Securities and Exchange Commission
                             Washington, D.C. 20549


                                   FORM 10-KSB


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


                     For the fiscal year ended June 30, 2000

                          Commission File No.: 0-24479

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


      Federally Chartered                                   56-2098545
    State of Incorporation                             IRS Employer Number

                               21 East Ashe Street
                      West Jefferson, North Carolina 28694
                    (Address of Principal Executive Offices)

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

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

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

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

     Indicate by check mark there is no disclosure of delinquent filers pursuant
to Item 405 of  Regulation  S-B  contained  herein or any amendment to this Form
10-KSB. /X/

     The  revenues  for the  issuer's  fiscal  year  ended  June  30,  2000  are
$11,214,209.

     The issuer had 1,049,378  shares of common stock  outstanding  as of August
31, 2000. The aggregate value of the voting stock held by  non-affiliates of the
issuer, computed by reference to the price at which the common stock was sold on
August 31, 2000 was $8.75.

     Transitional Small Business Disclosure Format. Yes / / No /X/
                      DOCUMENTS INCORPORATED BY REFERENCE.
     Portions of the Annual Report to  Stockholders  for the year ended June 30,
2000 are incorporated by reference into Part I and II of this Form 10-KSB.

     Portions of the Proxy Statement for the 2000 Annual Meeting of Stockholders
are incorporated by reference into Part III of this Form 10-KSB.


<PAGE>


                                TABLE OF CONTENTS

<TABLE>
<S>                  <C>                                                                                       <C>
PART I
         ITEM 1.     DESCRIPTION OF BUSINESS......................................................................1
         ITEM 2.     PROPERTIES..................................................................................31
         ITEM 3.     LEGAL PROCEEDINGS...........................................................................32
         ITEM 4.     SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.........................................32

PART II
         ITEM 5.     MARKET FOR COMMON STOCK AND RELATED STOCKHOLDER MATTERS.....................................32
         ITEM 6.     MANAGEMENT'S DISCUSSION AND ANALYSIS........................................................32
         ITEM 7.     FINANCIAL STATEMENTS........................................................................32
         ITEM 8.     CHANGES IN AND DISAGREEMENT WITH ACCOUNTANTS ON ACCOUNTING
                     AND FINANCIAL DISCLOSURE....................................................................33

PART III
         ITEM 9.     DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS................................33
         ITEM 10.    EXECUTIVE COMPENSATION......................................................................33
         ITEM 11.    SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT..............................33
         ITEM 12.    CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS..............................................33
         ITEM 13.    EXHIBITS AND REPORTS ON FORM 8-K............................................................33


SIGNATURES.......................................................................................................35
</TABLE>



<PAGE>


                                     PART I


ITEM 1.  DESCRIPTION OF BUSINESS

GENERAL

     AF Bankshares,  Inc. (the "Company") is a federally chartered stock holding
company  which owns 100% of the common stock of AF Bank (the  "Bank"),  formerly
Ashe Federal  Bank,  AF Insurance  Services,  Inc.  and AF  Brokerage,  Inc. The
Company  has no  operations  and  conducts  no  business  of its own other  than
ownership  of its  subsidiaries  and  investing  in  securities.  The  Bank is a
federally  chartered  stock savings bank which  conducts  business from its main
office located in West Jefferson,  North  Carolina,  branches in West Jefferson,
Jefferson and Warrensville,  North Carolina  operating under the trade name Ashe
Federal Bank; one branch in Alleghany County, North Carolina operating under the
trade name Alleghany First Bank and one branch in Watauga County, North Carolina
operating under the trade name  Appalachian  First Bank. The Bank was founded in
1939 as a building and loan association.  In the early 1980s, the Bank converted
from a North  Carolina  chartered  building  and loan to a  federally  chartered
mutual  savings  and loan  association,  and in  August of 1995  converted  to a
federally  chartered  mutual  savings bank.  During  fiscal year 1997,  the Bank
converted  from  a  federally  chartered  mutual  savings  bank  to a  federally
chartered stock savings bank which is majority owned by AsheCo, M.H.C., a mutual
holding company.  On June 16, 1998, the Bank completed its reorganization into a
two-tier  mutual  holding  company and became a wholly owned  subsidiary  of the
Company.  See "Management's  Discussion and Analysis -- The Reorganization." The
Bank's deposits are insured by the Savings  Association  Insurance Fund ("SAIF")
of the Federal Deposit Insurance  Corporation (the "FDIC") to the maximum extent
permitted by law. At June 30, 2000, the Bank had total assets of $133.4 million,
total deposits of $102.7 million and equity of $12.5 million.

     The  historical  operations  of the  Company  have been that of a portfolio
mortgage  lender,  providing  fixed rate loans for the residents of Ashe County,
North Carolina.  Management has recently expanded the market area of the Company
to include  Alleghany and Watauga counties and has diversified its product lines
by  engaging in  non-mortgage  lending and  offering  non-traditional  financial
services,  such as insurance and brokerage  products.  More specifically,  since
1996,  the  Company has made a major  commitment  to small  business  commercial
lending  and  consumer  lending  as a means to  increase  the  yield on its loan
portfolio  and  attract  lower  cost  deposit  accounts.  As a  result  of  this
commitment,  commercial  loans  increased  by 163.0%  and  consumer  loans  have
increased  by 109.8%  since June 30, 1998.  In  addition,  since July 1997,  the
Company has offered traditional property and casualty, life and health insurance
products through AF Insurance Services,  Inc., a wholly-owned  subsidiary of the
Company,  which operates under the trade name AF Ashelande  Insurance Service in
West  Jefferson,  AF Brown  Insurance  Agency in Wilkesboro,  AF Blair Insurance
Agency in Lenoir,  AF Insurance  Services,  Inc. in Sparta,  West  Jefferson and
Jefferson, and AF Insurance Service Center in Elkin, North Carolina. The Company
also has a brokerage subsidiary,  operating as AF Brokerage, Inc., which serves,
Ashe,  Alleghany,  Wilkes and Watauga  counties.  AF  Brokerage  offers  various
uninsured investment  products,  including fixed-rate and variable annuities and
mutual  funds.  The Company  believes  that its strategy of expanding its market
area and  diversifying  its product lines will enhance its  franchise  value and
strengthen earnings in the future.

     The Company's  operating results are primarily  dependent upon net interest
income, fees and charges and insurance  commissions.  Net interest income is the
difference  between interest earned on loans,  investments and  interest-earning
deposits  at other  financial  institutions  and the  interest  paid on  savings
deposits and borrowings of the company.  The primary  interest-earning  asset of
the Company is its mortgage loan  portfolio  representing  79.2% of total loans,
with approximately  36.0% of portfolio mortgage loans at fixed rates at June 30,
2000. The net interest  income of the Company is affected by changes in economic
conditions that influence  market  interest  rates.  This exposure to changes in
interest rates contributes to a moderate degree of interest rate risk because of
the negative  impact of increasing  rates to the Bank's  earnings and to the net
market value of its assets and liabilities.  Additionally,  the Company receives
fee  income  primarily  from loan  origination  fees,  late loan  payment  fees,
commissions  from  the sale of  credit  life,  accident  and  health  insurance,
insurance  commissions  generated  from the insurance  agency  subsidiary and in
payment for other  services  provided to the customer by the Company.  The major
non-interest costs to the Company include  compensation and benefits,  occupancy
and equipment and


                                       1

<PAGE>

data processing costs.  Other external factors that affect the operating results
of the Company include changes in government and accounting  regulations,  costs
of  implementing  information  technology,  and  changes  in  the  competition's
emphasis within the Company's market.

     As of June 30,  2000,  $86.2  million,  or 79.2% of the  Bank's  total loan
portfolio  consisted  of real  estate  loans.  Total loans at June 30, 2000 were
$114.0  million of which  $68.8  million or 63.3% were  secured by one-  to-four
family residences.  Total mortgage loans,  including construction loans, totaled
$86.2  million as of June 30,  2000.  Of that amount,  approximately  37.5% were
adjustable rate loans, or had remaining terms of 5 years of less. This change in
the  composition  of the mortgage  loan  portfolio  results  from the  Company's
strategy  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.

     The Bank also invests in consumer  loans and commercial  loans.  As of June
30, 2000, the Bank's  consumer loans and commercial  loan  portfolios were $27.8
million,  or 25.6% of total loans.  Commercial  loans totaled $10.5 million,  or
9.6% of the  Bank's  total  loan  portfolio.  The Bank  invests a portion of its
assets in debt and equity  securities  issued by the FHLB and the  Federal  Home
Loan Mortgage  Corporation (the "FHLMC") and began investing in  mortgage-backed
securities during fiscal 1996.  Mortgage-backed  securities totaled $3.2 million
or 2.4% of  total  assets  at June 30,  2000,  and  FHLB  and  FHLMC  securities
investments totaled $36.6 million, or 2.7%, of total assets at June 30, 2000.

REORGANIZATION

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

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

MARKET AREA AND COMPETITION

     During the year ended June 30, 1998, AsheCo, MHC's ownership of the company
decreased to 51.1% due to shares  issued  under the  recognition  and  retention
plan.  AsheCo,  MHC's  ownership  increased to 51.29% due to the  repurchase  of
shares held in treasury during the year ended June 30, 1999.

     Previously,  the Bank's  market area for deposit  gathering and lending has
been concentrated in Ashe County, North Carolina.  However,  management believes
that the Company  must expand its market base to build value for the Company and
its  shareholders.  In March  1998,  the  Company  opened a branch of AF Bank in
Alleghany  County and operates the branch under the trade name  Alleghany  First
Bank.  At the same time, an insurance  agency  branch of AF Insurance  Services,
Inc.,  was opened in the same location.  The staff of Alleghany  First came from
the local banking  community and is attuned to the needs and habits of Alleghany
citizens. The


                                       2
<PAGE>


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

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

     The Bank faces substantial competition for both the deposits it accepts and
the loans it makes.  Management  believes  that the Bank has the second  largest
deposit base in Ashe County,  and the second largest deposit base in the part of
Ashe County which  comprises its primary zip code,  28694.  Located  within Ashe
County are  branches  of six other  depository  institutions,  four of which are
commercial  banks and two of which are  credit  unions.  The Bank  competes  for
deposits  by  offering a variety of customer  services  and deposit  accounts at
competitive  interest  rates.  The Bank,  like its  competitors,  is affected by
general economic conditions, particularly changes in market interest rates, real
estate market values,  government policies and regulatory  authorities' actions.
Changes in the ratio of the demand for loans  relative  to the  availability  of
credit may affect the level of competition from financial institutions which may
have greater  resources than the Bank,  but which have not generally  engaged in
lending activities in the Bank's market area in the past, and from credit unions
that can expand into the Bank's  market area and compete for  customers  without
the level of taxation experienced by the Company.  Competition may also increase
as a result of the  lifting of  restrictions  on the  interstate  operations  of
financial institutions. See "--Regulation."

