##### Table of Contents

2004 Annual Report



Table of Contents



|                                                |  |   
|----------------------------------------------- |  | --
|Selected Financial Data                         |  | 2 
|                                                | 
|Letter to Shareholders                          |  | 4 
|                                                | 
|Managements Discussion and Analysis            |  | 7 
|                                                | 
|Consolidated Statements of Financial Condition  |  | 19
|                                                | 
|Consolidated Statements of Income (Loss)        |  | 20
|                                                | 
|Consolidated Statements of Stockholders Equity |  | 21
|                                                | 
|Consolidated Statements of Cash Flows           |  | 22
|                                                | 
|Notes to Consolidated Financial Statements      |  | 24
|                                                | 
|Independent Auditors Report                    |  | 50
|                                                | 
|Corporate Information                           |  | 51





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##### Table of Contents

Selected Financial Data and Other Data of the Company



The following table sets forth certain information concerning the consolidated financial position and results of operation of the Company at the dates and for the year end as indicated. The selected consolidated financial condition and
operating data were derived from the audited consolidated financial statements of the Company. The information should be read in conjunction with the consolidated financial statements of the Company and notes thereto presented elsewhere herein.



|                                                    |  |                                       |         |   |      |   |         |  |      |         |      |   |         |  |   |        
|--------------------------------------------------- |  | ------------------------------------- | ------- | - | ---- | - | ------- |  | ---- | ------- | ---- | - | ------- |  | - | -------
|                                                    |  | June 30,                             
|                                                    |  | 2004                                  |         |   | 2003 |   | 2002    |  | 2001 |         | 2000
|                                                    |  | (In thousands, except per share data)
|Selected Financial Condition Data:                  |  |                                       |         |   |      |   |         |  |      |         |      |   |         |  |   |        
|Total assets                                        |  | $                                     | 211,619 |   |      | $ | 191,973 |  | $    | 176,684 |      | $ | 153,448 |  | $ | 133,370
|Loans receivable, net1                              |  |                                       | 181,489 |   |      |   | 156,258 |  |      | 143,553 |      |   | 124,675 |  |   | 108,778
|Investment securities2                              |  |                                       | 6,501   |   |      |   | 8,754   |  |      | 11,422  |      |   | 7,844   |  |   | 9,835  
|Cash and cash equivalents3                          |  |                                       | 7,674   |   |      |   | 14,072  |  |      | 11,220  |      |   | 12,568  |  |   | 7,423  
|Savings deposits                                    |  |                                       | 157,434 |   |      |   | 149,571 |  |      | 136,769 |      |   | 120,074 |  |   | 102,680
|FHLB advances                                       |  |                                       | 33,144  |   |      |   | 21,146  |  |      | 18,910  |      |   | 16,962  |  |   | 15,513 
|Equity                                              |  |                                       | 12,474  |   |      |   | 12,960  |  |      | 12,777  |      |   | 13,027  |  |   | 12,540 
|Book value per share                                |  |                                       | 11.88   |   |      |   | 12.35   |  |      | 12.17   |      |   | 12.41   |  |   | 11.95  
|Selected Operating Data:                            |  |                                       |         |   |      |   |         |  |      |         |      |   |         |  |   |        
|Interest income and dividends                       |  | $                                     | 10,684  |   |      | $ | 11,011  |  | $    | 11,191  |      | $ | 11,648  |  | $ | 9,393  
|Interest expense                                    |  |                                       | 4,405   |   |      |   | 5,085   |  |      | 5,801   |      |   | 6,355   |  |   | 4,685  
|                                                    |  |                                       |         |   |      |   |         |  |      |         |      |   |         |  |   |        
|Net interest income                                 |  |                                       | 6,279   |   |      |   | 5,926   |  |      | 5,390   |      |   | 5,293   |  |   | 4,708  
|Provision for loan losses                           |  |                                       | 668     |   |      |   | 243     |  |      | 420     |      |   | 225     |  |   | 88     
|                                                    |  |                                       |         |   |      |   |         |  |      |         |      |   |         |  |   |        
|Net interest income after provision for loan losses |  |                                       | 5,611   |   |      |   | 5,683   |  |      | 4,970   |      |   | 5,068   |  |   | 4,620  
|Non-interest income                                 |  |                                       | 3,891   |   |      |   | 3,604   |  |      | 3,120   |      |   | 2,493   |  |   | 1,821  
|Non-interest expense                                |  |                                       | 9,933   |   |      |   | 8,656   |  |      | 7,998   |      |   | 6,757   |  |   | 5,660  
|                                                    |  |                                       |         |   |      |   |         |  |      |         |      |   |         |  |   |        
|Income (loss) before income tax expense             |  |                                       | (431    | ) |      |   | 631     |  |      | 92      |      |   | 804     |  |   | 781    
|Income tax expense (benefit)                        |  |                                       | (123    | ) |      |   | 256     |  |      | 56      |      |   | 315     |  |   | 328    
|                                                    |  |                                       |         |   |      |   |         |  |      |         |      |   |         |  |   |        
|Net income (loss)                                   |  | $                                     | (308    | ) |      | $ | 375     |  | $    | 36      |      | $ | 489     |  | $ | 453    
|                                                    |  |                                       |         |   |      |   |         |  |      |         |      |   |         |  |   |        
|Selected Ratios                                     |  |                                       |         |   |      |   |         |  |      |         |      |   |         |  |   |        
|Basic earnings per share4                           |  | $                                     | (0.30   | ) |      | $ | 0.36    |  | $    | 0.03    |      | $ | 0.48    |  | $ | 0.45   
|Diluted earnings per share4                         |  |                                       | (0.30   | ) |      |   | 0.36    |  |      | 0.03    |      |   | 0.48    |  |   | 0.45   
|Dividends per share                                 |  |                                       | 0.20    |   |      |   | 0.20    |  |      | 0.20    |      |   | 0.20    |  |   | 0.20   



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



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



|3. | Includes interest-earning deposit balances of $2.5 million, $6.2 million, $4.2 million, $7.8
million, and $2.6 million at June 30, 2004, 2003, 2002, 2001, and 2000, respectively.
|-- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



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##### Table of Contents

Selected Financial Data and Other Data of the Company



|                                                                         |  |             |    |  |        |   |  |        |   |  |        |   |  |        |  
|------------------------------------------------------------------------ |  | ----------- | -- |  | ------ | - |  | ------ | - |  | ------ | - |  | ------ | -
|                                                                         |  | At June 30, |   
|                                                                         |  | 2004        |    |  | 2003   |   |  | 2002   |   |  | 2001   |   |  | 2000   |  
|Selected Financial Ratios and Other Data:                                |  |             |    |  |        |   |  |        |   |  |        |   |  |        |  
|Performance Ratios: 1                                                    |  |             |    |  |        |   |  |        |   |  |        |   |  |        |  
|Return on average assets                                                 |  | (0.15       | )% |  | 0.20   | % |  | 0.02   | % |  | 0.34   | % |  | 0.37   | %
|Return on average equity                                                 |  | (2.46       | )% |  | 2.90   | % |  | 0.28   | % |  | 3.80   | % |  | 3.99   | %
|Average equity to average assets                                         |  | 6.25        | %  |  | 6.90   | % |  | 7.51   | % |  | 8.83   | % |  | 9.21   | %
|Equity to total assets at end of period                                  |  | 5.89        | %  |  | 6.75   | % |  | 7.23   | % |  | 8.49   | % |  | 9.40   | %
|Interest rate spread2                                                    |  | 3.38        | %  |  | 3.41   | % |  | 3.36   | % |  | 3.56   | % |  | 3.84   | %
|Average interest-earnings assets to average interest-bearing liabilities |  | 105.12      | %  |  | 104.35 | % |  | 106.35 | % |  | 108.48 | % |  | 108.18 | %
|Net interest margin3                                                     |  | 3.51        | %  |  | 3.54   | % |  | 3.52   | % |  | 3.97   | % |  | 4.18   | %
|Non-interest expense to average assets                                   |  | 4.96        | %  |  | 4.62   | % |  | 4.70   | % |  | 4.64   | % |  | 4.59   | %
|Efficiency ratio4                                                        |  | 97.67       | %  |  | 90.83  | % |  | 93.98  | % |  | 86.78  | % |  | 86.69  | %
|Dividend payout ratio5                                                   |  | (66.67      | )% |  | 55.56  | % |  | 666.67 | % |  | 41.67  | % |  | 44.44  | %
|Regulatory Capital Ratios: 6                                             |  |             |    |  |        |   |  |        |   |  |        |   |  |        |  
|Tangible capital                                                         |  | 8.11        | %  |  | 8.92   | % |  | 9.51   | % |  | 8.37   | % |  | 8.89   | %
|Core capital                                                             |  | 8.11        | %  |  | 8.92   | % |  | 9.51   | % |  | 8.37   | % |  | 8.89   | %
|Total risk based capital                                                 |  | 10.89       | %  |  | 12.89  | % |  | 13.00  | % |  | 12.28  | % |  | 11.94  | %
|Asset Quality Ratios and Other Data:                                     |  |             |    |  |        |   |  |        |   |  |        |   |  |        |  
|Ratios:                                                                  |  |             |    |  |        |   |  |        |   |  |        |   |  |        |  
|Nonperforming loans to total loans                                       |  | 0.28        | %  |  | 0.28   | % |  | 0.32   | % |  | 0.36   | % |  | 0.36   | %
|Nonperforming loans and real estate owned to total assets                |  | 0.25        | %  |  | 0.25   | % |  | 0.41   | % |  | 0.47   | % |  | 0.53   | %
|Allowance for loan losses to:                                            |  |             |    |  |        |   |  |        |   |  |        |   |  |        |  
|Nonperforming loans                                                      |  | 239.98      | %  |  | 250.79 | % |  | 245.92 | % |  | 213.36 | % |  | 238.20 | %
|Total loans                                                              |  | 0.68        | %  |  | 0.71   | % |  | 0.78   | % |  | 0.78   | % |  | 0.86   | %
|Number of full service Bank branches                                     |  | 7           |    |  | 7      |   |  | 7      |   |  | 5      |   |  | 5      |  



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



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



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



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



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



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



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##### Table of Contents

Dear Shareholder,



Fiscal Year 2004
ended a year of historically low interest rates and sluggish economic growth, both of which depressed your Companys operating results. However, we believe that our long term financial strategy over the last several years should produce
increased earnings and stronger growth in the coming year.



Total assets on June 30, 2004 were $211,619,177 an 10.2% increase over the June 30, 2003 total of $191,972,779. For the same period, net loans receivable stood at $181,489,159, representing a 16.2% rise from $156,257,890 at June 30, 2003.



The net loss was $308,254 in FY 2004, and interest income for
the period was $10,683,592; while non-interest income totaled $3,891,574 for the year ended June 30, 2004. As mentioned in Managements Discussion and Analysis, the net loss for the year includes a charge-off of $350,000 related to a single
commercial loan which negatively impacted earning for the year.



At June 30, 2004, retained earnings were $12,473,996, and the Banks regulatory capital was in excess of regulatory capital requirements. For detailed financial results and comparisons, please see Managements Discussion and
Analysis, the Consolidated Financial Statements, and the Notes To Consolidated Financial Statements contained in this report.



Our strategy during FY 2004 (and for the last several years) has been to avoid booking fixed-rate loans in the Companys loan portfolio; instead
carrying mostly variable rate, adjustable loans in portfolio. With interest rates at fifty-year lows, this strategy seemed prudent in the long run. Now, with interest rates poised to rise, that strategy should produce a significant increase in
earnings as new loan production better reflects market interest rates and the Companys interest rate spread improves.



Your Company made significant progress in a number of areas in the year just ended:



| |  | Check imaging was introduced to all our transaction account customers, giving them increased security, convenience, and ease of use.
| | - | ------------------------------------------------------------------------------------------------------------------------------------



| |  | Online bill payment has been added to the list of services now available to save customers time, and allow them to pay bills online 24 hours a day, seven days a week.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Continued enactment of our regulatory compliance plan, although expensive, has allowed us to be in good position for full compliance with the requirements of the Sarbannes-Oxley Act
enacted by Congress last year.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Of course, by far
the largest project underway during the year has been the construction of our new Boone Financial Center in Boone, North Carolina. This four-story building, with two floors of leased offices, is already being called the premier business location in
Boone. More importantly, it will bring together the services of AF Bank, AF Brokerage, and AF Insurance



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##### Table of Contents

Services under one roof in Boone. The new Boone Financial Center will serve as a prototype for future AF Financial Group centers throughout our market areas.
Look for the grand opening of the Center in the fall of 2004.



Even though earnings for FY 2004 were not as robust as we would have preferred, the prospects for increased profitability and growth in FY 2005 are excellent. Our expanded commitment in Boone, our continuing product development in response
to customer demands, and the heritage of service established by your Company all point to a successful Fiscal 2005.



Thank you for your continued support. If you have questions about the Company or we may better serve you, your family, or your business, please let us
know.



For AF Financial Group,/s/ Melanie P. MillerMelanie P. MillerActing Chief Executive OfficerChief Financial Officer




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##### Table of Contents

The corporate mission of AF Financial Group is to provide a return to its shareholders, customers, communities
and employees through its ability and commitment to deliver a full array of financial services and products on an individualized basis to people and companies in the northwestern corner of North Carolina, and the areas contiguous thereto.



[PHOTOS]



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##### Table of Contents

Managements Discussion and Analysis

June 30, 2004 and 2003



Managements Discussion and Analysis



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



General



AF Financial Group (the Company) is a federally chartered stock holding company for AF Bank (the Bank), AF Insurance
Services, Inc. (an independent insurance agency) and AF Brokerage, Inc. (a registered broker/dealer, member NASD and SIPC). AF Bank conducts business from its main office located in West Jefferson, North Carolina, with branches in Boone, Jefferson,
Sparta, Warrensville, and West Jefferson, North Carolina. Headquartered in West Jefferson, North Carolina, AF Insurance Services, Inc., has branches in Boone, Elkin, Jefferson, Lenoir, Sparta, West Jefferson, and North Wilkesboro, North Carolina. AF
Brokerage, Inc. serves Ashe, Alleghany, Wilkes and Watauga counties in North Carolina.



Overview



The Company realized a net loss of $308,254 for the
year ended June 30, 2004 and net income of $375,464 for the year ended June 30, 2003. The Companys operating results are primarily dependent upon net interest income, fees and charges and insurance commissions. Net interest income is the
difference between interest earned on loans, investments and interest-earning deposits at other financial institutions, and the cost of interest-bearing savings deposits and other borrowings. The primary interest-earning asset of the Company is its
mortgage loan portfolio, representing 86.8% of total loans with approximately 58.3% of portfolio mortgage loans at fixed rates as of June 30, 2004. The net interest income of the Company is affected by changes in economic conditions that influence
market interest rates and to a large extent by the monetary actions by the Federal Reserve. This exposure to changes in interest rates contributes to a moderate degree of interest rate risk because of the negative impact of changing rates to the
Banks earnings and to the new market value of its assets and liabilities. Historically, mortgage lenders have made loans and funded those loans with core and short-term deposits, exposing the lender to a higher level of interest rate risk in a
rising rate scenario. We have reduced our exposure to rising rates by limiting the term or the time to reprice of loans that we retain in our portfolio. During the rate environment of the fiscal year ending June 30, 2004, declining rates were less
favorable to the Bank than rising rates would have been from an interest rate risk perspective.



The Bank sells mortgage loans with terms exceeding 15 years unless the loan documents permit us to re-price the loan at an interval of ten years or less. Non-mortgage loans have rates that allow for adjustment as the
prime rate changes, where possible, and where non-mortgage loans are made with fixed terms, the terms typically do not exceed five years. We make fixed rate mortgage loans with provisions allowing the Bank to call the loan due after
three or five year periods, which reduces the period of time we are exposed to a fixed rate of interest in order to reduce interest rate risk. During the 2004 fiscal year, borrowers have been reluctant to accept a loan with a call provision and have
chosen longer-term mortgages that we sell in the secondary market. The call provision is now used primarily where the fixed rate mortgage does not qualify for sale in the secondary market, and where the borrower has no desire for an adjustable rate
mortgage. We also offer consumer loans, including automobile and home improvement loans. At June 30, 2004, consumer loans constituted approximately 6.3% of portfolio loans.



In addition, we offer commercial loans to small businesses in Ashe, Alleghany and Watauga Counties and to areas contiguous to those
counties. Commercial loans generally have rates based on the prime rate of interest that more closely reflects prevailing market interest rates than do fixed rate products or other rate indices. Consumer and



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##### Table of Contents

Managements Discussion and Analysis

June 30, 2004 and 2003



commercial loans also generally have shorter terms and greater interest rate sensitivity than mortgage loans. We have pursued the preceding mortgage and
non-mortgage loan strategies in order to reduce the level of interest rate risk in the Banks loan portfolio, while maintaining acceptable levels of credit risk. Funding for loan originations has been provided by aggressively marketing savings
and checking accounts, competitively pricing certificates of deposits, and borrowing from the Federal Home Loan Bank of Atlanta (FHLB). Deposits increased $7.9 million as the result of normal business activities and FHLB advances
increased $12.0 million during the year ended June 30, 2004.



In addition to
loans, the Bank invests in federal agency securities, overnight deposits with the FHLB, equity securities in the Federal Home Loan Mortgage Corporation (FHLMC), municipal bonds, and mortgage-backed securities issued by the Government National
Mortgage Association (GNMA) and Fannie Mae. We do not engage in the practice of trading securities; rather, the Banks investment portfolio consists primarily of securities designated as available for sale. We intend to maintain investment
securities to meet liquidity needs, as a supplement to our lending activities, and as a means to reduce the interest rate risk and credit risk of our asset base in exchange for lower rates of return than would typically be available with other
lending activities.



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



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



Critical Accounting Policies



The notes to our audited consolidated financial statements for the year ended June 30, 2004
contain a summary of our significant accounting policies. We believe that our policies with respect to the methodology for our determination of the allowance for loan losses, the fair value of mortgage servicing assets and asset impairment
judgments, including the recoverability of goodwill, involve a higher degree of complexity and require management to make difficult and subjective judgments which often require assumptions or estimates about highly uncertain matters. Changes in
these judgments, assumptions or estimates could cause reported results to differ materially. These critical policies and their application are periodically reviewed with the Audit Committee and our Board of Directors. We consider the following
accounting policies to be most critical in their potential effect on our financial position or results of operations:



Allowance for Loan Losses



The Allowance for Loan Losses (ALL) is established through a provision for loan losses based on our evaluation of the risks inherent in the Banks loan
portfolio, prior loss history and the general economy. The ALL is maintained at an amount we consider adequate to cover loan losses which are deemed probable and estimable. The allowance is based upon a number of factors, including asset
classifications, economic trends, industry experience and trends, industry and geographic concentrations, estimated collateral values, our assessment of the credit risk inherent in the portfolio, historical loan loss experience, and the Banks
underwriting policies. Our methodology for assessing the appropriations of the ALL consists of two components: Allowance for identified problem or impaired loans and a formula allowance for the remainder of the portfolio. Although we believe we have
established and maintained the ALL at appropriate levels, future adjustments may be necessary if economic, real estate and other conditions differ substantially from the current operating environment. We will continue to monitor and modify our ALL
as conditions dictate.



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##### Table of Contents

Managements Discussion and Analysis

June 30, 2004 and 2003



Goodwill



On July 1, 2002, we adopted the provisions of Financial Accounting Standards Board (FASB) Statement 142, Goodwill and Other Intangible Assets. Under
the provisions of the Statement, on July 1, 2002, we ceased to amortize goodwill. We will reevaluate the carrying value of goodwill annually by comparing the market value of the Company to the book value of the Company. Impairment would then be
determined if the book value of the Company exceeds the market value of the Company. This evaluation is subjective as it requires material estimates that may be susceptible to significant change.



