | 3.88%       |  | 4.53%       |  | 4.90%      



The Company may also
obtain additional borrowings from other financial institutions or related parties to fund cash flow needs or to provide additional capital. The borrowings are listed on the balance sheet as either short-term or long-term borrowings depending on the
remaining maturity of the advance as of the balance sheet date.



Short-term and long-term borrowings are due in future years as follows:



|                     |  |        |            
|-------------------- |  | ------ | -----------
|Year ending June 30, |  | Amount
|2006                 |  | $      | 2,727,940  
|2007                 |  |        | 282,041    
|2008                 |  |        | 143,462    
|2009                 |  |        | 2,151,554  
|2010                 |  |        | 78,954     
|Thereafter           |  |        | 29,155,000 
|                     |  |        |            
|                     |  |        | $34,538,951
|                     |  |        |            





In addition, the Bank has a $1.5 million letter of credit from the FHLB used to collateralize public deposits.



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##### Table of Contents

Subsidiary Activities



AF Insurance Services, Inc., a wholly owned subsidiary of the Company, was formed in July 1997 upon the purchase of two independent insurance agencies for
the sole purpose of selling traditional property and casualty, life and health insurance. During the fiscal years ended June 30, 1999, 2000, 2001, 2002 and 2004, AF Insurance Services, Inc. purchased additional insurance agencies. AF Insurance
Services, Inc. offers these services in a segregated location at the Companys offices and branch locations in, Boone, Sparta, Lenoir, Jefferson, North Wilkesboro, West Jefferson and Elkin, North Carolina. The operating results of AF Insurance
Services, Inc. are not material to the operating results of the Company.



On July 16, 2001, AF Capital Trust I, a Delaware business trust, was formed by the Company and completed the sale of $5.0 million of 10.25% Capital Securities (liquidation amount of $1,000 per security) in a private
placement as part of a pooled capital securities transaction. The Trust also issued common securities to the Company and used the net proceeds from the offering to purchase a like amount of 10.25% Junior Subordinated Deferrable Interest Debentures
(the Subordinated Debentures) of the Company.





Personnel



As of June 30, 2005, the Company had 120 full-time employees. The employees are not represented by a collective bargaining unit and the Company considers
its relationship with its employees to be good. See Executive Compensation for a description of certain compensation and benefit programs offered to the Companys employees.



REGULATION



General



The Company and AsheCo, MHC, the mutual holding company (MHC) that owns 51.27% of the Companys common
stock, are regulated as savings and loan holding companies by the OTS. The Bank, as a federal stock savings bank, is subject to regulation, examination and supervision by the OTS. The Bank must file reports with the OTS concerning its activities and
financial condition. The Company and the MHC are also required to file reports with, and otherwise comply with the rules and regulations of the OTS. The Company is also required to file reports with, and otherwise comply with, the rules and
regulations of the SEC under the federal securities laws.



Federal Banking
Regulation



Activity Powers. The Bank derives its
lending and investment powers from the Home Owners Loan Act (HOLA), as amended, and the regulations of the OTS. Under these laws and regulations, the Bank may invest in mortgage loans secured by residential and commercial real
estate; commercial and consumer loans; certain types of debt securities; and certain other assets. The Bank may also establish service corporations that may engage in activities not otherwise permissible for the Bank, including certain real estate
equity investments and securities and insurance brokerage. The Banks authority to invest in certain types of loans or other investments is limited by federal law.



Loans-to-One-Borrower Limitations. The Bank is generally subject to the same limits on loans to one borrower as a
national bank. With specified exceptions, the Banks total loans or extensions of credit to a single borrower cannot exceed 15% of the Banks unimpaired capital and surplus which does not include accumulated other comprehensive income. The
Bank may lend additional amounts up to 10% of its unimpaired capital and surplus, if the loans or extensions of credit are fully-secured by readily-marketable collateral. The Bank currently complies with applicable loans-to-one-borrower limitations.



QTL Test. Under federal law, the Bank must comply with
the qualified thrift lender, or QTL test. Under the QTL test, the Bank is required to maintain at least 65% of its portfolio assets in certain qualified thrift investments in at least nine months of the most
recent 12-month period. Portfolio assets means, in general, the Banks total assets less the sum of:



| |  |  | specified liquid assets up to 20% of total assets;
| | - |  | --------------------------------------------------



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##### Table of Contents

| |  |  | goodwill and other intangible assets; and
| | - |  | -----------------------------------------

| |  |  | the value of property used to conduct the Banks business.
| | - |  | ----------------------------------------------------------



The Bank may also satisfy the QTL test by qualifying as a domestic building and loan association as defined in the Internal Revenue Code of
1986. The Bank met the QTL test at June 30, 2005, and in each of the prior 12 months, and, therefore, qualifies as a thrift lender. For purposes of calculating compliance with the QTL test, we use the cost basis of our investment in our FHLMC common
stock, rather than the current market value of the stock.



If
the Bank fails the QTL test it must either operate under certain restrictions on its activities or convert to a bank charter.



Capital Requirements. OTS regulations require the Bank to meet three minimum capital standards:



(1) a tangible capital ratio requirement of 1.5% of total assets, as
adjusted under the OTS regulations;



(2) a leverage ratio
requirement of 3% of core capital to such adjusted total assets, if a savings association has been assigned the highest composite rating of 1 under the Uniform Financial Institutions Ratings System; and



(3) a risk-based capital ratio requirement of 8% of core and supplementary
capital to total risk- weighted assets.



The minimum leverage
capital ratio for any other depository institution that does not have a composite rating of 1 will be 4%, unless a higher leverage capital ratio is warranted by the particular circumstances or risk profile of the depository institution. In
determining compliance with the risk-based capital requirement, the Bank must compute its risk-weighted assets by multiplying its assets and certain off-balance sheet items by risk-weights, which range from 0% for cash and obligations issued by the
United States Government or its agencies to 100% for consumer and commercial loans, as assigned by the OTS capital regulation based on the risks that the OTS believes are inherent in the type of asset.



Tangible capital is defined, generally, as common stockholders equity
(including retained earnings), certain non-cumulative perpetual preferred stock and related earnings and minority interests in equity accounts of fully consolidated subsidiaries, less intangibles (other than certain mortgage servicing rights) and
investments in and loans to subsidiaries engaged in activities not permissible for a national bank. Core capital is defined similarly to tangible capital, but core capital also includes certain qualifying supervisory goodwill and certain purchased
credit card relationships. Supplementary capital currently includes cumulative and other perpetual preferred stock, mandatory convertible securities, subordinated debt and intermediate preferred stock and the allowance for loan and lease losses, as
defined. In addition, up to 45% of unrealized gains on available-for-sale equity securities with a readily determinable fair value may be included in tier 2 capital. The allowance for loan and lease losses, as defined, is includable in tier 2
capital to a maximum of 1.25% of risk-weighted assets, and the amount of supplementary capital that may be included as total capital cannot exceed the amount of core capital. At June 30, 2005, the Bank met each of its capital requirements.



Community Reinvestment Act. Under the Community
Reinvestment Act (CRA), as implemented by OTS regulations, the Bank has a continuing and affirmative obligation to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The CRA does not
establish specific lending requirements or programs for the Bank nor does it limit its discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the CRA. The CRA requires
the OTS, in connection with its examination of the Bank, to assess the Banks record of meeting the credit needs of its community and to take the record into account in its evaluation of certain applications by the Bank. The CRA also requires
all institutions to make public disclosure of their CRA ratings. The Bank received a Satisfactory CRA rating in its most recent examination.



CRA regulations rate an institution based on its actual performance in meeting community needs. In particular, the system focuses on three tests:



| |  |  | a lending test, to evaluate the institutions record of making loans in its assessment areas;
| | - |  | ---------------------------------------------------------------------------------------------



- 19 -



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##### Table of Contents

| |  |  | an investment test, to evaluate the institutions record of investing in community development projects, affordable housing, and programs benefiting low or moderate income
individuals and businesses; and
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | a service test, to evaluate the institutions delivery of services through its branches, ATMs and other offices.
| | - |  | ----------------------------------------------------------------------------------------------------------------



Transactions with Related Parties. The Banks authority to engage
in transactions with its affiliates is limited by the OTS regulations and by Sections 23A and 23B of the Federal Reserve Act (the FRA). In general, these transactions must be on terms which are as favorable to the Bank as
comparable transactions with non-affiliates. In addition, certain types of these transactions are restricted to an aggregate percentage of the Banks capital. Collateral in specified amounts must usually be provided by affiliates in order to
receive loans from the Bank. In addition, the OTS regulations prohibit a savings association from lending to any of its affiliates that is engaged in activities that are not permissible for bank holding companies and from purchasing the securities
of any affiliate, other than a subsidiary.



Effective April 1, 2003, the FRB
rescinded its interpretations of Sections 23A and 23B of the FRA and replaced these interpretations with Regulation W (Regulation W expands the definition of what constitutes an affiliate subject to Sections 23A and 23B).



The Banks authority to extend credit to its directors, executive
officers and 10% shareholders, as well as to entities controlled by such persons, is currently governed by the requirements of Sections 22(g) and 22(h) of the FRA and Regulation O of the Federal Reserve Board. Among other things, these provisions
require that extensions of credit to insiders (a) be made on terms that are substantially the same as, and follow credit underwriting procedures that are not less stringent than, those prevailing for comparable transactions with unaffiliated persons
and that do not involve more than the normal risk of repayment or present other unfavorable features and (b) not exceed certain limitations on the amount of credit extended to such persons, individually and in the aggregate, which limits are based,
in part, on the amount of the Banks capital. The regulations allow small discounts on fees on residential mortgages for directors, officers and employees. In addition, extensions of credit in excess of certain limits must be approved by the
Banks Board of Directors.



Section 402 of the
Sarbanes-Oxley Act of 2002, (Sarbanes-Oxley) prohibits the extension of personal loans to directors and executive officers of issuers (as defined in Sarbanes-Oxley). The prohibition, however, does not apply to mortgages advanced by an
insured depository institution, such as the Bank, which are subject to the insider lending restrictions of Section 22(h) of the FRA.



Enforcement. The OTS has primary enforcement responsibility over savings associations, including the Bank. This enforcement authority includes,
among other things, the ability to assess civil money penalties, to issue cease and desist orders and to remove directors and officers. In general, these enforcement actions may be initiated in response to violations of laws and regulations and to
unsafe or unsound practices.



Standards For Safety And
Soundness. Under federal law, the OTS has adopted a set of guidelines prescribing safety and soundness standards. These guidelines establish general standards relating to internal controls, information systems, internal audit systems, loan
documentation, credit underwriting, interest rate exposure, asset growth, asset quality, earnings standards, and compensation, fees and benefits. In general, the guidelines require appropriate systems and practices to identify and manage the risks
and exposures specified in the guidelines.



In addition, the
OTS adopted regulations that authorize, but do not require, the OTS to order an institution that has been given notice that it is not satisfying these safety and soundness standards to submit a compliance plan. If, after being notified, an
institution fails to submit an acceptable plan or fails in any material respect to implement an accepted plan, the OTS must issue an order directing action to correct the deficiency and may issue an order directing corrective actions and may issue
an order directing other actions of the types to which an undercapitalized association is subject under the prompt corrective action provisions of federal law. If an institution fails to comply with such an order, the OTS may seek to
enforce such order in judicial proceedings and to impose civil money penalties.



Limitation on Capital Distributions. The OTS imposes various restrictions or requirements on the Banks ability to make capital distributions, including cash dividends. A savings institution that is the
subsidiary of a savings and loan holding company must file a notice with the OTS at least 30 days before making a capital distribution. The Bank must file an application for prior approval if the total amount of its capital distributions, including
the proposed distribution, for the applicable calendar year would exceed an amount equal to the Banks net income for that year plus the Banks retained net income for the previous two years.



- 20 -



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##### Table of Contents

The OTS may disapprove of a notice or application if:



| |  |  | the Bank would be undercapitalized following the distribution;
| | - |  | --------------------------------------------------------------



| |  |  | the proposed capital distribution raises safety and soundness concerns; or
| | - |  | --------------------------------------------------------------------------



| |  |  | the capital distribution would violate a prohibition contained in any statute, regulation or agreement.
| | - |  | -------------------------------------------------------------------------------------------------------



Liquidity. The Bank is required to maintain a sufficient amount of liquid assets to ensure its safe and sound
operation.



Prompt Corrective Action Regulations. Under
the OTS prompt corrective action regulations, the OTS is required to take certain, and is authorized to take other, supervisory actions against undercapitalized savings associations. For this purpose, a savings association would be placed in one of
the following four categories based on the associations capital:



| |  |  | well-capitalized;
| | - |  | -----------------



| |  |  | adequately capitalized;
| | - |  | -----------------------



| |  |  | undercapitalized; and
| | - |  | ---------------------



| |  |  | critically undercapitalized.
| | - |  | ----------------------------



At June 30, 2005, the Bank met the criteria for being considered well-capitalized.



When appropriate, the OTS can require corrective action by a savings
association holding company under the prompt corrective action provisions of federal law.



Insurance of Deposit Accounts. The Bank is a member of the Savings Association Insurance Fund, and the Bank pays its deposit insurance assessments
to the SAIF. The FDIC also maintains another insurance fund, the Bank Insurance Fund, which primarily insures the deposits of banks and state chartered savings banks.



Under federal law, the FDIC established a risk-based assessment system for determining the deposit insurance assessments to
be paid by insured depository institutions. Under the assessment system, the FDIC assigns an institution to one of three capital categories based on the institutions financial information as of its most recent quarterly financial report filed
with the applicable bank regulatory agency prior to commencement of the assessment period. An institutions assessment rate depends on the capital category and supervisory sub-category to which it is assigned. Under the regulation, there are
nine assessment risk classifications (i.e., combinations of capital groups and supervisory subgroups) to which different assessment rates are applied. Assessment rates currently range from 0.0% of deposits for an institution in the highest category
(i.e., well-capitalized and financially sound, with no more than a few minor weaknesses) to 0.27% of deposits for an institution in the lowest category (i.e., undercapitalized and substantial supervisory concern). The FDIC is authorized to raise the
assessment rates as necessary to maintain the required reserve ratio of 1.25%.



In addition, all FDIC insured institutions are required to pay assessments to the FDIC at an annual rate of approximately .0134% of insured deposits to fund interest payment on bonds issued by the Financing
Corporation, an agency of the federal government established to recapitalize the predecessor to the SAIF. These assessments will continue until the Financing Corporation bonds mature in 2017.



Federal Home Loan Bank System. The Bank is a member of the FHLB of
Atlanta, which is one of the regional FHLBs making up the FHLB System. Pursuant to regulations promulgated by the Federal Housing Finance Board, as required by Gramm-Leach-Bliley Act, the FHLB of Atlanta adopted a new capital plan on December 17,
2004. Under the new capital plan, each member of the FHLB of Atlanta has to maintain a minimum investment in FHLB of Atlanta stock in an amount estimated to be the sum of (i) an amount (up to a maximum of $25 million)



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##### Table of Contents

equal to approximately 0.20% of the members total assets and (ii) 4.5% of the members outstanding advances,
plus 4.5% of the outstanding assets purchased from the member and held by the FHLB under master commitments, plus 8% of any Affordable Multi-Family Participation Program loans purchased from the member. Any advances from a FHLB must be secured by
specified types of collateral, and all long-term advances may be obtained only for the purpose of providing funds for residential housing finance.



FHLBs are required to provide funds for the resolution of insolvent thrifts and to contribute funds for affordable housing programs. These requirements
could reduce the amount of earnings that the FHLBs can pay as dividends to their members and could also result in the FHLBs imposing a higher rate of interest on advances to their members. If dividends were reduced, or interest on future FHLB
advances increased, the Banks net interest income would be affected.



Prohibitions Against Tying Arrangements. Federal savings banks are subject to the prohibitions of 12 U.S.C. § 1972 on certain tying arrangements. A depository institution is prohibited, subject to some
exceptions, from extending credit to or offering any other service, or fixing or varying the consideration for such extension of credit or service, on the condition that the customer obtain some additional service from the institution or its
affiliates or not obtain services of a competitor of the institution.



Federal Reserve System



Under regulations of
the FRB, the Bank is required to maintain noninterest-earning reserves against its transaction accounts. FRB regulations generally require that reserves of 3% must be maintained against aggregate transaction accounts of $47.6 million or less,
subject to adjustment by FRB, and a reserve 10% of that portion of total transaction accounts in excess of $47.6 million. The first $7.0 million of otherwise reservable balances, subject to adjustments by FRB, are exempted from the reserve
requirements. The Bank is in compliance with these requirements. Because required reserves must be maintained in the form of either vault cash, a noninterest-bearing account at a Federal Reserve bank or a pass-through account as defined by FRB, the
effect of this reserve requirement is to reduce the Banks interest-earning assets, to the extent the requirement exceeds vault cash.



Holding Company Regulation



The Company and the MHC are savings and loan holding companies regulated by the OTS. As such, the Company and the MHC are registered with and are subject
to OTS examination and supervision, as well as certain reporting requirements. In addition, the OTS has enforcement authority over the Company and the MHC and any of their non-savings institution subsidiaries. Among other things, this authority
permits the OTS to restrict or prohibit activities that are determined to be a serious risk to the financial safety, soundness or stability of a subsidiary savings institution. Unlike bank holding companies, federal savings and loan holding
companies are not subject to any regulatory capital requirements or to supervision by the Federal Reserve System.



Restrictions Applicable to the Company. Because the Company was organized before May 4, 1999, under the GLB Act, it is grandfathered
under the GLB Act and generally has no restriction on its business activities.



Restrictions Applicable to Activities of Mutual Holding Companies. Under federal law, a mutual holding company may engage only in the following activities:



| |  |  | investing in the stock of a savings institution;
| | - |  | ------------------------------------------------



| |  |  | acquiring a mutual association through the merger of such association into a savings institution subsidiary of such holding company or an interim savings institution subsidiary of
such holding company;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | merging with or acquiring another holding company, one of whose subsidiaries is a savings institution;
| | - |  | ------------------------------------------------------------------------------------------------------



| |  |  | investing in a corporation the capital stock of which is available for purchase by a savings institution under federal law or under the law of any state where the subsidiary savings
institution or association is located; and
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the permissible activities described above for non-grandfathered savings and loan holding companies.
| | - |  | ----------------------------------------------------------------------------------------------------



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If a mutual holding company acquires or merges with another holding company, the holding company acquired
or the holding company resulting from such merger or acquisition may only invest in assets and engage in activities listed above, and it has a period of two years to cease any non-conforming activities and divest any non-conforming investments.



Restrictions Applicable to All Savings and Loan Holding
Companies. Federal law prohibits a savings and loan holding company, including the Company and the MHC, directly or indirectly, from acquiring:



| |  |  | control (as defined under HOLA) of another savings institution (or a holding company parent) without prior OTS approval;
| | - |  | ------------------------------------------------------------------------------------------------------------------------



| |  |  | through merger, consolidation, or purchase of assets, another savings institution or a holding company thereof, or acquiring all or substantially all of the assets of such
institution (or a holding company) without prior OTS approval; or
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | control of any depository institution not insured by the FDIC (except through a merger with and into the holding companys savings institution subsidiary that is approved by
the OTS).
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



A savings and loan holding company may
not acquire as a separate subsidiary an insured institution that has a principal office outside of the state where the principal office of its subsidiary institution is located, except: in the case of certain emergency acquisitions approved by the
FDIC;



| |  |  | if such holding company controls a savings institution subsidiary that operated a home or branch office in such additional state as of March 5, 1987; or
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | if the laws of the state in which the savings institution to be acquired is located specifically authorize a savings institution chartered by that state to be acquired by a savings
institution chartered by the state where the acquiring savings institution or savings and loan holding company is located or by a holding company that controls such a state chartered association.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



If the savings institution subsidiary of a federal mutual holding company
fails to meet the QTL test set forth in Section 10(m) of the HOLA and regulations of the OTS, the holding company must register with the FRB as a bank holding company under the BHC Act within one year of the savings institutions failure to so
qualify.



Federal Securities Law.Our common stock is
registered with the SEC under Section 12(g) of the Securities Exchange Act of 1934, as amended (the Exchange Act). We are subject to information, proxy solicitation, insider trading restrictions, and other requirements under the Exchange
Act.



Sarbanes-Oxley Act of 2002



On July 30, 2002, Sarbanes-Oxley was signed into law and became some
of the most sweeping federal legislation addressing accounting, corporate governance and disclosure issues. The impact of Sarbanes-Oxley is wide-ranging as it applies to all public companies and imposes significant new requirements for public
company governance and disclosure requirements. Some of the provisions of Sarbanes-Oxley became effective immediately while others are still in the process of being implemented.



In general, Sarbanes-Oxley mandates important new corporate governance and financial reporting requirements intended to
enhance the accuracy and transparency of public companies reported financial results. It establishes new responsibilities for corporate chief executive officers, chief financial officers and audit committees in the financial reporting process
and creates a new regulatory body to oversee auditors of public companies. It backs these requirements with new SEC enforcement tools, increases criminal penalties for federal mail, wire and securities fraud, and creates new criminal penalties for
document and record destruction in connection with federal investigations. It also increases the opportunity for more private litigation by lengthening the statute of limitations for securities fraud claims and providing new federal corporate
whistleblower protection.



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The economic and operational effects of this new legislation on public companies, including us, have been
and will continue to be significant in terms of the time, resources and costs associated with complying with the new law. Because Sarbanes-Oxley, for the most part, applies equally to larger and smaller public companies, we will be presented with
additional challenges as a smaller, community-oriented financial institution seeking to compete with larger financial institutions in our market.



USA Patriot Act of 2001



The USA Patriot Act of 2001 was enacted in response to the terrorist attacks that occurred in New York, Pennsylvania and Washington, D.C. on September 11,
2001. The Act is intended to strengthen the ability of U.S. law enforcement and the intelligence community to work cohesively to combat terrorism on a variety of fronts. The potential impact of the Act on financial institutions of all kinds is
significant and wide ranging. The Act contains sweeping anti-money laundering and financial transparency laws and requires various regulations, including standards for verifying customer identification at account opening, and rules to promote
cooperation among financial institutions, regulators, and law enforcement entities in identifying parties that may be involved in terrorism or money laundering.



Gramm-Leach-Bliley Act



The federal Gramm-Leach-Bliley Act enacted in 1999 (the GLB Act) dramatically changed various federal laws governing the banking, securities
and insurance industries. The GLB Act has expanded opportunities for banks and bank holding companies to provide services and engage in other revenue-generating activities that previously were prohibited to them. However, this expanded authority
also may present us with new challenges as our larger competitors are able to expand their services and products into areas that are not feasible for smaller, community oriented financial institutions. The GLB Act likely will have a significant
economic impact on the banking industry and on competitive conditions in the financial services industry generally.



FEDERAL AND STATE TAXATION



Federal Taxation



General. The following discussion is intended only as a summary and does not purport to be a comprehensive description of the tax rules applicable
to the Bank, the MHC or the Company. The Bank has not been audited by the Internal Revenue Service for the last eight years.



For federal income tax purposes, the Company reports its income on the basis of a taxable year ending June 30, using the accrual method of accounting, and
is subject to federal income taxation in the same manner as other corporations with some exceptions, including particularly the Banks tax reserve for bad debts, discussed below. The Bank, AF Insurance Services, Inc., and the Company constitute
an affiliated group of corporations and, therefore, are eligible to report their income on a consolidated basis. Because the MHC will own less than 80% of the Common Stock, it will not be a member of such affiliated group and will report its income
on a separate return.



Bad Debt Reserves. The Bank, as a
small bank (one with assets having an adjusted tax basis of $500 million or less), is permitted to maintain a reserve for bad debts with respect to qualifying loans, which, in general, are loans secured by certain interests
in real property, and to make, within specified formula limits, annual additions to the reserve which are deductible for purposes of computing the Banks taxable income. Pursuant to the Small Business Job Protection Act of 1996, the Bank is now
recapturing (taking into income) over a multi-year period a portion of the balance of its bad debt reserve as of June 30, 1996. Since the Bank has already provided a deferred tax liability equal to the amount of such recapture, the recapture will
not adversely impact the Banks financial condition or results of operations.



Distributions. To the extent that the Bank makes non-dividend distributions to shareholders, such distributions will be considered to result in distributions from the Banks base year
reserve, to the extent thereof and then from its supplemental reserve for losses on loans, and an amount based on the amount distributed will be included in the Banks taxable income. Non-dividend distributions include distributions in
excess of the Banks current and accumulated earnings and profits, distributions in redemption of stock and distributions in partial or complete liquidation. However, dividends paid out of the Banks current or accumulated earnings and
profits, as calculated for federal income tax purposes, will not constitute non-dividend distributions and, therefore, will not be included in the Banks income.



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##### Table of Contents

The amount of additional taxable income created from a non-dividend distribution is equal to the lesser
of the Banks base year reserve and supplemental reserve for losses on loans; or an amount that, when reduced by the tax attributable to the income, is equal to the amount of the distribution. Thus, in certain situations approximately one and
one-half times the non-dividend distribution would be includable in gross income for federal income tax purposes, assuming a 35% federal corporate income tax rate.



Corporate Alternative Minimum Tax. The Internal Revenue Code of 1986, as amended (the Code), imposes a
tax (AMT) on alternative minimum taxable income (AMTI) at a rate of 20%. Only 90% of AMTI can be offset by net operating loss carryovers. AMTI is also adjusted by determining the tax treatment of certain items in a manner
that negates the deferral of income resulting from the regular tax treatment of those items. Thus, the Banks AMTI is increased by an amount equal to 75% of the amount by which the Banks adjusted current earnings exceeds its AMTI
(determined without regard to this adjustment and prior to reduction for net operating losses).



Elimination of Dividends; Dividends Received Deduction. The Company may exclude from its income 100% of dividends received from the Bank as a
member of the same affiliated group of corporations. Because the

MHC is not a member of such affiliated group, it does not qualify for such
100% dividends exclusion, but will be entitled to deduct 70% of the dividends it receives from the Company so long as it owns more than 20% of the common stock.



State Taxation



Under North Carolina law, the corporate income tax is 6.9% of federal taxable income as computed under the Code, subject to certain prescribed
adjustments. An annual state franchise tax is imposed at a rate of 0.0015 applied to the greatest of the institutions (i) capital stock, surplus and undivided profits, (ii) investment in tangible property in North Carolina or (iii) 55% of the
appraised valuation of property in North Carolina.



