<PAGE>
 
--------------------------------------------------------------------------------
                                 UNITED STATES
                      SECURITIES AND EXCHANGE COMMISSION
                            Washington, D.C. 20549
                            ----------------------

                                   FORM 10-K


                ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE
                SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED]


                 For the fiscal year ended  September 30, 1997
                                           -------------------

                     Commission file number       0-21083
                                           ------------------            


                         SOUTH STREET FINANCIAL CORP.
                        -------------------------------
             (Exact name of registrant as specified in its charter)

        North Carolina                                 56-1973261
-------------------------------           -----------------------------------
(State or other jurisdiction of           (I.R.S. Employer Identification No.)
incorporation or organization)

         155 West South Street   
       Albemarle, North Carolina                          28001
---------------------------------------                 ----------
(Address of principal executive office)                 (Zip Code)
 
                      
Registrant's telephone number, including area code  (704) 982-9184
                                                  ------------------
 

      Securities Registered Pursuant to Section 12(b) of the Act:   None
                                                                 -----------

          Securities Registered Pursuant to Section 12(g) of the Act:

                          Common Stock, no par value
                      -----------------------------------
                               (Title of class)

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

Indicate by check mark if disclosure of delinquent filers in response to Item
405 of Regulation S-K is not contained herein, and will not 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-K or any amendment to this
Form 10-K.            [X]

State the aggregate market value of the voting stock held by non-affiliates of
the registrant.  The aggregate market value shall be computed by reference to
the price at which the stock was sold, or the average bid and asked prices of
such stock, as of a specified date within 60 days prior to the date of filing.
$75,232,433 common stock, no par value, based on the closing price of such
--------------------------------------------------------------------------
common stock on December 9, 1997.
----------------------------------

Indicate the number of shares outstanding of each of the registrant's classes of
common stock, as of the latest practicable date. 4,676,360 shares of common 
                                                 --------------------------
stock, no par value, outstanding at December 9, 1997.
-----------------------------------------------------
<PAGE>
 
                      DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Annual Report of South Street Financial Corp. for the year ended
September 30, 1997, are incorporated by reference into Part I, Part II and 
Part IV.

Portions of the Proxy Statement for the 1998 Annual Meeting of Shareholders of
South Street Financial Corp. to be held on February 9, 1998, are incorporated by
reference into Part III.

                                       2
<PAGE>
 
                                     PART I


ITEM 1.  BUSINESS

General

          Prior to October 2, 1996, Home Savings Bank of Albemarle, Inc., S.S.B.
(the "Bank") operated as a mutual North Carolina-chartered savings bank.  On
October 2, 1996, the Bank converted from a North Carolina-chartered mutual
savings bank to a North Carolina-chartered stock savings bank (the
"Conversion").  In connection with the Conversion, all of the issued and
outstanding capital stock of the Bank was acquired by South Street Financial
Corp., a North Carolina corporation (the "Company") which was organized to
become the holding company for the Bank.  At that time, the Company had an
initial public offering of its common stock, no par value (the "Common Stock").

          The Company is a bank holding company registered with the Board of
Governors of the Federal Reserve System (the "Federal Reserve") under the Bank
Holding Company Act of 1956, as amended (the "BHCA") and the savings bank
holding company laws of North Carolina.  The Company's office is located at 155
West South Street, Albemarle, North Carolina.  The Company's activities consist
of investing the proceeds of its initial public offering which were retained at
the holding company level, holding the indebtedness outstanding from the Home
Savings Bank of Albemarle, Inc., SSB Employee Stock Ownership Plan (the "ESOP")
and owning the Bank.  The Company's principal sources of income are earnings on
its investments and interest payments received from the ESOP with respect to the
ESOP loan.  In addition, the Company will receive any dividends which are
declared and paid by the Bank on its capital stock.

          The Bank was originally chartered in 1911.  It has been a member of
the Federal Home Loan Bank ("FHLB") system since 1954 and its deposits are
federally insured up to allowable limits.

          The Bank is engaged primarily in the business of attracting retail
deposits from the general public and using such deposits to make mortgage loans
secured by real estate.  The Bank makes mortgage loans secured by residential
real property, including one-to-four family residential real estate loans, home
equity line of credit loans and other subordinate lien loans, loans secured by
improved nonresidential real property, loans secured by undeveloped real
property and construction loans.  The Bank also makes a limited number of loans
which are not secured by real property, such as loans secured by savings
accounts.  The Bank's primary source of revenue is interest income from its
lending activities.  The Bank's other major sources of revenue are interest and
dividend income from investments and mortgage-backed securities, interest income
from its interest-bearing deposit balances in other depository institutions and
fee income from its lending and deposit activities.  The major expenses of the
Bank are interest on deposits and noninterest expenses such as compensation and
fringe benefits, federal deposit insurance premiums, data processing expenses
and branch occupancy and related expenses.

          The operations of the Bank and depository institutions in general are
significantly influenced by general economic conditions and by related monetary
and fiscal policies of depository institution regulatory agencies, including the
Federal Reserve, the Federal Deposit Insurance Corporation (the "FDIC") and the
North Carolina Administrator, Savings Institutions Division, North Carolina
Department of Commerce (the "Administrator").  Deposit flows and 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
of 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 local demand and availability of funds.

          At September 30, 1997, the Company had total assets of $241.1 million,
net loans of $112.0 million, deposits of $141.8 million, investment securities
of $123.0 million and stockholders' equity of $61.7 million.

          At September 30, 1997, the Company and the Bank had a total of 38
employees, all of whom are full-time.

                                       3
<PAGE>
 
          The Company has no operations and conducts no business of its own
other than owning the Bank, investing its portion of the net proceeds received
in the Conversion and lending funds to the ESOP.  Accordingly, the discussion of
the business which follows in the Form 10-K concerns the business conducted by
the Bank, unless otherwise indicated.

Market Area

          The Bank's primary market area is Stanly County, North Carolina.  The
Bank's principal office is in Albemarle, North Carolina and it has one full-
service branch in Locust, North Carolina.  Stanly County is located in south
central North Carolina;  Albemarle is approximately 30 miles from Charlotte,
North Carolina.

          The Bank's loans and deposits are primarily generated from the areas
where its offices are located.  It does not solicit deposits and loans outside
its primary market area and does not use brokers to obtain deposits.
Approximately 87% of the Bank's deposits are at the Albemarle office. Stanly
County is largely rural with a population of 56,000. Its economy is diversified
among manufacturing, trade and services.  Major area employers include
Wiscassett Mills Company, Collins and Aikman Corporation, Michelin Aircraft Tire
Company and Alcoa Aluminum Company.  Within the past five years several large
manufacturing companies have closed operations in Stanly County, resulting in
the loss of approximately 2,000 jobs.  Over the past five years the local
economy has weakened as a result of layoffs and plant closings by local
employers.  The North Carolina Department of Commerce has declared Stanly a
"distressed county" entitling it to use state grants and tax credits to lure
industry to the area.  Population and household growth, and median and per
capita income levels for Stanly County are generally lower than comparable
levels for North Carolina and the nation, while unemployment levels are
generally higher. Management regards the Stanly County market area as a low
growth area in which there is significant competition among financial services
providers for market share.  Management believes that opportunities for future
earnings growth in the Bank's primary market area are limited in light of these
factors.

Lending Activities

          General.  The Bank's primary source of revenue is interest and fee
income from its lending activities, consisting primarily of mortgage loans for
the purchase or refinancing of one-to-four family residential real property
located in its primary market area.  The Bank also makes loans secured by
improved nonresidential real estate, construction loans, loans secured by
undeveloped real estate and savings account loans.  Approximately 99% of the
Bank's net loan portfolio is secured by real estate.  As of September 30, 1997,
all of the loans in the Bank's real estate loan portfolio were secured by
properties in North Carolina.  On September 30, 1997, the Bank's largest single
outstanding loan had a balance of approximately $1.1 million.  This loan was
performing in accordance with its original terms.  In addition to interest
earned on loans, the Bank receives fees in connection with loan originations,
loan servicing, loan modifications, late payments, loan assumptions and other
miscellaneous services.

          Loan Portfolio Composition.  The Bank's net loan portfolio totaled
approximately $112.0 million at September 30, 1997 representing 46.5% of the
Bank's total assets at such date.  At September 30, 1997, 85.7% of the Bank's
net loan portfolio was composed of one-to-four family residential mortgage
loans.  Home equity loans, all of which have adjustable rates, represented 3.0%
of the Bank's net loan portfolio, and nonresidential real estate loans
represented 3.4% of the Bank's net loan portfolio on such date.

          The Bank no longer originates adjustable rate mortgage loans,
excluding home equity loans, but continues to hold a small number of adjustable
rate loans in its portfolio.  As of September 30, 1997, 3.2% of the loans in the
Bank's loan portfolio, excluding home equity loans, had adjustable interest
rates.

          The following table sets forth the composition of the Bank's loan
portfolio by type of loan at the dates indicated.

                                       4
<PAGE>
 
<TABLE>
<CAPTION>
                                                               At September 30,
                       ----------------------------------------------------------------------------------------------
                              1997               1996              1995               1994               1993
                       -----------------  -----------------  -----------------  ----------------- -------------------
                                  % of               % of               % of               % of                 % of
                        Amount    Total    Amount    Total    Amount    Total    Amount    Total    Amount     Total
                        ------    -----    ------    -----    ------    -----    ------    -----    ------     ----- 
                                                           (Dollars in Thousands)
<S>                    <C>       <C>      <C>       <C>      <C>       <C>      <C>       <C>      <C>        <C>   
Real estate loans:

  Residential
   1-4 family          $ 95,984   85.71%  $ 93,275   84.90%  $ 94,036   86.60%  $ 91,674   85.80%  $100,437    85.80%

  Residential                                                                                                 
   multi-family             555    0.50%       695    0.63%       840    0.77%       870    0.81%       731     0.62%

  Nonresidential                                                                                              
   real estate            3,774    3.37%     4,038    3.67%     3,013    2.77%     3,157    2.95%     3,655     3.12%

  Residential                                                                                                 
   construction           8,394    7.50%     4,720    4.30%     5,368    4.94%     6,015    5.63%     6,644     5.68%

  Land                    6,091    5.44%     6,304    5.74%     4,890    4.50%     4,998    4.68%     4,960     4.24%

  Line of credit          3,328    2.96%     3,786    3.45%     3,875    3.58%     4,056    3.81%     3,715     3.17%
                        -------  ------    -------  ------    -------  ------    -------  ------    -------   ------
  Total real estate                                                                                           
   loans:               118,126  105.48%   112,818  102.69%   112,022  103.16%   110,770  103.68%   120,142   102.63%
                        -------  ------    -------  ------    -------  ------    -------  ------    -------   ------ 
Consumer loans:                                                                                               
  Share                     488    0.44%       196    0.18%       110    0.10%       105    0.10%       290     0.25%
  Credit reserve             96    0.08%       470    0.43%       221    0.20%       176    0.16%       102     0.09%
                        -------  ------    -------  ------    -------  ------    -------  ------    -------   ------
  Total consumer
   loans                    584    0.52%       666    0.61%       331    0.30%       281    0.26%       392     0.34%
                        -------  ------    -------  ------    -------  ------    -------  ------    -------   ------
                                                                                                              
Less:                                                                                                         
  Unearned fees                                                                                               
   and discounts            636    0.57%       582    0.53%       519    0.48%       465    0.44%       440     0.38%
  Loans in process        5,655    5.05%     2,616    2.38%     3,100    2.85%     3,602    3.37%     2,895     2.47%
  Allowance for
   loan losses              429    0.38%       428    0.39%       137    0.13%       140    0.13%       144     0.12%
                        -------  ------    -------  ------    -------  ------    -------  ------    -------   ------
                                                                                                              
                                                                                                              
  Total reductions        6,720    6.00%     3,626    3.30%     3,756    3.46%     4,207    3.94%     3,479     2.97%
                        -------  ------    -------  ------    -------  ------    -------  ------    -------   ------
  Total loans                                                                                                 
   receivable, net     $111,990  100.00%  $109,858  100.00%  $108,597  100.00%  $106,844  100.00%  $117,055   100.00%
                        =======  ======    =======  ======    =======  ======    =======  ======    =======   ======
</TABLE>

          The following table sets forth the time to contractual maturity of the
Bank's loan portfolio at September 30, 1997.  Loans which have adjustable rates
are shown as being due in the period during which rates are next subject to
change while fixed rate and other loans are shown as due over the contractual
maturity.  Demand loans, loans having no stated maturity and overdrafts are
reported as due in one year or less.  The table does not include prepayments,
however, it does include scheduled principal repayments.  Prepayments and
scheduled repayments in the loan portfolio totaled $24.8 million, $20.2 million,
and $16.2 million in fiscal years ended September 30, 1997, 1996 and 1995,
respectively.  Amounts in the table are net of loans in process and are net of
unamortized loan fees.

                                       5
<PAGE>
 
<TABLE>
<CAPTION>

                                                                       At September 30, 1997
                                  --------------------------------------------------------------------------------------------

                                                     Over 1         Over 3           Over 5
                                    One Year         Year to       Years to         Years to        Over 10
                                     Or Less         3 Years        5 Years         10 Years         Years            Total
                                   ---------        ---------       ---------       ---------       ---------       ---------
                                                                          (In Thousands)
<S>                                <C>              <C>             <C>             <C>             <C>             <C>      
Mortgage loans:
Adjustable rate 1-4 family
   residential                     $   6,441        $       -       $       -       $       -       $       -       $   6,441
Fixed rate 1-4 family
   residential                         2,063              468           1,379          57,609          35,863          97,382
Other adjustable rate
   real estate loans                     427                -               -               -               -             427
Other fixed rate real
   estate loans                          630               41             227           6,270             417           7,585


Other loans                              234              350               -               -               -             584

Less:
   Allowance for loan losses            (429)               -               -               -               -            (429)
                                   ---------        ---------       ---------       ---------       ---------       ---------

                                   $   9,366        $     859       $   1,606       $  63,879       $  36,280       $ 111,990
                                   =========        =========       =========       =========       =========       =========
</TABLE>


         The following table sets forth the dollar amount at September 30, 1997
of all loans maturing or repricing on or after September 30, 1998 which have
fixed or adjustable interest rates.

