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, 1998

                          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,  1998  are
$8,347,654

     The issuer had 1,053,678 shares of common stock outstanding as of September
2, 1998. 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
September 2, 1998 ($19.00) was $8,416,430.

     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,
1998 are incorporated by reference into Part I and II of this Form 10-KSB.

     Portions of the Proxy Statement for the 1998 Annual Meeting of Stockholders
are incorporated by reference into Part III of this Form 10-KSB.



<PAGE>



                                TABLE OF CONTENTS


PART I  
 ITEM 1.  DESCRIPTION OF BUSINESS..............................................1
 ITEM 2.  PROPERTIES..........................................................30
 ITEM 3.  LEGAL PROCEEDINGS...................................................31
 ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.................31
 
        
PART II 
 ITEM 5.  MARKET FOR COMMON STOCK AND RELATED STOCKHOLDER MATTERS.............31
 ITEM 6.  MANAGEMENT'S DISCUSSION AND ANALYSIS................................31
 ITEM 7.  FINANCIAL STATEMENTS................................................31
 ITEM 8.  CHANGES IN AND DISAGREEMENT WITH ACCOUNTANTS ON ACCOUNTING
          AND FINANCIAL DISCLOSURE............................................32
        
        
PART III
 ITEM 9.  DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS........32
 ITEM 10. EXECUTIVE COMPENSATION..............................................32
 ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT......32
 ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS......................32
 ITEM 13. EXHIBITS, LISTS AND REPORTS ON FORM 8-K.............................32


SIGNATURES....................................................................34



<PAGE>



                                     PART I

ITEM 1. DESCRIPTION OF BUSINESS

GENERAL

     AF Bankshares,  Inc. (the "Company") is a federally chartered stock holding
company  for AF Bank (the "Bank "), a federally  chartered  stock  savings  bank
which conducts  business from its main office located in West  Jefferson,  North
Carolina, branches in Jefferson and Warrensville, North Carolina operating under
the trade name Ashe  Federal  Bank and one  branch in  Alleghany  County,  North
Carolina  operating  under the trade name  Alleghany  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, 1998,  the Bank had total assets of $99.6 million,
total deposits of $82.5 million and equity of $11.5 million.

     The  historical  operations  of the  Company  has been that of a  portfolio
mortgage  lender,  providing  fixed rate loans for the residents of Ashe County,
North  Carolina.  While the Company  plans to maintain its focus on  traditional
mortgage  lending,  management  has  recently  expanded  the market  area of the
Company to include  Alleghany  County 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 have  increased by 131.8% and consumer loans have
increased  by 66.9%  since June 30,  1996.  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
Bank.  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 plans
to offer such  investment  products  through  its own  broker-dealer  subsidiary
beginning in the third  quarter of fiscal 1998.  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-bearing  savings
deposits and with other borrowings.  The primary  interest-earning  asset of the
Company is its mortgage loan portfolio representing almost 83.8% of total loans,
with  approximately  one-half of portfolio mortgage loans at fixed rates at June
30,  1998.  The net  interest  income of the  Company is  affected by changes in
economic  conditions  that influence  market  interest  rates.  This exposure to
changes in interest rates contributes to a moderate degree of interest rate risk
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,  FDIC
insurance,  including  a  one-time  special  assessment  during  1997,  and data
processing  costs.  Other external factors that affect the operating  results of
the Company include changes in government and accounting




<PAGE>



regulations,  costs of implementing  information technology,  and changes in the
competition's emphasis within the Company's market.

     As of June 30,  1998,  $63.4  million,  or 83.8% of the  Bank's  total loan
portfolio  consisted  of real  estate  loans.  Total loans at June 30, 1998 were
$75.7 million of which $55.5 million or 73.3% were secured by one-to-four family
residences.  The Bank also invests in consumer loans and commercial loans. Total
mortgage loans,  including  construction loans, totaled $63.4 million as of June
30, 1998. Of that amount, 46.8% were adjustable rate loans.

     As of June  30,  1998,  the  Bank's  consumer  loans  and  commercial  loan
portfolios were $12.3 million, or 16.2% of total loans. Commercial loans totaled
$4.0  million,  or 5.2% 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 $2.2 million or 2.2% of total assets at June 30, 1998, and FHLB, Federal
Farm Credit Bank and FHLMC securities investments totaled $6.0 million, or 6.0%,
of total assets at June 30, 1998.

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
Alleghany  County and operates the branch under the trade name  Alleghany  First
Bank.  At the same time, an insurance  agency  branch of AF Insurance  Services,
Inc.,  was opened in the same location.  The staff of Alleghany  First came from
the local banking  community and is attuned to the needs and habits of Alleghany
citizens.  The insurance  agency personnel direct their attention to the special
needs of Alleghany  County citizens as well.  Management now believes that it is
delivering the same  personalized  customer  service to Alleghany County that it
has historically delivered to Ashe County.


                                       2

<PAGE>



     The Bank faces substantial competition for both the deposits it accepts and
the loans it makes.   Management  believes  that the Bank has the third  largest
deposit base in Ashe County,  with approximately 22% of the market for deposits,
and the second largest  deposit base in the part of Ashe County which  comprises
its primary zip code,  28694,  with  approximately  30% of that market.  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,
                                             1998                              1997                           1996
                                   ------------------------          -----------------------          ----------------------
                                                     % OF                             % OF                            % OF
                                     AMOUNT          TOTAL             AMOUNT         TOTAL             AMOUNT        TOTAL
                                   --------       --------           --------      --------           --------     --------
                                                                     (DOLLARS IN THOUSANDS)
<S>                                <C>               <C>             <C>              <C>             <C>             <C>   
Mortgage loans:
  One- to four-family..........    $ 55,462          76.36%          $ 53,903         76.75%          $ 51,401        82.26%
  Multi-family.................         668           0.92%               742          1.06%               638         1.02%
  Non-residential..............       1,418           1.95%             2,804          3.99%             3,413         5.46%
  Land.........................       2,424           3.34%             1,586          2.26%             1,708         2.73%
  Construction.................       3,477           4.79%             1,562          2.22%               798         1.28%
                                   --------       --------           --------      --------           --------     --------
   Total mortgage loans........    $ 63,449          87.36%            60,597         86.28%            57,958        92.75%
                                   ========       --------           ========      ========           ========     ========