Management Strategy



AF Financial Group is a financial services company that provides banking, insurance and investment services to residents in the northwest
corner of North Carolina. The Company was chartered in 1939 and the original lending objective of the Company was to provide fixed rate loans for the residents of Ashe County, North Carolina. Since that time, we have expanded the market area of the
Company to include Alleghany, Caldwell, Surry, Watauga and Wilkes counties and have diversified our product lines by engaging in non-residential mortgage and non-mortgage lending, as well as offering insurance and brokerage products. We now offer
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. We also operate a broker/dealer subsidiary, AF Brokerage, Inc., which serves Ashe, Alleghany, Wilkes and Watauga counties. AF Brokerage offers a full array of non-FDIC insured investment
products, including fixed-rate and variable annuities and mutual funds. We believe our strategy of expanding our market area and diversifying our product lines will strengthen earnings in the future.



We believe the foundation is in place to successfully compete in our established markets. In
all AF Bank markets, we have the capability to deliver comprehensive insurance services through our insurance subsidiary and the potential to deliver securities services through AF Brokerage, Inc. Our new Financial Center in Boone, North Carolina is
scheduled to open during the second quarter of the 2005 fiscal year. The Financial Center will combine banking, insurance and investments into one convenient location serving the Watauga County market. The challenge facing us is to provide the most
economical, efficient  and most importantly  desirable platform to offer AF customers, clients and prospects these services. It is a challenge we are working hard to meet.



We believe it is important to view the financial results for the year ended June 30, 2004
within the larger context of the Companys long-term strategic business plan. The cost of the infrastructure that we now have in place allowing us to successfully compete in our established markets, has had a negative impact on short term
earnings. However, we believe our established foundation and platform will drive our long-term viability as a competitively superior financial services provider in all markets. We are committed to the long-term profitability and success of the
Company. Given the foregoing foundation and platform, management and the board of directors are placing major emphasis upon improving the Companys net earnings and return on equity in 2005 and beyond. This will be accomplished by increasing
the overall productivity of the Company and its operating subsidiaries, controlling costs, and reducing or eliminating unprofitable activities whenever and wherever possible.



There are a number of positive factors and recent events which reflect our progress toward our long-term goals during the year ended June
30, 2004:



| |  | An increase in net loans of $25.2 million or 16.2%;
| | - | ---------------------------------------------------



| |  | Asset growth of $19.6 million or 10.2%;
| | - | ---------------------------------------



| |  | Deposit growth of $7.9 million or 5.3%;
| | - | ---------------------------------------



| |  | Nonperforming assets as a percentage of total assets equaled only .25%;
| | - | -----------------------------------------------------------------------



| |  | Loans to deposit ratio increased to 115.3%;
| | - | -------------------------------------------



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##### Table of Contents

Managements Discussion and Analysis

June 30, 2004 and 2003



| |  | The acquisition of another insurance agency in Sparta, North Carolina which expanded our market share in an existing market and increased the revenue stream for the Sparta insurance
operation while expanding our customer base in Alleghany County; and
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The October 2005 scheduled opening of the new Boone AF Financial Center.
| | - | ------------------------------------------------------------------------



Net income decreased $683,718, or 182.1%, to a net loss of $308,254 for the year ended June 30, 2004, compared to net income of $375,464 for the year ended June 30, 2003.
This change is primarily due to a $349,580 charge-off of one commercial line of credit and an increase in noninterest expense. While future charge-offs are uncertain, we believe that this charge-off was an isolated event and not an indication of the
overall quality of our loan portfolio. Noninterest expense increased primarily due to the increase in compensation expense due to staffing for the Financial Service Center in Boone, North Carolina.



We believe a positive upturn in economic indicators will have a positive impact on our net
income. Many economic advisors are predicting an overall 100 basis point rate hike by February 2005. At June 30, 2004 we had approximately $61.0 million in loans priced at prime or a margin thereto which provides for adjusting rates immediately
should market rates change. In a rising rate environment, our ability to make immediate rate adjustments serves to protect the interest margin against increases in rates at a more rapid speed than the increase in funding costs.



Our commitment to the long-term profitability and success of the Company prompted our
decision not to place long-term fixed rate mortgages in our portfolio, particularly in a low interest rate environment, due to the interest rate risk associated with an eventual rise in market rates. We have continued to minimize our exposure to
rising interest rates by selling long-term fixed rate mortgages and retaining the servicing. This strategy reduces short-term earnings but will provide protection when rates begin to rise.



Another challenge we face are the requirements under The Sarbanes-Oxley Act of 2002 (the
Act). The Act is a change that has significantly impacted us and our competitors. The Act, and its subsequent regulations, makes changes to the way we select and manage our outside auditors, establishes new independence requirements for
the board and its committees and includes provisions that increase our accountability regarding the presentation of the Companys financial condition. We made substantial changes to our governance procedures, code of ethics and internal
policies that we believe have allowed us to prudently comply with the rules and regulations created by the Act. We expect to spend a significant amount of time and assets during the 2005 fiscal year to comply with additional regulations from the
Act, including Section 404 which requires documentation and testing of our internal controls over financial reporting.



Comparison of Financial Condition at June 30, 2004 and 2003



Total assets increased by $19.6 million to $211.6 million at June 30, 2004 from $192.0 million at June 30, 2003. The increase in assets was primarily the result of an
increase of $25.2 million, or 16.2%, in net loans receivable and an increase of $2.8 million, or 32.5%, in net office properties and equipment from June 30, 2003 to June 30, 2004. The increase in net loans receivable and net office properties and
equipment was partially offset by a decrease of $6.4 million, or 45.5%, in cash and cash equivalents and a decrease of $3.3 million, or 43.2%, in securities available for sale from June 30, 2003 to June 30, 2004. The decrease in cash and cash
equivalents and securities available for sale was used to fund the $25.2 million increase in net loans receivable. The increase in net loans receivable is typical for the Bank, which operates in lending markets that have had sustained loan demand
over the last several years. The increase in office properties and equipment, net was primarily due to the costs to construct the new Financial Services Center in Boone, North Carolina and the addition of new equipment to assure our delivery
capabilities in the event of a disaster affecting our computer systems. These back-up facilities will be re-located to the Boone Financial Center that is currently under construction. Prior to completion, backup equipment has been positioned in
various branch locations sufficiently removed from the primary IT location. These investments in backup capacity allow us to assure our customers of stability in the event of a disastrous occurrence as well as to comply with regulatory requirements
for business continuity.



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##### Table of Contents

Managements Discussion and Analysis

June 30, 2004 and 2003



Securities available for sale decreased $3.3 million, or 43.2%, to $4.3 million at June 30, 2004 from $7.6 million at
June 30, 2003. This decrease was due to maturing investments. At June 30, 2004, the Companys investment portfolio had $17,064 in net unrealized gains as compared to net unrealized gains of $96,473 at June 30, 2003.



The Banks savings deposits increased by $7.9 million, or 5.3%, from $149.6 million at
June 30, 2003 to $157.4 million at June 30, 2004. We believe the increase in deposits is attributable to our continuing marketing efforts directed towards increasing balances in savings and transaction accounts and in smaller, stable certificates of
deposit. We intend to further focus our marketing efforts and to offer new products to increase lower cost core deposits. During the year ended June 30, 2004, the Bank entered an agreement with Promontory Interfinancial Network which allows us to
provide FDIC insurance coverage beyond the normal limits by using its network. The agreement allows us to maintain large deposit relationships when the customer desires FDIC coverage on all certificate of deposit balances. As of June 30, 2004, we
had $1.4 million placed in the Promontory Interfinancial Network.



Advances
from the FHLB increased $12.0 million, or 56.7%, to $33.1 million at June 30, 2004 from $21.1 million at June 30, 2003. The increase in advances from the FHLB was used to provide a portion of the funding for the $25.2 million increase in net loans
receivable.



Total stockholders equity decreased $486,288, or 3.7%, to
$12.5 million at June 30, 2004 from $13.0 million at June 30, 2003. The decrease in stockholders equity was primarily the result of the net loss of $308,254, the increase in the value of redeemable common stock held by the ESOP of $55,338, or
11.5%, dividends of $145,748 and a decrease in other comprehensive income of $48,348. These decreases were partially offset by ESOP expenses of $71,400. At June 30, 2004, the Banks regulatory capital amounted to $17.0 million compared to $16.9
million at June 30, 2003, which was in excess of regulatory capital requirements at both such dates.



The Banks level of non-performing loans, defined as loans past due 90 days or more, increased to $518,801, or 0.25% of total assets, at June 30, 2004 compared to $442,696, or 0.23% of total assets, at June 30,
2003. The Bank recognized net charge-offs of approximately $533,666 during the year ended June 30, 2004 compared to net charge-offs of $263,248 for the year ended June 30, 2003. The increase in net charge-offs was primarily attributable to a
$349,580 charge-off related to one commercial line of credit in the second quarter of fiscal 2004. While future loan loss provision requirements are uncertain, management believes that the loan loss provision for the year ending June 30, 2005 will
be less than the provision for 2004.



Comparison of Operating Results for
the Fiscal Years Ended June 30, 2004 and 2003



The Company had a net loss
for the year ended June 30, 2004 of $308,254 compared to net income of $375,464 for the year ended June 30, 2003. Changes in net income during the comparable twelve-month period were attributable to: an increase in the provision for loan losses; an
increase in net interest income; an increase in non-interest income and an increase in non-interest expense, which is explained below. In our opinion, there has not been a material change in interest rate risk from the end of the Companys most
recent fiscal year.



Interest Income. Interest income decreased by
$327,816 or 3.0% from $11,011,408 for the year ended June 30, 2003 to $10,683,592 for the year ended June 30, 2004. Interest income from loans decreased $181,704 or 1.7% from $10,580,406 for the year ended June 30, 2003 to $10,398,702 for the year
ended June 30, 2004. The decrease in interest income from loans for the year ended June 30, 2004 was attributable to a decrease in the weighted average rate of net loans receivable due to the low interest rate environment during the period. The
weighted average rate on portfolio loans declined .51% from 6.31% at June 30, 2003 to 5.80% at June 30, 2004.



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##### Table of Contents

Managements Discussion and Analysis

June 30, 2004 and 2003



Table 1.



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



|                                   |  |                                                  |     |   |                                                  |   |        |              |  |   |     |   |  |        |      |   |      |   |       |              |  |   |        |   |  |   |      |   |  |   |      |  
|---------------------------------- |  | ------------------------------------------------ | --- | - | ------------------------------------------------ | - | ------ | ------------ |  | - | --- | - |  | ------ | ---- | - | ---- | - | ----- | ------------ |  | - | ------ | - |  | - | ---- | - |  | - | ---- | -
|                                   |  | Year ended June 30, 2004compared toJune 30, 2003 |     |   | Year ended June 30, 2003compared toJune 30, 2002 |  
|                                   |  | Increase/(Decrease)Due to                        |     |   | Increase/(Decrease)Due to                        |  
|                                   |  | Volume                                           |     |   | Rate                                             |   |        | Rate/ Volume |  |   | Net |   |  | Volume |      |   | Rate |   |       | Rate/ Volume |  |   | Net    |  
|                                   |  | (In thousands)                                   |    
|Assets:                            |  |                                                  |     |   |                                                  |   |        |              |  |   |     |   |  |        |      |   |      |   |       |              |  |   |        |   |  |   |      |   |  |   |      |  
|Interest-earning assets:           |  |                                                  |     |   |                                                  |   |        |              |  |   |     |   |  |        |      |   |      |   |       |              |  |   |        |   |  |   |      |   |  |   |      |  
|Interest-bearing deposits          |  | $                                                | (20 | ) |                                                  | $ | (14    | )            |  | $ | 4   |   |  | $      | (30  | ) |      | $ | (69   | )            |  | $ | (75    | ) |  | $ | 27   |   |  | $ | (117 | )
|Investment securities              |  |                                                  | (67 | ) |                                                  |   | (61    | )            |  |   | 11  |   |  |        | (117 | ) |      |   | (113  | )            |  |   | (130   | ) |  |   | 25   |   |  |   | (218 | )
|Loans receivable                   |  |                                                  | 967 |   |                                                  |   | (1,051 | )            |  |   | (96 | ) |  |        | (180 | ) |      |   | 1,465 |              |  |   | (1,058 | ) |  |   | (149 | ) |  |   | 258  |  
|                                   |  |                                                  |     |   |                                                  |   |        |              |  |   |     |   |  |        |      |   |      |   |       |              |  |   |        |   |  |   |      |   |  |   |      |  
|Total                              |  |                                                  | 880 |   |                                                  |   | (1,126 | )            |  |   | (81 | ) |  |        | (327 | ) |      |   | 1,283 |              |  |   | (1,263 | ) |  |   | (97  | ) |  |   | (77  | )
|                                   |  |                                                  |     |   |                                                  |   |        |              |  |   |     |   |  |        |      |   |      |   |       |              |  |   |        |   |  |   |      |   |  |   |      |  
|Liabilities:                       |  |                                                  |     |   |                                                  |   |        |              |  |   |     |   |  |        |      |   |      |   |       |              |  |   |        |   |  |   |      |   |  |   |      |  
|Interest-bearing liabilities:      |  |                                                  |     |   |                                                  |   |        |              |  |   |     |   |  |        |      |   |      |   |       |              |  |   |        |   |  |   |      |   |  |   |      |  
|Interest-bearing checking accounts |  |                                                  | 15  |   |                                                  |   | (86    | )            |  |   | (7  | ) |  |        | (78  | ) |      |   | (16   | )            |  |   | (104   | ) |  |   | 5    |   |  |   | (115 | )
|Savings                            |  |                                                  | 73  |   |                                                  |   | (284   | )            |  |   | (26 | ) |  |        | (237 | ) |      |   | 259   |              |  |   | (205   | ) |  |   | (67  | ) |  |   | (13  | )
|Certificates of deposit            |  |                                                  | 42  |   |                                                  |   | (467   | )            |  |   | (8  | ) |  |        | (433 | ) |      |   | 179   |              |  |   | (835   | ) |  |   | (47  | ) |  |   | (703 | )
|Borrowed funds                     |  |                                                  | 184 |   |                                                  |   | (104   | )            |  |   | (12 | ) |  |        | 68   |   |      |   | 283   |              |  |   | (142   | ) |  |   | (26  | ) |  |   | 115  |  
|                                   |  |                                                  |     |   |                                                  |   |        |              |  |   |     |   |  |        |      |   |      |   |       |              |  |   |        |   |  |   |      |   |  |   |      |  
|Total                              |  |                                                  | 314 |   |                                                  |   | (941   | )            |  |   | (53 | ) |  |        | (680 | ) |      |   | 705   |              |  |   | (1,286 | ) |  |   | (135 | ) |  |   | (716 | )
|                                   |  |                                                  |     |   |                                                  |   |        |              |  |   |     |   |  |        |      |   |      |   |       |              |  |   |        |   |  |   |      |   |  |   |      |  
|Net interest income                |  | $                                                | 566 |   |                                                  | $ | (185   | )            |  | $ | (28 | ) |  | $      | 353  |   |      | $ | 578   |              |  | $ | 23     |   |  | $ | 38   |   |  | $ | 639  |  
|                                   |  |                                                  |     |   |                                                  |   |        |              |  |   |     |   |  |        |      |   |      |   |       |              |  |   |        |   |  |   |      |   |  |   |      |  



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##### Table of Contents

Managements Discussion and Analysis

June 30, 2004 and 2003



Table 2.



The following table provides information concerning the Banks yields on interest-earning assets and cost of funds on interest-bearing liabilities over the years
ended June 30, 2004 and 2003.



|                                                                 |  |                  |         |                    |        |   |                             |      |                        |  |                    |        |  |                 |   |          |   |                     |  |   |        |  |        |  
|---------------------------------------------------------------- |  | ---------------- | ------- | ------------------ | ------ | - | --------------------------- | ---- | ---------------------- |  | ------------------ | ------ |  | --------------- | - | -------- | - | ------------------- |  | - | ------ |  | ------ | -
|                                                                 |  |                  |         |                    |        |   | For the year ended June 30, |     
|                                                                 |  | At June 30, 2004 |         |                    | 2004   |   |                             | 2003 |                       
|                                                                 |  | Actual Balance   |         | AverageYield/ Rate |        |   | Average Balance             |      | Interest               |  | AverageYield/ Rate |        |  | Average Balance |   | Interest |   | Average Yield/ Rate | 
|                                                                 |  |                  |         |                    |        |   |                             |     
|                                                                 |  |                  |         |                    |        |   |                             |      | (Dollars in thousands) |  |                    |        |  |                 |   |          |  
|Assets:                                                          |  |                  |         |                    |        |   |                             |      |                        |  |                    |        |  |                 |   |          |   |                     |  |   |        |  |        |  
|Interest-earnings assets:                                        |  |                  |         |                    |        |   |                             |      |                        |  |                    |        |  |                 |   |          |   |                     |  |   |        |  |        |  
|Interest-bearing deposits                                        |  | $                | 2,499   |                    | 1.36   | % |                             | $    | 3,010                  |  | $                  | 43     |  | 1.43            | % |          | $ | 4,145               |  | $ | 73     |  | 1.76   | %
|Investment securities                                            |  |                  | 6,501   |                    | 3.95   | % |                             |      | 7,162                  |  |                    | 242    |  | 3.38            | % |          |   | 8,804               |  |   | 358    |  | 4.07   | %
|Loans receivable, net(1)                                         |  |                  | 181,489 |                    | 5.80   | % |                             |      | 168,738                |  |                    | 10,399 |  | 6.16            | % |          |   | 154,582             |  |   | 10,580 |  | 6.84   | %
|                                                                 |  |                  |         |                    |        |   |                             |      |                        |  |                    |        |  |                 |   |          |   |                     |  |   |        |  |        |  
|Total interest-earning assets                                    |  |                  | 190,489 |                    | 5.68   | % |                             |      | 178,910                |  |                    | 10,684 |  | 5.97            | % |          |   | 167,531             |  |   | 11,011 |  | 6.57   | %
|Non-interest-earning assets                                      |  |                  | 21,130  |                    |        |   |                             |      | 21,276                 |  |                    |        |  |                 |   |          |   | 19,645              |  |   |        |  |        |  
|                                                                 |  |                  |         |                    |        |   |                             |      |                        |  |                    |        |  |                 |   |          |   |                     |  |   |        |  |        |  
|Total assets                                                     |  | $                | 211,619 |                    |        |   |                             | $    | 200,186                |  |                    |        |  |                 |   |          | $ | 187,176             |  |   |        |  |        |  
|                                                                 |  |                  |         |                    |        |   |                             |      |                        |  |                    |        |  |                 |   |          |   |                     |  |   |        |  |        |  
|Liabilities and equity:                                          |  |                  |         |                    |        |   |                             |      |                        |  |                    |        |  |                 |   |          |   |                     |  |   |        |  |        |  
|Interest-bearing liabilities:                                    |  |                  |         |                    |        |   |                             |      |                        |  |                    |        |  |                 |   |          |   |                     |  |   |        |  |        |  
|Interest-bearing checking accounts                               |  | $                | 24,370  |                    | 0.49   | % |                             | $    | 23,085                 |  |                    | 122    |  | 0.53            | % |          | $ | 21,434              |  |   | 200    |  | 0.93   | %
|Savings                                                          |  |                  | 42,495  |                    | 1.12   | % |                             |      | 42,497                 |  |                    | 543    |  | 1.28            | % |          |   | 38,889              |  |   | 782    |  | 2.01   | %
|Certificates of deposit                                          |  |                  | 76,436  |                    | 2.55   | % |                             |      | 72,878                 |  |                    | 2,037  |  | 2.80            | % |          |   | 71,679              |  |   | 2,468  |  | 3.44   | %
|Borrowed funds                                                   |  |                  | 39,412  |                    | 4.61   | % |                             |      | 31,738                 |  |                    | 1,703  |  | 5.37            | % |          |   | 28,541              |  |   | 1,635  |  | 5.73   | %
|                                                                 |  |                  |         |                    |        |   |                             |      |                        |  |                    |        |  |                 |   |          |   |                     |  |   |        |  |        |  
|Total interest-bearing liabilities                               |  |                  | 182,713 |                    | 2.39   | % |                             |      | 170,198                |  |                    | 4,405  |  | 2.59            | % |          |   | 160,543             |  |   | 5,085  |  | 3.17   | %
|                                                                 |  |                  |         |                    |        |   |                             |      |                        |  |                    |        |  |                 |   |          |   |                     |  |   |        |  |        |  
|Other non-interest-bearing liabilities                           |  |                  | 16,432  |                    |        |   |                             |      | 17,471                 |  |                    |        |  |                 |   |          |   | 13,721              |  |   |        |  |        |  
|Equity                                                           |  |                  | 12,474  |                    |        |   |                             |      | 12,517                 |  |                    |        |  |                 |   |          |   | 12,912              |  |   |        |  |        |  
|                                                                 |  |                  |         |                    |        |   |                             |      |                        |  |                    |        |  |                 |   |          |   |                     |  |   |        |  |        |  
|Total liabilities and equity                                     |  | $                | 211,619 |                    |        |   |                             | $    | 200,186                |  |                    |        |  |                 |   |          | $ | 187,176             |  |   |        |  |        |  
|                                                                 |  |                  |         |                    |        |   |                             |      |                        |  |                    |        |  |                 |   |          |   |                     |  |   |        |  |        |  
|Net interest income and interest rate spread(2)                  |  |                  |         |                    | 3.29   | % |                             |      |                        |  | $                  | 6,279  |  | 3.38            | % |          |   |                     |  | $ | 5,926  |  | 3.41   | %
|                                                                 |  |                  |         |                    |        |   |                             |      |                        |  |                    |        |  |                 |   |          |   |                     |  |   |        |  |        |  
|Net interest-earning assets and net interest margin(3)           |  | $                | 7,776   |                    |        |   |                             | $    | 8,712                  |  |                    |        |  | 3.51            | % |          | $ | 6,988               |  |   |        |  | 3.54   | %
|                                                                 |  |                  |         |                    |        |   |                             |      |                        |  |                    |        |  |                 |   |          |   |                     |  |   |        |  |        |  
|Ratio of interest-earning assets to interest-bearing liabilities |  |                  |         |                    | 104.26 | % |                             |      |                        |  |                    |        |  | 105.12          | % |          |   |                     |  |   |        |  | 104.35 | %



