EXHIBIT 13.1


                              1998 ANNUANL REPORT








                                                         AF BANKSHARES, INC.(SM)



<PAGE>


                                    CONTENTS


Selected Financial Data                                                      1-2

President's Message                                                          3-4

Management's Discussion and Analysis of Financial Condition and
   Results of Operations                                                    5-18

Independent Auditor's Report                                                  19

Financial Statements                                                       20-51

Corporate Information                                                      52-54




<PAGE>

PRESIDENT'S MESSAGE





Dear Shareholders,

I am pleased to announce to our  shareholders  that AF  Bankshares,  Inc.  ("the
Company") has completed a successful  year. On June 16, 1998, AF Bank  completed
its  reorganization  into a two-tier  mutual  holding  company,  pursuant to the
agreement  and plan of  reorganization  approved by the Bank's  shareholders  on
December 8, 1997.  Under the  reorganization,  the Bank became the  wholly-owned
subsidiary  of AF  Bankshares,  Inc., a newly formed stock  holding  company and
holders of the Bank's common stock became holders of AF Bankshares,  Inc. stock,
on an equal share for share exchange.

We continued to see solid growth in the Company  throughout the year. Net income
for the year ended June 30,  1998 was  $708,403  or $.73 per share,  compared to
$343,438  or $.44 per  share,  at June  30,  1997.  Total  assets  increased  to
$99,593,042,  or 21.4%  during  the  year.  Stockholders'  equity  rose to $11.5
million at June 30, 1998,  up from $11.0  million at June 30, 1997.  The Company
issued a cash dividend of $.20 per share for the year ended June 30, 1998.

Special  attention was given to our product  delivery systems and our ability to
deliver quality and timely service to our customers. During fiscal year 1998, we
changed data  processing  service  bureaus,  automated  our proof  operation and
replaced our computer equipment. These changes enhanced our product delivery and
customer reporting functions and equipped the Company to properly deal with year
2000 issues.

We believe that our customers  are beginning to expect more than simply  banking
services, even from our small community oriented bank. We believe that to remain
competitive and to increase  shareholder value,  management must remain vigilant
in identifying customer needs and opportunities to meet those needs. One area of
the financial  services industry that fits well with financing real and personal
property is the property,  casualty, health and life insurance agency segment of
the industry.  All of our bank customers need insurance  coverage of one type or
another.  After  reviewing  the  possibilities,  the Bank acquired two insurance
agencies,  Ashelande Insurance Service,  Inc., located in West Jefferson,  North
Carolina and Brown Insurance Agency, located in North Wilkesboro, North Carolina
on July  1,  1997  and  formed  AF  Insurance  Services,  Inc.,  a  wholly-owned
subsidiary. The insurance subsidiary has had a successful first fiscal year, and
is expected to have continued success in the coming years.

We also believe that  expanding our potential  market area will add value to the
Company.  We will enter new  markets  when we can  structure  our  products  and
services  to meet  the  specific  needs  of the new  areas.  During  the year we
expanded into Alleghany  County,  North  Carolina,  staffing the new office with
local people  attuned to the specific  market needs of the local  community.  In
March,  we opened a branch of AF Bank,  operating  as  Alleghany  First  Bank in
Sparta,  North  Carolina.  Concurrently  and in the same facility,  we opened an
insurance  branch  operating  as AF  Insurance  Services,  Inc.,  to  serve  the
insurance needs of Alleghany County.

Adding the  insurance  agencies  and opening the  branches in  Alleghany  County
allows AF  Bankshares,  Inc.  the  ability  to  provide  broader  financial  and
insurance  services to people in our expanded market area, as well as increasing
the value of AF  Bankshares,  Inc.  as a whole.  During 1999 fiscal year we will
establish a broker-dealer  subsidiary in order to offer  alternative  investment
opportunities  to our  customers.  We believe  


<PAGE>

that our commitment to personal customer service,  to provide a broader range of
financial  services  and  expanded  product  lines will allow us to increase our
market share and shareholder value.

On behalf of the board of  directors,  and employees of AF  Bankshares,  Inc., I
would like to thank each of you for your business,  support and confidence shown
for our Company throughout the year.

Very truly yours,




James A. Todd
President and
Chief Executive Officer


<PAGE>



                SELECTED FINANCIAL AND OTHER DATA OF THE COMPANY

     The following tables set forth certain information concerning the financial
position and results of operations of the Company at the dates and for the years
indicated. The selected financial condition data and the selected operating data
for the years then ended were derived from the audited  financial  statements of
the Company.  The information  should be read in conjunction  with the Financial
Statements of the Company presented elsewhere.

<TABLE>
<CAPTION>
                                                                                  At June 30,
                                                        -----------------------------------------------------------------
                                                        1998           1997          1996          1995          1994    
                                                        ----           ----          ----          ----          ----    
                                                                     (In Thousands, Except Per Share Data)
<S>                                                    <C>           <C>           <C>           <C>           <C>       
Selected Financial Condition Data:
Total assets ...................................       $99,593       $82,024       $72,318       $65,440       $61,967   

Loans receivable, net (1) ......................        72,628        70,236        62,485        58,294        53,212   

Investment securities (2) ......................         9,017         6,937         5,560         2,754         3,666   

Cash and cash equivalents(3) ...................        14,308         2,533         1,830         2,469         3,238   

Savings deposits ...............................        82,488        68,218        63,468        58,496        55,596   

FHLB advances ..................................         4,116         1,654         1,250            --            --   

Equity .........................................        11,486        10,979         7,238         6,768         6,192   

Book value per share ...........................         10.90         10.98           N/A           N/A           N/A   
</TABLE>


<TABLE>
<CAPTION>
                                                                                 For the Year Ended June 30,
                                                                       --------------------------------------------------
                                                                       1998        1997      1996      1995      1994    
                                                                       ----        ----      ----      ----      ----    
                                                                           (In Thousands, Except Per Share Data)
<S>                                                                   <C>        <C>       <C>       <C>       <C>       
Selected Operating Data:
Interest  income and dividends ....................................   $ 7,356    $ 6,213   $ 5,683   $ 5,108   $ 4,602   
Interest expense ..................................................     3,795      3,245     3,204     2,630     2,287   

        Net interest income .......................................     3,561      2,968     2,479     2,478     2,315   
Provision for (recovery of)  loan losses ..........................       (25)        20        57       204       277   
        Net interest income after provision for (recovery of) loan
        losses ....................................................     3,586      2,948     2,422     2,274     2,038   
Non-interest income ...............................................       991        169       142       126       106   
Non-interest expense ..............................................     3,488      2,556     1,809     1,507     1,001   
Income before income tax expense and cumulative
        effect of change in accounting principles .................     1,089        561       755       893     1,143   
Income tax expense ................................................       381        218       301       347       445   
Income before cumulative effect of changes of accounting principles       708        343       454       546       698   
Cumulative effect on prior years of changing
        to a different method of accounting for income taxes (4) ..        --         --        --        --       309   
        Net income ................................................   $   708    $   343   $   454   $   546   $ 1,007   

Basic earnings per share (5) ......................................   $  0.73    $  0.44   $   N/A   $   N/A   $   N/A   
Diluted earnings per share (5) ....................................   $  0.72    $  0.44   $   N/A   $   N/A   $   N/A   

Dividends per share ...............................................   $  0.20    $  0.10   $   N/A   $   N/A   $   N/A   
</TABLE>


----------
(1)  Loans  receivable,  net is comprised of total loans less allowance for loan
     losses, undisbursed loan funds, and deferred loan fees.
(2)  Includes FHLB stock, certificates of deposit and investment securities.
(3)  Includes  interest-earning deposit balances of $11.4 million, $1.2 million,
     $840,000, $1.5 million, and $2.9 million at June 30, 1998, 1997, 1996, 1995
     and 1994 respectively.
(4)  Pursuant  to  Statement  of  Financial   Accounting   Standards   No.  109,
     "Accounting  for Income Taxes"  ("SFAS No. 109"),  on July 1, 1993 the Bank
     changed  prospectively  from the deferred method to the liability method of
     accounting for income taxes. The effect of the adoption of this standard is
     reflected in the financial  statements as the cumulative effect of adopting
     a change in accounting principle.
(5)  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.


                                       1

<PAGE>



<TABLE>
<CAPTION>
                                                                       AT OR FOR THE YEAR ENDED JUNE 30,
                                                                 --------------------------------------------------
                                                                 1998       1997      1996      1995      1994     
                                                                 ----       ----      ----      ----      ----     
<S>                                                               <C>       <C>       <C>       <C>       <C>      
SELECTED FINANCIAL RATIOS AND OTHER DATA: (1)

PERFORMANCE RATIOS:
        Return on average assets (2) ....................         0.77%     0.44%     0.65%     0.86%     1.20%    
        Return on average equity (2) ....................         6.31%     3.64%     6.50%     8.66%    12.92%    
        Average equity to average assets ................        12.21%    12.10%    10.05%     9.91%     9.29%    
        Equity to total assets at end of period .........        11.53%    13.39%    10.01%    10.34%     9.99%    
        Interest rate spread (3) ........................         3.64%     3.34%     3.38%     3.68%     3.74%    
        Average interest-earning assets to
             to average interest-bearing liabilities ....       111.95%   114.40%   107.79%   108.94%   108.41%  
        Net interest margin (4) .........................         4.17%     3.96%     3.76%     4.06%     4.09%    
        Non-interest expense to average assets ..........         3.80%     3.28%     2.62%     2.37%     1.72%    
        Efficiency ratio (5) ............................        76.63%    81.48%    69.20%    57.87%    41.35%    
        Dividend payout ratio (7) .......................        27.40%    22.73%      N/A       N/A       N/A     

REGULATORY CAPITAL RATIOS (6):
        Tangible capital ................................        10.90%    12.90%     9.80%    10.10%     9.99%    
        Core capital ....................................        10.90%    12.90%     9.80%    10.10%     9.99%    
        Total risk-based capital ........................        20.40%    26.30%    19.80%    21.60%    19.59%    

ASSET QUALITY RATIOS AND OTHER DATA:
        Ratios:
             Nonperforming loans to total loans .........         0.03%     0.18%     0.27%     1.12%     1.48%   
             Nonperforming loans and real estate owned to
                total assets ............................         0.06%     0.16%     0.24%     1.08%     1.45%   
             Allowance for loan losses to:
                Nonperforming loans .....................      4851.10%   787.02%   629.89%   179.38%   139.38%   
                Total loans .............................         1.60%     1.42%     1.70%     2.00%     2.06%   

        Number of full service branches .................         4         3         3         2         2       
</TABLE>

----------
(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 Ratios and Regulatory Capital
     Ratios are end of period ratios.

(2)  Income before cumulative effect of changes in accounting principles is used
     to calculate return on average assets and return on average equity ratios.

(3)  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.

(4)  The net interest  margin  represents  net  interest  income as a percent of
     average interest earning assets.

(5)  The efficiency ratio represents non-interest expense as a percentage of the
     sum of net interest income and non-interest income.

(6)  For definitions and further  information  relating to the Bank's regulatory
     capital  requirements,  see  "Regulation  - Regulation  of Federal  Savings
     Associations - Capital  Requirements." See "Regulatory  Capital Compliance"
     for the Bank's pro forma capital levels as a result of the Offering.

(7)  The dividend payout ratio represents the dividends per share divided by the
     earnings per share.  Earnings per share has been  calculated  in accordance
     with  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.  Dividends  declared
     amounted to $0.20 per share.

                                       2



<PAGE>
MANAGEMENT'S  DISCUSSION  AND  ANALYSIS OF  FINANCIAL  CONDITION  AND RESULTS OF
OPERATIONS

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 those  estimates.  Factors which
could  influence  the  estimates  include  changes in general  and local  market
conditions,  legislative and regulatory  conditions and an adverse interest rate
environment.  The  information  contained  in  this  section  should  be read in
conjunction  with  the  Financial  Statements,  the  accompanying  Notes  to the
Financial Statements and the other sections contained in this document.

REORGANIZATION.

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

On June 16, 1998, the Bank completed its  reorganization  into a two-tier mutual
holding company,  pursuant to the agreement and plan of reorganization  approved
by the Bank's  shareholders on December 8, 1997. Under the  reorganization,  the
Bank became the wholly-owned  subsidiary of AF Bankshares,  Inc., a newly formed
stock  holding  company (the  "Company")  and holders of the Bank's common stock
became  holders  of the  Company's  common  stock,  on an equal  share for share
exchange.  The Company  has no  operations  and  conducts no business of its own
other than  owning the Bank.  The 1997  financial  information  includes AF Bank
(formerly  Ashe Federal  Bank) only and the  "Company" is used  throughout  this
report for both 1998 and 1997. At June 30, 1998,  the mutual  holding  company's
primary assets  consist of owning 51.1% of AF Bankshares,  Inc. and 50% of AA&G,
Inc., a real estate brokerage company.

GENERAL. The Company had net income of $708,000 and $343,000 for the years ended
June 30,  1998 and 1997,  respectively.  The  Company's  operating  results  are
primarily  dependent  upon net interest  income,  fees and charges and insurance
commissions.  Net interest income is the difference  between  interest earned on
loans, investments and interest-earning deposits at other financial institutions
and the interest-bearing savings deposits and with other borrowings. The primary
interest-earning   asset  of  the  Company  is  its  mortgage   loan   portfolio
representing  87.4% of total  loans,  with  approximately  one-half of portfolio
mortgage loans at fixed rates at June 30, 1998.  The net interest  income of the
Company is affected  by changes in economic  conditions  that  influence  market
interest  rates.  This exposure to changes in interest  rates  contributes  to a
moderate  degree of interest rate risk, as evidenced by the impact of increasing
interest rates on the Company's  potential  earnings and on the net market value
of its assets and liabilities  (see "Net Portfolio  Value").  Additionally,  the
Company  receives fee income  primarily from loan  origination  fees,  late loan
payment  fees,  commissions  from the sale of credit  life,  accident and health
insurance,  insurance commissions generated from the insurance agency subsidiary
and in payment of other  services  provided to the customer by the Company.  The
major non-interest costs to the Company include compensation and benefits,  FDIC
insurance,  including  a  one-time  special  assessment  during  1997,  and data
processing  costs.  Other external factors that affect the operating  results of
the Company include changes in government and accounting  regulations,  costs of
implementing  information technology,  and changes in the competition's emphasis
within the Company's market area.


<PAGE>



MANAGEMENT STRATEGY.