Other loans:
  Commercial...................       3,975           5.48%             4,182          5.95%             1,715         2.75%
  Consumer loans...............       8,282          11.40%             7,705         10.97%             4,962         7.94%
                                   --------       --------           --------      --------           --------     --------
   Total other loans...........      12,257          16.88%            11,887         16.92%             6,677        10.69%
                                   --------       --------           --------      --------           --------     --------
  Gross loans..................      75.706         104.24%            72,484        103.20%            64,635       103.44%
                                   --------       --------           --------      --------           --------     --------

Less:
  Undisbursed loan funds.......       1,598           2.20%               759          1.08%               546         0.88%
  Deferred loan fees...........         316           0.44%               458          0.65%               508         0.81%
  Allowance for loan losses....       1,164           1.60%             1,031          1.47%             1,096         1.75%
                                   --------       --------           --------      --------           --------     --------
                                      3,078           4.24%             2,248          3.20%             2,150         3.44%
                                   --------       --------           --------      --------           --------     --------

   Loans, net..................      72,628         100.00%          $ 70,236        100.00%          $ 62,485       100.00%
                                   ========       ========           ========      ========           ========     ========


Loans serviced for others:
  One- to four-family and
     cooperative apartment.....       8,511         100.00%          $    383        100.00%          $     39       100.00%
                                   --------       --------           --------      --------           --------     --------
      Total loans serviced     
          for others...........       8,511         100.00%          $    383        100.00%          $     39       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,  1998.  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 $24.8 million for the year ended June 30, 1998, and $18.9
million  and  $13.5  million  for the  years  ended  June  30,  1997  and  1996,
respectively.

<TABLE>
<CAPTION>
                                                                                  AT JUNE 30, 1998
                                        ----------------------------------------------------------------------------------------
                                                                MORTGAGE LOANS
                                        ---------------------------------------------------------
                                         ONE- TO                                                                     
                                          FOUR-   MULTI-       NON-                                COMMERCIAL  CONSUMER   TOTAL
                                         FAMILY   FAMILY    RESIDENTIAL     LAND     CONSTRUCTION     LOANS      LOANS    LOANS
                                        -------- --------- ----------- ------------ ------------- ----------  --------  -------
                                                                              (IN THOUSANDS)
<S>                                      <C>      <C>       <C>          <C>          <C>          <C>        <C>       <C>    
Amount due:                                                              
  One year or less                       $ 2,947     $---     $    10    $     3       $ 3,477     $   876    $   372   $ 7,685
                                         -------  -------     -------    -------       -------     -------    -------   -------
                                                                                                             
After one year:                                                                                              
    One to three years                     2,313       --          38        139            --         632      1,187     4,309
    More than three years to five years    2,017       --          20        498            --         949      5,968     9,452
    More than five years to ten years      8,095      136         247        545            --         397        483     9,903
    More than ten years to                                                                                        272    24,504
      twenty years                        20,926      532       1,016        637            --       1,121   
    Over twenty years                     19,164       --          87        602            --          --         --    19,853
                                         -------  -------     -------    -------       -------     -------    -------   -------
  Total due or repricing after one year   52,515      668       1,408      2,421            --       3,099      7,910    58,021
                                         -------  -------     -------    -------       -------     -------    -------   -------
  Total amounts due or repricing, gross  $55,482  $   668     $ 1,418    $ 2,424       $ 3,477     $ 3,975    $ 8,282   $75,706
                                         =======  =======     =======    =======       =======     =======    =======   =======
</TABLE>                                                                



     The following  table sets forth the dollar amounts in each loan category at
June 30,  1998 that are due after June 30,  1999,  and  whether  such loans have
fixed or adjustable interest rates.

<TABLE>
<CAPTION>
                                                                                 DUE AFTER JUNE 30, 1999
                                                         --------------------------------------------------------------
                                                              FIXED                ADJUSTABLE                  TOTAL
                                                         -------------          ---------------            ------------
                                                                                 (IN THOUSANDS)
<S>                                                         <C>                    <C>                      <C>    
Mortgage loans:
  One- to four-family..........................             $30,184                $22,331                  $52,515
  Multi-family.................................                 332                    336                      668
  Non-residential..............................                 751                    657                    1,408
  Land.........................................               1,169                  1,252                    2,421
Commercial loans...............................                 711                  2,388                    3,099
Consumer loans.................................               2,408                  5,502                    7,910
                                                            -------                -------                  -------
                                                            $35,555                $32,466                  $68,021
                                                            =======                =======                  =======
</TABLE>

     Origination,  Purchase,  Sale and  Servicing of Loans.  The Bank's  lending
activities  are conducted  through its branches in Ashe and Alleghany  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, 1998,  the Bank
serviced approximately $8.5 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 Alleghany  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 origination,  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, 1998,  that Bank's  portfolio  contained  approximately  $3.5
million,  or 4.6%, 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  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,  1998,  the  Bank's  non-residential  mortgage  loan
portfolio  was $1.4  million,  or 2.0% of total loans  outstanding.  The largest
non-residential  mortgage  loan in the  Bank's  portfolio  at June 30,  1998 was
approximately $468,000 and is secured by a commercial property.

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


                                       6


<PAGE>



timely basis.  Because payments on loans secured by  non-residential  properties
are often dependent on the successful operation or management of the properties,
repayment of such loans may be subject to a greater extent to adverse conditions
in the real estate market or the economy. The Bank seeks to minimize these risks
through its underwriting standards,  which require such loans to be qualified on
the basis of the property's income and debt service ratio.

     Other  Mortgage  Lending.  The Bank also offers  loans  secured by land and
multi-family  residences.  Land loans generally consist of residential  building
lots  for  which  the  borrower  intends  to  ultimately  construct  residential
properties,  but may also include tracts  purchased for  agricultural  use and a
minor amount for speculative  purposes.  Multi-family loans generally consist of
residential  properties  with more than four units,  typically  small  apartment
complexes,  located in the Bank's  primary  lending area. At June 30, 1998,  the
Bank's total land loan portfolio was $2.4 million or 3.3% of total loans and its
multi-family loan portfolio was $668,000 or 0.9% 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, 1998, $8.3 million,  or 11.4%, 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 $4.1 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.  The remaining  deficiency usually does
not warrant further substantial collection efforts against the borrower.

     As of June 30, 1998, the Bank had $6,000 of non-performing  consumer loans.
Charge-offs  for consumer loans totaled  $13,000,  $69,000,  and $31,000 for the
years ended June 30, 1998, 1997 and 1996, respectively.