Risk Factors



Concentration of Operations



The Banks operations are concentrated in the western region of
North Carolina. As a result of this geographic concentration, the Banks results may correlate to the economic conditions in these areas. A deterioration in economic conditions in any of these market areas, particularly in the industries on
which these geographic areas depend, may adversely affect the quality of the Banks loan portfolio and the demand for the Banks products and services, and accordingly, its results of operations.



Risks Associated with Loans



A significant source of risk for the Bank arises from the possibility
that losses will be sustained because borrowers, guarantors and related parties may fail to perform in accordance with the terms of their loans. The Bank has underwriting and credit monitoring procedures and credit policies, including the
establishment and review of the allowance for loan losses, that management believes are appropriate to minimize this risk by assessing the likelihood of nonperformance, tracking loan performance and diversifying the Banks loan portfolio. Such
policies and procedures, however, may not prevent unexpected losses that could adversely affect results of operations.



Competition with Larger Financial Institutions



The banking and financial services business in the Banks market area continues to be a competitive field and is becoming more competitive as
a result of:



| |  |  | changes in regulations;
| | - |  | -----------------------



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##### Table of Contents

| |  |  | changes in technology and product delivery systems; and
| | - |  | -------------------------------------------------------



| |  |  | the accelerating pace of consolidation among financial services providers.
| | - |  | --------------------------------------------------------------------------



It may be difficult to compete effectively in the Banks market, and results of operations could be adversely affected
by the nature or pace of change in competition. The Bank competes for loans, deposits and customers with various bank and non-bank financial services providers, many of which are much larger in total assets and capitalization, have greater access to
capital markets and offer a broader array of financial services.



Trading
Volume



The trading volume in AF Financials
common stock on the OTC Bulletin Board has been comparable to other similarly sized banks and companies trading on the OTC Bulletin Board. Nevertheless, this trading is relatively low when compared with more seasoned companies listed on the Nasdaq
Small Cap Market, the Nasdaq National Market System, the New York Stock Exchange or other consolidated reporting systems or stock exchanges. The market in the Companys common stock may be limited in scope relative to other companies. AF
Financial cannot guarantee that a more active and liquid trading market for its common stock will develop in the future.



Technological Advances



The banking industry is undergoing technological changes with frequent introductions of new technology-driven products and services. In addition to
improving customer services, the effective use of technology increases efficiency and enables financial institutions to reduce costs. The Banks future success will depend, in part, on its ability to address the needs of its customers by using
technology to provide products and services that will satisfy customer demands for convenience as well as to create additional efficiencies in the Banks operations. Many of our competitors have substantially greater resources than the Company
and the Bank to invest in technological improvements.



Government
Regulations



Current and future legislation and the
policies established by federal and state regulatory authorities will affect the Companys and the Banks operations. The Bank is subject the supervision of and examination by the OTS and for some purposes by the FRB. AF Financial is also
subject to the supervision and regulation of the OTS. OTS regulations, designed primarily for the protection of depositors, may limit the Companys and the Banks growth and the return to our shareholders by restricting certain of AF
Financials and the Banks activities, such as:



| |  |  | the payment of dividends to the Companys shareholders;
| | - |  | -------------------------------------------------------



| |  |  | possible mergers with or acquisitions of or by other institutions;
| | - |  | ------------------------------------------------------------------



| |  |  | investment policies;
| | - |  | --------------------



| |  |  | loans and interest rates on loans;
| | - |  | ----------------------------------



| |  |  | interest rates paid on deposits;
| | - |  | --------------------------------



| |  |  | expansion of branch offices; and/or
| | - |  | -----------------------------------



| |  |  | the possibility to provide or expand securities or trust services.
| | - |  | ------------------------------------------------------------------



AF Financial cannot predict what changes, if any, will be made to existing federal and state legislation and regulations or the effect that any changes
may have on future business and earnings prospects. The cost of compliance with regulatory requirements may adversely affect the Companys and the Banks ability to operate profitably.





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##### Table of Contents

ITEM 2. PROPERTIES



The Company conducts its business through its main office, located in West Jefferson, North Carolina, and its branches located in Boone, Elkin, Jefferson, Lenoir, Sparta, Warrensville, North Wilkesboro and West
Jefferson, North Carolina. The Company owns the main office and corporate offices located in West Jefferson, the Mt. Jefferson Financial Center Office, the Lenoir branch, the Jefferson branch and the Boone branch. Management believes that the
Companys current facilities are adequate to meet the present and immediately foreseeable needs of the Company.



|                                                                                  |  |                |  |                        |  |                      |     |  |                                 |          
|--------------------------------------------------------------------------------- |  | -------------- |  | ---------------------- |  | -------------------- | --- |  | ------------------------------- | ---------
|                                                                                  |  | Leased orOwned |  | Date Leasedor Acquired |  | LeaseExpiration Date |     |  | Net Book Value at June 30, 2005
|Corporate Offices 21 East Ashe Street West Jefferson, NC 28694                    |  | Owned          |  | 06/15/2000             |  |                     |     |  | $                               | 1,518,707
|                                                                                  |  |                |  |                       
|Insurance and Investment Offices 206 S. Jefferson Avenue West Jefferson, NC 28694 |  | Owned          |  | 06/30/1997             |  |                     |     |  | $                               | 179,320  
|                                                                                  |  |                |  |                       
|AF Bank 205 S. Jefferson Avenue West Jefferson, NC 28694                          |  | Owned          |  | 06/30/1963             |  |                     |     |  | $                               | 77,337   
|                                                                                  |  |                |  |                       
|AF Bank 840 E. Main Street Jefferson, NC 28640                                    |  | Owned          |  | 05/18/1994             |  |                     |     |  | $                               | 445,193  
|                                                                                  |  |                |  |                       
|AF Bank 4951 NC Hwy. 88 West Warrensville, NC 28693                               |  | Leased         |  | 08/01/1995             |  | 07/31/2005           | *   |  |                                 |         
|                                                                                  |  |                |  |                       
|AF Bank 381 South Main Street Sparta, NC 28675                                    |  | Leased         |  | 01/09/1998             |  | 10/04/2005           | **  |  |                                 |         
|                                                                                  |  |                |  |                       
|AF Financial Center 1675 Blowing Rock Road Boone, NC 28607                        |  | Owned          |  | 10/04/2005             |  |                     |     |  | $                               | 7,291,738
|                                                                                  |  |                |  |                       
|AF Insurance Services, Inc. 315 Main Street North Wilkesboro, NC 28659            |  | Leased         |  | 06/01/2000             |  | 05/31/2006           | *** |  |                                 |         
|                                                                                  |  |                |  |                       
|AF Insurance Services, Inc. 324 Morganton Blvd., SW Lenoir, NC 28645              |  | Owned          |  | 07/03/2000             |  |                     |     |  | $                               | 111,315  
|                                                                                  |  |                |  |                       
|AF Insurance Services, Inc. 948 Johnson Ridge Road Elkin, NC 28621                |  | Leased         |  | 01/01/2002             |  | 12/30/09             |     |  |                                 |         
|                                                                                  |  |                |  |                       
|AF Insurance Services, Inc. 400 Shadowline Drive Boone, NC 28607                  |  | Leased         |  | 12/01/2000             |  | 09/30/2007           |     |  |                                 |         
|                                                                                  |  |                |  |                       
|AF Financial Center 1441 Mt. Jefferson Road West Jefferson, NC 28694              |  | Owned          |  | 04/10/2001             |  |                     |     |  | $                               | 1,294,185
|                                                                                  |  |                |  |                       
|AF Bank 1489 Mt. Jefferson Road West Jefferson, NC 28694                          |  | Leased         |  | 01/05/2001             |  | 01/08/2011           | *   |  |                                 |         

---

|* | Option to renew for an additional five-year period.
|- | ---------------------------------------------------

|** | Option to renew for an additional three-year period.
|-- | ----------------------------------------------------

|*** | Option to renew for four additional one-year periods.
|--- | -----------------------------------------------------



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##### Table of Contents

ITEM 3. LEGAL PROCEEDINGS



At June 30, 2005, the Company is not a party to, and its property is not the subject of, any pending legal proceedings at the present time other than
routine litigation that is incidental to the business.



ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS



None.



PART II



ITEM 5. MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND SMALL
BUSINESS ISSUER PURCHASES OF EQUITY SECURITIES



There is no established market for the Companys common stock, excluding occasional quotations, although the Companys common stock is quoted on
the OTC Electronic Bulletin Board. The table below reflects the stock trading and dividend payment frequency of the Company for the years ended June 30, 2005 and 2004. Stock prices reflect bid prices between broker/dealer, prior to any markups,
markdowns or commissions, is based upon information provided to management of the Company by certain securities firms effecting transactions in the Companys stock on an ongoing basis, and may not necessarily represent actual transactions.



|               |  |           |      |             |   |       |  |   |      
|-------------- |  | --------- | ---- | ----------- | - | ----- |  | - | -----
|               |  |           |      | Stock Price
|2005           |  | Dividends |      | High        |   | Low  
|First quarter  |  | $         | 0.05 |             | $ | 19.15 |  | $ | 16.30
|Second quarter |  |           | 0.05 |             |   | 23.00 |  |   | 18.50
|Third quarter  |  |           | 0.05 |             |   | 22.00 |  |   | 19.00
|Fourth quarter |  |           | 0.05 |             |   | 19.00 |  |   | 14.90
|               |  |          
|               |  |           |      | Stock Price
|2004           |  | Dividends |      | High        |   | Low  
|First quarter  |  | $         | 0.05 |             | $ | 20.30 |  | $ | 16.00
|Second quarter |  |           | 0.05 |             |   | 20.30 |  |   | 18.75
|Third quarter  |  |           | 0.05 |             |   | 23.00 |  |   | 20.00
|Fourth quarter |  |           | 0.05 |             |   | 21.00 |  |   | 16.50



A dividend declared by
the Board of Directors of the Bank is considered a capital distribution from the Bank to the stockholders, including the MHC. The MHC waived the right to receive any dividend to be paid on the common stock of the Company during the next four
calendar quarters beginning with the September 2005 quarter and ending with the June 2006 quarter.



Under the requirements of the OTS, there are certain restrictions on the ability of the Bank to pay a capital distribution. See Regulation 
Limitation on Capital Distributions.





The Company paid cash dividends totaling $.20 per share during each of the years ended June 30, 2005 and 2004. When the Company pays dividends to its
stockholders, it is required to pay dividends to the MHC, unless the MHC elects to waive dividends. The MHC waived dividends paid by the Company during each of the four quarters of the year ended June 30, 2005. Any decision to waive dividends will
be subject to regulatory approval.



As of June 30, 2005, the
Company had approximately 382 shareholders of record.



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##### Table of Contents

ITEM 6. MANAGEMENTS DISCUSSION AND ANALYSIS



This discussion contains certain forward-looking statements consisting of estimates with respect to the financial condition, results of
operations and other business of the Company, that are subject to various factors which could cause actual results to differ materially from the estimates. These factors include: changes in general, economic and market conditions; the development of
an interest rate environment that adversely affects the interest rate spread or other income anticipated from the Companys operations and investments; our ability to offer new products and increase lower cost core deposits; and depositor and
borrower preferences. The Company disclaims any obligation to publicly announce future events or developments that may affect the forward-looking statements contained herein. The information in this section should be read in conjunction with the
Consolidated Financial Statements, the accompanying Notes to the Consolidated Financial Statements and the other sections contained in this document.



The following table sets forth certain information concerning the consolidated financial position and results of operation of the Company at the dates and
for the year end as indicated. The selected consolidated financial condition and operating data were derived from the audited consolidated financial statements of the Company. The information should be read in conjunction with the consolidated
financial statements of the Company and notes contained in Item 7 of this Form 10-KSB.



|                                                    |  |                                       |         |   |      |   |         |      |  |      |         |      |   |         |  |   |        
|--------------------------------------------------- |  | ------------------------------------- | ------- | - | ---- | - | ------- | ---- |  | ---- | ------- | ---- | - | ------- |  | - | -------
|                                                    |  | June 30,                             
|                                                    |  | 2005                                  |         |   | 2004 |   |         | 2003 |  | 2002 |         | 2001
|                                                    |  | (In thousands, except per share data)
|Selected Financial Condition Data:                  |  |                                       |         |   |      |   |         |      |  |      |         |      |   |         |  |   |        
|Total assets                                        |  | $                                     | 214,101 |   |      | $ | 211,619 |      |  | $    | 191,973 |      | $ | 176,684 |  | $ | 153,448
|Loans receivable, net1                              |  |                                       | 181,242 |   |      |   | 180,156 |      |  |      | 156,258 |      |   | 143,553 |  |   | 124,675
|Investment securities2                              |  |                                       | 5,750   |   |      |   | 6,501   |      |  |      | 8,754   |      |   | 11,422  |  |   | 7,844  
|Cash and cash equivalents3                          |  |                                       | 8,809   |   |      |   | 7,674   |      |  |      | 14,072  |      |   | 11,220  |  |   | 12,568 
|Savings deposits                                    |  |                                       | 163,977 |   |      |   | 157,434 |      |  |      | 149,571 |      |   | 136,769 |  |   | 120,074
|FHLB advances                                       |  |                                       | 28,142  |   |      |   | 33,144  |      |  |      | 21,146  |      |   | 18,910  |  |   | 16,962 
|Equity                                              |  |                                       | 13,039  |   |      |   | 12,474  |      |  |      | 12,960  |      |   | 12,777  |  |   | 13,027 
|Book value per share                                |  |                                       | 12.42   |   |      |   | 11.88   |      |  |      | 12.35   |      |   | 12.17   |  |   | 12.41  
|                                                    |  |                                       |         |   |     
|Selected Operating Data:                            |  |                                       |         |   |      |   |         |      |  |      |         |      |   |         |  |   |        
|Interest income and dividends                       |  | $                                     | 11,995  |   |      | $ | 10,684  |      |  | $    | 11,011  |      | $ | 11,191  |  | $ | 11,648 
|Interest expense                                    |  |                                       | 4,733   |   |      |   | 4,405   |      |  |      | 5,085   |      |   | 5,801   |  |   | 6,355  
|                                                    |  |                                       |         |   |      |   |         |      |  |      |         |      |   |         |  |   |        
|Net interest income                                 |  |                                       | 7,262   |   |      |   | 6,279   |      |  |      | 5,926   |      |   | 5,390   |  |   | 5,293  
|Provision for loan losses                           |  |                                       | (79     | ) |      |   | 668     |      |  |      | 243     |      |   | 420     |  |   | 225    
|                                                    |  |                                       |         |   |      |   |         |      |  |      |         |      |   |         |  |   |        
|Net interest income after provision for loan losses |  |                                       | 7,341   |   |      |   | 5,611   |      |  |      | 5,683   |      |   | 4,970   |  |   | 5,068  
|Non-interest income                                 |  |                                       | 3,966   |   |      |   | 3,744   |      |  |      | 3,604   |      |   | 3,120   |  |   | 2,493  
|Non-interest expense                                |  |                                       | 10,165  |   |      |   | 9,786   |      |  |      | 8,656   |      |   | 7,998   |  |   | 6,757  
|                                                    |  |                                       |         |   |      |   |         |      |  |      |         |      |   |         |  |   |        
|Income (loss) before income tax expense             |  |                                       | 1,142   |   |      |   | (431    | )    |  |      | 631     |      |   | 92      |  |   | 804    
|Income tax expense (benefit)                        |  |                                       | 493     |   |      |   | (123    | )    |  |      | 256     |      |   | 56      |  |   | 315    
|                                                    |  |                                       |         |   |      |   |         |      |  |      |         |      |   |         |  |   |        
|Net income (loss)                                   |  | $                                     | 649     |   |      | $ | (308    | )    |  | $    | 375     |      | $ | 36      |  | $ | 489    
|                                                    |  |                                       |         |   |      |   |         |      |  |      |         |      |   |         |  |   |        
|Selected Ratios                                     |  |                                       |         |   |      |   |         |      |  |      |         |      |   |         |  |   |        
|                                                    |  |                                       |         |   |     
|Basic earnings (loss) per share4                    |  | $                                     | 0.62    |   |      | $ | (0.30   | )    |  | $    | 0.36    |      | $ | 0.03    |  | $ | 0.48   
|Diluted earnings (loss) per share4                  |  |                                       | 0.62    |   |      |   | (0.30   | )    |  |      | 0.36    |      |   | 0.03    |  |   | 0.48   
|Dividends per share                                 |  |                                       | 0.20    |   |      |   | 0.20    |      |  |      | 0.20    |      |   | 0.20    |  |   | 0.20   

---

|1. | Loans receivable, net is comprised of total loans less allowance for loan losses, loans sold, undisbursed loan funds, and deferred loan fees.
|-- | ---------------------------------------------------------------------------------------------------------------------------------------------

|2. | Includes FHLB stock, certificates of deposit and investment securities.
|-- | -----------------------------------------------------------------------

|3. | Includes interest-earning deposit balances of $2.7 million, $2.5 million, $6.2 million, $4.2 million, and $7.8 million at June 30, 2005, 2004, 2003, 2002, and 2001, respectively.
|-- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4. | Earnings per share has been calculated in accordance with the Statement of Financial Accounting Standards No. 128, Earnings Per Share, and is based on net income for the
year, divided by the weighted average number of shares outstanding for the year. In accordance with the AICPAs SOP 93-6, unallocated ESOP shares were deducted from outstanding shares used in the computation of earnings per share. Diluted
earnings per share includes the effect of dilutive common stock equivalents in the weighted average number of shares outstanding.
|-- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------





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##### Table of Contents

|                                                                         |  |             |   |  |        |    |  |        |   |  |        |   |  |        |  
|------------------------------------------------------------------------ |  | ----------- | - |  | ------ | -- |  | ------ | - |  | ------ | - |  | ------ | -
|                                                                         |  | At June 30, |  
|                                                                         |  | 2005        |   |  | 2004   |    |  | 2003   |   |  | 2002   |   |  | 2001   |  
|Selected Financial Ratios and Other Data:                                |  |             |   |  |        |    |  |        |   |  |        |   |  |        |  
|Performance Ratios: 1                                                    |  |             |   |  |        |    |  |        |   |  |        |   |  |        |  
|Return on average assets                                                 |  | 0.30        | % |  | (0.15  | )% |  | 0.20   | % |  | 0.02   | % |  | 0.34   | %
|Return on average equity                                                 |  | 5.13        | % |  | (2.46  | )% |  | 2.90   | % |  | 0.28   | % |  | 3.80   | %
|Average equity to average assets                                         |  | 5.78        | % |  | 6.25   | %  |  | 6.90   | % |  | 7.51   | % |  | 8.83   | %
|Equity to total assets at end of period                                  |  | 6.09        | % |  | 5.89   | %  |  | 6.75   | % |  | 7.23   | % |  | 8.49   | %
|Interest rate spread2                                                    |  | 3.73        | % |  | 3.38   | %  |  | 3.41   | % |  | 3.36   | % |  | 3.56   | %
|Average interest-earnings assets to average interest-bearing liabilities |  | 100.30      | % |  | 105.12 | %  |  | 104.35 | % |  | 106.35 | % |  | 108.48 | %
|Net interest margin3                                                     |  | 3.74        | % |  | 3.51   | %  |  | 3.54   | % |  | 3.52   | % |  | 3.97   | %
|Non-interest expense to average assets                                   |  | 4.65        | % |  | 4.89   | %  |  | 4.62   | % |  | 4.70   | % |  | 4.64   | %
|Efficiency ratio4                                                        |  | 90.53       | % |  | 97.64  | %  |  | 90.83  | % |  | 93.98  | % |  | 86.78  | %
|Dividend payout ratio5                                                   |  | 32.26       | % |  | (66.67 | )% |  | 55.56  | % |  | 666.67 | % |  | 41.67  | %
|                                                                         |  |             |   |  |       
|Regulatory Capital Ratios: 6                                             |  |             |   |  |        |    |  |        |   |  |        |   |  |        |  
|Tangible capital                                                         |  | 8.42        | % |  | 8.11   | %  |  | 8.92   | % |  | 9.51   | % |  | 8.37   | %
|Core capital                                                             |  | 8.42        | % |  | 8.11   | %  |  | 8.92   | % |  | 9.51   | % |  | 8.37   | %
|Total risk based capital                                                 |  | 11.36       | % |  | 10.89  | %  |  | 12.89  | % |  | 13.00  | % |  | 12.28  | %
|                                                                         |  |             |   |  |       
|Asset Quality Ratios and Other Data:                                     |  |             |   |  |        |    |  |        |   |  |        |   |  |        |  
|Ratios:                                                                  |  |             |   |  |        |    |  |        |   |  |        |   |  |        |  
|Nonperforming loans to total loans                                       |  | 0.10        | % |  | 0.29   | %  |  | 0.28   | % |  | 0.32   | % |  | 0.36   | %
|Nonperforming loans and real estate owned to total assets                |  | 0.09        | % |  | 0.25   | %  |  | 0.25   | % |  | 0.41   | % |  | 0.47   | %
|Allowance for loan losses to:                                            |  |             |   |  |        |    |  |        |   |  |        |   |  |        |  
|Nonperforming loans                                                      |  | 748.87      | % |  | 239.98 | %  |  | 250.79 | % |  | 245.92 | % |  | 213.36 | %
|Total loans                                                              |  | 0.76        | % |  | 0.69   | %  |  | 0.71   | % |  | 0.78   | % |  | 0.78   | %
|Number of full service Bank branches                                     |  | 7           |   |  | 7      |    |  | 7      |   |  | 7      |   |  | 5      |  

---

|1. | With the exception of end of period ratios, all ratios are based on average monthly or quarterly balances during the indicated periods, and are annualized where appropriate. Asset
Quality and Regulatory Capital Ratios are end of period ratios.
|-- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|2. | The interest rate spread represents the difference between the weighted-average yield on interest-bearing assets and the weighted-average cost of interest-bearing liabilities.
|-- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|3. | The net interest margin represents net interest income as a percent of average interest-earning assets.
|-- | -------------------------------------------------------------------------------------------------------

|4. | The efficiency ratio represents non-interest expense as a percentage of the sum of net interest income and non-interest income.
|-- | -------------------------------------------------------------------------------------------------------------------------------

|5. | The dividend payout ratio represents dividends per share as a percentage of basic earnings per share. Earnings per share has been calculated in accordance with the Statement of
Financial Accounting Standards No. 128, Earnings Per Share, and is based on net income for the year, divided by the weighted average number of shares outstanding for the year. In accordance with the AICPAs SOP 93-6, unallocated ESOP
shares were deducted from outstanding shares used in the computation of earnings per share.
|-- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|6. | For definitions and further information relating to the Banks regulatory capital requirements, see Note 8 of Notes to the Consolidated Financial Statements.
|-- | -------------------------------------------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

Critical Accounting Policies



We believe that our policies with respect to the methodology for our determination of the allowance for loan losses, the
fair value of mortgage servicing assets and asset impairment judgments, including the recoverability of goodwill, involve a higher degree of complexity and require management to make difficult and subjective judgments which often require assumptions
or estimates about highly uncertain matters. Changes in these judgments, assumptions or estimates could cause reported results to differ materially. These critical policies and their application are periodically reviewed with the Audit Committee and
our Board of Directors. We consider the following accounting policies to be most critical in their potential effect on our financial position or results of operations:



Allowance for Loan Losses



The Allowance for Loan Losses (ALL) is established through a provision for loan losses based on our evaluation of the risks inherent in AF
Banks loan portfolio, prior loss history and the general economy. The ALL is maintained at an amount we consider adequate to cover loan losses which are deemed probable and estimable. The allowance is based upon a number of factors, including
asset classifications, economic trends, industry experience and trends, industry and geographic concentrations, estimated collateral values, our assessment of the credit risk inherent in the portfolio, historical loan loss experience, and AF
Banks underwriting policies.



All loans in the portfolio
are assigned an allowance percentage requirement based on the type of underlying collateral and payment terms. Furthermore, loans are evaluated individually and are assigned a credit grade using such factors as the borrowers cash flow, the
value of the collateral and the strength of any guarantee. Loans identified as having weaknesses, or adverse credit grades, are assigned a higher allowance percentage requirement than loans where no weaknesses are identified. We routinely monitor
our loan portfolio to determine if a loan is deteriorating, therefore requiring a higher allowance requirement. Factors we consider are payment status, collateral value and the probability of collecting scheduled principal and interest payment when
due.



The allowance percentage requirement changes from period
to period as a result of a number of factors, including: changes in the mix of types of loans; changes in credit grades within the portfolio, which arise from a deterioration or an improvement in the performance of the borrower; changes in the
historical loss percentages and delinquency trends; current charge offs and recoveries; and changes in the amounts of loans outstanding.



Although we believe that we have established and maintained the allowance for loan losses at adequate levels, future adjustments may be necessary if
economic, real estate and other conditions differ substantially from the current operating environment. We will continue to monitor and modify our ALL as conditions dictate.



Mortgage Servicing Assets



Mortgage servicing assets represent the present value of the future net servicing fees from servicing mortgage loans sold to the secondary market. The
most critical accounting policy associated with mortgage servicing is the methodology used to determine the fair value of mortgage servicing assets, which requires the development of a number of assumptions, including anticipated loan principal
amortization and prepayments of principal. The value of mortgage servicing rights is significantly affected by mortgage interest rates available in the marketplace that influence the speed of mortgage loan prepayments. During periods of declining
interest rates, the value of mortgage servicing assets generally declines due to increasing prepayments attributable to increased mortgage refinance activity. Conversely, during periods of rising interest rates, the value of servicing assets
generally increases due to reduced refinance activity. We amortize mortgage servicing assets over the estimated period that servicing income is expected to be received based on estimates of the amount and timing of future cash flows. The amount and
timing of servicing asset amortization is adjusted quarterly based on actual results and updated projections.



Goodwill



On July 1,
2002, we adopted the provisions of Financial Accounting Standards Board Statement 142, Goodwill and Other Intangible Assets. Under the provisions of the Statement, on July 1, 2002, we ceased to amortize goodwill. We will reevaluate the carrying
value of goodwill annually by comparing the market value of



- 31 -



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##### Table of Contents

each reporting segment to the respective total equity at that level. Impairment would then be determined if the equity
exceeds the fair value of the reporting unit. This evaluation is subjective as it requires material estimates that may be susceptible to significant change.



Management Strategy



As mentioned above, AF Financial Group is a financial services company that provides banking, insurance and investment services to residents in the
northwest corner of North Carolina. We are committed to the long-term profitability and success of the Company. Management and the board of directors are placing major emphasis upon improving the Companys net earnings and return on equity in
2006 and beyond. This will be accomplished by increasing the overall productivity of the Company and its operating subsidiaries, controlling costs, and reducing or eliminating unprofitable activities whenever and wherever possible.



