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, 1999

                          Commission File No.: 0-24479

                               AF BANKSHARES, INC.

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

          Federally Chartered                               56-0125319
        State of Incorporation                         IRS Employer Number

                           206 South Jefferson Avenue
                                   P.O. Box 26
                      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. [ ]

         The  revenues  for the  issuer's  fiscal  year ended June 30,  1999 are
$9,084,938.

         The issuer  had  1,053,678  shares of common  stock  outstanding  as of
August 18, 1999. 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 18, 1999 ($11.25) was $4,287,128.

         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, 1999 are incorporated by reference into Part I and II of this Form 10-KSB.

         Portions  of the  Proxy  Statement  for  the  1999  Annual  Meeting  of
Stockholders are incorporated by reference into Part III of this Form 10-KSB.


<PAGE>


                                TABLE OF CONTENTS
<TABLE>
<CAPTION>

PART I

<S>     <C>                                                                                <C>
         ITEM 1.     DESCRIPTION OF BUSINESS................................................1
         ITEM 2.     PROPERTIES............................................................29
         ITEM 3.     LEGAL PROCEEDINGS.....................................................30
         ITEM 4.     SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS...................30

PART II

         ITEM 5.     MARKET FOR COMMON STOCK AND RELATED STOCKHOLDER MATTERS...............30
         ITEM 6.     MANAGEMENT'S DISCUSSION AND ANALYSIS..................................30
         ITEM 7.     FINANCIAL STATEMENTS..................................................30
         ITEM 8.     CHANGES IN AND DISAGREEMENT WITH ACCOUNTANTS ON ACCOUNTING
                     AND FINANCIAL DISCLOSURE..............................................31
PART III

         ITEM 9.     DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS..........31
         ITEM 10.    EXECUTIVE COMPENSATION................................................31
         ITEM 11.    SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT........31
         ITEM 12.    CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS........................31
         ITEM 13.    EXHIBITS, LISTS AND REPORTS ON FORM 8-K...............................31

SIGNATURES.................................................................................33
</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 Allegheny County, North Carolina operating under the
trade name Allegheny 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, 1999, the Bank had total assets of $109.9 million,
total deposits of $93.1 million and equity of $12.2 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  Allegheny 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 359% and consumer loans have increased
by 47% 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 and AF Insurance Services,  Inc. in Sparta, West Jefferson and Jefferson,
North  Carolina.  In August of 1998,  the Company  also began  offering  various
uninsured investment  products,  including fixed-rate and variable annuities and
mutual  funds  through a  relationship  with a  third-party  broker-dealer.  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 65.3% of total
loans, with approximately 50% of portfolio mortgage loans at fixed rates at June
30,  1999.  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 data processing costs.  Other external factors that affect the
operating  results of the Company  include  changes in



                                       1
<PAGE>



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, 1999,  $57.2 million,  or 65.3% of the Bank's total loan
portfolio  consisted  of real  estate  loans.  Total loans at June 30, 1999 were
$87.6  million of which  $48.4  million or 55.3%  were  secured   by one-to-four
family residences.  Total mortgage loans,  including construction loans, totaled
$57.2  million  as of June 30,  1999.  Of that  amount,  approximately  50% were
adjustable  rate loans.  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, 1999, the Bank's  consumer loans and commercial  loan  portfolios  were
$30.4 million, or 34.7% of total loans.  Commercial loans totaled $18.3 million,
or 20.9% of the Bank's total loan  portfolio.  The Bank invests a portion of its
assets  in  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 $4.7 million
or 4.3% of total assets at June 30, 1999, and FHLB, Federal Farm Credit Bank and
FHLMC securities  investments  totaled $5.3 million, or 4.9%, of total assets at
June 30, 1999.

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

         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 Allegheny  County and operates the branch under the trade name Allegheny
First  Bank.  At the same  time,  an  insurance  agency  branch of AF  Insurance
Services,  Inc., was opened in the same location.  The staff of Allegheny  First
came from the local banking  community and is attuned to the needs and habits of
Allegheny citizens. The insurance agency personnel direct their attention to the
special needs of Allegheny  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.  The Company  also added an  insurance  agency in
Lenoir, North Carolina operating under the name AF Blair Insurance Agency. Entry
into the  Boone  and  Allegheny  markets  significantly  expands  the  Company's
potential to market its banking, insurance and noninsured investment products to
a larger and more