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



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



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



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##### Table of Contents

Managements Discussion and Analysis

June 30, 2004 and 2003



Interest Expense. Interest expense decreased by $680,608 or 13.4% to $4,404,811 for the year ended June 30,
2004 from $5,085,419 for the year ended June 30, 2003. Interest expense on savings deposits decreased by $748,096 or 21.7% to $2,702,583 for the year ended June 30, 2004 from $3,450,679 for the year ended June 30, 2003. These decreases are the
result of the 0.47% decrease in the institutions weighted average rate of deposits during the year ended June 30, 2004 partially offset by the $7.9 million increase in savings deposits. Interest expense on FHLB advances increased $76,463 to
$1,129,778 for the year ended June 30, 2004 from $1,053,315 for the year ended June 30, 2003. This increase is the result of the $12.0 million increase in FHLB advances, partially offset by the 0.37% decrease in the weighted average interest rate on
the FHLB advances during the year ended June 30, 2004.



Net Interest
Income. Net interest income increased by $352,792 or 6.0% from $5,925,989 for the year ended June 30, 2003 to $6,278,781 for the year ended June 30, 2004. The changes in net interest income are a result of a drop in the institutions
weighted average rate paid for deposits and the reduction of the weighted average loan rates, partially offset by the increase in savings deposits and FHLB borrowings. We do not believe that there has been a material change in interest rate risk
from the end of the Companys most recent fiscal year.



Provision for Loan Losses. We made additional provision in the amount of $668,000 to the allowance for loan losses during the year ended June 30, 2004, compared to a $242,700 provision for loan losses made during the year
ended June 30, 2003. As previously noted, provisions to the allowance for loan losses in the year ended June 30, 2004 include a charge-off of $349,580 related to one commercial loan. Provisions for loan losses, which are charged to operations and
resulting loan loss allowances, are amounts that the we believe will be adequate to absorb probable losses on existing loans that may become uncollectible. Loans are charged off against the allowance when we believe collection is unlikely. The
evaluation to increase or decrease the provisions for loan losses and resulting allowances is based both on prior loan loss experience and other factors, such as changes in the nature and volume of the loan portfolio, overall portfolio quality and
current economic conditions.



The Bank made provisions for loan loss
allowances during the year ended June 30, 2004 based upon an analysis of the quality of its loan portfolio. At June 30, 2004, our level of allowance for loan losses amounted to $1,245,018, or 0.68% of total loans, as compared to $1,110,684 of
allowance for loan losses, or 0.71% of total loans at June 30, 2003, which we believe is adequate to absorb any probable losses inherent in our loan portfolio



Non-Interest Income. Non-interest income increased by $287,522 or 8.0% from $3,604,052 for the year ended June 30, 2003 to $3,891,574 for the year ended June
30, 2004. The increase in non-interest income during the year ended June 30, 2004 was primarily attributable to increases in transaction fees on deposit accounts partially offset by a decrease in revenue generated from insurance commissions. The
increase in transaction fees on deposit accounts is primarily attributable to an increase in the number of transaction accounts. These trends are expected to continue to produce growth in non-interest income. Insurance commissions decreased by
$42,777, or 1.8%, from $2,418,375 for the year ended June 30, 2003 to $2,375,598 for the year ended June 30, 2004. The decrease in insurance commissions is primarily due to a decrease in contingency income received from the insurance companies we
represent as compared to the same time period in 2003. The decrease in contingency income is due to the insurance companies we represent paying higher claims to our clients in calendar year 2004 as compared to calendar year 2003, resulting in lower
profit sharing payments.



Non-Interest Expense. Non-interest expense
increased by $1,277,569 or 14.8% from $8,655,755 for the year ended June 30, 2003 to $9,933,324 for the year ended June 30, 2004. The increase in non-interest expense for the year ended June 30, 2004 is primarily attributable to an increase in
compensation costs and occupancy expenses associated with adding computer equipment to provide backup facilities in case of a disaster and increased staffing for the Financial Service Center in Boone, North Carolina. Compensation costs increased by
$632,385, or 13.0%, for the year ended June 30, 2004. Occupancy and equipment costs increased by $131,802 or 11.6% for the year ended June 30, 2004. Other noninterest expense increased $423,251, or 20.1%, primarily due to an increase in attorney
fees, an increase in professional fees for guidance in complying with Section 404 of the Sarbanes-Oxley Act of 2002 and the establishment of an allowance for uncollectible trade accounts receivable. This reserve is established for amounts that we
believe we will be unable to collect.



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##### Table of Contents

Managements Discussion and Analysis

June 30, 2004 and 2003



Income Taxes.Income taxes resulted from applying normal, expected tax rates on income earned during the years
ended June 30, 2004 and 2003. The income tax credit was $122,715 for the year ended June 30, 2004 and the income tax expense was $256,122 for the year ended June 30, 2003. The effective tax rate was higher than expected tax rates for 2004, resulting
primarily from the fact that North Carolina corporations may not file consolidated income tax returns. This had the effect of taxing all income in a particular member of a consolidated group without permitting an offsetting benefit for losses
incurred in another member of the same group, creating a higher than expected overall state income tax expense.



Capital Resources and Liquidity



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



Liquidity management is both a daily and long-term function of management. If we require
funds beyond our ability to generate them internally, we believe we could borrow additional funds from the FHLB and use the wholesale deposit markets. At June 30, 2004, we had borrowings of $33,143,754 from the FHLB. The Bank also maintains
borrowing agreements with the Federal Reserve Bank of Richmond, VA.



The
Company anticipates that it will have sufficient funds available to meet its current loan origination commitments. Certificates of deposit scheduled to mature in one year or less totaled $63.9 million at June 30, 2004. Based upon historical
experience, we believe that a significant portion of such deposits will remain with the Bank. The Company anticipates an additional capital expenditure for the Boone Financial Center during the fiscal year ended June 30, 2005 of approximately $1.6
million. The total capital expenditure for this project is expected to be $5.4 million and $3.8 million was disbursed at June 30, 2004.



As of June 30, 2004, cash and cash equivalents, a significant source of liquidity, totaled $7,674,052. The Office of Thrift Supervision (OTS) regulations
require the Company to maintain sufficient liquidity to ensure its safe and sound operation. Given our level of liquidity and our ability to borrow from the FHLB, we believe we will have sufficient funds available to meet anticipated future loan
commitments, unexpected deposit withdrawals, and other cash requirements.



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



Asset/Liability Management



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



In the absence of other factors, the Companys overall yield on interest-earning assets will increase, as will its cost of funds on its
interest-bearing liabilities, when market rates increase over an extended period of time. Inversely, the



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##### Table of Contents

Managements Discussion and Analysis

June 30, 2004 and 2003



Companys yields and cost of funds will decrease when market rates decline. We are able to manage these fluctuations to some extent by attempting to
control the maturity or rate adjustments of our interest-earning assets and interest-bearing liabilities over given periods of time. One of our tools for monitoring interest rate risk is the measurement of the sensitivity of the net portfolio value
to changes in interest rates.



In order to minimize the potential effects of
adverse material and prolonged increases in market interest rates on the Companys operations, we have implemented an asset/liability program designed to improve the Companys interest rate risk exposure. The program emphasizes the
originations of three-and five-year fixed-rate balloon mortgages, adjustable-rate mortgages, selling long term fixed-rate loans to the secondary market, shorter term consumer and commercial loans, the investment of excess cash in short or
intermediate term interest-earning assets and the solicitation of deposit accounts that can be repriced rapidly in high rate scenarios and longer repricing terms in low rate environments. Competitive pressures and the propensity of customers to
assume the opposite position from the Bank make implementation of the strategy difficult. Our success in increasing our mortgage portfolio of callable and adjustable-rate loans was substantially curtailed during the 2004 and 2003 year end due to the
availability of longer term fixed-rate loans. We sold loans with low fixed rates in order to avoid increasing our exposure to rising rates.



Although the Companys asset/liability management program has generally helped to decrease the exposure of our earnings to interest rate increases, the residual
effect of reducing the Companys historical exposure to interest rate increases is a heightened exposure to interest rate decreases. Additionally, a decline in rates for earning assets may occur more rapidly than a decline in funding costs.
Certificates of deposit typically have terms ranging from three to thirty six months. Consequently, the rates paid for these deposits cannot be adjusted until the maturity date. Loans priced at prime or a margin thereto provide for adjusting rates
immediately when market rates change. The number of borrowers refinancing at lower rates accelerates the decline in loan rates during a declining rate environment as was experienced during the 2004 fiscal year. In a rising rate environment, the
ability to make immediate upward rate adjustments with adjustable-rate loans serves to protect the net interest margin against increases in rates at a more rapid speed than the increase in funding. In a declining rate environment, the rates on prime
rate based loans decrease immediately while certificate rates lag causing the interest margin to decline until the certificates mature offering an opportunity for repricing.



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



Net Portfolio Value



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



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



Our banking subsidiary, AF Bank, has historically been a mortgage lender, which means that it generally has longer terms before repricing its assets than it does
repricing its interest bearing liabilities or deposit accounts. Therefore, a rising rate environment will have the most negative impact on the NPV of the typical mortgage lender. We have implemented a strategy of limiting the terms of mortgage loans
that we cannot sell in the secondary market, increasing the level of loans tied more closely to market interest rates such as the prime rate, and generally reducing the terms of loans that the Company books for portfolio. This restructuring process
and the changes in market rates



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##### Table of Contents

Managements Discussion and Analysis

June 30, 2004 and 2003



have resulted in changing our risk from rising rates to falling rates. The following table presents the Companys NPV at June 30, 2004, as calculated by
the OTS, based on information provided to the OTS by the Company.



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



|                    |  |                      |                              |              |   |  |              |    |  |           |   |  |           
|------------------- |  | -------------------- | ---------------------------- | ------------ | - |  | ------------ | -- |  | --------- | - |  | ----------
|Net Portfolio Value |  |                      | NPV as % of PV (5) of Assets
|Change inRates      |  | $ Amount inThousands |                              | $ Change (1) |   |  | % Change (2) |    |  | Ratio (3) |   |  | Change (4)
|+300 bp             |  | 21,035               |                              | (1,833       | ) |  | (8           | %) |  | 9.94      | % |  | -51 bp    
|+200 bp             |  | 23,448               |                              | 581          |   |  | 3            | %  |  | 10.92     | % |  | 48 bp     
|+100 bp             |  | 23,228               |                              | 361          |   |  | 2            | %  |  | 10.70     | % |  | 26 bp     
|0 bp                |  | 22,868               |                              |             |   |  |             |    |  | 10.44     | % |  |          
|-100 bp             |  | 22,207               |                              | (661         | ) |  | (3           | %) |  | 10.10     | % |  | -34 bp    



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



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



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



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



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



At June 30, 2004, the estimated NPV decreased by 8% in a 300 basis point rising interest rate
shock scenario compared to a loss of 3% in a 100 basis point falling rate scenario. This compares to an increase of 14% under a similar rise and a decrease of 8% in a similar decline one year earlier. The interest rate risk is further measured by
the basis point decline in the ratio of NPV to PV of assets, defined as the Sensitivity Measure by the OTS. At June 30, 2004, the decline of the Sensitivity Measure was 34 basis points with a 100 basis point shock decrease in rates compared to a
decrease of 88 basis points under the same scenario at June 30, 2003. The OTS normally uses the 200 basis point shock scenario as the level for determining the Sensitivity Measure; however, with the current level of rates, the OTS no longer provides
NPV estimates for downward changes exceeding 100 basis points.



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



Table 4. Risk Measures: 200 bp Rate Shock



|                     |  |                            |  |              |    |  |              |   
|-------------------- |  | -------------------------- |  | ------------ | -- |  | ------------ | --
|                     |  |                            |  | June 30,2004 |    |  | June 30,2003 |   
|Pre-shock NPV Ratio: |  | NPV as a % of PV of Assets |  | 10.44        | %  |  | 10.28        | % 
|Exposure Measure:    |  | Post Shock NPV Ratio       |  | 10.10        | %  |  | 9.40         | % 
|Sensitivity Measure: |  | Change in NPV              |  | 34           | bp |  | 88           | bp



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



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##### Table of Contents

Managements Discussion and Analysis

June 30, 2004 and 2003



and its interest bearing deposits. Interest sensitive assets could be expected to have a positive effect on the Company when interest rates are increasing.



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



Future Reporting Requirements



FIN 46



In January 2003, the FASB issued FASB Interpretation No. (FIN) 46, Consolidation of Variable Interest Entities.This interpretation
addresses the consolidation by business enterprises of variable interest entities as defined in the interpretation. In December 2003, the FASB issued a revision to FIN 46 (FIN 46R) to clarify some of the provisions of FIN 46 and to exempt certain
entities from its requirements. FIN 46 is effective for public entities that have interests in structures that are commonly referred to as special-purpose entities for periods ending after December 15, 2003 or, for S-B filers like the Company, for
periods ending after December 31, 2004.



Adoption of FIN 46R will result in
deconsolidation of the Companys trust preferred subsidiary, AF Capital Trust. Upon deconsolidation, the junior subordinated debentures issued by the Company to the Trust will be included in long-term debt (instead of the Capital securities)
and the Companys equity interest in the trust will be included in other assets. If this Trust was deconsolidated as of June 30, 2004, the effect on the Companys statement of financial condition would be an increase in other assets of
$155,000 with a corresponding increase in long-term debt. The deconsolidation of the trust will not materially impact net income.



Impact of Inflation and Changing Prices



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



Subsequent Events



James A. Todd, the
President and Chief Executive Officer of the Companies, was terminated for cause pursuant to his employment agreements with the Companies, effective July 8, 2004. The termination followed and is based upon an investigation authorized by the Boards
of Directors of the Companies. Mr. Todd has threatened litigation in this matter. However, the Companies believe that any such litigation will be without merit and the Companies plan to defend vigorously any such litigation.



Since Mr. Todd was suspended and placed on leave with pay effective June 2, 2004, operations
of the Companies have continued in the ordinary course, with Chief Financial Officer Melanie Miller serving as Acting CEO. Ms. Miller will continue serving as Acting CEO of the Companies until further action by the Boards of Directors. Operations
are expected to continue as normal.



Off-Balance Sheet Arrangements



The Company does not have any off-balance sheet arrangements that have or
are reasonably likely to have a current or future effect on the Companys financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to
investors.