The historical  operations of the Company has been that of a portfolio  mortgage
lender,  providing  fixed rate loans for the  residents  of Ashe  County,  North
Carolina.  In the late 1980's adjustable rate mortgages (ARMs) were offered, and
at June 30, 1998, ARMs represented  approximately one-half of portfolio mortgage
loans  outstanding  compared to  approximately  one-third at June 30, 1997. This
change in the  composition  of the  mortgage  loan  portfolio  results  from the
Company's  strategy  implemented  during  the past year,  of selling  long term,
fixed-rate  mortgages while retaining the servicing.  The reduction in the level
of fixed rate mortgages has served to reduce the Company's  exposure to interest
rate risk.

During 1995,  management  introduced  fixed rate mortgage loans with  provisions
allowing  the Company to "call the loan due" after  three or five year  periods,
thus  reducing the period of time that the Company is exposed to a fixed rate of
interest in order to reduce  interest rate risk.  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  ARM.  At
approximately  the  same  time,  the  Company  began to  offer  consumer  loans,
including automobile and home improvement loans. In June 1998, the Company began
funding automobile loans originated by selected dealers in its market area where
the Company's loan officers have final  underwriting  authority to determine the
acceptability of the borrowers to the Company. At June 30, 1998, the Company had
closed  approximately  $416,000 of these loans. At June 30, 1998 consumer loans,
including home equity lines of credit (HELOCs), constituted approximately 11% of
gross portfolio  loans. In 1994, the Company began offering  commercial loans to
small businesses in Ashe County and expanded that business to include  Alleghany
County during the fiscal year.  Commercial  loans  generally have rates based on
the  prime  rate  of  interest.  Additionally,  consumer  and  commercial  loans
generally  have shorter terms and thus greater  interest rate  sensitivity  than
mortgage loans.  Management has pursued the above mortgage and non-mortgage loan
strategies  to reduce the level of interest  rate risk inherent in the Company's
loan portfolio and maintain  acceptable levels of credit risk.  Funding for loan
originations  has been provided by aggressively  marketing  savings and checking
accounts while  maintaining  competitive  pricing on  certificates  of deposits.
Additionally,  the Company took  advantage  of favorable  Federal Home Loan Bank
(FHLB) fixed rate loans that offered long term financing at favorable  rates. At
June 30, 1998, the Company had borrowed money totaling $4.1 million  compared to
$1.7 million at June 30, 1997.

In addition to loans,  the Company  invests in U.S.  Treasury and Federal agency
securities,  certificates  of  deposit  (generally  with  terms of five years or
less),  overnight  deposits with the FHLB, equity securities in the Federal Home
Loan Mortgage  Corporation  (FHLMC) and  mortgage-backed  securities  secured by
adjustable  rate  mortgages  and  issued  by the  Government  National  Mortgage
Association (GNMA) and Fannie Mae. Management does not engage in the practice of
trading  securities.  The Company's  investment  portfolio consists primarily of
securities  designated  as available  for sale.  Management  intends to maintain
investment securities as a supplement to its lending activities,  as a source of
liquidity  and as a means to reduce  interest  rate risk and credit  risk of its
asset  base in  exchange  for lower  rates of return  than  would  typically  be
available with other lending activities.

The Company is committed to delivering  financial products with personal service
to the residents of Ashe through its three banking locations within Ashe County.
Management  and  the  board  of  directors  realize  that  the  expectations  of
traditional  bank  customers  have  changed to include a broader  definition  of
financial  services.  The market place is  demonstrating  to our customers  that
financial  services  incorporate a wide variety of financial  products including
insurance  and  alternative  investment  products.  In response to the  changing
complexion of the financial service industry, the Company acquired two insurance
agencies and brought these agencies together under AF Insurance  Services,  Inc.
Additionally,  management  believes that the Company must expand its market base
in order to build value for the  Company.  In March 1998,  the Company  opened a
branch of AF Bank in  Alleghany  County and  operates the branch under the trade
name  Alleghany  First Bank. At the same time, an insurance  agency branch of AF
Insurance  Services,  Inc.,  was  opened  in the  same  location.  The  staff of
Alleghany  First  came from the local  banking  community  and is 


<PAGE>


attuned to the needs and habits of  Alleghany  citizens.  The  insurance  agency
personnel  direct  their  attention  to the special  needs of  Alleghany  County
citizens  as  well.  Management  now  believes  that it is  delivering  the same
personalized  customer  service to  Alleghany  County  that it has  historically
delivered to Ashe County.

BROKERAGE SERVICES

Management believes that the Company's  customers perceive "financial  services"
to include  three  elements:  funds  transfer  including  checking  accounts and
savings instruments,  insurance and securities  brokerage.  Further,  management
believes that failure to offer  insurance and brokerage  services will deter the
Company's growth and make retention of existing customers more difficult. During
the 1998 fiscal year, the Company acquired two insurance agencies to satisfy the
insurance portion of its customers'  expectations.  During the 1999 fiscal year,
the Company will offer brokerage  services through a subsidiary,  AF Securities,
Inc. AF Securities,  Inc. will initially  conduct  brokerage  services through a
third  party  vendor  but  expects  to  receive  approval  to  operate  with its
broker/dealer registration prior to the end of the fiscal year.

COMPARISON OF FINANCIAL CONDITION AT JUNE 30, 1998, 1997 AND 1996:

At June 30, 1998, 1997 and 1996 assets totaled $99.6 million, $82.0 million, and
$72.3 million,  respectively.  Total assets  increased by $17.6 million or 21.4%
from June 30, 1997 to June 30, 1998,  primarily a result of an increase of $11.8
million, or 472.0%, in cash and cash equivalents and an increase of $2.4 million
or 3.4% in net loans receivable from June 30, 1997 to June 30, 1998.  Management
believes that the increase in cash and cash equivalents is primarily a result of
an increase in  deposits,  FHLB  advances  and an  increase  in  portfolio  loan
refinances being sold in the secondary market.  The Company's deposits increased
by $14.3  million from $68.2  million at June 30, 1997 to $82.5  million at June
30, 1998.  Management  believes that the increase in deposits is attributable to
its  marketing  efforts  directed  towards  increasing  balances  in savings and
transaction  accounts.  The Company's  level of advances from the FHLB increased
$2.4  million  from $1.7  million at June 30,  1997 to $4.1  million at June 30,
1998.  The  Company's  level of loans  sold to the  secondary  market  increased
significantly during the period ended June 30, 1998, to $8.5 million,  primarily
due to the Company's  decision to sell less profitable loans with lower interest
rates. The growth in assets from June 30, 1996 to June 30, 1997 can primarily be
attributed to proceeds received in the reorganization and an increase in savings
deposits which funded increases in loans receivable,  investment  securities and
liquidity.  Net loans receivable,  increased from $62.5 million at June 30, 1996
to $72.6 million at June 30, 1998, a $10.1 million or a 16.2% increase.  Savings
deposits  increased  $19.0  million from $63.5 million at June 30, 1996 to $82.5
million at June 30, 1998 for a 30.0 % increase.

The principal  category of earning  assets is loans.  During the year ended June
30, 1998, loans  receivable,  net,  increased by $2.4 million compared to a $7.8
million  increase for the year ended June 30, 1997. The reduced  increase in net
loans is due to  management's  successful  efforts to sell  fixed rate  mortgage
loans  to the  secondary  market.  The  increase  in  net  loans  receivable  is
attributable to operating in lending markets that have had sustained loan demand
over the past several  years.  Net  originations  on loans  receivable  held for
investment  were $2.2 million and $7.6 million for the years ended June 30, 1998
and 1997,  respectively.  Beginning in the fiscal year ended June 30, 1997,  the
Company began actively  soliciting  banking  relationships with local commercial
customers. As a result of this focus, commercial loans receivable increased from
$1.7 million at June 30, 1996 to $4.0  million at June 30, 1998,  an increase of
$2.3 million or 131.9%. These loans generally have rates based on the prime rate
of interest and have terms of three years or less.  During 1996,  1997 and 1998,
the  Company  emphasized  home equity line of credit  loans.  Home equity  loans
increased  from $1.0  million at June 30, 1996 to $4.1 million at June 30, 1998,
contributing  to an increase of $10.1 million of net loans  receivable from June
30, 1996 to June 30, 1998.

The Company's level of non-performing  assets, defined as loans past due 90 days
or more and repossessed assets, decreased from .16 % of total assets at June 30,
1997, to .06 % of total assets at June 30, 1998. The decrease is attributable to
comprehensive  lending policies and collection  efforts.  The Company's level of
non-performing loans has remained  consistently low in relation to prior periods
and total loans outstanding.  


<PAGE>

The Company  recovered net of charge offs,  totaling  $158,000 during year ended
June 30, 1998 compared to net charge offs of $85,000 and $170,000, respectively,
for the  years  ended  June  30,  1997  and  1996.  As a  result  and  based  on
management's  analysis of its allowances,  no provision for additional loan loss
allowance  was made during the year ended June 30, 1998 other than that realized
through recoveries.

The Company's  investment  portfolio increased by $2.1 million from $6.9 million
at June 30, 1997 to $9.0 million at June 30, 1998.  The majority of  investments
consist of U.S.  Treasury  and federal  agency  securities  and  mortgage-backed
securities  secured by adjustable  rate  mortgages  issued by Fannie Mae and the
GNMA.  The increase  during 1998 was funded  through  deposit growth and selling
fixed rate mortgage loans in the secondary market.

The Company's net  investment  in property and equipment  increased  $800,000 to
$2.2 million at June 30, 1998 from $1.4 million at June 30, 1996, as a result of
acquiring and  renovating a building  located at 206 South  Jefferson  Avenue in
West  Jefferson,  acquiring  equipment for the Alleghany  First Bank,  leasehold
improvements  in  the  Alleghany   facility  and  updating  the  Company's  data
processing equipment.  The building at 206 South Jefferson Avenue is occupied by
the Company's insurance agency subsidiary, a board meeting room that also serves
as a community  meeting  room and the  corporate  offices for the  Company.  The
Alleghany  facility is occupied by the banking  offices as well as an  insurance
agency subsidiary  office.  The Company completed  replacing all of its computer
equipment  during the year with equipment that is compatible  with the year 2000
environment.

At June 30, 1998,  retained earnings  increased $214,000 or 3.0% to $7.3 million
dollars,  from  $7.1  million  at June 30,  1997,  as a result  of  earnings  of
$708,000,  a reduction for a fair market value adjustment for the ESOP stock put
option liability in the amount of $333,000 and dividends of $199,000. Additional
paid in capital  increased  by $1.0 million or 28.9% to $4.6 million at June 30,
1998 which was offset by an equal amount charged to a contra equity account,  as
a result of additional shares issued under the Bank's  Recognition and Retention
Plan.  Unrealized gain on securities  available for sale decreased by $56,000 or
15.9% at June 30,  1998  primarily  as a result  of the sale of 7,300  shares of
stock in Federal  Home Loan  Mortgage  Corporation.  At June 30, 1998 the Bank's
regulatory core capital  amounted to $10.9 million  compared to $12.9 million at
June 30,  1997,  which  as a  percentage  of  total  assets  was  10.9%  and was
considerably in excess of regulatory capital requirements at such date.


<PAGE>



COMPARISON  OF  OPERATING  RESULTS FOR THE FISCAL  YEARS ENDED JUNE 30, 1998 AND
1997:

GENERAL.  Net income for the years ended June 30, 1998 and 1997 was $708,000 and
$343,000, respectively. The increase of $365,000 or 106.3% during the year ended
June 30, 1998 were primarily attributable to lower FDIC premiums, the absence of
the one time  assessment  from SAIF during the year ended June 30, 1997 and from
an increase in net interest income. In management's  opinion,  there has been an
improvement  in the level of  interest  rate risk from the end of the  Company's
most recent fiscal year.

NET INTEREST  INCOME.  Net interest  income  increased by $594,000 or 20.0% from
$3.0 million for the year ended June 30, 1997 to $3.6 million for the year ended
June 30,  1998.  The  increase  is a result  of  increased  average  outstanding
balances  in  interest-earning  assets and an improved  interest  rate spread in
effect during the year. The Company's  interest rate spread increased  primarily
because the average  yield on loans was higher  during the year June 30, 1998 as
compared to the year ended in 1997.

INTEREST  INCOME.  Interest  income  increased from $6.2 million to $7.4 million
during the year ended June 30, 1998,  or an 18.4%  increase.  This  increase was
attributable  to both an overall  increase in the weighted  average yield of the
Company's   loan   portfolio   and  by  a  change  in  the  volume  and  mix  of
interest-earning assets outstanding.

INTEREST  EXPENSE.  Interest  expense for the year ended June 30, 1998 increased
$549,000  to $3.8  million.  The  increase  is the result of an  increase in the
average  outstanding  balances in the level of deposits and  borrowings  for the
year ended June 30, 1998 as compared  to the similar  year ended 1997.  However,
the increase was partially  offset by a slightly lower average rate for deposits
during the year ended June 30, 1998 than for the comparable year ended 1997, and
was an offsetting factor to interest expense.

PROVISION FOR LOAN LOSSES.  Management  did not make  additional  provisions for
loan  losses  during  the  year  ended  June  30,  1998;  however,  the  Company
experienced net recoveries of $158,000 that served to increase the level of loan
loss  reserves.  During  the year  ended  June 30,  1997,  provisions  were made
totaling $20,000. Provisions, which are charged to operations and resulting loan
loss  allowances,  are amounts that the  Company's  management  believes will be
adequate  to  absorb   potential  losses  on  existing  loans  that  may  become
uncollectible.  Loans are  charged off against  the  allowance  when  management
believes that collection is unlikely. The evaluation to increase or decrease the
provisions 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
Company's level of non-performing loans remained consistently low in relation to
prior periods and total loans  outstanding  during the year ended June 30, 1998.
At June 30, 1998 the Company's  level of general  valuation  allowances for loan
losses amounted to $1.2 million which management  believes is adequate to absorb
any losses that may exist in its loan portfolio.

NON-INTEREST  INCOME.  Non-interest  income  increased  by  $822,000 to $991,000
during the fiscal year 1998. The increase was primarily  attributable  to a gain
on the sale of FHLMC stock of $306,000  and  insurance  commissions  of $404,000
generated by the insurance agency during the year ended June 30, 1998.