                                       2
<PAGE>

diverse  market.  Management  now  believes  that  it  is  delivering  the  same
personalized  customer  service to Allegheny  and Watauga  counties  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 three elements:  funds transfer,  including loans, checking
accounts and savings instruments,  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 year ended  June 30,  1999,  the  Company  established  a
securities brokerage subsidiary, AF Brokerage, Inc., which has applied to become
a member of the National Association of Securities Dealers,  Inc. ("NASD").  The
Company  currently  conducts  brokerage  services  as a branch of a third  party
broker/dealer but will operate  independently  once its regulatory  applications
are approved.  The Company  expects to be accepted  into  membership in the NASD
within the first  quarter of the fiscal year ending  June 30,  2000.  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,
                                    -----------------------------------------------------------------------------------------------
                                                 1999                              1998                             1997
                                    -----------------------------     -----------------------------     ---------------------------
                                                          % OF                              % OF                           % OF
                                      AMOUNT              TOTAL         AMOUNT              TOTAL         AMOUNT           TOTAL
                                    ---------           ---------     ----------          ---------     ---------         ---------
<S>                                 <C>                   <C>         <C>                 <C>          <C>                  <C>
                                                                          (DOLLARS IN THOUSANDS)
Mortgage loans:
  One- to four-family......         $  48,433               59.68%    $   55,462              76.36%    $  53,903             76.75%
  Multi-family.............               316                0.39%           668               0.92%          742              1.06%
  Non-residential..........             2,068                2.55%         1,418               1.95%        2,804              3.99%
  Land.....................             1,258                1.55%         2,424               3.34%        1,586              2.26%
  Construction.............             5,082                6.26%         3,477               4.79%        1,562              2.22%
                                    ---------           ---------     ----------          ---------     ---------         ---------
   Total mortgage loans....            57,157               70.43%        63,449              87.36%       60,597             86.28%
                                    ---------           ---------     ----------          ---------     ---------         ---------
Other loans:
  Commercial...............            18,261               22.50%         3,975               5.48%        4,182              5.95%
  Consumer loans...........            12,144               14.96%         8,282              11.40%        7,705             10.97%
                                    ---------           ---------     ----------          ---------     ---------         ---------
   Total other loans.......            30,405               37.46%        12,257              16.88%       11,887             16.92%
                                    ---------           ---------     ----------          ---------     ---------         ---------
  Gross loans..............            87,562              107.89%        75,706             104.24%       72,484            103.20%
                                    ---------           ---------     ----------          ---------     ---------         ---------
Less:
  Undisbursed loan funds...             5,033                6.20%         1,598               2.20%          759              1.08%
  Deferred loan fees.......               249                0.31%           316               0.44%          458              0.65%
  Allowance for loan losses             1,123                1.38%         1,164               1.60%        1,031              1.47%
                                    ---------           ---------     ----------          ---------     ---------         ---------
                                        6,405                7.89%         3,078               4.24%        2,248              3.20%
                                    ---------           ---------     ----------          ---------     ---------         ---------
   Loans, net..............         $  81,157              100.00%    $   72,628             100.00%    $  70,236            100.00%
                                    =========           =========     ==========          =========     =========         =========
Loans serviced for others:
  One- to four-family and
     cooperative apartment.         $  20,657              100.00%    $    8,511             100.00%    $     383            100.00%
                                    ---------           ---------     ----------          ---------     ---------         ---------
      Total loans serviced
          for others.......         $  20,657              100.00%    $    8,511             100.00%    $     383            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,  1999.  Loans  that have
adjustable  rates are shown using scheduled  principal  amortization.  The table
does not consider estimated prepayments of principal.  Prepayments and scheduled
principal  amortization on the Bank's loan  portfolio,  excluding loan portfolio
held for sale, totaled $47.9 million for the year ended June 30, 1999, and $24.8
million  and  $18.9  million  for the  years  ended  June  30,  1998  and  1997,
respectively.

<TABLE>
<CAPTION>

                                                                            AT JUNE 30, 1999
                                        -------------------------------------------------------------------------------------------
                                                            MORTGAGE LOANS
                                        ---------------------------------------------------------
                                        ONE- TO
                                         FOUR-     MULTI-      NON-                                COMMERCIAL   CONSUMER     TOTAL
                                        FAMILY     FAMILY   RESIDENTIAL      LAND    CONSTRUCTION     LOANS       LOANS      LOANS
                                        -------    ------   -----------    -------   ------------  ----------   ---------   -------
<S>                                       <C>      <C>        <C>        <C>         <C>           <C>          <C>        <C>
                                                                              (IN THOUSANDS)
Amount due:
   One year or less................       $ 3,291  $     0    $     0    $     0     $ 5,082       $ 5,649      $ 1,312    $15,334
                                          -------  -------    -------    -------     -------       -------      -------    -------
   After one year:
     One to three years............         1,889        8        385        311           0         2,839        2,331      7,763
     More than three years to five
      years........................         2,711        0         39        219           0         3,804        6,660     13,433
     More than five years to ten
      years........................         8,239       80        615         92           0         2,509        1,458     12,993
     More than ten years to
      twenty years.................        15,173      228        606        636           0         3,220          384     20,247
     Over twenty years.............        17,129        0        423          0           0           240            0     17,792
                                          -------  -------    -------    -------     -------       -------      -------    -------
    Total due or repricing after one
      year..........................       45,141      316      2,068      1,258           0        12,612       10,833     72,228
    Total amounts due or repricing,       -------  -------    -------    -------     -------       -------      -------    -------
      gross.........................      $48,432  $   316    $ 2,068    $ 1,258     $ 5,082       $18,261      $12,145    $87,562
                                          =======  =======    =======    =======     =======       =======      =======    =======
</TABLE>

         The following table sets forth the dollar amounts in each loan category
at June 30, 1999 that are due after June 30,  2000,  and whether such loans have
fixed or adjustable interest rates.

<TABLE>
<CAPTION>

                                                                        DUE AFTER JUNE 30, 2000
                                                       --------------------------------------------------------
                                                          FIXED              ADJUSTABLE                TOTAL
                                                       -----------           ----------             -----------
<S>                                                     <C>                  <C>                    <C>
                                                                           (IN THOUSANDS)

Mortgage loans:                                        $    23,048           $   22,093             $   45,141
  One- to four-family.......................                   160                  156                    316
  Multi-family..............................                 1,855                  213                  2,068
  Non-residential...........................                   640                  618                  1,258
  Land......................................                 4,008                8,604                 12,612
Commercial loans............................                 8,359                2,474                 10,833
                                                       -----------           ----------             ----------
Consumer loans..............................           $    38,070           $   34,158             $   72,228
                                                       ===========           ==========             ==========
</TABLE>


         Origination,  Purchase, Sale and Servicing of Loans. The Bank's lending
activities  are  conducted  through its branches in Ashe,  Allegheny 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, 1999,  the Bank
serviced approximately $20.7 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 and Allegheny  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,   allow  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, 1999,  that Bank's  portfolio  contained  approximately  $5.1
million,  or 5.8%, 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, 1999, the Bank's non-residential  mortgage
loan portfolio was $2.1 million, or 2.4% of total loans outstanding. The largest
non-residential  mortgage  loan in the  Bank's  portfolio  at June 30,  1999 was
approximately $750,000 and is secured by a commercial property.