                                       7



<PAGE>



     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, 1998,  the Bank's  savings  account loan
portfolio totaled $312,000 or 0.43% 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 $4.1 million or 5.75% of
the total loan  portfolio  as of June 30, 1998.  The home equity  credit line is
available  on  any  owner-occupied   one-to-four  family  home,  townhouse,   or
condominium in the Bank's  lending area provided the homeowner  meets the Bank's
lending  criteria.  A home equity loan is an adjustable  rate mortgage  which is
based on the equity in the home,  and is generally  secured by a first or second
mortgage on the residence.  Loan amounts currently range from $5,000 to $100,000
(up to 80% of the  appraised  value of the  home  less  any  outstanding  senior
mortgage/lien.)  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, 1998,  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, 1998, 1997 or 1996.

     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 full 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 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



                                       8


<PAGE>



the renewed  loan  applying an interest  rate that  reflects  prevailing  market
conditions  and the  customer's  payment  history,  as well as the  value of the
underlying collateral property.

ASSET QUALITY

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

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

     Real Estate Owned. Property acquired by the Bank as a result of foreclosure
on a mortgage loan is classified as real estate owned ("REO"). At June 30, 1998,
the Bank held $38,000 in REO and non-performing loans, defined as loans that are
90 days  or more  delinquent,  totaled  $24,000.  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 takes
possession of the property.  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,
                                                -----------------------------------------------------------------
                                                         1998                   1997                  1996
                                                ----------------------- --------------------- -------------------
                                                                       (DOLLARS IN THOUSANDS)
<S>                                                   <C>                     <C>                   <C>   
Non-accrual mortgage loans:
    One- to four-family........................       $   --                  $   --                $   --
    Multi-family...............................           --                      --                    --
    Non-residential............................           --                      --                    --
    Land.......................................           --                      --                    --
    Construction...............................           --                      --                    --
                                                      ------                  ------                ------
        Total mortgage loans...................           --                      --                    --
                                                      ------                  ------                ------
    Commercial.................................           --                      --                    --
    Consumer Loans.............................           --                      --                    --
                                                      ------                  ------                ------
      Total non-accruing loans.................       $   --                  $   --                $   --
                                                      ------                  ------                ------

Loans  delinquent 90 or more days for
  which interest is fully reserved and still
  accruing:
    One- to four-family........................       $   18                  $  119                $  174
    Multi-family...............................           --                      --                    --
    Non-residential............................           --                      --                    --
    Land.......................................           --                      --                    --
    Construction...............................           --                      --                    --
                                                      ------                  ------                ------
       Total mortgage loans....................           18                     119                   174
                                                      ------                  ------                ------
    Commercial.................................           --                      --                    --
    Consumer Loans.............................            6                      12                    --
                                                      ------                  ------                ------
Total loans delinquent 90 or more days for which
    interest has been fully reserved...........           24                     131                   174
                                                      ------                  ------                ------
Total non-performing loans.....................       $   24                  $  131                $  174
                                                      ------                  ======                ======
Total real estate owned........................           38                      --                    --
                                                      ------                  ------                ------
    Total non-performing assets................       $   62                  $  131                $  174
                                                      ======                  ======                ======

Total non-performing loans to loans, gross.....         0.03%                   0.18%                 0.27%
Total non-performing assets to total assets....         0.06%                   0.16%                 0.24%
</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  Office  of  Thrift   Supervision   ("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



                                       10

<PAGE>



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

     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,  1998,  the Bank  had  $164,000  of  assets  classified  as
Substandard,  $6,000 of assets classified as Special Mention,  $26,000 of assets
classified as Loss and $6,000 of assets classified as Doubtful.

     Allowance for Loan Losses.  The 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, 1998, the Bank's ALL was $1.2
million,  or 1.5% of total loans,  as compared to $1.0 million or 1.4%,  at June
30, 1997. The Bank had non-performing  loans of $24,000 and $131,000 at June 30,
1998 and June 30,  1997,  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,
                                                      -----------------------------------------------------------
                                                              1998                 1997                 1996
                                                      ----------------------------------------- -----------------
                                                                          (DOLLARS IN THOUSANDS)
<S>                                                        <C>                  <C>                  <C>     
Total loans outstanding at end of period..............     $ 75,706             $ 72,484             $ 64,635
Average total loans outstanding.......................       74,095               69,332               61,677

Balance at beginning of year..........................        1,031                1,096                1,209
                                                           --------             --------             --------
Provision for loan losses.............................          (25)                  20                   57
                                                           --------             --------             --------

Charge-offs:
   One- to four-family residential....................           --                  (20)                (148)
   Multi-family residential...........................           --                   --                   --
   Non-residential and land...........................           --                   --                   --
   Construction.......................................           --                   --                   --
   Commercial.........................................           --                   --                   --
   Consumer loans.....................................          (13)                 (69)                 (31)
                                                           --------             ---------            ---------
     Total charge-offs................................          (13)                 (89)                (179)
                                                           --------             ---------            ---------

Recoveries............................................          171                    4                    9
                                                           --------             --------             --------

Balance at end of year................................     $  1,164             $  1,031             $  1,096
                                                           ========             ========             ========

Allowance for loan losses to total loans
  at end of period....................................         1.54%                1.42%                1.70%
                                                           ========             ========             ========

Allowance for loan losses to total non-performing
   assets at end of period............................      1877.42%              787.02%              629.89%
                                                           ========             ========             ========

Allowance for loan losses to total non-performing
   loans at end of period.............................      4850.00%              787.02%              629.89%
                                                           ========             ========             ========

Ratio of net charge-offs during the period
   To average loans outstanding during period.........         0.02%                0.13%                0.29%
                                                           ========             ========             ========
</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,
                          -------------------------------------------------------------------------------
                                          1998                                    1997                   
                          ------------------------------------- ---------------------------------------- 
                                                    Percent of                               Percent of  
                                                     Loans in                                 Loans in   
                                        Percent of     Each                     Percent of      Each     
                                         Allowance   Category                   Allowance     Category   
                            Allowance    to Total    to Total     Allowance     to Total      to Total   
                             Amount      Allowance     Loans       Amount       Allowance       Loans    
                             (DOLLARS IN THOUSANDS)
<S>                         <C>           <C>          <C>        <C>            <C>           <C>       
Mortgage loans:
  One- to four-family....   $  634        54.47%       73.26%     $  543         52.67%        74.37%    
  Multi-family...........        8         0.69%        0.88%          7          0.68%         1.02%    
  Non-residential and land      58         4.98%        5.07%         42          4.07%         6.06%    
  Construction...........        7         0.60%        4.59%          5          0.48%         2.15%    
Other:
  Consumer...............      457        39.26%       10.94%        434         42.10%        10.63%    
  Commercial.............       --           --         5.26%         --            --          5.77%    
                            ------       ------       ------      ------        ------        ------     
  Total..................   $1,164       100.00%      100.00%     $1,031        100.00%       100.00%    
                            ======       ======       ======      ======        ======        ======     