There are a number of positive factors and recent events which reflect our
progress toward our long-term goals during the year ended June 30, 2005:



| |  |  | An increase in net loans of $1.1 million or 0.6%;
| | - |  | -------------------------------------------------



| |  |  | An increase in savings deposits of $6.5 million or 4.2%
| | - |  | -------------------------------------------------------



| |  |  | Asset growth of $2.5 million or 1.2%;
| | - |  | -------------------------------------



| |  |  | An increase in stockholders equity of $564,973, or 4.5%;
| | - |  | ---------------------------------------------------------



| |  |  | An increase in net income of $957,031 during the year ended June 30, 2005 as compared to the year ended June 30, 2004;
| | - |  | ----------------------------------------------------------------------------------------------------------------------



| |  |  | An increase in noninterest income of $221,687, or 5.9% during the year ended June 30, 2005 as compared to the year ended June 30, 2004;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Our new Financial Center in Boone, North Carolina opened on October 4, 2004. The Financial Center combines banking, insurance and investments into one convenient highly visible
location serving the Watauga County market.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Net
income increased $957,031, or 310.5%, to net income of $648,777 for the year ended June 30, 2005, compared to a net loss of $308,254 for the year ended June 30, 2004. This change is primarily due to an increase in interest income due to the 200
basis point interest rate hike by the FRB during the year ended June 30, 2005 and from the reduction in the provision for loan losses due to a recovery of a charged off loan during the year ended June 30, 2005. We believe that a positive upturn in
economic indicators will continue to have a positive impact on our net income. At June 30, 2005 we had approximately $61.6 million in loans priced at prime or a margin thereto which provides for adjusting rates immediately when market rates change.
In a rising rate environment, our ability to make immediate rate adjustments serves to protect the interest margin against increases in rates at a more rapid speed than the increase in funding costs.



Comparison of Financial Condition at June 30, 2005 and 2004



Total assets increased by $2.5 million or 1.2% to $214.1 million at June 30,
2005 from $211.6 million at June 30, 2004. The increase in assets was primarily the result of an increase of $1.2 million, or 10.8%, in net office properties and equipment, an increase of $1.1 million, or 14.8% in cash and cash equivalents and an
increase of $1.1 million, or 0.6%, in net loans receivable from June 30, 2004 to June 30, 2005. The increase in net office properties and equipment, cash and cash equivalents and net loans receivable was partially offset by a decrease of $423,355,
or 9.8%, in securities available for sale from June 30, 2004 to June 30, 2005. The decrease in securities available for sale was used to partially fund the increases discussed above. The increase in office properties and equipment, net was primarily
due to the costs to construct the new Financial Services Center in Boone, North Carolina. The increase in net loans receivable is typical for the Bank, which operates in lending markets that have had sustained loan demand over the last several
years.





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As mentioned above, securities available for sale decreased $423,355, or 9.8%, to $3.9 million at June
30, 2005 from $4.3 million at June 30, 2004. This decrease was due to maturing investments. At June 30, 2005, the Companys investment portfolio had $65,978 in net unrealized gains as compared to net unrealized gains of $17,064 at June 30,
2004.



The Banks savings deposits increased by $6.5
million, or 4.2%, from $157.4 million at June 30, 2004 to $164.0 million at June 30, 2005. We believe the increase in deposits is attributable to our continuing marketing efforts directed towards increasing balances in savings and transaction
accounts and in smaller, stable certificates of deposit. We intend to further focus our marketing efforts and to offer new products to increase lower cost core deposits.



Short-term borrowings decreased $2.9 million, or 53.2%, from $5.5 million at June 30, 2004 to $2.6 million at June 30, 2005.
Long-term borrowings decreased $1.9 million, or 5.7%, from $33.9 million at June 30, 2004 to $32.0 million at June 30, 2005. The decreases in short-term and long-term borrowings were funded by the $6.5 million increase in savings deposits.



Total stockholders equity increased $564,973, or 4.5%,
to $13.0 million at June 30, 2005 from $12.5 million at June 30, 2004. The increase in stockholders equity was primarily the result of net income of $648,777, ESOP expenses of $71,021 and an increase in other comprehensive income of $29,782.
These increases were partially offset by the increase in the value of redeemable common stock held by the ESOP of $81,516, or 15.2%, and dividends of $103,091. At June 30, 2005, the Banks regulatory capital amounted to $17.9 million compared
to $17.0 million at June 30, 2004, which was in excess of regulatory capital requirements at both such dates.



The Banks level of non-performing loans, defined as loans past due 90 days or more, decreased to $185,000, or 0.09% of total assets, at June 30,
2005 compared to $518,801, or 0.25% of total assets, at June 30, 2004. The Bank recognized total charge-offs of $214,125 during the year ended June 30, 2005 compared to total charge-offs of $603,342 during the year ended June 30, 2004. The $389,217
decrease in total charge-offs was primarily related to one commercial line of credit totaling $349,580 that was charged off during the second quarter of the year ended June 30, 2004. The Bank recovered $309,080 of this previously charged off
commercial line of credit during the fiscal year ended June 30, 2005. Total recoveries during June 30, 2005 increased to $433,441 for the year ended June 30, 2005 from $69,676 for the year ended June 30, 2004 primarily due to the recovery mentioned
above. The Bank recognized net recoveries of approximately $219,316 during the year ended June 30, 2005 compared to net charge-offs of $533,666 for the year ended June 30, 2004. While future loan loss provision requirements are uncertain, management
believes that similar recoveries are unlikely.



Comparison of Operating
Results for the Fiscal Years Ended June 30, 2005 and 2004



The Company had net income for the year ended June 30, 2005 of $648,777 compared to a net loss of $308,254 for the year ended June 30, 2004. Changes in net income during the comparable twelve-month period were attributable to: an increase
in interest income and noninterest income and a decrease in the provision for loan losses partially offset by an increase in noninterest expense during the year ended June 30, 2005, which is explained below. In our opinion, there has not been a
material change in interest rate risk from the end of the Companys most recent fiscal year.



Interest Income. Interest income increased by $1,311,517 or 12.3% from $10,683,592 for the year ended June 30, 2004 to $11,995,109 for the year
ended June 30, 2005. Interest income from loans increased $1,295,101 or 12.5% from $10,398,702 for the year ended June 30, 2004 to $11,693,803 for the year ended June 30, 2005. The increase in interest income from loans for the year ended June 30,
2005 was attributable to an increase in the weighted average rate of net loans receivable due to the 200 basis point increase in the interest rates by the Federal Reserve during the year ended June 30, 2005. The weighted average rate on portfolio
loans increased .59% from 5.80% at June 30, 2004 to 6.39% at June 30, 2005.





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##### Table of Contents

Table 1.



The following table analyzes the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing
liabilities. The table distinguishes between (i) changes attributable to volume (changes in volume multiplied by the prior periods rate) (ii) changes attributable to rate (changes in rate multiplied by the prior periods volume) and (iii)
mixed changes (changes in volume multiplied by changes in rate). Rate/volume variances are allocated to the rate/volume column.



|                                   |  |                                                    |       |   |                                                    |   |      |             |  |   |     |   |  |        |       |   |      |   |     |             |  |   |        |   |  |   |     |   |  |   |      |  
|---------------------------------- |  | -------------------------------------------------- | ----- | - | -------------------------------------------------- | - | ---- | ----------- |  | - | --- | - |  | ------ | ----- | - | ---- | - | --- | ----------- |  | - | ------ | - |  | - | --- | - |  | - | ---- | -
|                                   |  | Year ended June 30, 2005 compared to June 30, 2004 |       |   | Year ended June 30, 2004 compared to June 30, 2003 |  
|                                   |  | Increase/(Decrease) Due to                         |       |   | Increase/(Decrease) Due to                         |  
|                                   |  | Volume                                             |       |   | Rate                                               |   |      | Rate/Volume |  |   | Net |   |  | Volume |       |   | Rate |   |     | Rate/Volume |  |   | Net    |  
|                                   |  | (In thousands)                                     |      
|Assets:                            |  |                                                    |       |   |                                                    |   |      |             |  |   |     |   |  |        |       |   |      |   |     |             |  |   |        |   |  |   |     |   |  |   |      |  
|Interest-earning assets:           |  |                                                    |       |   |                                                    |   |      |             |  |   |     |   |  |        |       |   |      |   |     |             |  |   |        |   |  |   |     |   |  |   |      |  
|Interest-bearing deposits          |  | $                                                  | (12   | ) |                                                    | $ | 56   |             |  | $ | (15 | ) |  | $      | 29    |   |      | $ | (20 | )           |  | $ | (14    | ) |  | $ | 4   |   |  | $ | (30  | )
|Investment securities              |  |                                                    | (28   | ) |                                                    |   | 17   |             |  |   | (2  | ) |  |        | (13   | ) |      |   | (67 | )           |  |   | (61    | ) |  |   | 11  |   |  |   | (117 | )
|Loans receivable                   |  |                                                    | 1,039 |   |                                                    |   | 234  |             |  |   | 24  |   |  |        | 1,297 |   |      |   | 967 |             |  |   | (1,051 | ) |  |   | (96 | ) |  |   | (180 | )
|                                   |  |                                                    |       |   |                                                    |   |      |             |  |   |     |   |  |        |       |   |      |   |     |             |  |   |        |   |  |   |     |   |  |   |      |  
|Total                              |  |                                                    | 999   |   |                                                    |   | 307  |             |  |   | 6   |   |  |        | 1,313 |   |      |   | 880 |             |  |   | (1,126 | ) |  |   | (81 | ) |  |   | (327 | )
|                                   |  |                                                    |       |   |                                                    |   |      |             |  |   |     |   |  |        |       |   |      |   |     |             |  |   |        |   |  |   |     |   |  |   |      |  
|Liabilities:                       |  |                                                    |       |   |                                                    |   |      |             |  |   |     |   |  |        |       |   |      |   |     |             |  |   |        |   |  |   |     |   |  |   |      |  
|Interest-bearing liabilities:      |  |                                                    |       |   |                                                    |   |      |             |  |   |     |   |  |        |       |   |      |   |     |             |  |   |        |   |  |   |     |   |  |   |      |  
|Interest-bearing checking accounts |  |                                                    | 42    |   |                                                    |   | (23  | )           |  |   | (8  | ) |  |        | 11    |   |      |   | 15  |             |  |   | (86    | ) |  |   | (7  | ) |  |   | (78  | )
|Savings                            |  |                                                    | (10   | ) |                                                    |   | (13  | )           |  |   |    |   |  |        | (23   | ) |      |   | 73  |             |  |   | (284   | ) |  |   | (26 | ) |  |   | (237 | )
|Certificates of deposit            |  |                                                    | 176   |   |                                                    |   | (81  | )           |  |   | (6  | ) |  |        | 89    |   |      |   | 42  |             |  |   | (467   | ) |  |   | (8  | ) |  |   | (433 | )
|Borrowed funds                     |  |                                                    | 527   |   |                                                    |   | (220 | )           |  |   | (68 | ) |  |        | 239   |   |      |   | 184 |             |  |   | (104   | ) |  |   | (12 | ) |  |   | 68   |  
|                                   |  |                                                    |       |   |                                                    |   |      |             |  |   |     |   |  |        |       |   |      |   |     |             |  |   |        |   |  |   |     |   |  |   |      |  
|Total                              |  |                                                    | 735   |   |                                                    |   | (337 | )           |  |   | (82 | ) |  |        | 316   |   |      |   | 314 |             |  |   | (941   | ) |  |   | (53 | ) |  |   | (680 | )
|                                   |  |                                                    |       |   |                                                    |   |      |             |  |   |     |   |  |        |       |   |      |   |     |             |  |   |        |   |  |   |     |   |  |   |      |  
|Net interest income                |  | $                                                  | 264   |   |                                                    | $ | 644  |             |  | $ | 88  |   |  | $      | 997   |   |      | $ | 566 |             |  | $ | (185   | ) |  | $ | (28 | ) |  | $ | 353  |  
|                                   |  |                                                    |       |   |                                                    |   |      |             |  |   |     |   |  |        |       |   |      |   |     |             |  |   |        |   |  |   |     |   |  |   |      |  





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Table 2.



The following table provides information concerning the Banks yields on interest-earning assets and cost of funds on interest-bearing liabilities
over the years ended June 30, 2005 and 2004.



|                                                                 |  |                        |         |                   |        |   |                             |      |          |  |                   |        |  |                |   |          |   |                   |  |   |                |  |          |    |                   |   |         |  |   |        |  |        |  
|---------------------------------------------------------------- |  | ---------------------- | ------- | ----------------- | ------ | - | --------------------------- | ---- | -------- |  | ----------------- | ------ |  | -------------- | - | -------- | - | ----------------- |  | - | -------------- |  | -------- | -- | ----------------- | - | ------- |  | - | ------ |  | ------ | -
|                                                                 |  |                        |         |                   |        |   | For the year ended June 30, |     
|                                                                 |  | At June 30, 2005       |         |                   | 2005   |   |                             | 2004 |          |  | 2003              |       
|                                                                 |  | ActualBalance          |         | AverageYield/Rate |        |   | AverageBalance              |      | Interest |  | AverageYield/Rate |        |  | AverageBalance |   | Interest |   | AverageYield/Rate |  |   | AverageBalance |  | Interest |    | AverageYield/Rate |  
|                                                                 |  | (Dollars in thousands) |         |                   |        |   |                             |      |          | 
|Assets:                                                          |  |                        |         |                   |        |   |                             |      |          |  |                   |        |  |                |   |          |   |                   |  |   |                |  |          |    |                   |   |         |  |   |        |  |        |  
|Interest-earnings assets:                                        |  |                        |         |                   |        |   |                             |      |          |  |                   |        |  |                |   |          |   |                   |  |   |                |  |          |    |                   |   |         |  |   |        |  |        |  
|Interest-bearing deposits                                        |  | $                      | 2,658   |                   | 3.28   | % |                             | $    | 2,187    |  | $                 | 72     |  | 3.29           | % |          | $ | 3,010             |  | $ | 43             |  | 1.43     | %  |                   | $ | 4,145   |  | $ | 73     |  | 1.76   | %
|Investment securities                                            |  |                        | 5,750   |                   | 4.14   | % |                             |      | 6,331    |  |                   | 229    |  | 3.62           | % |          |   | 7,162             |  |   | 242            |  | 3.38     | %  |                   |   | 8,804   |  |   | 358    |  | 4.07   | %
|Loans receivable, net (1)                                        |  |                        | 181,242 |                   | 6.39   | % |                             |      | 185,623  |  |                   | 11,694 |  | 6.30           | % |          |   | 168,738           |  |   | 10,399         |  | 6.16     | %  |                   |   | 154,582 |  |   | 10,580 |  | 6.84   | %
|                                                                 |  |                        |         |                   |        |   |                             |      |          |  |                   |        |  |                |   |          |   |                   |  |   |                |  |          |    |                   |   |         |  |   |        |  |        |  
|Total interest-earning assets                                    |  |                        | 189,650 |                   | 6.28   | % |                             |      | 194,141  |  |                   | 11,995 |  | 6.18           | % |          |   | 178,910           |  |   | 10,684         |  | 5.97     | %  |                   |   | 167,531 |  |   | 11,011 |  | 6.57   | %
|Non-interest-earning assets                                      |  |                        | 24,451  |                   |        |   |                             |      | 24,665   |  |                   |        |  |                |   |          |   | 21,276            |  |   |                |  |          |    |                   |   | 19,645  |  |   |        |  |        |  
|                                                                 |  |                        |         |                   |        |   |                             |      |          |  |                   |        |  |                |   |          |   |                   |  |   |                |  |          |    |                   |   |         |  |   |        |  |        |  
|Total assets                                                     |  | $                      | 214,101 |                   |        |   |                             | $    | 218,806  |  |                   |        |  |                |   |          | $ | 200,186           |  |   |                |  |          |    |                   | $ | 187,176 |  |   |        |  |        |  
|                                                                 |  |                        |         |                   |        |   |                             |      |          |  |                   |        |  |                |   |          |   |                   |  |   |                |  |          |    |                   |   |         |  |   |        |  |        |  
|Liabilities and equity:                                          |  |                        |         |                   |        |   |                             |      |          |  |                   |        |  |                |   |          |   |                   |  |   |                |  |          |    |                   |   |         |  |   |        |  |        |  
|Interest-bearing liabilities:                                    |  |                        |         |                   |        |   |                             |      |          |  |                   |        |  |                |   |          |   |                   |  |   |                |  |          |    |                   |   |         |  |   |        |  |        |  
|Interest-bearing checking accounts                               |  | $                      | 24,788  |                   | 0.64   | % |                             | $    | 31,138   |  |                   | 134    |  | 0.43           | % |          | $ | 23,085            |  |   | 122            |  | 0.53     | %  |                   | $ | 21,434  |  |   | 200    |  | 0.93   | %
|Savings                                                          |  |                        | 39,499  |                   | 1.43   | % |                             |      | 41,753   |  |                   | 521    |  | 1.25           | % |          |   | 42,497            |  |   | 543            |  | 1.28     | %  |                   |   | 38,889  |  |   | 782    |  | 2.01   | %
|Certificates of deposit                                          |  |                        | 81,427  |                   | 3.05   | % |                             |      | 79,138   |  |                   | 2,136  |  | 2.70           | % |          |   | 72,878            |  |   | 2,037          |  | 2.80     | %, |                   |   | 71,679  |  |   | 2,468  |  | 3.44   | %
|Borrowed funds                                                   |  |                        | 34,539  |                   | 5.38   | % |                             |      | 41,536   |  |                   | 1,942  |  | 4.68           | % |          |   | 31,738            |  |   | 1,703          |  | 5.37     | %  |                   |   | 28,541  |  |   | 1,635  |  | 5.73   | %
|                                                                 |  |                        |         |                   |        |   |                             |      |          |  |                   |        |  |                |   |          |   |                   |  |   |                |  |          |    |                   |   |         |  |   |        |  |        |  
|Total interest-bearing liabilities                               |  |                        | 180,253 |                   | 2.81   | % |                             |      | 193,565  |  |                   | 4,733  |  | 2.45           | % |          |   | 170,198           |  |   | 4,405          |  | 2.59     | %  |                   |   | 160,543 |  |   | 5,085  |  | 3.17   | %
|                                                                 |  |                        |         |                   |        |   |                             |      |          |  |                   |        |  |                |   |          |   |                   |  |   |                |  |          |    |                   |   |         |  |   |        |  |        |  
|Other non-interest-bearing liabilities                           |  |                        | 20,809  |                   |        |   |                             |      | 12,587   |  |                   |        |  |                |   |          |   | 17,471            |  |   |                |  |          |    |                   |   | 13,731  |  |   |        |  |        |  
|Equity                                                           |  |                        | 13,039  |                   |        |   |                             |      | 12,654   |  |                   |        |  |                |   |          |   | 12,517            |  |   |                |  |          |    |                   |   | 12,912  |  |   |        |  |        |  
|                                                                 |  |                        |         |                   |        |   |                             |      |          |  |                   |        |  |                |   |          |   |                   |  |   |                |  |          |    |                   |   |         |  |   |        |  |        |  
|Total liabilities and equity                                     |  | $                      | 214,101 |                   |        |   |                             | $    | 218,806  |  |                   |        |  |                |   |          | $ | 200,186           |  |   |                |  |          |    |                   | $ | 187,176 |  |   |        |  |        |  
|                                                                 |  |                        |         |                   |        |   |                             |      |          |  |                   |        |  |                |   |          |   |                   |  |   |                |  |          |    |                   |   |         |  |   |        |  |        |  
|Net interest income and interest rate spread (2)                 |  |                        |         |                   | 3.47   | % |                             |      |          |  | $                 | 7,262  |  | 3.73           | % |          |   |                   |  | $ | 6,279          |  | 3.38     | %  |                   |   |         |  | $ | 5,926  |  | 3.41   | %
|                                                                 |  |                        |         |                   |        |   |                             |      |          |  |                   |        |  |                |   |          |   |                   |  |   |                |  |          |    |                   |   |         |  |   |        |  |        |  
|Net interest-earning assets and net interest margin (3)          |  | $                      | 9,397   |                   |        |   |                             | $    | 576      |  |                   |        |  | 3.74           | % |          | $ | 8,712             |  |   |                |  | 3.51     | %  |                   | $ | 6,988   |  |   |        |  | 3.54   | %
|                                                                 |  |                        |         |                   |        |   |                             |      |          |  |                   |        |  |                |   |          |   |                   |  |   |                |  |          |    |                   |   |         |  |   |        |  |        |  
|Ratio of interest-earning assets to interest-bearing liabilities |  |                        |         |                   | 105.21 | % |                             |      |          |  |                   |        |  | 100.30         | % |          |   |                   |  |   |                |  | 105.12   | %  |                   |   |         |  |   |        |  | 104.35 | %

---

|(1) | Balance is net of deferred loan fees and loans in process. Non-accrual loans are included in the balances.
|--- | ----------------------------------------------------------------------------------------------------------

|(2) | Average interest rate spread represents the difference between the yield on average interest-earning assets and the cost of average interest-bearing liabilities.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | Net interest margin represents net interest income divided by average total interest-earning assets. With the exception of end of period ratios, all ratios are based on monthly or
quarterly balances during the indicated years. Management does not believe that the use of month and quarter end balances instead of daily balances has caused a material difference in the information presented.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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Interest Expense. Interest expense increased by $328,401 or 7.5% to $4,733,212 for the year ended
June 30, 2005 from $4,404,811 for the year ended June 30, 2004. Interest expense on savings deposits increased by $88,811 or 3.3% to $2,791,394 for the year ended June 30, 2005 from $2,702,583 for the year ended June 30, 2004. The increase in
interest expense on savings deposits is the result of the 0.33% increase in the institutions weighted average rate of deposits during the year ended June 30, 2005 and the $6.5 million increase in savings deposits. Interest expense on
short-term borrowings increased $105,217 to $138,041 for the year ended June 30, 2005 from $32,824 for the year ended June 30, 2004. Interest expense on long-term borrowings increased $134,373 to $1,803,777 for the year ended June 30, 2005 from
$1,669,404 for the year ended June 30, 2004. These increases are the result of the $9.8 million increase in average balances outstanding during the year ended June 30, 2005 in short-term and long-term borrowings. This average balance increase was
partially offset by the 0.69% decrease in the weighted average interest rate on the borrowings during the year ended June 30, 2005.



Net Interest Income. Net interest income increased by $983,116, or 15.7%, from $6,278,781 for the year ended June 30, 2005 to $7,261,897 for the
year ended June 30, 2005. The increase in net interest income is the result of the increase in outstanding loan balances and the increase in the weighted average interest rate earned on the loan portfolio, partially offset by the increase in
interest expense as discussed above. In a rising rate environment, we have the ability to make immediate rate adjustments on our loans priced at prime or a margin thereto, which allows us to increase loan rates at a more rapid speed than the
increase in funding costs. We do not believe that there has been a material change in interest rate risk from the end of our most recent fiscal year.



Provision for Loan Losses. The provision for loan losses charged to earnings is an amount sufficient to bring the allowance for loan losses to an
estimated balance considered adequate to absorb probable losses on existing loans that may become uncollectible. Loans are charged off against the allowance when we believe collection is unlikely. The allowance for loan losses changes from period to
period as a result of a number of factors, including: changes in the mix of types of loans; changes in credit grades within the portfolio, which arise from a deterioration or an improvement in the performance of the borrower; changes in the
historical loss percentages and delinquency trends; current charge offs and recoveries; and changes in the amounts of loans outstanding. The net change in all of the components results in the provision for loan losses. We had no significant changes
in any of the factors mentioned above during the year ended June 30, 2005.



All loans in the portfolio are assigned an allowance percentage requirement based on the type of underlying collateral and payment terms. Furthermore, loans are evaluated individually and are assigned a credit grade
using such factors as the borrowers cash flow, the value of the collateral and the strength of any guarantee. Loans identified as having weaknesses, or adverse credit grades, are assigned a higher allowance percentage requirement than loans
where no weaknesses are identified. We routinely monitor our loan portfolio to determine if a loan is deteriorating, therefore requiring a higher allowance requirement. Factors we consider are payment status, collateral value and the probability of
collecting scheduled principal and interest payment when due. Although we believe that we have established and maintained the allowance for loan losses at adequate levels, future adjustments may be necessary if economic, real estate and other
conditions differ substantially from the current operating environment.



We reversed provisions in the amount of $78,922 from the allowance for loan losses during the year ended June 30, 2005, compared to a $688,000 provision for loan losses made during the year ended June 30, 2004.



During the year ended June 30, 2005 we had net recoveries of $219,316
primarily due to a $309,080 recovery from a commercial loan that was previously charged off. We reversed provisions for loan loss allowances during the year ended June 30, 2005 based upon an analysis of the quality of our loan portfolio and the
aforementioned recovery. While future loan loss provision requirements are uncertain, management believes that similar recoveries are unlikely. At June 30, 2005, our level of allowance for loan losses amounted to $1,385,412, or 0.76% of total loans,
as compared to $1,245,018 of allowance for loan losses, or 0.69% of total loans at June 30, 2004, which we believe is adequate to absorb any probable losses inherent in our loan portfolio. We increased our allowance for loan losses as a percentage
of total loans during the year ended June 30, 2005 as compared to June 30, 2004 due to our decision to take a more conservative approach in estimating probable loan losses. We expect to maintain the level of allowance for loan losses to total loans
at approximately 0.76% during the 2006 fiscal year and beyond. We do not maintain an allowance for undisbursed loan commitments.



Non-Interest Income. Non-interest income increased by $221,687 or 5.9% from $3,743,830 for the year ended June 30, 2004 to $3,965,517 for the year
ended June 30, 2005. The increase in non-interest income during the year ended June 30, 2005 was primarily attributable to an increase in revenue generated from insurance



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commissions and from an increase in brokerage fees and commissions. The increase in insurance and noninsured investment
commissions is primarily due to an increase in number of sales due to increased emphasis on training and monitoring the sales activities of producers. These trends are expected to continue to produce growth in non-interest income. Insurance
commissions increased by $158,254, or 6.7%, from $2,375,598 for the year ended June 30, 2004 to $2,533,852 for the year ended June 30, 2005.





