U.S. 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 December 31, 1998

                         Commission File No.: 000-24933

                             HERITAGE BANCORP, INC.
                 (Name of Small Business Issuer in its charter)

        Virginia                                        54-1914902
(State or other jurisdiction of            (I.R.S. Employer Identification No.)
incorporation or organization)

                1313 Dolley Madison Blvd., McLean, Virginia 22101
                    (Address of principal executive offices)
                                 (703) 356-6060
                (Issuer's Telephone Number, Including Area Code)

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

                           Common Stock, no par value
                                (Title of Class)

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

         Check if there is no  disclosure  of  delinquent  filers in response to
Item 405 of Regulation S-B is not contained in this form, and no disclosure will
be contained,  to the best of  registrant's  knowledge,  in definitive  proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. [ X ]

         The revenues for the issuer's  fiscal year ended  December 31, 1998 are
$3,902,000.

         State the aggregate  market value of the voting and  non-voting  common
equity held by  non-affiliates  computed by  reference to the price at which the
common  equity was sold,  as of a  specified  date  within the last 60 days.  On
February 19, 1999: $9,752,122.

         State the number of shares  outstanding of each of the issuer's classes
of common equity,  as of the latest  practicable date. The Company had 2,294,617
shares outstanding as of March 10, 1999.

                       DOCUMENTS INCORPORATED BY REFERENCE

         None.

Transitional Small Business Disclosure Format (check one):
Yes           No   X

<PAGE>

<TABLE>


                                                 TABLE OF CONTENTS
                                                                                                               Page

<S>      <C>                <C>                                                                                <C>
PART

         ITEM 1.           BUSINESS...............................................................................1
         ITEM 2.           PROPERTIES............................................................................14
         ITEM 3.           LEGAL PROCEEDINGS.....................................................................14
         ITEM 4.           SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS...................................14

PART II

         ITEM 5.           MARKET FOR REGISTRANT'S COMMON EQUITY AND
                           RELATED STOCKHOLDER MATTERS...........................................................15
         ITEM 6.           MANAGEMENT'S DISCUSSION AND ANALYSIS..................................................16
         ITEM 7.           FINANCIAL STATEMENTS..................................................................34
         ITEM 8.           CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
                           ACCOUNTING AND FINANCIAL DISCLOSURE...................................................34
         ITEM 9.           DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND
                           CONTROL PERSONS; COMPLIANCE WITH SECTION 16(a)
                           OF THE EXCHANGE ACT  AND PRINCIPAL OFFICERS
                           OF THE COMPANY........................................................................34
         ITEM 10.          EXECUTIVE COMPENSATION................................................................34
         ITEM 11.          SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
                           AND MANAGEMENT........................................................................40
         ITEM 12.          CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS........................................40

PART III

         ITEM 13.          EXHIBITS, LIST AND REPORTS ON FORM 8-K..................................................

         AUDITED FINANCIAL STATEMENTS...........................................................................F-1

</TABLE>

                                        i

<PAGE>



                                     PART I

ITEM 1.           BUSINESS

General

         Heritage Bancorp, Inc. (the "Company"), a Virginia corporation,  is the
holding  company  for The  Heritage  Bank (the  "Bank"),  a  Virginia  chartered
commercial  bank.  On October 1, 1998,  the Company  acquired all of the capital
stock of the Bank and the  shareholders  of the Bank became  shareholders of the
Company in a share for share exchange under a plan of reorganization approved by
the  Bank's  shareholders  on August  26,  1998,  whereby  the Bank  became  the
wholly-owned  subsidiary  of the Company (the  "Reorganization").  The Company's
sole  business  activity is ownership of the Bank.  The  Company's  common stock
trades on the Nasdaq  SmallCap  Market under the symbol  "HBVA." At December 31,
1998,  the Company had total assets of $64.8  million,  total  deposits of $53.4
million and total stockholders'  equity of $8.9 million. Net income for the year
ended  December 31, 1998 was  $133,000,  a decrease of 76.67% from net income of
$570,000 for the  comparable  period in 1997.  Basic  earnings per share for the
year ended December 31, 1998 were $0.07 ($0.07 per share, assuming dilution), up
from $0.45 per share  ($0.44 per share,  assuming  dilution)  for the year ended
December 31, 1997. Unless otherwise disclosed, the information presented in this
Report on Form 10-KSB  represents  the activity of the Bank for the period prior
to October 1, 1998 and the  activity  of the  Company  consolidated  thereafter.
Unless the context otherwise requires, all references to the Bank or the Company
include the Company and the Bank on a consolidated basis.

         The Bank is the only independent financial institution headquartered in
McLean,  Virginia.  Established  in 1987,  the Bank  operated as a  wholly-owned
subsidiary of Heritage Bankshares, Inc. (formerly Independent Banks of Virginia,
Inc.),  until  1992  when it  became an  independent  bank.  The Bank is a well-
capitalized, profitable community bank dedicated to financing small business and
consumer needs in its market area and providing personalized  "hometown" quality
service to its  customers by tailoring  its products and services to appeal to a
local market. The Bank currently operates one full-service office and engages in
a broad range of lending and deposit services aimed at individual and commercial
customers in the McLean area of Fairfax  County,  Virginia.  The Bank closed its
secondary  offering of common  stock (the  "Offering")  in which it sold 805,000
share of common stock to the public at a per share price of $5.50, resulting the
raising of net proceeds to the Bank of approximately $4.1 million.

         The  business of the Bank  consists  of  attracting  deposits  from the
general  public and using these funds to originate  various  types of individual
and  commercial  loans  primarily  in the McLean  area.  The  Bank's  commercial
activities  include  providing  checking  accounts,  money  market  accounts and
certificates  of  deposit to small and medium  sized  businesses.  The Bank also
provides  credit  services,  such as lines of credit,  term loans,  construction
loans,  and letters of credit,  as well as real estate  loans and other forms of
collateralized   financing.   The  Bank's  personal  services  include  checking
accounts, NOW accounts, savings accounts,  certificates of deposit,  installment
accounts,  construction  and  other  personal  loans,  home  improvement  loans,
automobile and other consumer financing.

         The Bank's profitability  depends primarily on its net interest income,
the difference  between the interest income it earns on its loans and investment
portfolio  and its cost of funds,  which  consists  mainly of  interest  paid on
deposits.   Net  interest  income  is  affected  by  the  relative   amounts  of
interest-earning assets and interest-bearing  liabilities and the interest rates
earned or paid on these balances.  When  interest-earning  assets approximate or
exceed  interest-bearing  liabilities,  any positive  interest  rate spread will
generate net interest income.

         The  Bank's  profitability  is also  affected  by the  level  of  other
(noninterest) income and operating expenses.  Other income consists primarily of
service fees, loan servicing and other loan fees and gains on

                                        1

<PAGE>



sales of  investment  securities.  Operating  expenses  consist of salaries  and
benefits, occupancy-related expenses, and other general operating expenses.

         The operations of the Bank, and banking  institutions  in general,  are
significantly influenced by general economic conditions and related monetary and
fiscal policies of financial  institutions'  regulatory agencies.  Deposit flows
and the cost of funds are influenced by interest rates on competing  investments
and general  market rates of interest.  Lending  activities  are affected by the
demand for  financing  real estate and other  types of loans,  which in turn are
affected by the interest  rates at which such financing may be offered and other
factors affecting loan demand and the availability of funds.

Asset/Liability Management

         A  principal  operating  objective  of the  Bank is to  produce  stable
earnings by  achieving a favorable  interest  rate spread that can be  sustained
during  fluctuations in prevailing  interest rates.  Since the Bank's  principal
interest-earning assets have longer terms to maturity than its primary source of
funds,  i.e.,  deposit  liabilities,  increases in general  interest  rates will
generally  result in an increase in the Bank's cost of funds before the yield on
its asset portfolio  adjusts upward.  The Bank has sought to reduce its exposure
to adverse  changes in interest  rates by  attempting  to achieve a closer match
between   the   periods   in  which   its   interest-bearing   liabilities   and
interest-earning  assets can be expected to reprice  through the  origination of
adjustable-rate mortgages and loans with shorter terms and the purchase of other
shorter term interest-earning assets.

         The  term  "interest  rate  sensitivity"  refers  to those  assets  and
liabilities which mature and reprice periodically in response to fluctuations in
market  rates and yields.  As noted  above,  one of the  principal  goals of the
Bank's  asset/liability  program  is to  maintain  and match the  interest  rate
sensitivity characteristics of the asset and liability portfolios.

         In order to properly  manage  interest  rate risk,  the Bank's Board of
Directors has established an Asset/Liability  Management Committee ("ALCO") made
up of members  of  management  to  monitor  the  difference  between  the Bank's
maturing  and  repricing  assets and  liabilities  and to develop and  implement
strategies  to  decrease  the  "negative  gap"  between  the  two.  The  primary
responsibilities of the committee are to assess the Bank's  asset/liability mix,
recommend  strategies to the Board that will enhance  income while  managing the
Bank's  vulnerability  to changes in interest  rates and report to the Board the
results of the strategies used.

Credit Policies

         The Bank utilizes written policies and procedures to enhance management
of credit  risk.  The loan  portfolio  is managed  under a  specifically-defined
credit  process.  This process  includes  formulation  of  portfolio  management
strategy, guidelines for underwriting standards and risk assessment,  procedures
for ongoing  identification and management of credit deterioration,  and regular
portfolio  reviews to estimate loss exposure and ascertain  compliance  with the
Bank's  policies.  Lending  authority is granted to individual  lending officers
with the  current  highest  limit  being  $150,000  for  secured and $25,000 for
unsecured  loans.  Any two officers acting together may approve a loan up to the
amount of the lower  lending  authority of the two officers.  An Officers'  Loan
Committee  comprised of six officers is  authorized  to approve  credit of up to
$400,000 for secured  loans and $200,000 for unsecured  loans.  Approval of such
credits requires a majority vote of the Officers' Loan Committee. The Directors'
Loan  Committee is  authorized to approve loans up to the legal lending limit of
the Bank.

         The Bank's  management  generally  requires  that secured  loans have a
loan-to-value ratio of 80% or less. Management believes that when a borrower has
significant  equity in the assets securing the loan, the borrower is less likely
to default on the outstanding loan balance.


                                        2

<PAGE>

         A major  element of credit  risk  management  is  diversification.  The
Bank's  objective is to maintain a diverse loan portfolio to minimize the impact
of any single event or set of circumstances.  Concentration parameters are based
on  factors  of  individual  risk,  policy  constraints,   economic  conditions,
collateral and product type.

         Lending  activities  include a variety  of  consumer,  real  estate and
commercial loans with a strong emphasis on serving the needs of customers within
the Bank's  market  territory.  Consumer  loans are made  primarily on a secured
basis in the form of installment  obligations  or personal lines of credit.  The
focus of real estate  lending is  commercial  mortgages,  but also includes home
improvement  loans,  construction  lending  and home  equity  lines  of  credit.
Commercial  lending is provided to businesses seeking credit for working capital
and the purchase of equipment and facilities.  The principal lending activity of
the Bank is  concentrated  in mortgage loans secured by commercial  real estate,
usually  consisting of commercial and warehouse  facilities in the Bank's market
area.

Market Area

         The Bank  currently  has one office  serving the McLean area of Fairfax
County,  Virginia. From this office, the Bank serves its customers, the majority
of whom own  businesses  or reside in the  McLean/Great  Falls area of  Northern
Virginia, which is located eight miles west of Washington,  DC. The remainder of
the Bank's customers  reside  primarily in other  communities in Fairfax County,
and, to a lesser  extent,  Arlington  and Loudoun  counties.  A second branch is
scheduled to open in Loudoun County, Virginia (the "CountrySide Branch") in late
March or April, 1999.

         McLean lies in the northernmost  part of Fairfax County,  Virginia,  by
most measures, the wealthiest county in Virginia. The median household income in
Fairfax  County  in 1996 was  $78,000 - the  highest  in the  country.  The 1997
population of Fairfax  County is estimated to have been 913,012.  Fairfax County
is also home to many information technology firms including UUNet and PSINet. It
is estimated that nearly one-half of all  international  Internet  traffic flows
through one of the Fairfax-based access providers.

         McLean is home to the Central  Intelligence  Agency,  McLean's  largest
employer,  and the Federal Home Loan  Mortgage  Corporation.  The Bank  provides
financial  services to the many professional  service firms,  including lawyers,
accountants,  consultants  and engineers  that have offices in McLean.  McLean's
population is estimated to be approximately  63,000. The median household income
in McLean was  estimated to be $70,000 in 1996.  McLean also includes the Tysons
Corner area,  an office and  commercial  district  that is home to a significant
number of  high-technology  employers.  Major employers in Tysons Corner include
INOVA Health  Systems,  EDS,  SAIC and AT&T.  Tysons  Corner is also home to two
major shopping centers and several major hotels.

         With the opening of the CountrySide  branch, the Bank expects to expand
its market area to include a significant  portion of Loudoun County,  one of the
fastest growing counties in the United States.  According to census figures, the
1997  population  of  Loudoun  County has  increased  to  approximately  133,000
persons,  representing  an  increase of 55% since 1990  compared  to  population
growth of 9% in the  Washington,  D.C. region as a whole during the same period.
Among  counties with more than 10,000  residents,  Loudoun  County's 7.7% growth
rate  for  1996-97  ranked  eighth  in the  nation.  This  area is  experiencing
significant  economic  growth  as a  result  of  the  expansion  of  the  Dulles
International   Airport  technology  corridor  and  the  influx  of  "high-tech"
companies  from  Fairfax  County.  The Loudoun  County  market is  predominately
residential with a healthy mix of retail, service activities and light industry.

         Eastern Loudoun County,  with a population of approximately  50,000, is
the fastest  growing area of Loudoun County and Northern  Virginia.  It contains
several  mature   residential   neighborhoods  and  the  newer  developments  of
CountrySide,  Cascades,  and Ashburn Village.  Several large high-tech companies
such as America  Online and Alcatel  Data  Networks  have  recently  moved their
headquarters to eastern Loudoun County,  giving rise to accelerated  residential
building and retail  development in the area.  More than 4,000 housing sites are
in various stages of future  development in the area. In addition,  the 300-acre
regional mall,

                                        3

<PAGE>



Dulles Town Center,  is being  constructed  within one mile of the site. The new
branch will be located in the CountrySide  Shopping and  Professional  Center, a
350,000 square foot retail/professional/medical  campus near the entrance to the
2,500  unit  CountrySide  residential  community  that is  home  to over  12,000
persons. The site also borders on Cascades, a new 6,000-unit planned residential
development and associated shopping center,  Cascades Market Place. Over 100,000
persons with an average  family  income of $71,000 are  estimated to live within
five miles of the branch's  location.  The Bank  believes that  development  now
taking  place along the Route 7 and Route 28  corridors,  coupled with the rapid
population  growth in eastern  Loudoun  County,  will  provide the Bank with the
opportunity to expand its consumer and small business services.

Competition

         The Bank operates in the highly  competitive  environment of the McLean
area of Fairfax  County.  It competes  for  deposits  and loans with  commercial
banks,  savings  and  loans,  credit  unions and other  financial  institutions,
including non-bank  competitors such as loan companies,  insurance companies and
large  securities  firms.  Many of  these  organizations  possess  substantially
greater financial and technical resources than the Bank.

         In Fairfax County, the Bank commands 0.42% of the market,  according to
the most recent survey of deposits by the Federal Deposit Insurance  Corporation
("FDIC"). In McLean, the Bank commands 3.27% of the market. Seventeen banks with
31 branches  operate in the greater  McLean  area and 17 of these  branches  are
located in proximity to the Bank in the McLean Central  Business  District.  The
Heritage Bank is the only community bank headquartered in McLean.

          The market is mature and the growth of  deposits  and loan  demand has
slowed in recent years. While it can produce stable earnings from its operations
in the McLean office, the Bank believes the future growth of the Bank will be in
expansion to other parts of Northern Virginia, including Loudoun County.

         There are 12  commercial  banks  with 37  branches  located  in Loudoun
County with deposits totaling  approximating  $900 million. A number of mortgage
companies along with several non-bank financial institutions also compete in the
area.  Nine bank  branches  are  located  in  eastern  Loudoun  County.  All are
full-service  banks and  provide a wide  array of bank  products  and  services,
although  none of these banks is  considered  to be a community  bank,  like The
Heritage Bank. The Bank believes that it will enjoy a competitive  advantage due
to  its  local   community  bank   orientation   and  reputation  for  providing
personalized service to its customers.

         With  the  opening  of the  CountrySide  Branch,  the Bank  expects  to
increase its deposit base,  which in turn will increase the funds  available for
loans  and other  profitable  opportunities  for the  Bank.  While the Bank will
continue  to  experience  a  competitive  environment  in  Fairfax  and  Loudoun
counties,  there still exist  opportunities  to establish  new branches in those
areas where significant population increases and economic growth are occurring.

Year 2000 Issues

         Background.  The  "Year  2000  Problem"  centers  on the  inability  of
computer  systems to precisely  recognize the year 2000. Many existing  computer
programs  and  systems  were  originally  programmed  with six digit  dates that
provided  only two  digits to  identify  the  calendar  year in the date  field,
without  considering  the  upcoming  change in the century.  With the  impending
millennium,  these  programs and computers  will recognize "00" as the year 1900
rather than the year 2000.  If computer  systems are not  adequately  changed to
identify  the  year  2000,  many  computer  applications  could  fail or  create
erroneous results.  As a result,  many calculations which rely on the date/field
information,  such  as  interest,  payment  or due  dates  and  other  operating
functions, will generate results which could be significantly misstated, and the
Bank could  experience  a  temporary  inability  to process  transactions,  send
invoices or engage in similar normal business

                                        4

<PAGE>



activities.  In addition,  under  certain  circumstances,  failure to adequately
address the Year 2000 Problem could adversely affect the viability of the Bank's
suppliers and creditors and the creditworthiness of its borrowers.  Thus, if not
adequately  addressed,  the Year 2000  Problem  could  result  in a  significant
adverse impact on the Bank's products, services and competitive condition.

         In addition,  noninformation  technology  systems,  such as telephones,
copies  and  elevators  may  contain  embedded  technology  which  controls  its
operations  and  which may be  affected  by the Year 2000  Problem.  Thus,  even
noninformation  technology  systems  may  affect the  normal  operations  of the
Company upon the arrival of the Year 2000.

         Financial  institution  regulators have recently  increased their focus
upon year 2000 issues,  issuing  guidance  concerning  the  responsibilities  of
senior  management  and  directors.  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.

         Federal  banking  regulators  have also  issued  safety  and  soundness
guidelines  to be used in  conjunction  with  routine  regulatory  examinations.
Failure by federally regulated  institutions to adequately address the Year 2000
Problem  may  result in  supervisory  action,  including  the  reduction  to the
institution's  supervisory  rating,  the denial of applications  for approval of
mergers and acquisitions,  the denial of applications for new branch openings or
the imposition of civil money penalties.

         Risk.  Similar  to other  financial  institutions  and  companies  that
utilize  computer  technology,  the Company's  operations  may be  significantly
affected by the Year 2000  Problem  because of its reliance on  electronic  data
processing technology and date-sensitive  information.  The Year 2000 issue also
impacts other aspects of our non-technical business processes.  If the Year 2000
Problem is not  adequately  addressed,  and systems are not modified to properly
identify the Year 2000,  computer systems and software  applications may fail or
create erroneous information.

         If the Bank and the Company are affected by the Year 2000 Problem,  the
worst  case  scenario  may be that  information  that  relies on dates,  such as
interest  calculations,  loan payment  schedules and other operating  functions,
could  be  significantly  incorrect.  The  Bank  may  not  be  able  to  process
withdrawals or deposits,  prepare  account  statements,  or engage in any of the
many transactions that constitute its normal operations. The Bank's inability to
adequately  address the Year 2000 Problem could also have a significant  adverse
affect on the Bank's suppliers and service providers. Should the Bank experience
a Year  2000  failure  that  can  not  readily  be  fixed,  it may  result  in a
significant adverse impact on our financial condition and results of operations.

         State of  Readiness.  The  Company  believes  that  technology  plays a
critical role in its overall business strategy. It has consistently attempted to
stay current with  technological  advances in the industry.  In this regard, the
board of managers and senior management have consistently  supported  investment
in established and proven technologies. Because of this philosophy, the board of
managers and senior  management have been actively  engaged in managing the Year
2000 project.  Management  has  consistently  allocated both human and financial
resources to this project to achieve the objectives and time frames  mandated by
the FFIEC.

         To address the Year 2000 Problem,  the Bank hired an outside consultant
to assess the  impact of the Year 2000  Problem  on the Bank.  Because  the Bank
outsources its data processing operations, a significant

                                        5

<PAGE>



component  of the Year 2000 plan is working  with  external  vendors to test and
certify their systems as Year 2000  compliant.  The Bank's eternal  vendors have
surveyed  their  programs  to  inventory  the  necessary  changes and have begun
correcting the applicable  computer programs and replacing equipment so that the
Bank's information  systems will be Year 2000 compliant by the end of 1998. This
will enable the Bank to devote  substantial  time to the testing of the upgraded
systems  prior to the  arrival  of the  millennium  in order to comply  with all
applicable regulations.

         The Company's  timetable for working on the Year 2000 Problem, in order
to  achieve a  successful  transition  to the Year  2000,  is  divided  into the
following five phases:

<TABLE>
<CAPTION>


       PHASE                                   DESCRIPTION                                      STATUS
---------------------            -----------------------------------------------         ----------------------
<S>      <C>                     <C>                                                      <C>

1.       Awareness               Define the problem.                                      Completed  - 11/1/97

2.       Assessment              Identify all systems and criticality of systems.         Completed  - 6/1/98

3.       Renovation              Program enhancements, hardware and software              99% Complete -
                                 upgrades, system replacements, and vendor                11/30/98
                                 certifications.

4.       Validation              Test and verify system changes.                          99% Complete -
                                                                                          11/30/98

5.       Implementation          Components certified as Year 2000 compliant              99% Complete -
                                 and moved to production.                                 11/30/98
</TABLE>


         Contingency Planning.  The Bank has a contingency plan to keep the Bank
in operation in the event that some Year 2000 problems have been  overlooked and
system malfunctions occur at the turn of the century. This plan was developed by
the Bank's outside consultant with the help of Bank management.  The Company has
developed  contingency or alternate plans for its mission  critical systems on a
department-by-  department  basis in anticipation of potential  unplanned system
difficulties  or  third-party  failures  at  January  1,  2000 or dates  beyond.
However,  the Bank understands  that certain events beyond its control,  such as
extended power outages and loss of telecommunications,  may diminish its ability
to provide  minimum  levels of service.  Failure of these  services  will affect
companies,  individuals  and the  government,  and can not be remedied by anyone
other than the responsible party. For some systems, contingency plans consist of
using or reverting to manual systems until the problems can be corrected.

         While the Company expects to complete its Year 2000 project in a timely
manner, it can not guarantee that the systems of companies with whom it conducts
business,  will also be  completed  in a timely  manner.  The  failure  of these
entities to adequately  address the Year 2000 Problem could adversely affect the
Company's and Bank's ability to conduct business.

