<PAGE>

                      SECURITIES AND EXCHANGE COMMISSION
                            Washington, D.C. 20549

                                  Form 10-KSB

             Annual Report Pursuant to Section 13 or 15(d) of the
                        Securities Exchange Act of 1934

                    For the fiscal year ended June 30, 2001

                         Commission File No.: 0-24479

                              AF BANKSHARES, INC.
       (Exact name of small business issuer as specified in its charter)

        Federally Chartered                                  56-2098545
      State of Incorporation                            IRS Employer Number
                              21 East Ashe Street
                     West Jefferson, North Carolina 28694
                   (Address of Principal Executive Offices)

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

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

                    Common Stock, par value $0.01 per share
                                Title of Class

         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 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. [X]

         The revenues for the issuer's fiscal year ended June 30, 2001 are
$14,141,648.

         The issuer had 1,049,379 shares of common stock outstanding as of
August 31, 2001. 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, 2001 was $5,650,445.

                      Documents Incorporated by Reference.
         Portions of the Annual Report to Stockholders for the year ended June
30, 2001 are incorporated by reference into Part I and II of this Form 10-KSB.

         Portions of the Proxy Statement for the 2001 Annual Meeting of
Stockholders are incorporated by reference into Part III of this Form 10-KSB.

         Transitional Small Business Disclosure Format.       Yes [_]    No [X]
<PAGE>

                                TABLE OF CONTENTS

<TABLE>
<CAPTION>

<S>                                                                                                                 <C>
PART I...........................................................................................................    2
------
   Item 1.     Description of Business...........................................................................    2
   -------     -----------------------
   Item 2.     Properties........................................................................................   32
   -------     ----------
   Item 3.     Legal Proceedings.................................................................................   33
   -------     -----------------
   Item 4.     Submission of Matters to a Vote of Security Holders...............................................   33
   -------     ---------------------------------------------------

PART II..........................................................................................................   33
-------
   Item 5.     Market for Common Stock and Related Stockholder Matters...........................................   33
   -------     -------------------------------------------------------
   Item 6.     Management's Discussion and Analysis..............................................................   33
   -------     ------------------------------------
   Item 7.     Financial Statements..............................................................................   33
   -------     --------------------
   Item 8.     Changes in and Disagreement with Accountants on Accounting and Financial Disclosure...............   34
   -------     -----------------------------------------------------------------------------------

PART III.........................................................................................................   34
--------
   Item 9.     Directors, Executive Officers, Promoters and Control Persons......................................   34
   -------     ------------------------------------------------------------
   Item 10.    Executive Compensation............................................................................   34
   --------    ----------------------
   Item 11.    Security Ownership of Certain Beneficial Owners and Management....................................   34
   --------    --------------------------------------------------------------
   Item 12.    Certain Relationships and Related Transactions....................................................   34
   --------    ----------------------------------------------
   Item 13.    Exhibits and Reports on Form 8-K..................................................................   34
   --------    --------------------------------

SIGNATURES.......................................................................................................   36
----------
</TABLE>
<PAGE>

                                    PART I

Item 1.   Description of Business

General

         AF Bankshares, Inc. (the "Company") is a federally chartered stock
holding company which owns 100% of the common stock of AF Bank (the "Bank"), AF
Insurance Services, Inc. and AF Brokerage, Inc. The Company has no operations
and conducts no business of its own other than ownership of its subsidiaries and
investing in securities. The Bank is a federally chartered stock savings bank
which conducts business from its main office located in West Jefferson, North
Carolina, with branches in Boone, Jefferson, Sparta, Warrensville and West
Jefferson, North Carolina. The Bank was founded in 1939 as a building and loan
association. In the early 1980s, the Bank converted from a North Carolina
chartered building and loan to a federally chartered mutual savings and loan
association, and in August of 1995 converted to a federally chartered mutual
savings bank. During fiscal year 1997, the Bank converted from a federally
chartered mutual savings bank to a federally chartered stock savings bank which
is majority owned by AsheCo, M.H.C., a mutual holding company. On June 16, 1998,
the Bank completed its reorganization into a two-tier mutual holding company and
became a wholly owned subsidiary of the Company. See "Management's Discussion
and Analysis -- The Reorganization." The Bank's deposits are insured by the
Savings Association Insurance Fund ("SAIF") of the Federal Deposit Insurance
Corporation (the "FDIC") to the maximum extent permitted by law. At June 30,
2001, the Bank had total assets of $153.4 million, total deposits of $120.1
million and equity of $13.0 million.

         The historical operations of the Company have been that of a portfolio
mortgage lender, providing fixed rate loans for the residents of Ashe County,
North Carolina. Management has recently expanded the market area of the Company
to include Alleghany and Watauga counties and has diversified its product lines
by engaging in non-mortgage lending and offering non-traditional financial
services, such as insurance and brokerage products. More specifically, since
1996, the Company has made a major commitment to small business commercial
lending and consumer lending as a means to increase the yield on its loan
portfolio and attract lower cost deposit accounts. As a result of this
commitment, commercial loans increased by 211.4% and consumer loans have
increased by 69.7% since June 30, 1998. In addition, since July 1997, the
Company has offered traditional property and casualty, life and health insurance
products through AF Insurance Services, Inc., a wholly-owned subsidiary of the
Company, headquartered in West Jefferson, North Carolina and operating in Boone,
Elkin, Jefferson, Lenoir, Sparta, West Jefferson and Wilkesboro, North Carolina.
The Company also has a brokerage subsidiary, AF Brokerage, Inc., which serves
Ashe, Alleghany, Wilkes and Watauga counties. AF Brokerage offers various
uninsured investment products, including fixed-rate and variable annuities and
mutual funds. The Company believes that its strategy of expanding its market
area and diversifying its product lines will enhance its franchise value and
strengthen earnings in the future.

         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 interest paid on
savings deposits and borrowings of the Company. The primary interest-earning
asset of the Company is its mortgage loan portfolio representing 79.9% of total
loans, with approximately 56.0% of portfolio mortgage loans at fixed rates at
June 30, 2001. The net interest income of the Company is affected by changes in
economic conditions that influence market interest rates. 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 net market value of its assets and liabilities. Additionally, the Company
receives fee income primarily from loan origination fees, late loan payment
fees, commissions from the sale of credit life, accident and health insurance,
insurance commissions generated from the insurance agency subsidiary and in
payment for other services provided to the customer by the Company.

                                       2
<PAGE>

The major non-interest costs to the Company include compensation and benefits,
occupancy and equipment and data processing costs. Other external factors that
affect the operating results of the Company include changes in government and
accounting regulations, costs of implementing information technology, and
changes in the competition's emphasis within the Company's market.

         As of June 30, 2001, $105.0 million, or 79.9% of the Bank's total loan
portfolio consisted of real estate loans. Total loans at June 30, 2001 were
$131.4 million of which $79.5 million or 63.7% were secured by one- to-four
family residences. Total mortgage loans, including construction loans, totaled
$105.0 million as of June 30, 2001. Of that amount, approximately 44.0% was
adjustable rate loans, or had remaining terms of one year or less. The Company's
strategy is to sell long term, fixed-rate mortgages while retaining the
servicing. The reduction in the level of fixed rate mortgages has served to
reduce the Company's exposure to interest rate risk.

         The Bank also invests in consumer loans and commercial loans. As of
June 30, 2001, the Bank's consumer loans and commercial loan portfolios were
$26.4 million, or 21.2% of total loans. Commercial loans totaled $12.4 million,
or 9.9% of the Bank's total loan portfolio. The Bank invests a portion of its
assets in debt and equity securities issued by the FHLB and the Federal Home
Loan Mortgage Corporation (the "FHLMC") and began investing in mortgage-backed
securities during fiscal 1996. Mortgage-backed securities totaled $2.0 million
or 1.3% of total assets at June 30, 2001, and FHLB and FHLMC securities
investments totaled $3.8 million, or 2.5%, of total assets at June 30, 2001.

Reorganization

         On October 4, 1996, the Bank reorganized into the mutual holding
company form of organization. Members of the mutual holding company consist of
depositors of the Bank, who have the sole authority to elect the board of
directors of the mutual holding company for as long as it remains in mutual
form. Initially, the mutual holding company's principal assets are the shares of
the Bank's common stock received in the reorganization and on its initial
capitalization of $100,000 in cash. The mutual holding company, which by law
must own in excess of 50% of the stock of the Bank, was issued stock in the
Reorganization resulting in a majority ownership interest of 53.8% of the Bank.
The remaining shares of common stock of the Bank were sold to the depositors and
borrowers of the Bank. By virtue of its ownership of a majority of the
outstanding shares of the Bank, the mutual holding company can generally control
the outcome of most matters presented to the stockholders of the Bank for
resolution by vote except for certain matters related to stock compensation
plans, a vote regarding conversion of the mutual holding company to stock form,
or others matters which require a vote only by the minority stockholders. The
mutual holding company has registered as a savings and loan holding company and
its subject to regulation, examination, and supervision by the Office of Thrift
Supervision (OTS).

         On June 16, 1998, the Bank completed its reorganization into a two-tier
mutual holding company, pursuant to the agreement and plan of reorganization
approved by the Bank's shareholders on December 8, 1997. Under the
reorganization, the Bank became the wholly-owned subsidiary of AF Bankshares,
Inc., a newly formed stock holding company (the "Company") and holders of the
Bank's common stock became holders of the Company's common stock, on an equal
share for shares exchange. At June 30, 2001, the mutual holding company owned
51.3% of the Company.