<TABLE> 
<CAPTION> 
                                      Fixed                   Adjustable
                                      Rates                     Rates
                                   -----------                ---------- 
                                               (In Thousands)

               <S>                 <C>                        <C>     
               Mortgage loans      $   102,274                $        -

               Other loans
                                           350                         -
                                   -----------                ---------- 

                                   $   102,624                $        -
                                   ===========                ========== 
                                                                         
</TABLE> 

         Origination of Loans. Historically, the Bank has not originated its
one-to-four family residential mortgage or other loans with the intention that
they will be sold in the secondary market. Accordingly, the Bank originates
fixed rate one-to-four family residential real estate loans which satisfy the
Bank's underwriting requirements and are tailored to its local community, but do
not necessarily satisfy various technical FHLMC and FNMA underwriting
requirements and purchase requirements not related to documentation.

         Although the Bank believes that many of its nonconforming loans are
saleable in the secondary market, some of such nonconforming loans could be sold
only after the Bank incurred certain costs and/or discounted the purchase price.
As a result, the Bank's loan portfolio is less liquid than would be the case if
it was composed entirely of loans originated in conformity with secondary market
requirements. In addition, certain types of nonconforming loans are generally
thought to have greater risks of default and nonperformance. However, such loans
generally produce a higher yield than would be produced by conforming loans, and
the Bank has historically found that its origination of such loans 

                                       6
<PAGE>
 
has not resulted in a high level of nonperforming assets. These nonconforming
loans satisfy a need in the Bank's local community, and the Bank intends to
continue to originate nonconforming loans.

         Substantially all of the one-to-four family residential mortgage loans
originated by the Bank have a fixed rate of interest because there is very
little demand for adjustable rate loans in the Bank's market area. As a result,
the Bank offers 30-year fixed rate residential real estate loans but prices its
loans to encourage shorter terms of 10 to 15 years.

         The Bank has instituted a new marketing program in which all of the
Bank's loan officers visit local realtors to promote the Bank's residential
mortgage products.

         The table below sets forth the Bank's loan origination, purchase
activity and loan portfolio repayment experience during the periods indicated.

<TABLE>
<CAPTION>

                                                         Year Ended September 30,
                                             -----------------------------------------------
                                                1997              1996                1995
                                             ---------          ---------          ---------
                                                             (In Thousands)
<S>                                          <C>                <C>                <C>      
Loans receivable, net,
   beginning of period                       $ 109,858          $ 108,597          $ 106,844
                                             ---------          ---------          ---------

Loan originations:

   Residential 1-4 family                       17,998             13,773             10,190

   Residential multifamily                          --                 --                 58

   Nonresidential real estate                      524                 --                333

   Residential construction                      9,898              5,704              6,282

   Line of credit                                1,248                747                626

   Consumer                                        321              1,141                454
                                             ---------          ---------          ---------

     Total loan originations                    29,989             21,365             17,943

Principal repayments                           (24,763)           (20,234)           (16,192)

Other changes, net (1)                          (3,094)               130                  2
                                             ---------          ---------          ---------

Increase in loans receivable                     2,132              1,261              1,753
                                             ---------          ---------          ---------

Loans receivable, net, end of period         $ 111,990          $ 109,858          $ 108,597
                                             =========          =========          =========
</TABLE>

--------------------
(1)      Includes changes in deferred loan fees, allowance for loan losses and
         undisbursed portion of construction loans.

         Residential Real Estate Lending. The Bank's primary lending activity,
which it intends to continue to emphasize, is the origination of fixed-rate
mortgage loans to enable borrowers to purchase or refinance one-to-four family
residential real property. Consistent with the Bank's emphasis on being a
community-oriented financial institution, it is and has been the Bank's strategy
to focus its lending efforts in Stanly County, North Carolina and in contiguous
counties. On September 30, 1997, approximately 85.7% of the Bank's total net
real estate loan portfolio consisted of one-to-four family residential real
estate loans. These include both loans secured by detached single-family
residences and condominiums and loans secured by housing containing not more
than four separate dwelling units. Of such loans, excluding home equity loans,
2.8% had adjustable interest rates.

                                       7
<PAGE>
 
         The Bank also originates fixed-rate mortgage loans secured by owner
occupied property having terms generally ranging from 10 to 30 years in amounts
of up to 90% of the lesser of the value or purchase price. Private mortgage
insurance is always required if the loan amount exceeds 80% of the value of the
property. In addition, the Bank makes fixed-rate loans secured by non-owner
occupied residential real estate generally having terms of 15 to 20 years in
amounts of up to 80% of the value of the property. Substantially all of the
fixed-rate loans in the Bank's mortgage loan portfolio have due on sale
provisions allowing the Bank to declare the unpaid balance due and payable in
full upon the sale or transfer of an interest in the property securing the loan.

         While one-to-four family residential loans are normally originated for
10 to 30 year terms, such loans customarily remain outstanding for substantially
shorter periods because borrowers often prepay their loans in full upon sale of
the property pledged as security or upon refinancing the original loan. Thus,
average loan maturity is a function of, among other factors, the level of
purchase and sale activity in the real estate market, prevailing interest rates,
and the interest rates payable on outstanding loans. The thrift and mortgage
banking industries have generally used 12-year and 7-year average loan lives in
calculations calling for prepayment assumptions for 30-year residential loans
and 15-year residential loans, respectively. Management believes that the Bank's
recent loan prepayment experience has been shorter than these assumed average
loan lives due to recent periods of low interest rates and resulting high levels
of refinancing.

         The Bank requires title insurance for its one-to-four family
residential loans. The Bank also requires that fire and extended coverage
casualty insurance (and, if appropriate, flood insurance) be maintained in an
amount at least equal to the loan amount or replacement cost of the improvements
on the property securing the loans, whichever is greater.

         Residential Multifamily. At September 30, 1997, the Bank had
approximately $555,000 in outstanding loans secured by multifamily residential
real estate, comprising approximately .50% of its loan portfolio as of that
date. Substantially all of the Bank's loans secured by multifamily residential
real estate have fixed rates. Such loans are typically made to a maximum of 80%
of the lesser of the purchase price or appraised value of the property for a
maximum term of 20 years. All such loans are personally guaranteed by
individuals.

         Nonresidential Real Estate Lending. On September 30, 1997, the Bank had
$3.8 million in outstanding loans secured by nonresidential real estate,
including undeveloped land, comprising approximately 3.4% of its net loan
portfolio as of that date. Most of these loans are secured by office, retail,
other commercial real estate, as well as church properties. Loans secured by
undeveloped land generally do not exceed 65% of the appraised value of the real
estate securing the loans; loans secured by commercial real estate generally do
not exceed 80% of the appraised value of the real estate securing the loans.
Loans secured by commercial real estate and undeveloped land generally are
larger than one-to-four family residential loans and involve a greater degree of
risk. Payments on these loans depend to a large degree on results of operations
and management of the properties and may be affected to a greater extent by
adverse conditions in the real estate market or the economy in general. As of
September 30, 1997, the largest nonresidential real estate loan in the Bank's
loan portfolio totaled $1.1 million. This loan was performing in accordance with
the original loan contract.

         Home Equity Lines of Credit. At September 30, 1997, the Bank had
approximately $3.3 million in home equity line of credit loans, representing
approximately 3.0% of its net loan portfolio. These loans are often originated
at the time of the closing of a one-to-four family residential real estate loan
secured by the same property. The Bank's home equity lines of credit have
adjustable interest rates tied to prime interest rates plus a margin. The home
equity lines of credit require monthly payments until the loan is paid in full.
Home equity lines of credit are generally secured by subordinate liens against
residential real property. The Bank requires that fire and extended coverage
casualty insurance (and, if appropriate, flood insurance) be maintained in an
amount at least sufficient to cover its loan. Home equity loans are generally
limited so that the amount of such loans, along with any senior indebtedness,
does not exceed 80% of the value of the real estate security. Because home
equity loans involve revolving lines of credit which can be drawn over a period
of time, the Bank faces risks associated with changes in the borrower's
financial condition. Because home equity loans have adjustable interest rates
with no rate caps (other than usury limitations), increased delinquencies could
occur if interest rate increases occur and borrowers are unable to satisfy
higher payment requirements. The Bank 

                                       8
<PAGE>
 
intends to continue to emphasize its home equity program. The presence of home
equity loans in the Bank's portfolio allows the institution to manage the
interest sensitivity of its assets and liabilities because home equity lines of
credit have adjustable rates which are subject to change monthly and without any
significant rate caps.

         Construction Lending. The Bank makes construction loans primarily for
the construction of single-family dwellings. The aggregate outstanding balance
of such loans on September 30, 1997 was approximately $8.4 million, representing
approximately 7.5% of the Bank's net loan portfolio. Most of these loans were
made to persons who are constructing properties for the purpose of occupying
them. Loans made to individual property owners are "construction-permanent"
loans which generally provide for the payment of interest only during a
construction period, after which the loans convert to a permanent loan at fixed
rates having terms similar to other one-to-four family residential loans.
Construction loans to persons who intend to occupy the finished premises
generally have a maximum loan-to-value ratio of 90%.

         Construction loans are generally considered to involve a higher degree
of risk than long-term financing secured by real estate which is already
occupied. A lender's risk of loss on a construction loan is dependent largely
upon the accuracy of the initial estimate of the property's value at the
completion of construction and the estimated cost (including interest) of
construction. If the estimate of construction costs proves to be inaccurate, the
lender may be required to advance funds beyond the amount originally committed
in order to permit completion of construction. If the estimate of anticipated
value proves to be inaccurate, the lender may have security which has value
insufficient to assure full repayment.

         Consumer Loans. In addition to the loans described above, the Bank
provides overdraft lines of credit in amounts of up to $2,000. Payments are
required in amounts of 5% of the outstanding balance or $10, whichever is
greater. In addition, the Bank offers loans secured by savings accounts. As of
September 30, 1997, the Bank had approximately $584,000 of such loans
outstanding, representing approximately .5% of its net loan portfolio.

         Loan Solicitation, Processing and Underwriting. Loan originations are
derived from a number of sources such as referrals from real estate brokers,
present depositors and borrowers, builders, attorneys, walk-in customers and in
some instances, other lenders.

         During its loan approval process, the Bank assesses the applicant's
ability to make principal and interest payments on the loan and the value of the
property securing the loan. The Bank obtains detailed written loan applications
to determine the borrower's ability to repay and verifies responses on the loan
application through the use of credit reports, financial statements, and other
confirmations. Under current practice, the loan officer of the Bank analyzes the
loan application and the property involved, and an appraiser inspects and
appraises the property. The Bank requires independent fee appraisals on all
loans originated primarily on the basis of real estate collateral. The Bank also
obtains information concerning the income, financial condition, employment and
the credit history of the applicant.

         Mortgage loans of up to $300,000 are approved by the Bank's loan
committee which is composed of its President, Executive Vice President and one
other member of the Board of Directors. All loans in excess of $300,000 must be
approved by the entire Board of Directors.

         Normally, upon approval of a residential mortgage loan application, the
Bank gives a commitment to the applicant that it will make the approved loan at
a stipulated rate any time within a 30-day period. The loan is typically funded
at such rate of interest and on other terms which are based on market conditions
existing as of the date of the commitment. As of September 30, 1997, the Bank
had $7.1 million in such unfunded mortgage loan commitments. In addition, on
such date the Bank had $2.8 million in unfunded commitments for unused lines of
credit and letters of credit.

         Interest Rates, Terms, Points and Fees. Interest rates and fees charged
on the Bank's loans are affected primarily by the market demand for loans,
competition, the supply of money available for lending purposes and the Bank's
cost of funds. These factors are affected by, among other things, general
economic conditions and the policies of the federal government, including the
Federal Reserve, tax policies and governmental budgetary matters.

                                       9
<PAGE>
 
         In addition to earning interest on loans, the Bank receives fees in
connection with originating loans. Fees for loan servicing, loan modifications,
late payments, loan assumptions and other miscellaneous services in connection
with loans are also charged by the Bank.

         Nonperforming Assets and Asset Classification. When a borrower fails to
make a required payment on a loan and does not cure the delinquency promptly,
the loan is classified as delinquent. Delinquencies on all loans are reviewed
monthly by the Board of Directors. The normal procedure followed by the Bank
once a loan is classified as delinquent is to make contact with the borrower at
prescribed intervals in an effort to bring the loan to a current status, and
late charges are assessed as allowed by law. In most cases, delinquencies are
cured promptly. If a delinquency is not cured, the Bank normally, subject to any
required prior notice to the borrower, commences foreclosure proceedings. If the
loan is not reinstated within the time permitted for reinstatement, or the
property is not redeemed prior to sale, the property may be sold at a
foreclosure sale. In foreclosure sales, the Bank may acquire title to the
property through foreclosure, in which case the property so acquired is offered
for sale and may be financed by a loan involving terms more favorable to the
borrower than those normally offered. Any property acquired as a result of
foreclosure or by deed in lieu of foreclosure is classified as real estate owned
until such time as it is sold or otherwise disposed of by the Bank to recover
its investment. As of September 30, 1997, the Bank had two pieces of
single-family property classified as real estate owned. These properties were
recorded on the Bank's books at $18,000, the unpaid principal balance of loans
secured by such property. The appraised value of these properties exceeded their
unpaid principal balances. Real estate acquired through, or in lieu of, loan
foreclosure is initially recorded at fair value at the date of foreclosure,
establishing a new cost basis. After foreclosure, valuations are periodically
performed by management, and the real estate is carried at the lower of cost or
fair value minus costs to sell. Revenue and expenses from holding the properties
and additions to the valuation allowance are included in operations.

         The Bank continues to accrue interest on loans delinquent 90 days or
more. However, these loans are effectively placed on nonaccrual status as all
such interest income is reversed by the establishment of a reserve for
uncollected interest. Loans are returned to earning status when management
determines, based upon an evaluation of the underlying collateral, together with
the borrower's payment record and financial condition, that the borrower has the
capability and intent to meet the contractual obligations of the loan agreement.
Interest on loans placed on nonperforming status is charged off when management
determines it is not collectible. The allowance is established by a charge to
interest income equal to all interest previously accrued, and income is
subsequently recognized only to the extent cash payments are received until the
loan is returned to performing status. For the fiscal year ended September 30,
1997, interest income that would have been recorded net of interest income
actually recognized on nonperforming loans under the original terms of such
loans was $29,000.