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##### Table of Contents

Consolidated Statements of Financial Condition

June 30, 2004 and 2003



|                                                                                                                                               |  |      |             |   |      |   |             |  
|---------------------------------------------------------------------------------------------------------------------------------------------- |  | ---- | ----------- | - | ---- | - | ----------- | -
|                                                                                                                                               |  | 2004 |             |   | 2003 |  
|Assets                                                                                                                                         |  |      |             |   |      |   |             |  
|Cash and cash equivalents:                                                                                                                     |  |      |             |   |      |   |             |  
|Interest-bearing deposits                                                                                                                      |  | $    | 2,498,878   |   |      | $ | 6,151,744   |  
|Noninterest-bearing deposits                                                                                                                   |  |      | 5,175,174   |   |      |   | 7,920,274   |  
|Securities held to maturity (fair value $529,000 in 2004 and $100,000 in 2003)                                                                 |  |      | 529,000     |   |      |   | 100,000     |  
|Securities available for sale                                                                                                                  |  |      | 4,315,066   |   |      |   | 7,596,814   |  
|Federal Home Loan Bank stock                                                                                                                   |  |      | 1,657,200   |   |      |   | 1,057,300   |  
|Loans                                                                                                                                          |  |      | 182,734,177 |   |      |   | 157,368,574 |  
|Less allowance for loan losses                                                                                                                 |  |      | (1,245,018  | ) |      |   | (1,110,684  | )
|                                                                                                                                               |  |      |             |   |      |   |             |  
|Loans receivable, net                                                                                                                          |  |      | 181,489,159 |   |      |   | 156,257,890 |  
|                                                                                                                                               |  |      |             |   |      |   |             |  
|Real estate owned                                                                                                                              |  |      |            |   |      |   | 43,000      |  
|Office properties and equipment, net                                                                                                           |  |      | 11,515,179  |   |      |   | 8,691,947   |  
|Accrued interest receivable on loans                                                                                                           |  |      | 855,408     |   |      |   | 787,675     |  
|Accrued interest receivable on investment securities                                                                                           |  |      | 66,402      |   |      |   | 77,833      |  
|Prepaid expenses and other assets                                                                                                              |  |      | 1,560,688   |   |      |   | 1,342,633   |  
|Deferred income taxes, net                                                                                                                     |  |      | 280,577     |   |      |   | 349,223     |  
|Goodwill                                                                                                                                       |  |      | 1,676,446   |   |      |   | 1,596,446   |  
|                                                                                                                                               |  |      |             |   |      |   |             |  
|Total assets                                                                                                                                   |  | $    | 211,619,177 |   |      | $ | 191,972,779 |  
|                                                                                                                                               |  |      |             |   |      |   |             |  
|Liabilities and Stockholders Equity                                                                                                           |  |      |             |   |      |   |             |  
|Liabilities:                                                                                                                                   |  |      |             |   |      |   |             |  
|Savings deposits                                                                                                                               |  | $    | 157,433,544 |   |      | $ | 149,571,086 |  
|Notes payable                                                                                                                                  |  |      | 1,197,806   |   |      |   | 1,140,296   |  
|Note payable  ESOP                                                                                                                            |  |      | 70,420      |   |      |   | 107,420     |  
|Advances from Federal Home Loan Bank                                                                                                           |  |      | 33,143,754  |   |      |   | 21,145,669  |  
|Accounts payable and other liabilities                                                                                                         |  |      | 1,764,907   |   |      |   | 1,568,612   |  
|Redeemable common stock held by the ESOP, net of unearned ESOP shares                                                                          |  |      | 534,750     |   |      |   | 479,412     |  
|Capital securities                                                                                                                             |  |      | 5,000,000   |   |      |   | 5,000,000   |  
|                                                                                                                                               |  |      |             |   |      |   |             |  
|Total liabilities                                                                                                                              |  |      | 199,145,181 |   |      |   | 179,012,495 |  
|                                                                                                                                               |  |      |             |   |      |   |             |  
|Commitments and contingencies                                                                                                                  |  |      |             |   |      |   |             |  
|Stockholders equity:                                                                                                                          |  |      |             |   |      |   |             |  
|Common stock, par value $.01 per share; authorized 5,000,000 shares; 1,053,678 shares issued and 1,049,838 shares outstanding at 2004 and
2003 |  |      | 10,537      |   |      |   | 10,537      |  
|Additional paid-in capital                                                                                                                     |  |      | 4,653,933   |   |      |   | 4,619,570   |  
|Retained earnings, substantially restricted                                                                                                    |  |      | 7,874,017   |   |      |   | 8,346,320   |  
|Accumulated other comprehensive income                                                                                                         |  |      | 10,389      |   |      |   | 58,737      |  
|                                                                                                                                               |  |      |             |   |      |   |             |  
|                                                                                                                                               |  |      | 12,548,876  |   |      |   | 13,035,164  |  
|Less cost of 3,840 shares of treasury stock                                                                                                    |  |      | (74,880     | ) |      |   | (74,880     | )
|                                                                                                                                               |  |      |             |   |      |   |             |  
|Total stockholders equity                                                                                                                     |  |      | 12,473,996  |   |      |   | 12,960,284  |  
|                                                                                                                                               |  |      |             |   |      |   |             |  
|Total liabilities and stockholders equity                                                                                                     |  | $    | 211,619,177 |   |      | $ | 191,972,779 |  
|                                                                                                                                               |  |      |             |   |      |   |             |  



See Notes to Consolidated
Financial Statements



- 19 -



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##### Table of Contents

Consolidated Statements of Income (Loss)

Years ended June 30, 2004 and 2003



|                                                    |  |      |            |   |      |   |           
|--------------------------------------------------- |  | ---- | ---------- | - | ---- | - | ----------
|                                                    |  | 2004 |            |   | 2003
|Interest and dividend income:                       |  |      |            |   |      |   |           
|Loans                                               |  | $    | 10,398,702 |   |      | $ | 10,580,406
|Investment securities                               |  |      | 241,959    |   |      |   | 358,281   
|Interest-bearing deposits                           |  |      | 42,931     |   |      |   | 72,721    
|                                                    |  |      |            |   |      |   |           
|Total interest and dividend income                  |  |      | 10,683,592 |   |      |   | 11,011,408
|                                                    |  |      |            |   |      |   |           
|Interest expense:                                   |  |      |            |   |      |   |           
|Savings deposits                                    |  |      | 2,702,583  |   |      |   | 3,450,679 
|Federal Home Loan Bank advances                     |  |      | 1,129,778  |   |      |   | 1,053,315 
|Notes payable                                       |  |      | 58,546     |   |      |   | 68,639    
|Capital securities                                  |  |      | 513,904    |   |      |   | 512,786   
|                                                    |  |      |            |   |      |   |           
|Total interest expense                              |  |      | 4,404,811  |   |      |   | 5,085,419 
|                                                    |  |      |            |   |      |   |           
|Net interest income                                 |  |      | 6,278,781  |   |      |   | 5,925,989 
|Provision for loan losses:                          |  |      | 668,000    |   |      |   | 242,700   
|                                                    |  |      |            |   |      |   |           
|Net interest income after provision for loan losses |  |      | 5,610,781  |   |      |   | 5,683,289 
|                                                    |  |      |            |   |      |   |           
|Noninterest income:                                 |  |      |            |   |      |   |           
|Insurance commissions                               |  |      | 2,375,598  |   |      |   | 2,418,375 
|Gain on sale of investments available for sale      |  |      |           |   |      |   | 6,998     
|Other                                               |  |      | 1,515,976  |   |      |   | 1,178,679 
|                                                    |  |      |            |   |      |   |           
|Total noninterest income                            |  |      | 3,891,574  |   |      |   | 3,604,052 
|                                                    |  |      |            |   |      |   |           
|Noninterest expense:                                |  |      |            |   |      |   |           
|Compensation and employee benefits                  |  |      | 5,508,835  |   |      |   | 4,876,450 
|Occupancy and equipment                             |  |      | 1,267,694  |   |      |   | 1,135,892 
|Computer processing charges                         |  |      | 627,253    |   |      |   | 537,122   
|Other                                               |  |      | 2,529,542  |   |      |   | 2,106,291 
|                                                    |  |      |            |   |      |   |           
|Total noninterest expense                           |  |      | 9,933,324  |   |      |   | 8,655,755 
|                                                    |  |      |            |   |      |   |           
|Income (loss) before income taxes                   |  |      | (430,969   | ) |      |   | 631,586   
|Income taxes (benefit):                             |  |      | (122,715   | ) |      |   | 256,122   
|                                                    |  |      |            |   |      |   |           
|Net income (loss)                                   |  | $    | (308,254   | ) |      | $ | 375,464   
|                                                    |  |      |            |   |      |   |           
|Basic earnings (loss) per share                     |  | $    | (0.30      | ) |      | $ | 0.36      
|                                                    |  |      |            |   |      |   |           
|Diluted earnings (loss) per share                   |  | $    | (0.30      | ) |      | $ | 0.36      
|                                                    |  |      |            |   |      |   |           
|Basic weighted average shares outstanding           |  |      | 1,041,091  |   |      |   | 1,041,239 
|                                                    |  |      |            |   |      |   |           
|Diluted weighted average shares outstanding         |  |      | 1,041,091  |   |      |   | 1,041,239 
|                                                    |  |      |            |   |      |   |           
|Cash dividends per share                            |  | $    | 0.20       |   |      | $ | 0.20      
|                                                    |  |      |            |   |      |   |           



See Notes to Consolidated
Financial Statements



- 20 -



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##### Table of Contents

Consolidated Statements of Stockholders Equity

Years ended June 30, 2004 and 2003



|                                                                                           |  |             |        |                          |   |                  |  |   |                                           |   |  |               |         |   |                          |   |         |   |  |   |            |  
|------------------------------------------------------------------------------------------ |  | ----------- | ------ | ------------------------ | - | ---------------- |  | - | ----------------------------------------- | - |  | ------------- | ------- | - | ------------------------ | - | ------- | - |  | - | ---------- | -
|                                                                                           |  | CommonStock |        | AdditionalPaid-inCapital |   | RetainedEarnings |  |   | AccumulatedOtherComprehensiveIncome(Loss) |   |  | TreasuryStock |         |   | TotalStockholdersEquity |  
|Balance, June 30, 2002                                                                     |  | $           | 10,537 |                          | $ | 4,602,930        |  | $ | 8,200,866                                 |   |  | $             | 37,350  |   |                          | $ | (74,880 | ) |  | $ | 12,776,803 |  
|Transfer to redeemable common stock net of unearned ESOP shares                            |  |             |       |                          |   |                 |  |   | (88,173                                   | ) |  |               |        |   |                          |   |        |   |  |   | (88,173    | )
|ESOP contribution                                                                          |  |             |       |                          |   | 16,640           |  |   | 37,037                                    |   |  |               |        |   |                          |   |        |   |  |   | 53,677     |  
|Cash dividend, $.20 per share                                                              |  |             |       |                          |   |                 |  |   | (178,874                                  | ) |  |               |        |   |                          |   |        |   |  |   | (178,874   | )
|Net income                                                                                 |  |             |       |                          |   |                 |  |   | 375,464                                   |   |  |               |        |   |                          |   |        |   |  |   | 375,464    |  
|Other comprehensive income, net of tax:                                                    |  |             |        |                          |   |                  |  |   |                                           |   |  |               |         |   |                          |   |         |   |  |   |            |  
|Unrealized holding gains arising during period, net of taxes of $11,005                    |  |             |       |                          |   |                 |  |   |                                          |   |  |               | 25,647  |   |                          |   |        |   |  |   |           |  
|Less: reclassification adjustment for gains included in net income, net of taxes of $2,738 |  |             |       |                          |   |                 |  |   |                                          |   |  |               | 4,260   |   |                          |   |        |   |  |   |           |  
|                                                                                           |  |             |        |                          |   |                  |  |   |                                           |   |  |               |         |   |                          |   |         |   |  |   |            |  
|Other comprehensive income                                                                 |  |             |       |                          |   |                 |  |   |                                          |   |  |               | 21,387  |   |                          |   |        |   |  |   | 21,387     |  
|                                                                                           |  |             |        |                          |   |                  |  |   |                                           |   |  |               |         |   |                          |   |         |   |  |   |            |  
|Comprehensive income                                                                       |  |             |        |                          |   |                  |  |   |                                           |   |  |               |         |   |                          |   |         |   |  |   | 396,851    |  
|                                                                                           |  |             |        |                          |   |                  |  |   |                                           |   |  |               |         |   |                          |   |         |   |  |   |            |  
|Balance, June 30, 2003                                                                     |  |             | 10,537 |                          |   | 4,619,570        |  |   | 8,346,320                                 |   |  |               | 58,737  |   |                          |   | (74,880 | ) |  |   | 12,960,284 |  
|Transfer to redeemable common stock net of unearned ESOP shares                            |  |             |       |                          |   |                 |  |   | (55,338                                   | ) |  |               |        |   |                          |   |        |   |  |   | (55,338    | )
|ESOP contribution                                                                          |  |             |       |                          |   | 34,363           |  |   | 37,037                                    |   |  |               |        |   |                          |   |        |   |  |   | 71,400     |  
|Cash dividend, $.20 per share                                                              |  |             |       |                          |   |                 |  |   | (145,748                                  | ) |  |               |        |   |                          |   |        |   |  |   | (145,748   | )
|Net loss                                                                                   |  |             |       |                          |   |                 |  |   | (308,254                                  | ) |  |               |        |   |                          |   |        |   |  |   | (308,254   | )
|Other comprehensive loss, net of tax:                                                      |  |             |        |                          |   |                  |  |   |                                           |   |  |               |         |   |                          |   |         |   |  |   |            |  
|Unrealized holding loss arising during period, net of tax benefit of $31,061               |  |             |       |                          |   |                 |  |   |                                          |   |  |               | (48,348 | ) |                          |   |        |   |  |   | (48,348    | )
|                                                                                           |  |             |        |                          |   |                  |  |   |                                           |   |  |               |         |   |                          |   |         |   |  |   |            |  
|Comprehensive loss                                                                         |  |             |        |                          |   |                  |  |   |                                           |   |  |               |         |   |                          |   |         |   |  |   | (356,602   | )
|                                                                                           |  |             |        |                          |   |                  |  |   |                                           |   |  |               |         |   |                          |   |         |   |  |   |            |  
|Balance, June 30, 2004                                                                     |  | $           | 10,537 |                          | $ | 4,653,933        |  | $ | 7,874,017                                 |   |  | $             | 10,389  |   |                          | $ | (74,880 | ) |  | $ | 12,473,996 |  
|                                                                                           |  |             |        |                          |   |                  |  |   |                                           |   |  |               |         |   |                          |   |         |   |  |   |            |  



See Notes to Consolidated
Financial Statements



- 21 -



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##### Table of Contents

Consolidated Statements of Cash Flows

Years ended June 30, 2004 and 2003



|                                                                                         |  |      |             |   |      |   |             |  
|---------------------------------------------------------------------------------------- |  | ---- | ----------- | - | ---- | - | ----------- | -
|                                                                                         |  | 2004 |             |   | 2003 |  
|Cash flows from operating activities                                                     |  |      |             |   |      |   |             |  
|Net income (loss)                                                                        |  | $    | (308,254    | ) |      | $ | 375,464     |  
|Adjustments to reconcile net income (loss) to net cash provided by operating activities: |  |      |             |   |      |   |             |  
|Provision for loan losses                                                                |  |      | 668,000     |   |      |   | 242,700     |  
|Gain on sale of investments available for sale                                           |  |      |            |   |      |   | (6,998      | )
|Depreciation                                                                             |  |      | 885,163     |   |      |   | 781,836     |  
|Amortization of deferred loan fees                                                       |  |      | (131,777    | ) |      |   | (233,993    | )
|ESOP expense                                                                             |  |      | 71,400      |   |      |   | 53,676      |  
|Deferred income taxes                                                                    |  |      | 99,707      |   |      |   | 97,062      |  
|Change in operating assets and liabilities:                                              |  |      |             |   |      |   |             |  
|Accrued interest receivable                                                              |  |      | (56,302     | ) |      |   | 120,200     |  
|Accrued interest payable                                                                 |  |      | 36,710      |   |      |   | 154,870     |  
|Prepaid expenses and other assets                                                        |  |      | (133,835    | ) |      |   | 248,125     |  
|Accounts payable and other liabilities                                                   |  |      | 154,760     |   |      |   | (195,946    | )
|                                                                                         |  |      |             |   |      |   |             |  
|Net cash provided by operating activities                                                |  |      | 1,285,572   |   |      |   | 1,636,996   |  
|                                                                                         |  |      |             |   |      |   |             |  
|Cash flows from investing activities                                                     |  |      |             |   |      |   |             |  
|Increase in Federal Home Loan Bank stock                                                 |  |      | (599,900    | ) |      |   | (7,900      | )
|Purchases of investments held to maturity                                                |  |      | (1,099,000  | ) |      |   |            |  
|Proceeds from maturities of investments held to maturity                                 |  |      | 670,000     |   |      |   |            |  
|Purchases of securities available for sale                                               |  |      | (2,000,000  | ) |      |   | (3,730,118  | )
|Proceeds from principal repayment and maturities of securities available for sale        |  |      | 5,156,158   |   |      |   | 5,677,667   |  
|Process from sale of securities available for sale                                       |  |      |            |   |      |   | 756,998     |  
|Net originations of loans receivable                                                     |  |      | (25,789,637 | ) |      |   | (12,766,646 | )
|Investment in insurance agency                                                           |  |      | (80,000     | ) |      |   | 19,000      |  
|Purchases of office properties and equipment                                             |  |      | (3,728,434  | ) |      |   | (3,508,975  | )
|Proceeds from sale of real estate owned                                                  |  |      | 47,145      |   |      |   | 273,520     |  
|                                                                                         |  |      |             |   |      |   |             |  
|Net cash used in investing activities                                                    |  |      | (27,423,668 | ) |      |   | (13,286,454 | )
|                                                                                         |  |      |             |   |      |   |             |  
|Cash flows from financing activities                                                     |  |      |             |   |      |   |             |  
|Net increase in savings deposits                                                         |  |      | 7,867,283   |   |      |   | 12,643,360  |  
|FHLB advances, net                                                                       |  |      | 11,998,085  |   |      |   | 2,235,745   |  
|Notes payable (repayments), net                                                          |  |      | 20,510      |   |      |   | (198,328    | )
|Dividends paid                                                                           |  |      | (145,748    | ) |      |   | (178,874    | )
|                                                                                         |  |      |             |   |      |   |             |  
|Net cash provided by financing activities                                                |  |      | 19,740,130  |   |      |   | 14,501,903  |  
|                                                                                         |  |      |             |   |      |   |             |  
|Net increase (decrease) in cash and cash equivalents                                     |  |      | (6,397,966  | ) |      |   | 2,852,445   |  
|Cash and cash equivalents                                                                |  |      |             |   |      |   |             |  
|Beginning                                                                                |  |      | 14,072,018  |   |      |   | 11,219,573  |  
|                                                                                         |  |      |             |   |      |   |             |  
|Ending                                                                                   |  | $    | 7,674,052   |   |      | $ | 14,072,018  |  
|                                                                                         |  |      |             |   |      |   |             |  



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##### Table of Contents

Consolidated Statements of Cash Flows

Years ended June 30, 2004 and 2003



|                                                                                  |  |      |           |   |      |   |           |  
|--------------------------------------------------------------------------------- |  | ---- | --------- | - | ---- | - | --------- | -
|                                                                                  |  | 2004 |           |   | 2003 |  
|Supplemental disclosures of cash flow information                                 |  |      |           |   |      |   |           |  
|Cash payments for:                                                                |  |      |           |   |      |   |           |  
|Interest                                                                          |  | $    | 4,368,101 |   |      | $ | 4,919,009 |  
|Income taxes                                                                      |  |      | 78,760    |   |      |   | 302,250   |  
|Supplemental disclosure of noncash investing and financing activities             |  |      |           |   |      |   |           |  
|Net change in unrealized gain (loss) on securities available for sale, net of tax |  | $    | (48,348   | ) |      | $ | 21,387    |  
|Transfer from loans receivable to real estate owned                               |  |      | 22,145    |   |      |   | 237,948   |  
|Fair value of ESOP shares in excess of unearned ESOP shares                       |  |      | (18,302   | ) |      |   | (51,137   | )
|Transfer from retained earnings to ESOP redeemable common stock                   |  |      | (55,338   | ) |      |   | (88,173   | )



- 23 -



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##### Table of Contents

Notes to Consolidated Financial Statements



Note
1. Nature of Business and Summary of Significant Accounting Policies



Nature of business



AF Financial Group (the
Company) is a federally chartered thrift holding company which owns 100% of the common stock of AF Bank (the Bank), AF Insurance Services, Inc. and AF Brokerage, Inc. The Company also owns 100% of AF Capital Trust 1. The
Company has no operations and conducts no business of its own other than ownership of its subsidiaries. The Bank is a federally chartered stock savings bank, which conducts business from its main office located in West Jefferson, North Carolina and
seven branches in Sparta, Jefferson, Boone, Warrensville, and West Jefferson, North Carolina. The principal activities of the Bank consist of obtaining savings deposits and providing credit to customers in its primary market area, Ashe, Alleghany
and Watauga Counties. On April 15, 1996, the Board of Directors of the Bank adopted a Plan of Reorganization and related Stock Issuance Plan pursuant to which the Bank exchanged its federal mutual savings bank charter for a federal stock savings
bank charter, conducted a minority stock offering, and formed AsheCo, M.H.C., a mutual holding company which owned 53.8% of the common stock issued by the Bank. The Bank conducted its minority stock offering in July and August of 1996 and the
closing occurred on October 4, 1996. The Bank sold 461,779 shares of common stock in the minority stock offering, including 36,942 shares sold to its Employee Stock Ownership Plan (the ESOP), and issued 538,221 shares to the mutual
holding company.