<CAPTION>
                                       At June 30,
                          ------------------------------------- 
                                          1996
                          ------------------------------------- 
                                                    Percent of
                                                     Loans in
                                       Percent of      Each
                                        Allowance    Category
                            Allowance   to Total     to Total
                             Amount     Allowance      Loans
<S>                          <C>          <C>         <C>   
Mortgage loans:
  One- to four-family....    $  510       46.55%      79.53%
  Multi-family...........         6        0.58%       0.99%
  Non-residential and land       51        4.65%       7.93%
  Construction...........         3        0.22%       1.23%
Other:
  Consumer...............       526       48.00%       7.67%
  Commercial.............        --          --        2.65%
                             ------    --------    --------
  Total..................    $1,096      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,
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, and overnight
deposits at the FHLB. At June 30, 1998, the Bank held $9.0 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,
                                                            ---------------------------------------------------
                                                                   1998                1997                1996
                                                            ------------------- ------------------ ------------
                                                                                  (IN THOUSANDS)
<S>                                                              <C>                 <C>                <C>     
Amortized cost at beginning of period......................      $  6,362            $  5,272           $  2,493
Purchases, net.............................................         2,609               1,390              2,744
Principal payments from mortgage backed
     securities............................................          (731)               (316)                --
Gain on sales..............................................           306                  --                 --
Premium and discount amortization, net.....................           (13)                 16                 35
                                                                 --------            --------           --------
Amortized cost at end of period............................         8,533               6,362              5,272
Net unrealized gain(1).....................................           484                 575                288
                                                                 --------            --------           --------
Total securities, net......................................      $  9,017            $  6,937           $  5,560
                                                                 ========            ========           ========
</TABLE>

----------
(1)  The net  unrealized  gain at June  30,  1998,  1997  and  1996  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,
                                    -----------------------------------------------------------------------------------
                                               1998                        1997                        1996
                                    --------------------------- --------------------------- ---------------------------
                                       Amortized                   Amortized                   Amortized
                                         Cost      Fair Value        Cost       Fair Value       Cost       Fair Value
                                    ------------  -----------   ------------   ------------ ------------  -------------
                                                                      (IN THOUSANDS)
<S>                                   <C>           <C>           <C>            <C>          <C>            <C>   
Mortgage-backed securities:
  Fannie Mae.......................   $2,174        $2,235        $1,375         $1,440       $  853         $  887
                                      ------        ------        ------         ------       ------         ------
Other debt securities:
  U.S. Treasury and Agency.........    5,530         5,522         4,200          4,177        3,700          3,628
  Other............................      198           198           198            198          198            198
                                      ------        ------        ------         ------       ------         ------
Total debt securities..............    5,728         5,720         4,398          4,375        3,898          3,826
                                      ------        ------        ------         ------       ------         ------
Equity securities(1)...............        7           438            13            546           13            339
Federal Home Loan Bank Stock.......      624           624           576            576          508            508
Net unrealized gain(2).............      484            --           575             --          288             --
                                      ------        ------        ------         ------       ------         ------
Total securities, net..............   $9,017        $9,017        $6,937         $6,937       $5,560         $5,560
                                      ======        ======        ======         ======       ======         ======
</TABLE>

----------
(1)  Equity securities consist of FHLMC common stock.

(2)  The net  unrealized  gain at June  30,  1998,  1997  and  1996  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,
                                       ------------------------------------------------------------------------------------
                                                 1998                       1997                          1996
                                       ------------------------- --------------------------- ------------------------------
                                         Amortized                 Amortized                    Amortized
                                           Cost      Fair Value      Cost       Fair Value        Cost         Fair Value
                                       -----------   ----------  -----------   ------------- -------------  ---------------
                                                                       (In thousands)
<S>                                       <C>           <C>         <C>           <C>           <C>             <C>   
Held to Maturity
   Other debt securities...............   $  100        $  100      $  100        $  100        $  100          $  100
                                          ------        ------      ------        ------        ------          ------
         Total held to maturity........      100           100         100           100           100             100
                                          ------        ------      ------        ------        ------          ------

Available-for-Sale:
   Mortgage-backed securities..........    2,174         2,235       1,375         1,440           853             887
   Other debt securities:..............    5,430         5,422       4,100         4,077         3,600           3,528
   Equity securities...................        7           438          13           546            13             339
   Net unrealized gain(1)..............      484            --         575            --           288              --
                                          ------        ------      ------        ------        ------          ------
         Total available-for-sale......    8,095         8,095       6,063         6,063         4,754           4,754
                                          ------        ------      ------        ------        ------          ------

Certificates of deposit................      198           198         198           198           198             198
                                          ------        ------      ------        ------        ------          ------
Federal Home Loan Bank Stock...........      624           624         576           576           508             508
                                          ------        ------      ------        ------        ------          ------
   Total securities, net...............   $9,017        $9,017      $6,937        $6,937        $5,560          $5,560
                                          ======        ======      ======        ======        ======          ======
</TABLE>