Market Area and Competition

         Previously, the Bank's market area for deposit gathering and lending
has been concentrated in Ashe County, North Carolina. However, management
believes that the Company must expand its market base to build value for the
Company and its shareholders. In March 1998, the Company opened a branch of AF
Bank in Alleghany County and operates the branch under the trade name Alleghany
First Bank. At

                                       3
<PAGE>

the same time, an insurance agency branch of AF Insurance Services, Inc., was
opened in the same location. The staff of Alleghany First came from the local
banking community and is attuned to the needs and habits of Alleghany citizens.
The insurance agency personnel direct their attention to the special needs of
Alleghany County citizens as well. On March 1, 1999, the Bank also opened a
branch office in Boone, North Carolina operating under the trade name
Appalachian First Bank. In April 1999, the Company added an insurance agency in
Lenoir, North Carolina, in December 1999, the Company acquired an agency in
Elkin, North Carolina and in November 2000, the Company acquired an agency in
Boone, North Carolina. Entry into the Boone and Alleghany markets significantly
expands the Company's potential to market its banking, insurance and noninsured
investment products to a larger and more diverse market. Management now believes
that it is delivering the same personalized customer service to the new markets
that it has historically delivered to Ashe County. Management believes that
penetration into other markets increases the opportunity to deliver products
from all of the Company's subsidiaries to a broader market and will make the
insurance and brokerage subsidiaries more profitable investments by increasing
the economies of scale and adding to the products that are available for
delivery to the Company's customers. The Company continues to seek opportunities
to increase its market penetration for its services.

         Management believes that the Company's customers perceive "financial
services" to include five broad categories: funds transfer including checking
accounts; insured savings instruments; credit/lending services; insurance; and
securities brokerage. Further, management believes that failure to offer
insurance and brokerage services in addition to traditional "banking only"
services would impair the Company's growth and make retention of existing
customers more difficult. The Company continues to seek opportunities to
increase market penetration for its products and services, primarily in
northwestern North Carolina. During the three month period ending September 30,
1998, the Company established a securities brokerage subsidiary, AF Brokerage,
Inc., which currently conducts brokerage services in Ashe, Alleghany, Wilkes and
Watauga counties. AF Brokerage, Inc. applied to become a member of the National
Association of Securities Dealers, Inc. ("NASD") in the third quarter of 1998
and was granted membership on October 22, 1999. AF Brokerage, Inc. commenced
operation in the fourth quarter of 2000 as an independent broker/dealer.
Management continues to evaluate acquisitions and business opportunities that it
believes will provide access to customers and markets which would enhance the
Company's long-term value and earnings potential.

         On November 1, 2000, the Company purchased the assets of an insurance
agency in Boone, North Carolina, adding insurance products to the banking
services offered by the Company in Watauga County. Management believes that
penetration into new (especially contiguous) markets increases the opportunity
to deliver products from all of the Company's subsidiaries to a broader market
base, thereby making the insurance and brokerage subsidiaries more profitable
investments by increasing the economies of scale, as well as improving the
economies of scope, and at the same time adding to the products that are
available for delivery to the Company's customers. Of course, management is
equally committed to protecting and expanding the Company's market share in
existing markets. As evidence of this continuing commitment, the Company
executed a definitive agreement to allow AF Bank to be the only financial
institution located inside the new Wal-Mart superstore under construction in
West Jefferson, North Carolina. The Company also plans to build a freestanding,
full-service branch adjacent to Wal-Mart offering full service banking, full
line property and casualty, life and health insurance as well as mutual funds
and annuities. Thus, customers will enjoy the convenience of banking where they
shop --as well as having access to a comprehensive array of financial services
at the free-standing branch office (including ATM drive-through lanes, and a
commercial depository). The Company continues to seek opportunities to increase
the market penetration of its services.

         The Bank faces substantial competition for both the deposits it accepts
and the loans it makes. Management believes that the Bank has the second largest
deposit base in Ashe County, and the second largest deposit base in the part of
Ashe County which comprises its primary zip code, 28694. Located

                                       4
<PAGE>

within Ashe County are branches of seven other depository institutions, five of
which are commercial banks and two of which are credit unions. The Bank competes
for deposits by offering a variety of customer services and deposit accounts at
competitive interest rates. The Bank, like its competitors, is 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 the demand for loans relative to the availability of
credit may affect the level of competition from financial institutions which may
have greater resources than the Bank, but which have not generally engaged in
lending activities in the Bank's market area in the past, and from credit unions
that can expand into the Bank's 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."

Lending Activities

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

         The types of loans that the Bank 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 Federal Reserve Board (the "FRB"), and
legislative tax policies.

                                       5
<PAGE>

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

<TABLE>
<CAPTION>
                                                                           June 30,
                                         ------------------------------------------------------------------------------
                                                      2001                                           2000
                                         --------------------------------                ------------------------------
                                              Amount        % of Total                       Amount       % of Total
                                         --------------   ---------------                -------------   --------------
                                                                    (Dollars in thousands)
<S>                                      <C>              <C>                            <C>              <C>
Mortgage loans:
   One-to four-family...............      $  79,465              63.74%                   $  68,813            63.26%
   Multi-family.....................          3,507               2.81%                       2,277             2.09%
   Non-residential..................          8,359               6.70%                       8,577             7.89%
   Land.............................          8,298               6.66%                       2,440             2.24%
   Construction.....................          5,344               4.29%                       4,059             3.73%
                                          ---------            -------                    ---------          -------
     Total mortgage loans...........        104,973              84.20%                      86,166            79.21%
                                          ---------            -------                    ---------          -------

Other loans:
   Commercial.......................         12,378               9.93%                      10,456             9.62%
   Consumer loans...................         14,051              11.27%                      17,376            15.97%
                                         ----------            -------                   ----------          -------
     Total other loans..............         26,429              21.20%                      27,832            25.59%
                                         ----------            -------                   ----------          -------
   Gross loans......................        131,402             105.40%                     113,998           104.80%
                                         ----------            -------                   ----------          -------

Less:
   Undisbursed loan funds...........          5,479               4.39%                       3,993             3.67%
   Deferred loan fees...............            227               0.18%                         248             0.23%
   Allowance for loan losses........          1,022               0.82%                         979             0.90%
                                          ---------            -------                    ---------      -----------
                                              6,728               5.40%                       5,220             4.80%
                                          ---------            -------                    ---------          -------
   Loans, net.......................      $ 124,674             100.00%                   $ 108,778           100.00%
                                          =========            =======                    =========          =======

   Loans serviced for others:
   One-to four-family and
     cooperative apartment..........      $  25,196             100.00%                   $  22,613           100.00%
                                          ---------            -------                    ---------          -------
         Total loans serviced
         for others                       $  25,196             100.00%                   $  22,613           100.00%
                                          =========            =======                    =========          =======
</TABLE>

                                       6
<PAGE>

         Loan Maturity. The following table shows the maturity or period to
repricing of the Bank's loan portfolio at June 30, 2001. Loans that have
adjustable rates are shown using scheduled principal amortization. The table
does not consider estimated prepayments of principal.

<TABLE>
<CAPTION>
                                                                           At June 30, 2001

                                   One- to
                                    Four-     Multi-      Non-                                  Commercial   Consumer
                                   Family     Family    Residential    Land      Construction     Loans        Loans    Total Loans
                                  --------   --------  -------------  ------    --------------   -------      -------  -------------
                                                                            (In thousands)
<S>                               <C>        <C>       <C>            <C>       <C>             <C>           <C>       <C>

Amount due:
  One year or less................  $  6,822    $     -    $  1,706   $   970      $   3,930     $   5,533   $   2,289   $   21,250
                                    --------    -------    --------   -------      ---------     ---------   ---------   ----------

After one year:
  One to three years..............    16,265      1,476       2,970     3,052          1,414         2,656       7,676       35,509
  More than three years to five
  years...........................     8,855        488         821       688              -         1,723       3,281       15,856
  More than five years to ten
  years...........................     9,218        880         790     1,446              -         1,453         486       14,273
  More than ten years to
  twenty years....................    38,305        663       2,072     2,142              -         1,013         286        4,481
  Over twenty years...............         -          -           -         -              -             -          33           33
                                     -------    -------    --------   -------      ---------     ---------   ---------   ----------
Total due or repricing after one
year..............................    72,643      3,507       6,653     7,328          1,414         6,845      11,762      110,152
                                    --------    -------    --------   -------      ---------     ---------   ---------   ----------
Total amounts due or repricing,
   gross..........................  $ 79,465    $ 3,507    $  8,359   $ 8,298      $   5,344     $  12,378   $  14,051   $  131,402
                                    --------    -------    --------   -------      ---------     ---------   ---------   ----------
</TABLE>

         The following table sets forth the dollar amounts in each loan category
at June 30, 2001 that are due after June 30, 2002, and whether such loans have
fixed or adjustable interest rates.

<TABLE>
<CAPTION>
                                                                         Due after June 30, 2002
                                                    -----------------------------------------------------------------
                                                         Fixed                 Adjustable                 Total
                                                    ------------------      -----------------     -------------------
                                                                             (In thousands)
<S>                                                 <C>                     <C>                   <C>
Mortgage loans:
   One- to four-family.........................     $       46,517          $       26,126         $         72,643
   Multi-family................................                354                   3,153                    3,507
   Non-residential.............................              6,653                       -                    6,653
   Land........................................              4,946                   2,382                    7,328
   Construction................................                348                   1,066                    1,414
Commercial loans...............................              3,350                   3,495                    6,845
Consumer loans.................................             11,040                     722                   11,762
                                                    --------------          --------------         ----------------
                                                    $       73,208          $       36,944         $        110,152
                                                    ==============          ==============         ================
</TABLE>

         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.
Adjustable-rate mortgage loans carried in portfolio and fixed-rate mortgage
loans 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. Historically, the Bank held for its portfolio all loans it
originated. The Bank now sells all qualified fixed-rate loans to Fannie Mae, but
retains the servicing rights. The determination to sell loans is based upon
management's efforts to reduce interest rate risk. At June 30, 2001, the Bank
serviced approximately $25.2 million of loans for Fannie Mae.

         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 have higher interest rates and
shorter terms than those loans sold to Fannie Mae. Most are secured by property
located in

                                       7
<PAGE>

Ashe, Alleghany and Watauga counties, North Carolina. Loan originations are
generally obtained from existing or past customers and members of the local
communities. See "--Origination, Purchase, Sale and Servicing of Loans."