On June 16, 1998, the Board of Directors approved the
formation of a mid-tier federal thrift holding company, AF Bankshares, Inc., which became the 100% owner of the Bank in a stock swap with AsheCo, M.H.C., which was accounted for similar to a pooling of interests. At the Companys annual meeting
held on November 4, 2002, stockholders approved a resolution to change the Companys name from AF Bankshares, Inc. to AF Financial Group. At June 30, 2004, AsheCo, M.H.C.s ownership of AF Financial Group equaled 51.27%. No changes in
AsheCo, M.H.C.s ownership of AF Financial Group occurred during the year ended June 30, 2004.



On July 1, 1997, the Bank purchased two insurance agencies to form AF Insurance Services, Inc., which became a wholly owned subsidiary of the Bank. A plan of reorganization was completed during the year ended June 30,
1999 and AF Insurance Services, Inc. became a wholly owned subsidiary of AF Financial Group. During the fiscal years ended June 30, 1999, 2000, 2001, 2002 and 2004, AF Insurance Services, Inc. purchased additional insurance agencies. AF Insurance
Services, Inc. operates from its main office in West Jefferson, North Carolina and branch offices in Lenoir, North Wilkesboro, Jefferson, Elkin, Boone, Sparta and West Jefferson, North Carolina. The transactions were recorded under the purchase
method of accounting.



On August 5, 1998, the Company formed AF Brokerage,
Inc., which is a wholly owned subsidiary of the Company. Prior to receiving its approval from the NASD to become a registered broker/dealer, AF Brokerage, Inc. operated through the use of a third party clearing broker. AF Brokerage, Inc. began
operating as an independent broker/dealer in May 2000. Revenues are not material to the financial information. In addition, on July 16, 2001, the Company formed AF Capital Trust 1, a Delaware business trust, for the sole purpose of issuing trust
preferred securities in a pooled capital securities transaction. See Note 7 for additional information.



The following is a description of the significant accounting policies used in the preparation of the accompanying financial statements.



Principles of consolidation



The consolidated financial statements include the accounts of AF Financial Group and its wholly owned subsidiaries, AF Bank, AF Insurance Services, Inc., AF Brokerage,
Inc, and AF Capital Trust 1. All significant intercompany transactions and balances have been eliminated in consolidation.



Business segments



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



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 1. Nature of Business and Summary of Significant Accounting Policies, continued



Basis of financial statement presentation



The accounting and reporting policies of the Company conform to accounting principles
generally accepted in the United States of America and general practices within the financial services industry. In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported revenues and expenses for the period. Actual results could differ from those estimates.



Certain amounts in the financial statements for the year ended June 30, 2003 have been
reclassified to conform to the presentation of the financial statements for the year ended June 30, 2004. The reclassifications had no effect on net income or stockholders equity as previously reported.



Cash and cash equivalents



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



Investment securities



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



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



Securities available for sale



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



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



- 25 -



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 1. Nature of Business and Summary of Significant Accounting Policies, continued



Securities held to maturity



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



Investment in Federal Home Loan Bank stock



The Bank, as a member of the Federal Home Loan Bank (FHLB) system, is required to maintain
an investment in capital stock of the FHLB in an amount equal to the greater of $500 or 1% of its outstanding home loans or 5% of advances from the FHLB. No ready market exists for the FHLB stock, it has no quoted market value and it is carried at
cost. The FHLB stock also collateralizes the Companys borrowings from the FHLB.



Loans receivable



Loans receivable are stated at unpaid
principal balances, less the allowance for loan losses, the loans sold and net deferred loan-origination fees and costs. The Banks loan portfolio consists principally of mortgage loans collateralized by first trust deeds on single family
residences, other residential property, commercial property and land.



Allowance for loan losses



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



Impaired loans



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



Interest income



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



Loan origination fees and related costs



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



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 1. Nature of Business and Summary of Significant Accounting Policies, continued



Presold mortgages in process of settlement



As a part of normal business operations, the Bank originates residential mortgage loans that
have been pre-approved by secondary investors. The terms of the loans are set by the secondary investors and are transferred to them at par within several weeks of the Bank initially funding the loan. The Bank receives origination fees from
borrowers. Between the initial funding of the loans by the Bank and the subsequent reimbursement by the investors, the Bank carries the loans on its statement of financial condition at cost. These loans amount to $1,333,600 and $1,189,096 at June
30, 2004 and 2003, respectively.



Real estate owned



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



Office properties and equipment



Office properties and equipment are stated at cost less accumulated depreciation computed principally by the straight-line method over estimated useful lives of 15 years
for land improvements, 30 years for buildings, 7 years for furniture, fixtures, equipment and automobiles, and 5 years for leasehold improvements. The Company has executed a contract with a general contractor to construct a Financial Center in
Boone, North Carolina at a cost of approximately $5.4 million. The Company expects this facility to be completed in October 2004.



Goodwill



Goodwill is the cost of the investment by AF Insurance Services, Inc. in excess of the fair value of net tangible assets acquired at the date of purchase. On July 1, 2002, the Company adopted the provisions of
Financial Accounting Standards Board (FASB) Statement 142, Goodwill and Other Intangible Assets. Under the provisions of the Statement, on July 1, 2002, the Company eliminated the amortization of goodwill. On March 31, 2004, the
Company had no impairment of goodwill, but will reevaluate the carrying value of goodwill annually. The Company expects to perform this reevaluation as of March 31 in each of its fiscal years.



Employee benefit plans



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



Additionally, the Company has implemented a qualified stock option plan authorizing the grant of up to 21,707 stock options to certain officers and directors, either in the form of incentive stock options or non-incentive stock options. As
permitted under the generally accepted accounting principles, grants under the plan are accounted for following the provisions of Accounting Principles Board (APB) Opinion No. 25 and its related interpretations. Accordingly, no
compensation cost has been recognized for grants made to date. All options were fully vested on December 8, 2001.



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 1. Nature of Business and Summary of Significant Accounting Policies, continued



Advance payments by borrowers for taxes and insurance



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



Income taxes



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



Off- statement of financial condition risk



The Bank is a party to financial instruments with off-statement of financial condition risk such as commitments to extend credit and home
equity lines of credit. Management assesses the risk related to these instruments for potential losses on an ongoing basis. Such financial instruments are recorded when they are funded.



Earnings per share



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



Comprehensive income



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



Fair value of financial instruments



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



- 28 -



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 1. Nature of Business and Summary of Significant Accounting Policies, continued



The fair value estimates presented are based on pertinent information available to
management as of June 30, 2004 and 2003. Although management is not aware of any factors that would significantly affect the estimated fair value amount, such amounts have not been comprehensively revalued for purposes of these financial statements
since those dates and therefore, current estimates of fair value may differ significantly from the amounts presented herein.



New accounting pronouncements



In March 2004, the Emerging Issues Task Force (EITF) released EITF Issue 03-01, The Meaning of Other-Than-Temporary Impairment and its Application to
Certain Investments.The Issue provides guidance for evaluating whether an investment is other-than-temporarily impaired and requires certain disclosures with respect to these investments. The disclosure guidance is effective for years ending
after December 15, 2003. The recognition and measurement guidance for other-than-temporary impairment is applicable for reporting periods beginning after June 15, 2004. The adoption of Issue 03-1 did not result in any other-than-temporary
impairment.



On March 9, 2004, the SEC Staff issued Staff Accounting Bulletin
No. 105, Application of Accounting Principles to Loan Commitments(SAB 105). SAB 105 clarifies existing accounting practices relating to the valuation of issued loan commitments, including interest rate lock commitments
(IRLC), subject to SFAS No. 149 and Derivative Implementation Group Issue C13, Scope Exceptions: When a Loan Commitment is included in the Scope of Statement 133. Furthermore, SAB 105 disallows the inclusion of the values of a
servicing component and other internally developed intangible assets in the initial and subsequent IRLC valuation. The provisions of SAB 105 were effective for loan commitments entered into after March 31, 2004. The adoption of SAB 105 did not have
a material impact on the consolidated financial statements.



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 2. Debt and Equity Securities



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



|                                                        |  |               |           |                       |   |                        |  |   |            |   |  |   |          
|------------------------------------------------------- |  | ------------- | --------- | --------------------- | - | ---------------------- |  | - | ---------- | - |  | - | ---------
|                                                        |  | 2004         
|                                                        |  | AmortizedCost |           | Gross UnrealizedGains |   | Gross UnrealizedLosses |  |   | Fair Value
|Available for sale securities:                          |  |               |           |                       |   |                        |  |   |            |   |  |   |          
|Debt securities:                                        |  |               |           |                       |   |                        |  |   |            |   |  |   |          
|U.S. Government agency securities                       |  | $             | 1,300,000 |                       | $ | 1,248                  |  | $ | (1,405     | ) |  | $ | 1,299,843
|Fannie Mae and Government National Mortgage Association |  |               | 1,710,449 |                       |   | 10,515                 |  |   | (14,876    | ) |  |   | 1,706,088
|Municipals                                              |  |               | 286,436   |                       |   | 13,960                 |  |   |           |   |  |   | 300,396  
|Equity securities:                                      |  |               |           |                       |   |                        |  |   |            |   |  |   |          
|Mutual funds                                            |  |               | 1,000,000 |                       |   | 3,660                  |  |   | (79,743    | ) |  |   | 923,917  
|Federal Home Loan Mortgage Corporation common stock     |  |               | 1,117     |                       |   | 83,705                 |  |   |           |   |  |   | 84,822   
|                                                        |  |               |           |                       |   |                        |  |   |            |   |  |   |          
|                                                        |  | $             | 4,298,002 |                       | $ | 113,088                |  | $ | (96,024    | ) |  | $ | 4,315,066
|                                                        |  |               |           |                       |   |                        |  |   |            |   |  |   |          
|Held to maturity securities:                            |  |               |           |                       |   |                        |  |   |            |   |  |   |          
|Debt securities:                                        |  |               |           |                       |   |                        |  |   |            |   |  |   |          
|Federal Home Loan Bank                                  |  | $             | 100,000   |                       | $ |                       |  | $ |           |   |  | $ | 100,000  
|Certificates of deposit                                 |  |               | 429,000   |                       |   |                       |  |   |           |   |  |   | 429,000  
|                                                        |  |               |           |                       |   |                        |  |   |            |   |  |   |          
|                                                        |  | $             | 529,000   |                       | $ |                       |  | $ |           |   |  | $ | 529,000  
|                                                        |  |               |           |                       |   |                        |  |   |            |   |  |   |          
|                                                        | 
|                                                        |  | 2003         
|                                                        |  | AmortizedCost |           | Gross UnrealizedGains |   | Gross UnrealizedLosses |  |   | Fair Value
|Available for sale securities:                          |  |               |           |                       |   |                        |  |   |            |   |  |   |          
|Debt securities:                                        |  |               |           |                       |   |                        |  |   |            |   |  |   |          
|U.S. Government agency securities                       |  | $             | 3,235,000 |                       | $ | 35,399                 |  | $ |           |   |  | $ | 3,270,399
|Fannie Mae and Government National Mortgage Association |  |               | 2,978,510 |                       |   | 24,253                 |  |   | (1,064     | ) |  |   | 3,001,699
|Municipals                                              |  |               | 285,714   |                       |   | 21,732                 |  |   |           |   |  |   | 307,446  
|Equity securities:                                      |  |               |           |                       |   |                        |  |   |            |   |  |   |          
|Mutual funds                                            |  |               | 1,000,000 |                       |   | 15,477                 |  |   | (66,239    | ) |  |   | 949,238  
|Federal Home Loan Mortgage Corporation common stock     |  |               | 1,117     |                       |   | 66,915                 |  |   |           |   |  |   | 68,032   
|                                                        |  |               |           |                       |   |                        |  |   |            |   |  |   |          
|                                                        |  | $             | 7,500,341 |                       | $ | 163,776                |  | $ | (67,303    | ) |  | $ | 7,596,814
|                                                        |  |               |           |                       |   |                        |  |   |            |   |  |   |          
|Held to maturity securities:                            |  |               |           |                       |   |                        |  |   |            |   |  |   |          
|Debt securities:                                        |  |               |           |                       |   |                        |  |   |            |   |  |   |          
|Federal Home Loan Bank                                  |  | $             | 100,000   |                       | $ |                       |  | $ |           |   |  | $ | 100,000  
|                                                        |  |               |           |                       |   |                        |  |   |            |   |  |   |          



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 2. Debt and Equity Securities, continued



The amortized cost and estimated fair value of debt securities at June 30, 2004, by contractual maturity, are shown below. Fannie Mae and
Government National Mortgage Association securities are not included in the maturity categories because they do not have a single maturity date. Additionally, equity securities and mutual funds are not included in the maturity categories because
they do not have contractual maturities.



|                                                                        |  |                             |         |                                |   |               |  |            |           |  |   |          
|----------------------------------------------------------------------- |  | --------------------------- | ------- | ------------------------------ | - | ------------- |  | ---------- | --------- |  | - | ---------
|                                                                        |  | Held to maturitysecurities: |         | Available for sale securities:
|                                                                        |  | AmortizedCost               |         | Fair Value                     |   | AmortizedCost |  | Fair Value
|Due within one year                                                     |  | $                           | 429,000 |                                | $ | 429,000       |  | $          |          |  | $ |         
|Due from one year to five years                                         |  |                             | 100,000 |                                |   | 100,000       |  |            |          |  |   |         
|Due from five to ten years                                              |  |                             |        |                                |   |              |  |            | 1,300,000 |  |   | 1,299,843
|Due after ten years                                                     |  |                             |        |                                |   |              |  |            | 286,436   |  |   | 300,396  
|Fannie Mae and Government National Mortgage Association debt securities |  |                             |        |                                |   |              |  |            | 1,710,449 |  |   | 1,706,088
|Mutual funds                                                            |  |                             |        |                                |   |              |  |            | 1,000,000 |  |   | 923,917  
|Equity securities                                                       |  |                             |        |                                |   |              |  |            | 1,117     |  |   | 84,822   
|                                                                        |  |                             |         |                                |   |               |  |            |           |  |   |          
|                                                                        |  | $                           | 529,000 |                                | $ | 529,000       |  | $          | 4,298,002 |  | $ | 4,315,066
|                                                                        |  |                             |         |                                |   |               |  |            |           |  |   |          



Sales of securities are summarized as
follows for the years ended June 30:



|                                                             |  |      |   |      |   |         |  
|------------------------------------------------------------ |  | ---- | - | ---- | - | ------- | -
|                                                             |  | 2004 |   | 2003 |  
|Proceeds from sale of securities available for sale          |  | $    |  |      | $ | 756,998 |  
|Gross realized gain on sale of securities available for sale |  |      |  |      |   | (6,998  | )
|                                                             |  |      |   |      |   |         |  
|Cost of securities sold                                      |  | $    |  |      | $ | 750,000 |  
|                                                             |  |      |   |      |   |         |  



The Bank has pledged securities with a
fair value of $100,000 at June 30, 2004 as collateral on the treasury tax and loan account.



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 2. Debt and Equity Securities, continued



The following table shows investments gross unrealized losses and fair value, aggregated by investment category and length of time
that individual securities have been in a continuous unrealized loss position, at June 30, 2004. These unrealized losses on investment securities are a result of volatility in the market during 2004 and relate to one federal agency security, five
mortgage-backed securities, and two mutual funds. All unrealized losses on investment securities are considered by management to be temporary given the credit ratings and/ or histories on these investment securities and the short duration of the
unrealized loss.



|                                      |  |                     |           |                   |   |            |  |                  |         |            |   |                  |  |   |           |  |   |       
|------------------------------------- |  | ------------------- | --------- | ----------------- | - | ---------- |  | ---------------- | ------- | ---------- | - | ---------------- |  | - | --------- |  | - | ------
|                                      |  | Less Than 12 Months |           | 12 Months or More |   | Total     
|                                      |  | Fair Value          |           | UnrealizedLosses  |   | Fair Value |  | UnrealizedLosses |         | Fair Value |   | UnrealizedLosses
|Securities available for sale:        |  |                     |           |                   |   |            |  |                  |         |            |   |                  |  |   |           |  |   |       
|U.S. government agencies              |  | $                   | 498,595   |                   | $ | 1,405      |  | $                |        |            | $ |                 |  | $ | 498,595   |  | $ | 1,405 
|Mortgage-back securities              |  |                     | 1,117,422 |                   |   | 14,876     |  |                  |        |            |   |                 |  |   | 1,117,422 |  |   | 14,876
|Mutual funds                          |  |                     | 196,899   |                   |   | 3,102      |  |                  | 523,358 |            |   | 76,641           |  |   | 720,257   |  |   | 79,743
|                                      |  |                     |           |                   |   |            |  |                  |         |            |   |                  |  |   |           |  |   |       
|Total temporarily impaired securities |  | $                   | 1,812,916 |                   | $ | 19,383     |  | $                | 523,358 |            | $ | 76,641           |  | $ | 2,336,274 |  | $ | 96,024
|                                      |  |                     |           |                   |   |            |  |                  |         |            |   |                  |  |   |           |  |   |       



Note 3. Loans Receivable



Loans receivable at June 30, 2004 and 2003 consist of the following:
(Dollars in thousands)



|                          |  |      |         |      |   |        
|------------------------- |  | ---- | ------- | ---- | - | -------
|                          |  | 2004 |         | 2003
|One to four-family        |  | $    | 96,024  |      | $ | 88,725 
|Multifamily               |  |      | 5,728   |      |   | 6,226  
|Non-residential           |  |      | 28,958  |      |   | 18,873 
|Land                      |  |      | 13,906  |      |   | 7,961  
|Construction loans        |  |      | 14,203  |      |   | 9,383  
|Commercial loans          |  |      | 12,626  |      |   | 15,186 
|Consumer loans            |  |      | 11,512  |      |   | 11,227 
|                          |  |      |         |      |   |        
|                          |  |      | 182,957 |      |   | 157,581
|Less:                     |  |      |         |      |   |        
|Deferred loan fees        |  |      | 223     |      |   | 212    
|Allowance for loan losses |  |      | 1,245   |      |   | 1,111  
|                          |  |      |         |      |   |        
|                          |  | $    | 181,489 |      | $ | 156,258
|                          |  |      |         |      |   |        



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 3. Loans Receivable, continued



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



|                           |  |      |           |   |      |   |           |  
|-------------------------- |  | ---- | --------- | - | ---- | - | --------- | -
|                           |  | 2004 |           |   | 2003 |  
|Balance, beginning         |  | $    | 1,110,684 |   |      | $ | 1,131,232 |  
|Provisions for loan losses |  |      | 668,000   |   |      |   | 242,700   |  
|Charge-offs                |  |      | (603,342  | ) |      |   | (417,265  | )
|Recoveries                 |  |      | 69,676    |   |      |   | 154,017   |  
|                           |  |      |           |   |      |   |           |  
|Balance, ending            |  | $    | 1,245,018 |   |      | $ | 1,110,684 |  
|                           |  |      |           |   |      |   |           |  



SFAS No. 114, Accounting by
Creditors for Impairment of a Loan, as amended by SFAS No. 118, Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosure, requires that the Bank establish a specific allowance on impaired loans and disclosure of
the Banks method of accounting for interest income on impaired loans. The Company considers all loans delinquent more than 90 days to be impaired and such loans amounted to approximately $518,801 and $442,696 at June 30, 2004 and 2003,
respectively. These loans are primarily collateral dependent and management has determined that the underlying collateral value is in excess of the carrying amounts. As a result, the Company has determined that specific allowances on these loans are
not required. The Company established reserves for uncollectible interest totaling $3,538 and $8,615 at June 30, 2004 and 2003, respectively.