----------
(1)  The net  unrealized  gains  at June 30,  1998,  1997  and  1996  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, 1998,  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, 1998
                                           ----------------------------------------------------------------------------------------
                                                        HELD-TO-MATURITY                              AVAILABLE FOR SALE
                                           -------------------------------------------  -------------------------------------------
                                                                           WEIGHTED                                       WEIGHTED
                                            AMORTIZED        FAIR           AVERAGE        AMORTIZED        FAIR           AVERAGE
                                              COST           VALUE           YIELD           COST           VALUE           YIELD
                                           -------------  -----------  ---------------  -------------   ------------  --------------
                                                                             (DOLLARS IN THOUSANDS)
<S>                                         <C>            <C>                <C>          <C>            <C>              <C>     
Debt Securities
Mortgaged-backed securities:
  Due within 1 year.....................    $     --       $     --             --%       $     --       $     --              --%
  Due after 1 year but within 5 years...          --             --             --              --             --              --
  Due after 5 years but within 10 years.          --             --             --              --             --              --
  Due after 10 years....................          --             --             --           2,174          2,235            6.93
                                            --------       --------                       --------       --------
          Total.........................          --             --             --           2,174          2,235            6.93
                                            --------       --------                       --------       --------
U.S. Treasury and Agency:
  Due within 1 year.....................          --             --             --              --             --              --
  Due after 1 year but within 5 years...         100            100           5.83           5,430          5,422            6.16
  Due after 5 years but within 10 years.          --             --             --              --             --              --
  Due after 10 years....................          --             --             --              --             --              --
                                            --------       --------                       --------       --------
          Total.........................         100            100           5.83           5,430          5,422            6.16
                                            --------       --------                       --------       --------
Corporate & Other:
  Due within 1 year.....................          --             --             --              --             --              --
  Due after 1 year but within 5 years...         198            198           6.18              --             --              --
  Due after 5 years but within 10 years.          --             --             --              --             --              --
  Due after 10 years....................          --             --             --              --             --              --
                                            --------       --------                       --------       --------
          Total.........................         198            198           6.18              --             --              --
                                            --------       --------                       --------       --------
Equity Securities:......................          --             --             --               7            438              --
                                            --------       --------                       --------       --------
Total:
  Due within 1 year.....................          --             --             --              --             --              --
  Due after 1 year but within 5 years...         298            298           6.06           5,430          5,422            6.16
  Due after 5 years but within 10 years.          --             --             --              --             --              --
  Due after 10 years....................          --             --             --           2,174          2,235            6.93
  Equity Securities.....................          --             --             --               7            438              --
                                            --------       --------                       --------       --------
                                                 298            298           6.06           7,611          8,095            6.37
                                            --------       --------                       --------       --------
  Federal Home Loan Bank Stock..........         624            624             --              --             --              --
                                            --------       --------                       --------       --------
          Total.........................    $    922       $    922           6.06%       $  7,611       $  8,095            6.37%
                                            ========       ========                       ========       ========
</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,  1998,  the Bank's core  deposits  (which the Bank  considers  to consist of
checking  accounts,  regular savings  accounts and statement  savings  accounts)
constituted  37.0%  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 and Alleghany  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,
                                                --------------------------------------------------------------
                                                       1998                        1997                  1996
                                                -------------------------  ---------------------- ------------
                                                                         (IN THOUSANDS)
<S>                                                 <C>                        <C>                    <C>      
Total deposits at beginning of period,
  including accrued interest...................     $  68,218                  $  63,468              $  58,496
Net increase before interest credited..........        10,728                      1,554                  1,768
Interest credited..............................         3,542                      3,196                  3,204
                                                    ---------                  ---------              ---------
Total deposits at end of period................     $  82,488                  $  68,218              $  63,468
                                                    =========                  =========              =========
</TABLE>

     At June 30,  1998,  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
                                                                    ---------------       -----------------
                                                                                (IN THOUSANDS)
<S>                                                                 <C>                         <C>  
Maturity Period
   Within three months........................................      $    3,997                  5.57%
   After three but within six months..........................           3,072                  5.69%
   After six but within 12 months.............................           5,252                  5.74%
   After 12 months............................................           1,573                  5.45%
                                                                    ----------
              Total...........................................      $   13,894                  5.65%
                                                                    ==========
</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,
                          -----------------------------------------------------------------------------
                                           1998                                    1997                
                          --------------------------------------- -------------------------------------
                                        PERCENT       WEIGHTED                   PERCENT      WEIGHTED 
                                       OF TOTAL        AVERAGE                  OF TOTAL       AVERAGE 
                            AMOUNT     DEPOSITS         RATE        AMOUNT      DEPOSITS        RATE   
                          -----------------------------------------------------------------------------
                                                                           (DOLLARS IN THOUSANDS)
<S>                         <C>          <C>            <C>         <C>           <C>           <C>    
Checking accounts.......    $3,469       4.21%            --%       $  901        1.33%           --   
Now/Money Market
accounts................    10,321      12.51%          3.13%       11,347       16.63%         3.38%  
Passbook savings........    16,729      20.28%          4.25%       10,672       15.64%         4.03%  
Certificates of deposit.    51,801      62.80%          5.52%       45,133       66.16%         5.52%  
Accrued interest........       168       0.20%            --           165        0.24%           --   
                           -------     ------         ------       -------     -------        ------   
         Totals            $82,488     100.00%          4.94%      $68,218      100.00%         4.96%  
                           =======     ======         ======       =======     =======        ======   

<CAPTION>
                                   AT JUNE 30,
                          ----------------------------------------
                                       1996
                          ----------------------------------------
                                         PERCENT       WEIGHTED
                                         OF TOTAL       AVERAGE
                             AMOUNT      DEPOSITS        RATE
                          ----------------------------------------
<S>                          <C>         <C>           <C> 
Checking accounts.......     $  392       0.62%           --
Now/Money Market                      
accounts................      8,870      13.98%         3.50%
Passbook savings........      9,586      15.10%         4.06%
Certificates of deposit.     44,477      70.08%         5.60%
Accrued interest........        143       0.23%           --
                            -------     ------          ----
         Totals             $63,468     100.00%         5.13%
                            ========    ======          ====
</TABLE>                     
                           
     The  following  table  presents,  by interest  rate  ranges,  the amount of
certificate accounts outstanding at June 30, 1998 and the period to maturity.
<TABLE>
<CAPTION>
                                          PERIOD TO MATURITY AT JUNE 30, 1998
----------------------------------------------------------------------------------------------------------------
                                          LESS THAN              ONE TO               FOUR TO
        INTEREST RATE RANGE               ONE YEAR             THREE YEARS          FIVE YEARS          TOTAL
----------------------------------  --------------------- ---------------------  -----------------  ------------
                                                                 (DOLLARS IN THOUSANDS)
<S>      <C>                              <C>                   <C>                    <C>            <C>     
4.01% to 6.00%                            $39,114               $5,771                 $527           $45,412 
6.01% to 8.00%....................          4,557                1,696                  136             6,389 
                                          -------               ------                 ----           ------- 
               Total..............        $43,671               $7,467                 $663           $51,801 
                                          =======               ======                 ====           ======= 
</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,  1998,  the maximum
amount of FHLB advances  available to the Bank was $13.0  million.  The Bank had
short term advances of $4.1 million at June 30, 1998 from the FHLB.  Interest is
payable at rates  ranging from 5.68% to 6.87%.  $1.5 million of the advances are
due by August of 1998,  $2.5  million  are due by  September  of 2002,  with the
remaining amounts due January 2007.