LENDING ACTIVITIES

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

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


                                       3
<PAGE>


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

<TABLE>
<CAPTION>
                                                                    AT JUNE 30,
                                                                    -----------
                                                2000                                              1999
                                   -------------------------------                   -------------------------------
                                                             % OF                                              % OF
                                   AMOUNT                    TOTAL                   AMOUNT                    TOTAL
                                   ------                    -----                   ------                    -----
<S>                           <C>                        <C>                     <C>                         <C>
                                                                (DOLLARS IN THOUSANDS)
Mortgage loans:
  One- to four-family...       $   68,813                   63.26%                 $ 48,433                    59.68%
  Multi-family..........            2,277                    2.09%                      316                     0.39%
  Non-residential.......            8,577                    7.89%                    2,068                     2.55%
  Land..................            2,440                    2.24%                    1,258                     1.55%
  Construction..........            4,059                    3.73%                    5,082                     6.26%
                               ----------                  ------                  --------                   ------
   Total mortgage loans.           86,166                   79.21%                   57,157                    70.43%
                               ----------                  ------                  --------                   ------

Other loans:
  Commercial............           10,456                    9.62%                   18,261                    22.50%
  Consumer loans........           17,376                   15.97%                   12,144                    14.96%
                               ----------                  ------                  --------                   ------
   Total other loans....           27,832                   25.59%                   30,405                    37.46%
                               ----------                  ------                  --------                   ------
  Gross loans...........          113,998                  104.80%                   87,562                   107.89%
                               ----------                  ------                  --------                   ------

Less:
  Undisbursed loan funds           3,993                     3.67%                    5,033                     6.20%
  Deferred loan fees....             248                     0.23%                      249                     0.31%
  Allowance for loan
   losses...............             979                     0.90%                    1,123                     1.38%
                               ----------                  ------                  --------                   ------
                                   5,220                     4.80%                    6,405                     7.89%
                               ----------                  ------                  --------                   ------
   Loans, net...........       $ 108,778                   100.00%                 $ 81,157                   100.00%
                               ==========                  ======                  ========                   ======
Loans serviced for
others:
  One-to four-family and
   cooperative apartment.      $  22,613                   100.00%                 $ 20,657                   100.00%
                               ----------                  ------                  --------                   ------
    Total loans serviced
      for others.........      $  22,613                   100.00%                 $ 20,657                   100.00%
                               ==========                  ======                  ========                   ======
</TABLE>


                                       4
<PAGE>
     Loan  Maturity.  The  following  table  shows  the  maturity  or  period to
repricing  of the  Bank's  loan  portfolio  at June 30,  2000.  Loans  that have
adjustable  rates are shown using scheduled  principal  amortization.  The table
does not consider estimated prepayments of principal.

<TABLE>
<CAPTION>
                                                                             AT JUNE 30, 2000
                                                                              MORTGAGE LOANS
                                                                             ----------------
                                        ONE- TO
                                         FOUR-     MULTI-      NON-                               COMMERCIAL   CONSUMER      TOTAL
                                        FAMILY     FAMILY   RESIDENTIAL     LAND    CONSTRUCTION     LOANS       LOANS       LOANS
                                        -------    ------   -----------     ----    ------------  ----------   --------      -----
                                                                              (IN THOUSANDS)
<S>                                     <C>       <C>         <C>         <C>         <C>          <C>          <C>        <C>
Amount due:
   One year or less................     $21,641    $  813     $  1,257    $  694      $   4,059    $  7,660    $  3,467    $ 39,591
                                        -------    ------   -----------    -----    ------------  ----------   --------    --------
 After one year:
   One to three years..............       4,941       358        2,331       290              0         812       7,633      16,365
   More than three years to five
     years.........................      12,809       190        2,230       467              0         981       3,549      20,226
   More than five years to ten
     years.........................       8,625       836        1,039       375              0         948       2,218      14,041
   More than ten years to
     twenty years..................      17,858        80        1,634       297              0          55         509      20,433
   Over twenty years...............       2,939         0           86       317              0           0           0       3,342
                                        -------    ------   -----------    -----    ------------  ----------   --------    --------
 Total due or repricing after one
   year............................      47,172     1,464        7,320     1,746              0       2,796      13,909      74,407
                                        -------    ------   -----------    -----    ------------  ----------   --------    --------
 Total amounts due or repricing,
   gross...........................     $68,813   $ 2,277     $  8,577    $2,440      $   4,059    $ 10,456     $17,376    $113.998
                                        =======    ======   ===========    =====    ============  ==========   ========    ========
</TABLE>

     The following  table sets forth the dollar amounts in each loan category at
June 30,  2000 that are due after June 30,  2001,  and  whether  such loans have
fixed or adjustable interest rates.

<TABLE>
<CAPTION>
                                                                     DUE AFTER JUNE 30, 2001
                                                                     -----------------------
                                                         FIXED              ADJUSTABLE                TOTAL
                                                         -----              ----------                -----
<S>                                                   <C>                 <C>                     <C>
                                                                           (IN THOUSANDS)
Mortgage loans:
  One- to four-family.......................          $ 39,923              $   7,249              $  47,172
  Multi-family..............................             1,244                    220                  1,464
  Non-residential...........................             7,320                      0                  7,320
  Land......................................               812                    934                  1,746
Commercial loans............................               919                  1,877                  2,796
Consumer loans..............................            13,277                    632                 13,909
                                                      --------              ---------              ---------
                                                      $ 63,495              $  10,912              $  74,407
                                                      ========              =========              =========
</TABLE>

     Origination,  Purchase,  Sale and  Servicing of Loans.  The Bank's  lending
activities  are  conducted  through its branches in Ashe,  Alleghany and Watauga
counties,  North Carolina.  The Bank originates both  adjustable-rate  loans and
fixed-rate  mortgage  loans for portfolio and for sale in the secondary  market.
Adjustable-rate  mortgage  loans  carried in portfolio and  fixed-rate  mortgage
loans carry  maximum  maturities of 30 years and 15 years,  respectively.  Fixed
rate loans originated for sale in the secondary  market have maximum  maturities
of 30  years.  Historically,  the  Bank  held  for its  portfolio  all  loans it
originated. The Bank now sells all qualified fixed-rate loans to Fannie Mae, but
retains the  servicing  rights.  The  determination  to sell loans is based upon
management's  efforts to reduce  interest rate risk. At June 30, 2000,  the Bank
serviced approximately $22.6 million of loans for Fannie Mae.

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

                                       5
<PAGE>


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

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

     Construction  Lending. The Bank originates  construction loans primarily to
finance construction of one- to four-family homes to the individuals who will be
the owners and occupants upon  completion of  construction  in the Bank's market
area.  At June 30, 2000,  that Bank's  portfolio  contained  approximately  $4.1
million,  or 3.7%, of construction  loans. The Bank's policy is to disburse loan
proceeds as construction  progresses and as periodic inspections warrant.  These
loans are made primarily to the individuals who will ultimately occupy the home,
and are  structured to guarantee  the  permanent  financing to the Bank as well.
Thus construction loans typically "roll" into permanent financing.  Construction
loans are made for a maximum of 12 months,  by which  time  permanent  financing
must be obtained.

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

     Non-Residential  Mortgage  Lending.  The Bank  originates  commercial  real
estate mortgage loans that are generally secured by properties used for business
purposes and retail facilities, such as small office buildings and church loans.
The Bank's underwriting  procedures provide that non-residential  mortgage loans
may be made,  based on debt  service  coverage or in amounts up to the lesser of
(i) 80% of the lesser of the appraised  value or purchase  price of the property
or  (ii)  the  Bank's  current  loans-to-one-borrower  limit.  These  loans  are
generally  originated as three to five year call loans with amortization periods
of up to 15 years. The Bank considers factors such as the borrower's  expertise,
credit history, profitability,  cash flow, and the value of the collateral while
underwriting these loans. At June 30, 2000, the Bank's non-residential  mortgage
loan portfolio was $8.6 million, or 7.9% of total loans outstanding. The largest
non-residential  mortgage  loan in the  Bank's  portfolio  at June 30,  2000 was
approximately $1.5 million and is secured by a commercial property.

     Mortgage  loans  secured by  non-residential  properties  can be larger and
therefore may involve a greater  degree of credit risk than one- to  four-family
residential   mortgage  loans.  This  risk  is  attributable  to  the  uncertain
realization  of  projected  income-producing  cash flows  which are  affected by
vacancy rates, the ability to maintain rent levels against  competitively-priced
properties  and the  ability to  collect  rent from  tenants on a timely  basis.
Because  payments  on loans  secured  by  non-residential  properties  are often
dependent on the successful operation


                                       6
<PAGE>


or  management  of the  properties,  repayment of such loans may be subject to a
greater  extent to adverse  conditions in the real estate market or the economy.
The Bank seeks to minimize these risks through its underwriting standards, which
require  such loans to be qualified  on the basis of the  property's  income and
debt service ratio.

     Other  Mortgage  Lending.  The Bank also offers  loans  secured by land and
multi-family  residences.  Land loans generally consist of residential  building
lots  for  which  the  borrower  intends  to  ultimately  construct  residential
properties,  but may also include tracts  purchased for  agricultural  use and a
minor amount for speculative  purposes.  Multi-family loans generally consist of
residential  properties  with more than four units,  typically  small  apartment
complexes,  located in the Bank's  primary  lending area. At June 30, 2000,  the
Bank's total land loan portfolio was $2.4 million or 2.2% of total loans and its
multi-family loan portfolio was $2.3 million or 2.1% of total loans.

     The  Bank  requires  appraisals  of  all  mortgage  loans.  Appraisals  are
performed by  independent  appraisers  designated by the Bank. The appraisals of
such  properties  are then reviewed by the Bank's  management.  The  independent
appraisers used by the Bank are reviewed annually by management and the Board of
Directors.

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

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

     Consumer Loans.  Subject to the restrictions  contained in federal laws and
regulations,  the Bank also is  authorized  to make loans for a wide  variety of
personal or consumer purposes.  As of June 30, 2000, $17.4 million, or 16.0%, of
the Bank's total loan  portfolio  consisted of consumer  loans  (including  home
equity credit line loans and second mortgage  loans).  The primary  component of
the Bank's  consumer  loan  portfolio  was $9.3 million of auto loans.  Consumer
loans are available at fixed or variable interest rates.

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

     As of June  30,  2000,  the  Bank  had no  non-performing  consumer  loans.
Charge-offs for consumer loans totaled  $194,000 and $37,000 for the years ended
June 30, 2000 and 1999, respectively.

     The Bank  also  offers  loans  secured  by  savings  accounts  at the Bank.
Interest  rates  charged  on such  loans  are  tied to the  prime  rate  and are
available  in amounts  up to 90% of the value of the  account.  Savings  account
loans are reviewed and approved in  conformity  with  standards  approved by the
Bank's Board of Directors.  At June 30, 2000,  the Bank's  savings  account loan
portfolio totaled $367,000 or 0.32% of the total loans outstanding.