Loan activity to officers and directors of the Company during the years ended June 30, 2004 and 2003 is summarized as follows:



|                   |  |      |            |   |      |   |            |  
|------------------ |  | ---- | ---------- | - | ---- | - | ---------- | -
|                   |  | 2004 |            |   | 2003 |  
|Balance, beginning |  | $    | 3,215,408  |   |      | $ | 3,398,478  |  
|Disbursements      |  |      | 1,948,547  |   |      |   | 1,178,795  |  
|Payments received  |  |      | (1,170,783 | ) |      |   | (1,361,865 | )
|                   |  |      |            |   |      |   |            |  
|Balance, ending    |  | $    | 3,993,172  |   |      | $ | 3,215,408  |  
|                   |  |      |            |   |      |   |            |  



Mortgage loans serviced for others
consist of loans sold to Fannie Mae and are not included in the accompanying statements of financial condition. Mortgage loan portfolios serviced for Fannie Mae were $57,642,348 and $47,543,300 at June 2004 and 2003, respectively.



There were $1,333,600 outstanding commitments to sell loans as of June 30, 2004.



Note 4. Office Properties and Equipment



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



|                                               |  |      |            |   |      |   |            |  
|---------------------------------------------- |  | ---- | ---------- | - | ---- | - | ---------- | -
|                                               |  | 2004 |            |   | 2003 |  
|Land and land improvements                     |  | $    | 2,448,444  |   |      | $ | 2,410,797  |  
|Buildings                                      |  |      | 8,373,369  |   |      |   | 5,206,160  |  
|Furniture, fixtures, equipment and automobiles |  |      | 3,838,575  |   |      |   | 3,485,905  |  
|Leasehold improvements                         |  |      | 583,646    |   |      |   | 563,433    |  
|                                               |  |      |            |   |      |   |            |  
|                                               |  |      | 15,244,034 |   |      |   | 11,666,295 |  
|Accumulated depreciation                       |  |      | (3,728,855 | ) |      |   | (2,974,348 | )
|                                               |  |      |            |   |      |   |            |  
|                                               |  | $    | 11,515,179 |   |      | $ | 8,691,947  |  
|                                               |  |      |            |   |      |   |            |  



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 5. Savings Deposits



Savings deposits at June 30 consist of the following:



|                                                                               |  |      |             |   |      |   |             |  
|------------------------------------------------------------------------------ |  | ---- | ----------- | - | ---- | - | ----------- | -
|                                                                               |  | 2004 |             |   | 2003 |  
|Interest bearing checking accounts at 0.49% (2004) and 0.59% (2003)            |  | $    | 22,723,918  |   |      | $ | 18,893,034  |  
|Commercial and free checking (noninterest bearing)                             |  |      | 13,792,425  |   |      |   | 12,771,743  |  
|Savings accounts at 1.12% (2004) and 1.64% (2003)                              |  |      | 42,494,831  |   |      |   | 43,474,344  |  
|Money market demand accounts at 0.48% (2004) and 0.82% (2003)                  |  |      | 1,646,249   |   |      |   | 1,304,606   |  
|                                                                               |  |      |             |   |      |   |             |  
|                                                                               |  |      | 80,657,423  |   |      |   | 76,443,727  |  
|                                                                               |  |      |             |   |      |   |             |  
|Certificates of deposit weighted average rate of 2.55% (2004) and 3.13% (2003) |  |      |             |   |      |   |             |  
|Up to 6.00%                                                                    |  |      | 74,727,044  |   |      |   | 70,591,772  |  
|6.00% to 7.50%                                                                 |  |      | 1,708,880   |   |      |   | 2,190,565   |  
|                                                                               |  |      |             |   |      |   |             |  
|                                                                               |  |      | 76,435,924  |   |      |   | 72,782,337  |  
|                                                                               |  |      |             |   |      |   |             |  
|Accrued interest payable                                                       |  |      | 340,197     |   |      |   | 345,022     |  
|                                                                               |  |      |             |   |      |   |             |  
|                                                                               |  | $    | 157,433,544 |   |      | $ | 149,571,086 |  
|                                                                               |  |      |             |   |      |   |             |  
|Weighted average cost of savings deposits                                      |  |      | 1.62        | % |      |   | 2.09        | %
|                                                                               |  |      |             |   |      |   |             |  



At June 30, 2004, scheduled maturities
of certificates of deposit are as follows:



|               |  |      |            |      |   |           |  |      |           |       |   |         |  |   |         |  |   |           
|-------------- |  | ---- | ---------- | ---- | - | --------- |  | ---- | --------- | ----- | - | ------- |  | - | ------- |  | - | ----------
|               |  | 2005 |            | 2006 |   | 2007      |  | 2008 |           | After |   | Total  
|0.40% to 5.99% |  | $    | 63,646,541 |      | $ | 8,153,564 |  | $    | 1,689,994 |       | $ | 615,855 |  | $ | 621,090 |  | $ | 74,727,044
|6.00% to 7.50% |  |      | 204,936    |      |   | 1,503,944 |  |      |          |       |   |        |  |   |        |  |   | 1,708,880 
|               |  |      |            |      |   |           |  |      |           |       |   |         |  |   |         |  |   |           
|               |  | $    | 63,851,477 |      | $ | 9,657,508 |  | $    | 1,689,994 |       | $ | 615,855 |  | $ | 621,090 |  | $ | 76,435,924
|               |  |      |            |      |   |           |  |      |           |       |   |         |  |   |         |  |   |           



The aggregate amount of jumbo
certificates of deposit with a denomination of greater than $100,000 was $21,368,195 and $20,266,914 at June 30, 2004 and 2003, respectively. At June 30, 2004, scheduled maturities of jumbo certificates of deposit are as follows:



|                          |  |        |            |                       |      |  
|------------------------- |  | ------ | ---------- | --------------------- | ---- | -
|                          |  | Amount |            | Weighted Average Rate |     
|Maturity period:          |  |        |            |                       |      |  
|Within three months       |  | $      | 6,315,239  |                       | 2.49 | %
|Three through six months  |  |        | 5,299,181  |                       | 2.27 |  
|Six through twelve months |  |        | 6,361,048  |                       | 2.75 |  
|Over twelve months        |  |        | 3,392,727  |                       | 4.85 |  
|                          |  |        |            |                       |      |  
|                          |  | $      | 21,368,195 |                       | 2.89 | %
|                          |  |        |            |                       |      |  



Eligible savings accounts are insured
to $100,000 by the Savings Association Insurance Fund (SAIF) which is administered by the Federal Deposit Insurance Corporation (FDIC).



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 5. Savings Deposits, continued



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



|                                   |  |      |           |      |   |          
|---------------------------------- |  | ---- | --------- | ---- | - | ---------
|                                   |  | 2004 |           | 2003
|Interest-bearing checking accounts |  | $    | 122,264   |      | $ | 200,690  
|Savings accounts                   |  |      | 543,004   |      |   | 781,767  
|Certificate accounts               |  |      | 2,037,315 |      |   | 2,468,222
|                                   |  |      |           |      |   |          
|                                   |  | $    | 2,702,583 |      | $ | 3,450,679
|                                   |  |      |           |      |   |          



Note 6. Notes Payable and Federal
Home Loan Bank Advances



Notes payable consist of the following at June
30:



|                                                                                                                                                                                                                                                    |  |      |           |      |   |          
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---- | --------- | ---- | - | ---------
|                                                                                                                                                                                                                                                    |  | 2004 |           | 2003
|Note payable to AsheCo, M.H.C. at the FHLB overnight rate (1.70% at June 30, 2004).                                                                                                                                                                 |  | $    | 150,000   |      | $ |         
|Note payable, due in monthly installments of $7,808 including interest at the banks prime rate of 4.00% (4.25% at June 30, 2003) with a
balloon payment due November 6, 2005. Collateralized by insurance expirations and the right to renew them. |  |      | 347,806   |      |   | 440,296  
|Notes payable, unsecured, due in quarterly interest only installments at 5.50% through December 1, 2004, at which time repayments of principal
and interest will commence over a period of 60 months with first payment due on January 1, 2005.     |  |      | 700,000   |      |   | 700,000  
|                                                                                                                                                                                                                                                    |  |      |           |      |   |          
|                                                                                                                                                                                                                                                    |  | $    | 1,197,806 |      | $ | 1,140,296
|                                                                                                                                                                                                                                                    |  |      |           |      |   |          



FHLB advances consist of the
following:



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



As of June 30, 2004, the Company had a
$1,500,000 outstanding letter of credit from the FHLB used to collateralize public deposits.



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 6. Notes Payable and Federal Home Loan Bank Advances, continued



Notes payable are due in future years as follows:



|                     |  |        |           
|-------------------- |  | ------ | ----------
|Year ending June 30, |  | Amount
|2005                 |  | $      | 567,806   
|2006                 |  |        | 140,000   
|2007                 |  |        | 140,000   
|2008                 |  |        | 140,000   
|2009                 |  |        | 140,000   
|Thereafter           |  |        | 70,000    
|                     |  |        |           
|                     |  |        | $1,197,806
|                     |  |        |           



FHLB advances are due in future years
as follows:



|                     |  |        |            
|-------------------- |  | ------ | -----------
|Year Ending June 30, |  | Amount
|2005                 |  | $      | 5,000,000  
|2006                 |  |        |           
|2007                 |  |        | 5,143,754  
|2008                 |  |        |           
|2009                 |  |        | 2,000,000  
|Thereafter           |  |        | 21,000,000 
|                     |  |        |            
|                     |  |        | $33,143,754
|                     |  |        |            



Note 7. Capital Securities



On July 16, 2001, AF Capital Trust I (the Trust), a Delaware
business trust formed by the Company, completed the sale of $5.0 million of 10.25% Capital Securities (liquidation amount of $1,000 per security) (the Capital Securities) in a private placement as part of a pooled capital securities
transaction. The Trust also issued common securities to the Company and used the net proceeds from the offering to purchase a like amount of 10.25% Junior Subordinated Deferrable Interest Debentures (the Subordinated Debentures) of the
Company. The Subordinated Debentures are the sole assets of the Trust and are eliminated, along with the related income statement effects, in the consolidated financial statements of the Company. The Company has contributed $3.0 million of the
proceeds from the sale of the Subordinated Debentures to the Bank as Tier I Capital to support the Banks growth. Total expenses associated with the offering of $175,421 at June 30, 2004 were included in other assets and are being amortized on
a straight-line basis over the life of the Subordinated Debentures.



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



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



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 8. Stockholders Equity



The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to
meet minimum capital requirements can initiate certain mandatory  and possibly additional discretionary  actions by regulators that, if undertaken, could have a direct material effect on the Company and the Banks financial
statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative regulatory accounting practices. The Company and the
Banks capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Prompt corrective action provisions are not applicable to bank holding companies.



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



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



The Office of Thrift Supervision
(OTS) regulations require institutions to maintain amounts and ratios of total and Tier 1 capital to risk-weighted assets and Tier 1 capital to average assets. At June 30, 2004 and 2003, the Company and the Bank exceeded all of the capital
requirements.



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 8. Stockholders Equity, continued



As of June 30, 2004, the most recent notification from the OTS categorized the Bank as well capitalized under the regulatory framework for
prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the following tables. There are no conditions or events since that
notification that management believes have changed the Banks category.



|                                        |  |                        |        |       |                             |   |        |                                                                      |        |  |     |        |  |       |        |  |      |  
|--------------------------------------- |  | ---------------------- | ------ | ----- | --------------------------- | - | ------ | -------------------------------------------------------------------- | ------ |  | --- | ------ |  | ----- | ------ |  | ---- | -
|                                        |  | Actual                 |        |       | Minimum Capital Requirement |   |        | Minimumto be wellCapitalized UnderPrompt CorrectiveAction Provisions |       
|                                        |  | Amount                 |        | Ratio |                             |   | Amount |                                                                      | Ratio  |  |     | Amount |  | Ratio |       
|                                        |  | (Dollars in Thousands) |       
|June 30, 2004:                          |  |                        |        |       |                             |   |        |                                                                      |        |  |     |        |  |       |        |  |      |  
|Total Capital to Risk Weighted Assets:  |  |                        |        |       |                             |   |        |                                                                      |        |  |     |        |  |       |        |  |      |  
|Consolidated                            |  | $                      | 17,071 |       | 10.2                        | % |        | $                                                                    | 13,626 |  | 8.0 | %      |  | $     |       |  |     | %
|Bank                                    |  | $                      | 18,257 |       | 10.9                        | % |        | $                                                                    | 13,407 |  | 8.0 | %      |  | $     | 16,759 |  | 10.0 | %
|Tier 1 Capital to Risk Weighted Assets: |  |                        |        |       |                             |   |        |                                                                      |        |  |     |        |  |       |        |  |      |  
|Consolidated                            |  | $                      | 13,485 |       | 8.0                         | % |        | $                                                                    | 6,813  |  | 4.0 | %      |  | $     |       |  |     | %
|Bank                                    |  | $                      | 16,974 |       | 10.1                        | % |        | $                                                                    | 6,703  |  | 4.0 | %      |  | $     | 10,055 |  | 6.0  | %
|Tier 1 Capital to Average Assets:       |  |                        |        |       |                             |   |        |                                                                      |        |  |     |        |  |       |        |  |      |  
|Consolidated                            |  | $                      | 13,485 |       | 6.8                         | % |        | $                                                                    | 7,977  |  | 4.0 | %      |  | $     |       |  |     | %
|Bank                                    |  | $                      | 16,974 |       | 8.6                         | % |        | $                                                                    | 7,893  |  | 4.0 | %      |  | $     | 9,866  |  | 5.0  | %
|June 30, 2003:                          |  |                        |        |       |                             |   |        |                                                                      |        |  |     |        |  |       |        |  |      |  
|Total Capital to Risk Weighted Assets:  |  |                        |        |       |                             |   |        |                                                                      |        |  |     |        |  |       |        |  |      |  
|Consolidated                            |  | $                      | 17,445 |       | 12.4                        | % |        | $                                                                    | 11,259 |  | 8.0 | %      |  | $     |       |  |     | %
|Bank                                    |  | $                      | 18,015 |       | 12.9                        | % |        | $                                                                    | 11,177 |  | 8.0 | %      |  | $     | 13,971 |  | 10.0 | %
|Tier 1 Capital to Risk Weighted Assets: |  |                        |        |       |                             |   |        |                                                                      |        |  |     |        |  |       |        |  |      |  
|Consolidated                            |  | $                      | 14,131 |       | 10.0                        | % |        | $                                                                    | 5,630  |  | 4.0 | %      |  | $     |       |  |     | %
|Bank                                    |  | $                      | 16,875 |       | 12.1                        | % |        | $                                                                    | 5,588  |  | 4.0 | %      |  | $     | 8,382  |  | 6.0  | %
|Tier 1 Capital to Average Assets:       |  |                        |        |       |                             |   |        |                                                                      |        |  |     |        |  |       |        |  |      |  
|Consolidated                            |  | $                      | 14,131 |       | 7.6                         | % |        | $                                                                    | 7,445  |  | 4.0 | %      |  | $     |       |  |     | %
|Bank                                    |  | $                      | 16,876 |       | 9.2                         | % |        | $                                                                    | 7,340  |  | 4.0 | %      |  | $     | 9,175  |  | 5.0  | %



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



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 9. Employee Pension and Incentive Plans



The Company has profit-sharing plans for the benefit of substantially all employees. Contributions are discretionary and totaled $4,395 and
$61,908 for the years ended June 30, 2004 and 2003, respectively.



In addition,
the Company has 401(k) retirement plans which contain provisions for specified matching contributions by the Company. The Company funds contributions as they accrue and 401(k) plan expense amounted to $104,138 and $89,690 for the years ended June
30, 2004 and 2003, respectively.



Note 10. Employee Stock Ownership Plan



As part of the reorganization, the Company established an ESOP to benefit
substantially all employees. The ESOP purchased 36,942 shares of common stock with the proceeds from a loan from a third party financial institution. The note requires annual principal payments of $28,845 plus quarterly interest at the lending
institutions prime rate (4.25% at June 30, 2004). The Company is expected to make quarterly contributions to the ESOP in amounts sufficient to allow the ESOP to make its scheduled principal and interest payments on the note. The ESOP shares
are pledged as collateral for the debt. As the debt is repaid, shares are released from collateral and allocated to active employees, based on proportion of debt service paid in the year. The debt of the ESOP is recorded as debt in the
Companys accompanying statement of financial condition.



At June 30,
2004, future principal payments are due as follows:



|                     |  |        |       
|-------------------- |  | ------ | ------
|Year Ending June 30: |  | Amount
|2005                 |  | $      | 28,845
|2006                 |  |        | 28,845
|2007                 |  |        | 12,730



Excluding interest, expense of $71,400
and $53,676 during 2004 and 2003, respectively, has been incurred in connection with the ESOP. The expense includes, in addition to the cash contribution necessary to fund the ESOP, $34,363 in 2004 and $16,640 in 2003, which represents the
difference between the fair value of the shares which have been released or committed to be released to participants, and the cost of these shares to the ESOP. The Company has charged this amount to paid-in capital in accordance with the provisions
of AICPA Statement of Position 93-6.



At June 30, 2004 and 2003, 29,900 and
26,200 shares, respectively, held by the ESOP have been released or committed to be released to the plans participants for purposes of computing earnings per share. The fair value of the unallocated shares amounted to approximately $116,200
and $171,900 at June 30, 2004 and 2003, respectively.



The Bank has also
recorded, through a reduction in retained earnings, a liability for a put back option, which represents the excess of the fair market value of the total number of ESOP shares over the original cost of the unallocated ESOP shares. The liability
recorded under the put back option was $534,750 and $479,412 at June 30, 2004 and 2003, respectively.



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 11. Deferred Compensation and Retirement Plan Agreements



The Bank has an unfunded deferred compensation agreement providing retirement, disability,
and death benefits for directors. Vested benefits under the agreements are payable in monthly installments over a ten-year period upon the directors death, disability or retirement. The Bank also has a retirement plan for members of the Board
of Directors. The Plan states that outside directors with at least ten years of service will receive an amount equal to their annual retainer for ten years after their retirement from the Board. The liability for the benefits is being accrued over
the terms of active service of the directors. The amount charged to expense under these plans amounted to $54,880 and $53,569 for the years ended June 30, 2004 and 2003, respectively.



The Company has entered into a salary continuation agreement with its executive officer. Under this agreement, the executive will be paid
monthly amounts of $5,532, after retirement for a period of forty-three years. This agreement also provides for benefits upon death, disability, a change of control and early retirement. AF Financial Group maintained a similar agreement for its
former CEO, who was terminated for cause on July 8, 2004. Management does not believe there is any liability associated with this agreement.



Note 12. Stock Option Plan



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



At June 30, 2004, 21,707 options have been granted at an
exercise price of $18.50, of which 21,707 options are fully vested and therefore currently exercisable. No options have been exercised to date and all options granted are outstanding at June 30, 2004.



Note 13. Income Tax Matters



Under the Internal Revenue Code, the Bank is allowed a special bad debt deduction related to
additions to tax bad debt reserves established for the purpose of absorbing losses. The Bank is required to compute such deductions using an experience method. The Banks tax bad debt deduction was $533,665 and $263,248 in 2004 and 2003,
respectively.