NON-INTEREST  EXPENSE.  Non-interest expense increased by $932,000 or 36.5% from
$2.6 million for the year ended June 30, 1997 to $3.5 million for the year ended
June 30, 1998.  Increases for  non-interest  expense for the year ended June 30,
1998 are primarily  attributable  to  compensation  costs,  occupancy cost, data
processing  costs and legal expenses.  Compensation  costs increased by $866,000
for the year ended  June 30,  1998,  primarily  as the result of the cost of the
Bank's Recognition and Retention Plan, insurance agency employees' salaries, and
Alleghany First  employees'  salaries.  Occupancy cost increased by $110,000 for
the  year  ended  June 30,  1998,  because  of  increased  depreciation  expense
resulting  from the addition of the new office  facility at 206 South  Jefferson
Avenue,  the new branch  location  in Sparta,  computer  equipment  acquired  to
address the year 2000 problem and one-time charges associated with changing data
processing  providers  from NCR to Fiserv  Orlando in October  1997.  Additional
legal costs 



<PAGE>

during  the  current  period  were  the  result  of  obtaining  shareholder  and
regulatory  approvals for a recognition  and retention plan, a stock option plan
and establishing a mid-tier holding company.

INCOME TAXES. Income taxes resulted from applying normal,  expected tax rates on
income earned  during the year ended June 30, 1998 and 1997.  Income tax expense
was  $381,000  and  $218,000,  for the years ended June 30,  1998 and 1997.  The
effective  tax rate applied was slightly  lower than the  statutory  federal and
state tax rates,  primarily due to qualifying  investment income that was exempt
from state income taxes. Legislated decreases are expected in the North Carolina
corporate tax rate in future  periods,  which would lower the overall  effective
tax rate.

IMPACT OF THE YEAR 2000.  A lot of  attention  has been given to the impact that
the  year  2000  date  change  will  have on  businesses,  utilities  and  other
organizations  that rely on computerized  systems to help run their  operations.
The year 2000 date change can affect any system that uses  computer  software or
computer chips including  automated equipment and machinery.  For example,  many
computer programs and computer chips store the calendar year portion of the date
as two digits rather than four digits.  These software programs and chips record
the year 1999 as "99". This approach works until the year 2000 when the "00" may
be  interpreted  as the year 1900  instead of the year 2000.  Banks use computer
systems to perform financial  calculations,  transfer funds, record deposits and
loan payments,  run security systems and vaults and a myriad of other functions.
Because  banks rely heavily on their  computer  systems,  the Federal  Financial
Institutions  Examination  Council ("FFIEC") has placed significant  emphasis on
the  problems  surrounding  the year  2000  issues  and has  required  financial
institutions to document the assessment,  testing and corrections  made to ready
their computer systems and programs for the year 2000 date change. The FFIEC and
OTS have strict regulations,  guidelines, and milestones in place that each FDIC
insured financial  institution must follow in order to remain  operational.  The
Company's board of directors has remained informed of the Company's position and
progress in its year 2000 project.

The Company's year 2000 project remains on schedule  according to the guidelines
set forth by the FFIEC.  The Company replaced all of its computer systems in the
fall of 1997 with year 2000 compliant  systems.  The Company's internal software
remediation,  replacement,  and testing efforts are  approximately  85% complete
with full  completion  scheduled for December  1998. The Company's most critical
external  exposure  to year 2000  system  problems  is with its data  processing
provider,  Fiserv  Orlando.  Fiserv  renovated  its  systems in June 1998 and is
currently  testing  its  remediation  efforts.  Fiserv  plans to have all of its
systems year 2000  compliant  by December  1998.  In  addition,  the Company has
contacted its major  customers  and vendors to inquire  about their  progress in
addressing  the year 2000 problem and does not believe that the problems of such
customers and vendors will have a material  adverse effect on the Company or its
operations.  The Company will  continue to monitor the progress of these parties
in addressing the year 2000 problem as the new millennium approaches.

As noted,  the Company has replaced all of its  computers and printers at a cost
of $244,000.  Software costs amounted to $101,000 and include internal  software
for accounts  payable,  fixed assets,  payroll and insurance agency  management.
Management  believes  that all material  costs to prepare for the year 2000 that
are under the direct  control of the Company have been  incurred.  The remaining
costs are expected to amount to less than $10,000 and relate primarily to travel
in order to test Fiserv Orlando's renovations to its software.

The year 2000  problems can affect the  Company's  operation in a number of ways
but the mission  critical issue is maintaining  customers'  account  information
including tracking deposits, interest accruals and loan payments. The Company is
dependent  upon  electricity,  telephone  lines,  computer  hardware  and Fiserv
Orlando's data processing capability.

The Company is in contact  with its  electric  utility and the  utility's  staff
regularly  updates the Company as to its  progress.  Assurances  have been given
that no major  problems  exist and that the electric  company will have all year
2000 problems  addressed well before December 31, 1999. If the electric  utility
is unable to


<PAGE>

certify that its  renovation  is  completed  by June 30, 1999,  the Company will
acquire portable  generators with sufficient  capacity to run the system servers
and at least one work station in each branch office.

The  Company  uses  two  telephone   utilities:   Skyline  Telephone  Membership
Corporation and Sprint. Skyline Telephone has tested its system with the Company
and had no date related problems. Service between Fiserv Orlando and the Company
is the  responsibility of Fiserv Orlando.  Fiserv will certify to communications
by the end of 1998.

To prevent  difficulties  in the event there is an  unforeseen  interruption  in
either telephone or electrical  service when the year changes,  the Company will
print hard copies of all account  information.  In  addition,  the Company  will
download all account  information  into programs on the Company's  hardware that
will allow bank  personnel to extract  customer  information  without  regard to
outside  sources.  Additionally,  the Company  stores  customer  information  on
retrievable   media  in  house.   The  Company  has  tested  its  equipment  for
compatibility  with the year 2000. The insurance  agency's  computer hardware is
tested to be compliant with the year 2000 and tracking program will be compliant
by December 31, 1998.

Fiserv  Orlando has  responded to the Company that  renovation of its program is
virtually  complete.  Representatives  of the Company are  scheduled to test the
Fiserv program with the Company's applications in October 1998. All transactions
are to be tested using the  Company's  data and  procedures  and any  additional
corrections are to be made on or before  December 31, 1998.  Fiserv has reported
that the progress of the update is on schedule. In the event that Fiserv Orlando
is unable to make the necessary  corrections to its programs to accommodate  the
year 2000,  beginning in December 1998, the Company will convert its data to one
of the other Fiserv programs that is able to operate in the 2000 environment.


<PAGE>



COMPARISON  OF  OPERATING  RESULTS FOR THE FISCAL  YEARS ENDED JUNE 30, 1997 AND
1996:

GENERAL.  Net income for the years ended June 30, 1997 and 1996 was $343,000 and
$454,000,  respectively. The reduction in net income is primarily a result of an
increase in non-interest expenses of $747,000, consisting mainly of the one-time
SAIF  assessment  of  $369,000,  which was offset by an increase in net interest
income in fiscal 1997.

NET INTEREST INCOME. Net interest income increased by 19.7%, or $489,000 to $3.0
million during the year ended June 30, 1997. This increase is attributable to an
increase  in volume,  as the  increase in the  average  interest-earning  assets
exceeded  the  increase  in the  average  interest-bearing  liabilities  by $4.7
million  during the year.  The  increase in volume was funded  through  proceeds
received in the mutual holding company  formation and related stock offering and
savings  deposit  growth.  This was somewhat  offset by a slight decrease in the
interest rate spread from 3.38% in 1996 to 3.34% in 1997. Overall interest rates
for  interest-earning  assets and  interest-bearing  liabilities  both decreased
slightly during 1997.

INTEREST  INCOME.  Interest income from loans increased 7.9% or $422,000 to $5.7
million  during  the year  ended  June 30,  1997,  primarily  as a result  of an
increase  in the  average  balances  outstanding  of  $7.8  million,  which  was
partially offset by a 39 basis point decrease in the average rate.

Interest  income from  investment  securities  increased by $145,000 to $377,000
during  the year  ended June 30,  1997.  The change was due to a 58 basis  point
increase in the average yield of the portfolio and by a $1.9 million increase in
the average balance of investment securities outstanding during the year.

The Bank's  average  yield on interest  bearing-deposits  increased  by 86 basis
points during the year ended June 30, 1997 as the Company  continues to hold its
deposits  at the FHLB.  The  increase  in yield was offset by a declined  in the
average  balances of $813,000.  These factors  contributed to a 29.1% or $37,000
decrease in interest  income from  interest-bearing  deposits for the year ended
June 30, 1997.

INTEREST  EXPENSE.  Interest  expense for the year ended June 30, 1997 increased
$41,000 to $3.2 million.  Included in the total is interest  expense on borrowed
funds of $50,000.  The additional cost resulted from a $4.2 million  increase in
total average interest-bearing liabilities, including both deposits and borrowed
funds.  This  increase in volume was offset by a 25 basis point  decrease in the
weighted average cost of total interest bearing liabilities.

PROVISION  FOR LOAN LOSSES.  During fiscal year 1997,  the Bank's  provision for
loan losses decreased  $37,000.  The provision expense for the year declined due
to a marked  improvement  in levels of  delinquent  and problem loans and in the
overall improvement in loan quality,  reducing the need for additional reserves.
At June 30, 1997 and 1996 the  allowance  for loan  losses was $1.0  million and
$1.1 million or 1.47% and 1.70%, respectively of its loan portfolio. At June 30,
1997 loans  delinquent  90 days or more  dropped to  $131,000  or 0.16% of total
assets.  As the  delinquencies  and problem assets  declined to lower levels and
loan  quality  improved,  the  allowance  for loan  losses was reduced to levels
considered adequate by management.  Management's periodic evaluation to increase
or decrease the provision and resulting allowances is based upon 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.  Management
believes the  allowance for loan losses is adequate to absorb losses in its loan
portfolio,  however,  there can be no  assurances  that future  periods will not
require additional provisions.

     NON-INTEREST INCOME.  Non-interest income increased 19.4% or $28,000 during
fiscal year 1997 as a result of additional fees charges on deposit accounts.

NON-INTEREST  EXPENSE.  For the year ended June 30, 1997,  non-interest  expense
increased  $747,000 or 42%,  primarily  due to the one-time  SAIF  assessment of
$368,000, to $2.6 million from $1.8 million.  



<PAGE>


Compensation  and employee  benefits  represented  the largest cost to the Bank.
During the year ended June 30, 1997, salary adjustments, including ESOP expense,
bonuses and additional  personnel  increased  compensation  costs by $129,000 or
15.9%.  Included in this increase is compensation  expense of $46,000 recognized
for the ESOP  contribution.  Management  and the Board are committed to adequate
compensation  for the  Bank's  employees  and to  rewarding  its  employees  for
superior performance.

Additional  depreciation from the previous two years renovations and upgrades is
the primary  reason for the increases in occupancy and equipment  costs of 28.6%
or $48,000 for the fiscal year ended June 30, 1997.

For the year  ended  June 30,  1997,  the Bank was  required  to pay a  one-time
special assessment to recapitalize the Savings Association Insurance Fund (SAIF)
up to a statutory goal of 1.25% on insured deposits. The assessment was equal to
65.7 basis points of the SAIF assessable  deposit base as of March 31, 1995, and
amounted to $368,000.  Regular deposit insurance premiums,  also provided by the
SAIF and administered by the FDIC, decreased $50,000 to $86,000 during 1997.

The Bank uses a third party provider to supply data processing  services for its
loans deposits,  general ledger, and account payable functions.  Data processing
charges have  increased as deposits and loan accounts have  increased and as the
Bank has added branches and increased its product offerings,  both for loans and
deposits.  For the year ended June 30, 1997,  data  processing  costs  increased
11.6% or $14,000  compared  to the year  ended  June 30,  1996 due to the bank's
continued efforts to automate its general ledger activities.

Other non-interest expenses increased 37.8% or $223,000 for the 1997 fiscal year
compared to the 1996 fiscal year largely to increases in  professional  fees and
expenses associated with being a public company.

INCOME TAXES. Income taxes resulted from applying normal,  expected tax rates on
income earned  during the year ended June 30, 1997 and 1996.  Income tax expense
was  $218,000  and  $301,000,  for the  years  ended  June 30,  1997  and  1996,
respectively.

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  and  capital  expenditure  commitments,
maintain reserve  requirements,  pay operating  expenses,  and provide funds for
debt service,  dividends to stockholders,  and other institutional  commitments.
Funds  are  primarily  provided  through  financial   resources  from  operating
activities,  expansion  of the  deposit  base,  borrowings,  through the sale or
maturity of investments,  the ability to raise equity capital, or maintenance of
shorter term interest earning deposits.

During the year ended June 30, 1998,  cash and cash  equivalents,  a significant
source of liquidity,  increased by  approximately  $11.8 million.  A significant
portion of this increase is a direct result of the Company's banking  subsidiary
selling loans in the secondary  market,  increases  achieved in savings deposits
and retaining the proceeds in the Bank's Federal Home Loan Bank account.

As a federally  chartered  savings bank,  the Bank must maintain a daily average
balance  of liquid  assets  equal to at least 4% of  withdrawable  deposits  and
short-term  borrowings.  During the year ended June 30, 1998 the OTS reduced the
required  level of liquidity to 4% from 5%,  eliminated the short term liquidity
requirement and imposed a new requirement  that savings  associations  generally
maintain  sufficient  liquidity to ensure safe and sound operations.  The Bank's
liquidity  ratio at June 30,  1998,  as  computed  under  OTS  regulations,  was
considerably in excess of such requirements.  Given its excess liquidity and its
ability to borrow from the Federal  Home Loan Bank,  the Bank  believes  that it
will  have  sufficient   funds  available  to  meet   anticipated   future  loan
commitments, unexpected deposit withdrawals, and other cash requirements.


ASSET/LIABILITY MANAGEMENT.


<PAGE>

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

In the absence of other factors, the Company's overall yield on interest-earning
assets  will  increase  as  will  its  cost  of  funds  on its  interest-bearing
liabilities  when  market  rates  increase  over an  extended  period  of  time.
Inversely,  the  Company's  yields and cost of funds will  decrease  when market
rates decline.  The Company is able to manage these  fluctuations to some extent
by   attempting   to  control   the   maturity  or  rate   adjustments   of  its
interest-earning  assets and interest-bearing  liabilities over given periods of
time.  One  of  the  Company's  tools  to  monitor  interest  rate  risk  is the
measurement  of  sensitivity  of its 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,  management has
implemented  an  asset/liability  program  designed  to  improve  the  Company's
interest  rate risk  exposure.  The  program  emphasizes  that  originations  of
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.