     The Bank offers  adjustable rate home equity credit lines tied to the prime
interest rate. The home equity portfolio amounted to $4.7 million or 4.1% of the
total  loan  portfolio  as of June 30,  2000.  The home  equity  credit  line is
available  on  any  owner-occupied   one-to-four  family  home,  townhouse,   or
condominium in the Bank's  lending area provided the homeowner  meets the Bank's
lending  criteria.  A home equity loan is an adjustable  rate mortgage  which is
based on the equity in the home,  and is generally  secured by a first or second
mortgage on the


                                       7
<PAGE>


residence.  The  current  maximum  term is 180  months.  The Bank may offer home
equity  loans up to 100% of the value of the  collateral  to  certain  customers
meeting a higher level of credit criteria.

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

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

     As of June 30,  2000,  the Bank had $286,000 of  non-performing  commercial
business loans.  Charge-offs for commercial  business loans totaled $115,000 for
the year  ended  June 30,  2000.  The Bank had no  charge-offs  with  respect to
commercial business loans in the year ended June 30, 1999.

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

     For all loans  originated  by the Bank,  upon  receipt of a completed  loan
application from a prospective  borrower, a credit report is ordered and certain
other  information  supporting the borrower's  ability to repay is required.  An
appraisal performed by a Bank approved independent appraiser is required for all
real property  intended to secure the proposed loan. The Board annually approves
the independent  appraisers  used by the Bank and approves the Bank's  appraisal
policy.  It is the Bank's  policy to obtain  title  insurance on all real estate
loans of $50,000 or more and hazard insurance on all improved real estate loans.
In connection  with a borrower's  request for a renewal of a mortgage  loan, the
Bank evaluates both the borrower's  ability to service the renewed loan applying
an interest rate that reflects  prevailing  market conditions and the customer's
payment history, as well as the value of the underlying collateral property.

ASSET QUALITY

     Non-Performing  Loans.  Loans are considered  non-performing if they are in
foreclosure  or are 90 or more  days  delinquent.  Management  and the  Board of
Directors perform a monthly review of all delinquent loans. The actions taken by
the Bank with respect to delinquencies  vary depending on the nature of the loan
and period of delinquency. The Bank's policies generally provide that delinquent
mortgage  loans be reviewed and that a written  late charge  notice be mailed no
later  than  the 17th day of  delinquency.  The  Bank's  policies  provide  that
telephone  contact  and  further  written  notification  will  be  attempted  to
ascertain  the reasons for  delinquency  and the  prospects of  repayment.  When
contact is made with the  borrower  at any time prior to  foreclosure,  the Bank
attempts  to obtain  full  payment  or work out a  repayment  schedule  with the
borrower to avoid foreclosure.


                                       8
<PAGE>


     It is the Bank's general policy to reserve all accrued  interest due on all
loans that are 90 days or more past due.

     Real Estate Owned. Property acquired by the Bank as a result of foreclosure
on a mortgage loan is classified as real estate owned ("REO"). At June 30, 2000,
the Bank held $289,000 in REO, while non-performing loans, defined as loans that
are 90 days or more delinquent,  totaled  $411,000.  The Bank's REO is initially
recorded  at the fair value of the  related  assets at the date of  foreclosure.
Thereafter,  if there is a further  deterioration in value, the Bank provides an
REO valuation  allowance and charges operations for the diminution in value less
cost to sell.  It is the policy of the Bank to obtain an  appraisal  on all real
estate acquired through  foreclosure as soon as practicable  after it determines
that foreclosure is imminent.  The Bank generally reassesses the value of REO at
least annually thereafter. The policy for loans is to establish loss reserves in
accordance  with the Bank's  asset  classification  process,  based on Generally
Accepted Accounting Principles ("GAAP").



















                                       9
<PAGE>


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

<TABLE>
<CAPTION>
                                                                       AT JUNE 30,
                                                                       -----------
                                                         2000                              1999
                                                         ----                              ----
<S>                                                    <C>                               <C>
                                                                 (DOLLARS IN THOUSANDS)
Non-accrual mortgage loans:
    One- to four-family.......................         $  125                            $   52
    Multi-family..............................             --                                --
    Non-residential...........................             --                                --
    Land......................................             --                                --
    Construction..............................             --                                --
                                                       ------                            ------
        Total mortgage loans..................            125                                52
                                                       ------                            ------
    Commercial................................            286                                --
    Consumer Loans............................             --                                 8
                                                       ------                            ------
      Total non-accruing loans................         $  411                            $   60
                                                       ------                            ------
Loans delinquent 90 or more days for which
  interest is fully reserved and still
  accruing:
    One- to four-family.......................         $   --                            $   --
    Multi-family..............................             --                                --
    Non-residential...........................             --                                --
    Land......................................             --                                --
    Construction..............................             --                                --
                                                       ------                            ------
       Total mortgage loans...................             --                                --
                                                       ------                            ------
    Commercial................................             --                                --
    Consumer Loans............................             --                                --
                                                       ------                            ------
Total loans delinquent 90 or more days for
  which interest has been fully reserved......             --                                --
                                                       ------                            ------
Total non-performing loans....................         $  411                            $   60
                                                       ------                            ------

Total real estate owned.......................            289                                59
                                                       ------                            ------

    Total non-performing assets...............         $  700                            $  119
                                                       ------                            ------

Total non-performing loans to loans, gross....           0.36%                             0.07%
Total non-performing assets to total assets...           0.53%                             0.11%
</TABLE>


     Classified  Assets.  Federal  regulations and the Bank's  Classification of
Assets Policy require the Bank to use an internal asset classification system as
a means  of  reporting  problem  and  potential  problem  assets.  The  Bank has
incorporated  the OTS  internal  asset  classifications  as a part of its credit
monitoring system.  The Bank currently  classifies problem and potential problem
assets as "Special  Mention,"  "Substandard,"  "Doubtful" or "Loss"  assets.  An
asset is considered "Substandard" if it is inadequately protected by the current
equity and paying capacity of the obligor or of the collateral  pledged, if any.
"Substandard"  assets include those characterized by the "distinct  possibility"
that the insured  institution  will sustain "some loss" if the  deficiencies are
not  corrected.  Assets  classified  as  "Doubtful"  have all of the  weaknesses
inherent in those classified  "Substandard" with the added  characteristic  that
the weaknesses present make "collection or liquidation in full," on the basis of
currently


                                       10
<PAGE>


existing facts,  conditions,  and values,  "highly questionable and improbable."
Assets  classified as "Loss" are those  considered  "uncollectible"  and of such
little value that their  continuance  as assets without the  establishment  of a
specific loss reserve is not warranted. Assets which do not currently expose the
insured  institution to sufficient risk to warrant  classification in one of the
aforementioned  categories but possess  weaknesses are required to be designated
"Special Mention."

     The Bank's management  reviews and classifies the Bank's assets monthly and
reports the results to the Bank's  Board of Directors  on a monthly  basis.  The
Bank classifies  assets in accordance with the management  guidelines  described
above.  At June  30,  2000,  the Bank  had  $555,000  of  assets  classified  as
Substandard,  $40,000  of  assets  designated  as  Special  Mention,  no  assets
classified as Loss and no assets classified as Doubtful.

     Allowance  for Loan  Losses.  The  Allowance  for Loan  Losses  ("ALL")  is
established through a provision for loan losses based on management's evaluation
of the risks inherent in the Bank's loan portfolio and the general economy.  The
ALL is  maintained  at an amount  management  considers  adequate  to cover loan
losses which are deemed  probable and  estimable.  The allowance is based upon a
number of factors,  including asset classifications,  economic trends,  industry
experience  and  trends,  industry  and  geographic  concentrations,   estimated
collateral  values,  management's  assessment of the credit risk inherent in the
portfolio,   historical  loan  loss  experience,  and  the  Bank's  underwriting
policies. At June 30, 2000, the Bank's ALL was $979,000, or 0.9% of total loans,
as  compared  to  $1.1  million  or  1.3%,  at  June  30,  1999.  The  Bank  had
non-performing loans of $411,000 and $60,000 at June 30, 2000 and June 30, 1999,
respectively. The Bank will continue to monitor and modify its ALL as conditions
dictate.  Various regulatory agencies,  as an integral part of their examination
processes,  periodically  review the Bank's ALL.  These agencies may require the
Bank to establish additional valuation  allowances,  based on their judgments of
the information available at the time of the examination.











                                       11
<PAGE>


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

<TABLE>
<CAPTION>
                                                                  AT OR FOR THE YEAR ENDED JUNE 30,
                                                                  ---------------------------------
                                                                 2000                          1999
                                                                 ----                          ----
<S>                                                           <C>                         <C>
                                                                         (DOLLARS IN THOUSANDS)
Total loans outstanding at end of period............         $   113,998                   $    87,562
Average total loans outstanding.....................             100,228                        76,597

Balance at beginning of year........................               1,123                         1,164
                                                             -----------                   -----------
Provision for loan losses...........................                  88                            20
                                                             -----------                   -----------
Charge-offs:
   One- to four-family residential..................                 (19)                           (4)
   Multi-family residential.........................                  --                            --
   Non-residential and land.........................                  --                           (33)
   Construction.....................................                  --                            --
   Commercial.......................................                (115)                           --
   Consumer loans...................................                (194)                          (37)
                                                             -----------                   -----------
     Total charge-offs..............................                (328)                          (74)
                                                             -----------                   -----------

Recoveries..........................................                  96                            13
                                                             -----------                   -----------

Balance at end of year..............................         $       979                   $     1,123
                                                             ===========                   ===========

Allowance for loan losses to total loans
  at end of period..................................                0.86%                        1.28%
                                                             ===========                   ===========

Allowance for loan losses to total non-performing
   assets at end of period..........................              139.86%                      943.70%
                                                             ===========                   ===========

Allowance for loan losses to total non-performing
   loans at end of period...........................              238.20%                     1,871.14%
                                                             ===========                   ===========

Ratio of net charge-offs during the period
   To average loans outstanding during period.......                0.23%                         0.08%
                                                             ===========                   ===========
</TABLE>




                                       12
<PAGE>


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

<TABLE>
<CAPTION>
                                                               AT JUNE 30,
                                                               -----------
                                         2000                                             1999
                                         ----                                             ----
                                                       PERCENT OF                                       PERCENT OF
                                                        LOANS IN                                         LOANS IN
                                      PERCENT OF          EACH                          PERCENT OF         EACH
                                       ALLOWANCE        CATEGORY                         ALLOWANCE       CATEGORY
                       ALLOWANCE        TO TOTAL         TO TOTAL       ALLOWANCE         TO TOTAL        TO TOTAL
                        AMOUNT         ALLOWANCE          LOANS           AMOUNT         ALLOWANCE         LOANS
                        ------        -----------      ----------       ---------       ----------       ----------
<S>                   <C>            <C>              <C>             <C>              <C>              <C>
                                                        (DOLLARS IN THOUSANDS)
Mortgage loans:
  One- to
   four-family....     $  559             57.10%           60.37%         $  456            40.61%           55.32%
  Multi-family....         15              1.53%            2.00%             10             0.89%            0.36%
  Non-residential
   and land.......         60              6.13%            9.66%             61             5.43%            3.80%
  Construction....         19              1.94%            3.56%             14             1.25%            5.80%
Other:
  Consumer.....           255             26.05%            9.17%            442            39.36%           13.87%
  Commercial...            71              7.25%           15.24%            140            12.46%           20.85%
                        ------        -----------      ----------       ---------       ----------       ----------
  Total........        $  979            100.00%          100.00%         $1,123           100.00%          100.00%
                        ======        ===========      ==========       =========       ==========       ==========
</TABLE>


INVESTMENT ACTIVITIES

         The Bank's  investment  policy permits it to invest in U.S.  government
obligations,  certain  securities of various  government-sponsored  agencies and
municipal obligations, including mortgage-backed securities issued/guaranteed by
Fannie Mae, the FHLMC and the Government National Mortgage Association ("GNMA"),
certificates  of deposit of  insured  banks,  federal  funds,  mutual  funds and
overnight  deposits at the FHLB. At June 30, 2000, the Bank held $9.8 million in
investment securities.

