<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


             For the fiscal year ended         September 30, 1996
                                      ---------------------------

             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      No X
                                         ---     ---

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.    [ ]

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.
$55,992,881 common stock, no par value, based on the closing price of such
--------------------------------------------------------------------------
common stock on December 16, 1996.
----------------------------------

Indicate the number of shares outstanding of each of the registrant's classes of
common stock, as of the latest practicable date. 4,496,500 shares of common
                                                 --------------------------
stock, no par value, outstanding at December 16, 1996.
------------------------------------------------------
<PAGE>
 
                      DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Annual Report of South Street Financial Corp. for the year ended
September 30, 1996, are incorporated by reference into Part I, Part II and Part
IV.

Portions of the Proxy Statement for the 1997 Annual Meeting of Shareholders of
South Street Financial Corp. to be held on February 17, 1996, 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 and the Bank's principal
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 and owning the Bank.
The Company's principal sources of income are earnings on its investments. In
addition, the Company will receive any dividends which are declared and paid by
the Bank on its capital stock. The Company did not commence operations until
October 2, 1996 and conducted no business during the fiscal year ended September
30, 1996. Consequently, the following general business discussion pertains
primarily to Home Savings.

         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.

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.

                                       3
<PAGE>
 
         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, 1996,
all of the loans in the Bank's real estate loan portfolio were secured by
properties in North Carolina. On September 30, 1996, 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 $109.9 million at September 30, 1996 representing 50.4% of the
Bank's total assets at such date. At September 30, 1996, 84.9% 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 3.4% of the
Bank's net loan portfolio, and nonresidential real estate loans represented
3.67% 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, 1996, 4.0% 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,
                      ---------------------------------------------------------------------------------------------------------
                                1996                     1995                      1994                       1993    
                      ---------------------------------------------------------------------------------------------------------
                                      % of                     % of                       % of                       % of    
                         Amount       Total       Amount       Total        Amount        Total        Amount        Total   
                         ------       -----       ------       -----        ------        -----        ------        -----

                                                                 (Dollars in Thousands)
<S>                      <C>          <C>         <C>          <C>           <C>          <C>          <C>          <C> 
Real estate loans:

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

 Residential multi-           695       0.63%          840       0.77%            870       0.81%            731       0.62%
 family.............                                                                                                         
 
 Nonresidential real        4,038       3.67%        3,013       2.77%          3,157       2.95%          3,655       3.12%   
 estate.............
                             
 Residential                4,720       4.30%        5,368       4.94%          6,015       5.63%          6,644       5.68%
 construction.......                  
                             
 Land...............        6,304       5.74%        4,890       4.50%          4,998       4.68%          4,960       4.24% 
                           
 Line of credit.....        3,786       3.45%        3,875       3.58%          4,056       3.81%          3,715       3.17% 
                            -----       -----        -----       -----          -----       -----          -----       -----
                             
 Total real estate           
 loans:                   112,818     102.69%      112,022     103.16%        110,770     103.68%        120,142     102.63%
                          -------     -------      -------     -------        -------     -------        -------     -------
                           
Consumer loans:               

 Share..............          196       0.18%          110       0.10%            105       0.10%            290       0.25%
                              
 Credit reserve.....          470       0.43%          221       0.20%            176       0.16%            102       0.09%
                              ---       -----          ---       -----            ---       -----            ---       -----
                           
 Total consumer               666       0.61%          331       0.30%            281       0.26%            392       0.34%
 loans..............          ---       -----          ---       -----            ---       -----            ---       -----
                   
Less:
 Unearned fees and
 discounts..........          582       0.53%          519       0.48%            465       0.44%            440       0.38%
                               
 Loans in process...        2,616       2.38%        3,100       2.85%          3,602       3.37%          2,895       2.47%
                           
 Allowance for
 loan losses .......          428       0.39%          137       0.13%            140       0.13%            144       0.12%
                              ---       -----          ---       -----            ---       -----            ---       -----
                            
 Total reductions...        3,626       3.30%        3,756       3.46%          4,207       3.94%          3,479       2.97%
                            -----       -----        -----       -----          -----       -----          -----       -----
                             
 Total loans
 receivable, net....     $109,858     100.00%     $108,597     100.00%       $106,844     100.00%       $117,055     100.00%
                          =======     =======     ========     =======       ========     =======       ========     =======
</TABLE> 
  
<TABLE> 
<CAPTION> 
                               1992 
                        --------------------
                                      % of 
                          Amount      Total   
                          ------      -----

<S>                      <C>          <C> 
Real estate loans:

 Residential             $96,453      85.28%
 1-4 family.........     
                        
 Residential multi-          763       0.67%  
 family.............    
 
 Nonresidential real       4,104       3.63% 
 estate.............
                        