Non-Interest Expense. Non-interest expense increased by $378,833 or
3.9% from $9,785,580 for the year ended June 30, 2004 to $10,164,413 for the year ended June 30, 2005. The increase in non-interest expense for the year ended June 30, 2005 is primarily attributable to an increase in compensation costs, REO expense
and occupancy expenses. Compensation and employee benefits increased $230,327, or 4.2% from $5,508,835 at June 30, 2004 to $5,739,162 at June 30, 2005. The increase in compensation expense is primarily due to an increase in commissions paid to
employees whose pay is based on a percentage of insurance and noninsured investment commissions that the Company earns. REO expense increased $163,614 from $1,784 at June 30, 2004 to $165,398 at June 30, 2005. The increase in REO expense is
primarily due a loss realized on the sale of one property foreclosed on during the fiscal year ended June 30, 2005. The foreclosed loan was a construction loan and significant costs would have been required to finish the construction. We decided to
sale the property at a loss rather than incur the additional construction costs and the risk associated with holding the property for an extended period of time. Insurance commissions increased $158,254 for the year ended June 30, 2005. Occupancy
and equipment costs increased by $75,272 or 5.9% from $1,267,694 for the year ended June 30, 2004 to $1,342,966 for the year ended June 30, 2005. The increase in occupancy and equipment costs is primarily due to the increase in expenses associated
with the Boone Financial Center which opened in the second quarter of the fiscal year ended June 30, 2005.



Income Taxes.Income taxes resulted from applying normal, expected tax rates on income earned during the years ended June 30, 2005 and 2004. The
income tax expense was $493,146 for the year ended June 30, 2005 and the income tax credit was $122,715 for the year ended June 30, 2004. The effective tax rate was higher than expected tax rates for 2005, resulting primarily from the fact that
North Carolina corporations may not file consolidated income tax returns. This had the effect of taxing all income in a particular member of a consolidated group without permitting an offsetting benefit for losses incurred in another member of the
same group, creating a higher than expected overall state income tax expense.



Capital Resources and Liquidity



The term liquidity generally refers to an organizations ability to generate adequate amounts of funds to meet its needs for cash. More specifically, for financial institutions, liquidity ensures that adequate funds are
available to meet deposit withdrawals, fund loan demand and capital expenditure commitments, maintain reserve requirements, pay operating expenses, and provide funds for debt service, dividends to stockholders, and other institutional commitments.
The Companys primary sources of funds consist of deposits, borrowings, repayment and prepayment of loans, sales and participations of loans, maturities of securities and interest-bearing deposits, and funds provided from operations. While
scheduled repayments of loans and maturities of securities are predictable sources of funds, deposit flows and loan prepayments are greatly influenced by the general level of interest rates, economic conditions, and competition. The Company uses its
liquid resources primarily to fund existing and future loan commitments, to fund net deposit outflows, to invest in other interest-earning assets, to maintain liquidity, and to meet operating expenses. For additional information about cash flows
from the Companys operating, financing and investing activities, see Condensed Consolidated Statements of Cash Flow.



Liquidity management is both a daily and long-term function of management. If we require funds beyond our ability to generate them internally, we believe
we could borrow additional funds from the FHLB and use the wholesale deposit markets. At June 30, 2005, we had borrowings of $28.1 million from the FHLB. The Bank also maintains borrowing agreements with the FRB of Richmond, Virginia.



The Company anticipates that it will have sufficient funds available to meet
its current loan origination commitments. Certificates of deposit scheduled to mature in less than one year totaled $58.5 million at June 30, 2005. Based upon historical experience, we believe that a significant portion of such deposits will remain
with the Bank.



As of June 30, 2005, cash and cash equivalents,
a significant source of liquidity, totaled $8.8 million. The OTS regulations require the Company to maintain sufficient liquidity to ensure its safe and sound operation. Given our level of liquidity and our ability to borrow from the FHLB, we
believe that we will have sufficient funds available to meet anticipated future loan commitments, unexpected deposit withdrawals, and other cash requirements. We do not anticipate any financial or insurance acquisitions at this time.



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Capital management is another important daily and long-term function of management. While we currently
meet all regulatory capital levels, we monitor this level on an ongoing basis. Our principal goals related to capital management are to provide an adequate return to shareholders while retaining a sufficient foundation from which to support future
growth and to comply with all regulatory guidelines.



Asset/Liability
Management



The Companys asset/liability management
is focused primarily on evaluating and managing the Companys net interest income in relation to various risk criteria. Factors beyond the Companys control, such as the effects of changes in market interest rates and competition, may also
have an impact on the management of interest rate risk.



In the
absence of other factors, the Companys overall yield on interest-earning assets will increase, as will its cost of funds on its interest-bearing liabilities, when market rates increase over an extended period of time. Inversely, the
Companys yields and cost of funds will decrease when market rates decline. We are able to manage these fluctuations to some extent by attempting to control the maturity or rate adjustments of our interest-earning assets and interest-bearing
liabilities over given periods of time. One of our tools for monitoring interest rate risk is the measurement of the sensitivity of the net portfolio value to changes in interest rates.



In order to minimize the potential effects of adverse material and prolonged increases in market interest rates on the
Companys operations, we have implemented an asset/liability program designed to improve the Companys interest rate risk exposure. The program emphasizes the originations of three-and five-year fixed-rate balloon mortgages,
adjustable-rate mortgages, selling long term fixed-rate loans to the secondary market, shorter term consumer and commercial loans, the investment of excess cash in short or intermediate term interest-earning assets and the solicitation of deposit
accounts that can be repriced rapidly in high rate scenarios and longer repricing terms in low rate environments.



Although the Companys asset/liability management program has generally helped to decrease the exposure of our earnings to interest rate increases,
the residual effect of reducing the Companys historical exposure to interest rate increases is a heightened exposure to interest rate decreases. Additionally, a decline in rates for earning assets may occur more rapidly than a decline in
funding costs. Certificates of deposit typically have terms ranging from three to 36 months. Consequently, the rates paid for these deposits cannot be adjusted until the maturity date. Loans priced at prime or a margin thereto provide for adjusting
rates immediately when market rates change. In a rising rate environment, the ability to make immediate upward rate adjustments with adjustable-rate loans serves to protect the net interest margin against increases in rates at a more rapid speed
than the increase in funding. In a declining rate environment, the rates on prime rate based loans decrease immediately while certificate rates lag causing the interest margin to decline until the certificates mature offering an opportunity for
repricing.



We believe the Companys asset/liability
management program continues to function as a useful financial management tool, adequately providing for the safe, sound and prudent management of the Companys exposure to changes in interest rates.



Net Portfolio Value



All federally regulated financial institutions are required to measure the exposure to changes in interest rates.
Institutions with assets of less than $500 million may rely on outside sources of measurement such as those provided by the OTS. The purpose is to determine how changes in interest rates affect the estimated value or Net Portfolio Value
(NPV) of the insured institutions statement of financial condition under several immediate or shock changes in market rates.



Since the timing of repricing opportunities for interest-earning assets and interest-bearing liabilities are different, the impact of shock changes will
have a negative, neutral or positive impact on the NPV of the bank based upon the structure of the banks assets and liabilities. Thus, NPV is the difference between incoming and outgoing discounted cash flows from assets, liabilities and
off-balance sheet contracts.



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Our banking subsidiary, AF Bank, has historically been a mortgage lender, which means that it generally
has longer terms before repricing its assets than it does repricing its interest bearing liabilities or deposit accounts. Therefore, a rising rate environment will have the most negative impact on the NPV of the typical mortgage lender. The
following table presents the Companys NPV at June 30, 2005, as calculated by the OTS, based on information provided to the OTS by the Company.



Table 3. Interest Rate Sensitivity of Net Portfolio Value (NPV)



|                    |  |                      |                              |             |   |  |              |    |  |           |   |  |           
|------------------- |  | -------------------- | ---------------------------- | ----------- | - |  | ------------ | -- |  | --------- | - |  | ----------
|Net Portfolio Value |  |                      | NPV as % of PV (5) of Assets
|Change inRates      |  | $ Amount inThousands |                              | $ Change(1) |   |  | % Change (2) |    |  | Ratio (3) |   |  | Change (4)
|+300 bp             |  | 21,379               |                              | (6,432      | ) |  | (23          | )% |  | 10.01     | % |  | -261 bp   
|+200 bp             |  | 23,784               |                              | (4,026      | ) |  | (14          | )% |  | 11.00     | % |  | -162 bp   
|+100 bp             |  | 25,997               |                              | (1,814      | ) |  | (7           | )% |  | 11.89     | % |  | -73 bp    
|0 bp                |  | 27,811               |                              |            |   |  |             |    |  | 12.62     | % |  |          
|-100 bp             |  | 28,868               |                              | 1,057       |   |  | 4            | %  |  | 13.05     | % |  | 43 bp     
|-200 bp             |  | 29,775               |                              | 1,964       |   |  | 7            | %  |  | 13.44     | % |  | 82 bp     

---

|(1) | Represents the change in NPV from the base (zero change in rates) assuming the indicated change in interest rates.
|--- | ------------------------------------------------------------------------------------------------------------------

|(2) | Calculated as the percentage of change in the estimated NPV compared to the base scenario.
|--- | ------------------------------------------------------------------------------------------

|(3) | Calculated as the estimated NPV divided by average total assets.
|--- | ----------------------------------------------------------------

|(4) | Represents the change, expressed in basis points (bp), in the ratio of NPV to Assets in each scenario compared to the base.
|--- | -----------------------------------------------------------------------------------------------------------------------------

|(5) | PV means present value.
|--- | -----------------------



At June 30, 2005, the estimated NPV decreased by 23% in a 300 basis point rising interest rate shock scenario compared to an increase of 4% in a 100 basis
point falling rate scenario. This compares to a decrease of 8% under a similar rise and a decrease of 3% in a similar decline one year earlier. The interest rate risk is further measured by the basis point decline in the ratio of NPV to PV of
assets, defined as the Sensitivity Measure by the OTS.



At June
30, 2005, the decline of the Sensitivity Measure was 162 basis points with a 200 basis point shock decrease in rates compared to a decrease of 35 basis points under a 100 basis point shock at June 30, 2004.



The following table provided by the OTS reflects further measures of the
Companys interest rate risk.



Table 4. Risk Measures: 200 bp Rate
Shock



|                     |  |                            |  |              |   |  |              |  
|-------------------- |  | -------------------------- |  | ------------ | - |  | ------------ | -
|                     |  |                            |  | June 30,2005 |   |  | June 30,2004 |  
|Pre-shock NPV Ratio: |  | NPV as a % of PV of Assets |  | 12.62        | % |  | 10.44        | %
|Exposure Measure:    |  | Post Shock NPV Ratio       |  | 11.00        | % |  | 10.10        | %
|Sensitivity Measure: |  | Change in NPV              |  | 162 bp       |   |  | 35 bp        |  



Certain shortcomings
are inherent in the methodology used in the above table. Modeling changes in NPV require making certain assumptions that may tend to oversimplify the manner in which actual yields and costs respond to changes in market interest rates. First, the
models assume that the composition of the Banks interest sensitive assets and liabilities existing at the beginning of a period remains constant over the period being measured. Second, the models assume that a particular change in interest
rates is reflected uniformly across the yield curve regardless of the duration to maturity of the repricing of specific assets and liabilities. Accordingly, although the NPV measurements do provide an indication of the Companys interest rate
risk exposure at a particular point in time, such measurements are not intended to provide a precise forecast of the effect of changes in market interest rates on the Companys net interest income. Furthermore, in times of decreasing interest
rates, the value of fixed-rate assets could increase in value and the lag in repricing of interest rate sensitive assets could be expected to have a



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negative effect on the Company because of the timing differences in the repricing opportunities for its interest earning
assets and its interest bearing deposits. Interest sensitive assets could be expected to have a positive effect on the Company when interest rates are increasing.



We believe the NPV method of assessing the Companys exposure to interest risk and potential reductions in net interest
income is a useful tool for measuring risk. The strategies that are currently in place to reduce the level of interest rate risk under an increasing rate assumption will reduce the impact of rising rates as long term mortgages are sold and replaced
with shorter term mortgages and non-mortgage loans with rates that can be adjusted to more closely simulate market rates of interest.



Future Reporting Requirements



In December 2004, the FASB issued SFAS No. 123(R), Accounting for Stock-Based Compensation (SFAS No. 123(R)). SFAS No. 123(R) establishes standards
for the accounting for transactions in which an entity exchanges its equity instruments for goods or services. This Statement focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment
transactions. SFAS No. 123(R) requires that the fair value of such equity instruments be recognized as an expense in the historical financial statements as services are performed. Prior to SFAS No. 123(R), only certain pro forma disclosures of fair
value were required. The provisions of this Statement are effective for the first interim reporting period of the first fiscal year that begins on or after December 15, 2005. Accordingly, we will adopt SFAS No. 123(R) commencing with the quarter
ending September 30, 2006. Since all options granted were fully vested on December 8, 2001 there would be no cost of employee stock option compensation in our consolidated financial statements for the years ended June 30, 2005 and 2004. Accordingly,
the adoption of SFAS No. 123(R) is not expected to have a material effect on our consolidated financial statements.



Impact of Inflation and Changing Prices



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



Off-Balance Sheet Arrangements



Information about our off-balance sheet risk exposure is presented in Note 17 to the consolidated financial statements. As part of our on-going business, we do not participate in transactions that generate relationships with unconsolidated
entities or financial partnerships, such as entities referred to as special purpose entities (SPEs), which generally are established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.
See Note 17 Commitments and Contingencies in the Notes to Consolidated Financial Statements provided under Item 7.



- 40 -



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##### Table of Contents

ITEM 7 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA



LOGO



REPORT OF INDEPENDENT
REGISTERED PUBLIC ACCOUNTING FIRM



To the Board of Directors

AF Financial Group and Subsidiaries

West Jefferson, North Carolina



We have audited the accompanying consolidated statements of financial
condition of AF Financial Group and subsidiaries as of June 30, 2005 and 2004, and the related consolidated statements of income (loss), stockholders equity, and cash flows for the years then ended. These consolidated financial statements are
the responsibility of the Companys management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.



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



In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of AF Financial Group and subsidiaries as of June 30, 2005 and 2004, and the results of their operations and their cash flows for the years then ended, in conformity with accounting
principles generally accepted in the United States of America.





|                         
|-------------------------
|LOGO                     
|                         
|Charlotte, North Carolina
|September 6, 2005        



- 41 -



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##### Table of Contents

Consolidated Statements of Financial Condition

June 30, 2005 and 2004



|                                                                                                                                               |  |      |             |   |      |   |             |  
|---------------------------------------------------------------------------------------------------------------------------------------------- |  | ---- | ----------- | - | ---- | - | ----------- | -
|                                                                                                                                               |  | 2005 |             |   | 2004 |  
|Assets                                                                                                                                         |  |      |             |   |      |   |             |  
|Cash and cash equivalents:                                                                                                                     |  |      |             |   |      |   |             |  
|Interest-bearing deposits                                                                                                                      |  | $    | 2,657,931   |   |      | $ | 2,498,878   |  
|Noninterest-bearing deposits                                                                                                                   |  |      | 6,150,597   |   |      |   | 5,175,174   |  
|Securities held to maturity (fair value $153,787 in 2005 and $529,000 in 2004)                                                                 |  |      | 153,787     |   |      |   | 529,000     |  
|Securities available for sale                                                                                                                  |  |      | 3,891,711   |   |      |   | 4,315,066   |  
|Federal Home Loan Bank stock                                                                                                                   |  |      | 1,704,800   |   |      |   | 1,657,200   |  
|Loans                                                                                                                                          |  |      | 182,627,642 |   |      |   | 181,400,577 |  
|Less allowance for loan losses                                                                                                                 |  |      | (1,385,412  | ) |      |   | (1,245,018  | )
|                                                                                                                                               |  |      |             |   |      |   |             |  
|Loans receivable, net                                                                                                                          |  |      | 181,242,230 |   |      |   | 180,155,559 |  
|Loans held for sale                                                                                                                            |  |      | 1,226,750   |   |      |   | 1,333,600   |  
|Office properties and equipment, net                                                                                                           |  |      | 12,756,375  |   |      |   | 11,515,179  |  
|Accrued interest receivable on loans                                                                                                           |  |      | 886,813     |   |      |   | 855,408     |  
|Accrued interest receivable on investment securities                                                                                           |  |      | 62,373      |   |      |   | 66,402      |  
|Prepaid expenses and other assets                                                                                                              |  |      | 1,719,280   |   |      |   | 1,459,810   |  
|Deferred income taxes, net                                                                                                                     |  |      |            |   |      |   | 381,455     |  
|Goodwill                                                                                                                                       |  |      | 1,648,468   |   |      |   | 1,676,446   |  
|                                                                                                                                               |  |      |             |   |      |   |             |  
|Total assets                                                                                                                                   |  | $    | 214,101,115 |   |      | $ | 211,619,177 |  
|                                                                                                                                               |  |      |             |   |      |   |             |  
|Liabilities and Stockholders Equity                                                                                                           |  |      |             |   |      |   |             |  
|Liabilities:                                                                                                                                   |  |      |             |   |      |   |             |  
|Savings deposits                                                                                                                               |  | $    | 163,976,928 |   |      | $ | 157,433,544 |  
|Short-term borrowings                                                                                                                          |  |      | 2,570,544   |   |      |   | 5,497,818   |  
|Long-term borrowings                                                                                                                           |  |      | 31,968,407  |   |      |   | 33,914,162  |  
|Accounts payable and other liabilities                                                                                                         |  |      | 1,853,628   |   |      |   | 1,764,907   |  
|Deferred income taxes, net                                                                                                                     |  |      | 76,373      |   |      |   |            |  
|Redeemable common stock held by the Employee Stock Ownership Plan (ESOP), net of unearned ESOP shares                                          |  |      | 616,266     |   |      |   | 534,750     |  
|                                                                                                                                               |  |      |             |   |      |   |             |  
|Total liabilities                                                                                                                              |  |      | 201,062,146 |   |      |   | 199,145,181 |  
|                                                                                                                                               |  |      |             |   |      |   |             |  
|Commitments and contingencies                                                                                                                  |  |      |             |   |      |   |             |  
|Stockholders equity:                                                                                                                          |  |      |             |   |      |   |             |  
|Common stock, par value $.01 per share; authorized 5,000,000 shares; 1,053,675 shares issued and 1,049,835 shares outstanding at 2005 and
2004 |  |      | 10,537      |   |      |   | 10,537      |  
|Additional paid-in capital                                                                                                                     |  |      | 4,687,955   |   |      |   | 4,653,933   |  
|Retained earnings, substantially restricted                                                                                                    |  |      | 8,375,186   |   |      |   | 7,874,017   |  
|Accumulated other comprehensive income                                                                                                         |  |      | 40,171      |   |      |   | 10,389      |  
|                                                                                                                                               |  |      |             |   |      |   |             |  
|                                                                                                                                               |  |      | 13,113,849  |   |      |   | 12,548,876  |  
|Less cost of 3,840 shares of treasury stock                                                                                                    |  |      | (74,880     | ) |      |   | (74,880     | )
|                                                                                                                                               |  |      |             |   |      |   |             |  
|Total stockholders equity                                                                                                                     |  |      | 13,038,969  |   |      |   | 12,473,996  |  
|                                                                                                                                               |  |      |             |   |      |   |             |  
|Total liabilities and stockholders equity                                                                                                     |  | $    | 214,101,115 |   |      | $ | 211,619,177 |  
|                                                                                                                                               |  |      |             |   |      |   |             |  



See Notes to Consolidated
Financial Statements



- 42 -



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##### Table of Contents

Consolidated Statements of Income (Loss)

Years ended June 30, 2005 and 2004



|                                                    |  |      |            |   |      |   |            |  
|--------------------------------------------------- |  | ---- | ---------- | - | ---- | - | ---------- | -
|                                                    |  | 2005 |            |   | 2004 |  
|Interest and dividend income:                       |  |      |            |   |      |   |            |  
|Loans                                               |  | $    | 11,693,803 |   |      | $ | 10,398,702 |  
|Investment securities                               |  |      | 229,336    |   |      |   | 241,959    |  
|Interest-bearing deposits                           |  |      | 71,970     |   |      |   | 42,931     |  
|                                                    |  |      |            |   |      |   |            |  
|Total interest and dividend income                  |  |      | 11,995,109 |   |      |   | 10,683,592 |  
|                                                    |  |      |            |   |      |   |            |  
|Interest expense:                                   |  |      |            |   |      |   |            |  
|Savings deposits                                    |  |      | 2,791,394  |   |      |   | 2,702,583  |  
|Short-term borrowings                               |  |      | 138,041    |   |      |   | 32,824     |  
|Long-term borrowings                                |  |      | 1,803,777  |   |      |   | 1,669,404  |  
|                                                    |  |      |            |   |      |   |            |  
|Total interest expense                              |  |      | 4,733,212  |   |      |   | 4,404,811  |  
|                                                    |  |      |            |   |      |   |            |  
|Net interest income                                 |  |      | 7,261,897  |   |      |   | 6,278,781  |  
|Provision for loan losses:                          |  |      | (78,922    | ) |      |   | 668,000    |  
|                                                    |  |      |            |   |      |   |            |  
|Net interest income after provision for loan losses |  |      | 7,340,819  |   |      |   | 5,610,781  |  
|                                                    |  |      |            |   |      |   |            |  
|Noninterest income:                                 |  |      |            |   |      |   |            |  
|Insurance commissions                               |  |      | 2,533,852  |   |      |   | 2,375,598  |  
|Other                                               |  |      | 1,431,665  |   |      |   | 1,368,232  |  
|                                                    |  |      |            |   |      |   |            |  
|Total noninterest income                            |  |      | 3,965,517  |   |      |   | 3,743,830  |  
|                                                    |  |      |            |   |      |   |            |  
|Noninterest expense:                                |  |      |            |   |      |   |            |  
|Compensation and employee benefits                  |  |      | 5,739,162  |   |      |   | 5,508,835  |  
|Occupancy and equipment                             |  |      | 1,342,966  |   |      |   | 1,267,694  |  
|Computer processing charges                         |  |      | 673,244    |   |      |   | 627,253    |  
|Other                                               |  |      | 2,409,041  |   |      |   | 2,381,798  |  
|                                                    |  |      |            |   |      |   |            |  
|Total noninterest expense                           |  |      | 10,164,413 |   |      |   | 9,785,580  |  
|                                                    |  |      |            |   |      |   |            |  
|Income (loss) before income taxes                   |  |      | 1,141,923  |   |      |   | (430,969   | )
|Income taxes (benefit):                             |  |      | 493,146    |   |      |   | (122,715   | )
|                                                    |  |      |            |   |      |   |            |  
|Net income (loss)                                   |  | $    | 648,777    |   |      | $ | (308,254   | )
|                                                    |  |      |            |   |      |   |            |  
|Basic earnings (loss) per share                     |  | $    | 0.62       |   |      | $ | (0.30      | )
|                                                    |  |      |            |   |      |   |            |  
|Diluted earnings (loss) per share                   |  | $    | 0.62       |   |      | $ | (0.30      | )
|                                                    |  |      |            |   |      |   |            |  
|Basic weighted average shares outstanding           |  |      | 1,044,791  |   |      |   | 1,041,091  |  
|                                                    |  |      |            |   |      |   |            |  
|Diluted weighted average shares outstanding         |  |      | 1,045,185  |   |      |   | 1,041,091  |  
|                                                    |  |      |            |   |      |   |            |  



See Notes to Consolidated
Financial Statements



- 43 -



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##### Table of Contents

Consolidated Statements of Stockholders Equity

Years ended June 30, 2005 and 2004



|                                                                               |  |              |        |                            |   |                   |  |   |                                       |   |  |                |         |   |                            |   |         |   |  |   |            |  
|------------------------------------------------------------------------------ |  | ------------ | ------ | -------------------------- | - | ----------------- |  | - | ------------------------------------- | - |  | -------------- | ------- | - | -------------------------- | - | ------- | - |  | - | ---------- | -
|                                                                               |  | Common Stock |        | Additional Paid-in Capital |   | Retained Earnings |  |   | Accumulated Other ComprehensiveIncome |   |  | Treasury Stock |         |   | Total Stockholders Equity |  
|Balance, June 30, 2003                                                         |  |              | 10,537 |                            |   | 4,619,570         |  |   | 8,346,320                             |   |  |                | 58,737  |   |                            |   | (74,880 | ) |  |   | 12,960,284 |  
|                                                                               |  |              |        |                            |   |                  
|Transfer to redeemable common stock net of unearned ESOP shares                |  |              |       |                            |   |                  |  |   | (55,338                               | ) |  |                |        |   |                            |   |        |   |  |   | (55,338    | )
|ESOP contribution                                                              |  |              |       |                            |   | 34,363            |  |   | 37,037                                |   |  |                |        |   |                            |   |        |   |  |   | 71,400     |  
|Cash dividend, $.20 per share                                                  |  |              |       |                            |   |                  |  |   | (145,748                              | ) |  |                |        |   |                            |   |        |   |  |   | (145,748   | )
|Net loss                                                                       |  |              |       |                            |   |                  |  |   | (308,254                              | ) |  |                |        |   |                            |   |        |   |  |   | (308,254   | )
|Other comprehensive loss, net of tax:                                          |  |              |        |                            |   |                   |  |   |                                       |   |  |                |         |   |                            |   |         |   |  |   |            |  
|Unrealized holding loss arising during period, net of tax benefit of $31,061   |  |              |       |                            |   |                  |  |   |                                      |   |  |                | (48,348 | ) |                            |   |        |   |  |   | (48,348    | )
|                                                                               |  |              |        |                            |   |                   |  |   |                                       |   |  |                |         |   |                            |   |         |   |  |   |            |  
|Comprehensive loss                                                             |  |              |        |                            |   |                   |  |   |                                       |   |  |                |         |   |                            |   |         |   |  |   | (356,602   | )
|                                                                               |  |              |        |                            |   |                   |  |   |                                       |   |  |                |         |   |                            |   |         |   |  |   |            |  
|Balance, June 30, 2004                                                         |  |              | 10,537 |                            | $ | 4,653,933         |  | $ | 7,874,017                             |   |  | $              | 10,389  |   |                            | $ | (74,880 | ) |  | $ | 12,473,996 |  
|                                                                               |  |              |        |                            |   |                  
|Transfer to redeemable common stock net of unearned ESOP shares                |  |              |       |                            |   |                  |  |   | (81,516                               | ) |  |                |        |   |                            |   |        |   |  |   | (81,516    | )
|ESOP contribution                                                              |  |              |       |                            |   | 34,022            |  |   | 36,999                                |   |  |                |        |   |                            |   |        |   |  |   | 71,021     |  
|Cash dividend, $.20 per share                                                  |  |              |       |                            |   |                  |  |   | (103,091                              | ) |  |                |        |   |                            |   |        |   |  |   | (103,091   | )
|Net income                                                                     |  |              |       |                            |   |                  |  |   | 648,777                               |   |  |                |        |   |                            |   |        |   |  |   | 648,777    |  
|Other comprehensive income, net of tax:                                        |  |              |        |                            |   |                   |  |   |                                       |   |  |                |         |   |                            |   |         |   |  |   |            |  
|Unrealized holding income arising during period, net of tax benefit of $19,132 |  |              |       |                            |   |                  |  |   |                                      |   |  |                | 29,782  |   |                            |   |        |   |  |   | 29,782     |  
|                                                                               |  |              |        |                            |   |                   |  |   |                                       |   |  |                |         |   |                            |   |         |   |  |   |            |  
|Comprehensive income                                                           |  |              |        |                            |   |                   |  |   |                                       |   |  |                |         |   |                            |   |         |   |  |   | 678,559    |  
|                                                                               |  |              |        |                            |   |                   |  |   |                                       |   |  |                |         |   |                            |   |         |   |  |   |            |  
|Balance, June 30, 2005                                                         |  | $            | 10,537 |                            | $ | 4,687,955         |  | $ | 8,375,186                             |   |  | $              | 40,171  |   |                            | $ | (74,880 | ) |  | $ | 13,038,969 |  
|                                                                               |  |              |        |                            |   |                   |  |   |                                       |   |  |                |         |   |                            |   |         |   |  |   |            |  