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

<TABLE>
<CAPTION>
                                                                         FOR THE YEAR ENDED JUNE 30,
                                                                         ----------------------------
                                                                         2000                    1999
                                                                         ----                    ----
  <S>                                                                <C>                    <C>
                                                                                (IN THOUSANDS)
     Amortized cost at beginning of period..................         $  11,464              $    8,533
     Purchases, net.........................................              (228)                  4,122
     Principal payments from mortgage backed securities.....            (1,387)                 (1,333)
     Gain on sales..........................................                95                     166
     Premium and discount amortization, net.................               (62)                    (24)
                                                                    ----------              ----------
     Amortized cost at end of period........................             9,882                  11,464
     Net unrealized gain(1).................................               (47)                    334
     Total securities, net..................................        $    9,835              $   11,798
                                                                    ==========              ==========
</TABLE>

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


                                       13
<PAGE>

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

<TABLE>
<CAPTION>
                                                                    AT JUNE 30,
                                                                    -----------
                                                   2000                                    1999
                                                   ----                                    ----
                                      AMORTIZED                                AMORTIZED
                                        COST             FAIR VALUE              COST            FAIR VALUE
                                        ----             ----------              ----            ----------
<S>                                 <C>                 <C>                  <C>                <C>
                                                                     (IN THOUSANDS)
Mortgage-backed securities:
  Fannie Mae and Government
  National Mortgage Association...    $  3,205            $ 3,155               $ 4,626            $  4,672
                                      --------            --------              -------             -------
Other debt securities:
  U.S. Treasury and Agency........       4,515              4,428                 4,624               4,589
  Other...........................         382                370                   480                 459
                                      --------            --------              -------             -------
Total debt securities.............       4,897              4,798                 5,104               5,048
                                      --------            --------              -------             -------
Equity securities(1)..............       1,004              1,106                 1,210               1,554
Federal Home Loan Bank Stock......         776                776                   524                 524
Net unrealized gain (loss)(2).....         (47)                --                   334                  --
                                      --------            --------              -------             -------
Total securities, net.............    $  9,835            $ 9,835               $11,798             $11,798
                                      ========            =======               =======             =======
</TABLE>
-----------------------
(1)  Equity securities consist of FHLMC common stock.
(2)  The net  unrealized  gain  (loss)  at June 30,  2000 and  1999  relates  to
     available  for sale  securities  in  accordance  with SFAS No.115.  The net
     unrealized gain is presented in order to reconcile the "Amortized  Cost" of
     the Bank's securities portfolio in the "Carrying Cost," as reflected in the
     Statements of Financial Condition.

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

<TABLE>
<CAPTION>
                                                                       AT JUNE 30,
                                                                       -----------
                                                  2000                     1999                         1998
                                                  ----                     ----                         ----
                                         AMORTIZED                AMORTIZED                    AMORTIZED
                                           COST      FAIR VALUE     COST       FAIR VALUE        COST       FAIR VALUE
                                           ----      ----------     ----       ----------        ----       ----------
<S>                                     <C>         <C>          <C>          <C>             <C>          <C>
                                                                     (IN THOUSANDS)
Held to Maturity
   Other debt securities.............     $  100      $   100      $  100       $   100         $  100        $  100
                                          ------      -------      ------       -------         ------        ------
         Total held to maturity......        100          100         100           100            100           100
                                          ------      -------      ------       -------         ------        ------
Available-for-Sale:
   Mortgage-backed securities........      3,205        3,155       4,626         4,672          2,174         2,235
   Other debt securities:............      4,698        4,599       4,806         4,750          5,430         5,422
   Equity securities.................      1,004        1,106       1,210         1,554              7           438
   Net unrealized gain (loss) (1)....        (47)          --         334            --            484            --
                                          ------      -------      ------       -------         ------        ------
         Total available-for-sale....      8,860        8,860      10,976        10,976          8,095         8,095
                                          ------      -------      ------       -------         ------        ------

Certificates of deposit..............         99           99         198           198            198           198
                                          ------      -------      ------       -------         ------        ------
Federal Home Loan Bank Stock.........        776          776         524           524            624           624
                                          ------      -------      ------       -------         ------        ------

   Total securities, net.............     $9,835       $9,835     $11,798       $11,798         $9,017        $9,017
                                          ======       ======     =======       =======         ======        ======
</TABLE>

(1)  The net unrealized  gains (loss) at June 30, 2000,  1999 and 1998 relate to
     available  for sale  securities  in  accordance  with SFAS No. 115. The net
     unrealized  gain (loss) is presented in order to reconcile  the  "Amortized
     Cost"  of the  Bank's  securities  portfolio  in the  "Carrying  Cost,"  as
     reflected in the Statements of Financial Condition.

                                       14
<PAGE>


     The following table sets forth certain information  regarding the amortized
cost,  fair value and weighted  average  yield of the Bank's debt  securities at
June 30, 2000,  by remaining  period to  contractual  maturity.  With respect to
mortgage-backed  securities,  the entire  amount is  reflected  in the  maturity
period that includes the final security payment date and, accordingly, no effect
has been given to periodic repayments or possible prepayments.

<TABLE>
<CAPTION>
                                                                           AT JUNE 30, 2000
                                                                           ----------------
                                                      HELD-TO-MATURITY                           AVAILABLE FOR SALE
                                                      ----------------                           ------------------
                                                                       WEIGHTED                                   WEIGHTED
                                            AMORTIZED      FAIR         AVERAGE       AMORTIZED       FAIR         AVERAGE
                                              COST         VALUE         YIELD          COST          VALUE         YIELD
                                              ----         -----         -----          ----          -----         -----
<S>                                          <C>             <C>          <C>            <C>             <C>         <C>
                                                                       (DOLLARS IN THOUSANDS)
Debt Securities
Mortgaged-backed securities:
  Due within 1 year......................    $ --            $ --           --%          $   --          $   --        --%
  Due after 1 year but within 5 years....      --              --           --               64              65      7.29
  Due after 5 years but within 10 years..      --              --           --               --              --        --
  Due after 10 years.....................      --              --           --            3,141           3,090      6.71
                                             ----            ----                        ------          ------
         Total...........................      --              --           --            3,205           3,155      6.72
                                             ----            ----                        ------          ------
U.S. Treasury and Agency:
  Due within 1 year......................      --              --           --               --              --        --
  Due after 1 year but within 5 years....     100             100         5.50            3,270           3,220      5.77
  Due after 5 years but within 10 years..      --              --           --              500             492      7.55
  Due after 10 years.....................      --              --           --              645             616      5.85
                                             ----            ----                        ------          ------
         Total...........................     100             100         5.50            4,415           4,328      5.99
                                             ----            ----                        ------          ------
Corporate & Other:
  Due within 1 year......................      --              --           --               --              --        --
  Due after 1 year but within 5 years....      99              99         7.25               --              --        --
  Due after 5 years but within 10 years..      --              --           --               --              --        --
  Due after 10 years.....................      --              --           --              283             271      4.60
                                             ----            ----                        ------          ------
         Total...........................      99              99         7.25              283             271      4.60
                                             ----            ----                        ------          ------
Equity Securities........................      --              --           --            1,004           1,106        --
                                             ----            ----                        ------          ------
Total:
  Due within 1 year......................      --              --           --               --              --        --
  Due after 1 year but within 5 years....     199             199         6.37            3,334           3,285      5.80
  Due after 5 years but within 10 years..      --              --           --              500             492      7.55
  Due after 10 years.....................      --              --           --            4,069           3,977      6.45
  Equity Securities......................      --              --           --            1,004           1,106        --
                                             ----            ----                        ------          ------
                                              199             199         6.37            8,907           8,860      6.23
                                             ----            ----                        ------          ------
  Federal Home Loan Bank Stock...........     776             776           --               --              --        --
                                             ----            ----                        ------          ------
         Total...........................    $975            $975         6.37%          $8,907          $8,860      6.23%
                                             ====            ====                        ======          ======
</TABLE>


                                       15

<PAGE>

SOURCES OF FUNDS

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

     Deposits.  The Bank  offers a variety of deposit  accounts  with a range of
interest  rates and terms.  The Bank's  deposits  consist of regular  (passbook)
savings accounts,  checking accounts,  money market deposit accounts,  statement
savings  accounts,  IRAs and certificates of deposit.  In recent years, the Bank
has offered  certificates of deposit with maturities of up to 48 months. At June
30,  2000,  the Bank's core  deposits  (which the Bank  considers  to consist of
checking  accounts,  regular savings  accounts and statement  savings  accounts)
constituted  44.4%  of  total  deposits.  The  flow of  deposits  is  influenced
significantly  by general  economic  conditions,  changes in money market rates,
prevailing  interest  rates and  competition.  The Bank's  deposits are obtained
predominantly  from  Ashe,  Alleghany  and  Watauga  counties.  The Bank  relies
primarily on customer service and long-standing  relationships with customers to
attract and retain these  deposits;  however,  market  interest  rates and rates
offered by  competing  financial  institutions  significantly  affect the Bank's
ability to attract and retain deposits.