Although the Company's  asset/liability  management program has generally helped
to decrease the exposure of its earnings to interest rate increases, the Company
continues to be susceptible to increased  levels of interest  rates,  which will
adversely affect earnings during prolonged  periods of rising interest rates and
positively affect earnings during prolonged periods of interest rate declines.

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 that provided by
the Office of Thrift  Supervision  (OTS) and the Federal  Home Loan Bank (FHLB).
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 on 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.  Generally,  the level of  interest  rate risk is
measured  in a 200 basis  point  shock  environment  that has the most  negative
impact on the Company.


<PAGE>



The Company's  banking  subsidiary,  AF Bank, has  historically  been a mortgage
lender which means that it  generally  has longer  terms  before  repricing  its
assets  than  does  its  interest  bearing   liabilities  or  deposit  accounts;
therefore,  a rising rate  environment will have the most negative impact on the
NPV of the Company.  Management has implemented a strategy of limiting the terms
of mortgage  loans that it 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  offers for
portfolio.  The following  table presents the Company's NPV at June 30, 1998, as
calculated by the OTS, based on information provided to the OTS by the Company.

<TABLE>
<CAPTION>

<S>                         <C>            <C>              <C>                   <C>                <C>
-------------------------------------------------------------------------------------------------------------------------
                                                                                   NPV as % of PV (5) of
-------------------------------------------------------------------------------------------------------------------------
                               Net Portfolio Value                                           Assets
                               -------------------                                           ------
-------------------------------------------------------------------------------------------------------------------------
   Change in Rates          $ Amount       $ Change (1)      % of Change (2)       Ratio (3)          Change (4)
   ---------------          --------       ------------      ----------------      ---------          ----------
-------------------------------------------------------------------------------------------------------------------------
                                        (Dollars in Thousands)
-------------------------------------------------------------------------------------------------------------------------
       +400 bp               10,752           -2,621               -20%             10.99%             -211 bp
-------------------------------------------------------------------------------------------------------------------------
       +300 bp               11,669            1,703               -13%             11.77%             -133 bp
-------------------------------------------------------------------------------------------------------------------------
       +200 bp               12,477            -895                -7%              12.44%              -67 bp
-------------------------------------------------------------------------------------------------------------------------
       +100 bp               13,096            -276                -2%              12.92%              -18 bp
-------------------------------------------------------------------------------------------------------------------------
         0 bp                13,372              0                  0%              13.10%               0 bp
-------------------------------------------------------------------------------------------------------------------------
       -100 bp               13,719             347                 3%              13.34%              +24 bp
-------------------------------------------------------------------------------------------------------------------------
       -200 bp               14,153             780                 6%              13.65%              +54 bp
-------------------------------------------------------------------------------------------------------------------------
       -300 bp               14,752            1,380               10%              14.08%              +98 bp
-------------------------------------------------------------------------------------------------------------------------
       -400 bp               15,474            2,102               16%              14.61%             +150 bp
-------------------------------------------------------------------------------------------------------------------------
</TABLE>

(1) Represents the excess  (deficiency) of NPV assuming the indicated  change in
interest rates minus the estimated NPV assuming no change in interest rates. 
(2) Calculated  as the  amount of change in the  estimated  NPV  divided  by the
estimated NPV assuming no change in interest rates.
(3) Calculated as the estimated NPV divided by average total assets.
(4) Calculated  as the  excess  (deficiency)  of  the  NPV  ratio  assuming  the
indicated  change in interest  rates over the  estimated  NPV ratio  assuming no
change in interest rates.
(5) PV means present value.
<TABLE>
<CAPTION>

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

     <S>                                                 <C>                <C>
      RISK MEASURES: 200BP RATE SHOCK:                    June 30, 1998     June 30, 1997
      Pre-Shock NPV Ratio: NPV as a % of PV of Assets     13.10%            16.23%
      Exposure Measure: Post Shock NPV Ratio              12.44%            13.92%
      Sensitivity Measure: Change in NPV                  -67 bp            -231 bp
</TABLE>

Certain  shortcomings  are inherent in the methodology  used in the above table.
Modeling changes in NPV requires the making of 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 or 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



<PAGE>


the lag in repricing of interest rate sensitive assets could be expected to have
a positive effect on the Company.

Management  believes that the NPV method of assessing the Company's  exposure to
interest rate risk and potential  reductions in net interest  income is a useful
tool for measuring  risk.  Management  also believes that the charts reflect the
positive  impact of  strategies to reduce  interest rate risk as evidenced  most
prominently by the reduction in the  Sensitivity  Measure that shows a reduction
in the  amount of decline in NPV from 231 basis  point as  measured  at June 30,
1997 to 67 basis points at June 30, 1998. The  strategies  that have reduced the
level of interest rate risk under an increasing rate assumption will continue to
reduce the impact or rising rates as long term  mortgages  are sold and replaced
with  shorter  term  mortgage  and  non-mortgage  loans  with  rates that can be
adjusted to more closely simulate market rates of interest.  Management believes
that a  strong  equity  capital  position  and the  existence  of the  corporate
authority  to raise  additional  capital as necessary  act as valuable  tools to
absorb interest rate risk.

FUTURE REPORTING REQUIREMENTS

The FASB has issued SFAS No. 130, Reporting Comprehensive Income, which the Bank
has not been  required to adopt as of June 30,  1998.  The  Statement,  which is
effective  for fiscal years  beginning  after  December  15,  1997,  establishes
standards for reporting and display of  comprehensive  income and its components
of comprehensive  income be reported in a financial  statement that is displayed
with the same prominence as other financial statements.

IMPACT OF INFLATION AND CHANGING PRICES

The  financial  statements  and  accompanying  footnotes  have been  prepared in
accordance with GAAP,  which require 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 Bank 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.

<PAGE>



                          INDEPENDENT AUDITOR'S REPORT

To the Board of Directors
AF Bankshares, Inc. and Subsidiary
West Jefferson, North Carolina

We have audited the accompanying  consolidated statements of financial condition
of AF  Bankshares,  Inc. and  Subsidiary  as of June 30, 1998 and 1997,  and the
related consolidated statements of income,  stockholders' equity, and cash flows
for the years then ended.  These financial  statements are the responsibility of
the Company's  management.  Our responsibility is to express an opinion on these
financial statements based on our audits.

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

In our opinion,  the financial  statements  referred to above present fairly, in
all  material  respects,  the  financial  position of AF  Bankshares,  Inc.  and
Subsidiary as of June 30, 1998 and 1997, and the results of their operations and
their cash flows for the years then ended, in conformity with generally accepted
accounting principles.



/s/ McGladrey & Pullen, LLP
--------------------------- 
Charlotte, North Carolina
July 30, 1998


<PAGE>

AF BANKSHARES, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
JUNE 30, 1998 AND 1997

<TABLE>
<CAPTION>
ASSETS                                                                                        1998                 1997
------------------------------------------------------------------------------------------------------------------------
<S>                                                                              <C>                       <C>
Cash and cash equivalents:
  Interest-bearing deposits                                                      $         11,358,167      $    1,166,463
  Noninterest-bearing deposits                                                              2,949,842           1,366,042
Certificates of deposit, at cost                                                              198,000             198,000
Securities held to maturity (fair value $100,000 in 1998 and
  1997) (Note 2)                                                                              100,000             100,000
curities available for sale (Note 2)                                                        8,094,739           6,063,321
Federal Home Loan Bank stock (Notes 2 and 6)                                                  624,000             575,700
Loans receivable, net (Notes 3 and 6)                                                      72,627,870          70,235,670
Real estate owned                                                                              38,115
Office properties and equipment, net (Note 4)                                               2,160,783           1,375,773
Accrued interest receivable on loans                                                          321,679             315,044
Accrued interest receivable on investment securities                                           87,880              77,567
Prepaid expenses and other assets                                                             439,663             280,285
Deferred income taxes, net (Note 12)                                                          307,294             270,444
Intangible assets, net of accumulated amortization of $34,990                                 285,010                  --
                                                                             --------------------------------------------
       TOTAL ASSETS                                                            $           99,593,042      $   82,024,309
                                                                             ============================================
LIABILITIES AND STOCKHOLDERS' EQUITY
-------------------------------------------------------------------------------------------------------------------------
Liabilities:
  Savings deposits (Note 5)                                                    $           82,488,216      $   68,218,496
  Note payable - ESOP (Note 9 and 17)                                                         295,420             332,420
  Advances from Federal Home Loan Bank (Note 6)                                             4,115,596           1,654,231
  Accounts payable and other liabilities (Notes 8 and 10)                                     699,555             664,936
  Redeemable common stock held by the ESOP, net of       
  unearned ESOP shares (Notes 9 and 17)                                                       508,069             175,533
                                                                             --------------------------------------------
       TOTAL LIABILITIES                                                                   88,106,856          71,045,616
                                                                             --------------------------------------------

Commitments and Contingencies (Notes 10 and 13)
Stockholders' equity:  (Note 17)
  Common stock, par value $.01 per share; authorized 5,000,000   
    shares; issued 1,053,678 shares at 1998 and 1,000,000 shares 
    at 1997 (Note 7)                                                                           10,537              10,000
  Additional paid-in capital                                                                4,580,151           3,552,726
  Retained earnings, substantially restricted (Notes 7 and 12)                              7,279,694           7,065,824
  Deferred recognition and retention plan (Note 11)                                           678,576                  --
  Unrealized gain on securities available for sale,              
    net of tax (Note 2)                                                                       294,380             350,143
                                                                             --------------------------------------------
        TOTAL STOCKHOLDERS' EQUITY                                                         11,486,186          10,978,693
                                                                             --------------------------------------------
        TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY                             $           99,593,042      $   82,024,309
                                                                             ============================================
</TABLE>

See Notes to Consolidated Financial Statements.

<PAGE>
AF BANKSHARES, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED JUNE 30, 1998 AND 1997

<TABLE>
<CAPTION>
                                                                                        1998                            1997
                                                                               ------------------          ----------------------
<S>                                                                            <C>                         <C>                   
Interest income:
  Loans                                                                        $          6,667,587          $         5,746,015
  Investment securities                                                                     421,609                      377,226
  Interest-bearing deposits                                                                 267,162                       90,026
                                                                               --------------------          -------------------
                                                                                          7,356,358                    6,213,267
                                                                               --------------------          -------------------
Interest expense:
  Deposits (Note 5)                                                                       3,541,900                    3,195,675
  Federal Home Loan Bank  advances (Note 6)                                                 226,392                       27,710
  Note payable, ESOP                                                                         26,512                       22,015
                                                                               --------------------          -------------------
                                                                                          3,794,804                    3,245,400
                                                                               --------------------          -------------------
          NET INTEREST INCOME                                                             3,561,554                    2,967,867
Provision for (recovery of) loan losses (Note 3)                                            (25,000)                      20,000
                                                                               --------------------          -------------------
          NET INTEREST INCOME AFTER
           PROVISION FOR (RECOVERY OF) LOAN LOSSES                                        3,586,554                    2,947,867
                                                                               --------------------          -------------------
Noninterest  income
  Insurance commissions                                                                     403,900                           --
  Gain on sale on investments available for sale                                            305,550                           --
  Other                                                                                     281,846                      169,629
                                                                               --------------------          -------------------
                                                                                            991,296                      169,629
                                                                               --------------------          -------------------
Noninterest expenses:
  Compensation and employee        
   benefits (Notes 8, 9, 10 and 11)                                                       1,801,254                      935,503
  Occupancy and equipment                                                                   327,944                      217,645
  Deposit insurance premiums                                                                 43,696                       86,179
  Computer processing charges                                                               138,511                      136,880
  SAIF assessment (Note 16)                                                                 368,022                           --
  Amortization                                                                               34,990                           --
  Other                                                                                   1,141,797                      812,155
                                                                               --------------------          -------------------
                                                                                          3,488,192                    2,556,384
                                                                               --------------------          -------------------
          INCOME BEFORE INCOME TAXES                                                      1,089,658                      561,112
Income taxes (Note 12)                                                                      381,255                      217,674
                                                                               --------------------          -------------------
          NET INCOME                                                           $            708,403          $           343,438
                                                                               ====================          ===================
Basic earning per share (Note 14)                                              $               0.73          $              0.44
                                                                               ====================          ===================
Diluted earnings per share (Note 14)                                           $               0.72          $              0.44
                                                                               ====================          ===================
Cash dividends per share                                                       $               0.20          $              0.10
                                                                               =====================         ===================
</TABLE>

See Notes to Consolidated Financial Statements

                                       21
<PAGE>

AF BANKSHARES, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED JUNE 30, 1998 AND 1997

<TABLE>
<CAPTION>
                                                                                        Additional
                                                                     Common              Paid-In              Retained
                                                                     Stock               Capital              Earnings
------------------------------------------------------------------------------------------------------------------------------
<S>                                                            <C>                  <C>                  <C>
Balance, June 30, 1996                                         $            --      $              --      $       7,062,76
 Issuance of common stock,                   
  net of conversion costs                                                 4,249              3,543,720                   --
 Capitalization of mutual holding company                                 5,382                                    (105,382)
 ESOP shares issued                                                         369                369,051                   --
 Transfer to redeemable common stock         
  net of unearned ESOP shares                                                --               (369,420)            (138,533)
 ESOP contribution                                                           --                  9,375                   --
 Cash dividend, $.10 per share                                               --                     --              (96,475)
 Net change in unrealized gain on securities 
  available for sale, net (Note 2)                                           --                     --                   --
 Net income                                                                  --                     --              343,438
                                                             -----------------------------------------------------------------
Balance, June 30, 1997                                                   10,000              3,552,726            7,065,824
 Adoption of recognition and retention plan                                 537                992,506                   --
 Vesting of recognition and retention plan                                   --                     --                   --
 Transfer to redeemable common stock        
  net of unearned ESOP shares                                                                        --             (332,536)
 ESOP contribution                                                           --                 34,919               37,000
 Cash dividend, $.20 per share                                               --                     --             (198,997)
                                                                                                                           
 Net change in unrealized gain on securities
  available for sale, net (Note 2)                                            --                    --                    --
 Net income                                                                  --                    --               708,403
                                                             -----------------------------------------------------------------
Balance, June 30, 1998                                         $         10,537    $         4,580,151    $       7,279,694
                                                             =================================================================
</TABLE>


See Notes to Consolidated Financial Statements.