See Notes to Consolidated
Financial Statements



- 44 -



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##### Table of Contents

Consolidated Statements of Cash Flows

Years ended June 30, 2005 and 2004



|                                                                                         |  |      |             |   |      |   |             |  
|---------------------------------------------------------------------------------------- |  | ---- | ----------- | - | ---- | - | ----------- | -
|                                                                                         |  | 2005 |             |   | 2004 |  
|Cash flows from operating activities                                                     |  |      |             |   |      |   |             |  
|Net income (loss)                                                                        |  | $    | 648,777     |   |      | $ | (308,254    | )
|Adjustments to reconcile net income (loss) to net cash provided by operating activities: |  |      |             |   |      |   |             |  
|Provision for loan losses                                                                |  |      | (78,922     | ) |      |   | 668,000     |  
|Depreciation                                                                             |  |      | 931,819     |   |      |   | 885,163     |  
|Gain on loans held for sale                                                              |  |      | (75,606     | ) |      |   | (59,607     | )
|Proceeds from loans held for sale                                                        |  |      | 17,574,106  |   |      |   | 28,095,228  |  
|Originations of loans held for sale                                                      |  |      | (17,391,650 | ) |      |   | (28,180,125 | )
|Amortization of deferred loan fees                                                       |  |      | (135,184    | ) |      |   | (131,777    | )
|ESOP expense                                                                             |  |      | 71,021      |   |      |   | 71,400      |  
|Deferred income taxes                                                                    |  |      | 438,696     |   |      |   | (1,171      | )
|Change in operating assets and liabilities:                                              |  |      |             |   |      |   |             |  
|Accrued interest receivable                                                              |  |      | (27,376     | ) |      |   | (56,302     | )
|Accrued interest payable                                                                 |  |      | (79,729     | ) |      |   | 36,710      |  
|Prepaid expenses and other assets                                                        |  |      | 166,035     |   |      |   | (32,957     | )
|Accounts payable and other liabilities                                                   |  |      | 84,412      |   |      |   | 154,760     |  
|                                                                                         |  |      |             |   |      |   |             |  
|Net cash provided by operating activities                                                |  |      | 2,126,399   |   |      |   | 1,141,068   |  
|                                                                                         |  |      |             |   |      |   |             |  
|Cash flows from investing activities                                                     |  |      |             |   |      |   |             |  
|Purchases of Federal Home Loan Bank stock                                                |  |      | (47,600     | ) |      |   | (599,900    | )
|Purchases of investments held to maturity                                                |  |      | (438,787    | ) |      |   | (1,099,000  | )
|Proceeds from maturities of investments held to maturity                                 |  |      | 814,000     |   |      |   | 670,000     |  
|Purchases of securities available for sale                                               |  |      | (1,900,000  | ) |      |   | (2,000,000  | )
|Proceeds from principal repayment and maturities of securities available for sale        |  |      | 2,355,753   |   |      |   | 5,156,158   |  
|Net originations of loans receivable                                                     |  |      | (1,352,377  | ) |      |   | (25,645,133 | )
|Recovery (investment) in insurance agency assets                                         |  |      | 27,978      |   |      |   | (80,000     | )
|Purchases of office properties and equipment                                             |  |      | (2,267,192  | ) |      |   | (3,728,434  | )
|Proceeds from sale of real estate owned                                                  |  |      | 320,000     |   |      |   | 47,145      |  
|                                                                                         |  |      |             |   |      |   |             |  
|Net cash used in investing activities                                                    |  |      | (2,488,225  | ) |      |   | (27,279,164 | )
|                                                                                         |  |      |             |   |      |   |             |  
|Cash flows from financing activities                                                     |  |      |             |   |      |   |             |  
|Net increase in savings deposits                                                         |  |      | 6,627,422   |   |      |   | 7,867,283   |  
|Short-term borrowings (repayments), net                                                  |  |      | (2,927,274  | ) |      |   | 11,998,085  |  
|Long-term borrowings (repayments), net                                                   |  |      | (2,100,755  | ) |      |   | 20,510      |  
|Dividends paid                                                                           |  |      | (103,091    | ) |      |   | (145,748    | )
|                                                                                         |  |      |             |   |      |   |             |  
|Net cash provided by financing activities                                                |  |      | 1,496,302   |   |      |   | 19,740,130  |  
|                                                                                         |  |      |             |   |      |   |             |  
|Net increase (decrease) in cash and cash equivalents                                     |  |      | 1,134,476   |   |      |   | (6,397,966  | )
|Cash and cash equivalents                                                                |  |      |             |   |      |   |             |  
|Beginning                                                                                |  |      | 7,674,052   |   |      |   | 14,072,018  |  
|                                                                                         |  |      |             |   |      |   |             |  
|Ending                                                                                   |  | $    | 8,808,528   |   |      | $ | 7,674,052   |  
|                                                                                         |  |      |             |   |      |   |             |  



See Notes to Consolidated
Financial Statements



- 45 -



---

##### Table of Contents

Consolidated Statements of Cash Flows

Years ended June 30, 2005 and 2004



|                                                                                  |  |      |           |   |      |   |           |  
|--------------------------------------------------------------------------------- |  | ---- | --------- | - | ---- | - | --------- | -
|                                                                                  |  | 2005 |           |   | 2004 |  
|Supplemental disclosures of cash flow information                                 |  |      |           |   |      |   |           |  
|Cash payments for:                                                                |  |      |           |   |      |   |           |  
|Interest                                                                          |  | $    | 4,812,941 |   |      | $ | 4,368,101 |  
|Income taxes                                                                      |  |      | 48,540    |   |      |   | 78,760    |  
|Supplemental disclosure of noncash investing and financing activities             |  |      |           |   |      |   |           |  
|Net change in unrealized gain (loss) on securities available for sale, net of tax |  | $    | 29,782    |   |      | $ | (48,348   | )
|Transfer from loans receivable to real estate owned                               |  |      | 479,812   |   |      |   | 22,145    |  
|Fair value of ESOP shares in excess of unearned ESOP shares                       |  |      | (44,516   | ) |      |   | (18,302   | )
|Transfer from retained earnings to ESOP redeemable common stock                   |  |      | (81,516   | ) |      |   | (55,338   | )



See Notes to Consolidated
Financial Statements



- 46 -



---

##### Table of Contents

Notes to Consolidated Financial Statements



Note 1. Summary of Significant Accounting Policies



Principles of consolidation



The accompanying consolidated financial statements include the accounts of AF Financial Group and its wholly owned subsidiaries, AF Bank and AF Insurance Services, Inc.,
together referred to as the Company. All significant intercompany transactions and balances have been eliminated in consolidation.



Business segments



The Company reports its activities in various business segments. In determining appropriate segment definition, the Company considers the materiality of potential
segments and components of the business about which financial information is available and regularly evaluated, relative to resource allocation and performance assessment.



Use of Estimates



The accounting and reporting policies of the Company conform to accounting principles generally accepted in the United States of America and general practices within the
financial services industry. In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the
date of the financial statements and the reported revenues and expenses for the period. Actual results could differ from those estimates. Material estimates that are particularly sensitive to significant change relate to the determination of the
allowance for loan losses, mortgage servicing assets and goodwill.



Reclassifications



Certain amounts in the financial
statements for the year ended June 30, 2004 have been reclassified to conform to the presentation of the financial statements for the year ended June 30, 2005. The reclassifications had no effect on net income (loss) or stockholders equity as
previously reported.



Cash and cash equivalents



For purposes of reporting the statement of cash flows, the Company
includes cash on hand and demand deposits at other financial institutions with terms less than 90 days as cash and cash equivalents. Cash flows from loans and deposits are reported net. The Company maintains amounts due from banks which, at times,
may exceed federally insured limits. The Company has not experienced any losses in such accounts.



Investment securities



The Bank
has investments in debt and equity securities. Debt securities consist primarily of U.S. Government agency securities, Federal Home Loan Bank bonds, Fannie Mae and Government National Mortgage Association securities and certificates of deposit.
Equity securities consist of Federal Home Loan Mortgage Corporation (FHLMC) stock and mutual funds.



Management classifies all debt securities and certain equity securities as trading, available for sale, or held to maturity as individual investment securities are acquired, and thereafter the appropriateness of such
classification is reassessed at each statement of financial condition date. Because the Company does not buy investment securities in anticipation of short-term fluctuations in market prices, none of the investment securities are classified as
trading in accordance with Statement of Financial Accounting Standards (SFAS) No. 115. All securities have been classified as either available for sale or held to maturity.



Declines in the fair value of individual securities classified as either available for sale or held to maturity below their amortized cost,
that are determined to be other than temporary, result in write-downs of the individual securities to their fair value with the resulting write-downs included in current earnings as realized losses. In estimating other



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 1. Summary of Significant Accounting Policies, continued



than temporary impairment losses, management considers (1) the length of time and the extent to which the fair value has been less than
cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer of a period of time sufficient to allow for any anticipated recovery in fair value.



Securities available for sale



Securities classified as available for sale are those securities that the Company intends to
hold for an indefinite period of time but, in the case of debt securities, not necessarily to maturity. Any decision to sell a security classified as available for sale would be based on various factors, including significant movements in interest
rates, changes in the maturity mix of the Companys assets and liabilities, liquidity needs, regulatory capital considerations, and other similar factors. Securities available for sale are carried at fair value. Premiums and discounts are
amortized using the interest method over the securities contractual lives. Unrealized gains or losses are reported as increases or decreases in equity, net of the related deferred tax effect. Realized gains or losses, determined on the basis
of the cost of specific securities sold, are included in income.



Securities held to maturity



Securities classified as
held to maturity are those securities for which the Company has both the intent and ability to hold to maturity regardless of changes in market conditions, liquidity needs or changes in general economic conditions. These securities are carried at
cost adjusted for amortization of premium and accretion of discount, computed by the interest method over their contractual lives. Based on the Companys financial position and liquidity, management believes the Company has the ability to hold
these securities to maturity.



Investment in Federal Home Loan Bank stock



The Bank, as a member of the Federal Home Loan Bank (FHLB) system, is
required to maintain an investment in capital stock of the FHLB. No ready market exists for the FHLB stock, it has no quoted market value and it is carried at cost. The FHLB stock also collateralizes the Companys borrowings from the FHLB. Due
to the redemption provisions of the FHLB, the Company estimated that the fair value equals cost and that this investment was not impaired at June 30, 2005.



Loans receivable



The Bank grants mortgage, commercial and consumer loans to customers. The Banks loan portfolio consists principally of mortgage loans collateralized by first trust deeds on single family residences, other
residential property, commercial property and land. The ability of the Banks debtors to honor their contracts is dependent upon the real estate and general economic conditions in the market area.



Loans receivable are stated at unpaid principal balances, less the allowance for loan losses,
the loans sold and net deferred loan-origination fees and costs. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the related
loan yield using the interest method.



The accrual of interest on loans is
discontinued at the time the loan is 90 days past due or impaired. Past due status is based on contractual terms of the loan. In all cases, loans are placed on non-accrual or charged-off at an earlier date if collection of principal or interest is
considered doubtful according to internal evaluation policies.



All interest
accrued but not collected for loans that are placed on non-accrual or charged off is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual.
Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 1. Summary of Significant Accounting Policies, continued



Loans held for sale



Mortgage loans originated and intended for sale in the secondary market are carried at the lower of aggregate cost or fair value as determined by aggregate outstanding
commitments from investors. Market values on mortgage loans originated and intended for sale in the secondary market are determined by discounting future cash flows at current market rates. Mortgage loans held for sale are sold with servicing rights
retained. Gains or losses on sales of mortgage loans are recognized based upon the difference between the selling price and the carrying value of the related mortgage loans sold. The terms of the loans are set by the secondary investors and are
transferred to them at par within several weeks of the Bank initially funding the loan. The Bank receives origination fees from borrowers. Between the initial funding of the loans by the Bank and the subsequent reimbursement by the investors, the
Bank carries the loans on its statement of financial condition at cost. The Bank has no recourse obligation on loans sold.



Allowance for loan losses



The allowance for loan losses is increased by charges to income and decreased by charge-offs (net of recoveries) based on the Banks evaluation of the potential and
inherent risk of losses in its loan portfolio. The allowance for loan losses is evaluated on a regular basis by management and is based upon periodic review of the Banks past loan loss experience, known and inherent risks in the portfolio,
adverse situations that may affect the borrowers ability to repay, the estimated value of any underlying collateral, and current economic conditions. While management uses the best information available to make evaluations, future adjustments
may be necessary if economic or other conditions differ or change substantially from the assumptions used.



The allowance consists of specific, general and unallocated components. The specific component relates to loans that are classified as doubtful, substandard or special mention. The general component covers
non-classified loans and is based on historical loss experience adjusted for qualitative factors. An unallocated component is maintained to cover uncertainties that could affect managements estimate of probable losses. The unallocated
component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.



Impaired loans



SFAS No. 114, Accounting by Creditors for Impairment of a Loan, requires that the Bank establish a specific loan allowance on an impaired loan if the present value
of the future cash flows discounted using the loans effective interest rate is less than the carrying value of the loan. An impaired loan can also be valued based upon its fair value or the market value of the underlying collateral if the loan
is primarily collateral dependent. The Bank assesses all loans delinquent more than 90 days for impairment. See Note 3 for further information.



Interest income



SFAS No. 118, Accounting by Creditors for Impairment of a Loan  Income Recognition and Disclosures, which amended SFAS No. 114 requires disclosure of the Banks method of accounting for interest
income on impaired loans. The Bank does not accrue interest on loans delinquent 90 days or more. In addition, interest accrued up to 90 days is reversed by the establishment of a reserve for uncollectible interest if in the opinion of management
collectibility is uncertain. Such interest, if ultimately collected, is credited to income in the period received.



Loan origination fees and related costs



Loan fees and certain direct loan origination costs are deferred, and the net fee or cost is recognized as an adjustment to interest income using the interest method over
the contractual life of the loans, adjusted for actual prepayments.



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 1. Summary of Significant Accounting Policies, continued



Real estate owned



Real estate owned is initially recorded at the estimated fair value at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations of
the property are periodically performed by management and the real estate is carried at the lower of cost or fair value minus estimated costs to sell. Costs relating to improvement of the property are capitalized, while holding costs of the property
are charged to expense in the period incurred.



Office properties and
equipment



Land is carried at cost. Office premises and equipment are
stated at cost less accumulated depreciation. Depreciation of premises and equipment is recorded on a straight-line basis over the estimated useful lives of the related assets. Expenditures for maintenance and repairs are charged to expense as
incurred, while those for improvements are capitalized. The costs and accumulated depreciation relating to premises and equipment retired or otherwise disposed of are eliminated from the accounts and any resulting gains or losses are credited or
charged to income.



Goodwill



Goodwill is the cost of the investment by AF Insurance Services, Inc. in excess of the fair
value of net tangible assets acquired at the date of purchase. On July 1, 2002, the Company adopted the provisions of Financial Accounting Standards Board (FASB) Statement 142, Goodwill and Other Intangible Assets. Under the
provisions of the Statement, on July 1, 2002, the Company eliminated the amortization of goodwill. During the 2005 fiscal year a goodwill impairment test was performed and the Company had no impairment of goodwill, but will reevaluate the carrying
value of goodwill annually.



Mortgage Servicing Rights



When mortgage loans are sold, the proceeds are allocated between the
related loans and the retained mortgage servicing rights based on their relative fair value. Servicing assets are amortized over the average period of estimated net servicing income. All servicing assets are assessed for impairment based on their
fair value.



The Company recorded amortization of mortgage servicing rights of
$41,138 for prepayments during the year ended June 30, 2005. The Company recognized impairments of $22,371 during the year ended June 30, 2005.



Employee benefit plans



The Company has deferred compensation and retirement plan agreements for the benefit of the Board of Directors and a key officer. These plans are unfunded and the
liabilities are being accrued over the terms of active service. The Company also has an ESOP which covers substantially all of its employees. Contributions to the plan are based on amounts necessary to fund the amortization requirements of the
ESOPs debt to an unrelated third party financial institution, subject to compensation limitations, and are expensed based on the AICPAs Statement of Position 93-6, Employers Accounting for Employee Stock Ownership Plans.



Additionally, the Company has implemented a qualified stock option plan
authorizing the grant of up to 14,573 stock options to certain officers and directors, either in the form of incentive stock options or non-incentive stock options. As permitted under the generally accepted accounting principles, grants under the
plan are accounted for following the provisions of Accounting Principles Board (APB) Opinion No. 25 and its related interpretations. Accordingly, no compensation cost has been recognized for grants made to date. All options were fully
vested on December 8, 2001.



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 1. Summary of Significant Accounting Policies, continued



Advance payments by borrowers for taxes and insurance



Certain borrowers make monthly payments, in addition to principal and interest, in order to accumulate funds from which the Bank can pay the
borrowers property taxes and insurance premiums.



Income taxes



Deferred taxes are provided on an asset and liability method whereby
deferred tax assets are recognized for deductible temporary differences and operating loss and tax credit carryforwards, and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between
the reported amounts of assets and liabilities and their tax basis. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not
be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.



Off-balance sheet credit related financial instruments



The Bank is a party to financial instruments with off-statement of financial condition risk such as commitments to extend credit and home equity lines of credit.
Management assesses the risk related to these instruments for potential losses on an ongoing basis. Such financial instruments are recorded when they are funded. No allowance for loan losses is provided against these off-balance sheet commitments.



Earnings per share



SFAS No. 128, Earnings Per Share, requires the presentation of earnings per share by
all entities that have common stock or potential common stock, such as options, warrants and convertible securities outstanding that trade in a public market. Basic per-share amounts are computed by dividing net income or loss (the numerator) by the
weighted-average number of common shares outstanding (the denominator). Diluted per-share amounts assume the conversion, exercise or issuance of all potential common stock instruments unless the effect is to reduce the loss or increase the income
per common share from continuing operations. For both computations, the number of shares of common stock purchased by the Companys employee stock ownership plan which have not been allocated to participant accounts are not assumed to be
outstanding.



Comprehensive income



SFAS No. 130, Reporting Comprehensive Income, established standards for reporting and
display of comprehensive income and its components (revenues, expenses, gains and losses) in a full set of general-purpose financial statements. This statement requires that all items that are recognized under accounting standards as components of
comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. Accumulated other comprehensive income in the Companys financial statements relates solely to unrealized gains
and losses on available-for-sale securities.



Insurance Income



Insurance commissions from agency bill policies, or polices where we
bill the customer directly, are earned when due as determined by the respective policy. Commissions from direct bill insurance policies, or policies where the insurance companies we represent bill our customers directly, are recorded when received.



Brokerage Income



Brokerage commissions are recognized in income on a trade-date basis.



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 1. Summary of Significant Accounting Policies, continued



Fair value of financial instruments



The estimated fair values required under SFAS No. 107, Disclosures About Fair Value of Financial Instruments, have been determined by the Company using
available market information and appropriate valuation methodologies. However, considerable judgment is required to develop the estimates of fair value. Accordingly, the estimates presented for the fair value of the Companys financial
instruments are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions or estimation methodologies may have a material effect on the estimated fair market value
amounts.



Note 2. Debt and Equity Securities



Debt and equity securities have been classified in the statements of financial condition
according to managements intent. The carrying amount of securities and approximate fair values as of June 30 were as follows:



|                                                        |  |               |           |                      |   |                       |  |   |            |   |  |   |          
|------------------------------------------------------- |  | ------------- | --------- | -------------------- | - | --------------------- |  | - | ---------- | - |  | - | ---------
|                                                        |  | 2005         
|                                                        |  | AmortizedCost |           | GrossUnrealizedGains |   | GrossUnrealizedLosses |  |   | Fair Value
|Available for sale securities:                          |  |               |           |                      |   |                       |  |   |            |   |  |   |          
|Debt securities:                                        |  |               |           |                      |   |                       |  |   |            |   |  |   |          
|U.S. Government agency securities                       |  | $             | 1,400,000 |                      | $ |                      |  | $ | (8,121     | ) |  | $ | 1,391,879
|Fannie Mae and Government National Mortgage Association |  |               | 1,137,488 |                      |   | 14,776                |  |   | (3,518     | ) |  |   | 1,148,746
|Municipals                                              |  |               | 287,128   |                      |   | 16,934                |  |   |           |   |  |   | 304,062  
|Equity securities:                                      |  |               |           |                      |   |                       |  |   |            |   |  |   |          
|Mutual funds                                            |  |               | 1,000,000 |                      |   |                      |  |   | (40,384    | ) |  |   | 959,616  
|Federal Home Loan Mortgage Corporation common stock     |  |               | 1,117     |                      |   | 86,291                |  |   |           |   |  |   | 87,408   
|                                                        |  |               |           |                      |   |                       |  |   |            |   |  |   |          
|                                                        |  | $             | 3,825,733 |                      | $ | 118,001               |  | $ | (52,023    | ) |  | $ | 3,891,711
|                                                        |  |               |           |                      |   |                       |  |   |            |   |  |   |          
|Held to maturity securities:                            |  |               |           |                      |   |                       |  |   |            |   |  |   |          
|Debt securities:                                        |  |               |           |                      |   |                       |  |   |            |   |  |   |          
|Certificates of deposit                                 |  |               | 153,787   |                      |   |                      |  |   |           |   |  |   | 153,787  
|                                                        |  |               |           |                      |   |                       |  |   |            |   |  |   |          
|                                                        |  | $             | 153,787   |                      | $ |                      |  | $ |           |   |  | $ | 153,787  
|                                                        |  |               |           |                      |   |                       |  |   |            |   |  |   |          



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 2. Debt and Equity Securities, continued



|                                                        |  |               |           |                      |   |                       |  |   |            |   |  |   |          
|------------------------------------------------------- |  | ------------- | --------- | -------------------- | - | --------------------- |  | - | ---------- | - |  | - | ---------
|                                                        |  | 2004         
|                                                        |  | AmortizedCost |           | GrossUnrealizedGains |   | GrossUnrealizedLosses |  |   | Fair Value
|Available for sale securities:                          |  |               |           |                      |   |                       |  |   |            |   |  |   |          
|Debt securities:                                        |  |               |           |                      |   |                       |  |   |            |   |  |   |          
|U.S. Government agency securities                       |  | $             | 1,300,000 |                      | $ | 1,248                 |  | $ | (1,405     | ) |  | $ | 1,299,843
|Fannie Mae and Government National Mortgage Association |  |               | 1,710,449 |                      |   | 10,515                |  |   | (14,876    | ) |  |   | 1,706,088
|Municipals                                              |  |               | 286,436   |                      |   | 13,960                |  |   |           |   |  |   | 300,396  
|Equity securities:                                      |  |               |           |                      |   |                       |  |   |            |   |  |   |          
|Mutual funds                                            |  |               | 1,000,000 |                      |   | 3,660                 |  |   | (79,743    | ) |  |   | 923,917  
|Federal Home Loan Mortgage Corporation common stock     |  |               | 1,117     |                      |   | 83,705                |  |   |           |   |  |   | 84,822   
|                                                        |  |               |           |                      |   |                       |  |   |            |   |  |   |          
|                                                        |  | $             | 4,298,002 |                      | $ | 113,088               |  | $ | (96,024    | ) |  | $ | 4,315,066
|                                                        |  |               |           |                      |   |                       |  |   |            |   |  |   |          
|Held to maturity securities:                            |  |               |           |                      |   |                       |  |   |            |   |  |   |          
|Debt securities:                                        |  |               |           |                      |   |                       |  |   |            |   |  |   |          
|Federal Home Loan Bank                                  |  | $             | 100,000   |                      | $ |                      |  | $ |           |   |  | $ | 100,000  
|Certificates of deposit                                 |  |               | 429,000   |                      |   |                      |  |   |           |   |  |   | 429,000  
|                                                        |  |               |           |                      |   |                       |  |   |            |   |  |   |          
|                                                        |  | $             | 529,000   |                      | $ |                      |  | $ |           |   |  | $ | 529,000  
|                                                        |  |               |           |                      |   |                       |  |   |            |   |  |   |          



The following table shows
investments gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at June 30, 2005. These unrealized losses on investment
securities are a result of volatility in the market during 2005 and relate to four federal agency securities, one mortgage-back security, and two mutual funds. All unrealized losses on investment securities are considered by management to be
temporary given the credit ratings on these investment securities and the short duration of the unrealized loss.