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

<TABLE>
<CAPTION>
                                                               FOR THE YEAR ENDED JUNE 30,
                                                               ---------------------------
                                                                2000                        1999
                                                                ----                        ----
                                                                           (IN THOUSANDS)
<S>                                                       <C>                         <C>
Total deposits at beginning of period,
  including accrued interest.......................       $  93,106                   $  82,488
Net increase before interest credited..............           5,505                       6,848
Interest credited..................................           4,069                       3,770
                                                          ---------                   ---------
Total deposits at end of period....................       $ 102,680                   $  93,106
                                                          =========                   =========
</TABLE>

     At June 30,  2000,  the  Bank  had  approximately  $17.1  million  in Jumbo
certificate of deposits (accounts in amounts over $100,000) maturing as follows:

<TABLE>
<CAPTION>
                                                                                            WEIGHTED
                                                      AMOUNT                              AVERAGE RATE
                                                      ------                              ------------
                                                                            (IN THOUSANDS)
<S>                                                    <C>                                  <C>
Maturity Period
   Within three months.......................          $   5,568                            5.81%
   After three but within six months.........              4,749                            5.99%
   After six but within 12 months............              4,720                            6.08%
   After 12 months...........................              2,044                            5.58%
                                                       ---------                            -----
                  Total......................          $  17,081                            5.89%
                                                       =========                            =====
</TABLE>


                                       16
<PAGE>

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

<TABLE>
<CAPTION>
                                                                           AT JUNE 30,
                                                                           -----------
                                                     2000                                               1999
                                                     ----                                               ----
                                                    PERCENT         WEIGHTED                           PERCENT
                                                   OF TOTAL          AVERAGE                          OF TOTAL
                                                   DEPOSITS           RATE            AMOUNT          DEPOSITS          AMOUNT
                                                   --------           ----            ------          --------          ------
                                                                     (DOLLARS IN THOUSANDS)
<S>                            <C>                  <C>                 <C>       <C>                 <C>                  <C>
Noninterest bearing
checking accounts.........     $  3,960               3.86%            0.00%      $ 3,914                4.20%               --%

Interest bearing checking/
Money Market accounts.....       18,589              18.10%            1.92%       15,425              16.57%              2.28%

Savings...................       23,032              22.43%            3.83%       21,841              23.46%              3.05%

Certificates of deposit...       56,937              55.45%            5.71%       51,788              55.62%              4.94%

Accrued interest..........          162               0.16%            0.00%           38               0.15%                --%
                               --------             -------            -----           --               -----              ----

        Totals                 $102,680             100.00%            4.34%      $93,106             100.00%              4.29%
                               ========             ======             =====      =======             ======               ====
</TABLE>

     The  following  table  presents,  by interest  rate  ranges,  the amount of
certificate accounts outstanding at June 30, 2000 and the period to maturity.

<TABLE>
<CAPTION>
                                         PERIOD TO MATURITY AT JUNE 30, 2000
                                         -----------------------------------
                                          LESS THAN             ONE TO              FOUR TO
       INTEREST RATE RANGE                ONE YEAR            THREE YEARS         FIVE YEARS           TOTAL
       -------------------                --------            -----------         ----------           -----
                                                                  (DOLLARS IN THOUSANDS)
<S>                                         <C>                  <C>                 <C>               <C>
4.00% to 5.99%                              $33,438              $5,261              $224              $38,923
6.01% to 7.99%..................             14,523               3,344               147               18,014
                                            -------              ------              ----              -------
              Total.............            $47,961              $8,605              $371              $56,937
                                            =======              ======              ====              =======
</TABLE>

     Borrowings.  The Bank  historically  has not used borrowings as a source of
funds.  However, the Bank may obtain advances from the FHLB as an alternative to
retail  deposit  funds  and may do so in the  future  as  part of its  operating
strategy.  These  advances would be  collateralized  primarily by certain of the
Bank's mortgage loans and secondarily by the Bank's  investment in capital stock
of the FHLB. See  "Regulation--Regulation of Federal Savings Banks--Federal Home
Loan Bank  System."  Such  advances  may be made  pursuant to several  different
credit  programs,  each  of  which  has its  own  interest  rate  and  range  of
maturities.   The  maximum   amount  that  the  FHLB  will   advance  to  member
institutions,  including  the Bank,  fluctuates  from time to time in accordance
with the  policies  of the OTS and the FHLB.  As of June 30,  2000,  the maximum
amount of FHLB advances  available to the Bank was $46.6  million.  The Bank had
short term advances of $15.5 million at June 30, 2000 from the FHLB. Interest is
payable at rates ranging from 6.13% to 6.95%. $4,000,000 of the advances are due
in June 2001,  $862,500 are due by August 2002,  $150,507 are due January  2007,
$5,000,000  are due August  2009,  and  $3,00,000  is due  September  2009.  The
remaining  $2,500,000 is an advance borrowed under the Daily Rate Credit Program
at the FHLB and has no maturity date.

SUBSIDIARY ACTIVITIES

     AF Insurance Services,  Inc., a wholly owned subsidiary of the Company, was
formed in July 1997 upon the purchase of two independent  insurance agencies for
the sole purpose of selling traditional  property and casualty,  life and health
insurance.  Additional  insurance  agencies were  purchased in April of 1999 and
December 1999. AF


                                       17
<PAGE>

Insurance  Services,  Inc. offers these services in a segregated location at the
Bank's executive offices, Sparta, Lenoir, Jefferson, North Wilkesboro and Elkin,
North Carolina.

AF BROKERAGE, INC.

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

PERSONNEL

     As of June 30, 2000, the Company had 81 full-time employees.  The employees
are not represented by a collective  bargaining  unit and the Company  considers
its relationship with its employees to be good. See "Executive Compensation" for
a description of certain compensation and benefit programs offered to the Bank's
employees.

                                   REGULATION

GENERAL

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

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

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

REGULATION OF FEDERAL SAVINGS BANKS

     Business  Activities.  The Bank derives its lending and  investment  powers
from  the  Home  Owner's  Loan  Act  ("HOLA")  and  the  regulations  of the OTS
thereunder.  Under these laws and  regulations,  the Bank may invest in mortgage
loans secured by residential  and  non-residential  real estate,  commercial and
consumer loans,  certain types of debt securities and certain other assets.  The
Bank may also establish  service  corporations that may engage in activities not
otherwise  permissible  for the  Bank,  including  certain  real  estate  equity
investments and securities and insurance brokerage.  These investment powers are
subject  to  various  limitations,  including  (a)  a  prohibition  against  the
acquisition  of any corporate debt security that is not rated in one of the four
highest rating  categories;  (b) a limit of 400% of an association's  capital on
the aggregate amount of loans secured by  non-residential  real estate property;
(c) a limit of 20% of an association's  assets on commercial  loans; (d) a limit
of 35% of an association's  assets on the aggregate amount of consumer loans and
acquisitions  of  certain  debt  securities;  (e) a  limit  of 5% of  assets  on
non-conforming  loans (loans in excess of the specific limitations of HOLA); and
(f) a limit of


                                       18
<PAGE>

the greater of 5% of assets or an association's  capital on certain construction
loans  made for the  purpose  of  financing  what is or is  expected  to  become
residential property.

     Loans to One  Borrower.  Under HOLA,  savings  associations  are  generally
subject to the same  limits on loans to one  borrower as are imposed on national
banks. Generally,  under these limits, a savings institution may not make a loan
or extend  credit to a single or related  group of borrowers in excess of 15% of
the  association's  unimpaired  capital and surplus.  Additional  amounts may be
lent, not exceeding 10% of the association's  unimpaired capital and surplus, if
such  loans and  extensions  of credit are fully  secured by  readily-marketable
collateral.  Such  collateral  is  defined to  include  certain  debt and equity
securities and bullion,  but generally does not include real estate. At June 30,
2000, the Bank's limit on loans to one borrower was approximately  $1.6 million.
At June 30, 2000, the Bank's largest  aggregate  amount of loans to one borrower
was $1.5 million and is secured by a mix of one- to four-family  and multifamily
properties.   The  second   largest   borrower  had  an  aggregate   balance  of
approximately $1.4 million, secured by an multifamily complex. At June 30, 2000,
all of the  loans in both of these  lending  relationships  were  performing  in
accordance with their terms.

     QTL Test.  HOLA requires a savings  institution to meet a Qualified  Thrift
Lender  ("QTL")  test.  A  savings  institution  may  satisfy  the  QTL  test by
maintaining at least 65% of its "portfolio  assets" in certain "qualified thrift
investments" in at least 9 months of the most recent 12-month period. "Portfolio
assets" means,  in general,  an  association's  total assets less the sum of (a)
specified  liquid  assets up to 20% of total  assets,  (b) certain  intangibles,
including  goodwill and credit card and purchased  mortgage servicing rights and
(c) the value of property used to conduct the association's  business.  The term
"qualified  thrift  investments"  includes  various  types  of  loans  made  for
residential  and  housing  purposes,   investments  related  to  such  purposes,
including  certain  mortgage-backed  and  related  securities,   and  loans  for
personal,  family,  household and certain other purposes up to a limit of 20% of
an association's  portfolio assets.  Recent  legislation  broadened the scope of
"qualified thrift  investments" to include 100% of an institution's  credit card
loans, education loans, and small business loans. A savings association may also
satisfy the QTL test by qualifying as a "domestic building and loan association"
as defined in the  Internal  Revenue Code of 1986.  At June 30,  2000,  the Bank
maintained 71.6% of its portfolio assets in qualified  thrift  investments.  The
Bank  had  also  satisfied  the QTL test in each of the  prior  12  months  and,
therefore, was a qualified thrift lender.

     A savings  institution  that fails the QTL test must either  operate  under
certain restrictions on its activities or convert to a bank charter. The initial
restrictions  include  prohibitions against (a) engaging in any new activity not
permissible  for a national bank,  (b) paying  dividends not  permissible  under
national  bank  regulations,  (c)  obtaining  new advances from any FHLB and (d)
establishing any new branch in a location not permissible for a national bank in
the association's home state. In addition, within one year of the date a savings
institution ceases to meet the QTL test, any company controlling the association
would have to register  under,  and become subject to the  requirements  of, the
Bank  Holding  Company  Act of 1956,  as amended  ("BHC  Act").  If the  savings
institution  does not requalify under the QTL test within the three-year  period
after it failed the QTL test, it would be required to terminate any activity and
to dispose of any investment not  permissible for a national bank and would have
to repay as  promptly as  possible  any  outstanding  advances  from an FHLB.  A
savings  institution  that has failed the QTL test may  requalify  under the QTL
test and be free of such limitations, but it may do so only once.

     Capital  Requirements.  The OTS regulations require savings associations to
meet three minimum capital  standards:  a tangible capital ratio  requirement of
1.5% of total assets as adjusted  under the OTS  regulations,  a leverage  ratio
requirement of 3% of core capital to such adjusted total assets and a risk-based
capital  ratio  requirement  of 8% of core and  supplementary  capital  to total
risk-weighted  assets.  The OTS and the federal banking regulators have proposed
amendments  to their  minimum  capital  regulations  to provide that the minimum
leverage  capital ratio for a depository  institution that has been assigned the
highest composite rating of 1 under the Uniform Financial  Institutions  Ratings
System  will be 3% and that the  minimum  leverage  capital  ratio for any other
depository  institution  will be 4%, unless a higher  leverage  capital ratio is
warranted by the  particular  circumstances  or risk  profile of the  depository
institution.  In determining compliance with the risk-based capital requirement,
a savings  association must compute its risk-weighted  assets by multiplying its
assets and certain off-balance sheet items by risk-weights,  which range from 0%
for cash and obligations  issued by the United States Government or


                                       19
<PAGE>

its agencies to 100% for consumer and commercial  loans,  as assigned by the OTS
capital regulation based on the risks OTS believes are inherent in the assets.