SUBSIDIARY ACTIVITIES

     AF Insurance  Services,  Inc., a wholly owned  subsidiary of the Bank,  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.  AF Insurance  Services,  Inc.  offers these services in a segregated
location at the Bank's executive  offices,  Sparta and North  Wilkesboro,  North
Carolina.


                                       17

<PAGE>



PERSONNEL

     As of June 30, 1998, the Company had 39 full-time employees and 9 part-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.

     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,


                                       18

<PAGE>



but generally  does not include real estate.  At June 30, 1998, the Bank's limit
on loans to one borrower was approximately  $1.72 million. At June 30, 1998, the
Bank's  largest  aggregate  amount  of  loans  to  one  borrower  was  $772,000,
consisting  of four loans,  the largest of which was  approximately  $246,000 at
June 30, 1998, 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  $608,000,  secured by an apartment complex. At June 30, 1998, all
of the  loans  in  both  of  these  lending  relationships  were  performing  in
accordance with their terms.

     QTL Test.  HOLA requires a savings  institution to meet a Qualified  Thrift
Lender  ("QTL")  test.  A  savings  institution  may  satisfy  the  QTL  test by
maintaining at least 65% of its "portfolio  assets" in certain "qualified thrift
investments" in at least 9 months of the most recent 12-month period. "Portfolio
assets" means,  in general,  an  association's  total assets less the sum of (a)
specified  liquid  assets up to 20% of total  assets,  (b) certain  intangibles,
including  goodwill and credit card and purchased  mortgage servicing rights and
(c) the value of property used to conduct the association's  business.  The term
"qualified  thrift  investments"  includes  various  types  of  loans  made  for
residential  and  housing  purposes,   investments  related  to  such  purposes,
including  certain  mortgage-backed  and  related  securities,   and  loans  for
personal,  family,  household and certain other purposes up to a limit of 20% of
an association's  portfolio assets.  Recent  legislation  broadened the scope of
"qualified thrift  investments" to include 100% of an institution's  credit card
loans, education loans, and small business loans. A savings association may also
satisfy the QTL test by qualifying as a "domestic building and loan association"
as defined in the  Internal  Revenue Code of 1986.  At June 30,  1998,  the Bank
maintained 96.6% of its portfolio assets in qualified  thrift  investments.  The
Bank  had  also  satisfied  the QTL test in each of the  prior  12  months  and,
therefore, was a qualified thrift lender.

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

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

     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

                                       19


<PAGE>



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 regulations authorize the Director of the OTS to waive or defer an
association's  interest rate risk component on a case-by-case basis. 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,  1998,  the Bank was not  required  to  maintain  any
additional  risk-based  capital under this rule. At June 30, 1998,  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, 1998:

<TABLE>
<CAPTION>
                                                                      Capital           Excess
                                                   AMOUNT          Requirements         Capital
                                                   ------          ------------         -------
                                                                  (In thousands)
<S>                                                 <C>               <C>                <C>   
Core capital..................................      $10,907           $2,989             $7,918
Risk-based capital............................       11,607            4,543              7,064
</TABLE>

     A reconciliation  between  regulatory  capital and GAAP capital at June 30,
1998 in the accompanying financial statements is presented below:
<TABLE>
<CAPTION>
                                                                           Risk-
                                                         Core              Based
                                                        Capital           Capital
                                                        -------           -------
<S>                                                 <C>               <C>        
GAAP capital......................................  $    11,486       $    11,486
Net unrealized gain on available for
  sale investment securities, net of tax..........         (294)             (294)
Allowance for loan losses included as
  supplementary capital...........................           --               715
Goodwill and other nonincludible assets...........         (285)             (300)
                                                    -----------      ------------
Regulatory capital................................  $    10,907       $    11,607
                                                    ===========       ===========
</TABLE>



                                       20

<PAGE>



     Limitation  on Capital  Distributions.  OTS  regulations  currently  impose
limitations  upon capital  distributions by savings  institutions,  such as cash
dividends,  payments to repurchase or otherwise acquire its shares,  payments to
shareholders   of  another   institution  in  a  cash-out   merger,   and  other
distributions  charged  against  capital.  At least 30-days prior written notice
must be  given  to the  OTS of a  proposed  capital  distribution  by a  savings
institution,  and capital  distributions  in excess of specified  earnings or by
certain institutions are subject to approval by the OTS. An association that has
capital in excess of all fully phased-in  regulatory capital requirements before
and after a proposed capital  distribution and that is 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 one-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 distribution would require prior OTS approval.
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." The OTS has proposed amendments of
its capital  distribution  regulations to reduce  regulatory  burdens on savings
associations.  If adopted as  proposed,  certain  savings  associations  will be
permitted to pay capital  distributions  within the amounts  described above for
Tier 1 institutions  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 after the Reorganization, will continue to have to file a notice unless
the specific capital distribution requires an application.

     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, 1998 was  approximately  25.7% which  exceeded  the
applicable  requirements.  The Bank has never been subject to monetary penalties
for failure to meet its liquidity requirements.

     Assessments.  Savings  institutions  are required by OTS  regulation to pay
assessments  to  the  OTS  to  fund  the  operations  of the  OTS.  The  general
assessment,   paid  on  a  semi-annual  basis,  is  computed  upon  the  savings
institution's total assets, including consolidated subsidiaries,  as reported in
the Bank's latest  quarterly  Thrift  Financial  Report.  The deposit  insurance
premium  expense  incurred by the Bank for the fiscal years ended June 30, 1998,
1997 and 1996 totaled $44,000, $86,000 and $136,000, respectively. Additionally,
the Bank paid a one time special  SAIF  assessment  of $368,000  during the year
ended June 30, 1997.

     The OTS has proposed  amendments  to its  regulations  that are intended to
assess savings  associations on a more equitable basis. The proposed regulations
would  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 percentage
increases for any savings  institution  with a composite  rating of 3, 4 or 5 in
its most recent  safety and  soundness  examination;  and the  complexity of the
association's  operations,  which would  result in  percentage  increases  for a
savings  association that managed over $1 billion in trust assets,  serviced for
others loans aggregating more than $1 billion,  or had certain off-balance sheet
assets  aggregating more than $1 billion.  In order to avoid a  disproportionate
impact on the smaller savings  institutions,  the OTS is proposing to permit the
portion  of the  assessment  based on  assets  size  either  under  the  current
regulations or under the amended regulations. Management believes that, assuming
the proposed regulations are adopted as proposed,  any change in its rate of OTS
assessments will not be material.