         The following table sets forth information with respect to
nonperforming assets identified by the Bank, including nonperforming loans and
real estate owned at the dates indicated.

                                       10
<PAGE>
 
<TABLE>
<CAPTION>

                                                                               At September 30,
                                                 --------------------------------------------------------------------------------

                                                   1997              1996             1995              1994              1993
                                                 --------          --------          --------          --------          --------
                                                                              (Dollars in Thousands)
<S>                                              <C>               <C>               <C>               <C>               <C>  
Total nonaccrual loans
   Mortgage loans delinquent 90 days or more     $    490          $    631          $    923          $    910          $    762
   Consumer loans delinquent 90 days or more           20                23                58                36                82

Real estate owned                                      18                18               135               176               119
                                                 --------          --------          --------          --------          --------
   Total non-performing assets                   $    528          $    672          $  1,116          $  1,122          $    963
                                                 ========          ========          ========          ========          ========

Non-performing loans to total gross loans            0.43%             0.58%             0.87%             0.85%             0.70%

Non-performing assets to total assets                0.22%             0.31%             0.70%             0.76%             0.61%

Total assets                                     $241,061          $217,954          $159,863          $147,837          $157,909

Total gross loans                                $118,710          $113,484          $112,353          $111,051          $120,534
</TABLE>

         Applicable regulations require the Bank to "classify" its own assets on
a regular basis. In addition, in connection with examinations of savings
institutions, regulatory examiners have authority to identify problem assets
and, if appropriate, classify them. Problem assets are classified as
"substandard,""doubtful" or "loss," depending on the presence of certain
characteristics as discussed below.

         An asset is considered "substandard" if not adequately protected by the
current net worth and paying capacity of the obligor or the collateral pledged,
if any. "Substandard" assets include those characterized by the "distinct
possibility" that the insured institution will sustain "some loss" if the
deficiencies are not corrected. Assets classified as "doubtful" have all of the
weaknesses inherent in those classified "substandard" with the added
characteristic that the weaknesses present make "collection or liquidation in
full," on the basis of currently existing facts, conditions, and values, "highly
questionable and improbable". Assets classified "loss" are those considered
"uncollectible" and of such little value that their continuance as assets
without the establishment of a loss reserve is not warranted.

         As of September 30, 1997, the Bank had approximately $975,000 of loans
internally classified as "substandard", and no loans classified as "doubtful" or
"loss". The Bank also identifies assets which possess credit deficiencies or
potential weaknesses deserving close attention by management. These assets may
be considered "special mention" assets and do not yet warrant adverse
classification. At September 30, 1997, the Bank had approximately $1.0 million
of loans in the "special mention" category.

         When an insured institution classifies problem assets as either
substandard or doubtful, it is required to establish general allowances for loan
losses in an amount deemed prudent by management. These allowances represent
loss allowances which have been established to recognize the inherent risk
associated with lending activities and the risks associated with particular
problem assets. When an insured institution classifies problem assets as "loss,"
it charges off the balance of the asset. The Bank's determination as to the
classification of its assets and the amount of its valuation allowances is
subject to review by the FDIC and the Administrator which can order the
establishment of additional loss allowances.

                                       11
<PAGE>
 
         The following table sets forth at September 30, 1997, the Bank's
aggregate carrying value of the assets classified as substandard, doubtful, loss
or "special mention":
<TABLE> 
<CAPTION> 

                      
                          Special Mention List           Substandard                   Doubtful                        Loss
                          --------------------       --------------------        ---------------------         ---------------------


                           Number      Amount        Number        Amount        Number         Amount         Number         Amount
                           ------      ------        ------        ------        ------         ------         ------         ------


                                                              (Dollars in Thousands)
<S>                        <C>         <C>           <C>           <C>            <C>           <C>            <C>            <C> 
Real estate loans:
  Residential 1-4 family       30      $1,004            33        $  944            --          $    --           --           $ --

  Residential real estate      --          --            --            --            --               --           --             --

  Nonresidential real estate   --          --            --            --            --               --           --             --

  Residential construction     --          --            --            --            --               --           --             --

  Land                         --          --            --            --            --               --           --             --

  Line of credit               --          --             3            28            --               --           --             --

                             ----       -----          ----         -----          ----           ------         ----           ----
    Total real estate loans    30       1,004            36           972            --               --           --             --
                             ----       -----          ----         -----          ----           ------         ----           ----


Consumer loans:                                                                    
  Share                        --          --            --            --            --               --           --             --

  Credit reserve               --          --             3             3            --               --           --             --

    Total consumer loans       --          --             3             3            --               --           --             --

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

Total                          30      $1,004            39        $  975          $ --          $    --      $    --           $ --
                             ====       =====          ====         =====          ====           ======         ====           ====

</TABLE> 
                                                                               


         Allowance for Loan Losses. In originating loans, the Bank recognizes
that credit losses will be experienced and that the risk of loss will vary with,
among other things, the type of loan being made, the creditworthiness of the
borrower over the term of the loan and, in the case of a secured loan, the
quality of the security for the loan as well as general economic conditions. It
is management's policy to maintain an adequate allowance for loan losses based
on, among other things, the Bank's historical loan loss experience, evaluation
of economic conditions and regular reviews of delinquencies and loan portfolio
quality. Specific allowances are provided for individual loans when ultimate
collection is considered in doubt by management after reviewing the current
status of loans which are contractually past due and considering the fair value
of the security for the loans.

         Management continues to actively monitor the Bank's asset quality, to
charge off loans against the allowance for loan losses when appropriate and to
provide specific loss reserves 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 substantially from the economic conditions in the assumptions
used in making the initial determinations. During the fiscal year ended
September 30, 1997, the Bank maintained its level of allowance for loan losses
which management believes is adequate based on the risks inherent in the loan
portfolio.

                                       12
<PAGE>
 
         The following table describes the activity related to the Bank's
allowance for loan losses for the periods indicated.
<TABLE> 
<CAPTION> 

                                                                            Year Ended September 30,
                                                          ----------------------------------------------------------

                                                              1997         1996        1995        1994       1993
                                                           ----------   ----------  ----------  ----------  --------

                                                                            (Dollars In Thousands)
<S>                                                         <C>         <C>         <C>         <C>         <C>  
Balance, beginning of period                                 $ 428         $ 137       $ 140        $ 144     $ 144

Provision for loan losses                                        -           300           -            -         -

Charge-offs:

    Residential 1-4 family                                      (1)           (8)         (3)          (3)        -

    Line of credit                                               -           (10)          -           (1)       (1)

Recoveries:

    Residential 1-4 family                                       2             6            -           -         -

    Line of credit                                               -             3            -           -         1
                                                            ------        ------       ------      ------    ------
Balance, end of period                                       $ 429         $ 428        $ 137       $ 140     $ 144
                                                            ======        ======       ======      ======    ======

Net charge-offs (recoveries) as a % of average loans        (0.001%)       0.008%       0.003%      0.004%        -
outstanding

Allowance at period end as a % of nonperforming loans        84.12%        65.44%        13.97%      14.80%    17.06%

Allowance at period end as a % of nonperforming assets       81.25%        63.69%        12.28%      12.48%    14.95%

Allowance at period end as a % of total gross loans           0.36%         0.38%         0.12%       0.13%     0.12%
</TABLE> 

         The following table sets forth the composition of the allowance for
loan losses by type of loan at the dates indicated. The allowance is allocated
to specific categories of loans for statistical purposes only, and may be
applied to loan losses incurred in any loan category.

                                       13
<PAGE>

<TABLE> 
<CAPTION> 
                                                                       At September 30,
                                    --------------------------------------------------------------------------------------
                                              1997                          1996                          1995               
                                      -------------------            -------------------          -------------------
                                                    Amount of                     Amount of                     Amount of      
                                    Amount of       Loans to       Amount of      Loans to       Amount of      Loans to       
                                    Allowance      Gross Loans     Allowance     Gross Loans     Allowance     Gross Loans     
                                    ---------      -----------     ---------     -----------     ---------     -----------      
                                                                     (Dollars In Thousands)
<S>                                 <C>            <C>             <C>           <C>             <C>           <C>    
Real estate loans:

    Residential 1-4 family            $   262           80.86%        $  243          82.19%        $  125          83.70%

    Residential multi-family                1            0.47%             1           0.61%            --           0.75%

    Nonresidential real estate              4            3.18%             4           3.56%             3           2.68%


    Residential construction               --            7.07%            --           4.16%            --           4.78%

    Land                                    4            5.13%             6           5.56%            --           4.35%

    Line of credit                          7            2.80%            10           3.34%             8           3.45%
                                      -------          -------        ------         -------         -----         -------
          Total real estate loans         278           99.51%           264          99.42%           136          99.71%
                                      -------          -------        ------         -------         -----         -------

Consumer loans:

    Share                                  --            0.41%            --           0.17%            --           0.10%

    Credit reserve                         --            0.08%            --           0.41%             1           0.19%
                                      -------          -------        ------         -------         -----         -------

          Total consumer loans             --            0.49%            --           0.58%             1           0.29%
                                      -------          -------        ------         -------         -----         -------

Unallocated                               151               --           164              --            --              --   
                                      -------          -------        ------         -------         -----         -------

Total allowance for loan losses       $   429          100.00%        $  428         100.00%         $ 137         100.00%
                                      =======          =======        ======         =======         =====         =======

                                                        At September 30,
                                     --------------------------------------------------------
                                              1994                           1993
                                        -----------------              -----------------              
                                                     Amount of                    Amount of     
                                     Amount of        Loans to      Amount of      Loans to     
                                     Allowance       Gross Loans    Allowance     Gross Loans    
                                     ---------       -----------    ---------     -----------
                                                      (Dollars in Thousands)
<S>                                  <C>             <C>            <C>           <C>    
Real estate loans:

    Residential 1-4 family            $    77           82.60%        $  129          83.33%

    Residential multi-family               --            0.78%            --           0.61%

    Nonresidential real estate              4            2.83%             6           3.03%

    Residential construction               --            5.41%            --           5.51%

    Land                                   --            4.50%            --           4.12%

    Line of credit                         --            3.64%            --           3.08%
                                      -------          -------        ------         -------

          Total real estate loans          81           99.76%           135          99.68%
                                      -------          -------        ------         -------
                                

Consumer loans:

    Share                                  --            0.09%            --           0.08%

    Credit reserve                         --            0.15%            --           0.24%
                                      -------          -------        ------         -------

          Total consumer loans             --            0.24%            --           0.32%
                                      -------          -------        ------         -------

Unallocated                                59              --              9             --
                                      -------          -------        ------         -------
Total allowance for loan losses       $   140          100.00%        $  144         100.00%
                                      =======          =======        ======         =======
</TABLE> 
                                
<PAGE>
 
Investment Securities

         Interest and dividend income from investment securities generally
provides the second largest source of income to the Bank after interest on
loans. In addition, the Bank receives interest income from deposits in other
financial institutions. On September 30, 1997, the carrying value of the Bank=s
investment securities portfolio totaled approximately $123.0 million and
consisted of interest-bearing deposits, U.S. government and agency securities,
mortgage-backed securities, FHLMC stock, stock in the FHLB of Atlanta and in
Central Service Corporation. The investment securities portfolio includes
interest-bearing deposits of $25.2 million at September 30, 1997. The
mortgage-backed securities consist of mortgage-backed securities issued by the
GNMA, FNMA and FHLMC.

         Investments in mortgage-backed securities involve a risk that, because
of changes in the interest rate environment, actual prepayments may be greater
than estimated prepayments over the life of the security, which may require
adjustments to the amortization of any premium or accretion of any discount
relating to such instruments, thereby reducing the net yield on such securities.
There is also reinvestment risk associated with the cash flows from such
securities. In addition, the market value of such securities may be adversely
affected by changes in interest rates.

         The FASB has issued Statement of Financial Accounting Standards No. 115
("SFAS 115"), "Accounting for Certain Investments in Debt and Equity Securities"
which addresses the accounting and reporting for investments in equity
securities that have readily determinable fair values and for all investments in
debt securities. These investments are to be classified in three categories and
accounted for as follows: (1) debt securities that the entity has the positive
intent and ability to hold to maturity are classified as held-to-maturity and
reported at amortized cost; (2) debt and equity securities that are bought and
held principally for the purpose of selling them in the near term are classified
as trading securities and reported at fair value, with net unrealized gains and
losses included in earnings; and (3) debt securities not classified as either
held-to-maturity or trading securities and equity securities not classified as
trading securities are classified as securities available-for-sale and reported
at fair value, with unrealized gains and losses excluded from earnings and
reported as a separate component of equity. The Bank has no trading securities.
See Notes 3 and 4 of "Notes to Financial Statements".

         The amortized cost of securities classified as held-to-maturity or
available-for-sale is adjusted for amortization of premiums and accretion of
discounts to maturity, or in the case of mortgage-backed securities, over the
estimated life of the security. Such amortization is included in interest income
from investments. Realized gains and losses, and declines in value judged to be
other than temporary are included in net securities gains (losses).
The cost of securities sold is based on the specific identification method.

         As a member of the FHLB of Atlanta, the Bank is required to maintain an
investment in stock of the FHLB of Atlanta equal to the greater of 1% of the
Bank's outstanding home loans or 5% of its outstanding advances from the FHLB of
Atlanta. No ready market exists for such stock, which is carried at cost.
As of September 30, 1997, the Bank's investment in stock of the FHLB of Atlanta
was $2.3 million.

         North Carolina regulations require the Bank to maintain a minimum
amount of liquid assets which may be invested in specified short-term
securities. The Bank is also permitted to make certain other securities
investments. The Bank's current investment policy states that the Bank's
investments will be limited to U.S. Treasury obligations, federal agency
securities, corporate notes and time deposits in the FHLB.