<PAGE>


         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, 1999,  the
Bank's total land loan portfolio was $1.3 million or 1.4% of total loans and its
multi-family loan portfolio was $316,000 or 0.36% 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, 1999, $12.1 million, or 13.9%, 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 $4.8 million of home equity credit lines.
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,  1999,  the Bank had $8,000 of  non-performing  consumer
loans.  Charge-offs for consumer loans totaled $37,000,  $13,000 and $69,000 for
the years ended June 30, 1999, 1998 and 1997, 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, 1999,  the Bank's  savings  account loan
portfolio totaled $302,000 or 0.34% 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 $4.8 million or 5.4%
of the total loan  portfolio as of June 30, 1999. 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, 1999, the Bank had no non-performing commercial business
loans. The Bank had no charge-offs with respect to commercial  business loans in
the years ended June 30, 1999, 1998 or 1997.

         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 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,  collection officer and compliance officer, meets twice a
week  to  review  all  loan  applications,  except  for  secured  consumer  loan
applications  for less than $25,000 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, 1999, the Bank held $59,000 in REO, while non-performing loans, defined
as loans that are 90 days or more delinquent, totaled $60,000. 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,
                                                ---------------------------------------------------------
                                                         1999                   1998              1997
                                                ---------------------- --------------------- ------------
<S>                                             <C>                    <C>                   <C>
                                                                    (DOLLARS IN THOUSANDS)
Non-accrual mortgage loans:
    One- to four-family.......................  $         52           $         --          $         --
    Multi-family..............................            --                     --                    --
    Non-residential...........................            --                     --                    --
    Land......................................            --                     --                    --
    Construction..............................            --                     --                    --
                                                ------------           ------------          ------------
        Total mortgage loans..................            52                     --                    --
                                                ------------           ------------          ------------
    Commercial................................            --                     --                    --
    Consumer Loans............................             8                     --                    --
                                                ------------           ------------          ------------
      Total non-accruing loans................  $         60           $         --          $         --
                                                ------------           ------------          ------------
Loans delinquent 90 or more days for which
  interest is fully reserved and still
  accruing:
    One- to four-family.......................  $         --           $         18          $        119
    Multi-family..............................            --                     --                    --
    Non-residential...........................            --                     --                    --
    Land......................................            --                     --                    --
    Construction..............................            --                     --                    --
                                                ------------           ------------          ------------
       Total mortgage loans...................            --                     18                   119
                                                ------------           ------------          ------------
    Commercial................................            --                     --                    --
    Consumer Loans............................            --                      6                    12
                                                ------------           ------------          ------------
Total loans delinquent 90 or more days for
which interest has been fully reserved........            --                     24                   131
                                                ------------           ------------          ------------
Total non-performing loans....................  $         60           $         24          $        131
                                                ------------           ------------          ------------
Total real estate owned.......................            59                     38                    --
                                                ------------           ------------          ------------
    Total non-performing assets...............  $        119           $         62          $        131
                                                ============           ============          ============
Total non-performing loans to loans, gross....          0.07%                  0.03%                 0.18%
Total non-performing assets to total assets...          0.11%                  0.06%                 0.16%

</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  existing



                                       10
<PAGE>


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,  1999,  the  Bank  had  $68,000  of  assets  classified  as
Substandard,  $6,000 of  assets  classified  as  Special  Mention,  $0 of assets
classified as Loss and $6,000 of 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, 1999,  the Bank's ALL was $1.1 million,  or 1.3% of total
loans,  as  compared to $1.2  million or 1.5%,  at June 30,  1998.  The Bank had
non-performing  loans of $60,000 and $24,000 at June 30, 1999 and June 30, 1998,
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,
                                                       ----------------------------------------------------
                                                             1999                1998               1997
                                                       ------------------- ------------------- ------------
<S>                                                         <C>                 <C>                 <C>
                                                                     (DOLLARS IN THOUSANDS)