                                       21

<PAGE>



     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.

     In April  1995,  the OTS and the other  federal  banking  agencies  adopted
amendments  revising their CRA regulations.  Among other things, the amended CRA
regulations  substitute  for the prior  process-based  assessment  factors a new
evaluation system that would rate an institution based on its actual performance
in meeting  community  needs. In particular,  the proposed system would focus 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.  The  amended  CRA
regulations  clarify how an institution's CRA performance would be considered in
the application process.

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

     The Bank's authority to extend credit to its directors, executive officers,
and 10%  shareholders,  as well as to entities  controlled by such  persons,  is
currently  governed by the  requirements  of Sections 22(g) and 22(h) of the FRA
and Regulation O of the FRB  thereunder.  Among other things,  these  provisions
require  that  extensions  of credit to  insiders  (a) be made on terms that are
substantially the same as, and follow credit


                                       22

<PAGE>



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  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


                                       23

<PAGE>



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."

     The  severity  of the action  authorized  or required to be taken under the
prompt  corrective  action  regulations  increases as an  association's  capital
deteriorates within the three undercapitalized  categories. All associations are
prohibited  from  paying  dividends  or other  capital  distributions  or paying
management fees to any controlling person if, following such  distribution,  the
association  would  be  undercapitalized.  An  undercapitalized  association  is
required  to file a  capital  restoration  plan  within  45 days of the date the
association receives notice that it is within any of the three  undercapitalized
categories.  The  OTS  is  required  to  monitor  closely  the  condition  of an
undercapitalized  association  and to restrict the asset  growth,  acquisitions,
branching,  and new  lines of  business  of such an  association.  Significantly
undercapitalized  associations  are subject to  restrictions  on compensation of
senior executive officers; such an association may not, without OTS consent, pay
any bonus or  provide  compensation  to any senior  executive  officer at a rate
exceeding the officer's average rate of compensation  (excluding bonuses,  stock
options and  profit-sharing)  during the 12 months  preceding the month when the
association   became   undercapitalized.    A   significantly   undercapitalized
association  may also be subject,  among other things,  to forced changes in the
composition  of  its  board  of  directors  or  senior  management,   additional
restrictions  on  transactions  with  affiliates,  restrictions on acceptance of
deposits from correspondent associations,  further restrictions on asset growth,
restrictions  on rates paid on  deposits,  forced  termination  or  reduction of
activities  deemed  risky,  and  any  further  operational  restrictions  deemed
necessary by the OTS.

     If one or more grounds exist for  appointing a conservator  or receiver for
an association,  the OTS may require the association to issue additional debt or
stock, sell assets, be acquired by a depository  association  holding company or
combine with another depository  association.  The OTS and the FDIC have a broad
range of grounds under which they may appoint a receiver or  conservator  for an
insured depositary  association.  Under FDICIA, the OTS is required to appoint a
receiver (or with the  concurrence of the FDIC, a conservator)  for a critically
undercapitalized  association  within  90 days  after  the  association  becomes
critically  undercapitalized  or, with the concurrence of the FDIC, to take such
other  action that would better  achieve the  purposes of the prompt  corrective
action provisions. Such alternative action can be renewed for successive 90- day
periods. However, if the association continues to be critically undercapitalized
on  average  during the  quarter  that  begins  270 days  after it first  became
critically undercapitalized,  a receiver must be appointed, unless the OTS makes
certain findings with which the FDIC concurs and the Director of the OTS and the
Chairman of the FDIC certify that the  association  is viable.  In addition,  an
association  that is  critically  undercapitalized  is  subject  to more  severe
restrictions on its activities, and is prohibited, without prior approval of the
FDIC

                                       24


<PAGE>



from, among other things,  entering into certain material transactions or paying
interest  on new or  renewed  liabilities  at a rate  that  would  significantly
increase the association's weighted average cost of funds.

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

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

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

     The Funds Act also amended the FDIA to expand the  assessment  base for the
payments on the FICO bonds.  Beginning  January 1, 1997, the assessment base for
the FICO bonds included the deposits of both BIF- and SAIF-insured institutions.
Until  December  31,  1999,  or such  earlier  date on which  the  last  savings
association ceases to exist, the rate of assessment for BIF-assessable  deposits
shall be one-fifth of the rate imposed on SAIF-assessable  deposits.  The annual
rate of  assessments  for the  payments  on the FICO  bonds for the  semi-annual
period  beginning  on July 1, 1998 was 0.0122% for  BIF-assessable  deposits and
0.0610% for SAIF-assessable deposits.

     The Funds Act also  provides  for the merger of the BIF and SAIF on January
1, 1999, with such merger being  conditioned  upon the prior  elimination of the
thrift charter.  The Funds Act required the Secretary of the Treasury to conduct
a study of relevant  factors with respect to the development of a common charter
for all insured  depository  institutions and abolition of separate charters for
banks and thrifts and to report the Secretary's  conclusions and findings to the
Congress.  The  Secretary of the Treasury  recommended  to the Congress that the
separate charter for thrifts be eliminated only if other  legislation is adopted
that  permits  bank  holding  companies  to  engage  in  certain   non-financial
activities.  However, the current version of bank modernization legislation, The
Financial  Services Act of 1998,  H.R. 10, which was passed by the U.S. House of
Representatives  in May  1998  and is  currently  being  considered  by the U.S.
Senate, does not require thrift institutions to convert to bank charter.


                                       25

<PAGE>



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

     Federal Home Loan Bank System. The Bank is a member of the FHLB of Atlanta,
which is one of the regional FHLBs composing the FHLB System. Each FHLB provides
a central credit facility primarily for its member institutions.  The Bank, as a
member of the FHLB of Atlanta, is required to acquire and hold shares of capital
stock in the FHLB of Atlanta in an amount at least equal to the greater of 1% of
the aggregate  principal  amount of its unpaid  residential  mortgage  loans and
similar  obligations  at the  beginning  of each  year  or 1/20 of its  advances
(borrowings)  from the FHLB of  Atlanta.  The Bank was in  compliance  with this
requirement  with an  investment  in FHLB of Atlanta  stock at June 30, 1997, of
$576,000.  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, 1998, 1997 and 1996, dividends from the
FHLB  of  Atlanta  to  the  Bank  amounted  to  $43,000,  $38,000  and  $36,000,
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 $49.3  million.  The  amount of
aggregate  transaction accounts in excess of $49.3 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  $4.4  million of  otherwise  reservable
balances from the reserve  requirements,  which exemption is adjusted by the FRB
at the end of each year.  The Bank is in compliance  with the foregoing  reserve
requirements. Because required reserves must be maintained in the form of either
vault cash,  a  non-interest-bearing  account at a Federal  Reserve  Bank,  or a
pass-through  account  as  defined  by the  FRB,  the  effect  of  this  reserve
requirement  is to reduce  the  Bank's  interest-earning  assets.  The  balances
maintained  to meet the reserve  requirements  imposed by the FRB may be used to
satisfy liquidity  requirements imposed by the OTS. FHLB System members are also
authorized  to  borrow  from the  Federal  Reserve  "discount  window,"  but FRB
regulations  require  such  institutions  to  exhaust  all FHLB  sources  before
borrowing from a Federal Reserve Bank.