         Investment decisions are made by authorized officers of the Bank under
policies established by the Board of Directors. Such investments are managed in
an effort to produce the highest yield consistent with maintaining safety of
principal and compliance with regulations governing the savings industry.

         The following table sets forth certain information regarding the Bank's
interest-bearing deposits and the amortized cost and market values of the Bank's
investment and mortgage-backed securities portfolios at the dates indicated.

                                      15
<PAGE>
 
<TABLE> 
<CAPTION> 
                                                                         At September 30,
                                          ------------------------------------------------------------------------------------
                                                   1997                         1996                           1995
                                          ------------------------      -----------------------       ------------------------
                                          Amortized       Market        Amortized       Market        Amortized       Market
                                            Cost           Value          Cost           Value          Cost           Value
                                         ----------      ---------      ----------     ---------      ----------     ---------
                                                                       (In Thousands)
<S>                                      <C>            <C>            <C>             <C>            <C>            <C> 
Interest-bearing deposits(2)             $  25,187      $  25,187      $  59,348       $  59,348      $   8,622      $   8,622
                                         ---------      ---------      ---------       ---------      ---------      

Mortgage-backed securities, held to
maturity                                    21,661         21,561          5,496           5,511          4,529          4,642
                                         ---------      ---------      ---------       ---------      ---------      ---------

Investment Securities:
 Available for sale:
    U.S. Treasury and agency securities     68,556         68,639         34,827          34,769         30,907         30,959
Mortgage-backed securities                   4,901          4,932              -              -               -              -
Non-marketable equity securities:
   Federal Home Loan Bank stock              2,250          2,250          1,346           1,346          1,346          1,346
 Other                                         315            315             15              15             15             15
                                         ---------      ---------      ---------       ---------      ---------      ---------

                                            76,022         76,136         36,188          36,130         32,268         32,320
                                          ========      =========      =========       =========      =========      =========
Unrealized gain (loss) on securities
available for sale(1)                          114             -             (58)             -              52              -
                                         ---------      ---------      ---------       ---------      ---------      ---------

Total                                    $ 122,984      $ 122,884      $ 100,974       $ 100,989      $  45,471      $  45,584
                                         =========      =========      =========       =========      =========      =========
</TABLE> 

    (1)  The net unrealized gain (loss) at September 30, 1997, 1996 and 1995
         relates to available for sale securities in accordance with SFAS No.
         115. The net unrealized gain (loss) is presented in order to reconcile
         the "Amortized Cost" of the Bank's securities portfolio in the
         "Carrying Cost," as reflected in the Statements of Financial Condition.

    (2)  Includes interest-bearing cash and federal funds sold.

         The following table sets forth certain information regarding the
carrying value, weighted average yields and contractual maturities of the Bank's
interest-bearing deposits, investment and mortgage-backed securities as of
September 30, 1997.
<TABLE> 
<CAPTION> 
                                           After One Through     After Five Through
                        One Year or Less       Five Years             Ten Years            After Ten Years          Total
                      -------------------  -------------------   ------------------      ------------------   -------------------
<S>                   <C>        <C>       <C>        <C>        <C>       <C>           <C>      <C>         <C>        <C> 
                                 Weighted             Weighted             Weighted               Weighted               Weighted
                      Carrying   Average   Carrying    Average   Carrying   Average      Carrying  Average    Carrying    Average
                       Value      Yield      Value      Yield      Value     Yield         Value    Yield      Value       Yield
                      --------   --------  --------   --------   --------   -------      -------- --------    --------   -------- 
                                                                 (Dollars in Thousands)

Interest-bearing
  deposits            $ 25,187      5.58%   $     -          -   $      -         -      $      -        -    $ 25,187      5.58%
                                                                                                           
Mortgage-backed                                                                                            
  securities held to                                                                                       
  maturity                   -         -          -          -          -          -       21,661     8.03%     21,661      8.03%
                                                                                                           
Available-for-sale                                                                                         
  securities            15,513      5.60%     38,432      6.06%     10,806       7.14%      8,820     7.64%     73,571      6.31%
                                                                                                           
Federal Home Loan                                                                                          
  Bank Stock (1)             -         -           -         -           -          -       2,250     6.71%      2,250      6.71%
Other (1)                    -         -           -         -           -          -         315        -         315         -
                      --------     -----    --------     -----    --------      -----    --------     -----    -------      ----- 
Total                 $ 40,700      5.59%   $ 38,432      6.06%   $ 10,806       7.14%   $ 33,046     7.76%   $122,984      6.45%
                      ========     =====    ========     =====    ========      =====    ========     =====   ========      ===== 
</TABLE> 

(1) Nonmarketable equity security; substantially all required to be maintained
    and assumed to mature in period greater than 10 years.

                                      16
<PAGE>
 
Deposits and Borrowings

         General. Deposits are the primary source of the Bank's funds for
 lending and other investment purposes. In addition to deposits, the Bank
 derives funds from loan principal repayments, loan interest income, the stock
 offering, investment income, interest-bearing deposit income, interest income
 from mortgage-backed securities and otherwise from its operations. Loan
 repayments are a relatively stable source of funds while deposit inflows and
 outflows may be significantly influenced by general interest rates and money
 market conditions. Borrowings may be used on a short-term basis to compensate
 for reductions in the availability of funds from other sources. They may also
 be used on a longer term basis for general business purposes. The Bank has
 $35.0 million in borrowings outstanding from the FHLB of Atlanta at September
 30, 1997.

         Deposits. On September 30, 1997, 1996 and 1995, the Bank's deposits
totaled $141.8 million, $146.4 million, and $137.6 million, respectively.

         The following table sets forth information relating to the Bank's
 deposit flows during the periods shown and total deposits at the end of the
 periods shown.
<TABLE> 
<CAPTION> 


                                                At or For the Year Ended September 30,
                                    ---------------------------------------------------------------------------      
                                    1997              1996             1995             1994              1993
                                    ----              ----             ----             ----              ----
                                                                  (In Thousands)
<S>                               <C>               <C>              <C>              <C>               <C> 
Total deposits at                 $ 146,398         $ 137,647        $ 127,312        $ 139,685         $ 138,753
beginning of period

Net increase (decrease)             (11,998)              976            4,355          (17,346)           (5,105)
before interest credited

Interest credited                     7,355             7,775            5,980            4,973             6,037
                                  ---------         ---------        ---------        ---------         ---------

Total deposits at end of
period                            $ 141,755         $ 146,398        $ 137,647        $ 127,312         $ 139,685
                                  =========         =========        =========        =========         =========
</TABLE> 

         The Bank attracts both short-term and long-term deposits from the
 general public by offering a variety of accounts and rates. The Bank offers
 statement savings accounts, negotiable order of withdrawal accounts, money
 market accounts, and fixed interest rate certificates with varying maturities.
 All deposit flows are greatly influenced by economic conditions, the general
 level of interest rates, competition, and other factors, including the
 restructuring of the thrift industry. The Bank's savings deposits traditionally
 have been obtained primarily from its primary market area. The Bank utilizes
 traditional marketing methods to attract new customers and savings deposits,
 including print media advertising, local radio, local cable television and
 direct mailings. The Bank does not advertise for deposits outside of its local
 market area or utilize the services of deposit brokers. The vast majority of
 the Bank's depositors are residents of North Carolina. In the unlikely event
 the Bank is liquidated following the Conversion, depositors will be entitled to
 full payment of their deposit accounts prior to any payment being made to
 stockholders.


                                      17
<PAGE>
 
         The following table sets forth certain information regarding the
Bank's savings deposits at the dates indicated.
<TABLE> 
<CAPTION> 
                                                                          At June 30,
                           ---------------------------------------------------------------------------------------------------------

                                           1997                             1996                               1995
                             -----------------------------    ---------------------------------   ---------------------------------
                                      Weighted                            Weighted                            Weighted
                                       Average     % of                    Average       % of                  Average       % of
                             Amount     Rate      Deposits     Amount       Rate       Deposits     Amount       Rate      Deposits
                            --------  --------    --------    --------    ---------    ---------    --------  ---------    -------- 

                                                                                       (Dollars in Thousands)
<S>                        <C>        <C>        <C>          <C>        <C>          <C>         <C>        <C>          <C>  
Demand Accounts: (1)

  Passbook savings          $ 15,311     3.00%     10.80%     $ 17,953       3.00%      12.26%     $ 15,490       3.00%     11.25%

  NOW accounts                 7,307     2.32%      5.15%        6,369       2.59%       4.35%        6,331       3.02%      4.60%


  Money market deposit 
   accounts                    6,266     3.00%      4.42%        6,674       3.00%       4.56%        7,809       3.25%      5.67%

  Noninterest bearing 
  accounts                       689       --       0.49%          819         --        0.56%          562         --       0.41%
                              ------    ------      -----       ------      ------       -----       ------       -----      -----

      Total demand deposits   29,573     2.76%     20.86%       31,815       2.84%      21.73%       30,192       3.01%     21.93%
                              ------     -----     ------       ------       -----      ------       ------       -----     ------

Certificates of Deposit      111,957     5.85%     78.98%      114,307       5.96%      78.08%      107,280       6.10%     77.94%
                             -------     -----     ------      -------       -----      ------      -------       -----     ------

Accrued Interest                 225                0.16%          276                   0.19%          175                  0.13%
                              ------               ------       ------                  ------          ---                  -----

Total Deposits...........   $141,755     5.20%    100.00%     $146,398       5.21%     100.00%     $137,647       5.43%    100.00%
                            ========     =====    =======     ========       =====     =======     ========      ======    ======= 

</TABLE> 
         
         (1)     In addition, the Bank had deposits received for the stock
         offering totaling $46.6 million with a weighted average rate of 3.00%
         outstanding at September 30, 1996.

                 As of September 30, 1997, the aggregate amount of time
         certificates of deposit in amounts greater than or equal to $100,000
         was $13.3 million. (Some of these deposits were deposits of state and
         local governments which are subject to rebidding from time to time and
         to securitization requirements.) The following table presents the
         maturity of these time certificates of deposit at the dates indicated.
<TABLE> 
<CAPTION> 
                                                              At
                                                       September 30, 1997   
                                                       ------------------         
                                                         (In Thousands)
         <S>                                           <C> 

         3 Months or less                                 $3,485,000           
         Over 3 months through 6 months                    3,636,000
         Over 6 months through 12 months                   2,504,000
         Over 12 months                                    3,703,000
                                                           ---------
                  Total                                  $13,328,000
                                                         ===========
</TABLE> 

                 Borrowings. The FHLB system functions in a reserve credit
         capacity for savings institutions. As a member, the Bank is required to
         own capital stock in the FHLB of Atlanta and is authorized to apply for
         advances from the FHLB of Atlanta on the security of that stock and a
         floating lien on certain of its real estate secured loans and other
         assets. Each credit program has its own interest rate and range of
         maturities. Depending on the program, limitations on the amount of
         advances are based either on a fixed percentage of an institution's net
         worth or on the FHLB of Atlanta's assessment of the institution's
         creditworthiness. The Bank had $35.0 million outstanding borrowings
         from the FHLB of Atlanta at September 30, 1997.

                                      18


<PAGE>
 
Subsidiaries

          The Company has no subsidiaries other than the Bank. The Bank has no
subsidiaries.

 Competition

          The Bank faces strong competition both in attracting deposits and
 making real estate and other loans. Its most direct competition for deposits
 has historically come from other savings institutions, credit unions and
 commercial banks located in its primary market area, including large financial
 institutions which have greater financial and marketing resources available to
 them. The Bank has also faced additional significant competition for investors'
 funds from short-term money market securities and other corporate and
 government securities. At September 30, 1997, there were at least 7 other
 commercial banks, credit unions and mortgage companies as well as numerous
 other financial services providers located in the Bank's market area. At
 September 30, 1997, the Bank had a deposit market share of approximately 23% in
 Stanly County. The ability of the Bank to attract and retain savings deposits
 depends on its ability to generally provide a rate of return, liquidity and
 risk comparable to that offered by competing investment opportunities.

          The Bank experiences strong competition for real estate loans from
 other savings institutions, commercial banks, and mortgage banking companies.
 The Bank competes for loans primarily through the interest rates and loan fees
 it charges, the efficiency and quality of services it provides borrowers, and
 its more flexible underwriting standards. Competition may increase as a result
 of the continuing reduction of restrictions on the interstate operations of
 financial institutions.

          Employees are not represented by any union or collective bargaining
group, and the Bank considers its employee relations to be good.

 Federal Income Taxation

          Savings institutions such as the Bank are subject to the taxing
 provisions of the Code, for corporations, as modified by certain provisions
 specifically applicable for financial or thrift institutions. Income is
 reported using the accrual method of accounting. The maximum corporate federal
 income tax rate is 35%.

          For fiscal years beginning prior to December 31, 1995, thrift
 institutions which qualified under certain definitional tests and other
 conditions of the Code were permitted certain favorable provisions regarding
 their deductions from taxable income for annual additions to their bad debt
 reserve. A reserve could be established for bad debts on qualifying real
 property loans (generally loans secured by interests in real property improved
 or to be improved) under (i) a method based on a percentage of the
 institution's taxable income, as adjusted (the "percentage of taxable income
 method") or (ii) a method based on actual loss experience (the "experience
 method"). The reserve for nonqualifying loans was computed using the experience
 method.

          The percentage of taxable income method was limited to 8% of taxable
 income. This method could not raise the reserve to exceed 6% of qualifying real
 property loans at the end of the year. Moreover, the additions for qualifying
 real property loans, when added to nonqualifying loans, could not exceed 12% of
 the amount by which total deposits or withdrawable accounts exceed the sum of
 surplus, undivided profits and reserves at the beginning of the year. This
 limitation precluded the Bank from taking a bad debt deduction in its 1996 and
 1995 tax returns. The experience method was the amount necessary to increase
 the balance of the reserve at the close of the year to the greater of (i) the
 amount which bore the same ratio to loans outstanding at the close of the year
 as the total net bad debts sustained during the current and five preceding
 years bore to the sum of the loans outstanding at the close of such six years
 or (ii) the balance in the reserve account at the close of the last taxable
 year beginning before 1988 (assuming that the loans outstanding have not
 declined since such date).