Total loans outstanding at end of period............   $      87,562       $      75,706       $      72,484
Average total loans outstanding.....................          76,597              74,095              69,332
Balance at beginning of year........................           1,164               1,031               1,096
                                                       -------------       -------------       -------------
Provision for loan losses...........................              20                 (25)                 20
                                                       -------------       -------------       -------------
Charge-offs:
   One- to four-family residential..................              (4)                 --                 (20)
   Multi-family residential.........................              --                  --                  --
   Non-residential and land.........................             (33)                 --                  --
   Construction.....................................              --                  --                  --
   Commercial.......................................              --                  --                  --
   Consumer loans...................................             (37)                (13)                (69)
                                                       --------------      -------------       -------------
     Total charge-offs..............................             (74)                (13)                (89)
                                                       --------------      -------------       -------------
Recoveries..........................................              13                 171                   4
                                                       -------------       -------------       -------------
Balance at end of year..............................        $  1,123            $  1,164            $  1,031
                                                       =============       =============       =============
Allowance for loan losses to total loans
  at end of period..................................            1.28%               1.54%               1.42%
                                                       =============       =============       =============
Allowance for loan losses to total non-performing
  assets at end of period...........................          943.70%           1,877.42%             787.02%
                                                       =============       =============       =============
Allowance for loan losses to total non-performing
   loans at end of period...........................        1,871.14%           4,851.00%             787.02%
                                                       =============       =============       =============
Ratio of net charge-offs during the period
   To average loans outstanding during period.......            0.08%               0.02%               0.13%
                                                       =============       =============       =============
</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,
                          ---------------------------------------------------------------------------------------------------------
                                        1999                               1998                                 1997
                          ----------------------------------    ------------------------------- -----------------------------------
                                                  PERCENT OF                         PERCENT OF                          PERCENT OF
                                                   LOANS IN                           LOANS IN                             LOANS IN
                                      PERCENT OF     EACH                 PERCENT OF   EACH                   PERCENT OF    EACH
                                      ALLOWANCE    CATEGORY               ALLOWANCE   CATEGORY                 ALLOWANCE  CATEGORY
                          ALLOWANCE    TO TOTAL    TO TOTAL    ALLOWANCE   TO TOTAL   TO TOTAL  ALLOWANCE      TO TOTAL   TO TOTAL
                            AMOUNT    ALLOWANCE      LOANS      AMOUNT    ALLOWANCE    LOANS     AMOUNT        ALLOWANCE   LOANS
                          --------   ----------- -----------   ---------  ---------   --------- ---------     ---------- ----------
<S>                          <C>         <C>         <C>        <C>         <C>        <C>      <C>             <C>        <C>
                                                              (DOLLARS IN THOUSANDS)

Mortgage loans:
  One- to four-family..   $    456       40.61%      55.32%    $   634      54.47%      73.26%  $   543          52.67%     74.37%
  Multi-family.........         10        0.89%       0.36%          8       0.69%       0.88%        7           0.68%      1.02%
  Non-residential and           61        5.43%       3.80%         58       4.98%       5.07%       42           4.07%      6.06%
   land................
  Construction.........         14        1.25%       5.80%          7       0.60%       4.59%        5           0.48%      2.15%
Other:
  Consumer.............        442       39.36%      13.87%        457      39.26%      10.94%      434          42.10%     10.63%
  Commercial...........        140       12.46%      20.85%         --         --        5.26%       --             --       5.77%
                          --------      ------      ------     -------     ------      ------   -------         ------     ------
  Total................   $  1,123      100.00%     100.00%    $ 1,164     100.00%     100.00%  $ 1,031         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 and  savings  institutions,  federal
funds,  mutual funds and overnight  deposits at the FHLB. At June 30, 1999,  the
Bank held $11.8 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,
                                                             ---------------------------------------------------
                                                                    1999             1998               1997
                                                             ----------------  ---------------   ---------------
<S>                                                          <C>               <C>               <C>
                                                                              (IN THOUSANDS)

Amortized cost at beginning of period...................     $       8,533     $       6,362     $       5,272
Purchases, net..........................................             4,122             2,609             1,390
Principal payments from mortgage backed securities......            (1,333)             (731)             (316)
Gain on sales...........................................               166               306                --
Premium and discount amortization, net..................               (24)              (13)               16
                                                             --------------    -------------     -------------
Amortized cost at end of period.........................            11,464             8,533             6,362
Net unrealized gain(1)..................................               334               484               575
                                                             -------------     -------------     -------------
Total securities, net...................................     $      11,798     $       9,017     $       6,937
                                                             =============     =============     =============
</TABLE>