         Costs.  The Company  currently  estimates its total direct and indirect
cost will be  $35,000.  To date,  the  Company  has spent  $31,000  on Year 2000
issues.  The  costs  of the  project  and the date on  which  the Bank  plans to
complete the Year 2000  modifications  are based on management's best estimates,
which were derived utilizing numerous assumptions of future events including the
continued availability of certain resources,  third party modification plans and
other factors.  However,  there can be no guarantee that these estimates will be
achieved,  and actual  results  could differ  materially  from those  plans.  In
addition, there can be no guarantee that the systems of other companies on which
the Bank's systems rely will be timely  converted,  or that a failure to convert
by  another  company,  or a  conversion  that is  incompatible  with the  Bank's
systems, would not have a material adverse effect on the Bank.


                                        6

<PAGE>

Employees

         At December 31, 1998, the Bank had  twenty-seven  full-time  equivalent
employees.  None of its employees is represented  by any  collective  bargaining
unit. The Bank considers relations with its employees to be good.

Federal Taxation

         General.  The  following is intended  only as a discussion  of material
federal  income  tax  matters  and  does  not  purport  to  be  a  comprehensive
description  of the  federal  income  tax  rules  applicable  to the Bank or the
Company.  For federal income tax purposes,  the Company and the Bank, as members
of the same affiliated group, file consolidated income tax returns on a December
31 fiscal year basis using the accrual  method of accounting  and are 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.

         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  December  31,  1995.  See Note 8  to the  consolidated  financial
statements.

         Distributions.  To that the extent  that the Bank  makes  "non-dividend
distributions"  to the Company,  such  distributions  will be considered to have
been  made  from the  Bank's  "base  year  reserve",  and then  from the  Bank's
supplemental  reserve for losses on loans, to the extent thereof,  and an amount
based  on the  amount  distributed  (but not in  excess  of the  amount  of such
reserves)  will be included  in the Bank's  income.  Non-dividend  distributions
include  distributions in excess of the Bank's current and accumulated  earnings
and profits,  as calculated  for federal income tax purposes,  distributions  in
redemption  of stock,  and  distributions  in partial or  complete  liquidation.
Dividends  paid out of the Bank's  current or  accumulated  earnings and profits
will not be so included in the Bank's income.

         The amount of additional  taxable  income  created from a  non-dividend
distribution  is an amount  that,  when reduced by the tax  attributable  to the
income,  is equal to the amount of the  distribution.  Thus, if the Bank makes a
non-dividend  distribution to the Company,  approximately one and one-half times
the  amount  of such  distribution  (but not in  excess  of the  amount  of such
reserves) would be includible in income, assuming a 34% federal corporate income
tax rate.  The Bank does not  intend to pay  dividends  that  would  result in a
recapture of any portion of its bad debt reserves.

         Corporate  Alternative  Minimum  Tax. 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). The Bank does not expect to be subject to the AMT.

         Elimination of Dividends; Dividends Received Deduction. The Company may
exclude from its income 100% of dividends  received from the Bank as a member of
the same affiliated group of corporations.

                                       7

<PAGE>

State Taxation

         The Bank is exempt from paying state income tax to the  Commonwealth of
Virginia.  Under  Virginia law,  however,  banks must pay a franchise tax at the
rate of $1 on each $100 of net  capital  as  defined  under  Virginia  law.  For
additional  information regarding taxation, see Note 8 of the Notes to Financial
Statements.


                           REGULATION AND SUPERVISION

         The Bank is extensively regulated under both federal and state law. The
following  is a  brief  summary  of  certain  statutes,  rules  and  regulations
affecting the Company and the Bank. This summary is qualified in its entirety by
reference to the  particular  statutory and  regulatory  provisions  referred to
below and is not  intended to be an  exhaustive  description  of the statutes or
regulations applicable to the Bank's business.

Regulation of the Bank

         The Bank is organized as a  Virginia-chartered  banking corporation and
is  regulated  and  supervised  by the  Virginia  State  Corporation  Commission
("SCC").  In addition,  the Bank is regulated and  supervised by the FRB,  which
serves as its primary federal regulator,  and is subject to certain  regulations
promulgated by the FDIC. The SCC and the FRB conduct regular examinations of the
Bank, reviewing the adequacy of its loan loss reserves, the quality of its loans
and investments, the propriety of management practices, compliance with laws and
regulations,  and other aspects of the Bank's  operations.  In addition to these
regular  examinations,  the  Bank  must  furnish  to the FRB  quarterly  reports
containing detailed financial statements and schedules.

         Federal and Virginia  banking laws and regulations  govern all areas of
the  operations of the Bank,  including  reserves,  loans,  mortgages,  capital,
issuance of  securities,  payment of dividends  and  establishment  of branches.
Federal and state bank  regulatory  agencies also have the general  authority to
limit the dividends paid by insured banks.  See "--Limits on Dividends and Other
Payments."  As its primary  federal  regulator,  the FRB has authority to impose
penalties,  initiate  civil and  administrative  actions  and take  other  steps
intended to prevent the Bank from  engaging in unsafe or unsound  practices.  In
this  regard,  the Federal  Reserve has adopted  capital  adequacy  requirements
applicable to state member banks such as the Bank. See "--Capital Requirements."

         Transactions  with  Affiliates  and Insiders of the Bank.  Transactions
between  an  insured  bank,  such as the  Bank,  and any of its  affiliates  are
governed by Sections  23A and 23B of the Federal  Reserve Act. An affiliate of a
bank is any  company or entity  which  controls,  is  controlled  by or is under
common  control  with the bank.  Generally,  Sections  23A and 23B (i) limit the
extent  to  which  the  bank  or  its   subsidiaries   may  engage  in  "covered
transactions"  with  any  one  affiliate  to an  amount  equal  to 10%  of  such
institution's  capital stock and surplus,  and limit all such  transactions with
all  affiliates  to an amount equal to 20% of such capital stock and surplus and
(ii) require that all such  transactions  be on terms that are  consistent  with
safe and  sound  banking  practices.  In  addition,  any  purchase  of assets or
services by a bank from an affiliate must be on terms that are substantially the
same,  or at least as  favorable,  to the  institution  as those  that  would be
provided to a non-affiliate.  The term "covered transaction" includes the making
of loans, purchase of assets,  issuance of guarantees and similar other types of
transactions.  Further,  most loans by a bank to its affiliate must be supported
by collateral in amounts ranging from 100 to 130 percent of the loan amounts.

         Banks are also subject to the  restrictions  contained in Section 22(h)
of the  Federal  Reserve  Act and  the  Federal  Reserve  Board's  Regulation  O
thereunder on loans to executive officers, directors and principal stockholders.
Under Section 22(h), loans to a director, an executive officer or a greater than
10% stockholder of a bank as well as certain affiliated  interests of any of the
foregoing,  may not exceed,  together with all other  outstanding  loans to such
person and affiliated interests, the  loans-to-one-borrower  limit applicable to
national  banks  (generally  15% of the  institution's  unimpaired  capital  and
surplus),  and all loans to all such persons in the aggregate may not exceed the
institution's  unimpaired  capital and  unimpaired  surplus.  Regulation  O also
prohibits the making of loans in an amount greater than $25,000 or 5% of capital
and surplus but in any event over $500,000, to directors, executive officers and
greater than 10% stockholders of a bank, and their respective affiliate,  unless
such loans are  approved in advance by a majority of the Board of  Directors  of
the  bank  with any  "interested"  director  not  participating  in the  voting.
Further,  Regulation O requires that loans to directors,  executive officers and
principal stockholders be made on terms substantially the same as those that are
offered in comparable transactions to other persons. Regulation O

                                        8

<PAGE>



also prohibits a depository  institution  from paying the overdrafts over $1,000
of any of its executive  officers or directors  unless they are paid pursuant to
written pre-authorized extension of credit or transfer of funds plans.

         Community  Reinvestment.  Under the Community Reinvestment Act ("CRA"),
as  implemented  by FRB  regulations,  a bank 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 FRB, in
connection  with its  examination  of a bank,  to assess  the  bank'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 bank. 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.

         In April 1995, the 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
service 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. Small banks would be assessed pursuant to a streamlined
approach  focusing on a lesser range of information and  performance  standards.
The term "small bank" is defined as including  banks with less than $250 million
in assets or an affiliate of a holding company with banking and thrift assets of
less than $1 billion, which would include the Bank.

          The  regulatory  agency's  assessment  of the  bank's  record  is made
available to the public.  Further, such assessment is required by any bank which
has applied  to,  among other  things,  establish a new branch  office that will
accept  deposits,  relocate an existing  office,  or merge,  consolidate with or
acquire the assets or assume the liabilities of a federally-regulated  financial
institution.

         Safety and Soundness Standards. Pursuant to the requirements of Section
39 of the FDICIA, as amended by the Riegle Community  Development and Regulatory
Improvement Act of 1994,  each federal  banking  agency,  including the FRB, has
adopted guidelines establishing general standards relating to internal controls,
information and internal audit systems, loan documentation, credit underwriting,
interest rate exposure, asset growth, asset quality,  earnings 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.

Capital Requirements

         The  Federal  Deposit  Insurance  Corporation  Act of  1991  ("FDICIA")
requires the Federal Reserve to take "prompt  corrective action" with respect to
any insured depository institution which does not meet specified minimum capital
requirements.  The applicable regulations establish five capital levels, ranging
from "well-capitalized" to "critically  undercapitalized," and require or permit
the Federal Reserve to take supervisory action in certain  circumstances.  Under
these   regulations,   an   insured   depository   institution   is   considered
well-capitalized if it has a Total Risk-based Capital ratio of 10.0% or greater,
a Tier 1 Risk-based  Capital ratio of 6.0% or greater,  and a Leverage  ratio of
5.0% or greater, and it is not subject to an order,  written agreement,  capital
directive or prompt corrective action directive to meet and maintain a specific

                                        9

<PAGE>



capital level for any capital  measure.  An insured  depository  institution  is
considered adequately  capitalized if it has a Total Risk-based Capital ratio of
8.0% or greater, a Tier I Risk-based Capital ratio and Leverage ratio of 4.0% or
greater  (or a Leverage  ratio of 3.0% or greater  if the  institution  is rated
composite 1 in its most recent  report of  examination,  subject to  appropriate
federal  banking  agency  guidelines),  and the  institution  does  not meet the
definition of an undercapitalized institution. An insured depository institution
is considered  undercapitalized  if it has a Total Risk-based Capital ratio that
is less than 8.0%, a Tier 1 Risk-based  Capital ratio that is less than 4.0%, or
a  Leverage  ratio  that is less than  4.0%.  A  significantly  undercapitalized
institution is one which has a Total Risk-based  Capital ratio that is less than
6.0%, a Tier 1 Risk-based  Capital  ratio that is less than 3.0%,  or a Leverage
ratio that is less than 3.0%. A critically  undercapitalized  institution is one
which has a ratio of  tangible  equity to total  assets that is equal to or less
than 2.0%. As of December 31, the Bank was classified as  well-capitalized.  The
Bank's Tier 1 and Total  Risk-based  Capital ratios as of December 31, 1997 were
17.4% and 18.6%, respectively.

         The severity of action  authorized or required to be taken under prompt
corrective action regulations  increases as a bank's capital deteriorates within
the three  undercapitalized  categories.  All banks are  prohibited  from paying
dividends  or other  capital  distributions  or  paying  management  fees to any
controlling   person,  if,  following  such  distribution,   the  bank  will  be
undercapitalized.  The Federal  Reserve is  authorized by this  legislation  and
under  Regulation  H  (which  regulates  state  member  banks)  to take  various
enforcement actions against any undercapitalized  insured depository institution
and any  insured  depository  institution  that  fails to submit  an  acceptable
capital  restoration  plan or fails to implement a plan  accepted by the Federal
Reserve. These powers include, among other things,  requiring the institution to
be  recapitalized,  prohibiting asset growth,  restricting  interest rates paid,
requiring  prior approval of capital  distributions  by any bank holding company
which controls the institution,  requiring divestiture by the institution of its
subsidiaries or by the holding company of the institution itself,  requiring new
election of directors, and requiring the dismissal of directors and officers.

         With  certain  exceptions,  insured  depository  institutions  will  be
prohibited from making capital  distributions  or paying  management fees if the
payment   of  such   distributions   or  fees   will   cause   them  to   become
undercapitalized.  Furthermore, undercapitalized insured depository institutions
will be required to file  capital  restoration  plans with the Federal  Reserve.
Undercapitalized  insured  depository  institutions  also  will  be  subject  to
restrictions  on growth,  acquisitions,  branching  and engaging in new lines of
business unless they have an approved capital plan that permits  otherwise.  The
Federal  Reserve  also may,  among  other  things,  require an  undercapitalized
insured  depository  institution to issue shares or obligations,  which could be
voting stock, to recapitalize  the institution or, under certain  circumstances,
to divest itself of any subsidiary.

         Significantly  and  critically   undercapitalized   insured  depository
institutions  may be subject to more  extensive  control  and  supervision.  The
Federal  Reserve may prohibit any such  institutions  from,  among other things,
entering into any material  transaction  not in the ordinary course of business,
amending  their  Articles  of  Incorporation  or bylaws,  or engaging in certain
transactions   with  affiliates.   In  addition,   critically   undercapitalized
institutions  generally will be prohibited  from making payments of principal or
interest  on  outstanding  subordinated  debt.  Within  90  days  of an  insured
depository institution becoming critically undercapitalized, the Federal Reserve
must appoint a receiver or  conservator  unless  certain  findings are made with
respect  to  the  prospect  for  the  institution's  continued  viability.   See
"Management's  Discussion  and  Analysis of Financial  Condition  and Results of
Operations -- Analysis of Financial Condition -- Capital  Requirements" for more
information about the Bank's capital ratios and applicable minimum ratios.

Branching

         Under the Riegle-Neal  Interstate Banking and Branching  Efficiency Act
of 1994 (the "Riegle Act"), the Federal Reserve may approve bank holding company
acquisitions  of banks in other  states,  subject to certain  aging and  deposit
concentration  limits.  As of June 1,  1997,  banks in one state may merge  with
banks

                                       10

<PAGE>



in another  state,  unless the other  state has  chosen  not to  implement  this
section of the Riegle Act.  These  mergers are also subject to similar aging and
deposit concentration limits.

         Virginia  "opted-in" to the provisions of the Riegle Act. Since July 1,
1995, an  out-of-state  bank that did not already  maintain a branch in Virginia
was permitted to establish and maintain a de novo branch in Virginia, or acquire
a branch in  Virginia,  if the laws of the home state of the  out-of-state  bank
permit  Virginia  banks to engage in the same  activities  in that  state  under
substantially the same terms as permitted by Virginia.  Also, Virginia banks may
merge with  out-of-state  banks, and an out-of-state bank resulting from such an
interstate merger  transaction may maintain and operate the branches in Virginia
of a merged  Virginia  bank,  if the laws of the home state of the  out-of-state
bank involved in the interstate merger transaction permit interstate merger.

Legislative Developments

         On September 30, 1996, President Clinton signed the Economic Growth and
Regulatory Paperwork Reduction Act of 1996 (the "Growth Act"), which contained a
comprehensive  approach to recapitalize the FDIC's Savings Association Insurance
Fund (the  "SAIF")  and to assure  payment  of the  Financing  Corporation  (the
"FICO") obligations.  Most of the Bank's deposits are insured by the FDIC's Bank
Insurance  Fund (the "BIF").  Under the Growth Act, banks with deposits that are
insured under the BIF are required to pay a portion of the interest due on bonds
that were  issued by FICO to help shore up the ailing  Federal  Savings and Loan
Insurance Corporation in 1987. The Growth Act stipulates that the BIF assessment
rate to contribute  toward the FICO  obligations  must be equal to one-fifth the
SAIF  assessment  rate through  year-end 1999, or until the insurance  funds are
merged,  whichever  occurs first.  The amount of FICO debt service to be paid by
all BIF-insured  institutions is  approximately  $0.0126 per $100 of BIF-insured
deposits for each year from 1997 through 1999 when the obligation of BIF-insured
institutions increases to approximately $0.0240 per $100 of BIF-insured deposits
per year through the year 2019,  subject in all cases to adjustments by the FDIC
on a quarterly basis. The Growth Act also contained provisions  protecting banks
from  liability for  environmental  clean-up  costs;  prohibiting  credit unions
sponsored by Farm Credit System banks; easing application  requirements for most
bank  holding  companies  when they acquire a thrift or a  permissible  non-bank
operation;  easing Fair Credit Reporting Act  restrictions  between bank holding
company  affiliates;  and  reducing  regulatory  burden  under  the Real  Estate
Settlement  Procedures Act, the  Truth-in-Savings  Act, the Truth-in-Lending Act
and the Home Mortgage Disclosure Act.

Federal Reserve System

         Pursuant to regulations of the FRB, a bank must maintain  average daily
reserves equal to 3% on the first $52 million of net transaction accounts,  plus
10% on the  remainder.  This  percentage  is subject to  adjustment  by the FRB.
Because  required  reserves must be maintained in the form of vault cash or in a
non-interest  bearing  account  at a Federal  Reserve  Bank,  the  effect of the
reserve   requirement   is  to   reduce   the   amount   of  the   institution's
interest-earning  assets.  As of  December  31,  1998,  the Bank met its reserve
requirements.

Effect of Economic Environment

         The policies of regulatory  authorities,  including the monetary policy
of the Federal Reserve,  have a significant  effect on the operating  results of
banks and their  subsidiaries.  Among the means available to the Federal Reserve
to  affect  the money  supply  are open  market  operations  in U.S.  government
securities,  changes in the discount rate on member bank borrowings, and changes
in reserve  requirements  against member bank deposits.  These means are used in
varying combinations to influence overall growth and distribution of bank loans,
investments  and deposits,  and their use may affect  interest  rates charged on
loans or paid for deposits.


                                       11

<PAGE>



         Federal  Reserve  monetary   policies  have  materially   affected  the
operating  results of commercial  banks in the past and are expected to continue
to do so in the future. The nature of future monetary policies and the effect of
such policies on the business and income of the Bank cannot be predicted.

Limits on Dividends and Other Payments

         As a state  member  bank  subject  to the  regulations  of the  Federal
Reserve,  the Bank must  obtain the  approval  of the  Federal  Reserve  for any
dividend  if the total of all  dividends  declared  in any  calendar  year would
exceed the total of its net profits, as defined by the Federal Reserve, for that
year,  combined with its retained net profits for the  preceding  two years.  In
addition,  the  Bank  may not pay a  dividend  in an  amount  greater  than  its
undivided  profits then on hand after  deducting  its losses and bad debts.  For
this purpose, bad debts are generally defined to include the principal amount of
loans  which are in  arrears  with  respect to  interest  by six months or more,
unless such loans are fully-secured and in the process of collection.  Moreover,
for purposes of this limitation, the Bank is not permitted to add the balance in
its  allowance for loan losses  account to its  undivided  profits then on hand;
however, it may net the sum of its bad debts, as so defined, against the balance
in its allowance for loan losses account and deduct from undivided  profits only
bad debts, as so defined,  in excess of that account.  At December 31, 1998, the
Bank could not declare or pay any  dividends  and had made no requests to do so.
The Bank expects that it will qualify to pay dividends in 1999.

         In addition,  the Federal  Reserve is  authorized  to  determine  under
certain  circumstances  relating to the  financial  condition  of a state member
bank, that the payment of dividends  would be an unsafe or unsound  practice and
to prohibit  payment  thereof.  The payment of  dividends  that would  deplete a
bank's  capital  base  could be deemed to  constitute  such an unsafe or unsound
practice.  The Federal Reserve has indicated that banking  organizations  should
generally pay dividends only out of current operating earnings.

         FDICIA  provides that no insured  depository  institution  may make any
capital   distribution,   including  a  cash   dividend  if,  after  making  the
distribution,  the  institution  would not  satisfy  one or more of its  minimum
capital requirements.

         In addition,  Virginia law imposes  restrictions  on the ability of all
banks  chartered  under  Virginia law to pay  dividends.  Under Virginia law, no
dividend may be declared or paid that would impair a  Virginia-chartered  bank's
paid-in capital. The SCC also has authority to limit the payment of dividends by
a Virginia bank if it determines the limitation is in the public interest and is
necessary to ensure the bank's financial soundness.

Regulation of Holding Company

         Federal Regulation.  The Company is subject to examination,  regulation
and periodic  reporting  under the BHCA, as administered by the FRB. The FRB has
adopted capital adequacy guidelines for bank holding companies on a consolidated
basis substantially similar to those of the FRB for the Bank.

         The  Company is  required  to obtain the prior  approval  of the FRB to
acquire  all, or  substantially  all, of the assets or any bank of bank  holding
company.  Prior FRB approval will be required for the Company to acquire  direct
or indirect  ownership or control of any voting  securities  of any bank or bank
holding company if, after giving effect to such acquisition,  it would, directly
or indirectly, own or control more than 5% of any class of voting shares of such
bank or bank holding company.

         The  Company is required  to give the FRB prior  written  notice of any
purchase  or  redemption  of its  outstanding  equity  securities  if the  gross
consideration  for the  purchase  or  redemption,  when  combined  with  the net
consideration paid for all such purchases or redemptions during the preceding 12
months, is equal to 10% or more of the Company's consolidated net worth. The FRB
may disapprove  such a purchase or redemption if it determines that the proposal
would constitute an unsafe and unsound practice, or would

                                       12

<PAGE>



violate any law,  regulation,  FRB order or directive,  or any condition imposed
by, or written agreement with, the FRB. Such notice and approval is not required
for a bank  holding  company that would be treated as "well  capitalized"  under
applicable  regulations  of the FRB,  that has  received a composite  "1" or "2"
rating at its most recent bank holding  company  inspection by the FRB, and that
is not the subject of any unresolved supervisory issues.

         The status of the Company as a registered  bank holding  company  under
the BHCA does not exempt it from certain  federal and state laws and regulations
applicable to corporations  generally,  including,  without limitation,  certain
provisions of the federal securities laws.

         In  addition,  a bank  holding  company is  prohibited  generally  from
engaging in, or acquiring  5% or more of any class of voting  securities  of any
company engaged in, non-banking  activities.  One of the principal exceptions to
this  prohibition is for activities found by the FRB to be so closely related to
banking or managing or  controlling  banks as to be a proper  incident  thereto.
Some of the principal activities that the FRB has determined by regulation to be
so closely related to banking as to be a proper incident thereto are: (i) making
or servicing  loans;  (ii) performing  certain data processing  services;  (iii)
providing discount brokerage services;  (iv) acting as fiduciary,  investment or
financial  advisor;   (v)  leasing  personal  or  real  property;   (vi)  making
investments in corporations or projects designed  primarily to promote community
welfare; and (vii) acquiring a savings and loan association.

         Under FIRREA, depository institutions are liable to the FDIC for losses
suffered or anticipated by the FDIC in connection with the default of a commonly
controlled depository institution or any assistance provided by the FDIC to such
an institution in danger of default. This law would have potential applicability
if Bancorp ever acquired as a separate  subsidiary a depository  institution  in
addition to the Bank. There are no current plans for such an acquisition.

         Subsidiary  banks of a bank  holding  company  are  subject  to certain
quantitative and qualitative  restrictions imposed by the Federal Reserve Act on
any  extension of credit to, or purchase of assets from,  or letter of credit on
behalf of, the bank holding company or its  subsidiaries,  and on the investment
in or  acceptance  of  stocks  or  securities  of such  holding  company  or its
subsidiaries  as collateral  for loans.  In addition,  provisions of the Federal
Reserve Act and FRB  regulations  limit the amounts of, and  establish  required
procedures and credit  standards with respect to, loans and other  extensions of
credit to  officers,  directors  and  principal  stockholders  of the Bank,  the
Company,  any  subsidiary of the Company and related  interests of such persons.
Moreover, subsidiaries of bank holding companies are prohibited from engaging in
certain  tie-in   arrangements   (with  the  holding   company  or  any  of  its
subsidiaries)  in  connection  with any  extension  of credit,  lease or sale of
property or furnishing of services.