          In order to qualify for the percentage of income method, an
 institution had to have at least 60% of its assets as "qualifying assets" which
 generally included, cash, obligations of the United States government or an
 agency or 

                                       19
<PAGE>
 
 instrumentality thereof or of a state or political subdivision, residential
 real estate-related loans, or loans secured by savings accounts and property
 used in the conduct of its business. In addition, it had to meet certain other
 supervisory tests and operate principally for the purpose of acquiring savings
 and investing in loans.

          Institutions which became ineligible to use the percentage of income
 method had to change to either the reserve method or the specific charge-off
 method that applied to banks. Large thrift institutions, those generally
 exceeding $500 million in assets, had to convert to the specific charge-off
 method. In computing its bad debt reserve for federal income taxes, the Bank
 used the reserve method in fiscal years 1997, 1996 and 1995.

          Bad debt reserve balances in excess of the balance computed under the
 experience method or amounts maintained in a supplemental reserve built up
 prior to 1962 ("excess bad debt reserve") require inclusion in taxable income
 upon certain distributions to its stockholders. Distributions in redemption or
 liquidation of stock or distributions with respect to its stock in excess of
 earnings and profits accumulated in years beginning after December 31, 1951,
 are treated as a distribution from the excess bad debt reserve. When such a
 distribution takes place and it is treated as from the excess bad debt reserve,
 the thrift is required to reduce its reserve by such amount and simultaneously
 recognize the amount as an item of taxable income increased by the amount of
 income tax imposed on the inclusion. Dividends not in excess of earnings and
 profits accumulated since December 31, 1951 will not require inclusion of part
 or all of the bad debt reserve in taxable income. The Bank has accumulated
 earnings and profits since December 31, 1951 and has an excess in its bad debt
 reserve. Distributions in excess of current and accumulated earnings and
 profits will increase taxable income. Net retained earnings at September 30,
 1997 includes approximately $2.9 million for which no provision for federal
 income tax has been made. See Note 13 to "Notes to Financial Statements".

          Legislation passed by the U.S. Congress and signed by the President in
 August 1996 contains a provision that repeals the percentage of taxable income
 method of accounting for thrift bad debt reserves for tax years beginning after
 December 31, 1995. The legislation will trigger bad debt reserve recapture for
 post-1987 excess reserves over a six-year period. At September 30, 1997, the
 Bank's post-1987 excess reserves amounted to approximately $1.0 million. A
 special provision suspends recapture of post-1987 excess reserves for up to two
 years if, during those years, the institution satisfies a "residential loan
 requirement." This requirement will be met if the principal amount of the
 institution's residential loans exceeds a base year amount, which is determined
 by reference to the average of the institution's residential loans during the
 six taxable years ending before January 1, 1996. However, notwithstanding this
 special provision, recapture will begin no later than the first taxable year
 beginning after December 31, 1997. The Bank met the requirement at September
 30, 1997.

          The Bank may also be subject to the corporate alternative minimum tax
 ("AMT"). This tax is applicable only to the extent it exceeds the regular
 corporate income tax. The AMT is imposed at the rate of 20% of the
 corporation's alternative minimum taxable income ("AMTI") subject to applicable
 statutory exemptions. AMTI is calculated by adding certain tax preference items
 and making certain adjustments to the corporation's regular taxable income.
 Preference items and adjustments generally applicable to financial institutions
 include, but are not limited to, the following: (i) the excess of the bad debt
 deduction over the amount that would have been allowable on the basis of actual
 experience; (ii) interest on certain tax-exempt bonds issued after August 7,
 1986; and (iii) 75% of the excess, if any, of a corporation's adjusted earnings
 and profits over its AMTI (as otherwise determined with certain adjustments).
 Net operating loss carryovers, subject to certain adjustments, may be utilized
 to offset up to 90% of the AMTI. Credit for AMT paid may be available in future
 years to reduce future regular federal income tax liability. The Bank has not
 been subject to the AMT in recent years.

          The Bank's federal income tax returns have not been audited in over 10
years.

 State Taxation

          Under North Carolina law, the corporate income tax is 7.50% of federal
 taxable income as computed under the Code, subject to certain prescribed
 adjustments. In addition, for tax years beginning in 1991, 1992, 1993 and 1994,
 corporate taxpayers were required to pay a surtax equal to 4%, 3%, 2% and 1%,
 respectively, of the state income tax 

                                       20
<PAGE>
 
 otherwise payable by it. An annual state franchise tax is imposed at a rate of
 0.15% applied to the greatest of the institutions (i) capital stock, surplus
 and undivided profits, (ii) investment in tangible property in North Carolina
 or (iii) appraised valuation of property in North Carolina.

          The North Carolina corporate tax rate will drop to 7.25% in 1998,
7.00% in 1999 and 6.90% thereafter.

                          SUPERVISION AND REGULATION

 Regulation of the Company

          General. The Company was organized for the purpose of acquiring and
 holding all of the capital stock of the Bank to be issued in the Conversion. As
 a bank holding company subject to the Bank Holding Company Act of 1956, as
 amended ("BHCA"), the Company is subject to certain regulations of the Federal
 Reserve. Under the BHCA, the Company's activities and those of its subsidiaries
 are limited to banking, managing or controlling banks, furnishing services to
 or performing services for its subsidiaries or engaging in any other activity
 which the Federal Reserve determines to be so closely related to banking or
 managing or controlling banks as to be a proper incident thereto. The BHCA
 prohibits the Company from acquiring direct or indirect control of more than 5%
 of the outstanding voting stock or substantially all of the assets of any bank
 or savings bank or merging or consolidating with another bank holding company
 or savings bank holding company without prior approval of the Federal Reserve.

          Additionally, the BHCA prohibits the Company from engaging in, or
 acquiring ownership or control of, more than 5% of the outstanding voting stock
 of any company engaged in a nonbanking business unless such business is
 determined by the Federal Reserve to be so closely related to banking as to be
 properly incident thereto.

          Similarly, Federal Reserve approval (or, in certain cases,
 non-disapproval) must be obtained prior to any person acquiring control of the
 Company. Control is conclusively presumed to exist if, among other things, a
 person acquires more than 25% of any class of voting stock of the holding
 company or controls in any manner the election of a majority of the directors
 of the holding company. Control is presumed to exist if a person acquires more
 than 10% of any class of voting stock and the stock is registered under Section
 12 of the Exchange Act or the acquiror will be the largest shareholder after
 the acquisition.

          There are a number of obligations and restrictions imposed on bank
 holding companies and their depository institution subsidiaries by law and
 regulatory policy that are designed to minimize potential loss to the
 depositors of such depository institutions and the FDIC insurance funds in the
 event the depository institution becomes in danger of default or in default.
 For example, to avoid receivership of an insured depository institution
 subsidiary, a bank holding company is required to guarantee the compliance of
 any insured depository institution subsidiary that may become
 "undercapitalized" with the terms of any capital restoration plan filed by such
 subsidiary with its appropriate federal banking agency up to the lesser of (i)
 an amount equal to 5% of the institution's total assets at the time the
 institution became undercapitalized or (ii) the amount which is necessary (or
 would have been necessary) to bring the institution into compliance with all
 acceptable capital standards as of the time the institution fails to comply
 with such capital restoration plan. Under a policy of the Federal Reserve with
 respect to bank holding company operations, a bank holding company is required
 to serve as a source of financial strength to its subsidiary depository
 institutions and to commit resources to support such institutions in
 circumstances where it might not do so absent such policy. The Federal Reserve
 under the BHCA also has the authority to require a bank holding company to
 terminate any activity or to relinquish control of a nonbank subsidiary (other
 than a nonbank subsidiary of a bank) upon the Federal Reserve's determination
 that such activity or control constitutes a serious risk to the financial
 soundness and stability of any bank subsidiary of the bank holding company.

          In addition, the "cross-guarantee" provisions of the Federal Deposit
 Insurance Act, as amended ("FDIA") require insured depository institutions
 under common control to reimburse the FDIC for any loss suffered by either the
 Savings Association Insurance Fund (the "SAIF") or the Bank Insurance Fund (the
 "BIF") as a result of the default of a commonly controlled insured depository
 institution or for any assistance provided by the FDIC to a commonly controlled
 insured depository institution in danger of default. The FDIC may decline to
 enforce the cross-guarantee 

                                       21
<PAGE>
 
 provisions if it determines that a waiver is in the best interest of the SAIF
 or the BIF or both. The FDIC's claim for damages is superior to claims of
 stockholders of the insured depository institution or its holding company but
 is subordinate to claims of depositors, secured creditors and holders of
 subordinated debt (other than affiliates) of the commonly controlled insured
 depository institutions.

          Federal regulations require that the Company must notify the Federal
 Reserve Bank of Richmond prior to repurchasing Common Stock in excess of 10% of
 its net worth during a rolling 12 month period. As a result of the Company's
 ownership of the Bank, the Company will be registered under the savings bank
 holding company laws of North Carolina. Accordingly, the Company is also
 subject to regulation and supervision by the Administrator.

          Capital Adequacy Guidelines for Holding Companies. The Federal Reserve
 has adopted capital adequacy guidelines for bank holding companies and banks
 that are members of the Federal Reserve system and have consolidated assets of
 $150 million or more. For bank holding companies with less than $150 million in
 consolidated assets, the guidelines are applied on a bank-only basis unless the
 parent bank holding company (i) is engaged in nonbank activity involving
 significant leverage or (ii) has a significant amount of outstanding debt that
 is held by the general public.

          Bank holding companies are required to comply with the Federal
 Reserve's risk-based capital guidelines. Under these regulations, the minimum
 ratio of total capital to risk-weighted assets (including certain off-balance
 sheet activities, such as standby letters of credit) is 8%. At least half of
 the total capital is required to be "Tier I capital," principally consisting of
 common stockholders' equity, noncumulative perpetual preferred stock, and a
 limited amount of cumulative perpetual preferred stock, less certain goodwill
 items. The remainder ("Tier II capital") may consist of a limited amount of
 subordinated debt, certain hybrid capital instruments and other debt
 securities, perpetual preferred stock, and a limited amount of the general loan
 loss allowance. In addition to the risk-based capital guidelines, the Federal
 Reserve has adopted a minimum Tier I capital (leverage) ratio, under which a
 bank holding company must maintain a minimum level of Tier I capital to average
 total consolidated assets of at least 3% in the case of a bank holding company
 which has the highest regulatory examination rating and is not contemplating
 significant growth or expansion. All other bank holding companies are expected
 to maintain a Tier I capital (leverage) ratio of at least 1% to 2% above the
 stated minimum.

          Federal Securities Law. The Company has registered its Common Stock
 with the SEC pursuant to Section 12(b) of the Exchange Act and will not
 deregister the Common Stock for a period of three years following the
 completion of the Conversion. As a result of such registration, the proxy and
 tender offer rules, insider trading reporting requirements, annual and periodic
 reporting and other requirements of the Exchange Act are applicable to the
 Company.

          The registration under the Securities Act of the Offerings of the
 Common Stock does not cover the resale of such shares. Shares of the Common
 Stock purchased by persons who are not affiliates of the Company may be resold
 without registration. Shares purchased by an affiliate of the Company are
 subject to the resale provisions of Rule 144 under the Securities Act. So long
 as the Company meets the current public information requirements of Rule 144
 under the Securities Act, each affiliate of the Company who complies with the
 other conditions of Rule 144 (including those that require the affiliate's sale
 to be aggregated with those of certain other persons) will be able to sell in
 the public market, without registration, a number of shares not to exceed, in
 any three-month period, the greater of (i) 1% of the outstanding shares of the
 Company or (ii) the average weekly volume of trading in such shares during the
 preceding four calendar weeks. Provision may be made in the future by the
 Company to permit affiliates to have their shares registered for sale under the
 Securities Act under certain circumstances. There are currently no demand
 registration rights outstanding. However, in the event the Company at some
 future time determines to issue additional shares from its authorized but
 unissued shares, the Company might offer registration rights to certain of its
 affiliates who want to sell their shares.

                                       22
<PAGE>
 
 Regulation of the Bank

          General. Federal and state legislation and regulation have
 significantly affected the operations of federally insured savings institutions
 and other federally regulated financial institutions in the past several years
 and have increased competition among savings institutions, commercial banks and
 other providers of financial services. In addition, federal legislation has
 imposed new limitations on investment authority, and higher insurance and
 examination assessments on savings institutions and has made other changes that
 may adversely affect the future operations and competitiveness of savings
 institutions with other financial institutions, including commercial banks and
 their holding companies. The operations of regulated depository institutions,
 including the Bank, will continue to be subject to changes in applicable
 statutes and regulations from time to time.

          The Bank is a North Carolina-chartered savings bank, is a member of
 the FHLB system, and its deposits are insured by the FDIC through the SAIF. It
 is subject to examination and regulation by the FDIC and the Administrator and
 to regulations governing such matters as capital standards, mergers,
 establishment of branch offices, subsidiary investments and activities, and
 general investment authority. Generally, North Carolina state chartered savings
 banks whose deposits are issued by the SAIF are subject to restrictions with
 respect to activities and investments, transactions with affiliates and
 loans-to-one borrower similar to those applicable to SAIF insured savings
 associations. Such examination and regulation is intended primarily for the
 protection of depositors and the federal deposit insurance funds.

          The Bank is subject to various regulations promulgated by the Federal
 Reserve including, without limitation, Regulation B (Equal Credit Opportunity),
 Regulation D (Reserves), Regulation E (Electronic Fund Transfers), Regulation O
 (Loans to Executive Officers, Directors and Principal Shareholders), Regulation
 Z (Truth in Lending), Regulation CC (Availability of Funds) and Regulation DD
 (Truth in Savings). As creditors of loans secured by real property and as
 owners of real property, financial institutions, including the Bank, may be
 subject to potential liability under various statutes and regulations
 applicable to property owners generally, including statutes and regulations
 relating to the environmental condition of real property.

          The FDIC has extensive enforcement authority over North
 Carolina-chartered savings banks, including the Bank. This enforcement
 authority includes, among other things, the ability to assess civil money
 penalties, to issue cease and desist or removal orders and to initiate
 injunctive actions. In general, these enforcement actions may be initiated in
 response to violations of laws and regulations and unsafe or unsound practices.