                                       22
<PAGE>

<TABLE>
<CAPTION>
                              
                               Unrealized 
       Deferred                  Gain on                
     Recognition               Securities               Unearned                  Total    
         and                    Available                 ESOP                Stockholders'
    Retention Plan              for Sale                 Shares                  Equity
-------------------------------------------------------------------------------------------------
<S>                        <C>                        <C>                   <C>
$          --               $         175,051       $           --       $        7,237,827

           --                            --                      --                3,547,969
           --                            --                      --                 (100,000)
           --                            --                  (369,420)                 --

           --                            --                   332,420               (175,533)
           --                            --                    37,000                 46,375
           --                            --                      --                  (96,475)

           --                          175,092                   --                  175,092
           --                            --                      --                  343,438
--------------------------------------------------------------------------------------------

           --                          350,143                   --               10,978,693
        (993,043)                        --                      --                    --
        (314,467)                                                                    314,467

           --                            --                      --                 (332,536)
           --                            --                      --                  (71,919)
           --                            --                      --                 (198,997)

           --                          (55,763)                  --                  (55,763)
           --                            --                      --                 (708,403)
--------------------------------------------------------------------------------------------
$       (678,576)           $          294,380         $         --        $      11,486,186
============================================================================================
</TABLE>

                                       23

<PAGE>

AF BANKSHARES, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED JUNE 30, 1998 AND 1997

<TABLE>
<CAPTION>
                                                                                        1998                   1997
------------------------------------------------------------------------------------------------------------------------
<S>                                                                       <C>                     <C>                 
Cash Flows from Operating Activities
 Net income                                                               $           708,403      $         343,438
 Adjustments to reconcile net income to net cash
   provided by operating activities:                
   Provision for (recovery of) loan losses                                            (25,000)                20,000
   Loss on disposal of fixed assets                                                     9,146                  1,125
   Gain on sale of investments available for sale                                    (305,550)                  --
   Provision for depreciation                                                         238,568                154,346
   Amortization of goodwill and noncompete covenant                                    34,990                   --
   Amortization of deferred loan fees                                                (222,904)              (134,638)
   Amortization of premium/discount                 
    on investments                                                                     12,687                 16,275
   Amortization of unearned ESOP shares                                                37,000                 37,000
   ESOP fair value adjustment                                                          34,919                  9,375
   Vesting of recognition and retention plan                                          314,467                   --
   Proceeds from sale of loans held for sale                                        8,091,901                   --
   Origination of loans held for sale                                              (8,084,101)                  --
   Gain on sale of loans held for sale                                                 (7,800)                  --
   Deferred income taxes                                                               (1,026)                55,627
   (Increase) decrease in operating assets:   
      Accrued interest receivable                                                     (16,948)               (84,817)
      Prepaid expenses and other assets                                              (159,378)               155,634
   Increase in liabilities:
      Accrued interest payable                                                          2,630                 22,116
      Accounts payable and other liabilities                                           34,619                302,928
                                                                        --------------------------------------------
           NET CASH PROVIDED BY                                                      
              OPERATING ACTIVITIES                                                    696,623                865,859
                                                                        --------------------------------------------
                                                                                     
Cash Flows from Investing Activities
 Purchases of securities available for sale                                        (5,922,587)            (1,922,013)
 Purchase of FHLB stock                                                               (48,300)               (67,400)
 Proceeds from calls of securities          
   available for sale                                                               3,050,000                600,000
 Proceeds from sale of securities           
   available for sale                                                                 311,633                   -- 
                                            
                                                     (Continued)
</TABLE>


<PAGE>

AF BANKSHARES, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
YEARS ENDED JUNE 30, 1998 AND 1997

<TABLE>
<CAPTION>
                                                                                   1998                   1997



------------------------------------------------------------------------------------------------------------------------
<S>                                                                        <C>                    <C>                 
  Principal payments received on                
   securities available for sale                                                     730,812                316,694
  Net originations of loans receivable                                            (2,195,238)            (7,636,514)
  Purchase of office properties and equipment                                     (1,036,924)              (270,534)
  Proceeds from sale of properties and equipment                                       4,200                   --
  Proceeds from sale of real estate owned                                             12,827                   --
  Purchase of goodwill and noncompete agreement                                     (320,000)                  --
                                                                         -----------------------------------------------
          NET CASH USED IN INVESTING ACTIVITIES                                   (5,413,577)            (8,979,767
                                                                         -----------------------------------------------

Cash Flows from Financing Activities
  Net increase in savings deposits                                         $      14,267,090      $       4,728,625
  Net borrowings on FHLB advances                                                  2,461,365                404,231
  Net proceeds from issuance of common stock                                            --                3,547,969
  Proceeds from borrowings                                                              --                  369,420
  Principal payments on borrowings                                                   (37,000)               (37,000)
  Capitalization of mutual holding company                                              --                 (100,000)
  Cash dividends paid                                                               (198,997)               (96,475)
                                                                         -----------------------------------------------
          NET CASH PROVIDED BY   
             FINANCING ACTIVITIES                                                 16,492,458              8,816,770
                                                                         -----------------------------------------------
          NET INCREASE IN CASH   
             AND CASH EQUIVALENTS                                                 11,775,504                702,862
          
Cash and cash equivalents:
  Beginning                                                                        2,532,505              1,829,643
                                                                         -----------------------------------------------
  Ending                                                                   $      14,308,009     $        2,532,505
                                                                         ===============================================
Supplemental Schedule of Cash and
  Cash Equivalents
    Interest-bearing deposits                                              $      11,358,167    $         1,166,463
    Noninterest-bearing                                                            2,949,842              1,366,042
                                                                         -----------------------------------------------
                                                                           $      14,308,009    $         2,532,505
                                                                         ===============================================
 Supplemental Disclosures of Cash
  Flow Information
  Cash payments for:
    Interest                                                               $       3,792,174    $         3,223,284
    Income taxes                                                                     485,178                 92,035
</TABLE>

                                       25



                                                     (Continued)


<PAGE>

AF BANKSHARES, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
YEARS ENDED JUNE 30, 1998 AND 1997

<TABLE>
<CAPTION>
                                                                                        1998                   1997
------------------------------------------------------------------------------------------------------------------------
<S>                                                                         <C>                   <C>               
Supplemental Disclosure of Noncash
  Investing and Financing Activities                        
  Net change in unrealized gain on securities               
   available for sale, net of tax                                           $          (55,763)   $          175,092
  Transfer from loans receivable to real estate owned                                   50,942                 --
  Unearned ESOP shares issued                                                            --                 (369,420)
  Par value of common stock issued                          
   to mutual holding company                                                             --                   (5,382)
  Fair value of ESOP shares in excess                       
   of unearned ESOP shares                                                             295,536               138,533
  Transfer from retained earnings to redeemable common stock                           332,536               175,533
</TABLE>







See Notes to Consolidated Financial Statements.

                                       26

<PAGE>

AF BANKSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------



NOTE 1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Nature of  business:  AF  Bankshares,  Inc.  (the  "Company")  is a bank holding
company  which owns 100% of the common stock of AF Bank (the  "Bank"),  formerly
Ashe Federal Bank. The 1997 financial statements include Ashe Federal Bank only.
The Company  has no  operations  and  conducts no business of its own other than
owning the Bank.  The Bank is a federally  chartered  stock  savings  bank which
conducts business from its main office located in West Jefferson, North Carolina
and three branches in Sparta,  Jefferson and Warrensville,  North Carolina.  The
principal  activities  of the Bank  consist of  obtaining  savings  deposits and
providing  credit to customers in its primary  market area,  Ashe and  Alleghany
Counties. On April 15,1996, the Board of Directors of the Bank adopted a Plan of
Reorganization  and a 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.  See Note 17 for additional  information  concerning the
minority stock offering and the  reorganization.  On June 16, 1998, the Board of
Directors  approved the formation of a mid-tier holding company,  AF Bankshares,
Inc. which became a 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 June 30, 1998,
AsheCo, M.H.C.'s ownership of AF Bankshares,  Inc. decreased to 51.1% due to the
shares issued under the recognition and retention plan discussed in Note 11.

On July 1, 1997, the Bank purchased two insurance companies to form AF Insurance
Services, Inc., which became a wholly owned subsidiary of the Bank. AF Insurance
Services,  Inc. operates from its main office in West Jefferson,  North Carolina
and  branch  offices  in  North  Wilkesboro  and  Sparta,  North  Carolina.  The
transaction  was accounted  for as a purchase.  Revenues are not material to the
financial 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 Bankshares, Inc. and its wholly owned subsidiary, AF Bank and the
Bank's wholly owned  subsidiary,  AF Insurance  Services,  Inc. All  significant
intercompany transactions and balances have been eliminated in consolidation.

Basis of financial statement presentation: The accounting and reporting policies
of the Company conform to generally accepted  accounting  principles 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.

Cash and cash  equivalents:  For purposes of reporting  the  statements  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.  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.


<PAGE>


AF BANKSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------


NOTE 1.  NATURE OF  BUSINESS  AND  SUMMARY OF  SIGNIFICANT  ACCOUNTING  POLICIES
         (CONTINUED)

Investment  securities:  The Bank has investments in debt and equity securities.
Debt securities  consist primarily of U. S. Treasury Notes,  Federal Farm Credit
Notes, 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.

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  Bank  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 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 Bank intends to hold for an indefinite  period of time
but,  as 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  Bank'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
amoritized  using the interest  method over the securities'  contractual  lives.
Unrealized gains or losses are reported as increases or decreases in equity, net
of the related deferred tax effect. Realized gains or losses,  determined on the
basis of the cost of specific securities sold, are included in income.

Securities held to maturity: Securities classified as held to maturity are those
securities  for  which  the  Bank 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 Bank's financial position and
liquidity, management believes the Bank 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 Federal  Home Loan Bank in an amount  equal to the greater of 1% of
its  outstanding  home loans or 5% of advances  from the FHLB.  No ready  market
exists for the Federal Home Loan Bank stock, and it has no quoted market value.

Loans receivable: Loans receivable are stated at unpaid principal balances, less
the allowance for loan losses,  the undisbursed  portion of construction  loans,
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.


<PAGE>


AF BANKSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------


NOTE 1.  NATURE OF  BUSINESS  AND  SUMMARY OF  SIGNIFICANT  ACCOUNTING  POLICIES
        (CONTINUED)

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 for impairment all loans delinquent more than 90 days. See Note 3 for a
further  explanation of the  Statement.  No loans were impaired at June 30, 1998
and 1997,  and there is no specific SFAS No. 114 allowance  associated  with the
portfolio.

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 generally  continues to accrue interest on loans  delinquent 90
days  or  more.   However,   all  such  accrued  interest  is  reversed  by  the
establishment  of a reserve  for  uncollected  interest,  if in the  opinion  of
management  collectibility is uncertain. Such interest, if ultimately collected,
is credited to income in the period received.  The Bank anticipates that it will
account for interest on impaired loans in a similar fashion in the future if and
when it has impaired loans.

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.

Loans held for sale: Loans held for sale are those loans the Bank has the intent
to sell in the  foreseeable  future.  They are carried at the lower of aggregate
cost or market  value.  Gains and  losses  on sales of loans are  recognized  at
settlement dates and are determined by the difference between the sales proceeds
and the carrying value of the loans.  All sales are made without  recourse.  The
Bank has no loans held for sale at June 30, 1998 or 1997.

Real estate  owned:  Real estate owned is initially  recorded at 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.


<PAGE>


AF BANKSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

NOTE 1.  NATURE OF  BUSINESS  AND  SUMMARY OF  SIGNIFICANT  ACCOUNTING  POLICIES
        (CONTINUED)

Intangible assets:  Goodwill is the cost of investment in AF Insurance Services,
Inc.  in excess of the fair value of net assets at the date of  purchase  and is
being  amoritized  by the straight  line method over a period of fifteen  years.
Noncompete agreement is stated at cost less accumulated  amoritization  computed
by the straight-line method over a period of seven years.

Pension plans: The Bank has a 401(k)  retirement plan available to substantially
all employees.  The Bank matches certain portions of voluntary  contributions by
participating employees.

The Bank has  deferred  compensation  and  retirement  plan  agreements  for the
benefit of the Board of Directors.  Both plans are unfunded and the  liabilities
are being accrued over the terms of active  service of the  directors.  The Bank
also has an ESOP which covers substantially all of it's 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 21,322  stock  options to certain  officers  and
directors at the time of the  adoption,  either in the form of  incentive  stock
options  or  non-incentive  stock  options.  The  Bank has  also  implemented  a
recognition  and retention  plan by reserving  53,678 shares of common stock for
issuance to certain officers and directors at the time of adoption.

Income taxes: Deferred taxes are provided on a 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 bases.
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.

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.

The fair value estimates presented are based on pertinent  information available
to management as of June 30, 1998 and 1997.  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 that date and therefore,  current  estimates of fair
value may differ significantly from the amounts presented herein.


<PAGE>


AF BANKSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

NOTE 1.  NATURE OF  BUSINESS  AND  SUMMARY OF  SIGNIFICANT  ACCOUNTING  POLICIES
        (CONTINUED)

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.

Earnings per share: The FASB has issued  Statement No. 128,  Earnings Per Share,
which supersedes APB Opinion No. 15. Statement No. 128 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. Those entities that have only common stock outstanding
are  required to present  basic  earnings  per-share  amounts.  Basic  per-share
amounts  are   computed  by  dividing   net  income  (the   numerator)   by  the
weighted-average  number of common shares  outstanding  (the  denominator).  All
other  entities are  required to present  basic and diluted  per-share  amounts.
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.  The earnings
per share  computation  for 1997 is based on net income  earned from the date of
reorganization October 4, 1996, divided by the weighted average number of shares
outstanding from the date of reorganization to the end of the 1997 fiscal year.

The Company initially applied Statement No. 128 for the year ended June 30, 1998
and, as required by the Statement,  has restated all per share  information  for
the  prior  years  to  conform  to  the  Statement.  See  Note  14  for  further
information.