     Tangible  capital is defined,  generally,  as common  stockholders'  equity
(including retained earnings),  certain non-cumulative perpetual preferred stock
and  related  earnings  and  minority  interests  in  equity  accounts  of fully
consolidated  subsidiaries,   less  intangibles  (other  than  certain  mortgage
servicing  rights)  and  investments  in and loans to  subsidiaries  engaged  in
activities  not  permissible  for a  national  bank.  Core  capital  is  defined
similarly to tangible capital, but core capital also includes certain qualifying
supervisory   goodwill  and  certain   purchased   credit  card   relationships.
Supplementary   capital  currently  includes   cumulative  and  other  perpetual
preferred  stock,  mandatory  convertible  securities,   subordinated  debt  and
intermediate  preferred  stock and the allowance for loan and lease losses.  The
allowance for loan and lease losses  includable in supplementary  and capital is
limited  to a  maximum  of 1.25% of  risk-weighted  assets,  and the  amount  of
supplementary  capital that may be included as total  capital  cannot exceed the
amount of core capital.

     The federal banking agencies,  including the OTS, have adopted  regulations
to require  an  assessment  of an  institution's  exposure  to  declines  in the
economic  value of a bank's  capital  due to  changes  in  interest  rates  when
assessing the bank's capital adequacy.  Under such a risk assessment,  examiners
will evaluate a bank's capital for interest rate risk on a  case-by-case  basis,
with  consideration of both quantitative and qualitative  factors.  According to
the agencies, applicable considerations include:

o    the quality of the bank's interest rate risk management process;
o    the overall financial condition of the bank; and
o    the level of other risks at the bank for which capital is needed.

     Institutions  with  significant  interest rate risk may be required to hold
additional capital.  The agencies also issued a joint policy statement providing
guidance  on  interest  rate risk  management,  including  a  discussion  of the
critical  factors  affecting the  agencies'  evaluation of interest rate risk in
connection with capital adequacy.

     The table below presents the Bank's  regulatory  capital as compared to the
OTS regulatory capital requirements at June 30, 2000:

<TABLE>
<CAPTION>
                                                                           CAPITAL            EXCESS
                                                          AMOUNT        REQUIREMENTS          CAPITAL
                                                          ------        ------------          -------
                                                                       (IN THOUSANDS)
<S>                                                      <C>             <C>                 <C>
          Core capital...........................        $11,717         $5,270              $6,447

          Risk-based capital.....................         11,688          8,427               4,151
</TABLE>

     A reconciliation  between  regulatory  capital and GAAP capital at June 30,
2000 in the accompanying financial statements is presented below:

<TABLE>
<CAPTION>
                                                                                              RISK-
                                                                            CORE              BASED
                                                                           CAPITAL           CAPITAL
                                                                           -------           -------
<S>                                                                       <C>               <C>
            GAAP capital..........................................        $11,688           $11,668

            Net unrealized loss on available for
              sale investment securities, net of tax..............             29                29

            Allowance for loan losses included as
              supplementary capital...............................             --               979

            Equity investment and other assets....................             --              (118)
                                                                          -------           -------

            Regulatory capital....................................        $11,717           $12,578
                                                                          =======           =======
</TABLE>


                                       20
<PAGE>

     Limitation  on Capital  Distributions.  Effective  April 1,  1999,  the OTS
amended its capital  distribution  regulations to reduce  regulatory  burdens on
savings  associations.  The  regulations  being  replaced,  which were effective
throughout 1998,  established  limitations upon capital distributions by savings
associations,  such as cash  dividends,  payments  to  repurchase  or  otherwise
acquire its shares, payments to shareholders of another institution in a cashout
merger,  and other  distributions  charged  against  capital.  At least  30-days
written notice to the OTS was required for a proposed capital  distribution by a
savings association,  and capital  distributions in excess of specified earnings
or by certain  institutions  were subject to approval by the OTS. An association
that  had  capital  in  excess  of  all  fully  phased  in  regulatory   capital
requirements  before and after a proposed capital  distribution and that was not
otherwise restricted in making capital distributions,  could, after prior notice
but  without  the  approval  of the OTS,  make  capital  distributions  during a
calendar  year  equal to the  greater  of (a) 100% of its net  earnings  to date
during the calendar  year plus the amount that would reduce by half its "surplus
capital   ratio"  (the  excess   capital   over  its  fully  phased  in  capital
requirements)  at the  beginning  of the  calendar  year,  or (b) 75% of its net
earnings for the previous four quarters.  Any additional  capital  distributions
would  require  prior OTS  approval.  Under the  amendments  adopted by the OTS,
certain  savings  associations  will be permitted  to pay capital  distributions
during a calendar year that do not exceed the  association's net income for that
year plus its retained net income for the prior two years, without notice to, or
the approval of, the OTS. However, a savings association subsidiary of a savings
and loan  holding  company,  such as the Bank,  will  continue to have to file a
notice unless the specific  capital  distribution  requires an  application.  In
addition,  the OTS can  prohibit  a  proposed  capital  distribution,  otherwise
permissible under the regulation, if the OTS has determined that the association
is in need of more than normal  supervision or if it determines  that a proposed
distribution by an association  would constitute an unsafe or unsound  practice.
Furthermore,  under the OTS prompt corrective action regulations, the Bank would
be prohibited from making any capital  distribution if, after the  distribution,
the Bank failed to meet its minimum capital  requirements,  as described  above.
See "--Prompt Corrective Regulatory Action."

     Liquidity.  The Bank is required to  maintain an average  daily  balance of
liquid assets (cash,  certain time  deposits,  bankers'  acceptances,  specified
United States Government, state or federal agency obligations, shares of certain
mutual funds and certain  corporate debt securities and commercial  paper) equal
to a  monthly  average  of not  less  than a  specified  percentage  of its  net
withdrawable  deposit  accounts  plus  short-term  borrowings.   This  liquidity
requirement may be changed from time to time by the OTS to any amount within the
range of 4% to 10% depending  upon economic  conditions and the savings flows of
member institutions,  and is currently 4%. Monetary penalties may be imposed for
failure to meet these liquidity requirements. The Bank's average liquidity ratio
for the month ended June 30, 2000 was  approximately  11.8% which  exceeded  the
applicable  requirements.  The Bank has never been subject to monetary penalties
for failure to meet its liquidity requirements.

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

     Branching.  Subject to certain  limitations,  HOLA and the OTS  regulations
permit federally  chartered  savings  institutions to establish  branches in any
state of the  United  States.  The  authority  to  establish  such a  branch  is
available  (a)  in  states  that   expressly   authorize   branches  of  savings
institutions  located in another  state and (b) to an  association  that  either
satisfies  the  "QTL"  test for a  qualified  thrift  lender or  qualifies  as a
"domestic building and loan association" under the Internal Revenue Code of 1986
(the "Code"), which imposes qualification


                                       21
<PAGE>

requirements  similar to those for a "qualified  thrift  lender" under HOLA. See
"--QTL Test." The authority for a federal  savings  institution  to establish an
interstate branch network would facilitate a geographic  diversification  of the
association's  activities.  This  authority  under HOLA and the OTS  regulations
preempts  any state law  purporting  to regulate  branching  by federal  savings
institutions.

     Community  Reinvestment.  Under the Community  Reinvestment Act ("CRA"), as
implemented  by OTS  regulations,  a savings  institution  has a continuing  and
affirmative obligation consistent with its safe and sound operation to help meet
the credit needs of its entire  community,  including  low and  moderate  income
neighborhoods.  The CRA does not  establish  specific  lending  requirements  or
programs  for  financial   institutions  nor  does  it  limit  an  institution's
discretion  to develop the types of products and  services  that it believes are
best  suited  to its  particular  community,  consistent  with the CRA.  The CRA
requires the OTS, in connection with its  examination of a savings  institution,
to assess the association's  record of meeting the credit needs of its community
and to take such record into account in its  evaluation of certain  applications
by such  association.  The CRA also  requires  all  institutions  to make public
disclosure of their CRA ratings.  The Bank received a "Satisfactory"  CRA rating
in its most recent examination on January 20, 1998.

     The  CRA  regulations   establish  an  assessment   system  that  bases  an
association's  rating on its actual  performance in meeting  community needs. In
particular, the assessment system focuses on three tests: (a) a lending test, to
evaluate the  institution's  record of making loans in its assessment areas; (b)
an  investment  test,  to evaluate  the  institution's  record of  investing  in
community development projects, affordable housing, and programs benefitting low
or moderate  income  individuals  and  businesses;  and (c) a service  test,  to
evaluate the institution's delivery of services through its branches,  ATMs, and
other offices.

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

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

     Enforcement.  Under the Federal Deposit  Insurance Act ("FDI Act"), the OTS
has primary  enforcement  responsibility  over savings  institutions and has the
authority  to  bring  enforcement  action  against  all  "institution-affiliated
parties,"  including any controlling  stockholder or any shareholder,  attorney,
appraiser  or  accountant  who  knowingly  or  recklessly  participates  in  any
violation of applicable law or regulation or breach of


                                       22
<PAGE>

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

     Standards for Safety and Soundness.  Pursuant to the FDI Act, as amended by
Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") and the
Riegle Community Development and Regulatory  Improvement Act of 1994 ("Community
Development  Act"),  the OTS,  together with the other  federal bank  regulatory
agencies,   adopted  a  set  of  guidelines  prescribing  safety  and  soundness
standards.  The  guidelines  establish  general  standards  relating to internal
controls and information  systems,  internal audit systems,  loan documentation,
credit  underwriting,  interest  rate  exposure,  asset growth,  asset  quality,
earnings  standards,  and  compensation,  fees and  benefits.  In  general,  the
guidelines  require,  among other things,  appropriate  systems and practices to
identify and manage the risks and  exposures  specified in the  guidelines.  The
guidelines prohibit excessive compensation as an unsafe and unsound practice and
describe  compensation  as excessive when the amounts paid are  unreasonable  or
disproportionate  to the services performed by an executive  officer,  employee,
director or principal  shareholder.  The OTS and the other  agencies  determined
that stock  valuation  standards  were not  appropriate.  In  addition,  the OTS
adopted  regulations  that  authorize,  but do not require,  the OTS to order an
institution  that has been given notice by the OTS that it is not satisfying any
of such safety and soundness  standards to submit a compliance  plan.  If, after
being so notified,  an institution fails to submit an acceptable compliance plan
or fails in any material  respect to implement an accepted  compliance plan, the
OTS must issue an order directing action to correct the deficiency and may issue
an order  directing  other  actions  of the  types to which an  undercapitalized
association  is subject  under the  "prompt  corrective  action"  provisions  of
FDICIA.  If an institution  fails to comply with such an order, the OTS may seek
to  enforce  such  order in  judicial  proceedings  and to  impose  civil  money
penalties.