          The grounds for appointment of a conservator or receiver for a North
 Carolina savings bank on the basis of an institution's financial condition
 include: (i) insolvency, in that the assets of the savings bank are less than
 its liabilities to depositors and others; (ii) substantial dissipation of
 assets or earnings through violations of law or unsafe or unsound practices;
 (iii) existence of an unsafe or unsound condition to transact business; (iv)
 likelihood that the savings bank will be unable to meet the demands of its
 depositors or to pay its obligations in the normal course of business; and (v)
 insufficient capital or the incurring or likely incurring of losses that will
 deplete substantially all of the institution's capital with no reasonable
 prospect of replenishment of capital without federal assistance.

          Transactions with Affiliates. Under current federal law, transactions
 between the Bank and any affiliate are governed by Sections 23A and 23B of the
 Federal Reserve Act. An affiliate of the Bank is any company or entity that
 controls, is controlled by or is under common control with the savings bank.
 Generally, subsidiaries of a bank, other than a bank subsidiary, and certain
 other types of companies are not considered to be affiliates. 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 the Bank's capital stock and surplus, and contain an aggregate
 limit on 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 substantially the same, or at least as favorable, to the Bank or the
 subsidiary as those provided to a nonaffiliate. The term "covered transaction"
 includes the making of loans or other extensions of credit to an affiliate, the
 purchase of assets from an affiliate, the purchase of, or an investment in, the
 securities of an affiliate, the acceptance of securities of an affiliate as
 collateral for a loan or extension of credit to any person, or issuance of a
 guarantee, acceptance or letter of credit on behalf of an affiliate.

                                       23
<PAGE>
 
          Further, current federal law has extended to savings banks the
 restrictions contained in Section 22(h) of the Federal Reserve Act with respect
 to loans to directors, executive officers and principal stockholders. Under
 Section 22(h), loans to directors, executive officers and stockholders who,
 directly or indirectly, own more than 10% of any class of voting securities of
 a savings bank, and certain affiliated entities of any of the foregoing, may
 not exceed, together with all other outstanding loans to such person and
 affiliated entities, the savings bank's loans-to-one borrower limit as
 established by federal law (as discussed below). Section 22(h) also prohibits
 loans above amounts prescribed by the appropriate federal banking agency to
 directors, executive officers or stockholders who own more than 10% of a
 savings bank, and their respective affiliates, unless such loan is approved in
 advance by a majority of the disinterested directors of the board of directors
 of the savings bank and the Company. Any "interested" director may not
 participate in the voting. The Federal Reserve has prescribed the loan amount
 (which includes all other outstanding loans to such person), as to which such
 prior board of director approval is required, as being the greater of $25,000
 or 5% of unimpaired capital and unimpaired surplus (up to $500,000). Further,
 pursuant to Section 22(h) the Federal Reserve requires that loans to directors,
 executive officers, and principal stockholders be made on terms substantially
 the same as offered in comparable transactions to other persons and not involve
 more than the normal risk of repayment or present other unfavorable features.
 Section 22(h) also generally prohibits a depository institution from paying the
 overdrafts of any of its executive officers or directors.

          Deposit Insurance. The Bank is required to pay assessments based on a
 percentage of its insured deposits to the FDIC for insurance of its deposits by
 the SAIF. Under the FDIC's risk-based deposit insurance assessment system, the
 assessment rate for an insured depository institution depends on the assessment
 risk classification assigned to the institution by the FDIC, which is
 determined by the institution's capital level and supervisory evaluations.
 Based on the data reported to regulators for the date closest to the last day
 of the seventh month preceding the semi-annual assessment period, institutions
 are assigned to one of three capital groups -- well capitalized, adequately
 capitalized or undercapitalized -- using the same percentage criteria as in the
 prompt corrective action regulations. See "-- Regulation of the Bank - Prompt
 Corrective Regulatory Action." Within each capital group, institutions are
 assigned to one of three subgroups on the basis of supervisory evaluations by
 the institution's primary supervisory authority and such other information as
 the FDIC determines to be relevant to the institution's financial condition and
 the risk posed to the deposit insurance fund. Subgroup A consists of
 financially sound institutions with only a few minor weaknesses. Subgroup B
 consists of institutions that demonstrate weaknesses which, if not corrected,
 could result in significant deterioration of the institution and increased risk
 of loss to the deposit insurance fund. Subgroup C consists of institutions that
 pose a substantial probability of loss to the deposit insurance fund unless
 effective corrective action is taken. The assessment rate for SAIF members had
 ranged from 0.23% of deposits for well capitalized institutions in Subgroup A
 to 0.31% of deposits for undercapitalized institutions in Subgroup C while
 assessments for over 90% of the BIF members had been the statutory minimum of
 $2,000. The Bank's federal deposit insurance premium expense was $70,000 and
 $318,000, not including a one-time special SAIF assessment incurred for the
 year ended September 30, 1996, for the years ended September 30, 1997 and 1996,
 respectively.

          Legislation provided for a one-time assessment of 65.7 basis points
 for the year ended September 30, 1996 of insured deposits as of March 31, 1995,
 that fully capitalized the SAIF and had the effect of reducing future SAIF
 assessments. Accordingly, although the special assessment resulted in a
 one-time charge to the Bank of approximately $838,000 pre-tax, the
 recapitalization of the SAIF had the effect of reducing the Bank's future
 deposit insurance premiums to the SAIF. Under the recently enacted legislation,
 both BIF and SAIF members will be assessed an amount for the Financing
 Corporation Bond payments. BIF members will be assessed approximately 1.3 basis
 points while the SAIF rate will be approximately 6.4 basis points until January
 1, 2000. At that time, BIF and SAIF members will begin pro rata sharing of the
 payment at an expected rate of 2.43 basis points.

          Community Reinvestment Act. The Bank, like other financial
 institutions, is subject to the Community Reinvestment Act, as amended ("CRA").
 A purpose of this Act is to encourage financial institutions to help meet the
 credit needs of its entire community, including the needs of low- and
 moderate-income neighborhoods. During the Bank's last compliance examination
 the Bank received a "satisfactory" rating with respect to CRA compliance. The
 Bank's rating with respect to CRA compliance would be a factor to be considered
 by the Federal Reserve and FDIC in considering applications submitted by the
 Bank to acquire branches or to acquire or combine with other financial
 institutions and take other actions and could result in the denial of such
 applications.

                                       24
<PAGE>
 
          The federal banking regulatory agencies have issued a rewrite of the
 CRA regulations, which became effective on January 1, 1996, to implement a new
 evaluation system that rates institutions based on their actual performance in
 meeting community credit needs. Under the regulations, a savings bank will be
 evaluated and rated under three categories: a lending test, an investment test
 and a service test. For each of these three tests, the savings bank will be
 given a rating of either "outstanding," "high satisfactory," "low
 satisfactory," "needs to improve" or "substantial non-compliance." A set of
 criteria for each rating has been developed and is included in the regulation.
 If an institution disagrees with a particular rating, the institution has the
 burden of rebutting the presumption by clearly establishing that the
 quantitative measures do not accurately present its actual performance, or that
 demographics, competitive conditions or economic or legal limitations peculiar
 to the service area should be considered. The ratings received under the three
 tests will be used to determine the overall composite CRA rating. The composite
 ratings will be the same as those that are currently given: "outstanding,"
 "satisfactory," "needs to improve" or "substantial non-compliance."

          Capital Requirements Applicable To The Bank. The FDIC requires the
 Bank to have a minimum leverage ratio of Tier I capital (principally consisting
 of common stockholders' equity, noncumulative perpetual preferred stock and
 minority interests in consolidated subsidiaries, less certain intangible items,
 goodwill items, identified losses and investments in securities subsidiaries)
 to total assets of at least 3%; provided, however that all institutions, other
 than those (i) receiving the highest rating during the examination process and
 (ii) not anticipating or experiencing any significant growth, are required to
 maintain a ratio of 1% or 2% above the stated minimum, with an absolute minimum
 leverage ratio of not less than 4%. The FDIC also requires the Bank to have a
 ratio of total capital to risk-weighted assets, including certain off-balance
 sheet activities, such as standby letters of credit, of at least 8%. At least
 half of the total capital is required to be Tier I capital. The remainder
 ("Tier II capital") may consist of a limited amount of subordinated debt,
 certain hybrid capital instruments, other debt securities, certain types of
 preferred stock and a limited amount of loan loss allowance.

          An institution which fails to meet minimum capital requirements may be
 subject to a capital directive which is enforceable in the same manner and to
 the same extent as a final cease and desist order, and must submit a capital
 plan within 60 days to the FDIC. If the leverage ratio falls to 2% or less, the
 bank may be deemed to be operating in an unsafe or unsound condition, allowing
 the FDIC to take various enforcement actions, including possible termination of
 insurance or placement of the institution in receivership. At September 30,
 1997, the Bank had a leverage ratio of 18.91%.

          The Administrator requires that net worth equal at least 5% of total
 assets. Intangible assets must be deducted from net worth and assets when
 computing compliance with this requirement.

          At September 30, 1997, the Bank complied with each of the capital
requirements of the FDIC and the Administrator.

          Each federal banking agency is required to establish risk-based
 capital standards that take adequate account of interest rate risk,
 concentration of credit risk, and the risk of nontraditional activities, as
 well as reflect the actual performance and expected risk of loss on multifamily
 mortgages.

          On August 2, 1995, the federal banking agencies issued a joint notice
 of adoption of final risk based capital rules to take account of interest rate
 risk. The final regulation required an assessment of the need for additional
 capital on a case-by-case basis, considering both the level of measured
 exposure and qualitative risk factors. The final rule also stated an intent to,
 in the future, establish an explicit minimum capital charge for interest rate
 risk based on the level of a bank's measured interest rate risk exposure.

          Effective June 26, 1996, the federal banking agencies issued a joint
 policy statement announcing the agencies' election not to adopt a standardized
 measure and explicit capital charge for interest rate risk at that time.
 Rather, the policy statement (i) identifies the main elements of sound interest
 rate risk management, (ii) describes prudent principles and practices for each
 of those elements, and (iii) describes the critical factors affecting the
 agencies' 

                                       25
<PAGE>
 
 evaluation of a bank's interest rate risk when making a determination of
 capital adequacy. The joint policy statement is not expected to have a material
 impact on Bank's management of interest rate risk.

          Loans-To-One-Borrower. The Bank is subject to the Administrator's
 loans-to-one-borrower limits. Under these limits, no loans and extensions of
 credit to any borrower outstanding at one time and not fully secured by readily
 marketable collateral shall exceed 15% of the net worth of the savings bank.
 Loans and extensions of credit fully secured by readily marketable collateral
 may comprise an additional 10% of net worth. These limits also authorize
 savings banks to make loans-to-one-borrower, for any purpose, in an amount not
 to exceed $500,000. A savings bank also is authorized to make
 loans-to-one-borrower to develop domestic residential housing units, not to
 exceed the lesser of $30 million or 30% of the savings bank's net worth,
 provided that the purchase price of each single-family dwelling in the
 development does not exceed $500,000 and the aggregate amount of loans made
 under this authority does not exceed 150% of net worth. These limits also
 authorize a savings bank to make loans-to-one-borrower to finance the sale of
 real property acquired in satisfaction of debts in an amount up to 50% of net
 worth.

          As of September 30, 1997, the largest aggregate amount of loans which
 the Bank had to any one borrower was $1.1 million. The Bank had no loans
 outstanding which management believes violate the applicable
 loans-to-one-borrower limits. The Bank does not believe that the
 loans-to-one-borrower limits will have a significant impact on its business,
 operations and earnings.

          Federal Home Loan Bank System. The FHLB system provides a central
 credit facility for member institutions. As a member of the FHLB of Atlanta,
 the Bank is required to own capital stock in the FHLB of Atlanta in an amount
 at least equal to the greater of 1% of the aggregate principal amount of its
 unpaid residential mortgage loans, home purchase contracts and similar
 obligations at the end of each calendar year, or 5% of its outstanding advances
 (borrowings) from the FHLB of Atlanta. On September 30, 1997, the Bank was in
 compliance with this requirement with an investment in FHLB of Atlanta stock of
 $2.3 million.

          Each FHLB is required to contribute at least 10% of its reserves and
 undivided profits to fund the principal and a portion of the interest on
 certain bonds and certain other obligations which are used to fund the
 resolution of troubled savings association cases, and to transfer a percentage
 of its annual net earnings to the Affordable Housing Program. These
 contributions continue to reduce the FHLB of Atlanta's earnings and the Bank's
 dividends on its FHLB of Atlanta stock.

          Federal Reserve System. Federal Reserve regulations require savings
 banks, not otherwise exempt from the regulations, to maintain reserves against
 their transaction accounts (primarily negotiable order of withdrawal accounts)
 and certain nonpersonal time deposits. The reserve requirements are subject to
 adjustment by the Federal Reserve. As of September 30, 1997, the Bank was in
 compliance with the applicable reserve requirements of the Federal Reserve.

          Restrictions on Acquisitions. Federal law generally provides that no
 "person," acting directly or indirectly or through or in concert with one or
 more other persons, may acquire "control," as that term is defined in FDIC
 regulations, of a state savings bank without giving at least 60 days' written
 notice to the FDIC and providing the FDIC an opportunity to disapprove the
 proposed acquisition. Pursuant to regulations governing acquisitions of
 control, control of an insured institution is conclusively deemed to have been
 acquired by, among other things, the acquisition of more than 25% of any class
 of voting stock. In addition, control is presumed to have been acquired,
 subject to rebuttal, upon the acquisition of more than 10% of any class of
 voting stock. Such acquisitions of control may be disapproved if it is
 determined, among other things, that (i) the acquisition would substantially
 lessen competition; (ii) the financial condition of the acquiring person might
 jeopardize the financial stability of the savings bank or prejudice the
 interests of its depositors; or (iii) the competency, experience or integrity
 of the acquiring person or the proposed management personnel indicates that it
 would not be in the interest of the depositors or the public to permit the
 acquisitions of control by such person.