         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 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, allows management
flexibility with respect to documentation of certain matters and certain credit
requirements. As a result, such underwriting guidelines in certain lending
situations are less rigid than comparable Fannie Mae underwriting guidelines.
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 Fannie Mae. The Bank sells all qualifying fixed-rate loans to Fannie
Mae, while retaining servicing rights. 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, 2001, that Bank's portfolio contained approximately $5.3
million, or 4.3%, of construction 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 as well.
Thus construction loans typically "roll" into permanent financing. Construction
loans are made for a maximum of 12 months, by which time permanent financing
must be obtained.

         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 estimate of
construction cost proves to be inaccurate, the Bank may be compelled to advance
additional funds to complete construction.

         Non-Residential Mortgage Lending. The Bank originates commercial real
estate mortgage loans that are generally secured by 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 or 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, 2001 the Bank's non-residential mortgage
loan portfolio was $8.4 million, or 6.7% of total loans outstanding.

                                       8
<PAGE>

The largest non-residential mortgage loan in the Bank's portfolio at June 30,
2001 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 for speculative purposes. Multi-family loans generally consist of
residential properties with more than four units, typically small apartment
complexes, located in the Bank's primary lending area. At June 30, 2001, the
Bank's total land loan portfolio was $8.3 million or 6.7% of total loans and its
multi-family loan portfolio was $3.5 million or 2.8% of total loans.

         The Bank requires appraisals of all mortgage loans. Appraisals 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.

         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, generally.

         Consumer Loans. Subject to the restrictions contained in federal laws
and regulations, the Bank also is authorized to make loans for a wide variety of
personal or consumer purposes. As of June 30, 2001, $14.1 million, or 11.3%, of
the Bank's total loan portfolio consisted of consumer loans (including home
equity credit line loans and second mortgage loans). The primary component of
the Bank's consumer loan portfolio was $9.2 million of auto loans. Consumer
loans are available at fixed or variable interest rates.

         The Bank offers adjustable rate home equity credit lines tied to the
prime interest rate. The home equity portfolio amounted to $6.9 million or 5.3%
of the total loan portfolio as of June 30, 2001. The home equity credit line is
available on any owner-occupied one-to-four family home, townhouse, or
condominium in the Bank's lending area provided the homeowner meets the Bank's
lending criteria. A home equity loan is an adjustable rate mortgage which is
based on the equity in the home, and is generally secured by a first or second
mortgage on the residence. The current maximum term is 180 months. The

                                       9
<PAGE>

Bank may offer home equity loans up to 100% of the value of the collateral to
certain customers meeting a higher level of credit criteria.

         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, 2001, the Bank's savings account loan
portfolio totaled $356,000 or 0.3% of the total loans outstanding.

         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 many 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, 2001, the Bank had $68,000 in non-performing consumer
loans. Charge-offs for consumer loans totaled $128,000 and $194,000 for the
years ended June 30, 2001 and 2000, 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 three 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 real estate and
receivables. The Bank requires principals of corporate borrowers to become
co-borrowers or obtains personal guarantees from the principals of the borrower
with respect to all commercial business loans.

         Commercial business lending generally entails significantly greater
credit risk than residential real estate 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, 2001, the Bank had no non-performing commercial business
loans. Charge-offs for commercial business loans totaled $172,000 and $115,000
for the year ended June 30, 2001 and 2000, respectively.

         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
and lending officers may approve loans in amounts within assigned lending
limits, and the Loan Committee, comprised of the Executive Committee of the
Board of Directors may approve loans up to the Bank's loans-to-one-borrower
limit. In addition, the staff loan committee, comprised of the chief executive
officer, chief financial officer, chief lending officer, credit analyst and
collection officer meets twice a week to review all loan applications that meet
all lending policy criteria. The staff loan committee can approve lending
relationships up to $750,000. Larger amounts must be approved by the Executive
Committee of the Board of Directors. The foregoing lending limits are reviewed
annually and, as needed, revised by the Board of Directors. The Board generally
ratifies all loans on a monthly basis.

                                       10
<PAGE>

         For all loans originated by the Bank, upon receipt of a completed loan
application from a prospective borrower, a credit report is ordered and certain
other information supporting the borrower's ability to repay is required. An
appraisal performed by a Bank approved independent appraiser is required for all
real property intended to secure the proposed loan. 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 $50,000 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. Management and 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, 2001, the Bank held $248,000 in REO, while non-performing loans,
defined as loans that are 90 days or more delinquent, totaled $479,000. 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").

                                       11
<PAGE>

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

<TABLE>
<CAPTION>
                                                                                         At June 30,
                                                                             --------------------------------
                                                                                2001                 2000
                                                                             ----------          -----------
                                                                                   (Dollars in thousands)
<S>                                                                          <C>                 <C>
Non-accrual mortgage loans:
     One-to four-family................................................      $      -             $    125
     Multi-family......................................................             -                    -
     Non-residential...................................................             -                    -
     Land..............................................................             -                    -
     Construction......................................................             -                    -
                                                                             --------             --------
         Total mortgage loans..........................................             -                  125
                                                                             --------             --------
     Commercial........................................................             -                  286
     Consumer Loans....................................................             -                    -
                                                                             --------             --------
         Total non-accruing loans                                            $      -             $    411
                                                                             --------             --------

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.............................................      $    479             $    411
                                                                             --------             --------

Total real estate owned................................................           248                  289
                                                                             --------             --------
     Total non-performing assets.......................................      $    727             $    700
                                                                             --------             --------

Total non-performing loans to loans, gross.............................          0.36%                0.36%
Total non-performing assets to total assets............................          0.47%                0.53%
</TABLE>

         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 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 deteriorate
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."

                                       12
<PAGE>

         The Bank's management reviews and classifies the Bank's assets monthly
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, 2001, the Bank had $614,000 of assets classified as
Substandard, $2.0 million of assets designated as Special Mention, no assets
classified as Loss and no assets classified as Doubtful.

         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 and the general economy. The
ALL is maintained at an amount management considers 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, management's assessment of the credit risk inherent in the
portfolio, historical loan loss experience, and the Bank's underwriting
policies. At June 30, 2001, the Bank's ALL was $1.0 million, or 0.8% of total
loans, as compared to $979,000 or 0.9%, at June 30, 2000. The Bank had
non-performing loans of $479,000 and $411,000 at June 30, 2001 and June 30,
2000, respectively. The Bank will continue to monitor and modify its ALL as
conditions dictate. 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.

                                       13
<PAGE>

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

<TABLE>
<CAPTION>
                                                                              At or for the Year Ended June 30,
                                                                             ------------------------------------
                                                                                 2001                    2000
                                                                             --------------        --------------
                                                                                    (Dollars in thousands)
<S>                                                                          <C>                   <C>
Total loans outstanding at end of period..............................        $   131,402           $   113,998
Average total loans outstanding.......................................            119,965               100,228

Balance at beginning of year..........................................                979                 1,123
                                                                              -----------           -----------
Provision for loan losses.............................................                225                    88
                                                                              -----------           -----------

Charge-offs:
     One- to four-family residential..................................                  -                   (19)
     Multi-family residential.........................................                  -                     -
     Non-residential and land.........................................                 (5)                    -
     Construction.....................................................                  -                     -
     Commercial.......................................................               (172)                 (115)
     Consumer loans...................................................               (126)                 (194)
                                                                              -----------           -----------
         Total charge-offs............................................               (303)                 (328)
                                                                              -----------           -----------

Recoveries............................................................                121                    96
                                                                              -----------           -----------

Balance at end of year................................................        $     1,022           $       979
                                                                              ===========           ===========

Allowance for loan losses to total loans
     at end of period.................................................               0.78%                 0.86%
                                                                              ===========           ===========

Allowance for loan losses to total non-performing
     assets at end of period..........................................             140.58%               139.86%
                                                                              ===========           ===========

Allowance for loan losses to total non-performing
     loans at end of period........................................                213.36%               238.20%
                                                                              ===========           ===========

Ratio of net charge-offs during the period
     to average loans outstanding during period.......................               0.15%                 0.23%
                                                                              ===========           ===========
</TABLE>

                                       14
<PAGE>

         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.

<TABLE>
<CAPTION>
                                                                              At June 30,
                                     ---------------------------------------------------------------------------------------------
                                                         2001                                           2000
                                     --------------------------------------------  -----------------------------------------------
                                                     Percent of      Percent of                                       Percent of
                                                    Allowance to   Loans in Each                     Percent of     Loans in Each
                                       Allowance        Total       Category to      Allowance      Allowance to     Category to
                                        Amount        Allowance     Total Loans       Amount      Total Allowance    Total Loans
                                     ------------  --------------  --------------  ------------  -----------------  --------------
                                                                        (Dollars in thousands)
<S>                                  <C>           <C>             <C>             <C>           <C>                <C>
Mortgage Loans:
   One-to four family............        $  572           55.97%         60.47%        $  559           57.10%            60.37%
   Multi-family..................            15            1.47%          2.67%            15            1.53%             2.00%
   Non-residential and land......            61            5.97%         12.68%            60            6.13%             9.66%
   Construction..................            15            1.47%          4.07%            19            1.94%             3.56%
Other:
   Consumer......................           284           27.79%         10.69%           255           26.05%             9.17%
   Commercial....................            75            7.34%          9.42%            71            7.25%            15.24%
                                         ------         -------        -------         ------         -------           -------
   Total.........................        $1,022          100.00%        100.00%        $  979          100.00%           100.00%
                                         ======         =======        =======         ======         =======           =======
</TABLE>


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
Fannie Mae, the FHLMC and the Government National Mortgage Association ("GNMA"),
certificates of deposit of insured banks, federal funds, mutual funds and
overnight deposits at the FHLB. At June 30, 2001, the Bank held $7.7 million in
investment securities.