Deferred taxes have been provided for certain increases in the
Banks tax bad debt reserves subsequent to 1987 which are in excess of additions to recorded loan loss allowances. At June 30, 2004, retained earnings contain certain historical additions to bad debt reserves for income tax purposes of
approximately $870,000, the balance at June 30, 1987, for which no deferred taxes have been provided because the Bank does not intend to use these reserves for purposes other than to absorb losses. If amounts which qualified as bad debt deductions
are used for purposes other than to absorb bad debt losses or adjustments arising from the carryback of net operating losses, income taxes may be imposed at the then existing rates. The approximate amount of unrecorded deferred tax liability
associated with these historical additions is approximately $340,000. In the future, if the Bank does not meet the income tax requirements necessary to permit the deduction of an allowance for bad debts, the Banks effective tax rate would
increase to the maximum percent under existing law.



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 13. Income Tax Matters, continued



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



|                                                 |  |      |         |   |      |   |         |  
|------------------------------------------------ |  | ---- | ------- | - | ---- | - | ------- | -
|                                                 |  | 2004 |         |   | 2003 |  
|Deferred tax assets                              |  |      |         |   |      |   |         |  
|Reserve for loan losses                          |  | $    | 479,955 |   |      | $ | 428,213 |  
|Reserve for uncollected interest                 |  |      | 1,364   |   |      |   | 3,321   |  
|Deferred compensation                            |  |      | 358,143 |   |      |   | 299,515 |  
|Deferred loan fees                               |  |      | 85,872  |   |      |   | 81,789  |  
|Other                                            |  |      | 41,204  |   |      |   | 2,085   |  
|State net economic loss carryforwards            |  |      | 22,670  |   |      |   | 25,400  |  
|                                                 |  |      |         |   |      |   |         |  
|                                                 |  |      | 989,208 |   |      |   | 840,323 |  
|Less valuation allowance                         |  |      | (22,670 | ) |      |   | (16,236 | )
|                                                 |  |      |         |   |      |   |         |  
|                                                 |  |      | 966,538 |   |      |   | 824,087 |  
|                                                 |  |      |         |   |      |   |         |  
|Deferred tax liabilities                         |  |      |         |   |      |   |         |  
|Unrealized gain on securities available for sale |  |      | 6,675   |   |      |   | 37,736  |  
|Depreciation                                     |  |      | 157,670 |   |      |   | 75,714  |  
|FHLB stock dividends                             |  |      | 60,061  |   |      |   | 60,067  |  
|Prepaid expenses                                 |  |      | 86,172  |   |      |   |        |  
|Deferred loan fees                               |  |      | 375,383 |   |      |   | 301,347 |  
|                                                 |  |      |         |   |      |   |         |  
|                                                 |  |      | 685,961 |   |      |   | 474,864 |  
|                                                 |  |      |         |   |      |   |         |  
|Net deferred tax asset                           |  | $    | 280,577 |   |      | $ | 349,223 |  
|                                                 |  |      |         |   |      |   |         |  



During the year ended June 30, 2004,
the Company recorded a valuation allowance of $6,434 on the deferred tax assets to reduce the total to an amount that management believes will ultimately be realized. Realization of deferred tax assets is dependent upon sufficient future taxable
income during the period that deductible temporary differences and carryforwards are expected to be available to reduce taxable income. There was no other activity in the valuation allowance account during 2004 or 2003.



The provision for income taxes charged to operations for the years ended June 30, 2004 and
2003 consists of the following:



|                             |  |      |          |   |      |   |        
|---------------------------- |  | ---- | -------- | - | ---- | - | -------
|                             |  | 2004 |          |   | 2003
|Current                      |  | $    | (222,422 | ) |      | $ | 145,326
|Deferred                     |  |      | 99,707   |   |      |   | 110,796
|                             |  |      |          |   |      |   |        
|Income tax expense (benefit) |  | $    | (122,715 | ) |      | $ | 256,122
|                             |  |      |          |   |      |   |        



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 13. Income Tax Matters, continued



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



|                                  |  |        |          |   |         |       |    |        |   |         |         |  |      |  
|--------------------------------- |  | ------ | -------- | - | ------- | ----- | -- | ------ | - | ------- | ------- |  | ---- | -
|                                  |  | 2004   |          |   | 2003    |      
|                                  |  | Amount |          |   | Percent |       |    | Amount |   |         | Percent | 
|Tax at statutory rate             |  | $      | (146,530 | ) |         | (34.0 | )% |        | $ | 214,739 |         |  | 34.0 | %
|State tax, net of federal benefit |  |        | 25,332   |   |         | 5.9   |    |        |   | 50,326  |         |  | 8.0  |  
|Municipal interest income         |  |        | (18,411  | ) |         | (4.4  | )  |        |   | (34,988 | )       |  | (5.5 | )
|Permanent differences             |  |        | 12,715   |   |         | 3.0   |    |        |   | 27,373  |         |  | 4.2  |  
|Other                             |  |        | 4,179    |   |         | 1.0   |    |        |   | (1,328  | )       |  | (0.1 | )
|                                  |  |        |          |   |         |       |    |        |   |         |         |  |      |  
|Total                             |  | $      | (122,715 | ) |         | (28.5 | )% |        | $ | 256,122 |         |  | 40.6 | %
|                                  |  |        |          |   |         |       |    |        |   |         |         |  |      |  



Note 14. Other Noninterest Income
and Expense



The major components of other noninterest income for the
years ended June 30, 2004 and 2003 are as follows:



|                                        |  |      |           |      |   |          
|--------------------------------------- |  | ---- | --------- | ---- | - | ---------
|                                        |  | 2004 |           | 2003
|Service charges on deposit accounts     |  | $    | 558,192   |      | $ | 475,783  
|Cardholder and merchant services income |  |      | 244,557   |      |   | 205,689  
|Brokerage fees and commissions          |  |      | 177,173   |      |   | 223,373  
|Mortgage income                         |  |      | 175,477   |      |   | 136,408  
|Other                                   |  |      | 360,577   |      |   | 137,426  
|                                        |  |      |           |      |   |          
|Total                                   |  | $    | 1,515,976 |      | $ | 1,178,679
|                                        |  |      |           |      |   |          



The major components of other
noninterest expense for the years ended June 30, 2004 and 2003 are as follows:



|                                          |  |      |           |      |   |          
|----------------------------------------- |  | ---- | --------- | ---- | - | ---------
|                                          |  | 2004 |           | 2003
|Cleaning, postage and office supplies     |  | $    | 340,151   |      | $ | 354,264  
|Advertising and promotion                 |  |      | 171,690   |      |   | 159,837  
|Travel, meals, dues and subscriptions     |  |      | 244,348   |      |   | 215,584  
|Telephone and utilities                   |  |      | 247,579   |      |   | 233,645  
|Training                                  |  |      | 116,132   |      |   | 171,247  
|Fees and charges                          |  |      | 216,045   |      |   | 177,305  
|Professional fees and contracted services |  |      | 561,298   |      |   | 308,380  
|Other                                     |  |      | 632,299   |      |   | 486,029  
|                                          |  |      |           |      |   |          
|Total                                     |  | $    | 2,529,542 |      | $ | 2,106,291
|                                          |  |      |           |      |   |          



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 15. Commitments and Contingencies



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



A summary of the contract amount of the Banks exposure to off-statement of financial
condition risk, except for undisbursed construction loan funds, is as follows at June 30, 2004:



|                                                                    |  |                |          
|------------------------------------------------------------------- |  | -------------- | ---------
|                                                                    |  | NotionalAmount
|Financial instruments whose contract amounts represent credit risk: |  |                |          
|Undisbursed home equity lines of credit                             |  | $              | 9,104,651
|Undisbursed consumer lines of credit                                |  |                | 3,875,508
|Undisbursed commercial lines of credit                              |  |                | 4,512,900
|Letters of credit                                                   |  |                | 473,800  
|Commitments outstanding to originate loans                          |  |                | 1,031,045



The Bank evaluates each
customers credit worthiness on a case-by-case basis. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Home equity lines of credit have variable
rates based on the prime rate of interest. Home equity lines are reassessed every five years. Because many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash
requirements. The collateral obtained by the Bank upon extension of credit is based on managements credit evaluation of the customer. The collateral held is the underlying real estate. Commercial lines of credit have variable rates tied to
prime and are reassessed on an annual basis. Prime at June 30, 2004 was 4.00%.



The Company has entered into operating leases for AF Bank branch locations in Warrensville, Sparta and Boone, North Carolina, and also a branch inside Wal-Mart in West Jefferson, North Carolina, and for AF Insurance branches located in
Boone, Elkin and Wilkesboro, North Carolina. These leases generally contain renewal options for periods ranging from two to five years and require the Company to pay all executory costs such as maintenance and insurance. Rental expense for operating
leases was $167,044 and $158,259 during 2004 and 2003.



Future minimum lease
payments under noncancelable operating leases as of June 30, 2004 are:



|                             |  |   |        
|---------------------------- |  | - | -------
|Year Ending June 30:         |  |   |        
|2005                         |  | $ | 128,270
|2006                         |  |   | 67,545 
|2007                         |  |   | 61,920 
|2008                         |  |   | 28,980 
|2009                         |  |   | 18,000 
|After 2009                   |  |   | 42,000 
|                             |  |   |        
|Total minimum lease payments |  | $ | 346,715
|                             |  |   |        



The Company has executed a contract
with a general contractor to construct the Financial Center in Boone, North Carolina at a cost of approximately $5.4 million. The Company expects the construction project to be completed in October 2004.



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 16. Dividends Declared



On June 25, 2004, the Board of Directors of the Company declared a dividend of $0.05 a share for stockholders of record as of July 2, 2004
and payable on July 16, 2004. The dividends declared were accrued and reported in accounts payable and other liabilities in the June 30, 2004 Consolidated Statement of Financial Condition. AsheCo, MHC elected to waive the receipt of dividends
declared during the quarters ended September 30, 2003, December 31, 2003 and March 31, 2004.



Note 17. Fair Value of Financial Instruments



The following table reflects a comparison of carrying amounts and the fair values of the financial instruments as of June 30, 2004 and 2003:



|                             |  |                |             |            |   |                |  |            |             |  |   |            
|---------------------------- |  | -------------- | ----------- | ---------- | - | -------------- |  | ---------- | ----------- |  | - | -----------
|                             |  | 2004           |             | 2003      
|                             |  | Carrying Value |             | Fair Value |   | Carrying Value |  | Fair Value
|Financial assets:            |  |                |             |            |   |                |  |            |             |  |   |            
|Cash                         |  |                |             |            |   |                |  |            |             |  |   |            
|Interest-bearing             |  | $              | 2,498,878   |            | $ | 2,498,878      |  | $          | 6,151,744   |  | $ | 6,151,744  
|Noninterest-bearing deposits |  |                | 5,175,174   |            |   | 5,175,174      |  |            | 7,920,274   |  |   | 7,920,274  
|Investments                  |  |                | 4,844,066   |            |   | 4,844,066      |  |            | 7,696,814   |  |   | 7,696,814  
|Loans receivable, net        |  |                | 181,489,159 |            |   | 178,972,982    |  |            | 156,257,890 |  |   | 159,837,247
|Accrued interest receivable  |  |                | 921,810     |            |   | 921,810        |  |            | 865,508     |  |   | 865,508    
|FHLB stock                   |  |                | 1,657,200   |            |   | 1,657,200      |  |            | 1,057,300   |  |   | 1,057,300  
|Financial liabilities:       |  |                |             |            |   |                |  |            |             |  |   |            
|Deposits                     |  |                | 157,433,544 |            |   | 156,375,461    |  |            | 149,571,086 |  |   | 149,035,141
|Advances from FHLB           |  |                | 33,143,754  |            |   | 33,143,754     |  |            | 21,145,669  |  |   | 21,145,669 
|Notes payable                |  |                | 6,197,806   |            |   | 6,197,806      |  |            | 6,140,296   |  |   | 6,140,296  
|Notes payable, ESOP          |  |                | 70,420      |            |   | 70,420         |  |            | 107,420     |  |   | 107,420    



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



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



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



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



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



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



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



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 17. Fair Value of Financial Instruments, continued



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



Advances from FHLB,
Notes payable and Note payable, ESOP: The fair value of the advances from FHLB, notes payable and note payable, ESOP is approximately equal to the carrying value of the liability.



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



Note 18. Mid-Tier Holding Company and Mutual Holding Company Data



The following are the condensed financial statements of AF Financial Group as of and for the
years ended June 30, 2004 and 2003:



AF Financial Group

Condensed Balance Sheets

June 30, 2004 and 2003



|                                                                      |  |      |            |   |      |   |            |  
|--------------------------------------------------------------------- |  | ---- | ---------- | - | ---- | - | ---------- | -
|                                                                      |  | 2004 |            |   | 2003 |  
|Assets                                                                |  |      |            |   |      |   |            |  
|Non interest-bearing deposits                                         |  | $    | 8,241      |   |      | $ | 274,235    |  
|Investment in AF Bank                                                 |  |      | 16,983,827 |   |      |   | 16,933,036 |  
|Investment in AF Insurance Services, Inc.                             |  |      | 738,911    |   |      |   | 763,815    |  
|Investment in AF Brokerage, Inc.                                      |  |      | 227,894    |   |      |   | 273,793    |  
|Investment in AF Capital Trust 1                                      |  |      | 155,000    |   |      |   | 155,000    |  
|Property and equipment, net                                           |  |      | 14,688     |   |      |   | 27,009     |  
|Prepaid financing costs, net                                          |  |      | 175,421    |   |      |   | 181,898    |  
|Other assets                                                          |  |      | 366,601    |   |      |   | 369,964    |  
|                                                                      |  |      |            |   |      |   |            |  
|Total assets                                                          |  | $    | 18,670,583 |   |      | $ | 18,978,750 |  
|                                                                      |  |      |            |   |      |   |            |  
|Liabilities and Stockholders Equity                                  |  |      |            |   |      |   |            |  
|Liabilities                                                           |  |      |            |   |      |   |            |  
|Accounts payable                                                      |  | $    | 280,476    |   |      | $ | 270,693    |  
|Note payable                                                          |  |      | 150,000    |   |      |   |           |  
|Note payable  ESOP                                                   |  |      | 70,420     |   |      |   | 107,420    |  
|Deferred income taxes                                                 |  |      | 5,941      |   |      |   | 5,941      |  
|Redeemable common stock held by the ESOP, net of unearned ESOP shares |  |      | 534,750    |   |      |   | 479,412    |  
|Junior subordinated debentures                                        |  |      | 5,155,000  |   |      |   | 5,155,000  |  
|                                                                      |  |      |            |   |      |   |            |  
|Total liabilities                                                     |  |      | 6,196,587  |   |      |   | 6,018,466  |  
|                                                                      |  |      |            |   |      |   |            |  
|Stockholders equity                                                   |  |      |            |   |      |   |            |  
|Common stock                                                          |  |      | 10,537     |   |      |   | 10,537     |  
|Additional paid-in capital                                            |  |      | 11,933,628 |   |      |   | 11,899,264 |  
|Retained earnings                                                     |  |      | 594,322    |   |      |   | 1,066,626  |  
|Accumulated other comprehensive income                                |  |      | 10,389     |   |      |   | 58,737     |  
|                                                                      |  |      |            |   |      |   |            |  
|                                                                      |  |      | 12,548,876 |   |      |   | 13,035,164 |  
|Less cost of 3,840 shares of treasury stock                           |  |      | (74,880    | ) |      |   | (74,880    | )
|                                                                      |  |      |            |   |      |   |            |  
|Total stockholders equity                                            |  |      | 12,473,996 |   |      |   | 12,960,284 |  
|                                                                      |  |      |            |   |      |   |            |  
|Total liabilities and stockholders equity                            |  | $    | 18,670,583 |   |      | $ | 18,978,750 |  
|                                                                      |  |      |            |   |      |   |            |  



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 18. Mid-Tier Holding Company and Mutual Holding Company Data, continued



AF Financial Group

Condensed Statements of Income (Loss)

Years ended June 30, 2004 and 2003



|                                   |  |      |          |   |      |   |          |  
|---------------------------------- |  | ---- | -------- | - | ---- | - | -------- | -
|                                   |  | 2004 |          |   | 2003 |  
|Interest and investment income     |  | $    |         |   |      | $ | 15,696   |  
|Equity in earnings of subsidiaries |  |      | 328,335  |   |      |   | 999,812  |  
|Income tax credit                  |  |      | 329,091  |   |      |   | 321,474  |  
|Professional fees                  |  |      | (311,555 | ) |      |   | (234,327 | )
|Interest expense                   |  |      | (514,596 | ) |      |   | (512,786 | )
|Other expense                      |  |      | (139,529 | ) |      |   | (214,405 | )
|                                   |  |      |          |   |      |   |          |  
|Net income (loss)                  |  | $    | (308,254 | ) |      | $ | 375,464  |  
|                                   |  |      |          |   |      |   |          |  



AF Financial Group

Condensed Statements of Cash Flows

Years ended June 30, 2004 and 2003



|                                                              |  |      |          |   |      |   |           |  
|------------------------------------------------------------- |  | ---- | -------- | - | ---- | - | --------- | -
|                                                              |  | 2004 |          |   | 2003 |  
|Cash Flows from Operating Activities:                         |  |      |          |   |      |   |           |  
|Net income (loss)                                             |  | $    | (308,254 | ) |      | $ | 375,464   |  
|ESOP expense                                                  |  |      | 71,400   |   |      |   | 53,676    |  
|Deferred income taxes                                         |  |      |         |   |      |   | 896       |  
|Amortization of premium on investments                        |  |      |         |   |      |   | 12,409    |  
|Gain on sale on investments available for sale                |  |      |         |   |      |   | (4,487    | )
|Depreciation and amortization                                 |  |      | 18,798   |   |      |   | 19,169    |  
|Change in assets and liabilities:                             |  |      |          |   |      |   |           |  
|Equity in earnings of subsidiaries                            |  |      | (328,336 | ) |      |   | (999,812  | )
|Decrease in other assets                                      |  |      | 3,363    |   |      |   | 72,759    |  
|Increase (decrease) in accounts payable and other liabilities |  |      | 9,783    |   |      |   | (273,035  | )
|                                                              |  |      |          |   |      |   |           |  
|Net cash used in operating activities                         |  |      | (533,246 | ) |      |   | (742,961  | )
|                                                              |  |      |          |   |      |   |           |  
|Cash Flows from Investing Activities:                         |  |      |          |   |      |   |           |  
|Proceeds from sale of securities available for sale           |  |      |         |   |      |   | 504,487   |  
|Proceeds from sale of properties and equipment                |  |      |         |   |      |   | 1,784     |  
|Capitalization of AF Brokerage, Inc.                          |  |      | (50,000  | ) |      |   |          |  
|Capitalization of AF Insurance Services, Inc.                 |  |      |         |   |      |   | 225,000   |  
|Capitalization of AF Bank                                     |  |      | 350,000  |   |      |   | 600,000   |  
|                                                              |  |      |          |   |      |   |           |  
|Net cash provided by investing activities                     |  |      | 300,000  |   |      |   | 1,331,271 |  
|                                                              |  |      |          |   |      |   |           |  
|Cash Flows from Financing Activities:                         |  |      |          |   |      |   |           |  
|Proceeds from note payable                                    |  |      | 150,000  |   |      |   |          |  
|Principal payments on notes payable                           |  |      | (37,000  | ) |      |   | (126,823  | )
|Cash dividends paid                                           |  |      | (145,748 | ) |      |   | (178,874  | )
|                                                              |  |      |          |   |      |   |           |  
|Net cash used in financing activities                         |  |      | (32,748  | ) |      |   | (305,697  | )
|                                                              |  |      |          |   |      |   |           |  
|Net increase (decrease) in cash                               |  |      | (265,994 | ) |      |   | 282,613   |  
|Cash, beginning                                               |  |      | 274,235  |   |      |   | (8,378    | )
|                                                              |  |      |          |   |      |   |           |  
|Cash, ending                                                  |  | $    | 8,241    |   |      | $ | 274,235   |  
|                                                              |  |      |          |   |      |   |           |  



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 18. Mid-Tier Holding Company and Mutual Holding Company Data, continued



The following are the condensed financial statements of the mutual holding company, AsheCo,
M.H.C., as of and for the years ended June 30, 2004 and 2003:



AsheCo, M.H.C.