Federal Securities Laws

         The  Company's  Common Stock is  registered  with the SEC under Section
12(g) of the Securities  Exchange Act of 1934 (the "Exchange  Act"). The Company
is subject to the information, proxy solicitation,  insider trading restrictions
and other requirements under the Exchange Act.

ITEM 2.           PROPERTIES

         The  principal  office of the Bank is  located at 1313  Dolley  Madison
Boulevard,  McLean,  Virginia where the Bank leases  approximately  8,407 square
feet in an  office  building.  All of the  Bank's  administrative  and  customer
service  facilities are at this  location.  The lease was for an initial term of
ten years,  beginning July 1988, with three 5 year renewal options.  The current
monthly  rent is  $15,046.  The Bank also owns a parcel of land in Great  Falls,
Virginia  valued at $245,000,  which it is holding for future bank use. The Bank
has  classified  one parcel of real estate,  acquired  through  foreclosure,  as
"other real estate owned" totaling $263,000.


                                       13

<PAGE>



         The Bank also  entered  into a  ten-year  lease for its  future  branch
office.  The  lease  is ten  years  and  commences  on June  1,  1998 or 15 days
following the issuance of an occupancy  certificate,  whichever  occurs last. In
the first year of the  lease,  the  minimum  monthly  rent will be $6,500,  with
minimal  increases in subsequent years. The Bank made the first lease payment on
March 1 1999.

ITEM 3.           LEGAL PROCEEDINGS

         In the normal course of its  operations,  the Bank from time to time is
party to various legal proceedings.  Based upon information currently available,
and after  consultation  with its counsel,  management  believes that such legal
proceedings,  in the aggregate,  will not have a material  adverse effect on the
Bank's  business,  financial  position or results of operations,  except for the
following.

         The  Heritage  Bank is a defendant in a suit in Fairfax  Circuit  Court
styled Brault & Associates,  et al. v. The Heritage Bank, Law No. 174525. In the
suit the plaintiffs allege conversion (Count I), breach of fiduciary duty (Count
II),  defamation (Count III), and breach of contract (Count IV) as a result of a
dispute over a loan  repayment and the  collateral  securing such loan. The Bank
filed an answer denying the plaintiffs'  claims.  The Bank's  insurance  carrier
contributed  Thirty Thousand Dollars  ($30,000.00)  towards a settlement of this
matter and the Bank has settled this matter in principle as of March 2, 1999 for
a total cash payment of Fifty Thousand  Dollars  ($50,000.00),  which involves a
Twenty Thousand Dollar  ($20,000.00)  payment from the Bank. The parties are now
in the process of preparing final settlement  documents for execution which will
result in the dismissal of the above case with prejudice.

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

          None.



                                       14

<PAGE>



                                     PART II

ITEM 5.           MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
                   STOCKHOLDER MATTERS

         Heritage Bancorp,  Inc.'s common stock is traded on the Nasdaq SmallCap
Market and quoted under the symbol  "HBVA." Prior to its  secondary  offering of
805,000 shares on May 18, 1998 (the  "Offering") and  commencement of trading on
the Nasdaq SmallCap Market,  the common stock of The Heritage Bank traded on the
OTC Bulletin Board on a limited basis. The Bank's common stock traded as Company
common stock when Reorganization  became effective in October 1998, prior to the
end of the Company's 1998 fiscal year.

         At December 31, 1998,  the last  trading date in the  Company's  fiscal
year, the Company's  common stock closed at $3.75. At March 10, 1999, there were
2,294,617 shares of the Company's common stock  outstanding,  which were held of
record by approximately 2,000 stockholders.

         The  Board  of  Directors  has  not  paid a  cash  dividend  since  its
incorporation. The Board of Directors may consider the payment of cash dividends
dependant on the results of operations  and financial  condition of the Company,
tax  considerations,   industry  standards,   economic  conditions,   regulatory
restrictions and other factors.  There are significant regulatory limitations on
the Company's  ability to pay  dividends  depending on the dividends it receives
from its subsidiary, The Heritage Bank, which are subject to regulations and the
Bank's  continued  compliance with all regulatory  capital  requirements and the
overall health of the institution.

         The table below  shows the high and low sales price  during the periods
indicated.



                                                            Price Range ($)
                                                       -------------------------

                 Quarter Ended                              High         Low
--------------------------------------------------------------------------------

Fiscal year ended December 31, 1998:
     Second Quarter ended June 30, 1998...............      6 3/4        4 3/4
     Third Quarter ended September 30, 1998...........      5 1/2        3 3/4
     Fourth Quarter ended December 31, 1998 ..........      4 3/4        3 1/2

     Based on information available to the Bank from a limited number of sellers
and  purchasers  of the Bank's  common  stock  prior to the  Offering,  the Bank
believes  that the selling  price for the Bank common stock ranged from $2.25 to
$4.00 during 1997 and from $4.00 to $4.625 from  January 1, 1998  through  March
31, 1998.

                                       15

<PAGE>



ITEM 6.           MANAGEMENT'S DISCUSSION AND ANALYSIS

                             SELECTED FINANCIAL DATA

     The year-end income statement data, the year-end balance sheet data and the
year-end per share data regarding net income contained in the following selected
financial  data for the five years ended  December 31, 1998 are derived from the
financial  statements of the Company and the Bank, which have been audited on an
annual basis. The selected  financial  information should be read in conjunction
with the financial statements and the notes thereto.

<TABLE>
<CAPTION>

                                                                       Years ended December 31,
                                                  ---------------------------------------------------------------------
                                                             (Dollars in thousands, except per share data)
<S>                                                   <C>              <C>             <C>          <C>         <C>    
Summary of operating results:

     Total interest income.......................       $   3,766     $   3,256      $   3,420    $   3,048    $  3,034
     Total interest expense......................           1,272         1,111          1,411        1,165         960
                                                      -----------------------------------------------------------------
     Net interest income.........................       $   2,494     $   2,145          2,009        1,883       2,074
     Provision for (recovery of) loan losses.....             117             4              -         (87)         488
                                                      -----------------------------------------------------------------
     Net interest income after provision for
      recovery of) loan losses...................       $   2,377     $   2,141          2,009        1,970       1,586
     Other income................................             137           181            119           98         168
     Other expenses..............................           2,421         1,836          1,725        1,854       1,868
                                                      -----------------------------------------------------------------
     Income (loss) before taxes..................              93           486            403          214        (114)
     Income tax expense (benefit)(1).............             (40)          (85)             -           31           -
                                                      --------- ------------- -----------------------------------------
     Net income (loss)...........................       $     133     $     571      $     403    $     183    $   (114)
                                                      =================================================================
Per share:
     Basic earnings (loss) per share.............       $    0.07     $    0.45      $    0.32    $    0.15    $  (0.09)
     Diluted earnings (loss) per share...........            0.07          0.44           0.32         0.15       (0.09)
     Dividend payout ratio.......................               -             -              -            -           -
     Book value at period end....................            3.89          3.18           2.84         2.52        2.30
     Common shares outstanding...................       2,294,617     1,489,636      1,249,634    1,249,634   1,249,634

Balance sheet data (at period end):
     Loans, net of unearned interest.............       $  29,610     $  23,390         25,202       24,346       27,426
     Allowance for loan loss.....................             429           634            617          685        1,164
     Total assets................................          64,776        45,450         46,075       46,874       41,944
     Total deposits..............................          53,442        40,604         42,387       43,539       38,933
     Total stockholders' equity..................           8,928         4,730          3,543        3,149        2,878

Performance and asset quality ratios:

     Return on average total assets..............            0.26%         1.33%          0.87%        0.46%       (0.26)%
     Return on average stockholders' equity......            1.79         15.24          12.05         5.89        (3.84)
     Average stockholders' equity to average
      total assets...............................           14.47          8.74           7.19         7.74         6.81
     Non-accrual and past due loans to total loans           1.35           .98           1.85         2.93         3.11
     Allowance for loan losses to total loans....            1.45          2.71           2.45         2.81         4.24
     Net yield...................................            3.87          4.29           3.69         3.96         4.26
     Net interest margin(2)......................            5.09          5.25           4.54         4.93         4.37

</TABLE>

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


(1)      At December 31, 1998, the Bank had available  approximately $139,000 of
         an operating  loss  carryforward  which could be offset  against future
         income.

(2)      Net interest  margin is  calculated as net interest  income  divided by
         average  earning  assets  and  represents  the  Bank's net yield on its
         earning assets.


                                       16

<PAGE>



         Management's Discussion and Analysis of Financial Condition and
                              Results of Operations

         The following discussion is intended to assist readers in understanding
and evaluating the financial  condition and results of operations of the Company
and the  Bank.  This  review  should  be read in  conjunction  with the  audited
financial  statements and accompanying notes. This analysis provides an overview
of the significant changes that occurred during the periods presented.

Results of Operations

         The Bank' s operating  results  depend  primarily upon its net interest
income,  the  difference  between the  interest  earned on its  interest-bearing
assets   (loans  and   investment   securities)   and  the   interest   paid  on
interest-bearing  liabilities  (deposits).  Operating  results are significantly
affected by provisions  for loan losses,  other income and  operating  expenses.
Each of these factors is significantly affected not only by the Bank's policies,
to varying  degrees,  but general  economic and  competitive  conditions  and by
policies of state and federal regulatory authorities.

Comparison of Financial Condition at December 31, 1998 and 1997

         The  management  team  has  been  concentrating  on a  growth  oriented
strategy  designed  to  enhance  the  Company's  franchise  value and  operating
profitability  by  increasing  the size and  quality of the Bank's  assets.  The
Company has also tried to improve long term  profitability by strengthening  the
quality of the Bank's loan portfolio. As a result of this strategy, total assets
increased  $19.3  million,  or 42.5%,  from $45.4 at December  31, 1997 to $64.7
million at December 31, 1998.

         Loans  increased  by $6.4  million  during  1998 from $22.8  million at
December  31, 1997 to $29.1  million at December  31,  1998.  This  increase was
primarily  due to  increased  loan  demand due to the  favorable  interest  rate
environment  in 1998.  The proceeds of the Offering  also  increased the Bank' s
legal lending limit, permitting the Bank to originate a higher volume of loans.

          Securities  increased by $7.8  million from $12.0  million at December
31, 1997 to $19.8 million on December 31, 1998.  This increase is due in part to
the receipt by the Bank of $4.1 million in net proceeds from the Offering  which
closed on May 18, 1998. In addition, Fed Funds sold increased $950,000 from $7.6
million at December 31, 1997 to $8,5 million at December 31, 1998. This shift in
assets was the result of the Bank's increase in deposits over 1997.

         Stockholders' equity at December 31, 1998 was $8.9 million, as compared
to $4.7 million on December 31, 1997. The increase in  stockholders'  equity was
due to net income for the year of $133,000 and to the sale of 805,000  shares of
common  stock at $5.50 per share in the  Offering  which  increased  capital and
surplus by $4.1 million.  Book value per share increased from $3.18 per share on
December 31, 1997 to $3.89 per share on December 31, 1998.

         Total deposits increased 31.6%, from $40.6 million at December 31, 1997
to $53.4  million  at  December  31,  1998.  Of the $12.8  million  increase  in
deposits,  $8.0  million were  deposits  that came into the Bank on the last two
days of 1998 into  attorneys  escrow  account  and the left the Bank within next
fifteen days.

         The  Company's  return on  average  assets  was 0.26% and its return on
average  equity  was 1.79% in fiscal  year 1998.  The  Bank's  return on average
assets  was 1.33% and its return on  average  equity  was 15.24% in fiscal  year
1997.

         The  Bank  is  required  to  meet  certain   capital   requirements  as
established  by the Federal  Reserve  Board.  At December 31, 1998 and 1997, the
Bank met all capital adequacy requirements to which it was subject.

                                       17

<PAGE>



Results of Operations for the Years Ended December 31, 1998 and 1997

         Net Income.  Net income for the year ended  December 31, 1998 decreased
$437,000  to  $133,000,  or $0.07  basic  earnings  per share  ($0.07 per share,
assuming  dilution),  from net income of $570,000,  or $0.45 basic  earnings per
share ($0.44 per share, assuming dilution) for the year ended December 31, 1997.
The  decrease  in net income was  primarily  due to loan loss from a  bankruptcy
during the third quarter totaling $141,456,  an increase in stockholder expenses
of $89,944 incurred in connection with the formation of the holding company,  an
increase  in legal fees of  $175,000  incurred  in  defending  lawsuits  and the
$25,000  settlement  of a lawsuit  plus the $25,000  loss due to a robbery.  The
expenses  associated with the formation of the holding  company,  the opening of
the  CountrySide  branch in Sterling,  Virginia,  and the legal fees incurred in
connection with the settlement of a lawsuit are  nonrecurring  items and are not
expected to have an impact on the long-term profitability of the Bank.

         Interest Income.  The major component of the Bank's net earnings is net
interest  income,  which is the excess of  interest  income on  interest-earning
assets over the interest expense on interest-bearing  liabilities.  Net interest
income is affected by changes in volume resulting from growth and alterations of
the  balance  sheet  composition  as  well as  fluctuations  in  interest  rates
("interest rate spread") and maturities of sources and uses of funds. The Bank's
management  seeks to maximize net interest  income by managing the balance sheet
and  determining  the optimal  product mix with  respect to yields on assets and
costs of funds in light of projected economic  conditions,  while maintaining an
acceptable level of risk.

         Interest  income  totaled $3.7 million for the year ended  December 31,
1998,  an increase of  $509,000 or 15.6% from $3.2  million  from the year ended
December  31,  1997.  The  increase  in  interest  income  was due to a $108,000
increase  in  interest  on federal  funds sold and an  increase  of  $302,000 on
securities held for investment.  Loan interest income also increased by $99,000.
The increase in interest on securities held for investment was the result of the
Bank  investing  the funds  received  from the sale of stock in the  Offering in
investment  bonds.  The  increase  in Fed Funds  interest  was the result of the
increase in deposits. The increase in interest income on loans was the result of
an  increase in the loan  portfolio,  due to the ability of the Bank to increase
its legal  lending  limit as a result of proceeds  received in the  Offering and
favorable interest rates in fiscal 1998.

         Interest Expense. Total interest expense increased $162,000, or 14.55%,
from $1.1  million for the year ended  December 31, 1997 to $1.3 million for the
year ended  December  31, 1998.  This  increase  was  primarily  due to the $3.1
million  increase in the average balance of  interest-bearing  liabilities  from
$30.2 million for the year ended December 31, 1997 to $33.3 million for the year
ended December 31, 1998.

         Net Interest Income. Net interest income increased by $349,000 or 16.3%
from $2.1  million for the year ended  December 31, 1997 to $2.5 million for the
year ended December 31, 1998.

         The Bank's net  interest  margin (net  interest  income  expressed as a
percentage of total average  interest-earning assets) decreased to 5.09% for the
year ended  December 31, 1998 compared to 5.25% for the year ended  December 31,
1997. The Bank's net yield (the average yield earned on interest-earning  assets
less the average rate incurred on  interest-bearing  liabilities)  was 4.69% and
4.29% for the years ended December 31, 1998 and 1997, respectively.

         Provision for Losses.  The provision for loan losses for the year ended
December 31, 1998 was $117,000 as compared to $3,825 for the year ended December
31,  1997.  This  increase  was  due to  loss  on a loan  in  connection  with a
bankruptcy.

         Management  believes  that  the  provision  for  loan  losses  and  the
allowance for loan losses are  reasonable and adequate to cover any known losses
and any losses  reasonably  expected  in the loan  portfolio.  While  management
estimates loan losses using the best available information,  no assurance can be
made that future additions to the allowance will not be necessary.

                                       18

<PAGE>




         Noninterest  Income.  Noninterest  income consists primarily of service
charges and fees associated with the Bank's loan and savings  accounts and gains
on the sale of  securities.  Noninterest  income for the year ended December 31,
1998 was  $137,000,  representing  a decrease  of $44,000  from the  noninterest
income of $181,000  for the year ended  December  31,  1997.  This  decrease was
caused  primarily  by a  $47,000  decrease  in gains  on the sale of  government
securities.

         Noninterest   Expense.   Noninterest   expense  consists  primarily  of
operating  expenses for compensation and related  benefits,  occupancy,  federal
insurance premiums and operating assessments, and equipment expenses.

         Noninterest  expense increased  $585,000 or 31.9% from $1.8 million for
the year ended December 31, 1997 to $2.4 million for the year ended December 31,
1998.  This  increase  was due in part to an increase in salaries  and  employee
benefits  expense of $121,000 or 12.7% from $953,000 for the year ended December
31, 1997 to $1,074,000  for the year ended  December 31, 1998.  Other  operating
expenses  increased  by $489,000 or 84.3% from  $580,000 to  $1,069,000  for the
years ended December 31, 1997 and 1998,  respectively.  This increase was due to
settlement  of a lawsuit of $108,800,  loss on a bankruptcy  of $141,456,  legal
fees of $175,732 incurred in defending a lawsuit,  expenses  associated with the
formation of the holding company of $89,944 and the $25,000 loss in a robbery.

         Income  Taxes.  The Bank had an income tax  benefit of $41,000  for the
year ended  December  31,  1998  compared  to a benefit  of $85,000 in 1997.  At
December 31, 1998, the Bank has operating loss  carryforwards  of  approximately
$139,000 that may be offset against future taxable  income.  The Bank expects to
use its net  operating  loss  carryforward  in its entirety by the end of fiscal
year 1999.

Results of Operations for the Years Ended December 31, 1997 and 1996

        Net Income.  Net income for the year ended  December 31, 1997  increased
$168,000  to  $571,000,  or $0.45  basic  earnings  per share  ($0.44 per share,
assuming  dilution),  from net income of $403,000,  or $0.32 basic  earnings per
share ($0.32 per share, assuming dilution) for the year ended December 31, 1996.
The  increase in net income is  primarily  due to an increase of $136,000 in net
interest  income to $2.1 million for the year ended  December 31, 1997 from $2.0
million for the year ended December 31, 1996.

         Interest Income.  The major component of the Bank's net earnings is net
interest  income,  which is the excess of  interest  income on  interest-earning
assets over the interest expense on interest-bearing  liabilities.  Net interest
income is affected by changes in volume resulting from growth and alterations of
the  balance  sheet  composition  as  well as  fluctuations  in  interest  rates
("interest rate spread") and maturities of sources and uses of funds. The Bank's
management  seeks to maximize net interest  income by managing the balance sheet
and  determining  the optimal  product mix with  respect to yields on assets and
costs of funds in light of projected economic  conditions,  while maintaining an
acceptable level of risk.

         Interest  income  totaled $3.3 million for the year ended  December 31,
1997,  a decrease  of  $164,000  or 4.8% from $3.4  million  from the year ended
December  31,  1996.  This  decrease  in  interest  income was due to a $121,000
decrease in interest on federal funds sold with lower yields on loans.  Interest
on federal funds sold decreased  because of the decrease in deposits,  resulting
in less federal funds available to sell. The decrease in interest income is also
due in part to a decrease in the loan portfolio which resulted from management's
policy to improve the overall  quality of the Bank's loan  portfolio.  Net loans
decreased by $1.8 million or 7.4% from December 31, 1996 to December 31, 1997.

         Interest Expense.  Total interest expense decreased $300,000, or 21.3%,
from $1.4  million for the year ended  December 31, 1996 to $1.1 million for the
year ended  December  31, 1997.  This  decrease  was  primarily  due to the $4.6
million  decrease in the average balance of  interest-bearing  liabilities  from
$34.8 million for the year ended December 31, 1996 to $30.2 million for the year
ended December 31, 1997. The

                                       19

<PAGE>



decrease   also   resulted   from  a  decrease  in  the  average  rate  paid  on
interest-bearing  liabilities  from 4.05% to 3.68% due to a management  decision
not to renew Certificates of Deposit at higher rates previously offered.

         Net Interest Income.  Net interest income increased by $136,000 or 6.8%
from $2.0  million for the year ended  December 31, 1996 to $2.1 million for the
year ended December 31, 1997.

         The Bank's net  interest  margin (net  interest  income  expressed as a
percentage of total average  interest-earning assets) increased to 5.25% for the
year ended  December 31, 1997 compared to 4.54% for the year ended  December 31,
1996. The Bank's net yield (the average yield earned on interest-earning  assets
less the average rate incurred on  interest-bearing  liabilities)  was 4.29% and
3.69% for the years ended December 31, 1997 and December 31, 1996, respectively.

         Provision for Losses.  The provision for loan losses for the year ended
December  31, 1997 was $3,825 as compared to $0 for the year ended  December 31,
1996.

         Management  believes  that  the  provision  for  loan  losses  and  the
allowance for loan losses are  reasonable and adequate to cover any known losses
and any losses  reasonably  expected  in the loan  portfolio.  While  management
estimates loan losses using the best available information,  no assurance can be
made that future additions to the allowance will not be necessary.

         Noninterest Income.  Noninterest income for the year ended December 31,
1997 was  $181,000,  representing  an increase of $62,000  from the  noninterest
income of $119,000  for the year ended  December  31,  1996.  This  increase was
caused  primarily  by an increase  in service  charges on deposit  accounts  and
$47,000 representing gains on the sale of government securities during 1997.

         Noninterest   Expense.   Noninterest   expense  consists  primarily  of
operating  expenses for compensation and related  benefits,  occupancy,  federal
insurance premiums and operating assessments, and equipment expenses.

         Noninterest  expense  increased  $111,000 or 6.5% from $1.7 million for
the year ended December 31, 1996 to $1.8 million for the year ended December 31,
1997.  This  increase  was due in part to an increase in salaries  and  employee
benefits  expense of $54,000 or 6.1% from  $899,000 for the year ended  December
31, 1996 to $953,000  for the year ended  December  31,  1997.  Other  operating
expenses  increased by $60,000 or 11.5% from  $520,000 to $580,000 for the years
ended  December  31, 1996 and 1997,  respectively.  This  increase  was due to a
normal increase in data processing  service contract charges of $8,000 from 1996
to 1997;  increases in stationery and supply expense of $17,000 primarily due to
additional  printing  expenses for brochures for the loan  department  and other
printing costs; and increases due to advertising  expense increasing $8,000, the
payment of  directors'  fees of $19,000 in 1997,  and an  increase  of $5,000 in
charitable contributions by the Bank.

         Income  Taxes.  The Bank had an income tax  benefit of $85,000  for the
year ended  December 31, 1997 and had no income tax liability for the year ended
December  31,  1996.  At  December  31,  1997,   the  Bank  has  operating  loss
carryforwards  of  approximately  $387,000  that may be  offset  against  future
taxable income.  The Bank expects to use its net operating loss  carryforward in
its entirety by the end of fiscal year 1998.

Year 2000 Issues

         For a  discussion  of the Year  2000  problem  see "Year  2000  Issues"
discussion in Item 1 - Business to this Report on Form 10-KSB.

                                       20

<PAGE>



Average Balances, Interest and Average Yields

         The  following  table sets  forth  information  relating  to the Bank's
average  balance sheet and reflects the average yield on assets and average cost
of liabilities for the periods indicated and the average yields earned and rates
paid for the  periods  indicated.  Such yields and costs are derived by dividing
income or expense  by the  average  daily  balances  of assets and  liabilities,
respectively, for the periods presented.