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

<TABLE>
<CAPTION>
                                                                  For the Year Ended June 30
                                                            --------------------------------------
                                                                 2001                    2000
                                                            -----------------   ------------------
                                                                        (In thousands)
<S>                                                         <C>                 <C>
Amortized cost at beginning of period...............          $   9,882               $  11,464
Proceeds, net.......................................             (1,132)                   (228)
Principal payments from mortgage backed
   securities.......................................             (1,184)                 (1,387)
Gain on sales.......................................                104                      95
Premium and discount amortization, net..............                 10                     (62)
                                                              ---------               ---------

Amortized cost at end of period.....................              7,680                   9,882
Net unrealized gain (loss) (1)......................                164                     (47)
                                                              ---------               ---------
Total securities, net...............................          $   7,844               $   9,835
                                                              =========               =========
</TABLE>

__________________________
(1)    The net unrealized gain (loss) at June 30, 2001and 2000 relates to
       available for sale securities in accordance with Statement of Financial
       Accounting Standards ("SFAS") No. 115. The net unrealized gain (loss) is
       presented in order to reconcile the "Amortized Cost" of the Bank's
       securities portfolio in the "Carrying Cost," as reflected in the
       Statements of Financial Condition.

                                       15
<PAGE>

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

<TABLE>
<CAPTION>
                                                                             At June 30,
                                              ---------------------------------------------------------------------
                                                              2001                                2000
                                              ---------------------------------------------------------------------
                                                Amortized Cost      Fair Value     Amortized Cost      Fair Value
                                              ------------------  --------------  ----------------   --------------
                                                                          (In thousands)
<S>                                           <C>                 <C>             <C>                <C>
Mortgage-backed securities:

   Fannie Mae and Government National
   Mortgage Association....................         $  1,987           $   1,993       $  3,205           $   3,155
                                                    --------           ---------       --------           ---------
Other debt securities:
   U.S. Treasury and Agency................            3,259               3,267          4,515               4,428
   Other...................................              382                 385            382                 370
                                                    --------           ---------       --------           ---------
Total debt securities......................            3,641               3,652          4,897               4,798
                                                    --------           ---------       --------           ---------
Equity securities(1).......................            1,003               1,150          1,004               1,106
Federal Home Bank Stock....................            1,049               1,049            776                 776
Net unrealized gain (loss)(2)..............              164                   -            (47)                  -
                                                    --------           ---------       --------           ---------
Total securities, net......................         $  7,844           $   7,844       $  9,835           $   9,835
                                                    ========           =========       ========           =========
</TABLE>

-----------------
(1)  Equity securities consist of FHLMC common stock and mutual fund securities.
(2)  The net unrealized gain (loss) at June 30, 2001 and 2000 relates to
     available for sale securities in accordance with SFAS No.115. The net
     unrealized gain (loss) is presented in order to reconcile the "Amortized
     Cost" of the Bank's securities portfolio in the "Carrying Cost," as
     reflected in the Statements of Financial Condition.


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

<TABLE>
<CAPTION>
                                                                        At June 30,
                                        ----------------------------------------------------------------------------
                                                 2001                      2000                       1999
                                        ----------------------    -----------------------    -----------------------
                                        Amortized                 Amortized                  Amortized
                                          Cost      Fair Value      Cost       Fair Value      Cost       Fair Value
                                        ---------   ----------    ---------   -----------   ----------    ----------
                                                                      (In thousands)
<S>                                    <C>          <C>          <C>          <C>           <C>           <C>
Held to Maturity
     Other debt securities..........     $   100      $   100      $   100      $   100       $   100      $   100
                                         -------      -------      -------      -------       -------      -------
         Total held to maturity.....         100          100          100          100           100          100
                                         -------      -------      -------      -------       -------      -------

Available-for-Sale:
     Mortgage-backed securities.....       1,987        1,993        3,205        3,155         4,626        4,672
     Other debt securities..........       3,442        3,453        4,698        4,599         4,806        4,750
     Equity securities:.............       1,003        1,150        1,004        1,106         1,210        1,554
     Net unrealized gain (loss)(1)..         164            -          (47)           -           334            -
                                         -------      -------      -------      -------       -------      -------
         Total available-for-sale...       6,596        6,596        8,860        8,860        10,976       10,976
                                         -------      -------      -------      -------       -------      -------

Certificates of deposit.............          99           99           99           99           198          198
                                         -------      -------      -------      -------       -------      -------
Federal Home Loan Bank Stock........       1,049        1,049          776          776           524          524
                                         -------      -------      -------      -------       -------      -------

     Total securities, net..........     $ 7,844      $ 7,844      $ 9,835      $ 9,835       $11,798      $11,798
                                         =======      =======      =======      =======       =======      =======
</TABLE>

-----------------
(1)      The net unrealized gains (loss) at June 30, 2001, 2000 and 1999 relate
         to available for sale securities in accordance with SFAS No. 115. The
         net unrealized gain (loss) is presented in order to reconcile the
         "Amortized Cost" of the Bank's securities portfolio in the "Carrying
         Cost," as reflected in the Statements of Financial Condition.

                                       16
<PAGE>

         The following table sets forth certain information regarding the
amortized cost, fair value and weighted average yield of the Bank's debt
securities at June 30, 2001, 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.

<TABLE>
<CAPTION>
                                                                            At June 30, 2001
                                             --------------------------------------------------------------------------------
                                                        Held-to-Maturity                       Available for Sale
                                             -------------------------------------  -----------------------------------------
                                                                         Weighted
                                               Amortized      Fair       Average      Amortized                 Weighted
                                                  Cost        Value       Yield         Cost      Fair Value  Average Yield
                                             -----------    --------   -----------  ------------  ----------  -------------
                                                                         (Dollars in thousands)
<S>                                          <C>            <C>        <C>          <C>           <C>         <C>
Debt Securities
Mortgaged-backed securities:
   Due within 1 year.......................     $      -      $     -           -%     $      -     $      -            -%
   Due after 1 year but within 5 years.....            -            -           -            63           64         7.29
   Due after 5 years but within 10 years...            -            -           -             -            -            -
   Due after 10 years......................            -            -           -         1,924        1,929         6.76
                                                --------      -------                  --------     --------
           Total...........................            -            -           -         1,987        1,993         6.78
                                                --------      -------                  --------     --------

U.S. Treasury and Agency:
   Due within 1 year.......................            -            -        6.01           500          506         6.42
   Due after 1 year but within 5 years.....          100          100           -         1,992        2,014         5.59
   Due after 5 years but within 10 years...            -            -           -             -            -            -
   Due after 10 years......................            -            -        6.01           666          647         5.90
                                                --------      -------                  --------     --------
           Total...........................          100          100                     3,158        3,167         5.78
                                                --------      -------                  --------     --------

Corporate & Other:
   Due within 1 year.......................           99           99         7.25            -            -            -
   Due after 1 year but within 5 years.....            -            -            -            -            -            -
   Due after 5 years but within 10 years...            -            -            -            -            -            -
   Due after 10 years......................            -            -            -          284          286         4.60
                                                --------      -------                  --------     --------
           Total...........................           99           99         7.25          284          286         4.60
                                                --------      -------                  --------     --------

Equity Securities:                                     -            -            -        1,003        1,150            -
                                                --------      -------                  --------     --------

Total:
   Due within 1 year.......................           99           99         7.25          500          508         6.42
   Due after 1 year but within 5 years.....          100          100         6.01        2,055        2,078         5.64
   Due after 5 years but within 10 years...            -            -            -            -            -            -
   Due after 10 years......................            -            -            -        2,874        2,862         6.35
   Equity Securities.......................            -            -            -        1,003        1,150            -
                                                --------      -------                  --------     --------
                                                     199          199         6.63        6,432        6,596         6.09
                                                --------      -------                  --------     --------
Federal Home Loan Bank Stock...............        1,049        1,049            -            -            -            -
                                                --------      -------                  --------     --------
   Total...................................     $  1,248      $ 1,248         6.63%    $  6,432     $  6,596         6.09%
                                                ========      =======                  ========     ========
</TABLE>

                                       17
<PAGE>

Sources of Funds

         General. Deposits, loans and security repayments and prepayments,
proceeds of refinanced loans sold to Fannie Mae 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 regular (passbook)
savings accounts, checking accounts, money market deposit accounts, statement
savings accounts, IRAs and certificates of deposit. In recent years, the Bank
has offered certificates of deposit with maturities of up to 48 months. At June
30, 2001, the Bank's core deposits (which the Bank considers to consist of
checking accounts, regular savings accounts and statement savings accounts)
constituted 42.4% 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.

<TABLE>
<CAPTION>
                                                                            For the Year Ended June 30,
                                                                 -----------------------     ----------------------
                                                                          2001                        2000
                                                                 -----------------------     ----------------------
                                                                                   (In thousands)
<S>                                                                  <C>                          <C>
Total deposits at beginning of period,
   including accrued interest.............................           $   102,680                  $    93,106
Net increase before interest credited.....................                12,164                        5,505
Interest credited.........................................                 5,230                        4,069
                                                                     -----------                  -----------
Total deposits at end of period...........................           $   120,074                  $   102,680
                                                                     ===========                  ===========
</TABLE>

         At June 30, 2001, the Bank had approximately $22.3 million in Jumbo
certificate of deposits (accounts in amounts over $100,000) maturing as follows:

<TABLE>
<CAPTION>
                                                                                                    Weighted
                                                                         Amount                   Average Rate
                                                                 -----------------------     ----------------------
                                                                                   (In thousands)
     <S>                                                         <C>                         <C>
     Maturity Period
         Within three months..............................           $     4,951                         5.91%
         After three but within six months................                 6,292                         6.03%
         After six but within 12 months...................                 6,454                         5.58%
         After 12 months..................................                 4,618                         6.60%
                                                                     -----------
                  Total...................................           $    22,315                         5.99%
                                                                     ===========
</TABLE>

                                       18
<PAGE>

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

<TABLE>
<CAPTION>
                                                                       At June 30,
                                 ---------------------------------------------------------------------------------------
                                                   2001                                         2000
                                 -----------------------------------------     -----------------------------------------
                                               Percent of      Weighted                       Percent        Weighted
                                                  Total         Average                       of Total        Average
                                   Amount       Deposits         Rate           Amount        Deposits         Rate
                                ------------ ------------- ---------------     --------      ----------   --------------
                                                               (Dollars in thousands)
<S>                             <C>          <C>           <C>               <C>           <C>          <C>
Noninterest bearing
checking accounts........       $    8,502           7.08%            0.00%   $    6,474          6.31%             0.00%

Interest bearing checking /
Money Market accounts....           20,597          17.15%            2.38%       16,075         15.65%             1.92%

Savings..................           21,823          18.17%            3.63%       23,032         22.43%             3.83%

Certificates of deposit..           68,909          57.39%            5.79%       56,937         55.45%             5.71%

Accrued interest.........              243           0.20%            0.00%          162          0.16%             0.00%
                                ----------    -----------       ----------    ----------   -----------        ----------

         Totals                 $  120,074         100.00%            4.39%   $  102,680        100.00%             4.34%
                                ----------    ===========       ==========    ----------   ===========        ==========
</TABLE>

         The following table presents, by interest rate ranges, the amount of
certificate accounts outstanding at June 30, 2001 and the period to maturity.