|                                                        |  |                     |           |                   |   |            |  |                  |           |            |   |                  |  |   |           |  |   |       
|------------------------------------------------------- |  | ------------------- | --------- | ----------------- | - | ---------- |  | ---------------- | --------- | ---------- | - | ---------------- |  | - | --------- |  | - | ------
|                                                        |  | 2005               
|                                                        |  | Less Than 12 Months |           | 12 Months or More |   | Total     
|                                                        |  | Fair Value          |           | UnrealizedLosses  |   | Fair Value |  | UnrealizedLosses |           | Fair Value |   | UnrealizedLosses
|Securities available for sale:                          |  |                     |           |                   |   |            |  |                  |           |            |   |                  |  |   |           |  |   |       
|U.S. government agencies                                |  | $                   | 599,250   |                   | $ | 750        |  | $                | 792,629   |            | $ | 7,371            |  | $ | 1,391,879 |  | $ | 8,121 
|Fannie Mae and Government National Mortgage Association |  |                     | 293,226   |                   |   | 3,518      |  |                  |          |            |   |                 |  |   | 293,226   |  |   | 3,518 
|Mutual funds                                            |  |                     | 199,779   |                   |   | 221        |  |                  | 548,540   |            |   | 51,460           |  |   | 748,319   |  |   | 51,681
|                                                        |  |                     |           |                   |   |            |  |                  |           |            |   |                  |  |   |           |  |   |       
|Total temporarily impaired securities                   |  | $                   | 1,092,255 |                   | $ | 4,489      |  | $                | 1,341,169 |            | $ | 58,831           |  | $ | 2,433,424 |  | $ | 63,320
|                                                        |  |                     |           |                   |   |            |  |                  |           |            |   |                  |  |   |           |  |   |       



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 2. Debt and Equity Securities, continued



|                                                        |  |                     |           |                   |   |            |  |                  |         |            |   |                  |  |   |           |  |   |       
|------------------------------------------------------- |  | ------------------- | --------- | ----------------- | - | ---------- |  | ---------------- | ------- | ---------- | - | ---------------- |  | - | --------- |  | - | ------
|                                                        |  | 2004               
|                                                        |  | Less Than 12 Months |           | 12 Months or More |   | Total     
|                                                        |  | Fair Value          |           | UnrealizedLosses  |   | Fair Value |  | UnrealizedLosses |         | Fair Value |   | UnrealizedLosses
|Securities available for sale:                          |  |                     |           |                   |   |            |  |                  |         |            |   |                  |  |   |           |  |   |       
|U.S. government agencies                                |  | $                   | 498,595   |                   | $ | 157        |  | $                |        |            | $ |                 |  | $ | 498,595   |  | $ | 157   
|                                                        |  |                     |           |                   |   |           
|Fannie Mae and Government National Mortgage Association |  |                     | 1,117,422 |                   |   | 14,877     |  |                  |        |            |   |                 |  |   | 1,117,422 |  |   | 14,877
|                                                        |  |                     |           |                   |   |           
|Mutual funds                                            |  |                     | 196,899   |                   |   | 3,101      |  |                  | 523,358 |            |   | 76,642           |  |   | 720,257   |  |   | 79,743
|                                                        |  |                     |           |                   |   |            |  |                  |         |            |   |                  |  |   |           |  |   |       
|Total temporarily impaired securities                   |  | $                   | 1,812,916 |                   | $ | 18,135     |  | $                | 523,358 |            | $ | 76,642           |  | $ | 2,336,274 |  | $ | 94,777
|                                                        |  |                     |           |                   |   |            |  |                  |         |            |   |                  |  |   |           |  |   |       



The amortized cost and estimated fair
value of debt securities at June 30, 2005, by contractual maturity are shown below. Fannie Mae and Government National Mortgage Association securities are not included in the maturity categories because they do not have a single maturity date.
Additionally, equity securities and mutual funds are not included in the maturity categories because they do not have contractual maturities.



|                                                                        |  |                              |         |                                |   |               |  |            |           |  |   |          
|----------------------------------------------------------------------- |  | ---------------------------- | ------- | ------------------------------ | - | ------------- |  | ---------- | --------- |  | - | ---------
|                                                                        |  | Held to maturity securities: |         | Available for sale securities:
|                                                                        |  | AmortizedCost                |         | Fair Value                     |   | AmortizedCost |  | Fair Value
|Due within one year                                                     |  | $                            | 153,787 |                                | $ | 153,787       |  | $          | -         |  | $ | -        
|Due from one year to five years                                         |  |                              |        |                                |   |              |  |            | 800,000   |  |   | 794,409  
|Due from five to ten years                                              |  |                              |        |                                |   |              |  |            | 600,000   |  |   | 597,470  
|Due after ten years                                                     |  |                              |        |                                |   |              |  |            | 287,128   |  |   | 304,062  
|Fannie Mae and Government National Mortgage Association debt securities |  |                              |        |                                |   |              |  |            | 1,137,488 |  |   | 1,148,746
|Mutual funds                                                            |  |                              |        |                                |   |              |  |            | 1,000,000 |  |   | 959,616  
|Equity securities                                                       |  |                              |        |                                |   |              |  |            | 1,117     |  |   | 87,408   
|                                                                        |  |                              |         |                                |   |               |  |            |           |  |   |          
|                                                                        |  | $                            | 153,787 |                                | $ | 153,787       |  | $          | 3,825,733 |  | $ | 3,891,711
|                                                                        |  |                              |         |                                |   |               |  |            |           |  |   |          





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##### Table of Contents

Notes to Consolidated Financial Statements



Note 3. Loans Receivable



Loans receivable at June 30, 2005 and 2004 consist of the following: (Dollars in thousands)



|                          |  |      |         |      |   |        
|------------------------- |  | ---- | ------- | ---- | - | -------
|                          |  | 2005 |         | 2004
|One to four-family        |  | $    | 96,368  |      | $ | 94,691 
|Multifamily               |  |      | 4,171   |      |   | 5,728  
|Non-residential           |  |      | 27,154  |      |   | 28,958 
|Land                      |  |      | 17,155  |      |   | 13,906 
|Construction loans        |  |      | 11,416  |      |   | 14,203 
|Commercial loans          |  |      | 15,972  |      |   | 12,626 
|Consumer loans            |  |      | 10,611  |      |   | 11,512 
|                          |  |      |         |      |   |        
|                          |  |      | 182,847 |      |   | 181,624
|Less:                     |  |      |         |      |   |        
|Deferred loan fees        |  |      | 220     |      |   | 223    
|Allowance for loan losses |  |      | 1,385   |      |   | 1,245  
|                          |  |      |         |      |   |        
|                          |  | $    | 181,242 |      | $ | 180,156
|                          |  |      |         |      |   |        



There were $1,226,750 outstanding
commitments to sell loans as of June 30, 2005.



The following is an analysis of
the allowance for loan losses for the years ended June 30:



|                           |  |      |           |   |      |   |           |  
|-------------------------- |  | ---- | --------- | - | ---- | - | --------- | -
|                           |  | 2005 |           |   | 2004 |  
|Balance, beginning         |  | $    | 1,245,018 |   |      | $ | 1,110,684 |  
|Provisions for loan losses |  |      | (78,922   | ) |      |   | 668,000   |  
|Charge-offs                |  |      | (214,125  | ) |      |   | (603,342  | )
|Recoveries                 |  |      | 433,441   |   |      |   | 69,676    |  
|                           |  |      |           |   |      |   |           |  
|Balance, ending            |  | $    | 1,385,412 |   |      | $ | 1,245,018 |  
|                           |  |      |           |   |      |   |           |  



SFAS No. 114, Accounting by Creditors
for Impairment of a Loan, as amended by SFAS No. 118, Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosure, requires that the Bank establish a specific allowance on impaired loans and disclosure of the Banks
method of accounting for interest income on impaired loans. The Company considers all loans delinquent more than 90 days to be impaired and such loans amounted to approximately $185,000 and $518,801 at June 30, 2005 and 2004, respectively. These
loans are primarily collateral dependent and management has determined that the underlying collateral value is in excess of the carrying amounts. As a result, the Company has determined that specific allowances on these loans are not required. The
Company established reserves for uncollectible interest totaling $2,161 and $3,538 at June 30, 2005 and 2004, respectively.



The effect of not recognizing interest income on non accrual loans in accordance with the original terms totaled approximately $25,724 and $38,943 during the years ended
June 30, 2005 and 2004, respectively. Interest income actually recognized on a cash basis on impaired loans during the years ended June 30, 2005 and 2004 was $14,094 and $24,965, respectively.



The Bank may renegotiate the terms of certain loans to provide a reduction of interest or
principal because of deterioration on the financial position of the borrower. These loans are considered troubled debt restructuring. As of June 30, 2005 and 2004, troubled debt restructured loans totaled $1,526,293 and $453,579, respectively.



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 4. Loan Servicing



Mortgage loans serviced for others consist of loans sold to Fannie Mae and are not included in the accompanying statements of financial condition. Mortgage loan
portfolios serviced for Fannie Mae were $63,589,523 and $57,642,348 at June 2005 and 2004, respectively.



Servicing loans for others generally consists of collecting mortgage payments, maintaining escrow accounts, disbursing payment to investors and foreclosure processing. The carrying value of mortgage servicing rights
is included as other assets in the Consolidated Balance Sheets. At June 30, 2005 and 2004, mortgage servicing assets were $307,660 and $203,734, respectively.



Mortgage servicing rights are amortized into non-interest income in proportion to and over the period of estimated future net servicing income of the underlying
financial assets. The amortization is adjusted prospectively in response to changes in estimated projections of future cash flows. Servicing assets are evaluated for impairment based upon the fair value of the rights as compared to amortized cost.
Impairment is determined by stratifying rights by predominant characteristics, such as interest rates and terms. Fair value is determined using prices for similar assets with similar characteristics. Impairment is recognized to the extent that the
capitalized amount for the stratum exceeds their fair value. The following summarizes mortgage servicing rights activity for the years ended June 30, 2005:



|                                            |  |      |         |  
|------------------------------------------- |  | ---- | ------- | -
|                                            |  | 2005 |        
|Mortgage servicing asset, beginning of year |  | $    | 203,734 |  
|Capitalized                                 |  |      | 167,435 |  
|Amortization                                |  |      | (41,138 | )
|Other than temporary impairment             |  |      | (22,371 | )
|                                            |  |      |         |  
|Mortgage servicing assets, end of year      |  | $    | 307,660 |  
|                                            |  |      |         |  



Note 5. Office Properties and
Equipment



Office properties and equipment at June 30 consist of the
following:



|                                               |  |      |            |   |      |   |            |  
|---------------------------------------------- |  | ---- | ---------- | - | ---- | - | ---------- | -
|                                               |  | 2005 |            |   | 2004 |  
|Land and land improvements                     |  | $    | 2,448,444  |   |      | $ | 2,448,444  |  
|Buildings                                      |  |      | 10,200,583 |   |      |   | 8,373,369  |  
|Furniture, fixtures, equipment and automobiles |  |      | 3,948,007  |   |      |   | 3,838,575  |  
|Leasehold improvements                         |  |      | 498,496    |   |      |   | 583,646    |  
|                                               |  |      |            |   |      |   |            |  
|                                               |  |      | 17,095,530 |   |      |   | 15,244,034 |  
|Accumulated depreciation                       |  |      | (4,339,155 | ) |      |   | (3,728,855 | )
|                                               |  |      |            |   |      |   |            |  
|                                               |  | $    | 12,756,375 |   |      | $ | 11,515,179 |  
|                                               |  |      |            |   |      |   |            |  



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 6. Savings Deposits



Savings deposits at June 30 consist of the following:



|                                                                                           |  |      |             |   |      |   |             |  
|------------------------------------------------------------------------------------------ |  | ---- | ----------- | - | ---- | - | ----------- | -
|                                                                                           |  | 2005 |             |   | 2004 |  
|Interest bearing checking accounts at 0.65% (2005) and 0.49% (2004)                        |  | $    | 23,770,734  |   |      | $ | 22,723,918  |  
|Noninterest bearing checking accounts                                                      |  |      | 18,007,299  |   |      |   | 13,792,425  |  
|Savings accounts at 1.43% (2005) and 1.12% (2004)                                          |  |      | 39,498,735  |   |      |   | 42,494,831  |  
|Money market demand accounts at 0.49% (2005) and 0.48% (2004)                              |  |      | 1,017,283   |   |      |   | 1,646,249   |  
|                                                                                           |  |      |             |   |      |   |             |  
|                                                                                           |  |      | 82,294,051  |   |      |   | 80,657,423  |  
|                                                                                           |  |      |             |   |      |   |             |  
|Certificates of deposit weighted average rate of 3.05% (2005) and 2.55% (2004) Up to 6.00% |  |      | 79,827,974  |   |      |   | 74,727,044  |  
|6.00% to 7.60%                                                                             |  |      | 1,598,743   |   |      |   | 1,708,880   |  
|                                                                                           |  |      |             |   |      |   |             |  
|                                                                                           |  |      | 81,426,717  |   |      |   | 76,435,924  |  
|                                                                                           |  |      |             |   |      |   |             |  
|Accrued interest payable                                                                   |  |      | 256,160     |   |      |   | 340,197     |  
|                                                                                           |  |      |             |   |      |   |             |  
|                                                                                           |  | $    | 163,976,928 |   |      | $ | 157,433,544 |  
|                                                                                           |  |      |             |   |      |   |             |  
|Weighted average cost of savings deposits                                                  |  |      | 1.95        | % |      |   | 1.62        | %
|                                                                                           |  |      |             |   |      |   |             |  



At June 30, 2005, scheduled maturities
of certificates of deposit are as follows:



|               |  |      |            |      |   |            |  |      |           |       |   |         |  |   |           |  |   |           
|-------------- |  | ---- | ---------- | ---- | - | ---------- |  | ---- | --------- | ----- | - | ------- |  | - | --------- |  | - | ----------
|               |  | 2006 |            | 2007 |   | 2008       |  | 2009 |           | After |   | Total  
|0.40% to 5.99% |  | $    | 56,938,731 |      | $ | 10,738,324 |  | $    | 9,497,243 |       | $ | 620,328 |  | $ | 2,033,348 |  | $ | 79,827,974
|6.00% to 7.99% |  |      | 1,598,743  |      |   |           |  |      |          |       |   |        |  |   |          |  |   | 1,598,743 
|               |  |      |            |      |   |            |  |      |           |       |   |         |  |   |           |  |   |           
|               |  | $    | 58,537,474 |      | $ | 10,738,324 |  | $    | 9,497,243 |       | $ | 620,328 |  | $ | 2,033,348 |  | $ | 81,426,717
|               |  |      |            |      |   |            |  |      |           |       |   |         |  |   |           |  |   |           



The aggregate amount of jumbo
certificates of deposit with a denomination of greater than $100,000 was $23,493,607 and $21,368,195 at June 30, 2005 and 2004, respectively. At June 30, 2005, scheduled maturities of jumbo certificates of deposit are as follows:



|                          |  |        |            |                      |      |  
|------------------------- |  | ------ | ---------- | -------------------- | ---- | -
|                          |  | Amount |            | WeightedAverage Rate |     
|Maturity period:          |  |        |            |                      |      |  
|Within three months       |  | $      | 6,239,611  |                      | 3.79 | %
|Three through six months  |  |        | 5,478,409  |                      | 2.97 |  
|Six through twelve months |  |        | 4,496,670  |                      | 3.06 |  
|Over twelve months        |  |        | 7,278,917  |                      | 3.84 |  
|                          |  |        |            |                      |      |  
|                          |  | $      | 23,493,607 |                      | 3.48 | %
|                          |  |        |            |                      |      |  



Eligible deposits are insured up to
$100,000 by the Savings Association Insurance Fund (SAIF) which is administered by the FDIC. At June 30, 2005 the Company had $25,808,340 in uninsured deposits.





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##### Table of Contents

Notes to Consolidated Financial Statements



Note 6. Savings Deposits, continued



Interest expense on savings deposits consists of the following for the years ended June 30:



|                                   |  |      |           |      |   |          
|---------------------------------- |  | ---- | --------- | ---- | - | ---------
|                                   |  | 2005 |           | 2004
|Interest-bearing checking accounts |  | $    | 134,116   |      | $ | 122,264  
|Savings accounts                   |  |      | 520,977   |      |   | 543,004  
|Certificate accounts               |  |      | 2,136,301 |      |   | 2,037,315
|                                   |  |      |           |      |   |          
|                                   |  | $    | 2,791,394 |      | $ | 2,702,583
|                                   |  |      |           |      |   |          



Note 7. Short-term and Long-term
Borrowings



Short-term borrowings consist of the following at June 30:



|                                                                                                                                                                                                                                                    |  |      |           |      |   |          
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---- | --------- | ---- | - | ---------
|                                                                                                                                                                                                                                                    |  | 2005 |           | 2004
|Note payable to AsheCo, M.H.C. at the FHLB overnight rate at 3.63% (1.70% at June 30, 2004).                                                                                                                                                        |  | $    | 300,000   |      | $ | 150,000  
|Note payable, due in monthly installments of $7,808 including interest at the banks prime rate of 6.25% (4.00% at June 30, 2004) with a
balloon payment due November 6, 2005. Collateralized by insurance expirations and the right to renew them. |  |      | 270,544   |      |   | 347,818  
|FHLB advances at 3.63% (1.40% at June 30, 2004)                                                                                                                                                                                                     |  |      | 2,000,000 |      |   | 5,000,000
|                                                                                                                                                                                                                                                    |  |      |           |      |   |          
|                                                                                                                                                                                                                                                    |  | $    | 2,570,544 |      | $ | 5,497,818
|                                                                                                                                                                                                                                                    |  |      |           |      |   |          



Long-term borrowings consist of the
following at June 30:



|                                                                                                                                                                                                                                            |  |      |            |      |   |           
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---- | ---------- | ---- | - | ----------
|                                                                                                                                                                                                                                            |  | 2005 |            | 2004
|FHLB advances at weighted average interest rate at June 30, 2005 of 4.57% (4.12% at June 30, 2004)                                                                                                                                          |  | $    | 26,141,664 |      | $ | 28,143,754
|ESOP note payable, interest due quarterly and principal payments due annually at the banks prime rate of 6.25% (4.00% at June 30, 2004).
Collateralized by stock owned by the ESOP.                                                        |  |      | 33,420     |      |   | 70,420    
|Capital securities at rate of 10.25% at June 30, 2005 and 2004                                                                                                                                                                              |  |      | 5,155,000  |      |   | 5,000,000 
|Notes payable, unsecured, due in quarterly interest only installments at 5.50% through December 1, 2004, at which time repayments of principal
and interest commenced over a period of 60 months with first payment due on January 1, 2005. |  |      | 638,322    |      |   | 699,988   
|                                                                                                                                                                                                                                            |  |      |            |      |   |           
|                                                                                                                                                                                                                                            |  | $    | 31,968,406 |      | $ | 33,914,162
|                                                                                                                                                                                                                                            |  |      |            |      |   |           



As of June 30, 2005, the Company had a
$1,500,000 outstanding letter of credit from the FHLB used to collateralize public deposits.



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 8. Related Party Transactions



AF Bank has had, and expect to have in the future, banking transactions in the ordinary course of business with directors, officers and their associates (Related
Parties), on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with others. Loan activity to officers and directors of the Company during the years ended June 30, 2005
and 2004 is summarized as follows:



|                   |  |      |            |   |      |   |            |  
|------------------ |  | ---- | ---------- | - | ---- | - | ---------- | -
|                   |  | 2005 |            |   | 2004 |  
|Balance, beginning |  | $    | 3,993,172  |   |      | $ | 3,215,408  |  
|Disbursements      |  |      | 601,550    |   |      |   | 1,948,547  |  
|Payments received  |  |      | (1,733,060 | ) |      |   | (1,170,783 | )
|                   |  |      |            |   |      |   |            |  
|Balance, ending    |  | $    | 2,861,662  |   |      | $ | 3,993,172  |  
|                   |  |      |            |   |      |   |            |  



Deposits of directors and officers
have terms consistent with those offered to other customers. At June 30, 2005 and 2004, outstanding deposits of directors and officers totaled $2.3 million and $2.0 million, respectively.



Note 9. Capital Securities



On July 16, 2001, AF Capital Trust I (the Trust), a Delaware business trust formed by the Company, completed the sale of $5.0 million of 10.25% Capital
Securities (liquidation amount of $1,000 per security) (the Capital Securities) in a private placement as part of a pooled capital securities transaction. The Trust also issued common securities to the Company and used the net proceeds
from the offering to purchase a like amount of 10.25% Junior Subordinated Deferrable Interest Debentures (the Subordinated Debentures) of the Company. Total expenses associated with the offering of $168,944 at June 30, 2005 were included
in other assets and are being amortized on a straight-line basis over the life of the Subordinated Debentures.



The Capital Securities accrue and pay distributions semi-annually on January 25thand July 25thof each year, commencing on January 25, 2002 at a
fixed annual rate of 10.25% of the stated liquidation amount of $1,000 per Capital Security. The Company has fully and unconditionally guaranteed all of the obligations of the Trust, including the semi-annual distributions and payments on
liquidation or redemption of the Capital Securities.



The Capital Securities
are mandatorily redeemable upon the maturing of the Subordinated Debentures on July 25, 2031 or upon earlier redemption as provided in the Indenture. The Company has the right to redeem the Subordinated Debentures, in whole or in part, on any
January 25thor July 25thon or after July 25, 2006 at the liquidation amount, plus any accrued but unpaid interest to the redemption date.



On December 31, 2004, the Company adopted FIN 46R which resulted in the deconsolidation of the Companys trust preferred subsidiary, AF
Capital Trust I (the Trust). Upon deconsolidation, the junior subordinated debentures issued by the Company to the trust were included in borrowings (instead of trust preferred securities) and the Companys equity interests in the
trust were included in other assets. As a result, other assets and borrowings increased by $155,000. Except for accounting treatment, the relationship between the Company and the Trust has not changed. AF Capital Trust I continues to be a wholly
owned trust preferred subsidiary of the Company and the full and unconditional guarantee of the Company for the repayment of the trust preferred securities remains in effect.



Note 10. Stockholders Equity



The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements
can initiate certain mandatory  and possibly additional discretionary  actions by regulators that, if undertaken, could have a direct material effect on the Company and the Banks financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative





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##### Table of Contents

Notes to Consolidated Financial Statements



Note 10. Stockholders Equity, continued



regulatory accounting practices. The Company and the Banks capital amounts and classifications are also subject to qualitative
judgments by the regulators about components, risk weightings, and other factors. Prompt corrective action provisions are not applicable to bank holding companies.



The Bank has established a liquidation account in an amount equal to its net worth as reflected in its latest statement of financial
condition used in its final offering circular. The liquidation account will be maintained for the benefit of eligible deposit account holders and supplemental eligible deposit account holders who continue to maintain their deposit accounts in the
Bank after the reorganization. Only in the event of a complete liquidation will eligible deposit account holders and supplemental eligible deposit account holders be entitled to receive a liquidation distribution from the liquidation account in the
amount of the then current adjusted sub account balance for deposit accounts then held before any liquidation distribution may be made with respect to common stock. Dividends paid by the Bank subsequent to the reorganization cannot be paid from this
liquidation account.



The Bank may not declare or pay a cash dividend on its
common stock if its stockholders equity would thereby be reduced below either the aggregate amount required for the liquidation account or the minimum regulatory capital requirements imposed by federal regulations.



The Office of Thrift Supervision (OTS) regulations require institutions to maintain amounts
and ratios of total and Tier 1 capital to risk-weighted assets and Tier 1 capital to average assets. At June 30, 2005 and 2004, the Company and the Bank exceeded all of the capital requirements.





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##### Table of Contents

Notes to Consolidated Financial Statements



Note 10. Stockholders Equity, continued



As of June 30, 2005, the most recent notification from the OTS categorized the Bank as well capitalized under the regulatory framework for
prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the following tables. There are no conditions or events since that
notification that management believes have changed the Banks category.



|                                        |  |                        |        |       |                             |   |        |                                                                       |        |  |     |        |  |       |        |  |      |  
|--------------------------------------- |  | ---------------------- | ------ | ----- | --------------------------- | - | ------ | --------------------------------------------------------------------- | ------ |  | --- | ------ |  | ----- | ------ |  | ---- | -
|                                        |  | Actual                 |        |       | Minimum Capital Requirement |   |        | Minimum to be wellCapitalized UnderPrompt CorrectiveAction Provisions |       
|                                        |  | Amount                 |        | Ratio |                             |   | Amount |                                                                       | Ratio  |  |     | Amount |  | Ratio |       
|                                        |  | (Dollars in Thousands) |       
|June 30, 2005:                          |  |                        |        |       |                             |   |        |                                                                       |        |  |     |        |  |       |        |  |      |  
|Total Capital to Risk Weighted Assets:  |  |                        |        |       |                             |   |        |                                                                       |        |  |     |        |  |       |        |  |      |  
|Consolidated                            |  | $                      | 17,774 |       | 10.5                        | % |        | $                                                                     | 13,587 |  | 8.0 | %      |  | $     |       |  |     | %
|Bank                                    |  | $                      | 19,255 |       | 11.4                        | % |        | $                                                                     | 13,560 |  | 8.0 | %      |  | $     | 16,950 |  | 10.0 | %
|                                        |  |                        |        |       |                             |  
|Tier 1 Capital to Risk Weighted Assets: |  |                        |        |       |                             |   |        |                                                                       |        |  |     |        |  |       |        |  |      |  
|Consolidated                            |  | $                      | 14,189 |       | 8.4                         | % |        | $                                                                     | 6,794  |  | 4.0 | %      |  | $     |       |  |     | %
|Bank                                    |  | $                      | 17,832 |       | 10.5                        | % |        | $                                                                     | 6,780  |  | 4.0 | %      |  | $     | 10,170 |  | 6.0  | %
|                                        |  |                        |        |       |                             |  
|Tier 1 Capital to Average Assets:       |  |                        |        |       |                             |   |        |                                                                       |        |  |     |        |  |       |        |  |      |  
|Consolidated                            |  | $                      | 14,189 |       | 6.5                         | % |        | $                                                                     | 8,732  |  | 4.0 | %      |  | $     |       |  |     | %
|Bank                                    |  | $                      | 17,832 |       | 8.3                         | % |        | $                                                                     | 8,636  |  | 4.0 | %      |  | $     | 10,794 |  | 5.0  | %
|                                        |  |                        |        |       |                             |  
|June 30, 2004:                          |  |                        |        |       |                             |   |        |                                                                       |        |  |     |        |  |       |        |  |      |  
|                                        |  |                        |        |       |                             |  
|Total Capital to Risk Weighted Assets:  |  |                        |        |       |                             |   |        |                                                                       |        |  |     |        |  |       |        |  |      |  
|Consolidated                            |  | $                      | 17,071 |       | 10.2                        | % |        | $                                                                     | 13,626 |  | 8.0 | %      |  | $     |       |  |     | %
|Bank                                    |  | $                      | 18,257 |       | 10.9                        | % |        | $                                                                     | 13,407 |  | 8.0 | %      |  | $     | 16,759 |  | 10.0 | %
|                                        |  |                        |        |       |                             |  
|Tier 1 Capital to Risk Weighted Assets: |  |                        |        |       |                             |   |        |                                                                       |        |  |     |        |  |       |        |  |      |  
|Consolidated                            |  | $                      | 13,485 |       | 8.0                         | % |        | $                                                                     | 6,813  |  | 4.0 | %      |  | $     |       |  |     | %
|Bank                                    |  | $                      | 16,974 |       | 10.1                        | % |        | $                                                                     | 6,703  |  | 4.0 | %      |  | $     | 10,055 |  | 6.0  | %
|                                        |  |                        |        |       |                             |  
|Tier 1 Capital to Average Assets:       |  |                        |        |       |                             |   |        |                                                                       |        |  |     |        |  |       |        |  |      |  
|Consolidated                            |  | $                      | 13,485 |       | 6.8                         | % |        | $                                                                     | 7,977  |  | 4.0 | %      |  | $     |       |  |     | %
|Bank                                    |  | $                      | 16,974 |       | 8.6                         | % |        | $                                                                     | 7,893  |  | 4.0 | %      |  | $     | 9,866  |  | 5.0  | %



Under the conversion regulations the
Bank may not declare or pay a cash dividend on any of its stock if the effect thereof would cause the Banks equity to be reduced below (1) the amount required for the liquidation account; or (2) the net worth requirements imposed by the OTS.