 Residential             
 construction.......       5,919       5.23% 
                         
 Land...............       5,689       5.03% 
                         
 Line of credit.....       3,358       2.97% 
                           -----       -----                          
                        
 Total real estate       
 loans:                  116,286     102.81% 
                         -------     -------                          
                           
Consumer loans:          

 Share..............         274       0.24%  
                        
 Credit reserve.....         102       0.08%  
                             ---       ----- 
                         
 Total consumer         
 loans..............         376       0.32%  
                             ---       -----
Less:
 Unearned fees and
 discounts..........         306       0.27% 
                         
 Loans in process...       3,096       2.74% 
                         
 Allowance for
 loan losses .......         144       0.13%  
                             ---       -----
                         
 Total reductions...       3,546       3.13%  
                           -----       -----
                         
 Total loans
 receivable, net....    $113,116     100.00%  
                        ========     =======
</TABLE> 

         The following table sets forth the time to contractual maturity of the
Bank's loan portfolio at September 30, 1996. 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 $20.2 million, $16.2 million
and $30.8 million in fiscal years ended September 30, 1996, 1995 and 1994,
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, 1996 
                                     --------------------------------------------------------------------------------------
                                                     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                     $7,108        $   516     $      --    $        --     $        --     $    7,624
  Fixed rate 1-4 family
         residential                          39            454         1,151         13,975          72,751         88,370
  Other adjustable rate real
          estate loans                       569              7            --             --              --            576
  Other fixed rate real estate
          loans                                2             47           205          2,352          10,444         13,050
Other loans                                  260            406            --             --              --            666
Less:
  Allowance for loan losses                (428)             --            --             --              --          (428)
                                           -----          -----         -----         ------          ------        ------- 
                                          $7,550         $1,430        $1,356        $16,327         $83,195       $109,858
                                          ======         ======        ======        =======         =======       ========
</TABLE> 

         The following table sets forth the dollar amount at September 30, 1996
of all loans maturing or repricing on or after September 30, 1997 which have
fixed or adjustable interest rates.

<TABLE> 
<CAPTION> 
                                                          Fixed                   Adjustable
                                                          Rates                     Rates    
                                                          -----                   ----------
                                                                   (In Thousands)
<S>                                                    <C>                        <C> 
Mortgage loans                                         $101,379                         $523
Other loans                                                 406                           --
                                                       --------                         ----
                                                       $101,785                         $523
                                                       ========                         ====
</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,
                                                                             ------------------------

                                                               1996                    1995                    1994    
                                                               ----                    ----                    ----    
                                                                                                                       
                                                                                  (In Thousands)                       
                                                                                                                       
<S>                                                        <C>                     <C>                     <C>         
Loans receivable, net, beginning of                                                                                    
period                                                     $108,597                $106,844                $117,055    
                                                            -------                 -------                 -------

Loan originations:                                                                                                     

   Residential 1-4 family                                    13,773                  10,190                  12,777    

   Residential multifamily                                       --                      58                      --    

   Nonresidential real estate                                    --                     333                     308    

   Residential construction                                   5,704                   6,282                   6,273    

   Line of credit                                               747                     626                     931    

   Consumer                                                   1,141                     454                     329    
                                                            -------                     ---                     ---

     Total loan originations                                 21,365                  17,943                  20,618    

Loans purchased                                                                          --                      --    

Principal repayments                                        (20,234)                (16,192)                (30,796)    

Other changes, net (1)                                          130                       2                     (33)    
                                                           --------                --------                --------
Increase in loans receivable                                  1,261                   1,753                 (10,211)     
                                                           --------                --------                --------

Loans receivable, net, end of period                       $109,858                $108,597                $106,844 
                                                           ========                ========                ========
</TABLE> 

         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, 1996, approximately 84.9% 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

                                       7
<PAGE>
 
residences and condominiums and loans secured by housing containing not more
than four separate dwelling units. Of such loans, excluding home equity loans,
4.7% had adjustable interest rates.

         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, 1996, the Bank had
approximately $695,000 in outstanding loans secured by multifamily residential
real estate, comprising approximately .63% 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, 1996, the Bank had
$4.0 million in outstanding loans secured by nonresidential real estate,
including undeveloped land, comprising approximately 3.7% 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, 1996, 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, 1996, the Bank had
approximately $3.8 million in home equity line of credit loans, representing
approximately 3.4% 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

                                       8
<PAGE>
 
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 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, 1996 was approximately $4.7 million, representing
approximately 4.3% 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, 1996, the Bank had approximately $666,000 of such loans
outstanding, representing approximately .61% 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 $250,000 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 $250,000 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, 1996, the Bank
had $4.6 million in such unfunded mortgage loan commitments. In addition, on
such date the Bank had $2.6 million in unfunded commitments for unused lines of
credit and letters of credit.

                                       9
<PAGE>
 
         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.

         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, 1996, 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,
1996, interest income that would have been recorded net of interest income
actually recognized on nonperforming loans under the original terms of such
loans was $40,000.