<TABLE>
<CAPTION>
                                                             Period to Maturity at June 30, 2001
                                           ------------------------------------------------------------------------
                                             Less than            One to           Four to Five
         Interest Rate Range                  One Year          Three years           Years               Total
         -------------------               --------------      -------------   --------------------    ------------
                                                                    (Dollars in thousands)
<S>                                        <C>                 <C>             <C>                     <C>
4.00% to 5.99%                               $   35,152          $    3,754         $       76          $   38,982
6.01% to 7.99%....................               22,181               6,477              1,269              29,927
                                             ----------          ----------         ----------          ----------
              Total...............           $   57,333          $   10,231         $    1,345          $   68,909
                                             ==========          ==========         ==========          ==========
</TABLE>

         Borrowings. The Bank historically has not used borrowings as a source
of funds. However, 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. As of June 30, 2001, the maximum
amount of FHLB advances available to the Bank was $26.3 million. The Bank had
advances of $17.0 million at June 30, 2001 from the FHLB. Interest is payable at
rates ranging from 4.30% to 6.87%. Advances of $813,000 are due August 2002,
$149,000 are due January 2007, $5.0 million are due September 2010, $7.0 million
are due November 2010, and $4.0 million are due January 2011.

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. Additional insurance agencies were purchased in April

                                       19
<PAGE>

of 1999, December 1999 and November 2000. AF Insurance Services, Inc. offers
these services in a segregated location at the Bank's executive offices, Boone,
Sparta, Lenoir, Jefferson, North Wilkesboro and Elkin, North Carolina.

AF Brokerage, Inc.

         AF Brokerage, Inc., a wholly owned subsidiary of the Company, was
formed in August 1998 for the purpose of selling brokerage and investment
products through a third-party vendor. During the 2000 fiscal year, AF
Brokerage, Inc.'s application for registration was accepted by the NASD and the
brokerage company began selling investment products directly. AF Brokerage, Inc.
offers these services in a segregated location at the Bank's executive offices
and branch locations.

Personnel

         As of June 30, 2001, the Company had 98 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 Bank's employees.

                                  REGULATION

General

         The Company and the Bank are subject to extensive regulation,
examination and supervision by the OTS, as their chartering agency. The Bank's
deposit accounts are insured up to applicable limits by the FDIC and it is a
member of the FHLB of Atlanta. The Bank must file reports with the OTS
concerning its activities and financial condition and it must obtain regulatory
approvals prior to entering into certain transactions, such as mergers with, or
acquisitions of, other depository institutions. The OTS conducts periodic
examinations to assess the Bank's compliance with various regulatory
requirements. This regulation and supervision establishes a comprehensive
framework of activities in which a savings institution can engage and is
intended primarily for the protection of the insurance fund and depositors. The
Company and the Holding Company, as savings and loan holding companies, are
required to file certain reports with, and otherwise comply with, the rules and
regulations of the OTS.

         The OTS has significant discretion in connection with their supervisory
and enforcement activities and examination policies, including policies with
respect to the classification of assets and the establishment of adequate loan
loss reserves for regulatory purposes. Any change in such policies, whether by
the OTS or the Congress, could have a material adverse impact on the Holding
Company, the Company or the Bank.

         The following discussion is intended to be a summary of the material
statutes and regulations applicable to savings institutions and their holding
companies, and it does not purport to be a comprehensive description of all such
statutes and regulations.

Regulation of Federal Savings Banks

         Business Activities. The Bank derives its lending and investment powers
from the Home Owner's Loan Act ("HOLA") and the regulations of the OTS
thereunder. Under these laws and regulations, the Bank may invest in mortgage
loans secured by residential and non-residential 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. These investment powers

                                       20
<PAGE>

are subject to various limitations, including (a) a prohibition against the
acquisition of any corporate debt security that is not rated in one of the four
highest rating categories; (b) a limit of 400% of an association's capital on
the aggregate amount of loans secured by non-residential real estate property;
(c) a limit of 20% of an association's assets on commercial loans; (d) a limit
of 35% of an association's assets on the aggregate amount of consumer loans and
acquisitions of certain debt securities; (e) a limit of 5% of assets on non-
conforming loans (loans in excess of the specific limitations of HOLA); and (f)
a limit of the greater of 5% of assets or an association's capital on certain
construction loans made for the purpose of financing what is or is expected to
become residential property.

         Loans to One Borrower. Under HOLA, savings associations are generally
subject to the same limits on loans to one borrower as are imposed on national
banks. Generally, under these limits, a savings institution may not make a loan
or extend credit to a single or related group of borrowers in excess of 15% of
the association's unimpaired capital and surplus. Additional amounts may be
lent, not exceeding 10% of the association's unimpaired capital and surplus, if
such loans and extensions of credit are fully secured by readily-marketable
collateral. At June 30, 2001, the Bank's limit on loans to one borrower was
approximately $1.6 million. At June 30, 2001, the Bank's largest aggregate
amount of loans to one borrower was $1.5 million and is secured by a mix of one-
to four-family and multifamily properties. The second largest borrower had an
aggregate balance of approximately $1.4 million, secured by an multifamily
complex. At June 30, 2001, all of the loans in both of these lending
relationships were performing in accordance with their terms.

         QTL Test. HOLA requires a savings institution to meet a Qualified
Thrift Lender ("QTL") test. A savings institution may satisfy the QTL test by
maintaining at least 65% of its "portfolio assets" in certain "qualified thrift
investments" in at least 9 months of the most recent 12-month period. "Portfolio
assets" means, in general, an association's total assets less the sum of (a)
specified liquid assets up to 20% of total assets, (b) certain intangibles,
including goodwill and credit card and purchased mortgage servicing rights and
(c) the value of property used to conduct the association's business. The term
"qualified thrift investments" includes various types of loans made for
residential and housing purposes, investments related to such purposes,
including certain mortgage-backed and related securities, and loans for
personal, family, household and certain other purposes up to a limit of 20% of
an association's portfolio assets. Recent legislation broadened the scope of
"qualified thrift investments" to include 100% of an institution's credit card
loans, education loans, and small business loans. A savings association may also
satisfy the QTL test by qualifying as a "domestic building and loan association"
as defined in the Internal Revenue Code of 1986. At June 30, 2001, the Bank
maintained 71.6% of its portfolio assets in qualified thrift investments. The
Bank had also satisfied the QTL test in each of the prior 12 months and,
therefore, was a qualified thrift lender. A savings institution that fails the
QTL test must either operate under certain restrictions on its activities or
convert to a bank charter.

         Capital Requirements. The OTS regulations require savings associations
to meet three minimum capital standards: a tangible capital ratio requirement of
1.5% of total assets as adjusted under the OTS regulations, a leverage ratio
requirement of 3% of core capital to such adjusted total assets and a risk-based
capital ratio requirement of 8% of core and supplementary capital to total
risk-weighted assets. The OTS and the federal banking regulators have proposed
amendments to their minimum capital regulations to provide that the minimum
leverage capital ratio for a depository institution that has been assigned the
highest composite rating of 1 under the Uniform Financial Institutions Ratings
System will be 3% and that the minimum leverage capital ratio for any other
depository institution 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,
a savings association 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 OTS believes are inherent in the assets.

                                       21
<PAGE>

         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. The
allowance for loan and lease losses includable in supplementary and capital is
limited 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.

         The table below presents the Bank's regulatory capital as compared to
the OTS regulatory capital requirements at June 30, 2001:

<TABLE>
<CAPTION>
                                                          Capital          Excess
                                          Amount       Requirements        Capital
                                         --------     --------------      ---------
                                                      (In thousands)
<S>                                      <C>          <C>                 <C>
Core Capital......................        12,665          6,048            6,617

Risk-based capital................        13,654          8,896            4,758
</TABLE>

         A reconciliation between regulatory capital and GAAP capital at June
30, 2001 in the accompanying financial statements is presented below:

<TABLE>
<CAPTION>
                                                                Core          Risk-Based
                                                               Capital         Capital
                                                              ---------     --------------
<S>                                                           <C>           <C>
GAAP capital...........................................       $  12,765     $     12,765

Net unrealized loss on available for
   sale investment securities, net of tax..............            (100)            (100)

Allowance for loan losses included as
   supplementary capital...............................               -            1,022

Equity investment and other assets.....................               -              (33)

Regulatory capital.....................................       $  12,665     $     13,654
                                                              =========     ============
</TABLE>

         Limitation on Capital Distributions. Effective April 1, 1999, the OTS
amended its capital distribution regulations to reduce regulatory burdens on
savings associations. The regulations being replaced, which were effective
throughout 1998, established limitations upon capital distributions by savings
associations, such as cash dividends, payments to repurchase or otherwise
acquire its shares, payments to shareholders of another institution in a cash
out merger, and other distributions charged against capital. At least 30-days
written notice to the OTS was required for a proposed capital distribution by a
savings association, and capital distributions in excess of specified earnings
or by certain institutions were subject to approval by the OTS. An association
that had capital in excess of all fully phased in regulatory capital
requirements before and after a proposed capital distribution and that was not
otherwise restricted in making capital distributions, could, after prior notice
but without the approval of the OTS, make capital distributions during a
calendar year equal to the greater of (a) 100% of its net earnings to date
during the calendar year plus the amount that would reduce by half its "surplus
capital ratio" (the excess capital over its fully phased in capital
requirements) at the beginning of the calendar year, or (b) 75% of its net
earnings for the previous four quarters. Any additional capital distributions
would require prior OTS approval. Under the amendments adopted by the OTS,
certain savings associations will be

                                       22
<PAGE>

permitted to pay capital distributions during a calendar year that do not exceed
the association's net income for that year plus its retained net income for the
prior two years, without notice to, or the approval of, the OTS. However, a
savings association subsidiary of a savings and loan holding company, such as
the Bank, will continue to have to file a notice unless the specific capital
distribution requires an application. In addition, the OTS can prohibit a
proposed capital distribution, otherwise permissible under the regulation, if
the OTS has determined that the association is in need of more than normal
supervision or if it determines that a proposed distribution by an association
would constitute an unsafe or unsound practice. Furthermore, under the OTS
prompt corrective action regulations, the Bank would be prohibited from making
any capital distribution if, after the distribution, the Bank failed to meet its
minimum capital requirements, as described above. See "--Prompt Corrective
Regulatory Action."