<PAGE>


AF BANKSHARES, INC. AND SUBSIDIARY
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 at June 30 were as follows:

<TABLE>
<CAPTION>
                                                                                      1998
                                              ------------------------------------------------------------------------------------
                                                                                Gross               Gross
                                                          Amortized          Unrealized          Unrealized              Fair
                                                            Cost                Gains              Losses                Value
                                              ------------------------------------------------------------------------------------
<S>                                              <C>                  <C>                 <C>                 <C>                
Available for sale securities:
  Debt securities:
    U.S. Government agency securities             $       5,029,967      $       4,453     $     (11,156)   $          5,023,264
    Federal Farm Credit Notes                               400,000               --              (1,062)                398,938
    Fannie Mae and Government        
     National Mortgage Association                        2,174,353             60,503              --                 2,234,856
Equity securities:
  Federal Home Loan Mortgage
  Corporation Common Stock                                    6,917            430,764              --                   437,681
                                              ------------------------------------------------------------------------------------
                                                          7,611,237            495,720           (12,218)              8,094,739
                                              ------------------------------------------------------------------------------------
Held to maturity securities:
  Debt securities:
  Student Loan Marketing
     Association                                            100,000              --                 --                   100,000
                                              ------------------------------------------------------------------------------------
Other securities:
  Federal Home Loan Bank stock                              624,000              --                 --                   624,000
                                              ------------------------------------------------------------------------------------
                                              $           8,335,237   $        495,720     $     (12,218)   $          8,818,739
                                              ====================================================================================
</TABLE>

                                       32

<PAGE>


AF BANKSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

NOTE 2. DEBT AND EQUITY SECURITIES (CONTINUED)

<TABLE>
<CAPTION>
                                                                                      1997
                                             -------------------------------------------------------------------------------------
                                                                                Gross               Gross
                                                         Amortized           Unrealized           Unrealized              Fair
                                                           Cost                 Gains               Losses               Value
                                             -------------------------------------------------------------------------------------
<S>                                            <C>                  <C>                  <C>                  <C>               
Available for sale securities:
  Debt securities:                  
    U.S. Government agency securities          $         3,499,769   $           2,501     $         (18,265)   $      3,484,005
    Federal Farm Credit Notes                              600,000                --                  (6,749)            593,251
    Fannie Mae and Government        
   National Mortgage Association                         1,375,461              64,604                  --             1,440,065
Equity securities:
 Federal Home Loan Mortgage
  Corporation Common Stock                                  13,000             533,000                  --               546,000
                                             -------------------------------------------------------------------------------------
                                                         5,488,230             600,105               (25,014)          6,063,321
                                             -------------------------------------------------------------------------------------

Held to maturity securities:
 Debt securities:
  Student Loan Marketing
    Association                                            100,000               --                    --                100,000
                                             -------------------------------------------------------------------------------------

Other securities:
 Federal Home Loan Bank stock                              575,700               --                    --                575,700
                                             -------------------------------------------------------------------------------------
                                               $         6,163,930   $         600,105   $          (25,014)   $        6,739,021
                                             =====================================================================================
</TABLE>

The amortized cost and estimated fair value of debt securities at June 30, 1998,
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 money market funds are not included in the maturity  categories because they
do not have contractual maturities.

<TABLE>
<CAPTION>
                                                Held to maturity securities:        Available for sale securities:
                                       ---------------------------------------------------------------------------
                                              Amortized                                  Amortized
                                                Cost          Fair Value           Cost               Fair Value
                                       ---------------------------------------------------------------------------
<S>                                      <C>             <C>                <C>               <C>                
Due from one year to five years          $      100,000  $      100,000     $      5,429,967      $   5,422,202
Fannie Mae and Government
 National Mortgage Association
 debt securities                                  --              --               2,174,353          2,234,856
Equity securities                                 --              --                   6,917            437,681
                                       ---------------------------------------------------------------------------
                                         $      100,000  $      100,000     $      7,611,237      $   8,094,739
                                       ===========================================================================
</TABLE>

                                       33

<PAGE>


AF BANKSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 2.  DEBT AND EQUITY SECURITIES (CONTINUED)

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

<TABLE>
<CAPTION>
                                                                                      1998                    1997
                                                                         -----------------------------------------------
<S>                                                                        <C>                     <C>                  
Proceeds from calls of securities available for sale                       $          3,050,000      $        600,000
Proceeds from sale of securities available for sale                                     311,633
                                                                         -----------------------------------------------
                                                                                      3,361,633               600,000
Realized gain on sale of  securities available for sale                                (305,550)
                                                                         -----------------------------------------------
Cost of securities sold                                                    $          3,056,083               600,000
                                                                         ===============================================
</TABLE>


The change in net unrealized  gains shown as a separate  component of equity for
the years ended June 30, are as follows:

<TABLE>
<CAPTION>
                                                                                      1998                    1997
                                                                         -----------------------------------------------
<S>                                                                        <C>                     <C>                
Balance in equity component, beginning                                     $           350,143      $         175,051
Change in net unrealized gains                                                         (91,589)               287,581
Change in deferred income taxes                                                         35,826               (112,489)
                                                                         -----------------------------------------------
Balance in equity component, ending                                        $           294,380      $         350,143
                                                                         ===============================================
</TABLE>


The Bank, as a member of the Federal Home Loan Bank (FHLB)  system,  is required
to maintain an  investment  in capital stock of the Federal Home Loan Bank in an
amount  equal  to the  greater  of 1% of its  outstanding  home  loans  or 5% of
advances  from the FHLB.  No ready market  exists for the Federal Home Loan Bank
stock, and it has no quoted market value. For presentation purposes,  such stock
is assumed to have a market value which is equal to cost.

NOTE 3. LOANS RECEIVABLE

Loans receivable at June 30, consist of the following:

<TABLE>
<CAPTION>
                                                                                            1998                   1997
                                                                               ------------------------------------------------
<S>                                                                                        <C>                    <C>      
  One to four-family                                                                       55,462,490              53,902,672
  Multi-family                                                                                668,146                 741,756
  Non residential                                                                           1,417,513               2,803,966
  Land                                                                                      2,423,690               1,586,514
  Construction loans                                                                        3,477,239               1,562,385
  Commercial loans                                                                          3,974,669               4,182,118
  Consumer loans                                                                            8,281,791               7,704,981
                                                                               ------------------------------------------------
                                                                                           75,705,538              72,484,392

Less:
  Undisbursed loan funds                                                                   (1,597,657)               (758,859)
  Deferred loan fees                                                                         (315,748)               (458,681)
  Allowance for loan losses                                                                (1,164,263)             (1,031,182)
                                                                               ------------------------------------------------
                                                                                           72,627,870              70,235,670
                                                                               ================================================
</TABLE>



                                       34

<PAGE>


AF BANKSHARES, INC. AND SUBSIDIARY

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:
<TABLE>
<CAPTION>
                                                                                               1998                   1997
                                                                             ------------------------------------------------
<S>                                                                           <C>                        <C>      
Balance, beginning                                                             $           1,031,182      $       1,096,368
  Provisions (recoveries) charged to operations                                               25,000                 20,000
  Charge-offs                                                                                (12,936)               (88,842)
  Recoveries                                                                                 171,017                  3,656
                                                                             ------------------------------------------------
Balance, ending                                                                $           1,164,263      $       1,031,182
                                                                             ================================================
</TABLE>


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 Bank assesses all loans  delinquent more than 90
days for  impairment  and such  loans  amounted  to  approximately  $24,000  and
$131,000 at June 30, 1998 and 1997,  respectively.  Average  balances  for loans
delinquent more than 90 days totaled approximately $111,000 and $142,000 for the
years ended June 30,  1998 and 1997,  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 Bank has
determined  that specific  allowances on these loans are not required.  Interest
income foregone during 1998 and 1997 was $509 and $8,186, respectively. The Bank
established  reserves for uncollectible  interest on mortgage and consumer loans
totaling $5,485 and $4,485 at June 30, 1998 and 1997, respectively.

Loans to officers and directors of the Company totaled  $943,194 and $855,339 at
June 30, 1998 and 1997, respectively.  Activity, in aggregate,  during the years
ended June 30, 1998 and 1997, is summarized as follows:


<TABLE>
<CAPTION>
                                                                                        1998                  1997
                                                                      ---------------------------------------------------
<S>                                                                      <C>                       <C>                  
Balance, beginning                                                       $             855,339     $           735,686
Disbursements                                                                          327,935                 269,907
Payments received                                                                     (240,080)               (150,254)
                                                                       ---------------------------------------------------
Balance, ending                                                          $             943,194     $           855,339
                                                                       ===================================================
</TABLE>


Mortgage  loans  serviced  for  others  are  not  included  in the  accompanying
statements of financial condition.  Mortgage loan portfolios serviced for Fannie
Mae  were  approximately  $8,511,000  and  383,000  at June 30,  1998 and  1997,
respectively.

There were no loans held for sale or outstanding commitments to sell loans as of
June 30, 1998.

                                       35

<PAGE>


AF BANKSHARES, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 4. OFFICE PROPERTIES AND EQUIPMENT

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

<TABLE>
<CAPTION>
                                                                                      1998                   1997
                                                                             ---------------------------------------------

<S>                                                                            <C>                   <C>                
Land and land improvements                                                     $          260,399     $      235,485
Buildings                                                                               1,239,304            831,226
Furniture and fixtures                                                                  1,065,993            683,388
Leasehold improvements                                                                    197,540            123,556
Automobiles                                                                                84,345             26,570
                                                                             ---------------------------------------------
                                                                                        2,847,581          1,900,225
Accumulated depreciation                                                                 (686,798)          (524,452)
                                                                             ---------------------------------------------
                                                                               $        2,160,783     $    1,375,773
                                                                             =============================================
</TABLE>

NOTE 5. SAVINGS DEPOSITS

Savings deposits at June 30 consist of the following:

<TABLE>
<CAPTION>
                                                                                  1998                   1997
                                                                       -----------------------------------------------------
<S>                                                                      <C>                     <C>                
NOW accounts at 3.00% (3.22% 1997)                                       $          8,465,225     $      8,849,683
Commercial and free checking (non-interest bearing)                                 3,469,656              900,676
Passbook savings 4.25% (4.03% 1997)                                                16,729,421            1,067,227
Money market demand accounts 3.75% (3.95% 1997)                                     1,855,571            2,497,556
                                                                       -----------------------------------------------------
                                                                                   30,519,873            2,292,019
                                                                       -----------------------------------------------------
Certificates of Deposit:
 weighted average rate of 5.52% (5.52% 1997)
   4.00% to 5.99%                                                                  45,411,880            3,873,050
   6.00% to 7.99%                                                                   6,388,645            6,402,610
                                                                       -----------------------------------------------------
                                                                                   51,800,525            4,513,311
                                                                       -----------------------------------------------------

Accrued interest payable                                                              167,818              165,188
                                                                       -----------------------------------------------------
                                                                         $         82,488,216    $      68,218,496
                                                                       =====================================================
Weighted average cost of savings deposits                                                4.94%                4.96%
                                                                       =====================================================
</TABLE>


At June 30,  1998,  scheduled  maturities  of  certificates  of  deposit  are as
follows:

<TABLE>
<CAPTION>
                          1999                  2000              2001                2002           After          Total
                   --------------------------------------------------------------------------------------------------------
                                                                          
<S>                  <C>             <C>                 <C>                 <C>             <C>              <C>           
4.00% to  5.99%      $     3,911,354   $      4,044,083   $     1,726,566      $     277,260   $     250,042   $  4,541,188
6.00% to  7.99%            4,557,050          1,570,003           126,489            135,103            --        6,388,645
                   --------------------------------------------------------------------------------------------------------
                     $    43,670,599   $      5,614,086   $     1,853,055      $     412,363   $     250,422   $ 51,800,525
                   ========================================================================================================
</TABLE>

                                       36


<PAGE>


AF BANKSHARES, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

NOTE 5. SAVINGS DEPOSITS (CONTINUED)

The  aggregate   amount  of  jumbo   certificates  of  deposit  with  a  minimum
denomination  of $100,000 was  $13,894,135  and $11,598,470 at June 30, 1998 and
1997, respectively. At June 30, 1998, scheduled maturities of jumbo certificates
of deposit are as follows:

<TABLE>
<CAPTION>
                                                                                                              Weighted
                                                                                   Amount                   Average Rate
                                                                   ------------------------------------------------------
<S>                                                                  <C>                                     <C>     
Maturity period:
  Within three months                                                $             3,997,344                   5.57%
  Three through six months                                                         3,071,983                   5.69
  Six through twelve months                                                        5,252,072                   5.74
  Over twelve months                                                               1,572,736                   5.45
                                                                   ------------------------------------------------------
                                                                     $            13,894,135                   5.65%
                                                                   ======================================================
</TABLE>


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).

The Bank has pledged  securities  with a fair value of $100,000 at June 30, 1998
as collateral on treasury tax and loan account

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

<TABLE>
<CAPTION>
                                                                                   1998                        1997
                                                                  ---------------------------------------------------
<S>                                                                 <C>                             <C>      
Now accounts and money market accounts                              $               353,185          $       343,841
Passbook savings accounts                                                           538,205                  416,153
Certificate accounts                                                              2,650,510                2,435,681
                                                                  ---------------------------------------------------
                                                                    $             3,541,900          $     3,195,675
                                                                  ===================================================
</TABLE>




NOTE 6. FEDERAL HOME LOAN BANK ADVANCES

The Bank had advances  outstanding of $4,115,596 and $1,654,231 at June 30, 1998
and 1997,  respectively,  from the Federal  Home Loan Bank  (FHLB).  Interest is
payable at rates ranging from 5.68% to 6.87%.  Pursuant to collateral agreements
with the FHLB,  advances are  collateralized by all the Bank's stock in the FHLB
and  qualifying  first  mortgage  loans.  $1,500,000  of the advances are due by
August  of 1998,  $2,462,500  are due by  September  of 2002  and the  remaining
$153,096 is due January 2007.  Interest expense was $226,392 and $27,710 for the
years ended June 30, 1998 and 1997, respectively.

  
                                     37

<PAGE>

AF BANKSHARES, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 7. STOCKHOLDERS' EQUITY

The Bank is 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
Bank's  financial   statements.   Under  capital  adequacy  guidelines  and  the
regulatory  framework for prompt corrective  action, the Bank must meet specific
capital guidelines that involve quantitative  regulatory  accounting  practices.
The Bank's capital amounts and  classifications  are also subject to qualitative
judgments  by the  regulators  about  components,  risk  weightings,  and  other
factors.

The Office of Thrift Supervision (OTS) regulations require  institutions to have
a minimum  regulatory  tangible capital equal to 1.5% of total assets, a minimum
3% of total assets for the core capital ratio and 8% of risk-weighted assets for
the  risk-based  capital  ratio.  At June 30, 1998, the Bank exceeded all of the
capital requirements.