   AVERAGE BALANCES, INTEREST INCOME AND EXPENSES AND AVERAGE YIELDS AND RATES
                             (Dollars in thousands)

<TABLE>
<CAPTION>

                                                                        Years ended December 31,
                                   -------------------------------------------------------------------------------------------------
                                               1998                            1997                                1996
                                   ------------------------------   -----------------------------    -------------------------------
                                              Interest    Average              Interest    Average              Interest    Average
                                   Average    Income/     Yield/    Average    Income/     Yield/    Average    Income/     Yield/
                                   Balance    Expense     Rate      Balance    Expense     Rate      Balance    Expense     Rate
                                   ---------  --------    -------   --------   -------     -------   --------   --------    -------
<S>                                <C>        <C>         <C>       <C>        <C>         <C>       <C>        <C>         <C>

EARNING ASSETS:
Loans receivable(1)..............  $  25,978   $ 2,386      9.18%   $ 24,533   $ 2,286      9.32%   $  24,458  $  2,322      9.49%
Investment securities, taxable...     18,208     1,118      6.14      13,432       816      6.08       14,597       823      5.64
Federal funds sold...............      4,830       262      5.42       2,867       154      5.37        5,148       275      5.34
                                    --------  --------              --------   -------               --------   -------
   Total earning assets..........     49,016     3,766      7.68      40,832     3,256      7.97       44,203     3,420      7.74
                                    --------  --------              --------   -------               --------   -------

NON-EARNING ASSETS:
Cash and due from banks..........      1,691                           1,649                            1,891
Other assets                             802                             414                              444
                                    --------                        --------                           ------
Total non-earning assets.........      2,493                           2,063                            2,335
                                    --------                        --------                         --------
   Total assets..................  $  51,509                        $ 42,895                        $  46,538
                                    ========                        ========                        =========

INTEREST-BEARING LIABILITIES:
Deposits:
   Interest-bearing demand (NOW)
    deposits.....................      5,696       133      2.33    $  5,073       113      2.23    $   5,495       119      2.17
   Money market deposits.........     10,875       363      3.34      10,377       330      3.19       10,535       335      3.18
   Savings deposits..............      3,298        97      2.94       3,369        99      2.94        3,259        97      2.98
   Time deposits.................     12,424       640      5.15      11,196       561      5.01       15,511       860      5.54
   Repurchase agreements  .......      1,069        39      3.65         159         7      4.40            -         -         -
                                    --------  --------   -------   ---------   -------     -----    ---------   -------    ------
      Total interest-bearing
       liabilities ..............     33,362     1,272      3.81      30,174     1,111      3.68       34,800     1,411      4.05
                                    --------  --------   -------    --------   -------     -----    ---------   -------    ------

NON-INTEREST-BEARING
   LIABILITIES:
Demand deposits..................     10,546                           8,829                            8,222
Other liabilities................        149                             145                              172
                                    --------                        --------                        ---------
   Total non-interest-bearing
    liabilities .................     10,695                           8,974                            8,394
                                    --------                        --------                        ---------
Stockholders' equity.............      7,452                           3,747                            3,344
                                    --------                        --------                        ---------
   Total liabilities and
      stockholders' equity.......  $  51,509                        $ 42,895                        $  46,538
                                    ========                        ========                        =========
Interest spread..................                           3.87                            4.29                             3.69
Net interest margin..............              $ 2,494      5.09%              $ 2,145      5.25%              $  2,009      4.54%
                                               ========                         ======                         ========
</TABLE>

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


(1)  Non-accrual  loan  balances  are  included  in the  calculation  of average
balances.



                                       21

<PAGE>



Rate/Volume Analysis

         The following table sets forth certain information regarding changes in
interest income and interest expense of the Bank for the periods indicated.  For
each  category  of  interest-earning   asset  and  interest-bearing   liability,
information  is  provided  on changes  attributable  to:  (i)  changes in volume
(changes in volume multiplied by old rate); and (ii) changes in rates (change in
rate  multiplied  by old  volume).  Changes  in  rate-volume  (changes  in  rate
multiplied by the changes in volume) are allocated  between  changes in rate and
changes in volume.

                            RATE AND VOLUME ANALYSIS
                             (Dollars in thousands)


<TABLE>
<CAPTION>

                                                         Year Ended                            Year Ended
                                                     December 31, 1998                     December 31, 1997
                                                        Compared To                           Compared To
                                                     December 31, 1997                     December 31, 1996
                                                 Increase (Decrease) Due to            Increase (Decrease) Due to
                                           ------------------------------------------------------------------------------

                                               Rate        Volume       Total        Rate        Volume       Total
                                           ------------------------------------------------------------------------------
<S>                                            <C>         <C>          <C>         <C>         <C>           <C>

INTEREST EARNED ON:
Loans receivable, net......................     $(34)      $  134       $  100      $ (43)      $   7      $  (36)
Investment securities, taxable.............        8          294          302        304        (311)         (7)
Federal funds sold.........................        1          107          108          2        (123)       (121)
                                                -----       ------       ------      -----       -----      ------
     Total interest income                       (25)         535          510        263        (427)       (164)
                                                -----       ------       ------      -----       -----      ------
INTEREST PAID ON:
Interest-bearing (NOW) deposits............        5           15           20          3          (9)         (6)
Money market deposits......................       16           17           33          1          (5)         (4)
Savings deposits...........................        -           (2)          (2)        (1)          3           2
Time deposits..............................       15           63           78        (77)       (222)       (299)
 Federal funds purchased...................        -           32           32          -           7           7
                                                -----        -----        -----      -----       -----      ------
     Total interest expense................       36          125          161        (74)       (226)       (300)
                                                -----       ------       ------      -----       -----      ------
        Net interest income................     $(61)      $  410       $  349      $ 337       $(201)     $  136
                                                =====       ======       ======      =====       =====      ======
</TABLE>

Interest Rate Sensitivity

         An important  element of both  earnings  performance  and  liquidity is
management of interest rate sensitivity.  Interest rate sensitivity reflects the
potential  effect on net interest  income of a movement in interest  rates.  The
difference between the Bank's  interest-sensitive  assets and interest-sensitive
liabilities  for a  specified  time frame is  referred  to as "gap." A financial
institution is considered to be asset-sensitive,  or having a positive gap, when
the amount of its  earning  assets  maturing  or  repricing  within a given time
period exceeds the amount of its  interest-bearing  liabilities also maturing or
repricing  within  that time  period.  Conversely,  a financial  institution  is
considered to be liability-sensitive, or have a negative gap, when the amount of
its  interest-bearing  liabilities  maturing or repricing  within a given period
exceeds the amount of earning assets also maturing or repricing within that time
period.  During a period of rising  interest rates, a positive gap would tend to
increase net interest income, while a negative gap would tend to have an adverse
effect on net interest  income.  During a period of falling  interest  rates,  a
positive gap would tend to have an adverse effect on net interest income,  while
a negative gap would tend to increase net interest income.

         The Bank  evaluates  interest  sensitivity  risk  and  then  formulates
guidelines regarding asset generation and pricing,  funding sources and pricing,
and off-balance sheet  commitments in order to decrease  sensitivity risk. These
guidelines are based upon  management's  outlook  regarding future interest rate
movements,  the state of the regional and national  economy and other  financial
and  business  risk  factors.  The Bank uses a static  gap model and a  computer
simulation to measure the effect on net interest income of various interest rate
scenarios over selected time periods. The gap can be managed by repricing assets
or  liabilities,  selling  investments  held  for  sale,  replacing  an asset or
liability prior to maturity or adjusting the interest rate during

                                       22

<PAGE>



the life of an asset or liability. Matching the amount of assets and liabilities
repricing  during the same time  interval  helps to reduce the risk and minimize
the impact on net  interest  income in  periods  of rising or  falling  interest
rates.

         As of December 31, 1998, the Bank's static  one-year  cumulative gap to
total  interest-sensitive  assets position was a positive 7.4% and the Bank was,
therefore, in a asset-sensitive position. It is the Bank's policy to control the
mix and rate  sensitivity of assets and liabilities  such that the revolving gap
(the gap is less than one year) will never exceed 10%  (positive or negative) of
assets.

         The following table  illustrates the interest  sensitivity gap position
of the Bank as of December 31, 1998 (focusing only on repricing  schedules,  not
fixed versus variable rates).  This table presents a position as of a particular
day, which position changes continually and is not necessarily indicative of the
Bank's position at any other time.

                          INTEREST SENSITIVITY ANALYSIS

                                December 31, 1998
                             (Dollars in thousands)

<TABLE>
<CAPTION>



                                                                      Maturing or Repricing In:
                                                       -------------------------------------------------

                                                          3 Months      4-12       1 to 5     More than
                                                           or Less     Months       Years      5 Years     Total
                                                       ------------  ----------   --------   ----------- ---------
<S>                                                    <C>            <C>           <C>         <C>           <C>

Interest-sensitive Assets:
     Loans (1).....................................     $  12,525     $  6,509    $  8,663     $ 1,518   $  29,215
     Securities....................................           500        3,200      15,359         500      19,824
     Federal funds sold............................         8,550            -           -           -       8,550
                                                        ---------    ---------    --------    --------    --------
         Total interest-sensitive assets...........        21,575        9,709      24,022       2,018      57,324
                                                        =========    =========    ========    ========    ========
Interest-sensitive Liabilities:
     Certificates of deposit > $100,000............         1,393        2,099       2,847           -       6,339
     Certificates of deposit (greater than) $100,000        1,320        3,945       3,719           -       8,984
     Super NOW accounts/Money Market deposit
         accounts(2)...............................        17,761            -           -           -      17,761
                                                        ---------    ---------    --------    --------    --------
         Total interest-sensitive liabilities......        20,474        6,044       6,566           -      33,084
                                                        =========    =========    ========    ========    ========

Period gap.........................................     $   1,101     $  3,665   $   17,456    $ 2,018   $  24,240

Cumulative gap.....................................     $   1,101     $  4,766   $   22,222    $24,240           -

Ratio of cumulative interest-
     sensitive liabilities to interest-sensitive asset       94.9%        84.8%        59.8%      37.7%          -
                                                         ========    =========    =========    =======
</TABLE>


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

(1)   Excludes non-accrual loans.
(2)   Non-certificate deposit accounts are shown as repricing within the 3 month
      or less  timeframe,  although  the  Bank  believes,  based  on  historical
      experience, that such deposits are less interest sensitive.


                         ANALYSIS OF FINANCIAL CONDITION

Loan Portfolio

         The loan portfolio is the largest category of the Bank's earning assets
and is comprised of commercial real estate loans,  commercial loans, home equity
loans,  construction  loans,  consumer loans and participation  loans with other
financial  institutions.  The  primary  markets  in which the Bank  makes  loans
include the town of McLean,  Virginia and Fairfax County,  Virginia.  The mix of
the  loan  portfolio  is  weighted  toward  loans  secured  by real  estate  and
commercial   loans.   In   management's   opinion,   there  are  no  significant
concentrations   of  credit  with  particular   borrowers   engaged  in  similar
activities.


                                       23

<PAGE>



         Net loans  consist of total loans minus the  allowance for loan losses,
unearned  discounts . The Bank's net loans were $29.2  million at  December  31,
1998,  representing a 28.3% increase over net loans of $22.8 million at December
31, 1997. Loan volume  increased in 1998 due to the Banks ability to make larger
loans  because of the increase in Bank's legal  lending limit as a result of the
Offering.  Net loans  decreased 7.4% in 1997, from a balance of $24.6 million at
December 31, 1996. The average balance of total loans as a percentage of average
earning  assets was 53.0% for December 31, 1998,  down from 60.1% for 1997.  The
average  balance of total loans as a percentage of average  earnings  assets was
55.3% for 1996.

         In the normal course of business, the Bank makes various commitments to
meet  the  financing  needs  of its  customers  and  incurs  certain  contingent
liabilities  , including  standby  letters of credit and  commitments  to extend
credit. At December 31, 1998,  commitments for standby letters of credit totaled
$181,000 and commitments to extend credit totaled $8.7 million.  Commitments for
standby  letters of credit  totaled  $191,000  and  $274,000 for the years ended
December 31, 1997 and 1996,  respectively.  Commitments to extend credit totaled
$6.7  million and $5.2  million for the years ended  December 31, 1997 and 1996,
respectively.

         The  following  table  summarizes  the  composition  of the Bank's loan
portfolio at the periods indicated:

                                 LOAN PORTFOLIO
                             (Dollars in thousands)

<TABLE>
<CAPTION>



                                                              December 31,
                       ------------------------------------------------------------------------------------------------
                               1998                1997               1996               1995               1994
                       ------------------- ------------------  -----------------  ------------------  -----------------
                        Amount    Percent   Amount    Percent   Amount   Percent   Amount    Percent   Amount   Percent
<S>                    <C>        <C>       <C>       <C>       <C>      <C>       <C>       <C>       <C>      <C>

Real estate:
    Mortgage.......    $ 24,077    77.5%   $17,532     75.0%   $19,524    77.5%   $18,735     76.9%   $21,219    77.4%
    Construction...         441     1.5        448      1.9        633     2.5        147      0.6        305     1.1
Commercial.........       3,786    14.5      4,191     17.9      4,210    16.7      4,526     18.6      4,851    17.7
Consumer...........       1,306     6.5      1,219      5.2        835     3.3        938      3.9      1,051     3.8
                       ----------  ----  ---------  -------  ---------  ------ ---------- --------  ---------- ------
Loans, gross.......      29,610     100%    23,390      100%    25,202    100.%    24,346     100.%    27,426     100%
                       ----------  ----  ---------  -------  ---------  ------ ---------- --------  ---------- ------
Less: allowance for
    loan losses....        (429)              (634)               (617)              (685)             (1,164)
                       --------            -------             -------            -------             -------
Loans, net.........    $ 29,181            $22,756             $24,585            $23,661             $26,262
                       ========            =======             =======            =======             =======

</TABLE>

         The following table sets forth certain  information with respect to the
Bank's  non-accrual,  restructured  and past due  loans,  as well as  foreclosed
assets, for the periods indicated.

                              NON-PERFORMING ASSETS
                             (Dollars in thousands)

<TABLE>
<CAPTION>

                                                                           Years Ended December 31,
                                                              ----------------------------------------------------

                                                                 1998       1997       1996       1995       1994
                                                              ----------------------------------------------------
<S>                                                           <C>          <C>         <C>        <C>        <C>


Non-accrual loans.........................................    $   395        222        465        445        594
Real estate owned.........................................        263        263        263        300        500
                                                              ----------------------------------------------------
    Total non-performing loans............................        658        485        728        745      1,094
                                                              ----------------------------------------------------
Loans past due 90 or more days accruing interest..........          -          7          -        268        260
Non-performing loans to total loans, at period end........        1.3%       0.9%       1.8%       1.8%       2.2%
Non-performing assets to period end assets................        1.0%       1.1%       1.6%       1.6%       2.6%
Non-performing assets: total loans
    and other real estate owned...........................        2.2%       2.1%       2.9%       3.0%       3.9%

</TABLE>

                                       24

<PAGE>



         The amount of  interest  on  non-accrual  loans  which  would have been
recorded  as income  under the  original  terms of such loans was  approximately
$32.800,  $34,300,  and $10,800 for the years ended December 31, 1998,  1997 and
1996, respectively.  Loans are placed on non-accrual when a loan is specifically
determined  to be impaired or when  principal or interest is  delinquent  for 90
days or more.

         In addition to the  nonaccrual  loans,  past due loans,  and other real
estate owned listed above, loans totaling $2.5 million or 8.4% of total loans at
December 31, 1998 were either  internally  classified  or  specially  mentioned,
require more than normal  attention,  and are  potential  problem  loans.  These
potential  problem  loans  represent an decrease  from $3.6 million of potential
problem  loans,  or 15.4% of total loans,  at December 31, 1997. The decrease is
related primarily to the Bank's efforts to improve loan quality.

    The Real  Estate  Owned of $263,000  in 1998  consists of a single  piece of
industrial property located in Loudoun County, Virginia which the Bank currently
has for sale.

Loan Maturity

    The following table shows the contractual maturity at December 31, 1998. The
table reflects the entire unpaid  principal  balance in the maturity period that
includes the final loan payment date and,  accordingly,  does not give effect to
periodic principal repayments or possible prepayments.

<TABLE>
<CAPTION>

                     MATURITY AND RATE SENSITIVITY OF LOANS
                             (Dollars in thousands)

                                                                  At December 31, 1998
                                 -----------------------------------------------------------------------------------
                                  One Year               Over One Year
                                   or Less            Through Five Years                     Over Five Years
                                  -------      ---------------------------------     -------------------------------
<S>                               <C>           <C>               <C>                <C>              <C>
                                               Fixed Rate        Floating Rate       Fixed Rate      Floating Rate
                                               ----------        -------------       ----------      --------------
Commercial                        $2,108         $793                $  753            $132              $  -
Real estate-construction             441           -                   -                 -                  -
                                  ------         ----                ------            ----              ----
                                  $2,549         $793                $  753            $132              $  -
                                  ======         ====                =======           ====              ====

</TABLE>

Allowance for Loan Losses

         In originating  loans,  the Bank  recognizes that credit losses will be
experienced  and the risk of loss will vary with,  among other  things,  general
economic  conditions,  the type of loan being made, the  creditworthiness of the
borrower  over the term of the loan and, in the case of a  collateralized  loan,
the quality of the collateral for such loan. The Bank maintains an allowance for
loan losses  based  upon,  among other  things,  such  factors as changes in the
character  and size of the loan  portfolio and related loan loss  experience,  a
review and  examination of overall loan quality which includes the assessment of
problem  loans,  the  amount  of  non-performing  assets,  regulatory  policies,
generally accepted accounting principles, general economic conditions, and other
factors  related to the  collectability  of loans in the Bank's  portfolios.  In
addition  to  unallocated  allowances,  specific  allowances  are  provided  for
individual  loans  when  ultimate  collection  is  considered   questionable  by
management  after reviewing the current status of loans which are  contractually
past due and after  considering  the net realizable  value of any collateral for
the loan.

         Management  actively  monitors the Bank's asset quality in a continuing
effort to charge-off  loans against the allowance for loan losses and to provide
specific loss allowances when necessary.  Although  management  believes it uses
the best  information  available  to make  determinations  with  respect  to the
allowance  for loan  losses,  future  adjustments  may be  necessary if economic
conditions   differ   from  the   assumptions   used  in  making   the   initial
determinations.  The Bank's allowance for loan losses was $429,000,  or 1.45% of
total loans, as of December 31, 1998,  $634,000,  or 2.71% of total loans, as of
December  31, 1997 and  $617,000,  or 2.45% of total  loans,  as of December 31,
1996.


                                       25

<PAGE>



         Management believes the allowance is adequate to absorb losses inherent
in the loan  portfolio.  The Bank expects that its  allowance for loan losses is
adequate and that with the expected increases in the Bank's loan portfolio,  the
allowance for loan losses  remains  adequate.  The Bank expects to grow its loan
portfolio and believes it has adequate reserves in the allowance for loan losses
to mirror the growth in the loan portfolio.

         In view of the Bank's plans for  expansion  and  possible  loan growth,
management will continue to closely monitor the performance of its portfolio and
make additional provisions as necessary.  The Bank does not presently anticipate
that such provisions  will have a material  adverse impact on the Bank's results
of operations in future periods.

         An analysis of the  allowance  for loan  losses,  including  charge-off
activity, is presented below:

                            ALLOWANCE FOR LOAN LOSSES
                             (Dollars in thousands)
<TABLE>
<CAPTION>

                                                                             Years Ended December 31,
                                                    ------------------------------------------------------------------
                                                       1998          1997         1996           1995         1994
                                                    ----------    ----------   ----------    -----------   -----------
<S>                                                 <C>           <C>          <C>           <C>           <C>

Allowance for loan losses:
Balance at beginning of year..................      $   634         $   617       $   685       $   1,164     $   959
Charge-offs:
     Commercial................................         332               8            70             360          85
     Real estate...............................           -              50            34             158         234
     Consumer..................................           7               3             5               2           5
                                                    -------         -------       -------       ---------     -------
         Total loans charged off...............         339              61           109             520         324
                                                    -------         -------       -------       ---------     -------
Recoveries:
     Commercial................................          13              60            15            32            35
     Real estate...............................           -              14            26            96             -
     Consumer..................................           4               -             -             -             6
                                                    -------         -------       -------       ---------     -------
         Total recoveries......................          17              74            41            128           41
                                                    -------         -------       -------       ---------     -------
Net charge-offs (recoveries)...................         322             (13)           68            392          283

Provision for (recovery of)  loan losses.......         117               4             -            (87)         488
                                                    -------         -------       -------       --------      -------

Balance at end of year.........................     $   429         $   634       $   617       $    685      $ 1,164
                                                    =======         =======       =======       ========      =======

Ratio of net charge-offs (recoveries) to
     average loans outstanding................         1.24%           (.05)%         .28%          1.49%        0.95%
Ratio of allowance for loan
     losses to loans at year-end...............        1.45%           2.71%         2.45%          2.81%        4.24%

</TABLE>

                                       26

<PAGE>



             A  breakdown  of the  allowance  for loan losses is provided in the
following  table.  However,  the Bank's  management  does not  believe  that the
allowance  for loan  losses  can be  allocated  by  category  with a  degree  of
precision  that would be useful to  investors.  Because all of these factors are
subject to change,  the allocation of loan losses in the following  table is not
necessarily  predictive of future loan losses in the indicated  categories.  See
Note  1 of the  notes  to  the  financial  statements  for  further  information
regarding the classification of loan losses.

                                      ALLOCATION OF ALLOWANCE FOR LOAN LOSSES
                                              (Dollars in thousands)
<TABLE>
<CAPTION>

                                                                       December 31,
                         ---------------------------------------------------------------------------------------------------------
                                1997                1996                 1995                  1994                  1993
                         -------------------  ------------------- -------------------   -------------------    -------------------
                         Amount   Percent(1)  Amount   Percent(1) Amount   Percent(1)   Amount   Percent(1)    Amount   Percent(1)
                         ------   ----------  ------   ---------- ------   ----------   ------   ----------    ------   ----------
<S>                      <C>      <C>         <C>      <C>        <C>      <C>          <C>      <C>           <C>       <C>
Commercial............    $ 82        14.5%    $109       17.9%    $105       16.7%     $ 88       18.6%       $  456       17.7%
Real Estate
    Mortgage and
    Construction......     334        79.0      502       76.9      492       80.0       560       77.5           656       78.5
Consumer..............      13         6.5       23        5.2       20        3.3        37        3.9            52        3.8
                          ----                 ----                ----                 ----                   ------
Total allowance for
 loan losses...........   $429                 $634                $617                 $ 85                   $1,164
                          ====                 ====                ====                 ====                   ======
</TABLE>

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

(1) Represents percentage of loans in each category to total loans.

Investment Activities

         The Bank is required to maintain an amount of liquid assets appropriate
to its level of net savings withdrawals and current borrowings. It has generally
been the Bank's policy to maintain a liquidity portfolio in excess of regulatory
requirements.  At December  31,  1998,  the Bank's  liquidity  ratio was 53.09%.
Liquidity  levels may be  increased or  decreased  depending  upon the yields on
investment  alternatives,  management's judgment as to the attractiveness of the
yields  then  available  in  relation  to  other   opportunities,   management's
expectations  of the level of yield  that will be  available  in the  future and
management's projections as to the short-term demand for funds to be used in the
Bank's loan origination and other activities.