(1)      The net  unrealized  gain at June 30,  1999,  1998 and 1997  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,
                                   -----------------------------------------------------------------------------
                                              1999                      1998                      1997
                                   -----------------------     ----------------------    -----------------------
                                    AMORTIZED                  AMORTIZED                 AMORTIZED
                                      COST      FAIR VALUE       COST      FAIR VALUE      COST       FAIR VALUE
                                   ----------   ----------     --------    ----------    --------     ----------
<S>                                   <C>           <C>          <C>           <C>         <C>            <C>
                                                             (IN THOUSANDS)
Mortgage-backed securities:
  Fannie Mae and Government
  National Mortgage Association...  $  4,626      $  4,672     $  2,174      $  2,235    $  1,375       $  1,440
                                                               --------      --------    --------       --------
Other debt securities:
  U.S. Treasury and Agency........     4,624         4,589        5,530         5,522       4,200          4,177
  Other...........................       480           459          198           198         198            198
                                    --------      --------     --------      --------    --------       --------
Total debt securities.............     5,104         5,048        5,728         5,720       4,398          4,375
                                    --------      --------     --------      --------    --------       --------
Equity securities(1)..............     1,210         1,554            7           438          13            546
Federal Home Loan Bank Stock......       524           524          624           624         576            576
Net unrealized gain(2)............       334            --          484            --         575             --
                                    --------      --------     --------      --------    --------       --------
Total securities, net.............  $ 11,798      $ 11,798     $  9,017      $  9,017    $  6,937       $  6,937
                                    ========      ========     ========      ========    ========       ========
</TABLE>
(1)  Equity securities consist of FHLMC common stock and mutual funds.
(2)  The net  unrealized  gain at June  30,  1999,  1998  and  1997  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,
                                          ---------------------------------------------------------------------------
                                                   1999                    1998                         1997
                                          ----------------------  ------------------------   ------------------------
                                          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........       4,626       4,672       2,174        2,235         1,375          1,440
   Other debt securities:............       4,806       4,750       5,430        5,422         4,100          4,077
   Equity securities.................       1,210       1,554           7          438            13            546
   Net unrealized gain(1)............         334          --         484           --           575             --
                                          -------     -------     -------      -------       -------        -------
         Total available-for-sale....      10,976      10,976       8,095        8,095         6,063          6,063
                                          -------     -------     -------      -------       -------        -------
Certificates of deposit..............         198         198         198          198           198            198
                                          -------     -------     -------      -------       -------        -------
Federal Home Loan Bank Stock.........         524         524         624          624           576            576
                                          -------     -------     -------      -------       -------        -------
   Total securities, net.............     $11,798     $11,798     $ 9,017      $ 9,017       $ 6,937        $ 6,937
                                          =======     =======     =======      =======       =======        =======
</TABLE>
(1)      The net  unrealized  gains at June 30,  1999,  1998 and 1997  relate to
         available for sale  securities in accordance with SFAS No. 115. The net
         unrealized gain is presented in order to reconcile the "Amortized Cost"
         of the 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, 1999, 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, 1999
                                           -------------------------------------------------------------------------------
                                                      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           --           --            --              66            66          7.29
  Due after 5 years but within 10
    years...............................        --           --            --              --            --            --
  Due after 10 years....................        --           --            --           4,560         4,606          6.76
                                                                                      -------       -------
              Total                             --           --            --           4,626         4,672          6.77
 U.S. Treasury and Agency:
  Due within 1 year.....................       100          100          5,83              --            --            --
  Due after 1 year but within 5 years           --           --            --           2,880         2,849          5.75
  Due after 5 years but within 10
   years................................        --           --            --           1,017         1,018          7.53
  Due after 10 years....................        --           --            --             627           622          5.80
                                                                                      -------       -------
              Total                            100          100          5.83           4,524         4,489          6.16
                                            ------        -----       -------         -------       -------
Corporate & Other:
  Due within 1 year.....................        99           99          5.10              --            --            --
  Due after 1 year but within 5 years           99           99          7.25              --            --            --
  Due after 5 years but within 10
   years................................        --           --            --              --            --            --
  Due after 10 years....................        --           --            --             282           261          4.60
                                                                                      -------
                                               198          198          6.18             282           261          4.60
                                                                                      -------
  Equity Securities:....................        --           --            --           1,210         1,554            --
                                                                                      -------
  Total:
    Due within 1 year...................       199          199          5.47              --            --            --
    Due after 1 year but within 5 years         99           99          7.25           2,946         2,915          5.79
    Due after 5 years but within 10
     years..............................        --           --            --           1,017         1,018          7.53
    Due after 10 years..................        --           --            --           5,469         5,489          6.54
    Equity Securities...................        --           --            --           1,210         1.554            --
                                                                                      -------       -------
                                               298          298          6.06          10,642        10,976          6.41
                                               ---          ---                       -------       -------
     Federal Home Loan Bank Stock.......       524          524            --              --            --            --
                                            ------        -----       --------        -------       -------        ------
                                            $  822        $ 822           6.06%       $10,642       $10,976          6.41%
                                            ======        =====       ========        =======       =======
</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,  1999,  the Bank's core  deposits  (which the Bank  considers  to consist of
checking  accounts,  regular savings  accounts and statement  savings  accounts)
constituted  44.2%  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,  Allegheny  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,
                                                   ---------------------------------------------------------
                                                          1999                  1998                1997
                                                   ---------------------  --------------------  ------------
<S>                                                   <C>                    <C>                  <C>
                                                                           (IN THOUSANDS)

Total deposits at beginning of period,
  including accrued interest..................         $  82,488              $  68,218           $   63,468
Net increase before interest credited.........             6,848                 10,728                1,554
Interest credited.............................             3,770                  3,542                3,196
                                                       ---------              ---------           ----------
Total deposits at end of period...............         $  93,106              $  82,488           $   68,218
                                                       =========              =========           ==========
</TABLE>

         At June 30, 1999,  the Bank had  approximately  $13.9  million in Jumbo
certificate of deposits (accounts in amounts over $100,000) maturing as follows:
<TABLE>
<CAPTION>


                                                                                             WEIGHTED
                                                                       AMOUNT              AVERAGE RATE
                                                                      --------            -------------
<S>                                                                 <C>                   <C>
                                                                               (IN THOUSANDS)

Maturity Period
   Within three months.....................................         $    4,975                 5.25%
   After three but within six months.......................              3,393                 4.76%
   After six but within 12 months..........................              4,232                 4.97%
   After 12 months.........................................              1,310                 4.92%
                                                                    ----------
              Total........................................         $   13,910                 5.01%
                                                                    ==========
</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,
                           --------------------------------------------------------------------------------------------------------
                                          1999                                 1998                                1997
                           ---------------------------------     ---------------------------------   ------------------------------
                                        PERCENT     WEIGHTED                PERCENT       WEIGHTED             PERCENT     WEIGHTED
                                       OF TOTAL     AVERAGE                 OF TOTAL      AVERAGE              OF TOTAL    AVERAGE
                            AMOUNT     DEPOSITS      RATE        AMOUNT     DEPOSITS       RATE      AMOUNT    DEPOSITS     RATE
                           --------    --------    ---------     ------     --------      --------   ------    --------    --------
<S>                         <C>          <C>        <C>        <C>           <C>          <C>        <C>       <C>         <C>
                                                           (DOLLARS IN THOUSANDS)