The  following is a  reconciliation  of the Bank's  capital in  accordance  with
generally  accepted  accounting  principles  (GAAP) to the three  components  of
regulatory capital calculated under the requirements of the OTS at June 30, 1998
and 1997:

<TABLE>
<CAPTION>
                                                                      June 30, 1998 Regulatory Capital
                            --------------------------------------------------------------------------------------------------------
                                           Percent of                        Percent of                     Percent of
                               Tangible     Tangible         Core             Tangible      Risk-based      Risk-based
                                Capital      Assets         Capital            Assets         Capital         Assets
                            --------------------------------------------------------------------------------------------------------
<S>                           <C>                            <C>                                 <C>
GAAP capital                  $ 11,486,186               $ 11,486,186                      $ 11,486,186
Goodwill and
 other nonincludable 
 assets                           (285,010)                  (285,010)                         (300,010)
Unrealized gain on
 securities        
 available for sale               (294,380)                  (294,380)                         (294,380)
Qualifying general
 loan loss 
 allowance                               _                          _                           715,254
                             -------------               ------------                      ------------
Regulatory capital              10,906,796    10.9%        10,906,796         10.9%          11,607,050         20.4%
Minimum capital
 requirement                    11,494,270     1.5          2,988,540          3.0            4,543,304          8.0
                             ---------------------------------------------------------------------------------------------
Excess regulatory
 capital                    $   9,412,526     9.4%      $  7,918,256          7.9%       $   7,063,746         12.4%
                             ==============================================================================================
</TABLE>

                                       38

<PAGE>

AF BANKSHARES, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 7. STOCKHOLDERS' EQUITY (CONTINUED)

<TABLE>
<CAPTION>
                                                                      June 30, 1998 Regulatory Capital
                            --------------------------------------------------------------------------------------------------------
                                                   Percent of                          Percent                             Percent
                                     Tangible       Tangible              Core        Tangible             Risk-based     Risk-based
                                     Capital         Assets              Capital        Assets               Capital        Assets
                            --------------------------------------------------------------------------------------------------------
<S>                           <C>                  <C>               <C>                      <C>              

GAAP capital                      $  10,978,693                          $ 10,978,693                    $ 10,978,693
Unrealized gain on
  securities        
  available for sale                   (350,143)                             (350,143)                       (350,143)  
Qualifying general
  loan loss  
  allowance                                   _                                     _                         540,788            
                                  -------------                           -----------                    ------------
Regulatory capital                   10,628,550        12.9%               10,628,550      12.9%           11,169,338        26.3%
Minimum capital
  requirement                         1,240,564         1.5                 2,481,128       3.0             3,421,449         8.0
                            --------------------------------------------------------------------------------------------------------
Excess regulatory
  capital                          $  9,387,986        11.4%             $  8,147,422       9.9%         $  7,747,889        18.3%
                            ========================================================================================================
</TABLE>


As of June 30,  1998,  the most  recent  notification  from the Office of Thrift
Supervision  (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  total  capital to risk  weighted  assets of 10%, Tier I
Capital to risk  weighted  assets of 6% and Tier I Capital to total assets of 5%
or $5,679,000, $3,407,000 and $4,981,000,  respectively. There are no conditions
or events since that  notification  that  management  believes  have changed the
Bank's category.

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.

The Company  paid cash  dividends  totaling  $.20 and $.10 per share  during the
years ended June 30, 1998 and 1997, respectively.  On July 20, 1998, the Company
declared a $.05 per share cash dividend for  stockholders of record as of August
7, 1998 to be paid on  September  2, 1998.  This  dividend  will be funded by an
upstream dividend from the Bank to the Company.

NOTE 8. EMPLOYEE PENSION AND INCENTIVE PLANS

The Bank has  adopted a  profit-sharing  plan  during  1997 for the  benefit  of
substantially all employees. Contributions are discretionary and totaled $52,300
and $36,749 for the years ended June 30, 1998 and 1997, respectively.

The Bank also has a discretionary bonus plan under which bonuses are paid to all
employees if approved by the Board of Directors  each year.  Expense  related to
these  incentives  was $54,289 and $60,787 for the years ended June 30, 1998 and
1997, respectively.

In addition, the Bank implemented a 401(k) retirement plan during the year ended
June 30, 1998 which contains provisions for specified matching  contributions by
the Bank.  The Bank funds  contributions  as they accrue and 401(k) plan expense
amounted to $74,239 for the year ended June 30, 1998.

                                       39

<PAGE>

AF BANKSHARES, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 9. EMPLOYEE STOCK OWNERSHIP PLAN

As  part  of the  reorganization,  the  Bank  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 10% of the outstanding  principal balance
plus  nterest at the lending  institution's  prime rate (8.5% at June 30,  1998)
less .5% with a balloon  payment  due June,  2002.  The Bank 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, 1998, future principal payments are due as follows:

<TABLE>
<CAPTION>
Year Ending June 30:                                          Amount
-------------------------------------------------------------------------

<S>                                                                <C>     
1999                                                               29,918

2000                                                               26,926

2001                                                               24,233

2002                                                              214,343
                                                      --------------------
                                                        $         295,420
                                                      ====================
</TABLE>


Dividends on unallocated shares may be used by the ESOP to repay the debt to the
Bank and are not reported as dividends in the financial statements. Dividends on
allocated or  committed  to be allocated  shares are credited to the accounts of
the participants and reported as dividends in the financial statements.

Excluding interest, expense of $71,919 and $46,375 during 1998 and 1997 has been
incurred in connection with the ESOP. The expense  includes,  in addition to the
cash  contribution  necessary  to fund the ESOP,  $34,919  in 1998 and $9,375 in
1997, 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 Bank has credited this amount to paid-in  capital
in accordance with the provisions of AICPA Statement of Position 93-6.

At June 30,  1998 and 1997,  7,400 and 3,700  shares  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 $643,000 and $457,000 at June 30, 1998 and 1997, respectively.

The Bank has also recorded 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  $508,069  and  $175,533  at  June  30,  1998  and  1997,
respectively.

                                       40

<PAGE>


AF BANKSHARES, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 10. 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 has insured the lives of
the directors for amounts  sufficient  to discharge  its  obligations  under the
agreements.  The Bank also has a  retirement  plan for  members  of the Board of
Directors  which 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 $78,812 and $83,590 for the years ended
June 30, 1998 and 1997, respectively.

NOTE 11. RECOGNITION AND RETENTION PLAN AND STOCK OPTION PLAN

The Bank's stockholders  approved the Bank's Recognition and Retention Plan (the
"RRP") and the Bank's  stock  option plan on December 8, 1997.  The stock option
plan provides for the issuance of up to 21,322 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.  Under the Plan
21,322 of options,  which vest at the rate of 20% annually beginning at the date
of grant,  were all  granted on December 8, 1997 and expire on December 8, 2007.
As permitted under the generally accepted  accounting  principles,  grants under
the plan are accounted  for  following the  provisions of APB Opinion No. 25 and
its  related  interpretations.   Accordingly,  no  compensation  cost  has  been
recognized for grants made to date. Had compensation  cost been determined based
on the fair value method  prescribed  in FASB  Statement  No. 123, the pro forma
effect on  reported  net income  for the year  ended  June 30,  1998 would be as
follows:


<TABLE>
<S>                                                             <C>            
Net income
  As reported                                                       $    708,403
  Pro forma                                                              679,748

Earnings per share
  As reported
    Basic                                                           $       0.73
    Diluted                                                                 0.72
  Pro forma
    Basic                                                                   0.70
    Diluted                                                                 0.69
</TABLE>

In determining the fair value of the option grant as prescribed in Statement No.
123,  the  Black-Scholes  option  pricing  model  was used  with  the  following
assumptions:  a risk-free  interest rate of 5.61%,  expected  lives of 10 years,
expected volatility of 17.19% and expected dividends of $0.20 per year.

At June 30,  1998,  21,322  options  have been  granted at an exercise  price of
$18.50, of which 4,264 options are currently  exercisable.  No options have been
exercised to date and all options granted are outstanding at June 30, 1998.

                                       41

<PAGE>


AF BANKSHARES, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 11. RECOGNITION AND RETENTION PLAN AND STOCK OPTION PLAN (CONTINUED)

The RRP reserved for issuance 53,678 shares of common stock to certain  officers
and  directors at the time of the  adoption.  The Bank issued shares to fund the
RRP in December of 1997. The restricted  common stock under the RRP vests at the
rate of 20% annually  beginning at the date of grant. The expense related to the
vesting of the RRP totaled $314,467 for the year ended June 30, 1998.

NOTE 12. 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.  Through 1996, the provisions of the Code permitted
the Bank to deduct from taxable income an allowance for bad debts based on 8% of
taxable income before such deduction or actual loss experience.  Tax legislation
passed in 1996  eliminates  the percentage of taxable income method as an option
for  computing bad debt  deductions in all future years.  The Bank will still be
permitted to take deductions for bad debts, but will be required to compute such
deductions using an experience method.

The Bank  will also  have to  recapture  its tax bad debt  reserves  which  have
accumulated  since 1988  amounting  to  approximately  $138,000  over a six year
period.  The tax  associated  with  the  recaptured  reserves  is  approximately
$54,000. The recapture was scheduled to begin with the Bank's 1997 year, but has
been delayed two years as the Bank has  originated  a certain  level of mortgage
loans.  Deferred  income taxes have been  previously  established  for the taxes
associated  with the recaptured  reserves and the ultimate  payment of the taxes
will not result in a charge to earnings.

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,  1998,  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 be increased to the maximum  percent under
existing law.


                                       42
<PAGE>


AF BANKSHARES, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 12. INCOME TAX MATTERS (CONTINUED)

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

<TABLE>
<CAPTION>
                                                                                  1998                     1997
                                                                       ---------------------------------------------------
<S>                                                                      <C>                      <C>                   
Deferred tax assets:
  Reserve for loan losses                                                $            453,480  $            403,399
  Reserve for uncollected interest                                                      2,137                 1,755
  Deferred loan fees                                                                    --                   97,492
  Deferred compensation                                                               176,954               143,548
  Recognition and retention plan                                                       44,793                 --
                                                                       --------------------------------------------
                                                                                      677,364               646,194
                                                                       --------------------------------------------

Deferred tax liabilities:
  Reserve for loan losses                                                              53,563                35,936
  Unrealized gain on securities available for sale                                    189,124               224,948
  Depreciation                                                                         44,319                4,7345
  FHLB stock dividends                                                                 60,949                6,0949
  Deferred loan fees                                                                   22,115                 --
  Other                                                                                                       6,572
                                                                       --------------------------------------------
                                                                                      370,070               375,750
                                                                       --------------------------------------------
              NET DEFERRED TAX ASSET                                     $            307,294  $            270,444
                                                                       ============================================
</TABLE>


At June 30, 1998 and 1997,  no valuation  allowance was recorded on deferred tax
assets.

The provision  for income taxes  charged to operations  for the years ended June
30, 1998 and 1997 consists of the following:

<TABLE>
<CAPTION>
                                                                                   1998                    1997
                                                                         -------------------------------------------------
<S>                                                                        <C>                    <C>                   
Current                                                                    $          382,281   $            162,047
Deferred                                                                               (1,026)                55,627
                                                                         -------------------------------------------------
                                                                           $          381,255   $            217,674
                                                                         =================================================
</TABLE>

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

<TABLE>
<CAPTION>
                                                       1998                                            1997
                                    ------------------------------------------------------------------------------------------------
                                                 Amount              Percent                     Amount              Percent
                                    ------------------------------------------------------------------------------------------------
<S>                                   <C>                            <C>          <C>                               <C>     
Tax at statutory rate                 $         370,484                 34.0%       $         190,775                34.0%
State tax, net of federal                       
   benefit                                       37,892                  3.5                   20,194                 3.6 
Municipal interest income                       (19,813)                (1.8)
Other                                             (7308)                (0.7)                   6,705                 1.2
                                    ------------------------------------------------------------------------------------------------
Total                                 $         381,255                 35.0%       $         217,674                38.8%
                                    ================================================================================================
</TABLE>



                                      43
<PAGE>


AF BANKSHARES, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 13. 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, 1998:

<TABLE>
<CAPTION>
                                                                                                         Notional
                                                                                                          Amount
                                                                                                   ---------------------
<S>                                                                                                  <C>              
     Financial instruments whose contract amounts represent credit risk:
         Undisbursed home equity lines of credit                                                     $        3,631,324
         Undisbursed commercial lines of credit                                                                 937,157
</TABLE>

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.  Undisbursed
commercial lines of credit have variable rates of prime plus two percent and are
reassessed on an annual basis. Prime at June 30, 1998 was 8.50%.

The Bank has entered  into  operating  leases for the  Warrensville  and Sparta,
North Carolina  branches.  The  Warrensville  lease is for a five-year term with
minimum  annual  lease  payments  of  $6,000,  and  the  Sparta  lease  is for a
three-year term with minimum annual lease payments of $8,400.


                                       44
<PAGE>


AF BANKSHARES, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

NOTE 14. EARNINGS PER SHARE

Earnings per share has been calculated in accordance  with Financial  Accounting
Standards  Board  Statement  No. 128,  "Earnings  Per Share",  and  Statement of
Position 93-6,  "Employers'  Accounting for Employee Stock Ownership Plans". For
purposes of this computation,  the number of shares of common stock purchased by
the Bank's  employee  stock  ownership  plan which  have not been  allocated  to
participant  accounts  are not  assumed to be  outstanding.  The  following  are
reconciliations of the amounts used in the per share calculations:

<TABLE>
<CAPTION>
                                                                      For the Year Ended June 30, 1998
                                                  ----------------------------------------------------------------
                                                            Income                 Shares               Per Share
                                                          (Numerator)            (Denominator)            Amount
                                                  ----------------------------------------------------------------
<S>                                                 <C>                         <C>         <C>                   
BASIC EPS
Income available to stockholders                    $        708,403              975,717       $           0.73
                                                                                                =================
EFFECT OF DILUTIVE SECURITIES
RRP restricted stock awards                         $          --                   3,189
Stock options                                                                       1,854
                                                  ---------------------------------------

DILUTED EPS
Income available to stockholders                    $        708,403              980,760       $           0.72
                                                  ================================================================

<CAPTION>
                                                        For the Period from October 4, 1996 to June 30, 1997
                                                  ----------------------------------------------------------------
                                                            Income                 Shares               Per Share
                                                          (Numerator)            (Denominator)            Amount
                                                  ----------------------------------------------------------------
<S>                                                 <C>                     <C>                <C>    
BASIC AND DILUTED EPS
Income available to stockholders from date
 of reorganization October 4, 1996 to
 June 30, 1997                                      $         426,845             965,215       $            0.44
                                                  ================================================================
</TABLE>




                                       45

<PAGE>


AF BANKSHARES, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 15. 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, 1998 and 1997:

<TABLE>
<CAPTION>
                                                              1998                                        1997
                                         -----------------------------------------------------------------------------------------
                                                    Carrying               Fair                   Carrying              Fair
                                                     Value                 Value                  Value                Value
                                         -----------------------------------------------------------------------------------------
<S>                                        <C>                   <C>                    <C>                  <C>                
Financial assets:
  Cash                         
    Interest-bearing                      $         11,358,167    $       11,358,167     $      1,166,463   $          1,166,463
    Noninterest-bearing deposits                     2,949,842             2,949,842            1,366,042              1,366,042
  Certificates of deposit                              198,000               198,000              198,000                198,000
  Investments                                        8,194,739             8,194,739            6,163,321              6,163,321
  Loans receivable                                  72,627,870            72,297,027            7,023,567              6,880,325
  Accrued interest receivable                          409,559               409,559              392,611                392,611
  FHLB stock                                           624,000               624,000              575,700                575,700
  
Financial liabilities:
  Deposits                                           2,488,216            82,589,250            6,821,849              6,840,647
  Advances from Federal
    Home Loan Bank                                   4,115,596             4,115,596            1,654,231              1,654,231
  Note payable, ESOP                                   295,420               295,420              332,420                332,420
</TABLE>


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.  The fair value of variable rate loans  approximates  their carrying
value as these loans reprice frequently.