         Interest  income from  investments  in various  types of liquid  assets
provides a significant  source of revenue for the Bank. The Bank invests in U.S.
Treasury and Federal Agency  securities,  bank certificates of deposits,  equity
securities,  corporate debt securities, taxable municipals and overnight federal
funds. The balance of investment  securities maintained by the Bank in excess of
regulatory   requirements   reflects   management's   historical   objective  of
maintaining  liquidity  at a level that  assures  the  availability  of adequate
funds,  taking into  account  anticipated  cash flows and  available  sources of
credit,  for meeting  withdrawal  requests and loan commitments and making other
investments. See "Liquidity and Capital Resources."

         The  Bank  purchases  securities  through  a  primary  dealer  of  U.S.
Government  obligations or such other securities dealers authorized by the Board
of Directors  and requires  that the  securities  be delivered to a  safekeeping
agent  before  the funds are  transferred  to the  broker  or  dealer.  The Bank
purchases investment  securities pursuant to an investment policy established by
the Board of Directors.

         Investment  securities  are  recorded  on  the  books  of the  Bank  in
accordance  with GAAP.  The Bank does not  purchase  investment  securities  for
trading.  Effective  January  1,  1994,  the  Bank  implemented  SFAS  No.  115.
Available-for-sale  securities are reported at fair value with unrealized  gains
or losses  reported as a separate  component  of net worth,  net of tax effects.
Held-to-maturity  securities are carried at amortized  cost.  Substantially  all
purchases of  investment  securities  conform to the Bank's  interest  rate risk
policy.


                                       27

<PAGE>



         The following table summarizes the carrying value of securities for the
dates indicated:



                              SECURITIES PORTFOLIO
                             (Dollars in thousands)

<TABLE>
<CAPTION>


                                                                                        December 31,
                                                                     -----------------------------------------------

                                                                           1998             1997              1996
                                                                     -----------------------------------------------
<S>                                                                  <C>                  <C>             <C>

AVAILABLE FOR SALE:
     U.S. treasury and other government agencies...................      $   17,333        $   9,828      $   12,854
     State, county and municipal...................................           1,685            1,854             340
     Other.........................................................             806              112              88
                                                                         ----------        ---------      ----------
         Total available for sale..................................          19,824           11,794          13,282
                                                                         ----------        ---------      ----------
HELD TO MATURITY:
     U.S. treasury and other government agencies...................               -              250             500
                                                                         ----------        ---------      ----------
         Total held to maturity....................................           -                  250             500
                                                                         ----------         --------      ----------
     Total securities..............................................      $   19,824        $  12,044      $   13,782
                                                                         ==========        =========      ==========

</TABLE>

                                       28

<PAGE>



         The following table sets forth the maturity  distribution  and weighted
average  yields of the  investment  portfolio at December 31, 1997. The weighted
average  yields are calculated on the basis of the book value of' the investment
portfolio and on the interest income of investments adjusted for amortization of
premium and accretion of discount.

                   INVESTMENT PORTFOLIO - MATURITY AND YIELDS
                             (Dollars in thousands)

<TABLE>
<CAPTION>


                                                     1 Year            1 Year           5 Years           After
                                                     or Less         to 5 Years       to 10 Years        10 Years
                                                --------------------------------------------------------------------
<S>                                              <C>                <C>               <C>                <C>
MATURITY DISTRIBUTION:
U.S. treasury issues............................   $   3,051         $        -       $      -            $     -
U.S. agency issues..............................         500             12,827            995                  -
Municipal issues................................         147              1,535              -                  -
Federal Reserve Bank Stock......................           -                  -              -                265
                                                     -------         ----------       --------            -------
     Total maturity distribution................   $   3,698         $   14,362       $    995            $   265
                                                     =======         ==========       ========            =======

WEIGHTED AVERAGE YIELD:
U.S. treasury issues............................        6.15%                 -              -                  -
U.S. agency issues..............................        5.34%              6.21%          6.21%                 -
Municipal issues................................        6.50%              6.28%             -                  -
Federal Reserve Bank Stock......................           -                  -              -               6.00%
                                                     -------         ----------       --------            -------
     Total......................................        6.00%              6.25%          6.21%              6.00%
                                                     =======         ==========       ========            =======

Total portfolio weighted average yield..........        6.18%
                                                     =======
</TABLE>

Deposits

         The Bank  primarily  uses  deposits  to fund its loans  and  investment
portfolio.  The Bank  offers a variety of deposit  accounts to  individuals  and
small- to medium-sized businesses.  Deposit accounts include checking,  savings,
escrow accounts,  money market and certificates of deposit. Average certificates
of deposit in amounts of $100,000 or more  totaled  $6.3 million at December 31,
1998 and $4.0  million at December  31,  1997.  Many of these  deposits are from
long-standing customers and, therefore, are believed by the Bank's management to
be as stable as, and for all practical  purposes,  no more rate sensitive  than,
core deposits.

         The following table details the average amount of, and the average rate
paid on, the following primary deposit categories for the periods indicated:

                     AVERAGE DEPOSITS AND AVERAGE RATES PAID
                             (Dollars in thousands)

<TABLE>
<CAPTION>


                                                                     Years Ended December 31,
                                             ----------------------------------------------------------------------

                                                      1998                     1997                  1996
                                             ----------------------------------------------------------------------
                                               Average     Average      Average    Average     Average     Average
                                               Balance      Rate        Balance     Rate       Balance      Rate
                                             ---------     -------      -------    -------    --------     --------
<S>                                           <C>          <C>           <C>       <C>         <C>          <C>
Interest-bearing deposits:
    NOW accounts............................  $  5,696      2.33%     $  5,073      2.23%    $  5,495       2.17%
    Money market savings....................    10,875      3.34        10,377      3.19       10,535       3.18
    Regular savings.........................     3,298      2.94         3,369      2.94        3,259       2.98
    Certificates of deposit.................    12,424      5.14        11,196      5.01       15,511       5.54
                                              --------                --------               --------
    Total interest-bearing deposits.........  $ 32,293                  30,015      3.68       34,800       4.05
Non-interest-bearing deposits...............    10,546                   8,829                  8,222
                                              --------                --------               --------
Total deposits..............................  $ 42,839                $ 38,843               $ 43,022
                                              ========                ========               ========
</TABLE>


         The following is a summary of the maturity distribution of certificates
of deposit in amounts of $100,000 or more as of December 31, 1998:

            MATURITIES OF CERTIFICATES OF DEPOSIT OF $100,000 OR MORE
                             (Dollars in thousands)


        Maturity Period                             Amount            Percent
        ---------------                             ------            -------
3 months or less..............................      $1,393             21.98%
Over 3 months to 6 months.....................         475              7.49
Over 6 months to 12 months....................       1,624             25.62
Over 12 months................................       2,847             44.91
                                                    ------            ------
     Total....................................      $6,339            100.00%
                                                    ======            ======

Short-Term Borrowings

         The  Bank  occasionally  finds  it  necessary  to  purchase  funds on a
short-term  basis due to fluctuations  in loan and deposit levels.  The Bank has
several  arrangements under which it may purchase funds. A Repurchase  Agreement
is  maintained  with First  Union  Bank for up to the  market  value of bonds in
safekeeping,  which as of December  31, 1998 was $6.5  million.  For the periods
ended December 31, 1998,  1997 and 1996, the expense for federal funds purchased
totaled approximately $0, $7,000, and $0, respectively.

Capital Requirements

         The determination of capital adequacy depends upon a number of factors,
such  as  asset  quality,  liquidity,   earnings,  growth  trends  and  economic
conditions.  The Bank seeks to  maintain a strong  capital  base to support  its
growth and expansion plans,  provide stability to current operations and promote
public confidence in the Bank.

         Management  believes that the Bank's capital  position,  as of December
31, 1998, exceeds all regulatory  minimums.  The federal banking regulators have
defined three tests for  assessing  the capital  strength and adequacy of banks,
based  on  two  definitions  of  capital.  "Tier  1  Capital"  is  defined  as a
combination  of  common  and  qualifying  preferred  stockholders'  equity  less
goodwill.  "Tier 2 Capital"  is defined as  qualifying  subordinated  debt and a
portion of the allowance for loan losses.  "Total  Capital" is defined as Tier 1
Capital plus Tier 2 Capital.  Three risk-based capital ratios are computed using
the above capital  definitions,  total assets and  risk-weighted  assets and are
measured  against  regulatory  minimums to  ascertain  adequacy.  All assets and
off-balance sheet risk items are grouped into categories  according to degree of
risk and  assigned a risk  weighing  and the  resulting  total is  risk-weighted
assets.  "Tier 1 Risk-based  Capital" is Tier 1 Capital divided by risk-weighted
assets.  "Total  Risk-based  Capital" is Total Capital divided by  risk-weighted
assets.  The Leverage Ratio is Tier 1 Capital  divided by total average  assets.
See "Supervision and Regulation--Capital Requirements."


                                       29

<PAGE>



         The  following  table shows the Bank's  capital  ratios and the minimum
ratios currently required by the Federal Reserve to be well-capitalized:

                                 CAPITAL RATIOS


<TABLE>
<CAPTION>

                                                     December 31,
                                        ---------------------------------------- Regulatory
                                           1998          1997           1996      Minimum
                                        ---------------------------------------- --------
<S>                                      <C>           <C>             <C>        <C>
Tier 1 Risk-based Capital...............  24.5%         17.4%          12.6%          4.0%
Total Risk-based Capital................  25.8          18.6           13.9           8.0
Leverage ratio..........................  13.8          11.0            7.8           4.0
</TABLE>

Liquidity and Capital Resources

         Liquidity  is a measure of the Bank's  ability to  generate  sufficient
cash to meet present and future financial obligations in a timely manner through
either the sale or maturity of existing  assets or the acquisition of additional
funds through liability  management.  These obligations include the credit needs
of customers,  funding deposit withdrawals, and the day-to-day operations of the
Bank. Liquid assets include cash,  interest-bearing deposits with banks, federal
funds  sold,  and  certain  investment  securities.  As a result  of the  Bank's
management  of liquid  assets and the  ability  to  generate  liquidity  through
liability funding, management believes that the Bank maintains overall liquidity
sufficient  to satisfy  its  depositors'  requirements  and meet its  customers'
credit needs.

         As of December 31, 1998,  cash,  federal  funds sold,  held-to-maturity
investment securities maturing within one year and available-for-sale securities
represented  61.23% of  deposits  and other  liabilities,  compared to 52.51% at
December  31,  1997  and  46.93%  at  December   31,  1996.   See  "--  Interest
Sensitivity."  At December 31, 1998,  based upon the Bank's  investment  policy,
approximately  100% of total investment  securities were available for sale, and
were primarily  invested in U.S. Treasury and agency  securities,  with a market
value of approximately $114,000 greater than their book value. See "--Investment
Activities."  Asset liquidity is also provided by managing loan  maturities.  At
December 31, 1998,  approximately  64% or $19.0 million of loans would mature or
reprice within a one-year period.

         The following table summarizes the Bank's liquid assets for the periods
indicated:

                            SUMMARY OF LIQUID ASSETS
                             (Dollars in thousands)
<TABLE>
<CAPTION>


                                                                               December 31,
                                                           ------------------------------------------------
                                                              1998               1997               1996
                                                           ------------------------------------------------
<S>                                                        <C>                <C>                <C>
Cash and due from banks...................................  $ 5,824            $ 1,987            $ 2,879
Federal funds sold........................................    8,550              7,600              3,800
Investment securities(1)...............................           -                  -                  -
Available-for-sale securities, at fair value..............   19,824             11,794             13,282
                                                             ------             ------             ------
Total liquid assets.......................................  $34,198            $21,381            $19,961
                                                            =======            =======            =======
Deposits and other liabilities............................  $55,848            $40,719            $42,532
Ratio of liquid assets to deposits and other liabilities..    61.23%             52.51%             46.93%
</TABLE>

------------------
(1)  Only  held-to-maturity  investment  securities  at  amortized  cost  with a
     maturity of one year or less are considered liquid assets for this table.


                                       30

<PAGE>



Impact of Inflation, Changing Prices and Monetary Policies

         The financial statements and related financial data concerning the Bank
presented  herein  have been  prepared in  accordance  with  generally  accepted
accounting  principles,  which require the measurement of financial position and
operating results in terms of historical dollars without  considering changes in
the relative  purchasing power of money over time due to inflation.  The primary
effect of  inflation  on the  operations  of the Bank is  reflected in increased
operating costs.  Unlike industrial  companies,  virtually all of the assets and
liabilities  of a financial  institution  are  monetary in nature.  As a result,
changes in interest rates have a more significant effect on the performance of a
financial  institution  than do the  effects of changes in the  general  rate of
inflation and changes in prices.  Interest rates do not necessarily  move in the
same  direction or in the same  magnitude  as the prices of goods and  services.
Interest rates are highly sensitive to many factors which are beyond the control
of the Bank, including the influence of domestic and foreign economic conditions
and the  monetary  and  fiscal  policies  of the  U.S.  government  and  federal
agencies, particularly the Federal Reserve.

         The Federal  Reserve  implements  national  monetary  policies  such as
seeking to curb inflation and combat recession by its open market  operations in
U.S. government securities, control of the discount rate applicable to borrowing
by banks, and establishment of reserve requirements  against bank deposits.  The
actions of the  Federal  Reserve  in these  areas  influence  the growth of bank
loans,  investments and deposits, and affect the interest rates charged on loans
and paid on  deposits.  The nature,  timing and impact of any future  changes in
federal  monetary and fiscal  policies on the Bank and its results of operations
are not predictable.

Accounting Matters

                  In  October   1998,   the  FASB  issued   Statement  No.  134,
"Accounting for Mortgage-Backed  Securities Retained after the Securitization of
Mortgage Loans Held for sale by a Mortgage Banking  Enterprise,  an amendment of
FSAB statement No. 65." FSAB  Statement No. 65, as amended,  requires that after
securitization  of a mortgage loan held for sale, an entity  engaged in mortgage
banking activities classify the resulting  mortage-backed  security as a trading
security.  This Statement  futher amends  Statement No, 65 to require that after
the  securitization  of the mortgage  loans held for sale,  an enity  engaged in
mortgage banking activities classify the resulting morgage-backed  securities or
other retained  interests  based on its ability and intent to sell or hold those
investments.  This Statement  conforms the subsequent  accounting for securities
retained  after the  securitization  of  mortgage  loans by a  mortgage  banking
enterprise  with the subsequent  accounting  for  securitits  retained after the
securitization  of other types of assets by a non-mortgage  banking  enterprise.
this Statement is effective beginning in 1999

         In June 1998, the FASB issued SFAS No. 133  "Accounting  for Derivative
Instruments and Hedging  Activities."  Statement No. 133 establishes  accounting
and  reporting  standards  for  derivative  instruments,   including  derivative
instruments  embedded  in  other  contracts  and  for  hedging  activities.  The
Statement is effective for all fiscal  quarters of fiscal years  beginning after
June 15, 1999.

ITEM 7.           FINANCIAL STATEMENTS

         Financial  Statements  are  included as pages F-1 through  F-26 to this
Form 10-KSB.

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

         None.

                                       31

<PAGE>

                                    PART III



ITEM 9.           DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL
                  PERSONS; COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
                  AND PRINCIPAL OFFICERS OF THE COMPANY

Directors

         The following lists the Board of Directors of the Company:

<TABLE>
<CAPTION>


                                                   Term           Position(s) Held             Director
                                  Age(1)         Expires           with the Company            Since(2)
                                  ------         -------          -----------------            --------
<S>                               <C>            <C>              <C>                          <C>
Nominees
--------
Harold E. Lieding                   62             2001                Chairman                  1990
Philip F. Herrick, Jr.              58             2001                Director                  1987
George K. Degnon                    58             2000                Director                  1993
Kevin P. Tighe                      54             2000                Director                  1994
Stanley I. Richards                 62             2001                Director                  1996
Ronald W. Kosh                      53             1999                Director                  1998
George P. Shafran                   72             1999              Vice Chairman               1997
</TABLE>

-------------------
(1) As of December 31, 1998.
(2) Includes terms as a director of The Heritage Bank.

Biographical Information

         Set forth below is certain  information  regarding  the  directors  and
executive officers of the Company. Unless otherwise indicated, each director and
executive officer has held his current position for the last five years.

         George K. Degnon has been a director  of the  Company  since 1998 and a
director of the Bank since  January,  1993.  He is the present  Secretary of the
Board of  Directors  of The  Heritage  Bank.  Mr.  Degnon is president of Degnon
Associates,  Inc. (a company that provides organizational management services to
national and international health and medical associations) in McLean, Virginia.

         Philip F.  Herrick,  Jr. has been a director of the Company  since 1998
and a director  of the Bank  since  1987.  He is the owner of  Herrick  Holdings
(investments and manages real estate) in Northern Virginia.

         Harold E.  Lieding has been a director of the Company  since 1998 and a
director  of the Bank since  1990.  He serves as chairman of the Company and has
served as chairman of the Board of Directors  of The  Heritage  Bank since June,
1993. He is a senior  partner in the law firm of Lieding and Anderson,  P.C., in
McLean,  Virginia,  and has practiced law in McLean since 1970. Mr. Lieding is a
member of the Fairfax Bar Association, the McLean Bar Association and the McLean
Planning & Zoning Committee.

         Stanley I. Richards has been a director of the Company since 1998 and a
director of The Heritage Bank since June, 1996. Mr. Richards is the Chairman and
President of the Richards  Corporation (a company engaged in the manufacture and
sale of imagery  interpretation  equipment)  in Sterling,  Virginia.  He is also
Chairman  and CEO of the TIA  Electric  Corporation  (a  company  engaged in the
manufacture  and sale of gallery  insert  equipment  for  aircraft) in Sterling,
Virginia.


                                       32

<PAGE>



         Kevin P.  Tighe has been a  director  of the  Company  since 1998 and a
director of the Bank since September, 1994. He is senior partner in the law firm
of Tighe, Patton, Tabackman and Babbin in Washington, D.C. Mr. Tighe is also the
owner and Chairman of the Board of the McLean Racquet and Health Club in McLean,
Virginia.

         George P.  Shafran has been a director of the Company  since 1998 and a
director of The Heritage Bank since June,  1997. He is the present Vice Chairman
of the Board of  Directors  of The  Heritage  Bank.  Mr.  Shafran  is a business
consultant  to a number  of  varied  clients.  He is also  involved  in  several
partnerships and is the chairman of the AAA  Mid-Atlantic  Advisory Board. He is
president of Geo. P. Shafran &  Associates,  Inc., a consulting  firm in McLean,
Virginia.

         Ronald W. Kosh has been a  director  of the  Company  since  1998 and a
director of The Heritage Bank since  February,  1998.  He is Vice  President and
Division  manager of AAA  MidAtlantic,  Inc.,  Fairfax,  Virginia.  Mr. Kosh was
General Manager of the American Automobile Association, Inc., Fairfax, Virginia,
from 1985 to 1997.

Executive Officers

         The following individual is an executive officer of the Company and The
Heritage Bank and holds the offices set forth below opposite his name.

Name                          Position(s) Held With the company and the Bank

William B. Sutphin            Secretary, Heritage Bancorp, Inc.
                              Senior Vice President/Chief Financial Officer,
                              The Heritage Bank

         William  B.  Sutphin,  64, has been the Senior  Vice  President  of The
Heritage Bank in charge of operations since 1987. Mr. Sutphin also serves as the
principal  accounting  officer.  Mr.  Sutphin  was Vice  President  in charge of
operations  and accounting of the McLean Bank from 1981 to 1987 and has 43 years
banking  experience.  Mr.  Sutphin  is the  present  Secretary  of the  Board of
Directors of Heritage Bancorp, Inc.

         The executive officers of the Company and the Bank are elected annually
and hold  office  until  their  respective  successors  have  been  elected  and
qualified or until  death,  resignation,  retirement  or removal by the board of
directors.


                                       33

<PAGE>



Section 16(a) Beneficial Ownership Reporting Compliance

         Section  16(a) of the Exchange Act  requires the  Company's  directors,
executive  officers,  and any  person  holding  more  than  ten  percent  of the
Company's  Common  Stock to file with the  Securities  and  Exchange  Commission
reports of ownership changes.  Officers,  directors and greater than ten percent
stockholders  are  required to furnish  the  Company  with copies of all Section
16(a)  forms they file.  Based  solely on its review of the copies of such forms
received by it, or written  representations  from certain reporting persons, the
Company  believes  that all  filing  requirements  applicable  to its  executive
officers, directors and greater than ten percent beneficial owners were complied
with.

ITEM 10.          EXECUTIVE COMPENSATION

Management Compensation

         Directors' Compensation.  The Company's outside directors are paid $250
per month.  Each director also receives $100 for each committee meeting attended
with  an  annual  payment  cap  of  $600  applicable  to the  committee  meeting
compensation  only. On March 26, 1997, each outside director was granted options
to  purchase  2,000  shares of Common  Stock at the higher of book value or fair
market value on that date.  The exercise price of all such options was deemed to
be $2.86 under these terms. Stock options must be exercised within 10 years from
date of award or within 60 days after the date which the director  leaves.  Each
director was also granted options under the 1998 Outside  Directors Stock Option
Plan approved by the Company's  shareholders at the 1998 Annual  Meeting.  For a
description  of the plan see  "--Directors  Stock  Option  Plan."  The  Board of
Directors of the Company do not receive separate  compensation for their service
on the Board.

Summary Compensation Table

         The following  table sets forth cash and noncash  compensation  for the
fiscal years ended December 31, 1998,  1997 and 1996 awarded to or earned by the
Bank's  Chief  Executive  Officer  and by each  other  executive  officer  whose
compensation  exceeded  $100,000 for services  rendered in all capacities to the
bank during such years ("Named Executive Officers").  No other officers received
total compensation in excess of $100,000 in such years.

                           SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>


                                                                                                     Long Term Compensation
                                                                                     ----------------------------------------------
                                                     Annual Compensation(1)                        Awards                  Payouts
                                             --------------------------------------- --------------------------------- ------------
                                                                           Other     Restricted
                                                                          Annual        Stock                 LTIP       All Other
       Name and Principal                                              Compensation    Awards    Options     Payouts   Compensation
            Positions               Year     Salary($)      Bonus($)        ($)        ($)(2)      (#)(2)    ($)(2)        ($)(3)
--------------------------------    ----     ---------      --------   ------------- ----------- ---------- ---------- ------------
<S>                                <C>       <C>            <C>         <C>           <C>         <C>       <C>         <C>
John T. Rohrback,                   1998      100,000           --            --           --      2,581            --     24,250
  President and Chief               1997      100,000           --            --           --         --            --      3,829
  Executive Officer                 1996      100,000(1)    10,000            --           --         --            --      3,751

Sidney E. Bostian,                  1996       76,663           --            --           --      5,000            --         --(5)
  President and Chief
  Executive Officer (4)
</TABLE>

----------------
(1)      Under Annual  Compensation,  the column titled  "Salary"  includes base
         salary, amounts deferred under the Bank's 401(k) plan (but not matching
         contributions   from  the  Bank)  and  payroll  deductions  for  health
         insurance  under the Bank's health  insurance  plan.  Mr.  Rohrback was
         elected as President and Chief  Executive  Officer (CEO) of the Bank by
         the  Board  of  Directors  effective  July, 1996.  Mr. Rohrback  earned
         $47,916 during 1996.