Condensed Balance Sheets

June 30, 2004 and 2003



|                                       |  |      |           |      |   |          
|-------------------------------------- |  | ---- | --------- | ---- | - | ---------
|                                       |  | 2004 |           | 2003
|Assets                                 |  |      |           |      |   |          
|Interest-bearing deposits              |  | $    | 163,390   |      | $ | 307,356  
|Investment in AA&G, Inc.               |  |      | 261,304   |      |   | 220,684  
|Investment in AF Financial Group       |  |      | 6,395,418 |      |   | 6,644,736
|Other assets                           |  |      | 233,242   |      |   | 146,916  
|                                       |  |      |           |      |   |          
|                                       |  | $    | 7,053,354 |      | $ | 7,319,692
|                                       |  |      |           |      |   |          
|Liabilities and Stockholders Equity   |  |      |           |      |   |          
|Liabilities                            |  |      |           |      |   |          
|Accounts payable and other liabilities |  | $    | 10,020    |      | $ | 3,000    
|                                       |  |      |           |      |   |          
|Stockholders equity                   |  |      |           |      |   |          
|Additional paid-in capital             |  |      | 5,753,979 |      |   | 5,845,255
|Retained earnings                      |  |      | 1,289,355 |      |   | 1,471,437
|                                       |  |      |           |      |   |          
|                                       |  |      | 7,043,334 |      |   | 7,316,692
|                                       |  |      |           |      |   |          
|                                       |  | $    | 7,053,354 |      | $ | 7,319,692
|                                       |  |      |           |      |   |          



AsheCo, M.H.C.

Condensed Statements of Income (Loss)

Years ended June 30, 2004 and 2003



|                                          |  |      |          |   |      |   |         |  
|----------------------------------------- |  | ---- | -------- | - | ---- | - | ------- | -
|                                          |  | 2004 |          |   | 2003 |  
|Interest income                           |  | $    | 2,424    |   |      | $ | 3,355   |  
|Equity in earnings (loss) of subsidiaries |  |      | (117,422 | ) |      |   | 242,853 |  
|Other expense                             |  |      | (67,083  | ) |      |   | (75,609 | )
|                                          |  |      |          |   |      |   |         |  
|Net income (loss)                         |  | $    | (182,081 | ) |      | $ | 170,599 |  
|                                          |  |      |          |   |      |   |         |  



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 18. Mid-Tier Holding Company and Mutual Holding Company Data, continued



AsheCo, M.H.C.

Condensed Statements of Cash Flows

Years ended June 30, 2004 and 2003



|                                                 |  |      |          |   |      |   |          |  
|------------------------------------------------ |  | ---- | -------- | - | ---- | - | -------- | -
|                                                 |  | 2004 |          |   | 2003 |  
|Cash Flows from Operating Activities:            |  |      |          |   |      |   |          |  
|Net income (loss)                                |  | $    | (182,081 | ) |      | $ | 170,599  |  
|Equity in earnings (loss) of subsidiaries        |  |      | 117,422  |   |      |   | (242,853 | )
|Change in assets and liabilities:                |  |      |          |   |      |   |          |  
|(Increase) decrease in other assets              |  |      | (86,327  | ) |      |   | 104,418  |  
|Increase in accounts payable                     |  |      | 7,020    |   |      |   | 2,000    |  
|                                                 |  |      |          |   |      |   |          |  
|Net cash provided (used) in operating activities |  |      | (143,966 | ) |      |   | 34,164   |  
|Cash Flows from Investing Activities:            |  |      |          |   |      |   |          |  
|Dividends from AF Financial Group                |  |      |         |   |      |   | 80,733   |  
|                                                 |  |      |          |   |      |   |          |  
|Net increase (decrease) in cash                  |  |      | (143,966 | ) |      |   | 114,897  |  
|Cash, beginning                                  |  |      | 307,356  |   |      |   | 192,459  |  
|                                                 |  |      |          |   |      |   |          |  
|Cash, ending                                     |  | $    | 163,390  |   |      | $ | 307,356  |  
|                                                 |  |      |          |   |      |   |          |  



Note 19. Segment Reporting



The Company has additional reportable segments: AF Bank, AF Insurance
Services, Inc. and AF Brokerage, Inc. AF Bank is a federally chartered stock savings bank. The principal activities of the Bank consist of obtaining savings deposits and providing credit to customers in its primary market area. AF Insurance
Services, Inc. and AF Brokerage, Inc. provide insurance and non-FDIC insured investment services respectively. Information about reportable segments, and reconciliation of such information to the consolidated financial statements as of and for the
year ended June 30, 2004 and June 30, 2003 is as follows (dollars in thousands):



|                                    |  |                  |      |   |         |   |                           |  |   |                 |   |  |                          |      |   |                    |   |      |   |  |   |         |  
|----------------------------------- |  | ---------------- | ---- | - | ------- | - | ------------------------- |  | - | --------------- | - |  | ------------------------ | ---- | - | ------------------ | - | ---- | - |  | - | ------- | -
|June 30, 2004                       |  | AFFinancialGroup |      |   | AF Bank |   | AFInsuranceServices, Inc. |  |   | AFBrokerageInc. |   |  | Inter-segmentElimination |      |   | ConsolidatedTotals |  
|Interest income                     |  | $                |     |   |         | $ | 10,691                    |  | $ |                |   |  | $                        |     |   |                    | $ | (8   | ) |  | $ | 10,683  |  
|Interest expense                    |  |                  | 514  |   |         |   | 3,835                     |  |   | 63              |   |  |                          |      |   |                    |   | (8   | ) |  |   | 4,404   |  
|                                    |  |                  |      |   |         |   |                           |  |   |                 |   |  |                          |      |   |                    |   |      |   |  |   |         |  
|Net interest income                 |  |                  | (514 | ) |         |   | 6,856                     |  |   | (63             | ) |  |                          |     |   |                    |   |     |   |  |   | 6,279   |  
|Provision for loan losses           |  |                  |     |   |         |   | 668                       |  |   |                |   |  |                          |     |   |                    |   |     |   |  |   | 668     |  
|                                    |  |                  |      |   |         |   |                           |  |   |                 |   |  |                          |      |   |                    |   |      |   |  |   |         |  
|Net interest income after provision |  |                  | (514 | ) |         |   | 6,188                     |  |   | (63             | ) |  |                          |     |   |                    |   |     |   |  |   | 5,611   |  
|Non-interest income                 |  |                  |     |   |         |   | 1,590                     |  |   | 2,433           |   |  |                          | 177  |   |                    |   | (309 | ) |  |   | 3,891   |  
|Non-interest expense                |  |                  | 452  |   |         |   | 7,077                     |  |   | 2,392           |   |  |                          | 321  |   |                    |   | (309 | ) |  |   | 9,933   |  
|                                    |  |                  |      |   |         |   |                           |  |   |                 |   |  |                          |      |   |                    |   |      |   |  |   |         |  
|Income (loss) before income taxes   |  |                  | (966 | ) |         |   | 701                       |  |   | (22             | ) |  |                          | (144 | ) |                    |   |     |   |  |   | (431    | )
|Income taxes                        |  |                  | (329 | ) |         |   | 251                       |  |   | 3               |   |  |                          | (48  | ) |                    |   |     |   |  |   | (123    | )
|                                    |  |                  |      |   |         |   |                           |  |   |                 |   |  |                          |      |   |                    |   |      |   |  |   |         |  
|Net income (loss)                   |  | $                | (637 | ) |         | $ | 450                       |  | $ | (25             | ) |  | $                        | (96  | ) |                    | $ |     |   |  | $ | (308    | )
|                                    |  |                  |      |   |         |   |                           |  |   |                 |   |  |                          |      |   |                    |   |      |   |  |   |         |  
|Assets                              |  | $                | 230  |   |         | $ | 209,228                   |  | $ | 2,302           |   |  | $                        | 193  |   |                    | $ | (334 | ) |  | $ | 211,619 |  
|                                    |  |                  |      |   |         |   |                           |  |   |                 |   |  |                          |      |   |                    |   |      |   |  |   |         |  



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##### Table of Contents

Notes to Consolidated Financial Statements



Note 19. Segment Reporting, continued



|                                    |  |                    |      |   |         |   |                          |  |   |                 |   |  |                          |     |   |                    |   |      |   |  |   |        
|----------------------------------- |  | ------------------ | ---- | - | ------- | - | ------------------------ |  | - | --------------- | - |  | ------------------------ | --- | - | ------------------ | - | ---- | - |  | - | -------
|June 30, 2003                       |  | AF Financial Group |      |   | AF Bank |   | AFInsuranceServices,Inc. |  |   | AFBrokerageInc. |   |  | Inter-segmentElimination |     |   | ConsolidatedTotals
|Interest income                     |  | $                  | 11   |   |         | $ | 11,006                   |  | $ |                |   |  | $                        | 2   |   |                    | $ | (8   | ) |  | $ | 11,011 
|Interest expense                    |  |                    | 512  |   |         |   | 4,513                    |  |   | 68              |   |  |                          |    |   |                    |   | (8   | ) |  |   | 5,085  
|                                    |  |                    |      |   |         |   |                          |  |   |                 |   |  |                          |     |   |                    |   |      |   |  |   |        
|Net interest income                 |  |                    | (501 | ) |         |   | 6,493                    |  |   | (68             | ) |  |                          | 2   |   |                    |   |     |   |  |   | 5,926  
|Provision for loan losses           |  |                    |     |   |         |   | 243                      |  |   |                |   |  |                          |    |   |                    |   |     |   |  |   | 243    
|                                    |  |                    |      |   |         |   |                          |  |   |                 |   |  |                          |     |   |                    |   |      |   |  |   |        
|Net interest income after provision |  |                    | (501 | ) |         |   | 6,250                    |  |   | (68             | ) |  |                          | 2   |   |                    |   |     |   |  |   | 5,683  
|Non-interest income                 |  |                    | 4    |   |         |   | 1,130                    |  |   | 2,471           |   |  |                          | 224 |   |                    |   | (225 | ) |  |   | 3,604  
|Non-interest expense                |  |                    | 449  |   |         |   | 5,974                    |  |   | 2,180           |   |  |                          | 278 |   |                    |   | (225 | ) |  |   | 8,656  
|                                    |  |                    |      |   |         |   |                          |  |   |                 |   |  |                          |     |   |                    |   |      |   |  |   |        
|Income (loss) before income taxes   |  |                    | (946 | ) |         |   | 1,406                    |  |   | 223             |   |  |                          | (52 | ) |                    |   |     |   |  |   | 631    
|Income taxes                        |  |                    | (321 | ) |         |   | 510                      |  |   | 87              |   |  |                          | (20 | ) |                    |   |     |   |  |   | 256    
|                                    |  |                    |      |   |         |   |                          |  |   |                 |   |  |                          |     |   |                    |   |      |   |  |   |        
|Net income (loss)                   |  | $                  | (625 | ) |         | $ | 896                      |  | $ | 136             |   |  | $                        | (32 | ) |                    | $ |     |   |  | $ | 375    
|                                    |  |                    |      |   |         |   |                          |  |   |                 |   |  |                          |     |   |                    |   |      |   |  |   |        
|Assets                              |  | $                  | 525  |   |         | $ | 189,310                  |  | $ | 2,446           |   |  | $                        | 305 |   |                    | $ | (613 | ) |  | $ | 191,973
|                                    |  |                    |      |   |         |   |                          |  |   |                 |   |  |                          |     |   |                    |   |      |   |  |   |        



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LOGO



Independent Auditors Report



To the Board of
Directors

AF Financial Group and Subsidiaries

West Jefferson,
North Carolina



We have audited the accompanying consolidated statement of
financial condition of AF Financial Group and subsidiaries as of June 30, 2004, and the related consolidated statements of income (loss), stockholders equity, and cash flows for the year then ended. These consolidated financial statements are
the responsibility of the Companys management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit. The consolidated financial statements of AF Financial Group and subsidiaries as of and
for the year ended June 30, 2003 were audited by other auditors whose report dated July 25, 2003 expressed an unqualified opinion on those statements.



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



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



|                         
|-------------------------
|LOGO                     
|                         
|Charlotte, North Carolina
|August 10, 2004          



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Corporate Information



Officers



Melanie Paisley Miller

Acting Chief Executive Officer, Chief Financial Officer, Executive Vice President, Secretary



Directors



|                                                                               |  |                                                            
|------------------------------------------------------------------------------ |  | -----------------------------------------------------------
|Jimmy D. Reeves, Chairman                                                      |  | Jan R. Caddell, Vice Chairman, Lead Director               
|Partner in the law firm of Vannoy & Reeves PLLC                                |  | President and General Manager of Caddell Broadcasting, Inc.
|                                                                               | 
|Wayne R. Burgess                                                               |  | Kenneth R. Greene                                          
|Vice President and Manager of Burgess Furniture                                |  | Owner of Builders Mart of Ashe, Inc.                       
|                                                                               | 
|Claudia L. Kelley, Ph.D                                                        |  | Donald R. Moore                                            
|Associate Professor of Accounting at Appalachian State University              |  | Restaurant Owner                                           
|                                                                               | 
|Jerry L. Roten                                                                 |  | Michael M. Sherman                                         
|Clerk of Superior Court of Ashe County                                         |  | President and Chief Executive Officer of Zibra, LLC        
|                                                                               | 
|James A. Todd                                                                  |  | John D. Weaver                                             
|Former President and Chief Executive Officer of AF Financial Group and AF Bank |  | Vice President of Weaver Tree Farm, Inc.                   



Offices



Corporate Office

21 East Ashe Street

West Jefferson, NC 28694



|                         |  |                          |  |                           
|------------------------ |  | ------------------------ |  | --------------------------
|AF Bank Offices          |  | AF Brokerage Offices     |  | AF Insurance Offices      
|205 S. Jefferson Avenue  |  | 206 S. Jefferson Avenue  |  | 206 S. Jefferson Avenue   
|West Jefferson, NC 28694 |  | West Jefferson, NC 28694 |  | West Jefferson, NC 28694  
|                         |  |                         
|840 E. Main Street       |  | 1441 Mt. Jefferson Road  |  | 315 Main Street           
|Jefferson, NC 28640      |  | West Jefferson, NC 28694 |  | North Wilkesboro, NC 28659
|                         |  |                         
|4951 NC Hwy, 88 West     |  | 1675 Blowing Rock Road   |  | 324 Morganton Blvd, SW    
|Warrensville, NC 28693   |  | Boone, NC 28607          |  | Lenoir, NC 28645          
|                         |  |                         
|381 South Main Street    |  |                          |  | 381 South Main Street     
|Sparta, NC 28675         |  |                          |  | Sparta, NC 28675          
|                         |  |                         
|1675 Blowing Rock Road   |  |                          |  | 948 Johnson Ridge Road    
|Boone, NC 28607          |  |                          |  | Elkin, NC 28621           
|                         |  |                         
|1489 Mt. Jefferson Road  |  |                          |  | 1675 Blowing Rock Road    
|West Jefferson, NC 28694 |  |                          |  | Boone, NC 28607           
|                         |  |                         
|1441 Mt. Jefferson Road  |  |                          |  | 840 East Main Street      
|West Jefferson, NC 28694 |  |                          |  | Jefferson, NC 28607       
|                         |  |                         
|                         |  |                          |  | 1441 Mt. Jefferson Road   
|                         |  |                          |  | West Jefferson, NC 28694  



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Corporate Information, continued



|                                                        |  |                                                
|------------------------------------------------------- |  | -----------------------------------------------
|STOCK TRANSFER AGENT                                    |  | LEGAL COUNSEL                                  
|American Stock Transfer & Trust Company                 |  | Vannoy & Reeves PLLC                           
|59 Maiden Lane                                          |  | 202 East Main Street                           
|New York, New York 10038                                |  | West Jefferson, North Carolina 28694           
|                                                        | 
|INDEPENDENT AUDITORS                                    |  | Thacher Proffitt & Wood LLP                    
|Dixon Hughes PLLC                                       |  | 1700 Pennsylvania Avenue, Suite 800            
|6525 Morrison Blvd, Suite 516                           |  | Washington, DC 20006                           
|Charlotte NC 28211-3563                                 |  |                                                
|                                                        |  | FORM 10-KSB                                    
|ANNUAL MEETING                                          |  | A copy of Form 10-KSB as filed with the U.S.   
|The 2004 annual meeting of stockholders of AF Financial |  | Securities and Exchange Commission will be     
|Group will be held on November 1, 2004 at 6 P.M. at the |  | furnished without charge to shareholders upon  
|Corporate Office of the Company, 21 East Ashe Street,   |  | written request to Melanie P. Miller, Executive
|West Jefferson, North Carolina 28694.                   |  | Vice President, AF Financial Group, 21 East    
|                                                        |  | Ashe Street, Post Office Box 26, West          
|                                                        |  | Jefferson, North Carolina 28694-0026. If you   
|                                                        |  | prefer, you may obtain a copy without cost at  
|                                                        |  | the SEC website (www.sec.gov).                 



COMMON STOCK



The Company had 1,049,838 shares of common stock outstanding at September 17, 2004, which
are held by approximately 400 shareholders of record. The majority of the outstanding shares are held by the mutual holding company AsheCo, M.H.C. The remaining 511,617 shares are owned by minority shareholders including the Companys ESOP.
Shares are quoted on the OTC Electronic Bulletin Board under the symbol ASFE.



MARKET FOR THE COMMON STOCK



There is
no established market for the Companys common stock, excluding occasional quotations, although the Companys common stock is quoted on the OTC Electronic Bulletin Board. The table below reflects the stock trading and dividend payment
frequency of the Company for the years ended June 30, 2004 and 2003. For further information regarding the Companys dividend policy and restrictions on dividends paid, please refer to Note 8 of the notes to the consolidated financial
statements. Stock prices reflect bid prices between broker/dealer, prior to any markups, markdowns or commissions, is based upon information provided to management of the Company by certain securities firms effecting transactions in the
Companys stock on an ongoing basis, and may not necessarily represent actual transactions.



|               |  |           |      |             |   |       |  |   |      
|-------------- |  | --------- | ---- | ----------- | - | ----- |  | - | -----
|               |  |           |      | Stock Price
|2004           |  | Dividends |      | High        |   | Low  
|First quarter  |  | $         | 0.05 |             | $ | 20.30 |  | $ | 16.00
|Second quarter |  |           | 0.05 |             |   | 20.30 |  |   | 18.75
|Third quarter  |  |           | 0.05 |             |   | 23.00 |  |   | 20.00
|Fourth quarter |  |           | 0.05 |             |   | 21.00 |  |   | 16.50
|               |  |          
|               |  |           |      | Stock Price
|2003           |  | Dividends |      | High        |   | Low  
|First quarter  |  | $         | 0.05 |             | $ | 14.40 |  | $ | 13.59
|Second quarter |  |           | 0.05 |             |   | 13.90 |  |   | 11.25
|Third quarter  |  |           | 0.05 |             |   | 15.00 |  |   | 14.15
|Fourth quarter |  |           | 0.05 |             |   | 16.00 |  |   | 14.60



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