         Liquidity. The Bank is required to maintain an average daily balance of
liquid assets (cash, certain time deposits, bankers' acceptances, specified
United States Government, state or federal agency obligations, shares of certain
mutual funds and certain corporate debt securities and commercial paper) equal
to a monthly average of not less than a specified percentage of its net
withdrawable deposit accounts plus short-term borrowings. This liquidity
requirement may be changed from time to time by the OTS to any amount within the
range of 4% to 10% depending upon economic conditions and the savings flows of
member institutions, and is currently 4%. Monetary penalties may be imposed for
failure to meet these liquidity requirements. The Bank's average liquidity ratio
for the month ended June 30, 2001 was approximately 14.9%, which exceeded the
applicable requirements. The Bank has never been subject to monetary penalties
for failure to meet its liquidity requirements.

         Assessments. The OTS has adopted amendments to its regulations,
effective January 1, 1999, that are intended to assess savings associations on a
more equitable basis. The new regulations will base the assessment for an
individual savings association on three components: the size of the association,
on which the basic assessment would be based; the association's supervisory
condition, which would result in an additional assessment based of a percentage
of the basic assessment for any savings institution with a composite rating of
3, 4 or 5 in its most recent safety and soundness examination; and the
complexity of the association's operations, which would result in an additional
assessment based of a percentage of the basic assessment for any savings
association that managed over $1.0 billion in trust assets, serviced for others
loans aggregating more than $1.0 billion, or had certain off-balance sheet
assets aggregating more than $1.0 billion. In order to avoid a disproportionate
impact on the smaller savings institutions, which are those whose total assets
never exceeded $100.0 million, the new regulations provide that the portion of
the assessment based on asset size will be the lesser of the assessment under
the amended regulations or the regulations before the amendment. Management
believes that any change in its rate of OTS assessments under the amended
regulations will not be material.

         Branching. Subject to certain limitations, HOLA and the OTS regulations
permit federally chartered savings institutions to establish branches in any
state of the United States. The authority to establish such a branch is
available (a) in states that expressly authorize branches of savings
institutions located in another state and (b) to an association that either
satisfies the "QTL" test for a qualified thrift lender or qualifies as a
"domestic building and loan association" under the Internal Revenue Code of 1986
(the "Code"), which imposes qualification requirements similar to those for a
"qualified thrift lender" under HOLA. See "--QTL Test." The authority for a
federal savings institution to establish an interstate branch network would
facilitate a geographic diversification of the association's activities. This
authority under HOLA and the OTS regulations preempts any state law purporting
to regulate branching by federal savings institutions.

         Community Reinvestment. Under the Community Reinvestment Act ("CRA"),
as implemented by OTS regulations, a savings institution has a continuing and
affirmative obligation consistent with its safe and sound operation 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

                                       23
<PAGE>

for financial institutions nor does it limit an institution's 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 a savings institution, to assess the
association's record of meeting the credit needs of its community and to take
such record into account in its evaluation of certain applications by such
association. 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 on January 20, 1998.

         The CRA regulations establish an assessment system that bases an
association's rating on its actual performance in meeting community needs. In
particular, the assessment system focuses on three tests: (a) a lending test, to
evaluate the institution's record of making loans in its assessment areas; (b)
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 (c) 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 ("FRA"). In general, an
affiliate of the Bank is any company that controls the Bank or any other company
that is controlled by a company that controls the Bank, excluding the Bank's
subsidiaries other than those that are insured depository institutions. The OTS
regulations prohibit a savings institution (a) from lending to any of its
affiliates that is engaged in activities that are not permissible for bank
holding companies under Section 4(c) of the BHC Act and (b) from purchasing the
securities of any affiliate other than a subsidiary. Section 23A limits the
aggregate amount of transactions with any individual affiliate to 10% of the
capital and surplus of the savings institution and also limits the aggregate
amount of transactions with all affiliates to 20% of the savings institution's
capital and surplus. Extensions of credit to affiliates are required to be
secured by collateral in an amount and of a type described in Section 23A, and
the purchase of low quality assets from affiliates is generally prohibited.
Section 23B provides that certain transactions with affiliates, including loans
and asset purchases, must be on terms and under circumstances, including credit
standards, that are substantially the same or at least as favorable to the
association as those prevailing at the time for comparable transactions with
non-affiliated companies. In the absence of comparable transactions, such
transactions may only occur under terms and circumstances, including credit
standards, that in good faith would be offered to or would apply to
non-affiliated companies.

         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 FRB thereunder. 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
association's capital. In addition, extensions of credit in excess of certain
limits must be approved by the association's board of directors.

         Enforcement. Under the Federal Deposit Insurance Act ("FDI Act"), the
OTS has primary enforcement responsibility over savings institutions and has the
authority to bring enforcement action against all "institution-affiliated
parties," including any controlling stockholder or any shareholder, attorney,
appraiser or accountant who knowingly or recklessly participates in any
violation of applicable law or regulation or breach of fiduciary duty or certain
other wrongful actions that causes or is likely to cause a more than a minimal
loss or other significant adverse effect on an insured savings institution.

                                       24
<PAGE>

Civil penalties cover a wide range of violations and actions and range from
$5,000 for each day during which violations of law, regulations, orders, and
certain written agreements and conditions continue, up to $1 million per day for
such violations if the person obtained a substantial pecuniary gain as a result
of such violation or knowingly or recklessly caused a substantial loss to the
institution. Criminal penalties for certain financial institution crimes include
fines of up to $1 million and imprisonment for up to 30 years. In addition,
regulators have substantial discretion to take enforcement action against an
institution that fails to comply with its regulatory requirements, particularly
with respect to its capital requirements. Possible enforcement actions range
from the imposition of a capital plan and capital directive to receivership,
conservatorship, or the termination of deposit insurance. Under the FDI Act, the
FDIC has the authority to recommend to the Director of OTS that enforcement
action be taken with respect to a particular savings institution. If action is
not taken by the Director of the OTS, the FDIC has authority to take such action
under certain circumstances.

         Standards for Safety and Soundness. Pursuant to the FDI Act, as amended
by Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") and
the Riegle Community Development and Regulatory Improvement Act of 1994
("Community Development Act"), the OTS, together with the other federal bank
regulatory agencies, adopted a set of guidelines prescribing safety and
soundness standards. The guidelines establish general standards relating to
internal controls and 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, among other things, appropriate systems and practices to
identify and manage the risks and exposures specified in the guidelines. The
guidelines prohibit excessive compensation as an unsafe and unsound practice and
describe compensation as excessive when the amounts paid are unreasonable or
disproportionate to the services performed by an executive officer, employee,
director or principal shareholder. The OTS and the other agencies determined
that stock valuation standards were not appropriate. In addition, the OTS
adopted regulations that authorize, but do not require, the OTS to order an
institution that has been given notice by the OTS that it is not satisfying any
of such safety and soundness standards to submit a compliance plan. If, after
being so notified, an institution fails to submit an acceptable compliance plan
or fails in any material respect to implement an accepted compliance plan, the
OTS must issue an order directing action to correct the deficiency 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
FDICIA. 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.

         Real Estate Lending Standards. The OTS and the other federal banking
agencies adopted regulations to prescribe standards for extensions of credit
that (a) are secured by real estate or (b) are made for the purpose of financing
the construction of improvements on real estate. The OTS regulations require
each savings institution to establish and maintain written internal real estate
lending standards that are consistent with safe and sound banking practices and
appropriate to the size of the association and the nature and scope of its real
estate lending activities. The standards also must be consistent with
accompanying OTS guidelines, which include loan-to-value ratios for the
different types of real estate loans. Banks are also permitted to make a limited
amount of loans that do not conform to the proposed loan-to-value limitations so
long as such exceptions are reviewed and justified appropriately. The guidelines
also list a number of lending situations in which exceptions to the
loan-to-value standards are justified.

         Prompt Corrective Regulatory Action. 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 institutions.
For this purpose, a savings institution would be placed in one of five
categories based on the association's capital. Generally, a savings institution
is treated as "well capitalized" if its ratio of total capital to risk-weighted
assets is at least 10.0%, its ratio of core capital to risk-weighted assets is
at least 6.0%, its ratio of core capital to total assets is at least 5.0%, and
it is not

                                       25
<PAGE>

subject to any order or directive by the OTS to meet a specific capital level. A
savings institution will be treated as "adequately capitalized" if its ratio of
total capital to risk-weighted assets is at least 8.0%, its ratio of core
capital to risk-weighted assets is at least 4.0%, and its ratio of core capital
to total assets is at least 4.0% (3.0% if the association receives the highest
rating on the CAMEL financial institutions rating system). A savings institution
that has a total risk-based capital of less than 8.0% or a leverage ratio or a
Tier 1 capital ratio that is less than 4.0% (3.0% leverage ratio if the
association receives the highest rating on the CAMEL financial institutions
rating system) is considered to be "undercapitalized." A savings institution
that has a total risk-based capital of less than 6.0% or a Tier 1 risk-based
capital ratio or a leverage ratio of less than 3.0% is considered to be
"significantly undercapitalized." A savings institution that has a tangible
capital to assets ratio equal to or less than 2% is deemed to be "critically
undercapitalized." The elements of an association's capital for purposes of the
prompt corrective action regulations are defined generally as they are under the
regulations for minimum capital requirements. See "--Capital Requirements." At
June 30, 2001, the Bank met the criteria for being considered "well-
capitalized."