(2)      Mr.  Rohrback  left the  employment of the Bank as of January 26, 1999.
         During the fiscal year ended December 31, 1998, Mr.  Rohrback  received
         options to  purchase  2,581  shares of common  stock  which  expire six
         month's from end of  employment.  During the fiscal year ended December
         31, 1997 and 1996, no restricted  stock awards,  stock options or other
         long-term incentive plans were awarded to Mr. Rohrback.

(3)      Includes  (a) the use of a  vehicle  provided  by the  Bank  valued  at
         $23,650,  $3,325 and $3,535 for the years ended December 31, 1998, 1997
         and 1996, respectively; and (b) the amount of insurance

                                       34

<PAGE>



         premiums paid by the Bank on behalf of Mr. Rohrback,  in the amounts of
         $600,  $504 and $216 for the years ended  December 31,  1998,  1997 and
         1996, respectively.

(4)      Mr. Bostian  resigned as Chief Executive  Officer of the Bank effective
         June 30, 1996. Mr. Bostian received the following  compensation for the
         1996 and 1995 fiscal year: (i) base salary of $125,000; (ii) Tower Club
         dues and use of a vehicle;  and (iii) options to purchase  5,000 shares
         of common stock which were terminated upon Mr. Bostian's resignation.

Employee Stock Option Plan

          The Company provides long-term incentives to executives, employees and
directors through the grant of options under its various stock option plans. The
Bank adopted the 1998 The Heritage  Bank  Employee  Incentive  Stock Option Plan
(the "Employee Stock Option Plan") which was approved by the Bank's shareholders
at the 1998 Annual  Meeting.  The Company  assumed  sponsorship  of the Employee
Stock Option Plan upon the effective  date of the  Reorganization.  The Employee
Stock Option Plan provides for the grant of options to purchase  Common Stock of
the Company  ("Options") to certain  officers and employees.  The Employee Stock
Option  Plan is not subject to ERISA and is not a  tax-qualified  plan under the
Code.

          The Board of  Directors  or a committee  of not less than 3 members of
the board (the "Option  Committee")  administers the Employee Stock Option Plan.
Subject  to  certain  specific  limitations  and  restrictions  set forth in the
Employee  Stock Option Plan, the Option  Committee has full and final  authority
to: (i)  determine  the fair market value of the shares  covered by each Option;
(ii)  interpret  the  Employee  Stock Option Plan;  (iii)  prescribe,  amend and
rescind rules and  regulations,  if any,  relating to the Employee  Stock Option
Plan, but not to the Employee Stock Option Plan itself; (iv) determine the terms
and  provisions of each Option granted under the Employee Stock Option Plan; (v)
accelerate the exercise date of any Option; (vi) authorize any person to execute
on behalf of the Company any  instrument  required to effectuate the grant of an
Option;  and  (vii)  make all  determinations  necessary  or  advisable  for the
administration of the Employee Stock Option Plan.

          Upon stockholder  approval,  the Company reserved 75,000 shares of the
Company's Common Stock ("Option  Shares") for issuance upon exercise of Options.
Any Option Shares  subject to grants under the Employee  Stock Option Plan which
expire or are terminated, forfeited or canceled without having been exercised or
vested in full,  shall again be available  for  purposes of the  Employee  Stock
Option Plan. The Employee Stock Option Plan is intended to provide for the grant
of  options  which  qualify  for  favorable  federal  income  tax  treatment  as
"incentive  stock  options"  ("ISOs") and stock  options which do not qualify as
ISOs are non-qualified stock options ("NQSOs").

Directors Stock Option Plan

          The Bank adopted the 1998 The Heritage  Bank Outside  Directors  Stock
Option Plan (the "Outside  Directors Stock Option Plan").  The Outside Directors
Stock Option Plan was approved by the Bank's shareholders on August 26, 1998 and
the  Company  assumed  sponsorship  of the plan upon the  effective  date of the
Reorganization.  The Outside  Directors Stock Option Plan provides for the grant
of  options to  purchase  Common  Stock of the  Company  ("Options")  to certain
outside  directors.  The Outside  Directors  Stock Option Plan is not subject to
ERISA and is not a tax-qualified plan under the Code.

          The Board of  Directors or a committee of not less than 3 members (the
"Option  Committee")  administers  the Outside  Directors Stock Option Plan. The
members of the  Committee are appointed by the Board of Directors of the Company
and  serve  at the  pleasure  of the  Board of  Directors  of the  Company.  The
Committee  is  composed  of the  following:  (1) one  outside  director;  (2) an
employee who is not an outside director; and (3) a stockholder who is neither an
employee nor an outside  director.  Subject to certain specific  limitations and
restrictions  set forth in the Outside  Directors  Stock Option Plan, the Option
Committee  has full and final  authority to: (i) determine the fair market value
of the shares covered by each Option; (ii)

                                       35

<PAGE>



interpret the Outside  Directors Stock Option Plan; (iii)  prescribe,  amend and
rescind rules and regulations,  if any,  relating to the Outside Directors Stock
Option Plan,  but not to the Outside  Directors  Stock Option Plan itself;  (iv)
determine  the terms and  provisions  of each Option  granted  under the Outside
Directors  Stock Option Plan;  (v)  accelerate  the exercise date of any Option;
(vi)  authorize  any person to execute on behalf of the Company  any  instrument
required to effectuate the grant of an Option; and (vii) make all determinations
necessary or advisable for the  administration  of the Outside  Directors  Stock
Option Plan.

          Upon stockholder  approval,  the Company reserved 75,000 shares of the
Company's Common Stock ("Option  Shares") for issuance upon exercise of Options.
Any members of the Board who are Outside  Directors are eligible to  participate
in the Outside  Directors Stock Option Plan.  Effective on the Outside Directors
Stock Option Plan Effective  Date,  each person who was an Eligible  Director on
such date was granted a NQSO to purchase  shares.  Such Options have an Exercise
Price equal to the fair market value of a share of the Company's Common Stock on
the date of grant and an  Exercise  Period  commencing  on the date of grant and
expiring  on the  earliest of (i) within 60 days of the date he or she ceases to
be an Eligible Director due to resignation or a removal for cause (in accordance
with the Bylaws of the Company or other  affiliate,  as applicable) and (ii) the
last day of the ten-year  period  commencing on the date the Option was granted.
All Option Shares not previously purchased or available for purchase will become
available  for purchase on the date of the option  holder's  death,  disability,
retirement or in the event of a Change in Control.  Options granted to directors
under the Outside Directors Stock Option Plan will be NQSOs.

1992 Stock Option Plan

          On March 26,  1992,  the Board of  Directors  of Heritage  Bankshares,
Inc.,  a  Virginia  corporation   ("Bankshares")   announced  its  intention  to
investigate  a spin-off of two of its  subsidiary  banks,  Princess Anne Bank, a
Virginia  corporation  ("Princess  Anne"),  and The Heritage Bank. On August 20,
1992, Bankshares Board of Directors declared a distribution (the "Distribution")
of all of Princess  Anne's  common stock and all of The Heritage  Bank's  common
stock to holders of Bankshares'  common stock. As a result of the  Distribution,
which was effected on August 31, 1992,  Princess Anne and The Heritage Bank each
became independent banks.

          Prior to the Distribution,  certain employees of Bankshares,  Princess
Anne and The Heritage Bank  participated  in  Bankshares'  employee stock option
plan (the "Bankshares Plan"). In connection with the Distribution,  (I) Princess
Anne and The Heritage Bank each adopted an employee stock option plan similar to
the Bankshares  Plan,  (ii) option holders in the Bankshares  Plan received,  in
addition  to their  existing  options to  acquire  common  stock of  Bankshares,
options  to  purchase  an  identical  number of  shares of common  stock in both
Princess Anne and The Heritage Bank, and (iii) the exercise price of all options
was adjusted to reflect the relative  appraised values of Bankshares (39% of the
value of all  three  entities),  Princess  Anne  (40% of the  value of all three
entities), and The Heritage Bank (21% of the value of all three entities). Thus,
for example, if a key employee of The Heritage Bank had options to acquire 1,000
shares of Bankshares'  common stock at $20.00 per share before the Distribution,
such  employee  would,  after  Distribution,  have  options to acquire (a) 1,000
shares of  Bankshares'  common stock at $7.80 per share (39% of $20),  (b) 1,000
shares of Princess  Anne's common stock at $8.00 per share (40% of $20), and (c)
1,000  shares of The  Heritage  Bank's  Common  Stock at $4.20 per share (21% of
$20).

          Under the  Company's  Employee  Stock  Option Plan (the "Stock  Option
Plan"),  full-time  employees and part-time  employees working at least 25 hours
per week are eligible to receive options to acquire Common Stock.  The Company's
Board of Directors and a Committee appointed by the Board of Directors may grant
options at prices  determined by the Board or the Committee.  Options expire ten
years after the date of the grant. The Stock Option Plan authorizes the Board of
Directors  or  committee  to grant  options to purchase  up to 50,000  shares of
Common Stock of the Company. A total of 30,625 of these 50,000 options have been
granted in  connection  with the  Distribution  as  discussed  in the  preceding
paragraph.


                                       36

<PAGE>

Stock Options - Named Executive Officer

          The  following  table  summarizes  the option grants that were made to
John T.  Rohrback  under the  Employee  Stock Option Plan during the fiscal year
1998.


                      Option/SAR Grants in Fiscal Year 1998

<TABLE>
<CAPTION>

                                                               Individual Grants
                                                      Percent of
                                    Number of            Total
                                   Securities        Options/SARs
                                   Underlying         Granted to
                                  Options/SARs       Employees in         Exercise or
                                     Granted          Fiscal Year         Base Price         Expiration
Name                                 (#)(1)               (%)            ($ per Share)          Date
----                           ------------------ ------------------    --------------     -------------

<S>                            <C>                 <C>                  <C>                <C>
John T. Rohrback
  President and Chief
  Executive Officer...........          2,581           28.92                3.875            9/22/08
</TABLE>

---------------
(1)      All options are immediately  exercisable upon grant, but are subject to
         forfeiture  within  six months of January  25,  1999,  that date of Mr.
         Rohrback's termination of employment with the Bank.

         The following table provides  information  with respect to Mr. Rohrback
concerning the exercise of options during the last fiscal year and the value for
"in-the-money"  options held by him at year end,  which  represents the positive
spread  between the exercise  price of any such  existing  stock options and the
year-end price of the Common Stock. Mr. Rohrback did not hold any "in-the-money"
options at year end.

<TABLE>
<CAPTION>

 Aggregated Option Exercises in 1998 Fiscal Year and 1998 Fiscal Year End Option/Values


                                                                    Number of Securities              Value of Unexercised
                                                                   Underlying Unexercised                 In-the-Money
                              Shares                               Options/SARs at Fiscal            Options/SARs at Fiscal
                            Acquired on          Value                    Year-end                          Year-end
                             Exercise          Realized                      (#)                               ($)
                                (#)        -      ($)       -     Exercisable/Unexercisable       Exercisable/Unexercisable(1)
Name                     ------------------ ---------------- -------------------------------  ------------------------------------
<S>                      <C>                 <C>              <C>                             <C>

John T. Rohrback                --                --                     2,581 / 0                            N/A
</TABLE>
----------------------
(1)      Based upon a market price of $3.75 per share at December 31, 1998 minus
         the exercise price.



                                       37

<PAGE>



ITEM 11.          SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
                  MANAGEMENT

      The  following  table  sets  forth,  as a group as of March 1,  1999,  the
beneficial  ownership of Common Stock of the Company by (i) each director of the
Company;  (ii) each executive officer named in the Summary  Compensation  Table;
(iii) each person who owns or is known by  management to own  beneficially  more
than five percent of the outstanding  shares of the Company's  Common Stock; and
(iv) all executive officers and directors as a group.

<TABLE>
<CAPTION>

          Name and Address                   Number of Shares          Percent of Class
       of Beneficial Owner(1)              Owned Beneficial(1)(2)       (Common Stock)(3)
       ----------------------              ----------------------       -----------------
<S>     <C>                                 <C>                         <C>
         George K. Degnon                        25,100(4)                    1.09%
         Philip F. Herrick, Jr.                 130,383(5)                    5.68
         Ronald W. Kosh                           7,900(6)                    0.34
         Harold E. Lieding                      351,393(7)                   15.31
         Stanley I. Richards                     13,602(8)                    0.59
         Kevin P. Tighe                           9,000(9)                    0.39
         George P. Shafran                       48,269(10)                   2.10
                                              ---------                      -----
           All Directors and
           Executive Officers as a
           Group (8 persons)                    592,482                      25.82%
-----------------------                       =========                      =====
</TABLE>

(1)        A person is deemed to be the beneficial  owner of securities that can
           be acquired by such  person  within 60 days from March 1, 1999.  Each
           beneficial  owner's  percentage  ownership is  determined by assuming
           that options or warrants  that are held by such person (but not those
           held by any other  person) and which are  exercisable  within 60 days
           from March 1, 1999. Unless otherwise indicated,  the Company believes
           that all persons  named in the table have sole voting and  investment
           power with respect to all shares of Common Stock  beneficially  owned
           by them. Unless otherwise indicated,  the address for the individuals
           listed above is c/o The Heritage  Bank,  1313 Dolley  Madison  Blvd.,
           McLean, Virginia 22101.

(2)        Includes  4,000 shares of Common Stock  issuable upon the exercise of
           stock options granted to each of the following outside directors: Mr.
           Degnon, Mr. Herrick,  Mr. Lieding,  Mr. Richards and Mr. Tighe; 3,000
           shares to Mr. Shafran; 1,500 shares to Mr. Kosh.

(3)        Based on 2,294,617 shares of Common Stock  outstanding as of March 1,
           1999. Does not include (i) 30,625 shares of Common Stock reserved for
           issuance  upon exercise of options  granted under the Company's  1992
           Employee  Stock  Option  Plan,  (ii)  19,375  shares of Common  Stock
           available  for future grant under the Company's  1992 Employee  Stock
           Option Plan. (iii) 8,925 shares of Common Stock reserved for issuance
           upon exercise of options  granted  under the Company's  1998 Employee
           Incentive  Stock  Option  Plan.  (iv) 66,075  shares of Common  Stock
           reserved for future grant under the Company's 1998 Employee Incentive
           Stock Option  Plan.  (v) 14,500  shares of Common Stock  reserved for
           issuance  upon exercise of options  granted under the Company's  1998
           Outside  Directors  Stock Option Plan.  (vi) 60,500  shares of Common
           Stock  available  for future grant under the  Company's  1998 Outside
           Directors Stock Option Plan.

(4)        Includes 110 shares held jointly with his spouse.

(5)        Includes 110,383 shares held jointly with his spouse.

(6)        Includes 3,700 shares held jointly with his spouse.

(7)        Includes 146,652 held in an individual retirement account.

(8)        Includes 7,000 shares jointly held with his spouse.

(9)        Includes 3,000 shares jointly held with his spouse.

(10)       Includes  3,634 shares that Mr.  Shafran  holds as custodian  for his
           minor grandchildren.

ITEM 12.          CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

      The officers, directors, their immediate families and affiliated companies
in which they are stockholders  maintain normal  relationships  with the Company
and the Bank. Loans made by the Bank are made in the ordinary course of business
on the same terms, including interest rates and collateral,  as those prevailing
at the time of comparable  transactions with others and do not involve more than
normal risks of collectability or present other unfavorable features. The amount
of such loans was approximately $279,384 and $348,483 as

                                       38

<PAGE>



of  December  31,  1998 and 1997,  respectively.  No loan to a  director  or any
director's related interest exceeded ten percent of capital or exceeded $300,000
at December 31, 1998.

ITEM 13.          EXHIBITS, LIST AND REPORTS ON FORM 8-K

(1) The  following  financial  statements  of  Heritage  Bancorp,  Inc.  and the
Heritage Bank are incorporated herein by reference in item 8:

         Balance Sheets - December 31 1998 and 1997.
         Statement of operation - Years ended December 31, 1998, 1997, and 1996.
         Statement of changes in Stockholders' Equity - Years ended December 31,
         1998,  1997,  and 1996
         Statements of Cash Flows - Years ended December 31, 1998, 1997 and 1996
         Notes to  Financial  statements.
         Report  of   independent accountants.

(2) Exhibits:


         2.1   Agreement  and Plan of  Reorganization  by and among The Heritage
               Bank and Heritage Bancorp, Inc.*
         3.1   Articles of Incorporation of Heritage Bancorp, Inc.*
         3.2   Bylaws of Heritage Bancorp, Inc.*
         3.3   Articles of Incorporation of The Heritage Bank*
         3.4   Bylaws of The Heritage Bank*
         4.1   Stock Certificate of Heritage Bancorp, Inc.*
         10.1  The Heritage Bank 1998 Employee Incentive Stock Option Plan*
         10.2  The Heritage Bank 1998 Outside Director Stock Option Plan*
         10.3  The Heritage Bank 1992 Employee Incentive Stock Option Plan*
         23.1  Consent of Yount, Hyde & Barbour, P.C.
         27.1  Financial Data Schedule (only filed in EDGAR format)

*Incorporated by reference to the initial filing of the  Registration  Statement
on Form S-4 as filed with the U.S. Securities and Exchange Commission on July 6,
1998, as amended,

(3)      Reports on Form 8-K:

         None.

                                       39

<PAGE>



SIGNATURES

         In  accordance  with  Section  13 or 15(d)  of the  Exchange  Act,  the
registrant  caused  this  report to be signed on its behalf by the  undersigned,
thereunto duly authorized.


HERITAGE BANCORP, INC.


By:   /s/   William B. Sutphin
   ----------------------------
    William B. Sutphin
    Senior Vice President

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

<TABLE>
<CAPTION>

                   Name                                          Title                            Date
                   ----                                          -----                            ----
<S>                                              <C>                                       <C>

/s/ Harold E. Lieding                             Chairman of the Board                      March 25, 1998
------------------------------------------
Harold E. Lieding

/s/ George K. Degnon                              Director                                   March 25, 1998
------------------------------------------
George K. Degnon

/s/ Kevin P. Tighe                                Director                                   March 25, 1998
------------------------------------------
Kevin P. Tighe

/s/ Philip F. Herrick, Jr.                        Director                                   March 25, 1998
------------------------------------------
Philip F. Herrick, Jr.

/s/ Ronald W. Kosh                                Director                                   March 25, 1998
------------------------------------------
Ronald W. Kosh

/s/ Stanley I. Richards                           Director                                   March 25, 1998
------------------------------------------
Stanley I. Richards

/s/ George P. Shafran                             Director and Vice Chairman                 March 25, 1998
------------------------------------------
George P. Shafran

</TABLE>




                                       40

<PAGE>




                            HERITAGE BANCORP, INC.
                                AND SUBSIDIARY

                               McLean, Virginia

                        CONSOLIDATED FINANCIAL REPORT

                              DECEMBER 31, 1998



<PAGE>



                               C O N T E N T S



                                                                            Page

INDEPENDENT AUDITOR'S REPORT                                               F-1

CONSOLIDATED FINANCIAL STATEMENTS

  Consolidated statements of condition                                     F-2
  Consolidated statements of operations                                    F-3
  Consolidated statements of changes in stockholders' equity               F-4
  Consolidated statements of cash flows                            F-5 and F-6
  Notes to consolidated financial statements                          F-7-F-26


<PAGE>



                         INDEPENDENT AUDITOR'S REPORT






To the Board of Directors
Heritage Bancorp, Inc. and Subsidiary
McLean, Virginia


          We have audited the accompanying  consolidated statements of condition
of Heritage  Bancorp,  Inc. and Subsidiary as of December 31, 1998 and 1997, and
the related  consolidated  statements of  operations,  changes in  stockholders'
equity  and cash  flows for the  three  years  then  ended.  These  consolidated
financial statements are the responsibility of the Corporation's management. Our
responsibility  is  to  express  an  opinion  on  these  consolidated  financial
statements based on our audits.


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


          In our opinion,  the  consolidated  financial  statements  referred to
above  present  fairly,  in all material  respects,  the  financial  position of
Heritage Bancorp,  Inc. and Subsidiary as of December 31, 1998 and 1997, and the
results of its operations and its cash flows for the three years then ended,  in
conformity with generally accepted accounting principles.


                                                 /s/ Yount, Hyde & Barbour, P.C.

Winchester, Virginia
February 5, 1999


<PAGE>



                            HERITAGE BANCORP, INC.
                                AND SUBSIDIARY

                     Consolidated Statements of Condition
                          December 31, 1998 and 1997

        Assets
                                                       1997         1998

Cash and due from banks                            $  5 824 649  $ 1 986 523
Federal funds sold and securities purchased under
  agreement to resell                                 8 550 000    7 600 000
                                                   ------------    ---------
        Total cash and cash equivalents            $ 14 374 649  $ 9 586 523

Securities available for sale, at approximate
  market value                                       19 823 754   11 793 716
Securities to be held to maturity (fair value:
  1998, $-0- and 1997, $249,375)                            - -      250 000

Loans, net                                           29 181 039   22 756 260

Premises and equipment, net                             376 453      378 939
Accrued interest receivable                             459 340      274 591
Other real estate owned                                 263 199      263 199
Other assets                                            297 160      146 415
                                                   ------------  -----------
        Total assets                               $ 64 775 594  $45 449 643
                                                   ============  ===========

    Liabilities and Stockholders' Equity

Liabilities
  Noninterest-bearing deposits                     $ 17 552 927  $11 855 769
  Savings and interest-bearing demand deposits       20 565 927   17 623 691
  Time deposits                                      15 323 125   11 124 375
                                                   ------------  -----------
        Total deposits                             $ 53 441 979  $40 603 835
  Accrued interest and other liabilities                119 170      115 460
  Securities sold under agreement to repurchase       2 286 781          - -
  Commitments and contingent liabilities                    - -          - -
                                                   ------------  -----------
        Total liabilities                          $ 55 847 930  $40 719 295
                                                   ------------  -----------

Stockholders' Equity
  Common stock, $1 par value; authorized 10,000,000
   shares; issued and outstanding 2,294,617 and
   1,489,636 shares, respectively                  $  2 294 617  $ 1 489 636
  Capital surplus                                     6 529 539    3 327 451
  Retained earnings (deficit)                            28 549     (104 856)
  Accumulated other comprehensive income                 74 959       18 117
                                                   ------------   ----------
        Total stockholders' equity                 $  8 927 664  $ 4 730 348
                                                   ------------   ----------

        Total liabilities and stockholders' equity $ 64 775 594  $45 449 643
                                                   ============  ===========

See Accompanying Notes to Consolidated Financial Statements.