                                       46

<PAGE>


AF BANKSHARES, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 15. FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)

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.

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.

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 Federal Home Loan Bank and Note payable,  ESOP:  The fair value of
the Advances from Federal Home Loan Bank and Note payable,  ESOP is equal to the
carrying value of the liability.

NOTE 16. SAIF ASSESSMENT

On September 30, 1996, the "Deposit Insurance Funds Act of 1996" was signed into
law. The legislation  included a special one-time assessment to recapitalize the
Savings  Association  Insurance  Fund (SAIF) up to a statutory  goal of 1.25% of
insured deposits. The assessment was equal to approximately 65.7 basis points of
the SAIF assessable  deposit base as of March 31, 1995. The expense recorded for
the special SAIF assessment for the year ending June 30, 1997 was $368,022.

NOTE 17. REORGANIZATION AND MINORITY STOCK OFFERING

On October 4, 1996, the Bank  consummated  its  reorganization,  as explained in
Note 1, and issued 461,779 shares in a minority stock offering (including 36,942
shares  to the  ESOP)  which  resulted  in  gross  proceeds  of  $4,617,790,  or
$3,917,389,  net of conversion  costs of $700,401.  At closing,  such costs were
netted  against  the  stock  proceeds  received  and  shown  as a  reduction  of
stockholders' equity. As a part of the reorganization,  the Bank formed a mutual
holding company,  AsheCo,  M.H.C., which was issued 538,221 shares of the Bank's
common stock. Members of the mutual holding company consist of depositors of the
Bank,  who have the sole authority to elect the board of directors of the mutual
holding company for as long as it remains in mutual form. Initially,  the mutual
holding  company's  principal  assets were the shares of the Bank's common stock
received in the reorganization and on its initial  capitalization of $100,000 in
cash. The mutual holding company,  which by law must own in excess of 50% of the
stock of the  Bank,  was  issued  stock in the  reorganization  resulting  in an
ownership  interest  of 53.8% of the  Bank.  By  virtue  of its  ownership  of a
majority of the  outstanding  shares of the Bank, the mutual holding company can
generally  control the outcome of most matters  presented to the stockholders of
the Bank for  resolution  by vote  except for certain  matters  related to stock
compensation plans, a vote regarding conversion of the mutual holding company to
stock  form,  or  other  matters  which  require  a vote  only  by the  minority
stockholders.  The mutual  holding  company has registered as a savings and loan
holding  company and is subject to regulation,  examination,  and supervision by
the Office of Thrift Supervision (OTS).

                                       47

<PAGE>


AF BANKSHARES, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

NOTE 17. REORGANIZATION AND MINORITY STOCK OFFERING (CONTINUED)

The Bank also established an ESOP which was issued 36,942 shares of common stock
in the  reorganization.  The funds used by the ESOP to acquire these shares were
obtained from borrowings from an  unaffiliated  third party lender.  The loan is
reflected in the financial  statements of the Bank which makes  contributions to
the ESOP necessary to amortize the debt. Such  contributions  are expensed based
upon the fair value of the ESOP shares released or committed to be released from
restriction (or no longer debt  financed).  The total number of shares of common
stock issued as a result of the offering and reorganization  were 1,000,000.  On
June 16,  1998,  the Board of  Directors  approved  the  formation of a mid-tier
holding company, AF Bankshares,  Inc. which became a 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 June 30, 1998, AsheCo,  M.H.C.'s ownership of AF Bankshares,  Inc.
decreased to 51.1% due to the shares issued under the  recognition and retention
plan discussed in Note 11.

Concurrent  with the  reorganization,  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
then  required for the  liquidation  account or the minimum  regulatory  capital
requirements imposed by federal regulations.


                                       48
<PAGE>


AF BANKSHARES, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 18. MID-TIER HOLDING COMPANY AND MUTUAL HOLDING COMPANY DATA

The mid-tier holding company, AF Bankshares,  Inc., was formed on June 16, 1998.
At June 30, 1998,  the  Company's  only asset was the  investment in AF Bank and
Subsidiary of $11,486,186. There were no significant operations from the date of
inception to June 30, 1998.

The  following  are the condensed  financial  statements  of the mutual  holding
company, AsheCo, M.H.C., as of and for the periods ended June 30, 1998 and 1997:

<TABLE>
<CAPTION>
                                             Condensed Balance Sheets
                                              June 30, 1998 and 1997

                                                                                    1998                    1997
                                                                          -----------------------------------------
<S>                                                                         <C>                     <C>                 
Assets:
Cash                                                                        $           154,534 $           123,374
Investment in AA&G, Inc. and Subsidiary                                                  42,574              18,156
Investment in AF Bankshares, Inc. and Subsidiary                                      6,290,429           6,014,340
Other assets                                                                             19,409               --
                                                                          -----------------------------------------
                                                                            $         6,506,946 $         6,155,870
                                                                          =========================================

Liabilities and Equity:
  Liabilities:
    Accounts payable                                                        $            12,000 $            14,838
                                                                          -----------------------------------------
Equity:
  Capitalization by AF Bankshares, Inc. and Subsidiary                                  105,382             105,382
  Equity in AF Bankshares, Inc. and Subsidiary                                        5,885,179           5,759,553
  Retained earnings                                                                     461,978             181,862
  Unrealized gain on securities available for sale, net                                  42,407              94,235
                                                                          -----------------------------------------
                                                                                      6,494,946           6,141,032
                                                                          -----------------------------------------
                                                                            $         6,506,946 $         6,155,870
                                                                          =========================================
</TABLE>

                                       49

<PAGE>


AF BANKSHARES, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 18. MID-TIER HOLDING COMPANY AND MUTUAL HOLDING COMPANY DATA (CONTINUED)

                         Condensed Statements of Income
     For the Period  From  October  4, 1996 to June 30,  1997 and the Year Ended
June 30, 1998

<TABLE>
<CAPTION>
                                                                                      1998                  1997
                                                                            ----------------------------------------------

<S>                                                                           <C>                    <C>                
Interest income                                                               $            4,770  $           2,911
Dividend income, AF Bankshares, Inc. and Subsidiary                                      107,644             53,822
Equity in earnings subsidiaries                                                          405,680            232,884
Income tax (expense) credits                                                              12,048            (14,838)
Other expense                                                                            (71,055)           (18,359)
                                                                            ----------------------------------------------
              NET INCOME                                                      $          459,087  $         256,420
                                                                            ==============================================
</TABLE>


                        Condensed Statement of Cash Flows
     For the Period  From  October  4, 1996 to June 30,  1997 and the Year Ended
June 30, 1998

<TABLE>
<CAPTION>
                                                                                      1998                  1997
                                                                            -----------------------------------------
<S>                                                                           <C>                    <C>             
Cash Flows from Operating Activities:
   Net income                                                                 $          459,087      $       256,420
   Change in assets and liabilities:              
     Equity in earnings of subsidiaries                                                 (405,680)            (232,884)
     Increase (decrease) in accounts payable                                              (2,838)              14,838
     Increase in other assets                                                            (19,409)                --
                                                                            -----------------------------------------
       Net cash provided by operating activities                                          31,160               38,374
                                                                            -----------------------------------------
Cash Flows from Investing Activities:
 Investment in AA&G, Inc.                                                                   --                (15,000)
                                                                            -----------------------------------------
Cash Flows from Financing Activities:
 Capitalization by AF Bankshares, Inc. and Subsidiary                                       --                100,000
                                                                            -----------------------------------------
Net increase in cash                                                                      31,160              123,374
 Cash - beginning                                                                        123,374                 --
                                                                            -----------------------------------------
 Cash - ending                                                                 $         154,534      $       123,374
                                                                            =========================================
</TABLE>

                                       50

<PAGE>


AF BANKSHARES, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 19. RECENT ACCOUNTING PRONOUNCEMENTS

The FASB has issued  SFAS No. 130,  Reporting  Comprehensive  Income,  which the
Company has not been required to adopt as of June 30, 1998. The Statement, which
is effective for fiscal years  beginning  after  December 15, 1997,  establishes
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.

                                       51

<PAGE>
A F BANKSHARES, INC.
CORPORATE INFORMATION
<TABLE>
<CAPTION>

                                    OFFICERS

<S>                                                      <C>
JAMES A. TODD, President and                             MELANIE PAISLEY MILLER, Senior Vice President,
  Chief Executive Officer                                  Secretary/Treasurer, CFO

MARTIN G. LITTLE, Senior Vice President                  PAMELA S. BARKER, Vice President

JAMES R. WALKER, Vice President                          LINDA H. WOODIE, Vice President

CHRISTOPHER J. HARTLEY, Assistant Vice
President                                                MARSHA B. GREENE, Vice President

ROBIN J. CARTER, Assistant Vice President                GARY E. JOINES, Vice President

MICHELLE T. COX, Assistant Secretary                     MICHAEL R. JOHNSON, Vice President

ROBIN D. STEPHENS, Assistant Secretary                   MARIE P. PARKER, Assistant Vice President

BARBARA E. SHUMATE, Assistant Secretary                  SANDY B. BROWN, Assistant Secretary

KIMBERLY W. OSBORNE,  Assistant Secretary                ANGELA S. ROTEN, Assistant Secretary

                                                         LINDA D. MATEJ, Assistant Secretary

                                    DIRECTORS

JAN R. CADDELL, Chairman                                 KENNETH R. GREENE, Vice Chairman

JAMES A. TODD                                            JOHN D. WEAVER

JERRY L. ROTEN                                           WAYNE R. BURGESS

W. O. ASHLEY, JR.                                        FRANK E. ROLAND
</TABLE>


                                       52

<PAGE>


CORPORATE INFORMATION (CONTINUED)
<TABLE>
<CAPTION>
                                     OFFICES

<S>                                                      <C>
Corporate Offices                                        West Jefferson Office

206 S. Jefferson Avenue                                  205 S. Jefferson Avenue

West Jefferson, North Carolina 28694                     West Jefferson, North Carolina 28694


Jefferson Office                                         Warrensville Office

840 E. Main Street                                       4951 NC Hwy 88 West

Jefferson, North Carolina 28640                          Warrensville, North Carolina 28693


Sparta Office-d/b/a Alleghany First Bank                 North Wilkesboro Office- AF Insurance

403 South Main                                           Services, Inc. only

Sparta, NC  28675                                        1347 West D Street

                                                         North Wilkesboro, NC  28659



         STOCK TRANSFER AGENT                                        LEGAL COUNSEL

ChaseMellon Sharholders Services, LLC                    Vannoy & Reeves

Overpeck Centre                                          306 East Main Street

85 Challenger Road                                       West Jefferson, North Carolina 28694

Ridgefield Park, New Jersey 07660

                                                         Thacher Proffitt & Wood

            AUDITORS                                     1700 Pennsylvania Avenue

McGladrey & Pullen, LLP                                  Washington, DC 20006

One Morrocroft Centre

6805 Morrison Boulevard, Suite 200                                       FORM 10-KSB

Charlotte, North Carolina 28211                          A copy of Form 10-KSB as filed with the

                                                         Office of Thrift Supervision will be

          ANNUAL MEETING                                 furnished without charge to shareholders upon

The 1998 annual meeting of stockholders of               written request to James A. Todd, President, AF

AF Bankshares, Inc. will be held on November 2,          Bankshares, Inc., 206 S. Jefferson Avenue,

1998 at 6:00 p.m. at the Corporate Office,               P. O. Box 26, West Jefferson, NC 28694.

206 S. Jefferson Avenue, West Jefferson,

North Carolina.
</TABLE>


                                       53
<PAGE>


COMMON STOCK

The Company had 1,053,678 shares of common stock outstanding at August 31, 1998,
which are held by 471  shareholders  of record.  The majority of the outstanding
shares are held by the mutual holding company AsheCo. MHC. The remaining 515,457
shares are owned by minority  shareholders  including the Company's ESOP. Shares
are quoted on the OTC Electronic Bullentin 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, 1998 and
1997.  For further  information  regarding  the  Company's  dividend  policy and
restrictions  on  dividends  paid,  please  refer to note 7 of the  notes to the
financial  statements.  Stock prices reflect bid prices between  broker-dealers,
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.


<TABLE>
<CAPTION>
                                                   STOCK PRICE
1998:                       DIVIDENDS        HIGH             LOW
-------------------------  --------------- ------------- -----------------
<S>                        <C>               <C>           <C>      
First Quarter              $   0.05        $   17.00       $   10.50

Second Quarter                 0.05            19.00           16.50

Third Quarter                  0.05            21.00           19.25

Fourth Quarter                 0.05            22.00           20.00
</TABLE>


<TABLE>
<CAPTION>
                                                   STOCK PRICE
1997:                         DIVIDENDS       HIGH             LOW
-------------------------  --------------- ------------- -----------------
<S>                        <C>              <C>            <C>    
First Quarter              $    -           $   -          $     -

Second Quarter                  -             12.00           10.75

Third Quarter                 0.05            13.63           11.25

Fourth Quarter                0.05            14.50           10.50
</TABLE>



DISCLAIMER:  This statement has not been reviewed,  or confirmed for accuracy or
relevance, by the Office of Thrift Supervision.