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

     Prompt Corrective Regulatory Action. Under the OTS prompt corrective action
regulations,  the OTS is required to take  certain,  and is  authorized  to take
other, supervisory actions against  undercapitalized  savings institutions.  For
this purpose,  a savings  institution  would be placed in one of five categories
based on the association's capital.  Generally, a savings institution is treated
as "well  capitalized" if its ratio of total capital to risk-weighted  assets is
at least 10.0%,  its ratio of core capital to  risk-weighted  assets is at least
6.0%,  its ratio of core capital to total assets is at least 5.0%, and it is not
subject to any order or directive by the OTS to meet a specific capital level. A
savings institution will be treated as "adequately  capitalized" if its ratio of
total  capital  to  risk-weighted  assets  is at least  8.0%,  its ratio of core
capital to risk-weighted  assets is at least 4.0%, and its ratio of core capital
to total assets is at least 4.0% (3.0% if the  association  receives the highest
rating on the CAMEL financial institutions rating system). A savings institution
that has a total  risk-based  capital of less than 8.0% or a leverage ratio or a
Tier 1  capital  ratio  that is less  than  4.0%  (3.0%  leverage  ratio  if the
association receives the highest rating on the CAMEL financial


                                       23
<PAGE>

institutions  rating system) is considered to be  "undercapitalized."  A savings
institution  that has a total  risk-based  capital of less than 6.0% or a Tier 1
risk-based  capital ratio or a leverage ratio of less than 3.0% is considered to
be "significantly  undercapitalized."  A savings institution that has a tangible
capital  to assets  ratio  equal to or less than 2% is deemed to be  "critically
undercapitalized."  The elements of an association's capital for purposes of the
prompt corrective action regulations are defined generally as they are under the
regulations for minimum capital requirements.  See "--Capital  Requirements." At
June   30,   2000,   the   Bank   met  the   criteria   for   being   considered
"well-capitalized."

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

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

     Pursuant to FDICIA, the FDIC established a new risk-based assessment system
for  determining  the  deposit  insurance  assessments  to be  paid  by  insured
depository  institutions.  Under the  assessment  system,  the FDIC  assigns  an
institution  to one of  three  capital  categories  based  on the  institution's
financial  information as of the reporting period ending seven months before the
assessment period. The three capital categories consist of (a) well capitalized,
(b) adequately  capitalized,  or (c) undercapitalized.  The FDIC also assigns an
institution to one of three supervisory subcategories within each capital group.
The  supervisory  subgroup  to which an  institution  is  assigned is based on a
supervisory evaluation provided to the FDIC by the institution's primary federal
regulator  and  information  that  the FDIC  determines  to be  relevant  to the
institution's  financial  condition and the risk posed to the deposit  insurance
funds.  An  institution's  assessment  rate depends on the capital  category and
supervisory  category to which it is assigned.  Under the regulation,  there are
nine assessment risk classifications  (i.e.,  combinations of capital groups and
supervisory   subgroups)  to  which  different  assessment  rates  are  applied.
Assessment rates currently range from 0.0% of deposits for an institution in the
highest category (i.e.,  well-capitalized  and financially  sound,  with no more
than a few minor  weaknesses)  to 0.27% of deposits  for an  institution  in the
lowest category (i.e.,  undercapitalized and substantial  supervisory  concern).
The FDIC is  authorized to raise the  assessment  rates as necessary to maintain
the required reserve ratio of 1.25%. As a result of the Deposit  Insurance Funds
Act of 1996 (the "Funds Act"),  both the BIF and the SAIF currently  satisfy the
reserve ratio  requirement.  If the FDIC determines that assessment rates should
be increased,  institutions in all risk categories  could be affected.  The FDIC
has exercised this authority several times in the past and could raise insurance
assessment  rates in the future.  If such action is taken by the FDIC,  it could
have an adverse effect on the earnings of the Bank.

     The Funds Act also amended the FDIA to expand the  assessment  base for the
payments on the FICO bonds.  Beginning  January 1, 1997, the assessment base for
the FICO bonds included the deposits of both BIF- and SAIF-insured institutions.
Until  December  31,  1999,  or such  earlier  date on which  the  last  savings
association ceases to exist, the rate of assessment for BIF-assessable  deposits
shall be one-fifth of the rate imposed on SAIF-assessable  deposits.  The annual
assessment  for the  payments  on the FICO  bonds for the  fiscal  year 2000 was
$36,365.

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

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


                                       24
<PAGE>

in compliance with this  requirement with an investment in FHLB of Atlanta stock
at June 30,  2000,  of  $776,000.  Any  advances  from a FHLB must be secured by
specified types of collateral,  and all long-term  advances may be obtained only
for the purpose of providing funds for residential housing finance.

     For the fiscal years ended June 30, 2000, 1999 and 1998, dividends from the
FHLB  of  Atlanta  to  the  Bank  amounted  to  $46,000,  $45,000  and  $43,000,
respectively.  If dividends  were  reduced,  or interest on future FHLB advances
increased, the Bank's net interest income would likely also be reduced.

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

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

REGULATION OF THE HOLDING COMPANY

     General.  The  Holding  Company  and  the  Company  are  holding  companies
chartered  pursuant to Section 10(o) of the HOLA. As such,  the Holding  Company
and  the  Company  are  registered  with  and  subject  to OTS  examination  and
supervision as well as certain reporting requirements.  In addition, the OTS has
enforcement  authority  over the Company and the Holding  Company and any of its
non-savings institution subsidiaries. Among other things, this authority permits
the OTS to restrict or prohibit  activities  that are determined to be a serious
risk to the financial safety,  soundness,  or stability of a subsidiary  savings
institution. Unlike bank holding companies, federal mutual holding companies are
not subject to any  regulatory  capital  requirements  or to  supervision by the
Federal Reserve System.

     Restrictions Applicable to Activities of Mutual Holding Companies. Pursuant
to Section  10(o) of the HOLA, a mutual  holding  company may engage only in the
following activities: (i) investing in the stock of a savings institution;  (ii)
acquiring a mutual  association  through the merger of such  association  into a
savings  institution  subsidiary of such holding  company or an interim  savings
institution  subsidiary of such holding company; (iii) merging with or acquiring
another holding  company,  one of whose  subsidiaries is a savings  institution;
(iv)  investing in a  corporation  the capital  stock of which is available  for
purchase  by a savings  institution  under  federal  law or under the law of any
state where the subsidiary  savings  institution or associations have their home
offices;  (v)  furnishing  or  performing  management  services  for  a  savings
institution subsidiary of such holding company;


                                       25
<PAGE>

(vi) holding,  managing,  or liquidating assets owned or acquired from a savings
institution  subsidiary  of such company;  (vii) holding or managing  properties
used or occupied by a savings  institution  subsidiary of such  company;  (viii)
acting as trustee  under a deed of trust;  (ix) any other  activity (a) that the
FRB, by regulation,  has determined to be permissible for bank holding companies
under  Section  4(c)  of the  BHC  Act,  unless  the  Director  of the  OTS,  by
regulation,  prohibits or limits any such  activity for savings and loan holding
companies,  or (b) in which  multiple  savings and loan holding  companies  were
authorized  by  regulation  to  directly  engage  on  March  5,  1987;  and  (x)
purchasing,  holding,  or  disposing  of stock  acquired  in  connection  with a
qualified  stock issuance if the purchase of such stock by such holding  company
is approved by the Director of the OTS. If a mutual holding company  acquires or
merges with another holding company, the holding company acquired or the holding
company  resulting from such merger or acquisition may only invest in assets and
engage in activities listed above, and it has a period of two years to cease any
non-conforming activities and divest any non-conforming investments.

     Restrictions Applicable to All Savings and Loan Holding Companies. The HOLA
prohibits a savings and loan holding company, including a federal mutual holding
company,  directly or  indirectly,  from acquiring (i) control (as defined under
HOLA) of another  savings  institution  (or a holding  company  parent  thereof)
without  prior OTS  approval;  (ii) more than 5% of the voting shares of another
savings   institution  (or  holding  company  parent  thereof)  that  is  not  a
subsidiary,  subject to certain exceptions; (iii) through merger, consolidation,
or purchase of assets, another savings institution or a holding company thereof,
or acquiring all or  substantially  all of the assets of such  institution (or a
holding  company  thereof)  without prior OTS  approval;  or (iv) control of any
depository institution not insured by the FDIC (except through a merger with and
into the holding  company's savings  institution  subsidiary that is approved by
the OTS).

     A savings and loan holding company may not acquire as a separate subsidiary
an insured  institution  that has a principal  office outside of the state where
the principal office of its subsidiary institution is located, except (i) in the
case of certain  emergency  acquisitions (as defined under HOLA) approved by the
FDIC; (ii) if such holding  company  controls a savings  institution  subsidiary
that  operated a home or branch office in such  additional  state as of March 5,
1987, and (iii) if the laws of the state in which the savings  institution to be
acquired is located  specifically  authorize a savings institution  chartered by
that state to be acquired by a savings institution  chartered by the state where
the acquiring savings institution or savings and loan holding company is located
or by a holding  company that controls such a state chartered  association.  The
conditions  imposed  upon  interstate  acquisitions  by those  states  that have
enacted   authorizing   legislation  vary.  Some  states  impose  conditions  of
reciprocity,  which have the effect of requiring that the laws of both the state
in which the acquiring holding company is located (as determined by the location
of its subsidiary savings institution) and the state in which the association to
be acquired is  located,  have each  enacted  legislation  allowing  its savings
institutions to be acquired by out-of-state  holding  companies on the condition
that the laws of the other state  authorize such  transactions  on terms no more
restrictive  than  those  imposed  on the  acquirer  by the state of the  target
association.  Some of these  states  also  impose  regional  limitations,  which
restrict such acquisitions to states within a defined geographic  region.  Other
states allow full nationwide banking without any condition of reciprocity.  Some
states do not authorize  interstate  acquisitions  of savings  institutions.  In
evaluating an application by a holding company to acquire a savings institution,
the OTS  must  consider  the  financial  and  managerial  resources  and  future
prospects  of the company and savings  institution  involved,  the effect of the
acquisition on the risk to the insurance funds, the convenience and needs of the
community, and competitive factors.

     If the savings  institution  subsidiary of a federal mutual holding company
fails  to meet  the QTL  test  set  forth  in  Section  10(m)  of the  HOLA  and
regulations of the OTS, the holding company must register with the FRB as a bank
holding  company under the BHC Act within one year of the savings  institution's
failure to so  qualify.  For  additional  information  in this  regard,  see "--
Regulation of Federal Savings Banks -- QTL Test."

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


                                       26
<PAGE>

REGULATION OF INSURANCE ACTIVITIES

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

REGULATION OF SECURITIES BROKERAGE ACTIVITIES

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

FEDERAL SECURITIES LAWS

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

                           FEDERAL AND STATE TAXATION

FEDERAL TAXATION

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

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

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

     Distributions.   To  the   extent   that  the  Bank   makes   "non-dividend
distributions" to shareholders,  such distributions will be considered to result
in  distributions  from the Bank's "base year reserve,"  i.e., its reserve as of
June 30, 2000, to the extent thereof and then from its supplemental  reserve for
losses on loans, and an amount based on the amount  distributed will be included
in the Bank's taxable income.  Non-dividend  distributions include distributions
in  excess  of  the  Bank's  current  and  accumulated   earnings  and  profits,
distributions  in redemption of stock and  distributions  in partial or complete
liquidation.  However,  dividends  paid out of the Bank's current or accumulated
earnings and profits,  as calculated for federal  income tax purposes,  will not
constitute  non-dividend  distributions and, therefore,  will not be included in
the Bank's income.