<PAGE>



                            HERITAGE BANCORP, INC.
                                AND SUBSIDIARY

                    Consolidated Statements of Operations
                 Years Ended December 31, 1998, 1997 and 1996

                                           1998         1997          1996
                                        ----------   ----------    ----------
Interest Income
  Loans                                 $2 386 091   $2 285 986    $2 321 858
  Securities                             1 117 858      816 256       822 760
  Federal funds sold                       262 053      154 066       274 892
                                        ----------   ----------    ----------
     Total interest income              $3 766 002   $3 256 308    $3 419 510
                                        ----------   ----------    ----------

Interest Expense
  Interest checking deposits            $  495 705   $  443 836    $  453 352
  Other time deposits                      520 405      512 337       744 650
  Certificates of deposit $100,000
    or more                                217 440      147 801       212 699
  Securities sold under agreement
    to repurchase                           38 859        6 797           - -
                                        ----------   ----------    ----------
     Total interest expense             $1 272 409   $1 110 771    $1 410 701
                                        ----------   ----------    ----------

     Net interest income                $2 493 593   $2 145 537    $2 008 809

Provision for loan losses                  117 000        3 825           - -
                                        ----------   ----------    ----------

     Net interest income after
      provision for loan losses         $2 376 593   $2 141 712    $2 008 809
                                        ----------   ----------    ----------

Other Income
  Service charges on deposit accounts   $  122 684   $  112 039    $  101 440
  Other operating income, net               15 477       21 233        17 660
  Gain (loss) on sale of securities           (781)      47 261           - -
                                        ----------   ----------    ----------
     Total other income                 $  137 380   $  180 533    $  119 100
                                        ----------   ----------    ----------

Other Expenses
  Salaries and employee benefits        $1 074 228   $  953 246    $  898 649
  Occupancy expense                        204 669      215 204       214 171
  Equipment expense                         73 667       88 275        91 687
  Other operating expenses               1 068 643      579 961       520 109
                                        ----------   ----------    ----------
     Total other expenses               $2 421 207   $1 836 686    $1 724 616
                                        ----------   ----------    ----------

     Income before income taxes         $   92 766   $  485 559    $  403 293

  Income tax expense (benefit)             (40 639)     (85 297)          - -
                                        ----------   ----------    ----------

     Net income                         $  133 405   $  570 856    $  403 293
                                        ==========   ==========    ==========

Earnings Per Share, basic               $      .07   $      .45    $      .32
                                        ==========   ==========    ==========

Earnings Per Share, assuming dilution   $      .07   $      .44    $      .32
                                        ==========   ==========    ==========


<PAGE>



                            HERITAGE BANCORP, INC.
                                AND SUBSIDIARY

          Consolidated Statements of Changes in Stockholders' Equity
                 Years Ended December 31, 1998, 1997 and 1996

<TABLE>
<CAPTION>

                                                                              Accumulated
                                                                                 Other
                                 Common          Capital      Retained       Comprehensive  Comprehensive
                                 Stock           Surplus      Earnings          Income          Income           Total
                               -------------   ------------   ------------   -------------  -------------    ------------
<S>                            <C>             <C>             <C>           <C>            <C>             <C>

Balance, December 31, 1995      $  1 249 634   $  2 967 448   $(1 079 005)     $  10 987                      $3 149 064
  Net income                             - -            - -       403 293            - -    $     403 293        403 293
  Other comprehensive income,
    net of tax
      Unrealized holding losses
        arising during period,
        net of tax of $-0-               - -            - -           - -         (9 523)          (9 523)        (9 523)
                                                                                            -------------
      Comprehensive income               - -            - -           - -            - -    $     393 770            - -
                                ------------   ------------   -----------      ---------    =============     ----------
Balance, December 31, 1996      $  1 249 634   $  2 967 448   $  (675 712)     $   1 464                      $3 542 834
  Net income                             - -            - -       570 856            - -    $     570 856        570 856
  Other comprehensive income,
    net of tax
      Unrealized holding gains
        arising during period,
        net of tax of $25,401            - -            - -           - -            - -           47 845            - -
      Less reclassification
        adjustment, net of tax
        of $16,068                       - -            - -           - -            - -          (31 192)           - -
                                                                                            -------------
      Other comprehensive income         - -            - -           - -         16 653    $      16 653         16 653
                                                                                            -------------
      Comprehensive income               - -            - -           - -            - -    $     587 509            - -
                                                                                            =============
  Warrants exercised                 240 002        360 003           - -            - -                         600 005
                                ------------   ------------   -----------      ---------                   -------------
Balance, December 31, 1997      $  1 489 636   $  3 327 451   $  (104 856)     $  18 117                      $4 730 348
  Net income                             - -            - -       133 405            - -    $     133 405        133 405
  Other comprehensive income,
    net of tax
      Unrealized holding gains
        arising during period,
        net of tax of $29,016            - -            - -           - -            - -           56 327            - -
      Add reclassification adjustment,
        net of tax of $266               - -            - -           - -            - -              515            - -
                                                                                            -------------
      Other comprehensive income         - -            - -           - -         56 842    $      56 842         56 842
                                                                                            =============
      Comprehensive income               - -            - -           - -            - -    $     190 247            - -
                                                                                            =============
  Stock options exercised              2 700          7 120           - -            - -                           9 820
  Repurchase of stock in odd
    lot tender                        (2 719)       (12 236)          - -            - -                         (14 955)
  Issuance of common stock           805 000      3 207 204           - -            - -                       4 012 204
                                ------------   ------------   -----------      ---------                      ----------
Balance, December 31, 1998      $  2 294 617   $  6 529 539   $    28 549      $  74 959                      $8 927 664
                                ============   ============   ===========      =========                      ==========

</TABLE>


See Accompanying Notes to Consolidated Financial Statements.


<PAGE>



                            HERITAGE BANCORP, INC.
                                AND SUBSIDIARY

                    Consolidated Statements of Cash Flows
                 Years Ended December 31, 1998, 1997 and 1996

                                               1998          1997        1996
                                            ----------    ----------  ---------

Cash Flows from Operating Activities
  Net income                                $  133 405   $  570 856  $ 403 293
  Adjustments to reconcile net income
    to net cash provided by (used in)
    operating activities:
      Provision for loan losses                117 000        3 825         - -
      (Gain) loss on sale of securities            781      (47 261)        - -
      Depreciation and amortization             50 958       67 733      72 182
      Deferred tax (benefit)                   (45 239)     (85 297)        - -
      Amortization of investment security
        premiums, net of discounts              37 438       13 845      24 245
      (Increase) decrease in accrued interest
         and other assets                     (319 486)      64 677    (109 696)
      Increase (decrease) in accrued interest
        and other liabilities                    5 412      (30 169)    (17 419)
                                            ----------    ---------   ---------
      Net cash provided by (used in)
        operating activities                $  (19 731)   $ 558 209  $  372 605
                                            -----------    --------   ---------

Cash Flows from Investing Activities
  Maturities and calls of securities
    available for sale                      $9 195 000   $1 800 000  $2 000 000
  Purchase of securities available
    for sale                               (17 676 403)  (9 236 816)(12 601 919)
  Maturities of securities held to maturity    250 000      250 000   1 550 000
  Proceeds from sale of securities available
    for sale                                   499 219    8 984 402       5 100
  Net (increase) decrease in loans          (6 543 481)   1 825 409  (1 010 908)
  Purchase of premises and equipment           (48 472)     (90 920)    (42 487)
  Proceeds from sale of other real
    estate owned                                   - -          - -     100 508
                                            ----------    ---------   ---------
      Net cash provided by (used in)
        investing activities              $(14 324 137)  $3 532 075 $(9 999 706)
                                            ----------   ----------  ----------

Cash Flows from Financing Activities
  Increase in demand deposits, NOW accounts
    and savings deposits                    $8 639 394     $550 791 $   986 664
  Increase (decrease) in certificates
    of deposit                               4 198 750   (2 333 488) (2 139 345)
  Proceeds from stock warrants exercised           - -      600 005         - -
  Proceeds from sale of common stock         4 022 024          - -         - -
  Repurchase of common stock                   (14 955)         - -         - -
  Increase in securities sold under agreement
    to repurchase                            2 286 781          - -         - -
                                            ----------  ------------ ----------
      Net cash provided by (used in)
        financing activities               $19 131 994  $(1 182 692)$(1 152 681)
                                            ----------  -----------  ----------



<PAGE>




                            HERITAGE BANCORP, INC.
                                AND SUBSIDIARY

                    Consolidated Statements of Cash Flows
                                 (Continued)
                 Years Ended December 31, 1998, 1997 and 1996


<TABLE>
<CAPTION>


                                                       1998         1997             1996
                                                       ----         -----           ------
<S>                                               <C>          <C>          <C>
      Net change in cash and cash equivalents   $   4 788 126    $2 907 592    $  (10 779 782)
Cash and Cash Equivalents, beginning of year        9 586 523     6 678 931        17 458 713
                                                -------------    ----------    --------------

Cash and Cash Equivalents, end of year          $  14 374 649    $9 586 523    $    6 678 931
                                                =============    ==========    ==============
Supplemental Disclosures of Cash Flow Information
  Cash payments for:
    Interest                                    $   1 269 516    $1 113 620    $    1 419 643
                                                =============    ==========    ==============

    Income taxes                                $         - -    $    9 187    $          - -
                                                =============    ==========    ==============


Supplemental Schedule of Noncash Investing
  Activities
    Other real estate acquired in settlement
      of loans                                  $         - -    $      - -    $       86 750
                                                =============    ==========    ==============


    Unrealized gain (loss) on securities
      available for sale                        $      86 124    $   25 986    $       (9 523)
                                                =============    ==========    ==============
</TABLE>

See Accompanying Notes to Consolidated Financial Statements.



<PAGE>



                            HERITAGE BANCORP, INC.
                                AND SUBSIDIARY

                  Notes to Consolidated Financial Statements
                       December 31, 1998, 1997 and 1996


Note 1. Nature of Banking Activities and Significant Accounting Policies

        General

         Heritage  Bancorp,  Inc.   (Corporation)  is  a  bank  holding  company
         organized  under Virginia law in October,  1998.  During 1998,  Bancorp
         acquired  The  Heritage  Bank  through  a share  exchange  in which the
         stockholders  of The  Heritage  Bank  received one share of Bancorp for
         each  share  of  The  Heritage   Bank.  The  exchange  was  a  tax-free
         transaction  for federal income tax purposes.  The merger was accounted
         for on the same basis as a  pooling-of-interests.  Financial statements
         for the year ended December 31, 1997, have been retroactively  adjusted
         for the exchange as if it occurred on January 1, 1997.

         The Corporation's wholly-owned subsidiary, The Heritage Bank (Bank) was
         incorporated  under Virginia law in 1987. It operated as a wholly-owned
         subsidiary of Heritage  Bankshares,  Inc. until September 1, 1992, when
         it  became  independent.  The Bank is a state  chartered  member of the
         Federal  Reserve  System with deposits  insured by the Federal  Deposit
         Insurance Corporation (FDIC) and is located in McLean, Virginia.

        Nature of Operations

         Heritage  Bancorp,  Inc.  is a bank  holding  company  that  provides a
         variety of banking services to individuals and businesses.  Its primary
         deposit  products are demand and savings  deposits and  certificates of
         deposit.  Its primary lending products are commercial business and real
         estate  mortgage  loans.  The loans are expected to be repaid from cash
         flow or proceeds from the sale of selected assets of the borrowers.

        Principles of Consolidation

         The accounting  and reporting  policies of Heritage  Bancorp,  Inc. and
         subsidiary (the "Corporation") conform to generally accepted accounting
         principles  and  general  practices  within the banking  industry.  The
         following is a description of the more significant of those policies:

          Securities

            Securities are  classified in three  categories and accounted for as
            follows:

            a.    Securities Held to Maturity

                Securities  classified  as  held  to  maturity  are  those  debt
                securities  the  Corporation  has both the intent and ability to
                hold to  maturity  regardless  of changes in market  conditions,
                liquidity needs or changes in general economic conditions. These
                securities  are carried at cost  adjusted  for  amortization  of
                premium and  accretion  of  discount,  computed by the  interest
                method over their contractual lives.


<PAGE>



            b.    Securities Available for Sale

                Securities  classified  as available for sale are those debt and
                equity  securities that the  Corporation  intends to hold for an
                indefinite period of time, but not necessarily to maturity.  Any
                decision to sell a security  classified  as  available  for sale
                would  be  based  on  various  factors,   including  significant
                movements in interest rates,  changes in the maturity mix of the
                Corporation's   assets   and   liabilities,   liquidity   needs,
                regulatory  capital  considerations,  and other similar factors.
                Securities  available  for  sale  are  carried  at  fair  value.
                Unrealized gains or losses are reported as a separate  component
                of  other  comprehensive  income.   Realized  gains  or  losses,
                determined on the basis of the cost of specific securities sold,
                are included in earnings.

            c.    Trading Securities

                Trading securities,  which are generally held for the short term
                in  anticipation  of market  gains,  are  carried at fair value.
                Realized  and  unrealized  gains and losses on  trading  account
                assets  are  included  in  interest  income on  trading  account
                securities.   The  Corporation  had  no  trading  securities  at
                December 31, 1998 and 1997.

         Loans

           Loans are shown on the  consolidated  balance  sheets net of unearned
           discounts and the allowance for loan losses.

           Interest on loans is computed by methods  which  generally  result in
           level rates of return on principal.  Interest accrual is discontinued
           when, in the opinion of  management,  the likelihood of collection is
           doubtful.  Loans are charged  off when in the  opinion of  management
           they are deemed to be uncollectible  after taking into  consideration
           such factors as the current  financial  condition of the customer and
           the underlying collateral and guarantees.

           Impairment  of  loans  that  have  been  separately   identified  for
           evaluation  is to be measured  based on the present value of expected
           future cash flows or,  alternatively,  the observable market price of
           the loans or the fair  value of the  collateral.  However,  for those
           loans that are collateral  dependent  (that is, if repayment of those
           loans is expected to be provided solely by the underlying collateral)
           and for which management has determined  foreclosure is probable, the
           measure of impairment of those loans is to be based on the fair value
           of the collateral.



<PAGE>




           The  Corporation   considers  all  consumer   installment  loans  and
           residential  mortgage loans to be homogeneous  loans. These loans are
           not subject to the above impairment provisions.  A loan is considered
           impaired when it is probable that the  Corporation  will be unable to
           collect  all  principal  and  interest   amounts   according  to  the
           contractual  terms  of  the  loan  agreement.   Factors  involved  in
           determining  impairment  include,  but are not limited  to,  expected
           future cash  flows,  financial  condition  of the  borrower,  and the
           current  economic  conditions.  A performing  loan may be  considered
           impaired, if the factors above indicate a need for impairment. A loan
           on  nonaccrual  status  may  not be  impaired  if in the  process  of
           collection or if there is an insignificant  shortfall in payment.  An
           insignificant  delay of less than 30 days or a shortfall of less than
           5% of the required  principal and interest payment generally does not
           indicate an impairment  situation,  if in  management's  judgment the
           loan will be paid in full. Loans that meet the regulatory definitions
           of  doubtful  or  loss  generally  qualifies  as  an  impaired  loan.
           Charge-offs  for impaired loans occur when the loan or portion of the
           loan is determined to be uncollectible, as is the case for all loans.

           Loans are placed on nonaccrual when a loan is specifically determined
           to be impaired or when  principal  or interest is  delinquent  for 90
           days or more. Any unpaid interest  previously  accrued on those loans
           is reversed from income.  Interest income generally is not recognized
           on specific  impaired  loans unless the likelihood of further loss is
           remote.  Interest  payments  received  on such loans are applied as a
           reduction of the loan  principal  balance.  Interest  income on other
           nonaccrual  loans  is  recognized  only  to the  extent  of  interest
           payments received.

         Allowance for Loan Losses

           The  allowance  for loan losses is  maintained  at a level which,  in
           management's  judgement, is adequate to absorb credit losses inherent
           in the  loan  portfolio.  The  amount  of the  allowance  is based on
           management's  evaluation of the collectibility of the loan portfolio,
           credit concentrations, trends in historical loss experience, specific
           impaired  loans,  and economic  conditions.  Allowances  for impaired
           loans are  generally  determined  based on  collateral  values or the
           present value of estimated cash flows.  The allowance is increased by
           a provision for loan losses,  which is charged to expense and reduced
           by charge-offs, net of recoveries. Changes in the allowances relating
           to impaired  loans are charged or credited to the  provision for loan
           losses.  Because of uncertainties inherent in the estimation process,
           management's estimate of credit losses inherent in the loan portfolio
           and the related allowance may change in the near term.

         Bank Premises and Equipment

           Premises  and   equipment   are  stated  at  cost  less   accumulated
           depreciation and amortization. Premises and equipment are depreciated
           over  their  estimated  useful  lives;   leasehold  improvements  are
           amortized  over the lives of the  respective  leases or the estimated
           useful  life  of  the  leasehold  improvement,   whichever  is  less.
           Depreciation  and  amortization  are  recorded  on the  straight-line
           method.


<PAGE>




           Costs of maintenance  and repairs are charged to expense as incurred.
           Costs of  replacing  structural  parts of major units are  considered
           individually and are expensed or capitalized as the facts dictate.

         Income Taxes

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

         Earnings Per Share

            In 1997, the Financial  Accounting  Standards Board issued Statement
            No.  128,   "Earnings   per  Share."   Statement  128  replaced  the
            calculation  of primary and fully  diluted  earnings  per share with
            basic and  diluted  earnings  per share.  Basic  earnings  per share
            excludes any dilutive  effects of options,  warrants and convertible
            securities.  Diluted  earnings  per  share  is very  similar  to the
            previously  reported fully diluted  earnings per share. All earnings
            per share  amounts for all periods  have been  presented,  and where
            appropriate, restated to conform to the statement 128 requirements.

         Nonrefundable Loan Fees and Costs

           Loan origination and commitment fees are being deferred and amortized
           as an adjustment of the related loan's yield.

         Cash and Cash Equivalents

           For  purposes  of  reporting  cash flows,  cash and cash  equivalents
           include cash on hand, amounts due from banks,  federal funds sold and
           securities  purchased under agreement to resell.  Generally,  federal
           funds are purchased and sold for one-day periods.

         Other Real Estate

           Real estate acquired  through  foreclosure is carried at the lower of
           cost or fair market value less estimated selling costs.



<PAGE>







         Use of Estimates

           The preparation of financial  statements in conformity with generally
           accepted accounting  principles requires management to make estimates
           and  assumptions  that  affect  the  reported  amounts  of assets and
           liabilities  and disclosure of contingent  assets and  liabilities at
           the date of the  financial  statements  and the  reported  amounts of
           revenues and expenses  during the reporting  period.  Actual  results
           could differ from those estimates.

         Advertising

           The  Corporation   follows  the  policy  of  charging  the  costs  of
           advertising  to  expense  as  incurred.  The  amount  of  advertising
           included in expense for December 31, 1998, 1997 and 1996 was $31,482,
           $20,394 and $13,071, respectively.

         Comprehensive Income

           As of January 1, 1998, the Corporation adopted Statement of Financial
           Accounting   Standards  (FASB)  No.  130,  "Reporting   Comprehensive
           Income."  FASB No. 130  establishes  new rules for the  reporting and
           display of  comprehensive  income and its  components;  however,  the
           adoption of this  statement  had no impact on the  Corporation's  net
           income  or  stockholders'   equity.   FASB  No.  130  requires  other
           comprehensive  income  to  include  unrealized  gains  and  losses on
           available for sale securities,  which prior to adoption were reported
           separately in  stockholders'  equity.  The December 31, 1997 and 1996
           financial  statements  have  been  reclassified  to  conform  to  the
           requirements of FASB No. 130.


Note 2.  Cash and Due From Banks

         The Bank is  required  to maintain  reserve  balances  with the Federal
         Reserve Bank. For the final weekly  reporting period in the years ended
         December  31, 1998 and 1997,  the  aggregate  amounts of daily  average
         required   balances   were   approximately   $391,000   and   $348,000,
         respectively.



<PAGE>




Note 3.  Securities

         The amortized cost,  unrealized  holding gains and losses, and the fair
         value of securities are summarized as follows:

<TABLE>
<CAPTION>

                                                 Gross        Gross
                                 Amortized     Unrealized   Unrealized      Fair
                                   Cost          Gains       (Losses)       Value
                                 ---------     ----------   ----------      -----
<S>                           <C>               <C>          <C>           <C>
        Available for sale
         securities:
          December 31, 1998:
           U.S. Treasury
            securities          $3 021 530     $  29 721    $    - -     $ 3 051 251
           U.S. Government
            agencies            14 769 231        57 082      (2 344)     14 823 969
           Obligations of
            states and political
            subdivisions         1 654 720        29 114         - -       1 683 834
           Other                   264 700           - -         - -         264 700
                                ----------     ---------    ---------     ----------
               Total           $19 710 181     $ 115 917    $  (2 344)   $19 823 754
                               ===========     =========    =========     ===========

          December 31, 1997:
           U.S. Treasury
            securities         $ 4 052 641     $  26 532    $  (3 001)   $ 4 076 172
           U.S. Government
            agencies             5 751 783         7 279       (7 841)     5 751 221
           Obligations of
            states and political
            subdivisions         1 849 592         5 819       (1 338)     1 854 073
           Other                   112 250           - -          - -        112 250
                                ----------     ---------    ---------     ----------
               Total           $11 766 266     $  39 630    $ (12 180)   $11 793 716
                               ===========     =========    =========     ==========

        Held-to-maturity
         securities:
          December 31, 1997:
           U.S. Government
            agencies           $   250 000     $     - -    $    (625)   $   249 375
                                ==========     =========    =========     ==========
</TABLE>



<PAGE>





        The  scheduled  maturities  of  securities  at December 31, 1998 were as
follows:


                                              Available  for Sale Securities
                                             -------------------------------
                                                 Amortized        Fair
                                                   Cost           Value

        Due in one year or less              $   4 666 530    $ 4 698 146
        Due from one year to five years         13 279 838     13 362 255
        Due from five years to ten years         1 499 113      1 498 653
        Federal reserve stock                      264 700        264 700
                                             -------------    -----------
          Total                              $  19 710 181    $19 823 754
                                             =============    ===========

        Proceeds  from sale of securities  available for sale during 1998,  1997
        and 1996 were  $499,219,  $8,984,402  and  $5,100.  Gross gains on those
        sales  during  1998,  1997 and 1996 were $-0-,  $47,261 and $-0-.  Gross
        losses on those  sales were $781,  $-0- and $-0- during  1998,  1997 and
        1996, respectively.

        Securities   having  a  book  value  of  approximately   $1,505,777  and
        $1,000,000 at December 31, 1998 and 1997,  were pledged to secure public
        deposits and letters of credit.


Note 4. Loans

        Major classifications of loans were as follows at December 31:

                                                        1998           1997
                                                    ----------    -----------
                                                           (In Thousands)
        Real estate:
          Mortgage                                  $  23 085      $  17 532
          Farm land                                       992            - -
          Construction                                    441            448
        Commercial                                      3 786          4 191
        Consumer loans                                  1 306          1 219
                                                    ---------     ----------
                                                    $  29 610     $   23 390
        Less:  allowance for loan losses                 (429)          (634)
                                                    ---------     ----------
        Loans, net                                  $  29 181     $   22 756
                                                    ==========    ==========





<PAGE>



Changes in the allowance for loan losses are summarized as follows for the years
ended December 31:
                                           1998         1997            1996
                                         ---------   -------------  ------------


          Balance, beginning of year     $633 797   $ 617 430     $  684 607
          Provision for loan losses       117 000       3 825            - -
          Loans charged-off              (338 944)    (61 336)      (108 402)
          Recoveries                       17 206      73 878         41 225
                                         --------   ---------     ----------
          Balance at end of year         $429 059   $ 633 797     $  617 430
                                         ========   =========     ==========

        Information  about impaired loans as of and for the years ended December
        31, 1998 and 1997 is as follows:
                                                      1998           1997
                                                    ---------     ----------

          Impaired loans for which an allowance
            has been provided                      $  29 370      $ 185 166
          Impaired loans for which no allowance
            has been provided                            - -            - -
                                                   ---------      ----------
              Total impaired loans                 $  29 370      $  185 166
                                                   =========      ==========

          Allowance provided for impaired loans,
            included in the allowance for loan
            losses                                 $  11 405      $   27 775
                                                   =========      ==========

          Average balance in impaired loans        $ 176 334      $  378 901
                                                   =========      ==========

          Interest income recognized               $  23 605      $   26 858
                                                   =========      ==========

        Nonaccrual  loans excluded from impaired loan disclosure  under FASB 114
        amounted  to  $365,670  and  $36,735  at  December  31,  1998 and  1997,
        respectively.  If interest on these loans had been accrued,  such income
        would have approximated  $26,836 and $5,852 for the years ended December
        31, 1998 and 1997.