          Liquidity. The Bank is subject to the Administrator's requirement that
 the ratio of liquid assets to total assets equal at least 10%. The computation
 of liquidity under North Carolina regulation allows the inclusion of

                                       26
<PAGE>
 
 mortgage-backed securities and investments which, in the judgment of the
 Administrator, have a readily marketable value, including investments with
 maturities in excess of five years. On September 30, 1997, the Bank's liquidity
 ratio, calculated in accordance with North Carolina regulations, was
 approximately 43%.

          Additional Limitations on Activities. Recent FDIC law and regulations
 generally provide that the Bank may not engage as principal in any type of
 activity, or in any activity in an amount, not permitted for national banks, or
 directly acquire or retain any equity investment of a type or in an amount not
 permitted for national banks. The FDIC has authority to grant exceptions from
 these prohibitions (other than with respect to non-service corporation equity
 investments) if it determines no significant risk to the insurance fund is
 posed by the amount of the investment or the activity to be engaged in and if
 the Bank is and continues to be in compliance with fully phased-in capital
 standards. National banks are generally not permitted to hold equity
 investments other than shares of service corporations and certain federal
 agency securities. Moreover, the activities in which service corporations are
 permitted to engage are limited to those of service corporations for national
 banks.

          Savings banks are also generally prohibited from directly or
 indirectly acquiring or retaining any corporate debt security that is not of
 investment grade (generally referred to as "junk bonds"). State savings banks
 are also required to notify the FDIC at least 30 days prior to the
 establishment or acquisition of any subsidiary, or at least 30 days prior to
 conducting any such new activity. Any such activities must be conducted in
 accordance with the regulations and orders of the FDIC and the Administrator.

          Prompt Corrective Regulatory Action. Federal law provides the federal
 banking agencies with broad powers to take corrective action to resolve
 problems of insured depository institutions. The extent of these powers depends
 upon whether the institutions in question are "well capitalized," "adequately
 capitalized," "undercapitalized," "significantly undercapitalized," or
 "critically undercapitalized." Under the FDIC regulations applicable to the
 Bank, an institution is considered "well capitalized" if it has (i) a total
 risk-based capital ratio of 10% or greater, (ii) a Tier I risk-based capital
 ratio of 6% or greater, (iii) a leverage ratio of 5% or greater and (iv) is not
 subject to any order or written directive to meet and maintain a specific
 capital level for any capital measure. An "adequately capitalized" institution
 is defined as one that has (i) a total risk-based capital ratio of 8% or
 greater, (ii) a Tier I risk-based capital ratio of 4% or greater and (iii) a
 leverage ratio of 4% or greater (or 3% or greater in the case of an institution
 with the highest examination rating and which is not experiencing or
 anticipating significant growth). An institution is considered (A)
 "undercapitalized" if it has (i) a total risk-based capital ratio of less than
 8%, (ii) a Tier I risk-based capital ratio of less than 4% or (iii) a leverage
 ratio of less than 4% (or 3% in the case of an institution with the highest
 examination rating and which is not experiencing or anticipating significant
 growth); (B) "significantly undercapitalized" if the institution has (i) a
 total risk-based capital ratio of less than 6%, or (ii) a Tier I risk-based
 capital ratio of less than 3% or (iii) a leverage ratio of less than 3% and (C)
 "critically undercapitalized" if the institution has a ratio of tangible equity
 to total assets equal to or less than 2%.

          Interstate Banking. The Riegle-Neal Interstate Banking and Branching
 Efficiency Act of 1994 (the "Interstate Banking Act"), effective September 29,
 1995, permits adequately capitalized bank and savings bank holding companies to
 acquire control of banks and savings banks in any state. The states may
 specifically permit interstate acquisitions prior to September 29, 1995, by
 enacting legislation that provides for such transactions. North Carolina
 adopted nationwide reciprocal interstate acquisition legislation in 1994.

          Such interstate acquisitions are subject to certain restrictions.
 States may require the bank or savings bank being acquired to have been in
 existence for a certain length of time but not in excess of five years. In
 addition, no bank or saving bank may acquire more than 10% of the insured
 deposits in the United States or more than 30% of the insured deposits in any
 one state, unless the state has specifically legislated a higher deposit cap.
 States are free to legislate stricter deposit caps.

          The Interstate Banking Act also provides for interstate branching,
 effective June 1, 1997, allowing interstate branching in all states, provided
 that a particular state has not specifically denied interstate branching by
 legislation prior to such time. Unlike interstate acquisitions, a state may
 deny interstate branching if it specifically elects to do so by June 1, 1997.
 States may choose to allow interstate branching prior to June 1, 1997 by
 opting-in to a group of 

                                       27
<PAGE>
 
 states that permits these transactions. These states generally allow interstate
 branching via a merger of an out-of-state bank with an in-state bank, or on a
 de novo basis. North Carolina has enacted legislation permitting branching
 transactions.

          It is anticipated that the Interstate Banking Act will increase
 competition within the markets in which the Bank now operates, although the
 extent to which such competition will increase in such markets or the timing of
 such increase cannot be predicted.

          Restrictions on Dividends and Other Capital Distributions. A North
 Carolina-chartered stock savings bank may not declare or pay a cash dividend
 on, or repurchase any of, its capital stock if the effect of such transaction
 would be to reduce the net worth of the institution to an amount which is less
 than the minimum amount required by applicable federal and state regulations.
 In addition, a North Carolina-chartered stock savings bank, for a period of
 five years after its conversion from mutual to stock form, must obtain the
 written approval from the Administrator before declaring or paying a cash
 dividend on its capital stock in an amount in excess of one-half of the greater
 of (i) the institution's net income for the most recent fiscal year end, or
 (ii) the average of the institution's net income after dividends for the most
 recent fiscal year end and not more than two of the immediately preceding
 fiscal year ends, if applicable. Under FDIC regulations, stock repurchases may
 be made by the savings bank only upon receipt of FDIC approval.

          Also, without the prior written approval of the Administrator, a North
 Carolina-chartered stock savings bank, for a period of five years after its
 conversion from mutual to stock form, may not repurchase any of its capital
 stock. The Administrator will give approval to repurchase only upon a showing
 that the proposed repurchase will not adversely affect the safety and soundness
 of the institution.

          In addition, the Bank is not permitted to declare or pay a cash
 dividend on or repurchase any of its capital stock if the effect thereof would
 be to cause its net worth to be reduced below the amount required for the
 liquidation account established in connection with the Bank's conversion from
 mutual to stock ownership.

          The Company paid cash dividends totaling $0.38 per share during the
 year ended September 30, 1997, and subsequent to September 30, 1997, declared a
 special return of capital dividend of $6.00 per share to be paid on January 8,
 1998 to shareholders of record as of December 17, 1997.

          Other North Carolina Regulations. As a North Carolina-chartered
 savings bank, the Bank derives its authority from, and is regulated by, the
 Administrator. The Administrator has the right to promulgate rules and
 regulations necessary for the supervision and regulation of North Carolina
 savings banks under his jurisdiction and for the protection of the public
 investing in such institutions. The regulatory authority of the Administrator
 includes, but is not limited to, the establishment of reserve requirements; the
 regulation of the payment of dividends; the regulation of stock repurchases,
 the regulation of incorporators, stockholders, directors, officers and
 employees; the establishment of permitted types of withdrawable accounts and
 types of contracts for savings programs, loans and investments; and the
 regulation of the conduct and management of savings banks, chartering and
 branching of institutions, mergers, conversions and conflicts of interest.
 North Carolina law requires that the Bank maintain federal deposit insurance as
 a condition of doing business.

          The Administrator conducts regular examinations of North
 Carolina-chartered savings banks. The purpose of such examinations is to assure
 that institutions are being operated in compliance with applicable North
 Carolina law and regulations and in a safe and sound manner. These examinations
 are usually conducted on a joint basis with the FDIC. In addition, the
 Administrator is required to conduct an examination of any institution when he
 has good reason to believe that the standing and responsibility of the
 institution is of doubtful character or when he otherwise deems it prudent. The
 Administrator is empowered to order the revocation of the license of an
 institution if he finds that it has violated or is in violation of any North
 Carolina law or regulation and that revocation is necessary in order to
 preserve the assets of the institution and protect the interests of its
 depositors. The Administrator has the power to issue cease and desist orders if
 any person or institution is engaging in, or has engaged in, any unsafe or
 unsound practice or unfair and discriminatory practice in the conduct of its
 business or in violation of any other law, rule or regulation.

                                       28
<PAGE>
 
          A North Carolina-chartered savings bank must maintain net worth,
 computed in accordance with the Administrator's requirements, of 5% of total
 assets and liquidity of 10% of total assets, as discussed above. Additionally,
 a North Carolina-chartered savings bank is required to maintain general
 valuation allowances and specific loss reserves in the same amounts as required
 by the FDIC.

          Subject to limitation by the Administrator, North Carolina-chartered
 savings banks may make any loan or investment or engage in any activity which
 is permitted to federally chartered institutions. However, a North
 Carolina-chartered savings bank cannot invest more than 15% of its total assets
 in business, commercial, corporate and agricultural loans. In addition to such
 lending authority, North Carolina-chartered savings banks are authorized to
 invest funds, in excess of loan demand, in certain statutorily permitted
 investments, including but not limited to (i) obligations of the United States,
 or those guaranteed by it; (ii) obligations of the State of North Carolina;
 (iii) bank demand or time deposits; (iv) stock or obligations of the federal
 deposit insurance fund or a FHLB; (v) savings accounts of any savings
 institution as approved by the board of directors; and (vi) stock or
 obligations of any agency of the State of North Carolina or of the United
 States or of any corporation doing business in North Carolina whose principal
 business is to make education loans.

          North Carolina law provides a procedure by which savings institutions
 may consolidate or merge, subject to approval of the Administrator. The
 approval is conditioned upon findings by the Administrator that, among other
 things, such merger or consolidation will promote the best interests of the
 members or stockholders of the merging institutions. North Carolina law also
 provides for simultaneous mergers and conversions and for supervisory mergers
 conducted by the Administrator.

          Future Requirements. Statutes and regulations are regularly introduced
 which contain wide-ranging proposals for altering the structures, regulations
 and competitive relationships of financial institutions. It cannot be predicted
 whether or what form any proposed statute or regulation will be adopted or the
 extent to which the business of the Company and the Bank may be affected by
 such statute or regulation.

 ITEM 2.  PROPERTIES

 Properties

          The following table sets forth the location of the Bank's principal
 office in Albemarle, North Carolina and its full service branch office in
 Locust, North Carolina, as well as certain other information relating to these
 offices as of September 30, 1997. The Bank owns both the Albemarle and Locust
 offices. The Bank also owns two vacant lots which are adjacent to its Albemarle
 office, but has no plans for these lots at the present time.

<TABLE> 
<CAPTION> 
                                                                           Net Book Value            Deposits
             Address                                                         of Property         (In Thousands)
             -------                                                       --------------        --------------
<S>                                                                        <C>                   <C> 
   Albemarle:                                                                  $593,000             $120,892        
   155 West South Street                                                                                            
   Albemarle, North Carolina 28001                                                                                  
                                                                                                                    
   Two (2) Vacant Lots                                                          $26,000                             
   South Second Street                                                                                              
   Albemarle, North Carolina 28001                                                                                  
                                                                                                                    
   Locust:                                                                     $231,000              $20,863        
   406 West Main Street                                                                                             
   Locust, North Carolina 28097                                                                                     
                                                                                                                    
                                                                               $850,000             $141,755        
                                                                               ========             ========         
</TABLE> 

                                       29
<PAGE>
 
          The Bank's management considers the property to be in good condition.
 The total net book value of the Bank's furniture, fixtures and equipment on
 September 30, 1997 was $308,000.

 ITEM 3.  LEGAL PROCEEDINGS

          In the opinion of management, neither the Company nor the Bank is
 involved in any pending legal proceedings other than routine, non-material
 proceedings occurring in the ordinary course of business.

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

          No matter was submitted to a vote of the Company's stockholders during
the quarter ended September 30, 1997.

                                       30
<PAGE>
 
                                    PART II

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

          See the information under the section captioned "Common Stock
 Information" on page 54 in the Company's 1997 Annual Report, which section is
 incorporated herein by reference. See "Item 1. DESCRIPTION OF
 BUSINESS--Regulation of the Bank--Restrictions on Dividends and Other Capital
 Distributions" above for regulatory restrictions which limit the ability of the
 Bank to pay dividends to the Company.

 ITEM 6.  SELECTED FINANCIAL DATA

          The information required by this Item is set forth in the table
 captioned "Selected Consolidated Financial Data" on page 1 of the Company's
 1997 Annual Report which is incorporated herein by reference.

 ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
          RESULTS OF OPERATION

          The table below sets forth certain performance ratios for the Company
for the periods indicated.

<TABLE> 
<CAPTION> 
                                                                                  Year Ended September 30,    
                                                                     -----------------------------------------------
                                                                        1997        1996        1995        1994
                                                                        ----        ----        ----        ----
<S>                                                                  <C>         <C>         <C>         <C> 
 Return on Average Assets (Net income divided by average total
    assets)                                                               1.24%       0.30%       1.23%       1.63%

 Return on Average Equity (Net income divided by average
    shareholders' equity                                                  4.70%       2.45%       9.50%      14.22%

 Average Equity to Average Assets Ratio (Average shareholders'
    equity divided by average total assets)                              26.40%      12.23%      12.97%      11.45%

 Interest Rate Spread for the Period                                      2.02%       2.52%       3.59%       4.38%

 Average Interest-Earning Assets to Average Interest-Bearing
    Liabilities                                                         136.08%     112.00%     112.74%     110.19%

 Net Interest Margin                                                      3.46%       3.09%       4.11%       4.72%

 Loan Loss Allowance to Nonperforming Assets at Period End               81.25%      63.69%      12.28%      12.48%

</TABLE> 
          See also the information set forth under Item 1 above and the
 information set forth under the section captioned "Management's Discussion and
 Analysis of Financial Condition and Results of Operation" on pages 3 through 17
 in the Company's 1997 Annual Report which section is incorporated herein by
 reference.

 ITEM 7A  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

          Pages 4 and 5 of the attached 1997 Annual Report to Stockholders are
herein incorporated by reference.