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##### Table of Contents

Notes to Consolidated Financial Statements



Note 11. Employee Pension and Incentive Plans



The Company has profit-sharing plans for the benefit of substantially all employees. Contributions are discretionary and totaled $48,424 and
$4,395 for the years ended June 30, 2005 and 2004, respectively.



In addition,
the Company has 401(k) retirement plans which contain provisions for specified matching contributions by the Company. The Company funds contributions as they accrue and 401(k) plan expense amounted to $111,992 and $104,138 for the years ended June
30, 2005 and 2004, respectively.



Note 12. Employee Stock Ownership Plan



As part of the reorganization, the Company established an ESOP to benefit
substantially all employees. The ESOP purchased 36,942 shares of common stock with the proceeds from a loan from a third party financial institution. The note requires annual principal payments of $28,845 plus quarterly interest at the lending
institutions prime rate (6.25% at June 30, 2005). The Company is expected to make quarterly contributions to the ESOP in amounts sufficient to allow the ESOP to make its scheduled principal and interest payments on the note. The ESOP shares
are pledged as collateral for the debt. As the debt is repaid, shares are released from collateral and allocated to active employees, based on proportion of debt service paid in the year. The debt of the ESOP is recorded as debt in the
Companys accompanying statement of financial condition.



At June 30,
2005, future principal payments are due as follows:



|                     |  |        |       
|-------------------- |  | ------ | ------
|Year Ending June 30: |  | Amount
|2006                 |  | $      | 28,845
|2007                 |  |        | 4,575 



Excluding interest, expense of $71,021
and $71,400 during 2005 and 2004, respectively, has been incurred in connection with the ESOP. The expense includes, in addition to the cash contribution necessary to fund the ESOP, $34,022 in 2005 and $34,363 in 2004, which represents the
difference between the fair value of the shares which have been released or committed to be released to participants, and the cost of these shares to the ESOP. The Company has credited this amount to paid-in capital in accordance with the provisions
of AICPA Statement of Position 93-6.



At June 30, 2005 and 2004, 33,600 and
29,900 shares, respectively, held by the ESOP have been released or committed to be released to the plans participants for purposes of computing earnings per share. The fair value of the unallocated shares amounted to approximately $63,500 and
$116,200 at June 30, 2005 and 2004, respectively.



The Bank has also recorded,
through a reduction in retained earnings, a liability for a put back option, which represents the excess of the fair market value of the total number of ESOP shares over the original cost of the unallocated ESOP shares. The liability recorded under
the put back option was $616,266 and $534,750 at June 30, 2005 and 2004, respectively.



In accordance with the ESOP, the Company is expected to honor the rights of certain participants to diversify their account balances or to liquidate their ownership of the common stock in the event of termination. The purchase price of the
common stock would be based on the fair market value of the Companys common stock as of the valuation date. Since the redemption of common stock is outside the control of the Company, the Companys maximum cash obligation based on the
approximate market process of common stock as of the reporting date has been presented outside of stockholders equity. The amount presented as redeemable commons tock held by the ESOP in the consolidated balance sheet represents the
Companys maximum cash obligation and has been reflected as a reduction of retained earnings. As of June 30, 2005 and 2004, the shares held by the ESOP, fair value and maximum cash obligation were as follows:



Note 12. Employee Stock Ownership Plan, continued



|                                                   |  |      |         |      |   |        
|-------------------------------------------------- |  | ---- | ------- | ---- | - | -------
|                                                   |  | 2005 |         | 2004
|Shares held by the ESOP, net of unallocated shares |  |      | 30,852  |      |   | 29,635 
|                                                   |  |      |         |      |   |        
|Fair value per share                               |  | $    | 19.00   |      | $ | 16.50  
|                                                   |  |      |         |      |   |        
|Maximum cash obligation                            |  | $    | 616,266 |      | $ | 534,750
|                                                   |  |      |         |      |   |        



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 13. Deferred Compensation and Retirement Plan Agreements



The Bank has an unfunded deferred compensation agreement providing retirement, disability, and death benefits for directors. Vested benefits
under the agreements are payable in monthly installments over a ten-year period upon the directors death, disability or retirement. The Bank also has a retirement plan for members of the Board of Directors. The Plan states that outside
directors with at least ten years of service will receive an amount equal to their annual retainer for ten years after their retirement from the Board. The liability for the benefits is being accrued over the terms of active service of the
directors. The amount charged to expense under these plans amounted to $47,895 and $54,880 for the years ended June 30, 2005 and 2004, respectively. The related liability recorded for these plans was $614,924 and $695,716 for the years ended June
30, 2005 and 2004, respectively.



The Company has entered into a salary
continuation agreement with the Chief Financial Officer. Under this agreement, the executive will be paid monthly amounts of $5,532, after retirement for a period of forty-three years. This agreement also provides for benefits upon death,
disability, a change of control and early retirement. The amount charged to expense under this plan amounted to $39,994 and $62,481 for the years ended June 30, 2005 and 2004, respectively. The related liability record for these plans was $159,112
and $119,118 for the years ended June 30, 2005 and 2004, respectively.



Note
14. Stock Option Plan



The Companys stockholders approved the
Banks Stock Option Plan (the Plan) on December 8, 1997. The stock option plan provides for the issuance of up to 21,707 stock options to certain officers and directors in the form of incentive stock options or non-incentive stock
options. The exercise price of the stock options may not be less than the fair market value of the Companys common stock at the date of grant.



At June 30, 2005, 14,573 options have been granted at an exercise price of $18.50, of which 14,573 options are fully vested and therefore currently exercisable. No
options have been exercised to date and all options granted are outstanding at June 30, 2005.



Note 15. Income Tax Matters



Deferred
taxes have been provided for certain increases in the Banks tax bad debt reserves subsequent to 1987 which are in excess of additions to recorded loan loss allowances. At June 30, 2005, retained earnings contain certain historical additions to
bad debt reserves for income tax purposes of approximately $870,000, the balance at June 30, 1987, for which no deferred taxes have been provided because the Bank does not intend to use these reserves for purposes other than to absorb losses. If
amounts which qualified as bad debt deductions are used for purposes other than to absorb bad debt losses or adjustments arising from the carryback of net operating losses, income taxes may be imposed at the then existing rates. The approximate
amount of unrecorded deferred tax liability associated with these historical additions is approximately $340,000. In the future, if the Bank does not meet the income tax requirements necessary to permit the deduction of an allowance for bad debts,
the Banks effective tax rate would increase to the maximum percent under existing law.





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##### Table of Contents

Notes to Consolidated Financial Statements



Note 15. Income Tax Matters, continued



The following provides the tax effects of temporary differences that gave rise to significant portions of the net deferred tax asset as of June 30:



|                                                 |  |      |         |   |      |   |           |  
|------------------------------------------------ |  | ---- | ------- | - | ---- | - | --------- | -
|                                                 |  | 2005 |         |   | 2004 |  
|Deferred tax assets                              |  |      |         |   |      |   |           |  
|Reserve for loan losses                          |  | $    | 449,576 |   |      | $ | 479,955   |  
|Reserve for uncollected interest                 |  |      | 13,612  |   |      |   | 1,364     |  
|Deferred compensation                            |  |      | 298,422 |   |      |   | 358,143   |  
|Deferred loan fees                               |  |      | 84,987  |   |      |   | 85,872    |  
|Other                                            |  |      | 53,836  |   |      |   | 55,910    |  
|State net economic loss carryforwards            |  |      | 14,767  |   |      |   | 22,670    |  
|                                                 |  |      |         |   |      |   |           |  
|                                                 |  |      | 915,200 |   |      |   | 1,003,914 |  
|Less valuation allowance                         |  |      | (14,767 | ) |      |   | (22,670   | )
|                                                 |  |      |         |   |      |   |           |  
|                                                 |  |      | 900,433 |   |      |   | 981,244   |  
|                                                 |  |      |         |   |      |   |           |  
|Deferred tax liabilities                         |  |      |         |   |      |   |           |  
|Unrealized gain on securities available for sale |  |      | 25,807  |   |      |   | 6,675     |  
|Depreciation                                     |  |      | 439,483 |   |      |   | 157,670   |  
|FHLB stock dividends                             |  |      | 60,067  |   |      |   | 60,061    |  
|Prepaid expenses                                 |  |      | 57,008  |   |      |   |          |  
|Deferred loan fees                               |  |      | 394,441 |   |      |   | 375,383   |  
|                                                 |  |      |         |   |      |   |           |  
|                                                 |  |      | 976,806 |   |      |   | 599,789   |  
|                                                 |  |      |         |   |      |   |           |  
|Net deferred tax asset (liability)               |  | $    | (76,373 | ) |      | $ | 381,455   |  
|                                                 |  |      |         |   |      |   |           |  



During the year ended June 30, 2005,
the Company recorded a decrease in the valuation allowance of $7,903 on the deferred tax assets to reduce the total to an amount that management believes will ultimately be realized. Realization of deferred tax assets is dependent upon sufficient
future taxable income during the period that deductible temporary differences and carryforwards are expected to be available to reduce taxable income.



The provision for income taxes charged to operations for the years ended June 30, 2005 and 2004 consists of the following:



|                             |  |      |         |   |      |   |          |  
|---------------------------- |  | ---- | ------- | - | ---- | - | -------- | -
|                             |  | 2005 |         |   | 2004 |  
|Current                      |  |      |         |   |      |   |          |  
|Federal                      |  | $    | (40,024 | ) |      | $ | (143,279 | )
|State                        |  |      | 94,474  |   |      |   | 21,735   |  
|                             |  |      |         |   |      |   |          |  
|Total                        |  |      | 54,450  |   |      |   | (121,544 | )
|Deferred                     |  |      |         |   |      |   |          |  
|Federal                      |  |      | 403,970 |   |      |   | (1,033   | )
|State                        |  |      | 34,726  |   |      |   | (138     | )
|                             |  |      |         |   |      |   |          |  
|Total                        |  |      | 438,696 |   |      |   | (1,171   | )
|                             |  |      |         |   |      |   |          |  
|Income tax expense (benefit) |  | $    | 493,146 |   |      | $ | (122,715 | )
|                             |  |      |         |   |      |   |          |  



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 15. Income Tax Matters, continued



A reconciliation of income taxes computed at the statutory federal income tax rate to the income tax provision follows:



|                                  |  |        |         |   |         |      |   |        |   |          |         |  |       |   
|--------------------------------- |  | ------ | ------- | - | ------- | ---- | - | ------ | - | -------- | ------- |  | ----- | --
|                                  |  | 2005   |         |   | 2004    |     
|                                  |  | Amount |         |   | Percent |      |   | Amount |   |          | Percent | 
|Tax at statutory rate             |  | $      | 388,254 |   |         | 34.0 | % |        | $ | (146,530 | )       |  | (34.0 | )%
|State tax, net of federal benefit |  |        | 85,272  |   |         | 7.5  |   |        |   | 25,332   |         |  | 5.9   |   
|Municipal interest income         |  |        | (21,330 | ) |         | (1.9 | ) |        |   | (18,411  | )       |  | (4.4  | ) 
|Nondeductible employee benefits   |  |        | 31,006  |   |         | 2.7  |   |        |   | 12,715   |         |  | 3.0   |   
|Other                             |  |        | 9,944   |   |         | 0.9  |   |        |   | 4,179    |         |  | 1.0   |   
|                                  |  |        |         |   |         |      |   |        |   |          |         |  |       |   
|Total                             |  | $      | 493,146 |   |         | 43.2 | % |        | $ | (122,715 | )       |  | (28.5 | )%
|                                  |  |        |         |   |         |      |   |        |   |          |         |  |       |   



Note 16. Other Noninterest Income
and Expense



The major components of other noninterest income for the
years ended June 30, 2005 and 2004 are as follows:



|                                        |  |      |           |      |   |          
|--------------------------------------- |  | ---- | --------- | ---- | - | ---------
|                                        |  | 2005 |           | 2004
|Service charges on deposit accounts     |  | $    | 537,516   |      | $ | 557,538  
|Cardholder and merchant services income |  |      | 126,269   |      |   | 96,813   
|Brokerage fees and commissions          |  |      | 321,654   |      |   | 177,173  
|Mortgage income                         |  |      | 205,230   |      |   | 175,477  
|Other                                   |  |      | 240,996   |      |   | 361,231  
|                                        |  |      |           |      |   |          
|Total                                   |  | $    | 1,431,665 |      | $ | 1,368,232
|                                        |  |      |           |      |   |          



The major components of other
noninterest expense for the years ended June 30, 2005 and 2004 are as follows:



|                                          |  |      |           |      |   |          
|----------------------------------------- |  | ---- | --------- | ---- | - | ---------
|                                          |  | 2005 |           | 2004
|Cleaning, postage and office supplies     |  | $    | 341,431   |      | $ | 340,151  
|Advertising and promotion                 |  |      | 150,581   |      |   | 171,690  
|Travel, meals, dues and subscriptions     |  |      | 246,225   |      |   | 244,348  
|Telephone and utilities                   |  |      | 267,648   |      |   | 247,579  
|Training                                  |  |      | 51,839    |      |   | 116,132  
|Fees and charges                          |  |      | 59,809    |      |   | 68,301   
|Professional fees and contracted services |  |      | 555,443   |      |   | 561,298  
|REO expense                               |  |      | 165,398   |      |   | 1,784    
|Other                                     |  |      | 570,667   |      |   | 630,515  
|                                          |  |      |           |      |   |          
|Total                                     |  | $    | 2,409,041 |      | $ | 2,381,798
|                                          |  |      |           |      |   |          



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 17. Commitments and Contingencies



The Bank is a party to financial instruments with off-statement of financial condition risk in the normal course of business to meet the financing needs of its customers.
These financial instruments include commitments to extend credit and equity lines of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the statement of financial
condition. The contract or notional amounts of those instruments reflect the extent of involvement the Bank has in particular classes of financial instruments.



A summary of the contract amount of the Banks exposure to off-statement of financial condition risk, except for undisbursed construction loan funds, is as
follows at June 30, 2005:



|                                                                    |  |                |           
|------------------------------------------------------------------- |  | -------------- | ----------
|                                                                    |  | NotionalAmount
|Financial instruments whose contract amounts represent credit risk: |  |                |           
|Undisbursed home equity lines of credit                             |  | $              | 10,194,829
|Undisbursed consumer lines of credit                                |  |                | 4,772,669 
|Undisbursed commercial lines of credit                              |  |                | 4,986,804 
|Letters of credit                                                   |  |                | 500,000   
|Commitments outstanding to originate loans                          |  |                | 1,449,800 



The Bank evaluates each
customers credit worthiness on a case-by-case basis. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Home equity lines of credit have variable
rates based on the prime rate of interest. Home equity lines are reassessed every five years. Because many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash
requirements. The collateral obtained by the Bank upon extension of credit is based on managements credit evaluation of the customer. The collateral held is the underlying real estate. Commercial lines of credit have variable rates tied to
prime and are reassessed on an annual basis. Prime at June 30, 2005 was 6.25%.



The Company has entered into operating leases for AF Bank branch locations in Warrensville and Sparta, North Carolina, and also a branch inside Wal-Mart in West Jefferson, North Carolina, and for AF Insurance branches located in Boone,
Elkin and Wilkesboro, North Carolina. These leases generally contain renewal options for periods ranging from two to five years and require the Company to pay all executory costs such as maintenance and insurance. Rental expense for operating leases
was $152,868 and $167,044 during 2005 and 2004.



Future minimum lease payments
under noncancelable operating leases as of June 30, 2005 are:



|                             |  |   |        
|---------------------------- |  | - | -------
|Year Ending June 30:         |  |   |        
|2006                         |  | $ | 106,794
|2007                         |  |   | 82,681 
|2008                         |  |   | 53,970 
|2009                         |  |   | 44,400 
|2010                         |  |   | 31,200 
|After 2010                   |  |   | 24,000 
|                             |  |   |        
|Total minimum lease payments |  | $ | 343,045
|                             |  |   |        



Note 18. Dividends Declared



On June 24, 2005, the Board of Directors of the Company declared a
dividend of $0.05 a share for stockholders of record as of June 24, 2005 and payable on July 5, 2005. The dividends declared were accrued and reported in accounts payable and other liabilities in the June 30, 2005 Consolidated Statement of Financial
Condition. AsheCo, MHC elected to waive the receipt of dividends declared.



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Notes to Consolidated Financial Statements



Note 19. Fair Value of Financial Instruments



The following table reflects a comparison of carrying amounts and the fair values of the financial instruments as of June 30, 2005 and 2004:



|                             |  |                |             |            |   |                |  |            |             |  |   |            
|---------------------------- |  | -------------- | ----------- | ---------- | - | -------------- |  | ---------- | ----------- |  | - | -----------
|                             |  | 2005           |             | 2004      
|                             |  | Carrying Value |             | Fair Value |   | Carrying Value |  | Fair Value
|Financial assets:            |  |                |             |            |   |                |  |            |             |  |   |            
|Cash                         |  |                |             |            |   |                |  |            |             |  |   |            
|Interest-bearing             |  | $              | 2,657,931   |            | $ | 2,657,931      |  | $          | 2,498,878   |  | $ | 2,498,878  
|Noninterest-bearing deposits |  |                | 6,150,597   |            |   | 6,150,597      |  |            | 5,175,174   |  |   | 5,175,174  
|Investments                  |  |                | 4,045,498   |            |   | 4,045,498      |  |            | 4,844,066   |  |   | 4,844,066  
|Loans receivable, net        |  |                | 181,242,230 |            |   | 181,964,592    |  |            | 180,155,559 |  |   | 177,639,382
|Loans held for sale          |  |                | 1,226,750   |            |   | 1,226,750      |  |            | 1,333,600   |  |   | 1,333,600  
|Accrued interest receivable  |  |                | 949,186     |            |   | 949,186        |  |            | 921,810     |  |   | 921,810    
|FHLB stock                   |  |                | 1,704,800   |            |   | 1,704,800      |  |            | 1,657,200   |  |   | 1,657,200  
|                             |  |                |             |           
|Financial liabilities:       |  |                |             |            |   |                |  |            |             |  |   |            
|Deposits                     |  |                | 163,976,928 |            |   | 163,779,345    |  |            | 157,433,544 |  |   | 156,375,461
|Borrowings                   |  |                | 34,538,951  |            |   | 34,826,767     |  |            | 39,411,980  |  |   | 39,411,980 



The fair values utilized in the table
were derived using the information described below for the group of instruments listed. It should be noted that the fair values disclosed in this table do not represent market values of all assets and liabilities of the Company and, thus, should not
be interpreted to represent the market or liquidation value of the Company.



The following methods and assumptions were used by the Company in estimating the fair value of its financial instruments:



Cash and certificates of deposits: The carrying amounts for cash and short-term instruments approximate their fair values.



Investment securities: Fair values for securities are based on quoted market prices,
where available. If quoted market prices are not available, fair values are based on quoted market prices of similar securities.



Loans receivable: The fair value of fixed rate loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made
to borrowers with similar credit ratings and for the same remaining maturities. Certain prepayment assumptions have also been made depending upon the original contractual lives of the loans. The fair value of variable rate loans approximates their
carrying value as these loans reprice frequently.



Loans held for sale:
The carrying amounts for loans held for sale approximate their fair values.



Accrued interest receivable and accrued interest payable: The fair value of accrued interest receivable and payable is the amount receivable or payable on demand at the statement of financial condition date.



FHLB stock: The fair value of FHLB stock is the stated value by the FHLB.



Deposits: The fair value of demand deposits, savings accounts and certain money
market deposits is the amount payable on demand at the statement of financial condition date. The fair value of fixed maturity certificates of deposit are estimated based upon the discounted value of contractual cash flows using rates currently
offered for deposits with similar remaining maturities.



Borrowings: The
fair value of borrowings is estimated based on present values using the current rates at which similar borrowings would be made to borrowers with similar credit ratings and for the same remaining maturities.





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##### Table of Contents

Notes to Consolidated Financial Statements



Note 19. Fair Value of Financial Instruments, continued



Off-statement of financial condition instruments: Fair values for the Companys off-statement of financial condition instruments
(loan commitments) are based on fees currently charged for similar agreements, taking into account the remaining terms of the agreements and the counterparties credit standings. The fair value for such commitments is nominal.



Note 20. Mid-Tier Holding Company and Mutual Holding Company Data



The following are the condensed financial statements of AF Financial Group as of and for the
years ended June 30, 2005 and 2004:



AF Financial Group

Condensed Balance Sheets

June 30, 2005 and 2004



|                                                                                                      |  |      |            |   |      |   |            |  
|----------------------------------------------------------------------------------------------------- |  | ---- | ---------- | - | ---- | - | ---------- | -
|                                                                                                      |  | 2005 |            |   | 2004 |  
|Assets                                                                                                |  |      |            |   |      |   |            |  
|Cash and cash equivalents:                                                                            |  |      |            |   |      |   |            |  
|Interest-bearing deposits                                                                             |  | $    | 11,787     |   |      | $ |           |  
|Non interest-bearing deposits                                                                         |  |      | 68,276     |   |      |   | 8,241      |  
|Investment in AF Bank                                                                                 |  |      | 17,903,244 |   |      |   | 16,983,827 |  
|Investment in AF Insurance Services, Inc.                                                             |  |      | 810,997    |   |      |   | 738,911    |  
|Investment in AF Brokerage, Inc.                                                                      |  |      |           |   |      |   | 227,894    |  
|Investment in AF Capital Trust I                                                                      |  |      | 155,000    |   |      |   | 155,000    |  
|Property and equipment, net                                                                           |  |      |           |   |      |   | 14,688     |  
|Prepaid financing costs, net                                                                          |  |      | 168,944    |   |      |   | 175,421    |  
|Other assets                                                                                          |  |      | 310,985    |   |      |   | 366,601    |  
|                                                                                                      |  |      |            |   |      |   |            |  
|Total assets                                                                                          |  | $    | 19,429,233 |   |      | $ | 18,670,583 |  
|                                                                                                      |  |      |            |   |      |   |            |  
|Liabilities and Stockholders Equity                                                                  |  |      |            |   |      |   |            |  
|                                                                                                      |  |     
|Liabilities                                                                                           |  |      |            |   |      |   |            |  
|Accounts payable                                                                                      |  | $    | 282,720    |   |      | $ | 280,476    |  
|Short-term borrowings                                                                                 |  |      | 300,000    |   |      |   | 150,000    |  
|Long-term borrowings                                                                                  |  |      | 5,188,420  |   |      |   | 5,225,420  |  
|Deferred income taxes                                                                                 |  |      | 2,857      |   |      |   | 5,941      |  
|Redeemable common stock held by the Employee Stock Ownership Plan (ESOP), net of unearned ESOP shares |  |      | 616,266    |   |      |   | 534,750    |  
|                                                                                                      |  |      |            |   |      |   |            |  
|Total liabilities                                                                                     |  |      | 6,390,263  |   |      |   | 6,196,587  |  
|                                                                                                      |  |      |            |   |      |   |            |  
|Stockholders equity                                                                                   |  |      |            |   |      |   |            |  
|Common stock                                                                                          |  |      | 10,537     |   |      |   | 10,537     |  
|Additional paid-in capital                                                                            |  |      | 11,967,650 |   |      |   | 11,933,628 |  
|Retained earnings                                                                                     |  |      | 1,095,492  |   |      |   | 594,322    |  
|Accumulated other comprehensive income                                                                |  |      | 40,171     |   |      |   | 10,389     |  
|                                                                                                      |  |      |            |   |      |   |            |  
|                                                                                                      |  |      | 13,113,850 |   |      |   | 12,548,876 |  
|Less cost of 3,840 shares of treasury stock                                                           |  |      | (74,880    | ) |      |   | (74,880    | )
|                                                                                                      |  |      |            |   |      |   |            |  
|Total stockholders equity                                                                            |  |      | 13,038,970 |   |      |   | 12,473,996 |  
|                                                                                                      |  |      |            |   |      |   |            |  
|Total liabilities and stockholders equity                                                            |  | $    | 19,429,233 |   |      | $ | 18,670,583 |  
|                                                                                                      |  |      |            |   |      |   |            |  





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Notes to Consolidated Financial Statements



Note 20. Mid-Tier Holding Company and Mutual Holding Company Data, continued



AF Financial Group

Condensed Statements of Income (Loss)

Years ended June 30, 2005 and 2004



|                                   |  |      |           |   |      |   |          |  
|---------------------------------- |  | ---- | --------- | - | ---- | - | -------- | -
|                                   |  | 2005 |           |   | 2004 |  
|Equity in earnings of subsidiaries |  | $    | 1,218,623 |   |      | $ | 328,335  |  
|Income tax credit                  |  |      | 275,908   |   |      |   | 329,091  |  
|Professional fees                  |  |      | (238,005  | ) |      |   | (311,555 | )
|Interest expense                   |  |      | (519,411  | ) |      |   | (514,596 | )
|Other expense                      |  |      | (88,338   | ) |      |   | (139,529 | )
|                                   |  |      |           |   |      |   |          |  
|Net income (loss)                  |  | $    | 648,777   |   |      | $ | (308,254 | )
|                                   |  |      |           |   |      |   |          |  



AF Financial Group

Condensed Statements of Cash Flows

Years ended June 30, 2005 and 2004



|                                                    |  |      |            |   |      |   |          |  
|--------------------------------------------------- |  | ---- | ---------- | - | ---- | - | -------- | -
|                                                    |  | 2005 |            |   | 2004 |  
|Cash Flows from Operating Activities:               |  |      |            |   |      |   |          |  
|Net income (loss)                                   |  | $    | 648,777    |   |      | $ | (308,254 | )
|ESOP expense                                        |  |      | 71,022     |   |      |   | 71,400   |  
|Deferred income taxes                               |  |      | (3,084     | ) |      |   |         |  
|Depreciation and amortization                       |  |      | 9,827      |   |      |   | 18,798   |  
|Loss on disposal of office properties and equipment |  |      | 11,338     |   |      |   |         |  
|Change in assets and liabilities:                   |  |      |            |   |      |   |          |  
|Equity in earnings of subsidiaries                  |  |      | (1,218,624 | ) |      |   | (328,336 | )
|Decrease in other assets                            |  |      | 55,616     |   |      |   | 3,363    |  
|Increase in accounts payable and other liabilities  |  |      | 2,244      |   |      |   | 9,783    |  
|                                                    |  |      |            |   |      |   |          |  
|Net cash used in operating activities               |  |      | (422,884   | ) |      |   | (533,246 | )
|                                                    |  |      |            |   |      |   |          |  
|Cash Flows from Investing Activities:               |  |      |            |   |      |   |          |  
|Equity investment in subsidiaries                   |  |      |           |   |      |   | (50,000  | )
|Dividends received from subsidiaries                |  |      | 484,797    |   |      |   | 350,000  |  
|                                                    |  |      |            |   |      |   |          |  
|Net cash provided by investing activities           |  |      | 484,797    |   |      |   | 300,000  |  
|                                                    |  |      |            |   |      |   |          |  
|Cash Flows from Financing Activities:               |  |      |            |   |      |   |          |  
|Short-term borrowings, net                          |  |      | 150,000    |   |      |   | 150,000  |  
|Long-term borrowings (repayments), net              |  |      | (37,000    | ) |      |   | (37,000  | )
|Cash dividends paid                                 |  |      | (103,091   | ) |      |   | (145,748 | )
|                                                    |  |      |            |   |      |   |          |  
|Net cash provided by (used in) financing activities |  |      | 9,909      |   |      |   | (32,748  | )
|                                                    |  |      |            |   |      |   |          |  
|Net increase (decrease) in cash                     |  |      | 71,822     |   |      |   | (265,994 | )
|                                                    |  |     
|Cash, beginning                                     |  |      | 8,241      |   |      |   | 274,235  |  
|                                                    |  |      |            |   |      |   |          |  
|Cash, ending                                        |  | $    | 80,063     |   |      | $ | 8,241    |  
|                                                    |  |      |            |   |      |   |          |  



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 20. Mid-Tier Holding Company and Mutual Holding Company Data, continued



The following are the condensed financial statements of the mutual holding company, AsheCo,
M.H.C., as of and for the years ended June 30, 2005 and 2004:



AsheCo, M.H.C.