         Where appropriate, the OTS can impose corrective action by a savings
and loan holding company under the "prompt corrective action" provisions of
FDICIA.

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

         Pursuant to FDICIA, the FDIC established a new 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 the reporting period ending seven months before the
assessment period. The three capital categories consist of (a) well capitalized,
(b) adequately capitalized, or (c) undercapitalized. The FDIC also assigns an
institution to one of three supervisory subcategories within each capital group.
The supervisory subgroup to which an institution is assigned is based on a
supervisory evaluation provided to the FDIC by the institution's primary federal
regulator and information that the FDIC determines to be relevant to the
institution's financial condition and the risk posed to the deposit insurance
funds. An institution's assessment rate depends on the capital category and
supervisory 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%. As a result of the Deposit Insurance Funds
Act of 1996 (the "Funds Act"), both the BIF and the SAIF currently satisfy the
reserve ratio requirement. If the FDIC determines that assessment rates should
be increased, institutions in all risk categories could be affected. The FDIC
has exercised this authority several times in the past and could raise insurance
assessment rates in the future. If such action is taken by the FDIC, it could
have an adverse effect on the earnings of the Bank.

         The Funds Act also amended the FDIA to expand the assessment base for
the payments on the FICO bonds. Beginning January 1, 1997, the assessment base
for the FICO bonds included the deposits of both BIF- and SAIF-insured
institutions. Until December 31, 1999, or such earlier date on which the last
savings association ceases to exist, the rate of assessment for BIF-assessable
deposits shall be one-fifth of the rate imposed on SAIF-assessable deposits. The
annual assessment for the payments on the FICO bonds for the fiscal year 2001
was $36,365.

                                       26
<PAGE>

         Under the FDI Act, insurance of deposits may be terminated by the FDIC
upon a finding that the institution has engaged in unsafe or unsound practices,
is in an unsafe or unsound condition to continue operations or has violated any
applicable law, regulation, rule, order or condition imposed by the FDIC or the
OTS. The management of the Bank does not know of any practice, condition or
violation that might lead to termination of deposit insurance.

         Federal Home Loan Bank System. The Bank is a member of the FHLB of
Atlanta, which is one of the regional FHLBs composing the FHLB System. Each FHLB
provides a central credit facility primarily for its member institutions. The
Bank, as a member of the FHLB of Atlanta, is required to acquire and hold shares
of capital stock in the FHLB of Atlanta in an amount equal to 1% of the
aggregate principal amount of its unpaid residential mortgage loans, home
purchase contracts and similar obligations, but not less than $500. The Bank was
in compliance with this requirement with an investment in FHLB of Atlanta stock
at June 30, 2001, of $1.0 million. 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.

         For the fiscal years ended June 30, 2001, 2000 and 1999, dividends from
the FHLB of Atlanta to the Bank amounted to $66,000, $46,000 and $45,000,
respectively. If dividends were reduced, or interest on future FHLB advances
increased, the Bank's net interest income would likely also be reduced.

         Federal Home Loan Bank System Modernization Act of 1999. Title 6 of the
Gramm-Leach-Bliley Act, entitled the Federal Home Loan Bank System Modernization
Act of 1999 (FHLB Modernization Act), has amended the FHLB Act by allowing for
voluntary membership and modernizing the capital structure and governance of the
FHLB system. The new capital structure established under the FHLB Modernization
Act sets forth new leverage and risk-based capital requirements based on
permanence of capital. It also requires some minimum investment in FHLB stock of
all member entities. Capital will include retained earnings and two forms of
stock: Class A stock redeemable within six months, written notice and Class B
stock redeemable within five years, written notice. The FHLB Modernization Act
provides a transition period to the new capital regime, which will not be
effective until the FHLB enacts implementing regulations. The FHLB Modernization
Act also reduces the period of time in which a member exiting the FHLB system
must stay out of the system.

         Federal Reserve System. The Bank is subject to provisions of the FRA
and the FRB's regulations pursuant to which depositary institutions may be
required to maintain non-interest-earning reserves against their deposit
accounts and certain other liabilities. Currently, reserves must be maintained
against transaction accounts (primarily NOW and regular checking accounts). The
FRB regulations generally require that reserves be maintained in the amount of
3% of the aggregate of transaction accounts up to $46.5 million. The amount of
aggregate transaction accounts in excess of $46.5 million are currently subject
to a reserve ratio of 10%, which ratio the FRB may adjust between 8% and 12%.
The FRB regulations currently exempt $4.9 million of otherwise reservable
balances from the reserve requirements, which exemption is adjusted by the FRB
at the end of each year. The Bank is in compliance with the foregoing reserve
requirements. Because required reserves must be maintained in the form of either
vault cash, a non-interest-bearing account at a Federal Reserve Bank, or a
pass-through account as defined by the FRB, the effect of this reserve
requirement is to reduce the Bank's interest-earning assets. The balances
maintained to meet the reserve requirements imposed by the FRB may be used to
satisfy liquidity requirements imposed by the OTS. FHLB System members are also
authorized to borrow from the Federal Reserve "discount window," but FRB
regulations require such institutions to exhaust all FHLB sources before
borrowing from a Federal Reserve Bank.

                                       27
<PAGE>

Regulation of the Holding Company

         General. The Holding Company and the Company are holding companies
chartered pursuant to Section 10(o) of the HOLA. As such, the Holding Company
and the Company are registered with and subject to OTS examination and
supervision as well as certain reporting requirements. In addition, the OTS has
enforcement authority over the Company and the Holding Company and any of its
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 mutual holding companies are
not subject to any regulatory capital requirements or to supervision by the
Federal Reserve System.

         Restrictions Applicable to Activities of Mutual Holding Companies.
Pursuant to Section 10(o) of the HOLA, a mutual holding company may engage only
in the following activities: (i) investing in the stock of a savings
institution; (ii) 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; (iii) merging
with or acquiring another holding company, one of whose subsidiaries is a
savings institution; (iv) 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 associations
have their home offices; (v) furnishing or performing management services for a
savings institution subsidiary of such holding company; (vi) holding, managing,
or liquidating assets owned or acquired from a savings institution subsidiary of
such company; (vii) holding or managing properties used or occupied by a savings
institution subsidiary of such company; (viii) acting as trustee under a deed of
trust; (ix) any other activity (a) that the FRB, by regulation, has determined
to be permissible for bank holding companies under Section 4(c) of the BHC Act,
unless the Director of the OTS, by regulation, prohibits or limits any such
activity for savings and loan holding companies, or (b) in which multiple
savings and loan holding companies were authorized by regulation to directly
engage on March 5, 1987; and (x) purchasing, holding, or disposing of stock
acquired in connection with a qualified stock issuance if the purchase of such
stock by such holding company is approved by the Director of the OTS. 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. The
HOLA prohibits a savings and loan holding company, including a federal mutual
holding company, directly or indirectly, from acquiring (i) control (as defined
under HOLA) of another savings institution (or a holding company parent thereof)
without prior OTS approval; (ii) more than 5% of the voting shares of another
savings institution (or holding company parent thereof) that is not a
subsidiary, subject to certain exceptions; (iii) 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 thereof) without prior OTS approval; or (iv) 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 (i) in the case of certain emergency acquisitions (as defined under HOLA)
approved by the FDIC; (ii) 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, and (iii) 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

                                       28
<PAGE>

state chartered association. The conditions imposed upon interstate acquisitions
by those states that have enacted authorizing legislation vary. Some states
impose conditions of reciprocity, which have the effect of requiring that the
laws of both the state in which the acquiring holding company is located (as
determined by the location of its subsidiary savings institution) and the state
in which the association to be acquired is located, have each enacted
legislation allowing its savings institutions to be acquired by out-of-state
holding companies on the condition that the laws of the other state authorize
such transactions on terms no more restrictive than those imposed on the
acquirer by the state of the target association. Some of these states also
impose regional limitations, which restrict such acquisitions to states within a
defined geographic region. Other states allow full nationwide banking without
any condition of reciprocity. Some states do not authorize interstate
acquisitions of savings institutions. In evaluating an application by a holding
company to acquire a savings institution, the OTS must consider the financial
and managerial resources and future prospects of the company and savings
institution involved, the effect of the acquisition on the risk to the insurance
funds, the convenience and needs of the community, and competitive factors.

         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. For additional information in this regard, see "--
Regulation of Federal Savings Banks -- QTL Test."

         For a description of certain restrictions on transactions between the
Bank and its affiliates, including, without limitation, the Holding Company, see
"-- Regulation of Federal Savings Banks -- Transactions with Related Parties."

Regulation of Insurance Activities

         The Company offers various insurance products through AF Insurance
Services, Inc., a wholly owned subsidiary of the Company. AF Insurance Services,
Inc. is licensed and regulated by the North Carolina Department of Insurance
(the "Department"). As such AF Insurance Services, Inc. is subject to the
supervision, examination and reporting requirements of the Department and its
activities are governed by the laws and regulations of the State of North
Carolina.

Regulation of Securities Brokerage Activities

         The Company offers brokerage and investment products through AF
Brokerage, Inc., a wholly owned subsidiary of the Company. AF Brokerage, Inc. is
a North Carolina corporation which is registered as a broker-dealer under
Section 15 of the Securities Exchange Act of 1934, as amended, and is a member
of the National Association of Securities Dealers, Inc. (the "NASD"). As such,
AF Brokerage, Inc. is subject to the supervision, examination and reporting
requirements of the SEC, the NASD and the various states in which it conducts
business.

Federal Securities Laws

         The Common Stock of the Company is registered with the SEC under the
Exchange Act. The Company is subject to the information, proxy solicitation,
insider trading restrictions and other requirements of the SEC under the
Exchange Act.