                                       31
<PAGE>
 
          Interest Rate Risk Management

          The Company's net income is dependent on its net interest income. Net
 interest income is susceptible to interest rate risk to the degree that
 interest-bearing liabilities mature or reprice on a different basis than
 interest-earning assets. When interest-bearing liabilities mature or reprice
 more quickly than interest-earning assets in a given period, a significant
 increase in market rates of interest could adversely affect net interest
 income. Similarly, when interest-earning assets mature or reprice more quickly
 than interest-bearing liabilities, falling interest rates could result in a
 decrease in net income.

          In an attempt to manage its exposure to changes in interest rates,
 management monitors the Company's interest rate risk. Management meets monthly
 to review the Company's interest rate risk position and profitability, and to
 recommend adjustments for consideration by the Board of Directors. Management
 also reviews the Bank's securities portfolio, formulates investment strategies,
 and oversees the timing and implementation of transactions to assure attainment
 of the Board's objectives in the most effective manner. Notwithstanding the
 Company's interest rate risk management activities, the potential for changing
 interest rates is an uncertainty that can have an adverse effect on net income.

          In adjusting the Company's asset/liability position, the Board and
 management attempt to manage the Company's interest rate risk while enhancing
 net interest margins. At times, depending on the level of general interest
 rates, the relationship between long and short-term interest rates, market
 conditions and competitive factors, the Board and management may determine to
 increase the Company's interest rate risk position somewhat in order to
 increase its net interest margin. The Company's results of operations and net
 portfolio values remain vulnerable to increases in interest rates and to
 fluctuations in the difference between long- and short-term interest rates.

          Consistent with the asset/liability management philosophy described
 above, the Company has taken several steps to manage its interest rate risk.
 First, the Company has structured the security portfolio to shorten the lives
 of its interest-earning assets. The Company's recent purchases of securities,
 including mortgage-backed securities have had short or medium terms to
 maturity. At September 30, 1997, the Company had securities totaling $123.0
 million, of which $79.1 million have contractual maturities of five years or
 less. Mortgage-backed securities amortize and experience prepayments of
 principal; the Company has received average cash flows from principal paydowns,
 sales, maturities and calls of securities of $15.4 million annually over the
 past three fiscal years. The Company also controls interest rate risk reduction
 by emphasizing non-certificate depositor accounts. The Board and management
 believe that such accounts carry a lower cost than certificate accounts, and
 that a material portion of such accounts may be more resistant to changes in
 interest rates than are certificate accounts. At September 30, 1997, the
 Company had $15.3 million of regular savings accounts, and $14.3 million of
 money market, demand and NOW accounts, representing 20.9% of total depositor
 accounts.

          The Company does not currently engage in trading activities or use
 derivative instruments to control interest rate risk. Even though such
 activities may be permitted with the approval of the Board of Directors, the
 Company does not intend to engage in such activities in the immediate future.
 Interest rate risk is the most significant market risk affecting the Company.
 Other types of market risk, such as foreign currency exchange rate risk and
 commodity price risk, do not arise in the normal course of the Company's
 business activities.

                                       32
<PAGE>
 
 ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

          The consolidated financial statements of the Company and supplementary
 data set forth on pages 19 through 51 of the Company's 1997 Annual Report are
 incorporated herein by reference.

 ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
          FINANCIAL DISCLOSURE

          N/A.

                                   PART III

 ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

          The information required by this Item regarding directors and
 executive officers of the Company is set forth under the sections captioned
 "Proposal 1 - Election of Directors - General" on pages 6 and 7 of the Proxy
 Statement and "Proposal 1 - Election of Directors - Executive Officers" on page
 11 of the Proxy Statement, which sections are incorporated herein by reference.

          The information required by this Item regarding compliance with
 Section 16(a) of the Securities Exchange Act of 1934 is set forth under the
 section captioned "Section 16(a) Beneficial Ownership Reporting Compliance" set
 forth on page 5 of the Proxy Statement, which is incorporated herein by
 reference.


 ITEM 11. EXECUTIVE COMPENSATION

          The information required by this Item is set forth under the sections
 captioned "Proposal 1 - Election of Directors - Directors' Compensation" on
 pages 8 through 11 and "- Executive Compensation" on pages 11 through 16 of
 the Proxy Statement, which sections are incorporated herein by reference.

 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

          The information  required by this Item is incorporated by reference 
 from the section captioned  "Security Ownership of Certain Beneficial Owners" 
 on  pages 3 through 5 of the Proxy Statement.

 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

          There have been no reportable transactions during the two most recent
 fiscal years nor are any reportable transactions proposed as of the date of
 this Form 10-K. See also the section captioned "Proposal 1 - Election of
 Directors - Certain Indebtedness and Transactions of Management" on page 19 of
 the Proxy Statement, which section is incorporated herein by reference.


                                    PART IV

 ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

 14(a)1.  Consolidated Financial Statements (contained in the Bank's 1997 Annual
          Report attached hereto as Exhibit (13) and incorporated herein by
          reference)

          (a)     Independent Auditors' Report

                                       33
<PAGE>
 
          (b)     Statements of Financial Condition as of September 30, 1997 and
                  1996

          (c)     Statements of Income for the Years Ended September 30, 1997,
                  1996 and 1995

          (d)     Statements of Equity for the Years Ended September 30, 1997,
                  1996 and 1995

          (e)     Statements of Cash Flows for the Years Ended September 30,
                  1997, 1996 and 1995

          (f)     Notes to Financial Statements

 14(a)2.  Financial Statement Schedules

          All schedules have been omitted as the required information is either
          inapplicable or included in the Notes to Consolidated Financial
          Statements.

<TABLE> 
<CAPTION> 
 14(a)3.  Exhibits
<C>       <C>                   <S> 
          Exhibit (3)(i)        Certificate of Incorporation, incorporated
                                herein by reference to Exhibit (3)(i) to the
                                Registration Statement on Form S-1, Registration
                                No. 333-04509, dated May 24, 1996, and amended
                                on July 25, 1996

          Exhibit (3)(ii)       Bylaws, incorporated herein by reference to
                                Exhibit (3)(ii) to the Registration Statement on
                                Form S-1, Registration No. 333-04509, dated May
                                24, 1996, and amended on July 25, 1996

          Exhibit (4)           Specimen Stock Certificate, incorporated
                                herein by reference to Exhibit (4) to the
                                Registration Statement on Form S-1, Registration
                                No. 333-04509, dated May 24, 1996, and amended
                                on July 25, 1996

          Exhibit (10)(i)       Employment Agreement between Carl M. Hill and
                                Home Savings Bank of Albemarle, Inc., S.S.B.,
                                incorporated herein by reference to the Form 10-
                                K dated September 30, 1996

          Exhibit (10)(ii)      Employment Agreement between R. Ronald Swanner
                                and Home Savings Bank of Albemarle, Inc.,
                                S.S.B., incorporated herein by reference to the
                                Form 10-K dated September 30, 1996

          Exhibit (10)(iii)     1985 Retirement Payment Agreements with Carl M.
                                Hill, R. Ronald Swanner, Caldwell A. Holbrook,
                                Jr. and Joel A. Huneycutt, incorporated herein
                                by reference to the Form 10-K dated September
                                30, 1996

          Exhibit (10)(v)       1995 Retirement Payment Agreements with Carl M.
                                Hill, R. Ronald Swanner, Caldwell A. Holbrook,
                                Jr., Joel A. Huneycutt, Douglas Dwight Stokes
                                and Greg E. Underwood, incorporated herein by
                                reference to the Form 10-K dated September 30,
                                1996

          Exhibit (10)(vi)      Directors Retirement Plan Agreements with Carl
                                M. Hill, R. Ronald Swanner, Caldwell A.
                                Holbrook, Jr., Joel A. Huneycutt, Douglas Dwight
                                Stokes and Greg E. Underwood, incorporated
                                herein by reference to the Form 10-K dated
                                September 30, 1996
</TABLE> 

                                       34
<PAGE>
 
<TABLE> 
<C>       <C>                   <S> 
          Exhibit (10)(vii)     1985 Supplemental Income Agreements with Carl M.
                                Hill and R. Ronald Swanner, incorporated herein
                                by reference to the Form 10-K dated September
                                30, 1996

          Exhibit (10)(viii)    1995 Supplemental Income Agreements with Carl M.
                                Hill and R. Ronald Swanner, incorporated herein
                                by reference to the Form 10-K dated September
                                30, 1996

          Exhibit (10)(ix)      South Street Financial Corp. Stock Option Plan
                                             
          Exhibit (10)(x)       Home Savings Bank of Albemarle, Inc., SSB
                                Management Recognition Plan and Trust Agreement
                                             
          Exhibit (11)          Statement Regarding Computation of Per Share 
                                Earnings
                                             
          Exhibit (12)          Statement Regarding Computation of Ratios
                                             
          Exhibit (13)          1997 Annual Report to Security Holders
                                             
          Exhibit (21)          See Item 1.  Business for discussion of 
                                subsidiaries
                                             
          Exhibit (27)          Financial Data Schedule           

 14(b)    The Company filed no reports on Form 8-K during the last quarter of 
          the fiscal year ended September 30, 1997.
</TABLE> 

                                       35
<PAGE>
 
                                  SIGNATURES

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

                                           SOUTH STREET FINANCIAL CORP.


 Date:  December 22, 1997                  By:    /s/ Carl M.  Hill
                                                 --------------------- 
                                                 Carl M.  Hill
                                           President and Chief Executive Officer


          Pursuant to the requirements of the Securities Exchange Act of 1934,
 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> 
 Signature                                           Title                                            Date
 ---------                                           -----                                            ----
<S>                                         <C>                                                 <C> 
 /s/ Carl M. Hill                           President, Chief Executive                          December 22, 1997
 -----------------------------------        Officer and Director 
 Carl M.  Hill                              

 /s/ R. Ronald Swanner                      Executive Vice President,                           December 22, 1997
 -----------------------------------        Secretary and Director
 R.  Ronald Swanner                         

 /s/ Christopher F. Cranford                Controller and Treasurer                            December 22, 1997
 -----------------------------------
 Christopher F. Cranford

 /s/ Caldwell A. Holbrook,                  Director                                            December 22, 1997
 ----------------------------------
 Caldwell A. Holbrook, Jr.

 /s/ Joel A. Huneycutt                      Director                                            December 22, 1997
 ----------------------------------
 Joel A. Huneycutt

 /s/ Douglas Dwight Stokes                  Director                                            December 22, 1997
 ----------------------------------
 Douglas Dwight Stokes

 /s/ Greg E. Underwood                      Director                                            December 22, 1997
 ----------------------------------
 Greg E. Underwood
</TABLE> 

                                       36
<PAGE>
 
                               INDEX TO EXHIBITS

<TABLE> 
<CAPTION> 
 Exhibit No.                                Description
 -----------                                -----------
 <S>                       <C> 
 Exhibit (3)(i)            Certificate of Incorporation, incorporated herein by
                           reference to Exhibit (3)(i) to the Registration
                           Statement on Form S-1, Registration No. 333-04509,
                           dated May 24, 1996, and amended on July 25, 1996

 Exhibit (3)(ii)           Bylaws, incorporated herein by reference to Exhibit
                           (3)(ii) to the Registration Statement on Form S-1,
                           Registration No. 333-04509, dated May 24, 1996, and
                           amended on July 25, 1996

 Exhibit (4)               Specimen Stock Certificate, incorporated herein by
                           reference to Exhibit (4) to the Registration
                           Statement on Form S-1, Registration No. 333-04509,
                           dated May 24, 1996, and amended on July 25, 1996

 Exhibit (10)(i)           Employment Agreement between Carl M. Hill and Home
                           Savings Bank of Albemarle, Inc., S.S.B., incorporated
                           herein by reference to the Form 10-K dated September
                           30, 1996

 Exhibit (10)(ii)          Employment Agreement between R. Ronald Swanner and
                           Home Savings Bank of Albemarle, Inc., S.S.B.,
                           incorporated herein by reference to the Form 10-K
                           dated September 30, 1996

 Exhibit (10)(iii)         1985 Retirement Payment Agreements with Carl M. Hill,
                           R. Ronald Swanner, Caldwell A. Holbrook, Jr. and Joel
                           A. Huneycutt, incorporated herein by reference to the
                           Form 10-K dated September 30, 1996

 Exhibit (10)(v)           1995 Retirement Payment Agreements with Carl M. Hill,
                           R. Ronald Swanner, Caldwell A. Holbrook, Jr., Joel A.
                           Huneycutt, Douglas Dwight Stokes and Greg E.
                           Underwood, incorporated herein by reference to the
                           Form 10-K dated September 30, 1996

 Exhibit (10)(vi)          Directors Retirement Plan Agreements with Carl M.
                           Hill, R. Ronald Swanner, Caldwell A. Holbrook, Jr.,
                           Joel A. Huneycutt, Douglas Dwight Stokes and Greg E.
                           Underwood, incorporated herein by reference to the
                           Form 10-K dated September 30, 1996, incorporated
                           herein by reference to the Form 10-K dated September
                           30, 1996

 Exhibit (10)(vii)         1985 Supplemental Income Agreements with Carl M. Hill
                           and R. Ronald Swanner, incorporated herein by
                           reference to the Form 10-K dated September 30, 1996

 Exhibit (10)(viii)        1995 Supplemental Income Agreements with Carl M. Hill
                           and R. Ronald Swanner

 Exhibit (10)(ix)          South Street Financial Corp. Stock Option Plan

 Exhibit (10)(x)           Home Savings Bank of Albemarle, Inc., SSB Management
                           Recognition Plan and Trust Agreement

 Exhibit (11)              Statement Regarding Computation of Per Share Earnings

 Exhibit (12)              Statement Regarding Computation of Ratios

 Exhibit (13)              1997 Annual Report to Security Holders
</TABLE> 
                                                       

                                       37
<PAGE>
 
<TABLE> 
<S>                        <C> 
Exhibit (21)               See Item 1.  Business for discussion of subsidiaries

Exhibit (27)               Financial Data Schedule

14(b)                      The Company filed no reports on Form 8-K during the
                           last quarter of the fiscal year ended September 30,
                           1997.
</TABLE> 

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