Noninterest bearing
checking accounts......   $  3,914          4.20%       --%    $  3,469         4.21%         --%    $   901     1.33%         --
Interest bearing
checking / Money Market     15,425         16.57%     2.28%      10,321        12.51%       3.13%     11,347    16.63%       3.38%
accounts..............
Passbook savings......      21,841         23.46%     3.05%      16,729        20.28%       4.25%     10,672    15.64%       4.03%
Certificates of deposit     51,788         55.62%     4.94%      51,801        62.80%       5.52%     45,133    66.16%       5.52%
Accrued interest......         138          0.15%       --          168         0.20%         --         165     0.24%         --
                          --------       -------    ------     --------      -------    --------     -------  -------     -------
        Totals            $ 93,106        100.00%     4.29%    $ 82,488       100.00%       4.94%    $68,218   100.00%       4.96%
                          ========       =======    ======     ========      =======    ========     =======  =======     =======
</TABLE>

         The following  table presents,  by interest rate ranges,  the amount of
certificate accounts outstanding at June 30, 1999 and the period to maturity.
<TABLE>
<CAPTION>

                                                       PERIOD TO MATURITY AT JUNE 30, 1999
------------------------------------------------------------------------------------------------------------
                                          LESS THAN             ONE TO              FOUR TO
       INTEREST RATE RANGE                ONE YEAR            THREE YEARS         FIVE YEARS        TOTAL
--------------------------------    -------------------  -------------------   ---------------  ------------
<S>                                  <C>                  <C>                  <C>              <C>
                                                           (DOLLARS IN THOUSANDS)
4.00% to 5.99%                      $       42,693        $       5,577        $       1,219    $      49,489
6.01% to 7.99%..................             1,964                  272                   63            2,299
  Total.............                $       44,657        $       5,849        $       1,282    $      51,788
                                    ==============        =============        =============    =============
</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,  1999,  the maximum
amount of FHLB advances  available to the Bank was $16.0  million.  The Bank had
short term advances of $2.6 million at June 30, 1999 from the FHLB.  Interest is
payable at rates  ranging from 5.68% to 6.87%.  $912,500 of the advances are due
by August of 2002, $1.5 million are due by September of 2002, with the remaining
$152,000 due January 2007.

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. An additional insurance agency was purchased in April of 1999.
AF Insurance  Services,  Inc. offers these services in a segregated  location at
the Bank's executive offices,  Sparta,  Lenoir,  Jefferson and North Wilkesboro,
North Carolina.


                                       17
<PAGE>


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. AF Brokerage,  Inc. offers these services
in a segregated location at the Bank's executive offices and branch locations.

PERSONNEL

         As of June 30,  1999,  the  Company  had 70  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 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.




                                       18
<PAGE>

         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,
1999, the Bank's limit on loans to one borrower was approximately  $1.8 million.
At June 30, 1999, 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, multifamily and
commercial  properties.  The second largest borrower had an aggregate balance of
approximately $1.4 million,  secured by an apartment complex.  At June 30, 1999,
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 Adomestic building and loan association@
as defined in the  Internal  Revenue Code of 1986.  At June 30,  1999,  the Bank
maintained 89.8% 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 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 of asset.




                                       19
<PAGE>



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

         The  OTS  has   promulgated  a  regulation   that  requires  a  savings
association with "above normal" interest rate risk, when determining  compliance
with its risk-based capital  requirement,  to hold additional capital to account
for its "above normal" interest rate risk. A savings association's interest rate
risk is measured by the decline in the net portfolio  value of its assets (i.e.,
the difference between incoming and outgoing  discounted cash flows from assets,
liabilities and off-balance  sheet  contracts)  resulting from a hypothetical 2%
increase or  decrease  in market  rates of  interest,  divided by the  estimated
economic value of the  association's  assets,  as calculated in accordance  with
guidelines  set forth by the OTS.  At the times when the 3-month  Treasury  bond
equivalent  yield falls below 4%, an  association  may compute its interest rate
risk on the basis of a decrease  equal to one-half of that  Treasury rate rather
than on the basis of 2%. A savings association whose measured interest rate risk
exposure  exceeds  2% would be  considered  to have  "above  normal"  risk.  The
interest  rate risk  component is an amount equal to one-half of the  difference
between the association's  measured interest rate risk and 2%, multiplied by the
estimated  economic  value of the  association's  assets.  That dollar amount is
deducted from an association's total capital in calculating  compliance with its
risk-based  capital  requirement.  Any required deduction for interest rate risk
becomes  effective on the last day of the third quarter  following the reporting
date of the  association's  financial  data on which the interest  rate risk was
computed.  The OTS has indefinitely  deferred the implementation of the interest
rate risk component in the computation of an  institution's  risk-based  capital
requirements.  The OTS continues to monitor the interest rate risk of individual
institutions and retains the right to impose additional capital  requirements on
individual institutions. At June 30, 1999, the Bank was not required to maintain
any  additional  risk-based capital under this rule. At June 30, 1999, the  Bank
met each of its capital requirements.