                                       29
<PAGE>

                          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, Mutual Company or Stock Company. The Bank has not been audited by
the Internal Revenue Service for the last eight years.

         For federal income tax purposes, the Bank 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 and Stock Company constitute an
affiliated group of corporations and, therefore, are eligible to report their
income on a consolidated basis. Because the Mutual Company 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," i.e., its reserve as of
June 30, 2000, 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.

         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 34% 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 of which the Bank currently has none. 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). Although the corporate environmental tax of 0.12% of the
excess of AMTI (with certain modifications) over $2.0 million has expired, under
current Administration proposals, such tax will be retroactively reinstated for
taxable years beginning after December 31, 1996 and before January 2008.

                                       30
<PAGE>

         Elimination of Dividends; Dividends Received Deduction. The Stock
Company may exclude from its income 100% of dividends received from the Bank as
a member of the same affiliated group of corporations. Because, following
completion of the Reorganization, Mutual Company will not be a member of such
affiliated group, it will not qualify for such 100% dividends exclusion, but
will be entitled to deduct 80% of the dividends it receives from Stock 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 .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.

                                       31
<PAGE>

Item 2.        Properties

         The Company conducts its business through its main office, located in
West Jefferson, North Carolina, and its branches located in Warrensville,
Jefferson, Sparta, Wilkesboro, Elkin, Lenoir and Boone, North Carolina. The
Company owns the main office, corporate offices, the Lenoir office and the
Jefferson Branch. Additionally, the Company entered an agreement with Wal-Mart
to lease the banking facilities inside the Super Wal-Mart to open during the
fourth calendar quarter of 2001 and to purchase an out parcel on which a full
service branch will be completed prior to the end of the 2002 fiscal year.
Management believes that the Bank's current and planned facilities are adequate
to meet the present and immediately foreseeable needs of the Bank and the
Holding Company.

<TABLE>
<CAPTION>
                                                                                                        Net Book
                                                                    Date Leased        Lease            Value at
                                                  Leased or Owned   or Acquired   Expiration Date    June 30, 2001
                                                 ----------------- ------------- -----------------  ---------------
                                                                         (Dollars in thousands)
<S>                                              <C>               <C>           <C>                 <C>
Corporate Offices...........................           Owned        06/15/2000            --          $1,689,234
21 East Ashe Street
West Jefferson, NC 28694

Insurance and Brokerage Offices.............           Owned         06/30/97             --          $ 369,344
206 S. Jefferson Avenue
West Jefferson, NC 28694

AF Bank.....................................           Owned         06/30/63             --          $ 159,705
205 S. Jefferson Avenue
West Jefferson, NC 28694

AF Bank.....................................           Owned         05/18/94             --          $ 490,169
840 E. Main Street
Jefferson, NC 28640

AF Bank.....................................          Leased         08/31/98     08/31/2003*                --
4951 NC Hwy. 88 West
Warrensville, NC 28693

AF Bank.....................................          Leased         01/09/98     12/31/2003*                --
403 South Main Street
Sparta, NC 28675

AF Bank.....................................          Leased         02/26/99     02/26/2003***              --
285 Hwy 105 Ext.
Boone, NC 28607

AF Insurance Services, Inc..................          Leased         09/01/97     08/31/2002****             --
315 Main Street
North Wilkesboro, NC 28659

AF Insurance Services, Inc..................           Owned        07/03/2000            --          $ 101,211
324 Morganton Blvd., SW
Lenoir, NC 28645

AF Insurance Services, Inc..................          Leased         12/01/99     11/30/2002**               --
277 A West Main Street
Elkin, NC 28621

AF Insurance Services, Inc..................          Leased         12/01/00     09/30/2007                 __
400 Shadowline Drive
Boone, NC 28607
</TABLE>

* Option to renew for two additional five-year periods.
** Option to renew for an additional three-year period.
*** Option to renew two additional one-year periods.
**** Option to renew for three additional one-year periods.

                                       32
<PAGE>

Item 3.        Legal Proceedings

         At June 30, 2001, there were no material legal proceedings to which the
Company or any of its subsidiaries was a party or to which any of its property
was subject.

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

         Not applicable.

                                    PART II

Item 5.        Market for Common Stock and Related Stockholder Matters

         Information relating to the market for Registrant's common equity and
related stockholder matters appears under "Common Stock" and "Market for the
Common Stock" in the Registrant's 2001 Annual Report to Stockholders on page
60, and is incorporated herein by reference.

         Information relating to the payment of dividends by the Registrant
appears under "Common Stock" and "Market for the Common Stock" in the
Registrant's 2001 Annual Report to Stockholders on page [ ], and is incorporated
herein by reference. A dividend declared by the Board of Directors of the Bank
is considered a capital distribution from the Bank to the stockholders,
including AsheCo, M.H.C., its mutual holding company. 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, 2001 and 2000.

Item 6.        Management's Discussion and Analysis

         Certain of the above-captioned information appears under "Selected
Financial and Other Data of the Company" "Management's Discussion and Analysis"
and in the Registrant's 2001 Annual Report to Stockholders on pages 1 through 2,
and 6 through 19 and is incorporated herein by reference.

Item 7.        Financial Statements
s
         The Financial Statements of AF Bankshares, Inc., together with the
report thereon by McGladrey & Pullen, LLP appears in the Registrant's 2001
Annual Report to Stockholders on pages 21 through 57 and are incorporated
herein by reference.

<TABLE>
<CAPTION>
                                                                           Page(s) in
                                                                         Annual Report
                                                                         -------------
<S>                                                                      <C>
 .  Independent Auditor's Report.......................................        21
 .  Consolidated Statements of Financial Condition,
     June 30, 2001 and 2000...........................................       22-23
 .  Consolidated Statements of Income
     Years Ended June 30, 2001 and 2000...............................        24
 .  Consolidated Statements of Stockholders' Equity,
     Years Ended June 30, 2001 and 2000...............................        25
 .  Consolidated Statements of Cash Flows,
     Years Ended June 30, 2001 and 2000...............................       27-28
 .  Notes to Consolidated Financial Statements.........................       29-57
</TABLE>

                                       33
<PAGE>

Item 8.        Changes in and Disagreement with Accountants on Accounting and
Financial Disclosure


         Not applicable.


                                   PART III

Item 9.        Directors, Executive Officers, Promoters and Control Persons

         The information relating to Directors and Executive Officers of the
Company is incorporated herein by reference to the Company's Proxy Statement for
the Annual Meeting of Stockholders to be held on November 5, 2001.

Item 10.       Executive Compensation

         The information relating to executive compensation is incorporated
herein by reference to the Company's Proxy Statement for the Annual Meeting of
Stockholders to be held on November 5, 2001.

Item 11.       Security Ownership of Certain Beneficial Owners and Management

         The information relating to security ownership of certain beneficial
owners and management is incorporated herein by reference to the Company's Proxy
Statement for the Annual Meeting of Stockholders to be held on November 5, 2001.

Item 12.       Certain Relationships and Related Transactions

         The information relating to certain relationships and related
transactions is incorporated herein by reference to the Company's Proxy
Statement for the Annual Meeting of Stockholders to be held on November 5, 2001.

Item 13.       Exhibits and Reports on Form 8-k

         (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 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).

               10.1       Employment Agreement with James A. Todd, President and
                          Chief Executive Officer (incorporated by reference to
                          the 10-KSB for the year ended June 30, 1998).*

                                       34
<PAGE>

                  10.2       Employment Agreement with Melanie Paisley Miller,
                             Executive Vice President, Chief Financial Officer,
                             Secretary and Treasurer (incorporated by reference
                             to the 10-KSB for the year ended June 30, 1998).*

                  10.3       Employment Agreement with Martin G. Little, Senior
                             Vice President and Chief Lending Officer
                             (incorporated by reference to the 10-KSB for the
                             year ended June 30, 1998).*

                  10.4       Employee Stock Ownership Plan of Ashe Federal Bank
                             (incorporated by reference to the Company's Annual
                             Report on Form 10-KSB for the year ended June 30,
                             1998).*

                  13.1       2001 Annual Report to Stockholders, is filed
                             herewith.

                  21.1       Subsidiary Information is incorporated herein by
                             reference to "Part I - Subsidiary Activities."

         (b)      Reports on Form 8-K

                  No reports on Form 8-K were filed during the fourth quarter of
the fiscal year ended June 30, 2001.

*Incorporated by reference to the Company's Annual Report on Form 10-KSB for the
year ended June 30, 1998 as filed with the SEC on September 29, 1998.

                                       35
<PAGE>

                                  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 Bankshares, Inc.
                                                         (Small Business Issuer)

Date:  September 21, 2001               By: /s/ James A. Todd
                                           -------------------------------------
                                           James A. Todd
                                           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.

<TABLE>
<CAPTION>
                                                                  Date
                                                           ------------------
<S>                                                        <C>
/s/ James A. Todd                                          September 21, 2001
-----------------------------------------------
James A. Todd
President, Chief Executive Officer and Director
(Principal Executive Officer)


/s/ Melanie Paisley Miller                                 September 21, 2001
-----------------------------------------------
Melanie Paisley Miller
Executive Vice President, Secretary, Treasurer
     and Chief Financial Officer
(Principal Financial Officer)


/s/ Jan R. Caddell                                         September 21, 2001
-----------------------------------------------
Jan R. Caddell - Director


/s/ Kenneth R. Greene                                      September 21, 2001
-----------------------------------------------
Kenneth R. Greene - Director


/s/ Wayne R. Burgess                                       September 21, 2001
-----------------------------------------------
Wayne R. Burgess - Director


/s/ Jimmy D. Reeves                                        September 21, 2001
-----------------------------------------------
Jimmy D. Reeves - Director


/s/ Frank E. Roland                                        September 21, 2001
-----------------------------------------------
Frank E. Roland - Director


/s/ Jerry L. Roten                                         September 21, 2001
-----------------------------------------------
Jerry L. Roten - Director


/s/ John D. Weaver                                         September 21, 2001
-----------------------------------------------
John D. Weaver - Director
</TABLE>