                                       27
<PAGE>

     The  amount  of  additional  taxable  income  created  from a  non-dividend
distribution  is equal  to the  lesser  of the  Bank's  base  year  reserve  and
supplemental reserve for losses on loans; or an amount that, when reduced by the
tax  attributable  to the  income,  is equal to the amount of the  distribution.
Thus,  in  certain   situations   approximately   one  and  one-half  times  the
non-dividend distribution would be includable in gross income for federal income
tax purposes, assuming a 34% federal corporate income tax rate.

     Corporate  Alternative  Minimum Tax. The Internal  Revenue Code of 1986, as
amended  (the  "Code"),  imposes a tax ("AMT") on  alternative  minimum  taxable
income  ("AMTI")  at a rate  of  20%.  Only  90% of AMTI  can be  offset  by net
operating  loss  carryovers of which the Bank  currently has none.  AMTI is also
adjusted by  determining  the tax  treatment  of certain  items in a manner that
negates the deferral of income resulting from the regular tax treatment of those
items.  Thus,  the Bank's  AMTI is  increased  by an amount  equal to 75% of the
amount  by  which  the  Bank's  adjusted   current  earnings  exceeds  its  AMTI
(determined  without  regard to this  adjustment  and prior to reduction for net
operating  losses).  Although the  corporate  environmental  tax of 0.12% of the
excess of AMTI (with certain modifications) over $2.0 million has expired, under
current Administration  proposals, such tax will be retroactively reinstated for
taxable years beginning after December 31, 1996 and before January 2008.

     Elimination of Dividends;  Dividends Received Deduction.  The Stock Company
may exclude from its income 100% of dividends received from the Bank as a member
of the same affiliated group of corporations.  Because,  following completion of
the  Reorganization,  Mutual  Company  will not be a member  of such  affiliated
group,  it will not  qualify  for such  100%  dividends  exclusion,  but will be
entitled to deduct 80% of the  dividends it receives  from Stock Company so long
as it owns more than 20% of the Common Stock.

STATE TAXATION

     Under  North  Carolina  law,  the  corporate  income tax is 7.0% of federal
taxable  income as  computed  under  the Code,  subject  to  certain  prescribed
adjustments. An annual state franchise tax is imposed at a rate of .0015 applied
to the greatest of the  institution's  (i) capital stock,  surplus and undivided
profits,  (ii) investment in tangible property in North Carolina or (iii) 55% of
the appraised valuation of property in North Carolina.


                                       28
<PAGE>

ITEM 2. PROPERTIES

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

<TABLE>
<CAPTION>
                                                                DATE                 LEASE             NET BOOK
                                           LEASED OR          LEASED OR           EXPIRATION           VALUE AT
                                             OWNED            ACQUIRED               DATE            JUNE 30, 2000
                                             -----            --------               ----            -------------
                                                                  (DOLLARS IN THOUSANDS)
<S>                                        <C>               <C>                <C>                     <C>
Corporate Offices................          Owned              06/15/00              --                 $ 1,700
21 East Ashe Street
West Jefferson, NC  28694

Insurance and Brokerage Offices..          Owned              06/30/97               --                    599
206 S. Jeferrson Avenue
West Jefferson, NC 28694

West Jefferson Branch............          Owned              06/30/63               --                    195
205 S Jefferson Avenue
West Jefferson, NC 28694

Jefferson Branch.................          Owned              05/18/94               --                    519
840  E. Main Street
Jefferson, NC 28640

Warrensville Branch..............          Leased             08/31/98           08/31/2000*               --
4951 NC Hwy. 88 West
Warrensville, NC 28693

Alleghany First..................          Leased             01/09/98           12/31/2000**              --
403 South Main Street
Sparta, NC 28675

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

AF Brown Insurance...............          Leased             09/01/97           08/31/1999****            --
315 Main Street
North Wilkesboro, NC 28659

AF Blair.........................          Leased             04/01/99           03/31/2004                --
324 Morganton Blvd., SW
Lenior, NC 28645

AF Insurance Center of Elkin.....          Leased             12/01/99           11/30/2002**              --
277 A West Main Street
Elkin, NC 28621
</TABLE>

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

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


                                       29
<PAGE>

ITEM 3. LEGAL PROCEEDINGS

     At June 30, 2000,  there were no material  legal  proceedings  to which the
Company or any of its  subsidiaries  was a party or to which any of its property
was subject.

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

     Not applicable.

                                     PART II

ITEM 5. MARKET FOR COMMON STOCK AND RELATED STOCKHOLDER MATTERS

     Information  relating  to the market  for  Registrant's  common  equity and
related  stockholder  matters  appears under "Common  Stock" and "Market for the
Common Stock" in the Registrant's 2000 Annual Report to Stockholders on page 56,
and is incorporated herein by reference.

     Information  relating to the payment of dividends by the Registrant appears
under "Common Stock" and "Market for the Common Stock" in the Registrant's  2000
Annual  Report  to  Stockholders  on page  56,  and is  incorporated  herein  by
reference.  A  dividend  declared  by the  Board  of  Directors  of the  Bank is
considered a capital  distribution from the Bank to the stockholders,  including
AsheCo,  M.H.C., its mutual holding company.  Under the requirements of the OTS,
there  are  certain  restrictions  on the  ability  of the Bank to pay a capital
distribution. See "Regulation--Limitation on Capital Distributions."

     The Company paid cash dividends  totaling $.20 per share during each of the
years ended June 30, 2000 and 1999.

ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS

     Certain  of  the   above-captioned   information  appears  under  "Selected
Financial and Other Data of the Company" "Management's  Discussion and Analysis"
and in the Registrant's 2000 Annual Report to Stockholders on pages 1 through 2,
and 5 through 18 and is incorporated herein by reference.

ITEM 7. FINANCIAL STATEMENTS

     The Financial  Statements of AF Bankshares,  Inc., together with the report
thereon by  McGladrey  & Pullen,  LLP  appears in the  Registrant's  2000 Annual
Report to  Stockholders  on pages 19 through 53 and are  incorporated  herein by
reference.

<TABLE>
<CAPTION>
                                                                                             Page(s) in
                                                                                            Annual Report
                                                                                          ------------------
<S>                                                                                              <C>
        o        Independent Auditor's Report.........................................           19
        o        Consolidated Statements of Financial Condition,
                    June 30, 2000 and 1999............................................           20
        o        Consolidated Statements of Income
                    Years Ended June 30, 2000 and 1999.................................          21
        o        Consolidated Statements of Stockholders' Equity,
                    Years Ended June 30, 2000 and 1999.................................          22
        o        Consolidated Statements of Cash Flows,
                    Years Ended June 30, 2000 and 1999.................................          24
        o        Notes to Consolidated Financial Statements............................          26
</TABLE>


                                       30
<PAGE>

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

     Not applicable.

                                    PART III

ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS

     The information relating to Directors and Executive Officers of the Company
is  incorporated  herein by reference to the Company's  Proxy  Statement for the
Annual Meeting of Stockholders to be held on November 6, 2000.

ITEM 10. EXECUTIVE COMPENSATION

     The information  relating to executive  compensation is incorporated herein
by  reference  to the  Company's  Proxy  Statement  for the  Annual  Meeting  of
Stockholders to be held on November 6, 2000.

ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

     The information relating to security ownership of certain beneficial owners
and  management  is  incorporated  herein by  reference to the  Company's  Proxy
Statement for the Annual Meeting of Stockholders to be held on November 6, 2000.

ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     The information relating to certain  relationships and related transactions
is  incorporated  herein by reference to the Company's  Proxy  Statement for the
Annual Meeting of Stockholders to be held on November 6, 2000.

ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K

     (a)  Exhibits
          --------
          2.1               Agreement and Plan of Reorganization dated September
                            15,  1997  by  and  among  Ashe  Federal   Bank,  AF
                            Bankshares,  Inc.  and  Ashe  Interim  Savings  Bank
                            (incorporated   by  reference  to  the  Registration
                            Statement on Form 8-A, as filed with the SEC on June
                            16, 1998 (the "Form 8-A")).

          3.1               Federal Stock  Charter of the Company  (Incorporated
                            by reference to Exhibit 3.1 of the Form 8-A).

          3.2               Bylaws of the Company  (Incorporated by reference to
                            Exhibit 3.2 of the Form 8-A).

          4.1               Common    Stock    Certificate    of   the   Company
                            (Incorporated  by  reference  to Exhibit  4.3 of the
                            Form 8-A).

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

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

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


                                       31
<PAGE>

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

          13.1              2000  Annual  Report  to   Stockholders,   is  filed
                            herewith.

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

          27.1              Financial Data Schedule.**

(b) REPORTS ON FORM 8-K
     No reports on Form 8-K were filed  during the fourth  quarter of the fiscal
year ended June 30, 2000.

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

**Filed in electronic format only.


                                       32
<PAGE>

                                   SIGNATURES

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

                                                 AF BANKSHARES, INC.
                                                 (Small Business Issuer)



Date:  September 22, 2000             By:  /s/James A. Todd
       ------------------------            ----------------------------
                                           James A. Todd
                                           President and Chief Executive Officer

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

<TABLE>
<CAPTION>
                                                                            Date
                                                                            ----
<S>                                                                    <C>
/s/James A. Todd                                                       September 22, 2000
------------------------------------------------------------
James A. Todd
President, Chief Executive Officer
     and Director
(Principal Executive Officer)

 /s/Melanie Paisley Miller                                             September 22, 2000
-----------------------------------------------------------
Melanie Paisley Miller
Executive Vice President, Secretary, Treasurer
     and Chief Financial Officer
(Principal Financial Officer)

/s/James A. Todd                                                       September 22, 2000
------------------------------------------------------------
Jan R. Caddell - Director

/s/Jan R. Caddell                                                      September 22, 2000
--------------------------------------------------------------
Kenneth R. Greene - Director

/s/William O. Ashley, Jr.                                              September 22, 2000
----------------------------------------------------------
William O. Ashley, Jr. - Director

/s/Wayne R. Burgess Director                                           September 22, 2000
------------------------------------------------------
Wayne R. Burgess - Director
</TABLE>


                                       33
<PAGE>
<TABLE>
<CAPTION>
<S>                                                                    <C>
/s/Frank E. Roland                                                     September 22, 2000
--------------------------------------------------------
Frank E. Roland - Director

/s/Jerry L. Roten                                                      September 22, 2000
----------------------------------------------------------
Jerry L. Roten - Director

/s/John D. Weaver                                                      September 22, 2000
--------------------------------------------------------
John D. Weaver - Director
</TABLE>





                                       34