         The table below presents the Bank's  regulatory  capital as compared to
the OTS regulatory capital requirements at June 30, 1999:
<TABLE>
<CAPTION>

                                                                CAPITAL           EXCESS
                                               AMOUNT         REQUIREMENTS        CAPITAL
                                             ---------      --------------       ----------
<S>                                           <C>              <C>                <C>
                                                          (IN THOUSANDS)

Core capital...........................       $   10,897       $    3,256         $    7,641
Risk-based capital.....................           11,901            5,484              6,417
</TABLE>


         A reconciliation  between  regulatory  capital and GAAP capital at June
30, 1999 in the accompanying financial statements is presented below:


                                       20
<PAGE>
<TABLE>
<CAPTION>

                                                                         RISK-
                                                        CORE             BASED
                                                       CAPITAL          CAPITAL
                                                    ------------      -----------
<S>                                                 <C>               <C>
GAAP capital....................................    $     11,063      $    11,063
Net unrealized gain on available for
  sale investment securities, net of tax........            (166)            (166)
Allowance for loan losses included as
  supplementary capital.........................              --              856
Goodwill and other nonincludible assets.........              --              148
                                                    ------------      -----------
Regulatory capital..............................    $     10,897      $    11,901
                                                    ============      ===========

</TABLE>



         Limitation on Capital  Distributions.  Effective April 1, 1999, the OTS
amended its capital  distribution  regulations to reduce  regulatory  burdens on
savings  associations.  The  regulations  being  replaced,  which were effective
throughout 1998,  established  limitations upon capital distributions by savings
associations,  such as cash  dividends,  payments  to  repurchase  or  otherwise
acquire its shares, payments to shareholders of another institution in a 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, 1999 was  approximately  19.7% 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



                                       21
<PAGE>

of 3, 4 or 5 in its  most  recent  safety  and  soundness  examination;  and the
complexity of the association's operations,  which would result in an additional
assessment  based  of a  percentage  of the  basic  assessment  for any  savings
association that managed over $1.0 billion in trust assets,  serviced for others
loans  aggregating  more than $1.0  billion,  or had certain  off-balance  sheet
assets aggregating more than $1.0 billion.  In order to avoid a disproportionate
impact on the smaller savings  institutions,  which are those whose total assets
never exceeded $100.0 million,  the new regulations  provide that the portion of
the assessment  based on asset size will be the lesser of the  assessment  under
the amended  regulations or the  regulations  before the  amendment.  Management
believes  that any  change  in its rate of OTS  assessments  under  the  amended
regulations will not be material.

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

         Community  Reinvestment.  Under the Community Reinvestment Act ("CRA"),
as implemented by OTS  regulations,  a savings  institution has a continuing and
affirmative obligation consistent with its safe and sound operation to help meet
the credit needs of its entire  community,  including  low and  moderate  income
neighborhoods.  The CRA does not  establish  specific  lending  requirements  or
programs  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.




                                       22
<PAGE>


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

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



                                       23
<PAGE>

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  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,   1999,   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-



                                       24
<PAGE>

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 rate of assessments for the payments on the
FICO bonds for the first,  second, third and fourth quarters of fiscal year 1999
were 0.0622%, 0.0610%, 0.0582% and 0.061%, respectively.

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

         Federal  Home  Loan  Bank  System.  The Bank is a member of the FHLB of
Atlanta, which is one of the regional FHLBs composing the FHLB System. Each FHLB
provides a central credit facility  primarily for its member  institutions.  The
Bank, as a member of the FHLB of Atlanta, is required to acquire and hold shares
of  capital  stock  in the  FHLB of  Atlanta  in an  amount  equal  to 1% of the
aggregate  principal  amount of its  unpaid  residential  mortgage  loans,  home
purchase contracts and similar obligations, but not less than $500. The Bank was
in compliance with this  requirement with an investment in FHLB of Atlanta stock
at June 30,  1999,  of  $524,000.  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, 1999, 1998 and 1997, dividends from
the FHLB of  Atlanta to the Bank  amounted  to  $45,000,  $43,000  and  $38,000,
respectively.  If dividends  were  reduced,  or interest on future FHLB advances
increased, the Bank's net interest income would likely also be reduced.

         Federal  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



                                       25
<PAGE>


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

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

         A savings  and loan  holding  company  may not  acquire  as a  separate
subsidiary an insured  institution  that has a principal  office  outside of the
state  where the  principal  office of its  subsidiary  institution  is located,
except (i) in the case of certain emergency acquisitions (as defined under HOLA)
approved  by  the  FDIC;  (ii)  if  such  holding  company  controls  a  savings
institution  subsidiary that operated a home or branch office in such additional
state as of March  5,  1987,  and  (iii) if the laws of the  state in which  the
savings institution to be acquired is located  specifically  authorize a savings
institution  chartered  by that state to be  acquired  by a savings  institution
chartered by the state where the acquiring  savings  institution  or savings and
loan holding  company is located or by a holding  company that  controls  such a
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."




                                       26
<PAGE>


         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."

THE YEAR 2000 PROBLEM

         Financial  institution  regulators have recently  increased their focus
upon Year 2000 issues,  issuing  guidance  concerning  the  responsibilities  of
senior management and directors.  The Federal Financial Institutions Examination
Council ("FFIEC") has issued several interagency statements on Year 2000 Project
Management Awareness.  These statements require financial institutions to, among
other things,  examine the Year 2000  implications of reliance on vendors,  data
exchange and potential  impact on  customers,  suppliers  and  borrowers.  These
statements also require each federally regulated financial institution to survey
its  exposure,  measure  its risk and  prepare a plan in order to solve the Year
2000 Problem.  In addition,  the FDIC and the other federal  banking  regulators
have issued safety and soundness guidelines to be followed by insured depository
institutions,  such as the Bank, to assure resolution of any Year 2000 problems.
The  federal  banking   agencies  have  asserted  that  Year  2000  testing  and
certification is a key safety and soundness issue in conjunction with regulatory
exams, and thus an institution's  failure to address appropriately the Year 2000
problem could result in supervisory  action,  including such enforcement actions
as the  reduction  of the  institution's  supervisory  ratings,  the  denial  of
applications for approval of a merger or acquisition, or the imposition of civil
money penalties.