REGULATION OF THE HOLDING COMPANY

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

     Restrictions Applicable to Activities of Mutual Holding Companies. Pursuant
to Section  10(o) of the HOLA, a mutual  holding  company may engage only in the
following activities: (i) investing in the stock of a savings institution;  (ii)
acquiring a mutual  association  through the merger of such  association  into a
savings  institution  subsidiary of such holding  company or an interim  savings
institution  subsidiary of such holding company; (iii) merging with or acquiring
another holding  company,  one of whose  subsidiaries is a savings  institution;
(iv)  investing in a  corporation  the capital  stock of which is available  for
purchase by a savings


                                       26

<PAGE>



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."


                                       27

<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 approximately
85% complete with full  completion  set for December  1998.  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 AF Bank. 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.

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.


                                       28

<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 be 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, 1998, 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


                                       29

<PAGE>



group,  it will not  qualify  for such  100%  dividends  exclusion,  but will be
entitled to deduct 80% of the  dividends it receives  from Stock Company so long
as it owns more than 20% of the Common Stock.

STATE TAXATION

     Under North  Carolina  law,  the  corporate  income tax is 7.50% 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
and Sparta, North Carolina. The Company owns the main office,  corporate offices
and the Jefferson Branch, with net book value for property of $210,000, $486,000
and $534,000,  respectively,  as of June 30, 1998.  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, 1998
                                 -------------------  ---------------------- ---------------------- ------------------
                                                                  (Dollars in thousands)
<S>                                                          <C>                      <C>                  <C>   
Corporate Offices..............         Owned                06/30/97                 --                   $  486
206 S. Jefferson Avenue
West Jefferson, NC 28694

West Jefferson Branch                   Owned                06/30/63                 --                      210
205 S. Jefferson Avenue
West Jefferson, NC 28694

Jefferson Branch...............         Owned                05/18/94                 --                      534
840 E. Main Street
Jefferson, NC 28640

Warrensville Branch............        Leased                08/31/95             08/31/2000*                  --
4951 NC Hwy. 88 West
Warrensville, NC 28693

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

</TABLE>

----------
*    Option to renew for two additional five-year periods.

**   Option to renew for an additional three-year period.


                                       30

<PAGE>



ITEM 3. LEGAL PROCEEDINGS

     At June 30, 1998,  there were no material  legal  proceedings  to which the
Bank 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 1998 Annual Report to Stockholders on page 54,
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  1998
Annual  Report  to  Stockholders  on page  54,  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 and $0.10 per share
during the years ended June 30, 1998 and 1997, respectively.

ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS

     Certain of the  above-captioned  information  appears  under  "Management's
Discussion and Analysis" and "Selected  Financial and Other Data of the Company"
in the  Registrant's  1998 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  1998 Annual
Report to  Stockholders  on pages 19 through 51 and are  incorporated  herein by
reference.

                                                                     Page(s) in
                                                                   Annual Report
                                                                   -------------
o    Independent Auditor's Report..................................        19
o    Consolidated Statements of Financial Condition,                   
          June 30, 1998 and 1997...................................        20
o    Consolidated Statements of Income,                                
          Years Ended June 30, 1998 and 1997.......................        21
o    Consolidated Statements of Stockholders' Equity,                  
          Years Ended June 30, 1998 and 1997.......................        22-23
o    Consolidated Statements of Cash Flows,                            
          Years Ended June 30, 1998 and 1997.......................        24-26
o    Notes Consolidated to Financial Statements....................        27-51
                                                                    






                                       31

<PAGE>



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

     Not applicable.

                                    PART III

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

     The information relating to Directors and Executive Officers of the Company
is  incorporated  herein by reference to the Company's  Proxy  Statement for the
Annual Meeting of Stockholders to be held on November 2, 1998.

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 2, 1998.

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 2, 1998.

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 2, 1998.

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 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, is filed herewith.

     10.2         Employment Agreement with Melanie Paisley Miller,  Senior Vice
                  President,  Chief Financial Officer,  Secretary and Treasurer,
                  is filed herewith.

     10.3         Employment  Agreement  with  Martin  G.  Little,  Senior  Vice
                  President and Chief Lending Officer, is filed herewith.



                                       32

<PAGE>



     10.4         Employee  Stock  Ownership  Plan of Ashe Federal Bank is filed
                  herewith.

     13.1         1998 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 year ended June 30, 1997.


---------
*Filed in electronic format only.



















                                       33

<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 24, 1998              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 24, 1998
----------------------------------------------               -------------------
James A. Todd
President, Chief Executive Officer
         and Director
(Principal Executive Officer)

/s/Melanie Paisley Miller                                     September 24, 1998
----------------------------------------------               -------------------
Melanie Paisley Miller
Senior Vice President, Secretary, Treasurer
         and Chief Financial Officer
(Principal Financial Officer) (Controller)

/s/Jan R. Caddell                                             September 24, 1998
----------------------------------------------               -------------------
Jan R. Caddell - Director

/s/Kenneth R. Greene                                          September 24, 1998
----------------------------------------------               -------------------
Kenneth R. Greene - Director

/s/William O. Ashley, Jr.                                     September 24, 1998
----------------------------------------------                ------------------
William O. Ashley, Jr. - Director

/s/Wayne R. Burgess                                           September 24, 1998
----------------------------------------------               -------------------
Wayne R. Burgess - Director





                                       34

<PAGE>



/s/Frank E. Roland                                            September 24, 1998
----------------------------------------------               -------------------
Frank E. Roland - Director

/s/Jerry L. Roten                                             September 24, 1998
----------------------------------------------               -------------------
Jerry L. Roten - Director

/s/John D. Weaver                                             September 24, 1998
----------------------------------------------               -------------------
John D. Weaver - Director









                                       35