Note 5. Related Party Transactions

        The  Corporation has loan  transactions  with its officers and directors
        and with  companies in which the officers and directors have a financial
        interest.  In the  opinion  of  management,  such loans were made in the
        ordinary  course  of  business  on  substantially  the  same  terms  and
        conditions, including interest rates and collateral, as those prevailing
        at the same time for comparable  transactions with other customers,  and
        did not represent more than normal credit risk.

        The  aggregate  amount of loans to such related  parties at December 31,
        1998 and 1997 was $279,384 and $348,483, respectively.  During 1998, new
        loans to such  related  parties  amounted  to  $209,000  and  repayments
        amounted to $278,099.


<PAGE>



        Note 6. Premises and Equipment

        Premises and equipment are summarized as follows at December 31:

                                                       1998           1997
                                                    ----------    -----------

          Land                                      $  245 000    $ 245 000
          Land improvements                             31 885          - -
          Leasehold improvements                       147 647      147 647
          Equipment, furniture and fixtures            354 200      337 613
                                                   -----------    ---------
                                                    $ 778 732     $ 730 260
            Less: accumulated depreciation and
              amortization                           (402 279)     (351 321)
                                                    ---------     ---------
                                                    $ 376 453     $ 378 939
                                                    =========     =========

        Depreciation  and  amortization  charged to operations  totaled $50,958,
        $67,733 and $72,182 in 1998, 1997 and 1996, respectively.

Note 7. Repurchase Agreement

        In 1994, the Corporation  executed a Master Repurchase  Agreement with a
        major financial institution.  Under this agreement,  the Bank may borrow
        short-term  funds by selling  securities  under agreement to repurchase.
        Generally,  these  securities  will be  limited to U.S.  Government  and
        government agency securities and agency mortgage-backed  securities. The
        amount available to be borrowed under this plan is limited by the amount
        of  securities  held  in  safekeeping  by  the  correspondent  financial
        institution,  which was  $2,994,677 at year end. As of December 31, 1998
        $2,286,781  was borrowed  under this  agreement.  No funds were borrowed
        under this agreement at December 31, 1997.

Note 8. Income Taxes

        Net deferred tax assets consist of the following as of December 31, 1998
        and 1997:
                                                       1998           1997
                                                    ----------    -----------
        Deferred tax assets:
         Net operating loss carryforwards           $   47 105    $   131 717
         Alternative minimum tax credits                 6 652         14 354
         Accumulated depreciation                       28 160         32 233
         Allowance for loan losses                      32 448            995
         Organization costs                             19 362            - -
         Other                                          11 163          5 649
         Less:  valuation allowance                        - -        (85 297)
                                                     ---------     ----------
            Gross deferred tax asset                $  144 890     $   99 651
                                                     ---------     ----------

        Deferred tax liabilities, unrealized gain
          on securities available for sale          $   38 615     $    9 333
                                                    ----------     ----------

            Net deferred tax asset                  $  106 275     $   90 318
                                                    ==========     ==========



The  provision  for income  taxes  charged  to  operations  for the years  ended
December 31, 1998, 1997 and 1996, consists of the following:

                                           1998         1997            1996
                                         ---------   -------------  -----------


          Current                       $  4 600    $     - -       $     - -
          Deferred                        40 058      161 717         132 611
          Change in valuation allowance  (85 297)    (247 014)       (132 611)
                                        --------    ---------       ---------
                                        $(40 639)   $ (85 297)      $     - -
                                         =======    =========       =========

        The  income  tax  provision  differs  from  the  amount  of  income  tax
        determined by applying the U.S. federal income tax rate to pretax income
        for the  years  ended  December  31,  1998,  1997 and  1996,  due to the
        following:

                                           1998         1997            1996
                                         ---------   -------------  -----------


          Tax expense at statutory rate  $ 31 540    $  165 090     $137 120
          Benefit of operating loss
            carryforwards                 (85 297)     (247 014)    (132 611)
          Other, net                       13 118        (3 373)      (4 509)
                                         --------     ---------     --------
                                         $(40 639)   $  (85 297)    $    - -
                                         ========    ==========     ========

        At December 31, 1998, the Corporation  has operating loss  carryforwards
        of  approximately  $138,543 that may be offset  against  future  taxable
        income and which will expire over various years from 2006 to 2010.


Note 9.  Deposits

         The  aggregate  amount  of jumbo  time  deposits,  each  with a minimum
         denomination  of $100,000 was  $6,339,277  and  $4,352,098  in 1998 and
         1997, respectively.

         At December 31, 1998, the scheduled  maturities of time deposits are as
         follows:

                                                (Amounts in Thousands)

               1999                                 $ 8 732 253
               2000                                   5 028 193
               2001                                   1 562 679
               2002                                         - -
               2003                                         - -
               2004 and thereafter                          - -
                                                    -----------
                                                    $15 323 125
                                                    ===========


<PAGE>




Note 10. Other Operating Expenses

         The components of other operating  expenses  consisted of the following
         for the years ended December 31:
                                            1998        1997           1996
                                         ---------  -----------   ------------

          Data processing               $   99 589  $    78 702   $     70 594
          Insurance                         24 626       21 498         29 192
          Professional fees                374 229      115 024        128 628
          Stationery and supplies           70 172       61 957         44 843
          Postage                           33 235       36 899         37 499
          Stockholder expense               77 524       18 116         10 294
          Other (includes no items in
            excess of 1% of
            total revenue)                 389 268      247 765        199 059
                                         ---------  -----------   ------------
                                        $1 068 643  $   579 961   $    520 109
                                         =========  ===========   ============


Note 11. Earnings Per Share

         The  following  shows the  weighted  average  number of shares  used in
         computing  earnings per share and the effect on weighted average number
         of shares of diluted potential common stock.  Potential dilutive common
         stock had no effect on income available to common stockholders.

<TABLE>
<CAPTION>

                                     1998                     1997                1996
                                        Per Share               Per Share             Per Share
                                Shares    Amount       Shares    Amount     Shares      Amount
                               -------   --------    ---------  ---------  -------    ----------
<S>                           <C>       <C>           <C>        <C>       <C>        <C>
         Basic earnings
           per share          1 890 666 $    .07    1 271 176   $    .45   1 249 634   $    .32
                                        ========                ========               ========
         Effect of dilutive
           securities:
             Stock options        5 585                 1 307                    - -
             Warrants               - -                22 726                    - -
                               --------              --------              ---------
         Diluted earnings
           per share          1 896 251 $   .07    1 295 209    $    .44   1 249 634   $    .32
                              ========= ========   =========    ========   =========   ========

</TABLE>


         Warrants  on  240,002  shares  of common  stock  were not  included  in
         computing diluted EPS in 1996 because their effects were antidilutive.

         Options on 30,675 shares of common stock were not included in computing
         diluted EPS in 1996 because their effects were antidilutive.


<PAGE>






Note 12. Commitments and Contingencies

         The Corporation  entered into a long-term lease for its main office and
         operations  center  which  expires in 2008.  The lease  contains  three
         five-year  renewal periods.  Total rent expense was $191,272,  $194,945
         and $197,096 for 1998, 1997 and 1996, respectively, and was included in
         occupancy expense.

         The following is a schedule by year of future  minimum  lease  payments
         required under the long-term noncancelable lease agreements.

               1999                     $  237 555
               2000                        256 371
               2001                        264 063
               2002                        271 985
               2003                        280 145
               Due thereafter            1 424 288
                                         ---------
                                        $2 734 407
                                        ==========

         The  Corporation  also  entered  into a long-term  lease for its future
         branch office on December 22, 1997.  The term of the lease is ten years
         commencing  June 1, 1998 or fifteen days  following  the issuance of an
         occupancy  permit,   whichever  occurs  last.  If  the  Certificate  of
         Occupancy  is not  granted,  the lease may be  declared  void by either
         party by providing written notice to the other party.

         The  Corporation is conducting a  comprehensive  review of its computer
         systems to identify the systems that could be affected by the Year 2000
         Issue,  and is developing a remediation  plan to resolve the Issue. The
         Issue   is   whether   computer   systems   will   properly   recognize
         date-sensitive  information when the year changes to 2000. Systems that
         do not properly  recognize such  information  could generate  erroneous
         data or cause a system to fail. The Corporation is heavily dependent on
         computer processing in the conduct of its business activities.  Failure
         of these systems could have a significant  impact on the  Corporation's
         operations.

         In  the  normal  course  of  business  there  are  outstanding  various
         commitments and contingent liabilities,  which are not reflected in the
         accompanying  consolidated  financial  statements.  Management does not
         anticipate any material losses as a result of these transactions.

         See   Note   15   with   respect   to   financial    instruments   with
         off-balance-sheet risk.



<PAGE>





Note 13. Stock-Based Compensation

         In 1998, the stockholders  approved an employee  incentive stock option
         plan.  The  option  price for shares  granted  under this plan shall be
         determined by a Committee of the Corporation's Board of Directors,  but
         in no event shall the option  price be less than the fair market  value
         of the  Corporation's  stock  at the  time of  grant.  The term of each
         option  granted  under the plan is ten years,  unless the  optionee has
         been discharged from his or her employment by the Corporation for cause
         in which case the  option  must be  exercised  no later than six months
         following the date of discharge. The maximum aggregate number of shares
         which may be optioned and sold under the plan is 75,000  shares.  As of
         December 31, 1998, 8,925 options were outstanding under this plan.

         In 1992, the Corporation adopted a nonqualified stock option plan which
         full-time  employees and part-time  employees working at least 25 hours
         per week were  eligible  to receive  options to acquire  Common  Stock.
         Options  expire  ten years  after the date of grant.  There are  20,625
         options outstanding under this plan as of December 31, 1998.

         Grants under the above plans are  accounted  for  following APB Opinion
         No. 25 and related interpretations.  Accordingly,  no compensation cost
         has been  recognized  for  grants  under the  stock  option  plans.  No
         employee   stock  options  were  granted  during  1997  and  1996.  Had
         compensation cost for the employee  stock-based  compensation plan been
         determined  based on the grant date fair  values of awards  (the method
         described in FASB Statement No. 123),  reported net income and earnings
         per common share would have been reduced to the pro forma amounts shown
         below for 1998:

               Net income:
                As reported                         $  133 405
                Pro forma                           $  116 581

               Basic earnings per share:
                As reported                         $     0.07
                Pro forma                           $     0.06

               Diluted earnings per share:
                As reported                         $     0.07
                Pro forma                           $     0.06

         The fair value of each grant is  estimated  at the grant date using the
         Black-Scholes  option-pricing  model.  The following  weighted  average
         assumptions for grants in 1998 were used:  price  volatility of 20.94%;
         risk-free interest rate of 4.50%; dividend rate of 0% and expected life
         of 10 years.


<PAGE>




         The status of the Option Plans during 1998 and 1997 is as follows:

<TABLE>
<CAPTION>

                          1998                        1997                  1996
                 ---------------------------------------------------------------------------
                             Weighted                    Weighted                  Weighted
                             Average                     Average                    Average
                 Number      Exercise        Number      Exercise    Number        Exercise
                of Shares      Price        of Shares      Price    of Shares       Price
                 ---------------------------------------------  ----------------------------
<S>               <C>        <C>           <C>          <C>         <C>           <C>

Outstanding at
  January 1        27 375    $   3.43         30 675      $ 3.51     40 675         $   3.26
    Granted         8 925        3.875           - -         - -        - -              - -
    Exercised      (2 700)       3.64            - -         - -        - -              - -
    Canceled       (4 050)       4.13         (3 300)       4.20    (10 000)            2.50
                  -------                     ------                -------
Outstanding at
  December 31      29 550    $   3.45         27 375      $ 3.43     30 675         $   3.51
                 ========                    =======                =======


Exercisable at
  end of year      29 550                     27 375                 30 675
                =========                   ========                 ======


Weighted-average
  fair value per
  option of options
  granted during
  the year       $   1.69                   $    - -               $    - -
                 ========                   ========                ========
</TABLE>

          The status of the  options  outstanding  at  December  31,  1998 is as
          follows:

                                         Number                     Weighted
                         Range of      Outstanding    Remaining     Average
                        Exercise         and         Contractual    Exercise
                           Price        Exercisable     Life         Price
                         -------       -----------  ------------   ----------

                           $3.10 - $3.15    18 125      1.75 years      $3.14
                             $3.875          8 925      9.75             3.875
                             $4.10           2 500       .75             4.10
                                          --------
                                            29 550      5.77             3.45
                                          ========



<PAGE>





Note 14.  Director Compensation Plan

          In 1998,  the  stockholders  approved a stock  option plan for outside
          directors of the Corporation. The option price for shares to be issued
          upon  exercise  of  any  option  granted  under  this  plan  shall  be
          determined by a Committee of the Corporation's Board of Directors, but
          in no event shall the option  price be less than the fair market value
          of the  Corporation's  stock  at the time of  grant.  The term of each
          option  granted  under  this plan  shall be ten years from the date of
          grant. If a director  resigns or is removed from the Board, all of the
          Director's stock options must be exercised within sixty days of his or
          her departure from the Board.  The maximum  aggregate number of shares
          which may be optioned and sold under the plan is 75,000 shares.  As of
          December 31, 1998, 16,000 options were outstanding under this plan.

          On March 26, 1997,  the Board of Directors  granted  stock  options to
          those members  serving on the Bank's Board of Directors,  who were not
          employees  or  officers  of the Bank,  to acquire  common  stock at an
          exercise price of $2.86.  The options expire ten years after the grant
          date, unless the Director ceases to be a member of the Bank's Board of
          Directors,  in which case the options expire sixty days following such
          date. As of December 31, 1998, there were 10,000 options outstanding.

          The status of the Option Plan during 1998 and 1997 is as follows:

                                               1998                   1997
                                  --------------------------------------------
                                             Weighted                Weighted
                                              Average                Average
                                    Number    Exercise     Number     Exercise
                                  of Shares   Price      of Shares    Price
                                  ---------   --------  ----------   ---------

          Outstanding at January 1   10 000   $   2.86       - -     $    - -
          Granted                    16 000       3.875   10 000         2.86
          Exercised                     - -         - -      - -          - -
          Forfeited                     - -         - -      - -          - -
                                     ------               ------
          Outstanding at December 31 26 000       3.48    10 000     $   2.86
                                     =======              ======

          The status of the options  outstanding  as of December  31, 1998 is as
          follows:

                    Weighted
                     Average                       Remaining
                     Exercise                     Contractual
                       Price          Number         Life
                      -------       ---------    -----------

                   $   2.86          10 000        8.25 years
                       3.875         16 000        9.75
                                    -------
                   $   3.48          26 000        9.17
                                    =======


<PAGE>




Note 15.  Financial Instruments With Off-Balance-Sheet Risk

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

          The   Corporation's   exposure   to  credit   loss  in  the  event  of
          nonperformance  by the other  party to the  financial  instrument  for
          commitments  to  extend  credit  and  standby  letters  of  credit  is
          represented  by the  contractual  amount  of  those  instruments.  The
          Corporation  uses the same credit  policies in making  commitments and
          conditional obligations as it does for on-balance-sheet instruments.

          A summary of the  contract  or  notional  amount of the  Corporation's
          exposure to off-balance-sheet risk as of December 31, 1998 and 1997 is
          as follows:

                                                          1998           1997
                                                    -----------   ------------
            Financial instruments whose contract
             amounts represent credit risk:
              Commitments to extend credit         $  8 708 866   $   6 654 155
              Standby letters of credit            $    181 900   $     191 257

         Commitments  to extend  credit are  agreements to lend to a customer as
         long as there  is no  violation  of any  condition  established  in the
         contract.  Commitments  generally have fixed  expiration dates or other
         termination clauses and may require payment of a fee. Since many of the
         commitments  are expected to expire without being drawn upon, the total
         commitment   amounts  do  not   necessarily   represent   future   cash
         requirements.   The  Corporation   evaluates  each  customer's   credit
         worthiness on a case-by-case basis. The amount of collateral  obtained,
         if deemed  necessary by the  Corporation  upon extension of credit,  is
         based on management's credit evaluation of the counterparty. Collateral
         held varies but may include accounts  receivable,  inventory,  property
         and equipment, and income-producing commercial properties.

         Standby  letters of credit are  conditional  commitments  issued by the
         Corporation  to  guarantee  the  performance  of a customer  to a third
         party.  Those  guarantees  are primarily  issued to support  public and
         private  borrowing  arrangements,   including  commercial  paper,  bond
         financing,  and  similar  transactions.  The credit  risk  involved  in
         issuing  letters of credit is essentially  the same as that involved in
         extending loan facilities to customers.  The Corporation holds cash and
         marketable securities supporting those commitments for which collateral
         is  deemed   necessary.   The  extent  of  collateral  held  for  those
         commitments  at December 31, 1998 varies from 0 percent to 100 percent;
         the average amount collateralized is 85 percent.

         The Corporation  maintains its cash accounts in other commercial banks.
         The amount on deposit with  correspondent  institutions at December 31,
         1998,  exceeded the insurance  limits of the Federal Deposit  Insurance
         Corporation by $55,465.


<PAGE>




Note 16. Restrictions on Transfers to Parent

         Transfers of funds from banking subsidiary to the Parent Corporation in
         the form of loans,  advances  and cash  dividends,  are  restricted  by
         federal and state regulatory authorities.  As of December 31, 1998, the
         aggregate amount of unrestricted  funds which could be transferred from
         the  banking  subsidiary  to  the  Parent  Corporation   without  prior
         regulatory approval totaled $1,107,554 or 12.4% of the consolidated net
         assets.


Note 17. Capital Requirements

         The Corporation is subject to various regulatory  capital  requirements
         administered by the Federal banking  agencies.  Failure to meet minimum
         capital   requirements  can  initiate  certain   mandatory  -  possibly
         additional  discretionary - actions by regulators  that, if undertaken,
         could  have a direct  material  effect on the  Corporation's  financial
         statements.  Under  capital  adequacy  guidelines  and  the  regulatory
         framework  for prompt  corrective  action,  the  Corporation  must meet
         specific capital guidelines that involve  quantitative  measures of the
         Corporation's assets, liabilities,  and certain off-balance-sheet items
         as calculated under regulatory accounting practices.  The Corporation's
         capital  amounts and  classification  are also  subject to  qualitative
         judgments by the regulators  about  components,  risk  weightings,  and
         other factors.

         Quantitative  measures  established  by  regulation  to ensure  capital
         adequacy require the Corporation to maintain minimum amounts and ratios
         (set  forth  in the  table  below)  of  total  and  Tier 1  capital  to
         risk-weighted  assets,  and  of  Tier  1  capital  to  average  assets.
         Management  believes,  as of December  31, 1998,  that the  Corporation
         meets all capital adequacy requirements to which it is subject.

         As of December 31, 1998, the most recent  notification from the Federal
         Reserve Bank categorized the Corporation as well capitalized  under the
         regulatory framework for prompt corrective action. To be categorized as
         well   capitalized,   the  Corporation   must  maintain  minimum  total
         risk-based,  Tier 1 risk-based, and Tier 1 leverage ratios as set forth
         in the table. There are no conditions or events since that notification
         that management believes have changed the institution's category.

The  Corporation  and  Subsidiary's  actual capital  amounts and ratios are also
presented in the table.  No amount was deducted  from capital for  interest-rate
risk.


<PAGE>

<TABLE>
<CAPTION>

                                                                                   To Be Well
                                                                                Capitalized Under
                                                       For Capital            Prompt Corrective
                                Actual                 Adequacy Purposes       Action Provisions
                           -------------------    --------------------------  ------------------------
                           Amount        Ratio      Amount          Ratio         Amount      Ratio
                                           (Amount in Thousands)
<S>                       <C>           <C>         <C>            <C>           <C>          <C>
As of December 31, 1998:
  Total Capital (to Risk
    Weighted Assets)
      Consolidated        $  9 282      25.7%      >$2 886           >8.0%              N/A
                                                   -                 -
      The Heritage Bank   $  9 282      25.7%      >$2 886           >8.0%      >$  3 607     >10.0%
                                                   -                 -          -             -
  Tier 1 Capital (to Risk
    Weighted Assets)
      Consolidated        $  8 853      24.5%      >$1 443           >4.0%              N/A
                                                   -                 -
      The Heritage Bank   $  8 853      24.5%      >$1 443           >4.0%      >$  2 164      >6.0%
  Tier 1 Capital (to                               -                 -          -              -
    Average Assets)
      Consolidated        $  8 853      17.2%      >$2 060           >4.0%              N/A
                                                   -                 -
      The Heritage Bank   $  8 853      17.2%      >$2 060           >4.0%      >$  2 575      >5.0%
                                                   -                 -          -              -
As of December 31, 1997:
  Total Capital (to Risk
    Weighted Assets)
      Consolidated        $  5 051      18.6%      >$2 170           >8.0%              N/A
                                                   -                 -
      The Heritage Bank   $  5 051      18.6%      >$2 170           >8.0%      >$  2 712      >10.0%
  Tier 1 Capital (to Risk                          -                 -          -              -
    Weighted Assets)
      Consolidated        $  4 712      17.4%      >$1 085           >4.0%              N/A
                                                   -                 -
      The Heritage Bank   $  4 712      17.4%      >$1 085           >4.0%      >$  1 627      >6.0%
  Tier 1 Capital (to                               -                 -          -              -
    Average Assets)
      Consolidated        $  4 712      11.0%      >$1 714           >4.0%              N/A
                                                   -                 -
      The Heritage Bank   $  4 712      11.0%      >$1 714           >4.0%      >$  2 142      >5.0%
                                                   -                 -          -              -
</TABLE>

Note 18.  Common Stock

          On May 18, 1998, the Corporation  completed a secondary stock offering
          in which it sold  805,000  shares of common  stock at a price of $5.50
          per share.  Net proceeds for the  Corporation  were  $4,012,204  after
          deducting  underwriting  commissions  of $309,925 and direct  offering
          costs of $105,371.  On June 8, 1998, the Corporation  used part of the
          new capital to  complete an odd-lot  tender  offer,  purchasing  2,719
          shares at $5.50 per share for a total cost of $14,954.50.


<PAGE>




Note 19.    Parent Corporation Only Financial Statements

                            HERITAGE BANCORP, INC.
                          (Parent Corporation Only)

                                Balance Sheet
                              December 31, 1998



Assets

  Investment in subsidiary, at cost, plus
   equity in undistributed net income                           $8 927 664
                                                                ==========


Shareholders' Equity

  Common stock                                                  $2 294 617
  Surplus                                                        6 529 539
  Retained earnings                                                 28 549
  Accumulated other comprehensive income                            74 959
                                                                ----------

                                                                $8 927 664
                                                                ==========