         The Company's  Year 2000 project  remains on schedule  according to the
guidelines  set forth by the FFIEC.  The Company  replaced  all of its  computer
systems  with Year 2000  compliant  systems in the fall of 1997.  The  Company's
internal software remediation, replacement and testing efforts are complete. The
Company is also monitoring the progress of its customers and vendors in becoming
Year 2000  compliant.  See  "Management  Discussion and Analysis - Impact of the
Year 2000."

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 has applied
for  membership in 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.




                                       27
<PAGE>



                           FEDERAL AND STATE TAXATION

FEDERAL TAXATION

         General.  The  following  discussion  is intended only as a summary and
does not purport to be a comprehensive  description of the tax rules  applicable
to the Bank, Mutual Company or Stock Company.  The Bank has not been audited for
the last seven 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., it reserve as of
June 30, 1999, to the extent thereof and then from its supplemental  reserve for
losses on loans, and an amount based on the amount  distributed will be included
in the Bank's taxable income.  Non-dividend  distributions include distributions
in  excess  of  the  Bank's  current  and  accumulated   earnings  and  profits,
distributions  in redemption of stock and  distributions  in partial or complete
liquidation.  However,  dividends  paid out of the Bank's current or accumulated
earnings and profits,  as calculated for federal  income tax purposes,  will not
constitute  non-dividend  distributions and, therefore,  will not be included in
the Bank's income.

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

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

         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.




                                       28
<PAGE>


STATE TAXATION

         Under North Carolina law, the corporate  income tax is 7.25% 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.

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,  Lenoir and Boone, North Carolina.  The Company
owns the main office,  corporate offices and the Jefferson Branch, with net book
value for property of $195,000, $599,000 and $519,000,  respectively, as of June
30, 1999. 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, 1999
                                 ------------------  --------------------  --------------------  -----------------
<S>                                  <C>                  <C>                  <C>                   <C>
                                                                 (DOLLARS IN THOUSANDS)

Corporate Offices............          Owned               06/30/97                 --                   $  599
206 S. Jefferson 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
Allegheny First..............          Leased              01/09/98            12/31/2000**                  --
403 South Main Street
Sparta, NC 28675
Appalachian First............          Leased              02/26/99            2/26/2003***                  --
285 Hwy 105 Ext.
Boone, NC 28607
AF Brown Insurance...........          Leased              09/01/97           8/31/1999****                  --
1347 West D Street
Wilkesboro, NC 28659
AF Blair.....................          Leased              04/01/99             03/31/2004                   --
324 Morganton Blvd., SW
Lenior, NC 28645
</TABLE>


                                       29
<PAGE>

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

*    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.

ITEM 3.       LEGAL PROCEEDINGS

         At June 30, 1999, 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 1999 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  1999
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 Bank paid cash  dividends  totaling  $0.20 per share  during  the years
ended June 30, 1999 and 1998, respectively.

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 1999 Annual Report to Stockholders on pages 1 and 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  1999 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,                                  20
     June 30, 1999 and 1998..............................................
o  Consolidated Statements of Income and Comprehensive Income                       21
     Years Ended June 30, 1999 and 1998..................................
o  Consolidated Statements of Stockholders' Equity,                               22-23
     Years Ended June 30, 1999 and 1998..................................
</TABLE>


                                       30
<PAGE>

<TABLE>
<CAPTION>

<S>                                                                               <C>
o  Consolidated Statements of Cash Flows,                                         24-25
     Years Ended June 30, 1999 and 1998.................................
o  Notes to Consolidated Financial Statements...........................          26-53
</TABLE>


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 1, 1999.

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 1, 1999.

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 1, 1999.

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 1, 1999.

ITEM 13. EXHIBITS, LISTS 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).


                                       31
<PAGE>

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

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

     13.1 1999 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, 1999.

   *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 27                      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.

                                                      Date
                                                      ----


/s/ James A. Todd                            September 27, 1999
---------------------------------------      -------------------------
James A. Todd
President, Chief Executive Officer
  and Director
(Principal Executive Officer)


/s/ Melanie Paisley Miller                   September 27, 1999
---------------------------------------      -------------------------
Melanie Paisley Miller
Executive Vice President, Secretary,
 Treasurer and Chief Financial Officer
(Principal Financial Officer)


/s/ Jan R. Caddell                           September 27, 1999
---------------------------------------      -------------------------
Jan R. Caddell - Director


/s/ Kenneth R. Greene                        September 27, 1999
---------------------------------------      -------------------------
Kenneth R. Greene - Director


/s/ William O. Ashley, Jr.                   September 27, 1999
---------------------------------------      -------------------------
William O. Ashley, Jr. - Director


/s/ Wayne R. Burgess                         September 27, 1999
---------------------------------------      -------------------------
Wayne R. Burgess - Director




                                       33
<PAGE>





 /s/ Frank E. Roland                          September 27, 1999
---------------------------------------      -------------------------
Frank E. Roland - Director


 /s/ Jerry L. Roten                           September 27, 1999
---------------------------------------      -------------------------
Jerry L. Roten - Director


/s/ John D. Weaver                            September 27, 1999
---------------------------------------      -------------------------
John D. Weaver - Director











                                       34