Condensed Balance Sheets

June 30, 2005 and 2004



|                                           |  |      |           |      |   |          
|------------------------------------------ |  | ---- | --------- | ---- | - | ---------
|                                           |  | 2005 |           | 2004
|Assets                                     |  |      |           |      |   |          
|Interest-bearing deposits                  |  | $    | 217,701   |      | $ | 163,390  
|Investment in AA&G, Inc.                   |  |      |          |      |   | 261,304  
|Investment in AF Financial Group           |  |      | 6,685,080 |      |   | 6,395,418
|Other assets                               |  |      | 328,720   |      |   | 233,242  
|                                           |  |      |           |      |   |          
|Total assets                               |  | $    | 7,231,501 |      | $ | 7,053,354
|                                           |  |      |           |      |   |          
|Liabilities and Shareholders Equity       |  |      |           |      |   |          
|                                           |  |     
|Liabilities                                |  |      |           |      |   |          
|Accounts payable and other liabilities     |  | $    | 7,020     |      | $ | 10,020   
|                                           |  |      |           |      |   |          
|Stockholders equity                       |  |      |           |      |   |          
|Additional paid-in capital                 |  |      | 5,717,328 |      |   | 5,748,653
|Retained earnings                          |  |      | 1,486,557 |      |   | 1,289,355
|Accumulated other comprehensive income     |  |      | 20,596    |      |   | 5,326    
|                                           |  |      |           |      |   |          
|Total shareholders equity                 |  |      | 7,224,481 |      |   | 7,043,334
|                                           |  |      |           |      |   |          
|Total liabilities and shareholders equity |  | $    | 7,231,501 |      | $ | 7,053,354
|                                           |  |      |           |      |   |          



AsheCo, M.H.C.

Condensed Statements of Income (Loss)

Years ended June 30, 2005 and 2004



|                                          |  |      |          |   |      |   |          |  
|----------------------------------------- |  | ---- | -------- | - | ---- | - | -------- | -
|                                          |  | 2005 |          |   | 2004 |  
|Interest income                           |  | $    | 7,883    |   |      | $ | 2,424    |  
|Equity in earnings (loss) of subsidiaries |  |      | 354,392  |   |      |   | (117,422 | )
|Loss on sale of subsidiary                |  |      | (133,068 | ) |      |   |         |  
|Other expense                             |  |      | (32,006  | ) |      |   | (67,083  | )
|                                          |  |      |          |   |      |   |          |  
|Net income (loss)                         |  | $    | 197,201  |   |      | $ | (182,081 | )
|                                          |  |      |          |   |      |   |          |  



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Notes to Consolidated Financial Statements



Note 20. Mid-Tier Holding Company and Mutual Holding Company Data, continued



AsheCo, M.H.C.

Condensed Statements of Cash Flows

Years ended June 30, 2005 and 2004



|                                          |  |      |          |   |      |   |          |  
|----------------------------------------- |  | ---- | -------- | - | ---- | - | -------- | -
|                                          |  | 2005 |          |   | 2004 |  
|Cash Flows from Operating Activities:     |  |      |          |   |      |   |          |  
|Net income (loss)                         |  | $    | 197,201  |   |      | $ | (182,081 | )
|Equity in earnings (loss) of subsidiaries |  |      | (354,392 | ) |      |   | 117,422  |  
|Change in assets and liabilities:         |  |      |          |   |      |   |          |  
|Loss on sale of subsidiary                |  |      | 133,068  |   |      |   |         |  
|Increase in other assets                  |  |      | (95,478  | ) |      |   | (86,327  | )
|Increase (decrease) in accounts payable   |  |      | (3,000   | ) |      |   | 7,020    |  
|                                          |  |      |          |   |      |   |          |  
|Net cash used in operating activities     |  |      | (122,601 | ) |      |   | (143,966 | )
|                                          |  |     
|Cash Flows from Investing Activities:     |  |      |          |   |      |   |          |  
|Dividends from AF Financial Group         |  |      | 26,912   |   |      |   |         |  
|Proceeds from sale of subsidiary          |  |      | 150,000  |   |      |   |         |  
|                                          |  |      |          |   |      |   |          |  
|Net cash provided by investing activities |  |      | 176,912  |   |      |   |         |  
|                                          |  |     
|Net increase (decrease) in cash           |  |      | 54,311   |   |      |   | (143,966 | )
|Cash, beginning                           |  |      | 163,390  |   |      |   | 307,356  |  
|                                          |  |      |          |   |      |   |          |  
|Cash, ending                              |  | $    | 217,701  |   |      | $ | 163,390  |  
|                                          |  |      |          |   |      |   |          |  



Note 21. Segment Reporting



The Company had additional reportable segments: AF Bank, AF Brokerage,
Inc. and AF Insurance Services, Inc. As of June 24, 2005, AF Brokerage, Inc. was dissolved as a separate entity and as of June 30, 2005, operated as AF Investments, a subsidiary of AF Bank. The information below includes the operating results of AF
Brokerage, Inc. during the 2005 fiscal year prior to the dissolution. AF Bank is a federally chartered stock savings bank. The principal activities of the Bank consist of obtaining savings deposits and providing credit to customers in its primary
market area. AF Insurance Services, Inc. provides insurance services. Information about reportable segments, and reconciliation of such information to the consolidated financial statements as of and for the year ended June 30, 2005 and June 30, 2004
is as follows (dollars in thousands):



|                                    |  |                    |      |   |         |   |         |                             |  |   |                   |   |  |                            |     |   |                     |   |      |   |  |   |         |  
|----------------------------------- |  | ------------------ | ---- | - | ------- | - | ------- | --------------------------- |  | - | ----------------- | - |  | -------------------------- | --- | - | ------------------- | - | ---- | - |  | - | ------- | -
|                                    |  | AF Financial Group |      |   | AF Bank |   |         | AF Insurance Services, Inc. |  |   | AF Brokerage Inc. |   |  | Inter- segment Elimination |     |   | Consolidated Totals |  
|                                    |  |                    |      |   |        
|                                    |  |                    |      |   |        
|June 30, 2005                       |  |                    |      |   |         |   |         |                             |  |   |                   |   |  |                            |     |   |                     |   |      |   |  |   |         |  
|Interest income                     |  | $                  |     |   |         | $ | 12,001  |                             |  | $ |                  |   |  | $                          | 1   |   |                     | $ | (7   | ) |  | $ | 11,995  |  
|Interest expense                    |  |                    | 519  |   |         |   | 4,163   |                             |  |   | 58                |   |  |                            |    |   |                     |   | (7   | ) |  |   | 4,733   |  
|                                    |  |                    |      |   |         |   |         |                             |  |   |                   |   |  |                            |     |   |                     |   |      |   |  |   |         |  
|Net interest income                 |  |                    | (519 | ) |         |   | 7,838   |                             |  |   | (58               | ) |  |                            | 1   |   |                     |   |     |   |  |   | 7,262   |  
|Provision for loan losses           |  |                    |     |   |         |   | (79     | )                           |  |   |                  |   |  |                            |    |   |                     |   |     |   |  |   | (79     | )
|                                    |  |                    |      |   |         |   |         |                             |  |   |                   |   |  |                            |     |   |                     |   |      |   |  |   |         |  
|Net interest income after provision |  |                    | (519 | ) |         |   | 7,917   |                             |  |   | (58               | ) |  |                            | 1   |   |                     |   |     |   |  |   | 7,341   |  
|Non-interest income                 |  |                    |     |   |         |   | 1,388   |                             |  |   | 2,593             |   |  |                            | 322 |   |                     |   | (338 | ) |  |   | 3,965   |  
|Non-interest expense                |  |                    | 326  |   |         |   | 7,367   |                             |  |   | 2,426             |   |  |                            | 383 |   |                     |   | (338 | ) |  |   | 10,164  |  
|                                    |  |                    |      |   |         |   |         |                             |  |   |                   |   |  |                            |     |   |                     |   |      |   |  |   |         |  
|Income (loss) before income taxes   |  |                    | (845 | ) |         |   | 1,938   |                             |  |   | 109               |   |  |                            | (60 | ) |                     |   |     |   |  |   | 1,142   |  
|Income taxes                        |  |                    | (275 | ) |         |   | 748     |                             |  |   | 37                |   |  |                            | (17 | ) |                     |   |     |   |  |   | 493     |  
|                                    |  |                    |      |   |         |   |         |                             |  |   |                   |   |  |                            |     |   |                     |   |      |   |  |   |         |  
|Net income (loss)                   |  | $                  | (570 | ) |         | $ | 1,190   |                             |  | $ | 72                |   |  | $                          | (43 | ) |                     | $ |     |   |  | $ | 649     |  
|                                    |  |                    |      |   |         |   |         |                             |  |   |                   |   |  |                            |     |   |                     |   |      |   |  |   |         |  
|Assets                              |  | $                  | 429  |   |         | $ | 211,781 |                             |  | $ | 2,377             |   |  | $                          |    |   |                     | $ | (486 | ) |  | $ | 214,101 |  
|                                    |  |                    |      |   |         |   |         |                             |  |   |                   |   |  |                            |     |   |                     |   |      |   |  |   |         |  



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Notes to Consolidated Financial Statements



Note 21. Segment Reporting, continued



|                                    |  |                  |      |   |         |   |                           |  |   |                 |   |  |                           |      |   |                    |   |      |   |  |   |         |  
|----------------------------------- |  | ---------------- | ---- | - | ------- | - | ------------------------- |  | - | --------------- | - |  | ------------------------- | ---- | - | ------------------ | - | ---- | - |  | - | ------- | -
|                                    |  | AFFinancialGroup |      |   | AF Bank |   | AFInsuranceServices, Inc. |  |   | AFBrokerageInc. |   |  | Inter- segmentElimination |      |   | ConsolidatedTotals |  
|June 30, 2004                       |  |                  |      |   |         |   |                           |  |   |                 |   |  |                           |      |   |                    |   |      |   |  |   |         |  
|Interest income                     |  | $                |     |   |         | $ | 10,691                    |  | $ |                |   |  | $                         |     |   |                    | $ | (8   | ) |  | $ | 10,683  |  
|Interest expense                    |  |                  | 514  |   |         |   | 3,835                     |  |   | 63              |   |  |                           |      |   |                    |   | (8   | ) |  |   | 4,404   |  
|                                    |  |                  |      |   |         |   |                           |  |   |                 |   |  |                           |      |   |                    |   |      |   |  |   |         |  
|Net interest income                 |  |                  | (514 | ) |         |   | 6,856                     |  |   | (63             | ) |  |                           |     |   |                    |   |     |   |  |   | 6,279   |  
|Provision for loan losses           |  |                  |     |   |         |   | 668                       |  |   |                |   |  |                           |     |   |                    |   |     |   |  |   | 668     |  
|                                    |  |                  |      |   |         |   |                           |  |   |                 |   |  |                           |      |   |                    |   |      |   |  |   |         |  
|Net interest income after provision |  |                  | (514 | ) |         |   | 6,188                     |  |   | (63             | ) |  |                           |     |   |                    |   |     |   |  |   | 5,611   |  
|Non-interest income                 |  |                  |     |   |         |   | 1,443                     |  |   | 2,433           |   |  |                           | 177  |   |                    |   | (309 | ) |  |   | 3,744   |  
|Non-interest expense                |  |                  | 452  |   |         |   | 6,930                     |  |   | 2,392           |   |  |                           | 321  |   |                    |   | (309 | ) |  |   | 9,786   |  
|                                    |  |                  |      |   |         |   |                           |  |   |                 |   |  |                           |      |   |                    |   |      |   |  |   |         |  
|Income (loss) before income taxes   |  |                  | (966 | ) |         |   | 701                       |  |   | (22             | ) |  |                           | (144 | ) |                    |   |     |   |  |   | (431    | )
|Income taxes                        |  |                  | (329 | ) |         |   | 251                       |  |   | 3               |   |  |                           | (48  | ) |                    |   |     |   |  |   | (123    | )
|                                    |  |                  |      |   |         |   |                           |  |   |                 |   |  |                           |      |   |                    |   |      |   |  |   |         |  
|Net income (loss)                   |  | $                | (637 | ) |         | $ | 450                       |  | $ | (25             | ) |  | $                         | (96  | ) |                    | $ |     |   |  | $ | (308    | )
|                                    |  |                  |      |   |         |   |                           |  |   |                 |   |  |                           |      |   |                    |   |      |   |  |   |         |  
|Assets                              |  | $                | 230  |   |         | $ | 209,228                   |  | $ | 2,302           |   |  | $                         | 193  |   |                    | $ | (334 | ) |  | $ | 211,619 |  
|                                    |  |                  |      |   |         |   |                           |  |   |                 |   |  |                           |      |   |                    |   |      |   |  |   |         |  



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ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE



Not
applicable.



ITEM 8A. CONTROLS AND PROCEDURES



The Company maintains a system of internal controls and procedures designed to provide reasonable assurance as to the reliability of our published
financial statements and other disclosures included in this report. The Companys Board of Directors, operating through its Audit Committee, which is composed entirely of independent outside directors, provides oversight of the Companys
financial reporting process.



Management, including the
Companys President and Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Companys disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of
the period covered by this report. Based upon that evaluation, the President and Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures were effective, in all material respects, to ensure that
information required to be disclosed in the reports the Company files and submits under the Exchange Act is recorded, processed, summarized and reported as and when required.



There have been no changes in the Companys internal control over financial reporting identified in connection with the
evaluation that occurred during the Companys last fiscal quarter that has materially affected, or that is reasonably likely to materially affect, the Companys internal control over financial reporting.



PART III



ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE
WITH SECTION 16(A) OF THE EXCHANGE ACT



The information required by this Item regarding (i) directors of the Company is set forth under the section captioned Proposal 1  Election of
Directors; (ii) Company executive officers is set forth under the section Proposal 1  Election of Directors  Executive Officers; (iii) Section 16(a) compliance is set forth under the section captioned Section
16(a) Beneficial Ownership Reporting Compliance in the Companys Proxy Statement for the Annual Meeting of Stockholders to be held November 7, 2005, all of which are incorporated herein by this reference.



The Company has adopted a written Code of Ethics for its principal executive
officer and senior financial officer as required by Sarbanes-Oxley and applicable SEC Rules. A copy of our Code of Ethics policy is available on our website at www.afgrp.com.



ITEM 10. EXECUTIVE COMPENSATION



The information requested by this Item is set forth under the section captioned Proposal 1  Election of Directors  Directors
Compensation and Executive Compensation in the Companys Proxy Statement for the Annual Meeting of Stockholders to be held on November 7, 2005 both of which are incorporated herein by reference.



ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
AND RELATED STOCKHOLDER MATTERS



The information relating to security ownership of certain beneficial owners and management is incorporated herein by reference to the section captioned
Security Ownership  Certain Beneficial Owners and Management in the Companys Proxy Statement for the Annual Meeting of Stockholders to be held on November 7, 2005.





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The following table sets forth the aggregate information with respect to the Companys equity
compensation plans as in effect as of June 30, 2005.



|                                                           |  |                                                                                           |  |                                                                          |       |                                                                                                                                        |    
|---------------------------------------------------------- |  | ----------------------------------------------------------------------------------------- |  | ------------------------------------------------------------------------ | ----- | -------------------------------------------------------------------------------------------------------------------------------------- | ---
|                                                           |  | Equity Compensation Plan Information                                                     
|Plan category                                              |  | Number of securities to be issued upon exercise ofoutstanding options,warrants and rights |  | Weighted-averageexercise price ofoutstanding options,warrants and rights |       | Number of securitiesremaining available forfuture issuance underequity compensationplans (excluding securitiesreflected in
column (a))
|                                                           |  | (a)                                                                                       |  |                                                                          | (b)   |                                                                                                                                        | (c)
|Equity compensation plans approved by security holders     |  | 14,573                                                                                    |  | $                                                                        | 18.50 |                                                                                                                                        |   
|                                                           |  |                                                                                           |  |                                                                          |       |                                                                                                                                        |    
|Equity compensation plans not approved by security holders |  |                                                                                          |  |                                                                          |      |                                                                                                                                        |   
|                                                           |  |                                                                                           |  |                                                                          |       |                                                                                                                                        |    
|Total                                                      |  | 14,573                                                                                    |  | $                                                                        | 18.50 |                                                                                                                                        |   
|                                                           |  |                                                                                           |  |                                                                          |       |                                                                                                                                        |    



ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS



The information relating to certain relationships and related transactions is incorporated herein by reference to the
section captioned Proposal 1  Election of Directors  Transactions with Certain Related Persons in the Companys Proxy Statement for the Annual Meeting of Stockholders to be held on November 7, 2005.



ITEM 13. EXHIBITS



|    |  |          |  |                                                                                                                                                                                                                                                                                               
|--- |  | -------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) |  | Exhibits |  |                                                                                                                                                                                                                                                                                               
|    |  |         
|    |  | 2.1      |  | Agreement and Plan of Reorganization dated September 15, 1997 by and among Ashe Federal Bank, AF Bankshares, Inc. and Ashe Interim Savings Bank (Incorporated by reference to Exhibit 2.1 of
the Registration Statement on Form 8-A, as filed with the SEC on June 16, 1998 (the Form 8-A)).
|    |  |         
|    |  | 3.1      |  | Federal Stock Charter of the Company (Incorporated by reference to Exhibit 3.1 of the Form 8-A).                                                                                                                                                                                              
|    |  |         
|    |  | 3.2      |  | Bylaws of the Company (Incorporated by reference to Exhibit 3.2 of the Form 8-A).                                                                                                                                                                                                             
|    |  |         
|    |  | 4.1      |  | Common Stock Certificate of the Company (Incorporated by reference to Exhibit 4.3 of the Form 8-A).                                                                                                                                                                                           
|    |  |         
|    |  | 4.2      |  | Indenture dated July 16, 2001 by and between AF Bankshares, Inc. and The Bank of New York (Incorporated by reference to Exhibit 4.2 of the Annual Report on Form 10-KSB, as filed with the SEC
on September 29, 2003 (the 2003 Form 10-KSB)).                                               
|    |  |         
|    |  | 4.3      |  | Guarantee Agreement of AF Bankshares, Inc. dated July 16, 2001 (Incorporated by reference to Exhibit 4.3 of the 2003 Form 10-KSB).                                                                                                                                                            
|    |  |         
|    |  | 10.1     |  | Employment Agreement between AF Bank and Melanie Paisley Miller dated November 18, 2002 (Incorporated by reference to Exhibit 10.2 of the 2003 Form 10-KSB).                                                                                                                                  





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| |  |       |  |                                                                                                                                                                                                                                                   
| |  | ----- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  |      
| |  | 10.2  |  | Employment Agreement with Martin G. Little, Senior Vice President and Chief Lending Officer (Incorporated by reference to Exhibit 10.3 of the Annual Report on Form 10-KSB, as filed with the
SEC on September 29, 1998 (the 1998 Form 10- KSB).
| |  |      
| |  | 10.3  |  | Employee Stock Ownership Plan of Ashe Federal Bank (Incorporated by reference to Exhibit 10.4 of the 1998 Form 10-KSB).                                                                                                                           
| |  |      
| |  | 10.4  |  | Amendment No. 1 to the Employee Stock Ownership Plan of AF Bank (Incorporated by reference to Exhibit 10.5 of the 2003 Form 10-KSB).                                                                                                              
| |  |      
| |  | 10.5  |  | Amendment No. 2 to the Employee Stock Ownership Plan of AF Bank (Incorporated by reference to Exhibit 10.6 of the 2003 Form 10-KSB).                                                                                                              
| |  |      
| |  | 10.6  |  | Amendment No. 3 to the Employee Stock Ownership Plan of AF Bank (Incorporated by reference to Exhibit 10.7 of the 2003 Form 10-KSB).                                                                                                              
| |  |      
| |  | 10.7  |  | Amendment No. 4 to the Employee Stock Ownership Plan of AF Bank (Incorporated by reference to Exhibit 10.7 of the 2003 Form 10-KSB).                                                                                                              
| |  |      
| |  | 10.8  |  | Salary Continuation Agreement between AF Bankshares, Inc. and Melanie Paisley Miller dated April 15, 2002 (Incorporated by reference to Exhibit 10.10 of the 2003 Form
10-KSB).                                                                   
| |  |      
| |  | 10.9  |  | Employment Agreement between AF Financial Group and Melanie Paisley Miller dated November 18, 2002 (Incorporated by reference to Exhibit 10.13 of the 2003 Form 10-KSB).                                                                          
| |  |      
| |  | 10.10 |  | Settlement Agreement dated September 24, 2004 by and between James A. Todd and AF Financial Group (Incorporated by reference to Exhibit 99.1 of the Current Report on Form 8-K, as filed with
the SEC on September 24, 2004).                     
| |  |      
| |  | 31.1  |  | Rule 13a-14(a)/15d-14(a) Certifications                                                                                                                                                                                                           
| |  |      
| |  | 32.1  |  | Section 1350 Certifications                                                                                                                                                                                                                       
| |  |      
| |  | 99.1  |  | Proxy Statement for the 2005 Annual Meeting of Stockholders for AF Financial Group.                                                                                                                                                               



ITEM 14.PRINCIPAL ACCOUNTANT FEES AND SERVICES



Information relating to the principal accountant fees and services is
incorporated herein by reference to the section captioned Proposal 1  Election of Directors  Principal Accountant Fees and Services and Pre-Approval of Audit and Permissible Non-Audit Services in the
Companys Proxy Statement for the Annual Meeting of Stockholders to be held on November 7, 2005.





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SIGNATURES



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



|                         |  |                    |  |                                      
|------------------------ |  | ------------------ |  | -------------------------------------
|                         |  | AF Financial Group
|                         |  | (Registrant)      
|                         |  |                   
|Date: September 23, 2005 |  | By:                |  | /s/ Robert E. Washburn               
|                         |  |                    |  | Robert E. Washburn                   
|                         |  |                    |  | President and Chief Executive Officer



In accordance with the
Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.



|                                                |  |                   
|----------------------------------------------- |  | ------------------
|                                                |  | Date              
|/s/ Robert E. Washburn                          |  | September 23, 2005
|Robert E. Washburn                              |  |                   
|President, Chief Executive Officer and Director |  |                   
|                                                | 
|/s/ Wayne R. Burgess                            |  | September 23, 2005
|Wayne R. Burgess - Director                     |  |                   
|                                                | 
|/s/ Jan R. Caddell                              |  | September 23, 2005
|Jan R. Caddell - Director                       |  |                   
|                                                | 
|/s/ Kenneth R. Greene                           |  | September 23, 2005
|Kenneth R. Greene  Director                    |  |                   
|                                                | 
|/s/ Claudia L. Kelley                           |  | September 23, 2005
|Claudia L. Kelley  Director                    |  |                   
|                                                | 
|/s/ Donald R. Moore                             |  | September 23, 2005
|Donald R. Moore - Director                      |  |                   
|                                                | 
|/s/ Jimmy D. Reeves                             |  | September 23, 2005
|Jimmy D. Reeves  Director                      |  |                   
|                                                | 
|/s/ Jerry L. Roten                              |  | September 23, 2005
|Jerry L. Roten - Director                       |  |                   
|                                                | 
|/s/ Michael M. Sherman                          |  | September 23, 2005
|Michael M. Sherman  Director                   |  |                   
|                                                | 
|/s/ John D. Weaver                              |  | September 23, 2005
|John D. Weaver - Director                       |  |                   



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