         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,
                                                                                  ----------------
                                                       1996                  1995                  1994                1993
                                                       ----                  ----                  ----                ---- 
                                                                               (Dollars in Thousands)
<S>                                                <C>                   <C>                   <C>                    <C>    
Total nonaccrual loans                         
   Mortgage loans delinquent 90 days or more       $    631              $    923              $    910                $762
   Consumer loans delinquent 90 days or more             23                    58                    36                  82
Real estate owned                                        18                   135                   176                 119
                                                        ---                   ---                   ---                 ---
   Total non-performing assets                     $    672              $  1,116              $  1,122                $963
                                                        ===                 =====                 =====                 ===
Non-performing loans to total gross loans             0.58%                 0.87%                 0.85%               0.70%
Non-performing assets to total assets                 0.31%                 0.70%                 0.76%               0.61%
Total assets                                       $217,954              $159,863              $147,837            $157,909
Total gross loans                                  $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, 1996, the Bank had approximately $825,000
       million 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,
       1996, the Bank had approximately $1.2 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 Banks 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, 1996, 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             32         $1,200          26         $769          --            --           --          --
   Residential real estate            --             --          --           --          --            --           --          --
   Nonresidential real estate         --             --          --           --          --            --           --          --
   Residential construction           --             --          --           --          --            --           --          --
   Land                               --             --          --           --          --            --           --          --
   Line of credit                     --             --           4           55          --            --           --          --
                                    ----           ----        ----         ----        ----          ----         ----        ----
      Total real estate loans         32          1,200          30          824          --            --           --          --
                                    ----          -----        ----         ----        ----          ----         ----        ---- 
Consumer loans:                                                                                                         
   Share                              --             --          --           --          --            --           --          --
   Credit reserve                     --             --           2            1          --            --           --          --
                                    ----           ----        ----         ----        ----          ----         ----        ----
      Total consumer loans            --             --           2            1          --            --           --          --
                                    ----           ----        ----         ----        ----          ----         ----        ----
Total                                 32         $1,200          32         $825          --            --           --          --
                                    ====           ====        ====         ====        ====          ====         ====        ====
</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, 1996, the Bank substantially increased its provision for
        loan losses because of the recent economic downturn in Stanly County as
        a result of manufacturing plant closings and in order to more closely
        approximate industry standards.
        
       
        
                                      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,
                                                                 ------------------------------------------------------------------
                                                                      1996          1995         1994         1993         1992
                                                                      ----          ----         ----         ----         ---- 
                                                                                        (Dollars In Thousands)
<S>                                                                 <C>           <C>          <C>          <C>          <C>   
Balance, beginning of period                                          $137          $140         $144         $144         $177
Provision for loan losses                                              300            --           --           --           --
Charge-offs:
    Residential 1-4 family                                             (8)           (3)          (3)           --         (34)
    Line of credit                                                    (10)            --          (1)          (1)           --
Recoveries:
    Residential 1-4 family                                               6            --           --                         1
    Line of credit                                                       3            --           --            1           --
                                                                      ----  
Balance, end of period                                                $428          $137         $140         $144         $144
                                                                       ===           ===          ===          ===          === 
Net charge-offs as a % of average loans outstanding                 0.008%        0.003%       0.004%           --       0.029%
Allowance at period end as a % of nonperforming loans               65.44%        13.97%       14.80%       17.06%           --
Allowance at period end as a % of nonperforming assets              63.69%        12.28%       12.48%       14.95%      177.78%
Allowance at period end as a % of total gross loans                  0.38%         0.12%        0.13%        0.12%        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,
                                  ---------------------------------------------------------------------------------------
                                                1996                          1995                         1994             
                                           -------------                  ------------                ------------   
                                                     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            $    243          82.19%     $    125          83.70%    $      77          82.60%     
    Residential multi-family                 1           0.61%           --           0.75%           --           0.78%     
    Nonresidential real estate               4           3.56%            3           2.68%            4           2.83%     
    Residential construction                --           4.16%           --           4.78%           --           5.41%     
    Land                                     6           5.56%           --           4.35%           --           4.50%     
    Line of credit                          10           3.34%            8           3.45%           --           3.64%     
                                      --------        --------     --------        --------     --------        --------  
          Total real estate loans          264          99.42%          136          99.71%           81          99.76%     
                                      --------        --------     --------        --------     --------        --------  
Consumer loans:                                                                                                              
    Share                                   --           0.17%           --           0.10%           --           0.09%     
    Credit reserve                          --           0.41%            1           0.19%           --           0.15%     
                                      --------        --------     --------        --------     --------        --------  
          Total consumer loans              --           0.58%            1           0.29%           --           0.24%     
                                      --------        --------     --------        --------     --------        --------  
Unallocated                                164              --           --              --           59              --     
                                      --------        --------     --------        --------     --------        --------  
Total allowance for loan losses       $    428         100.00%     $    137         100.00%     $    140         100.00%     
                                      ========        ========     ========        ========      =======        ========  
</TABLE> 

<TABLE> 
<CAPTION> 
                                                               At September 30,
                                       ------------------------------------------------------------       
                                                     1993                          1992             
                                                ------------                   ------------                                       
                                                          Amount of                     Amount of   
                                          Amount of       Loans to       Amount of      Loans to     
                                          Allowance      Gross Loans     Allowance     Gross Loans   
                                          ---------      -----------     ---------     -----------
<S>                                       <C>            <C>             <C>           <C>  
Real estate loans:                                                                         
    Residential 1-4 family                    129          83.33%       $   109         82.69%
    Residential multi-family                   --           0.61%            --          0.65%
    Nonresidential real estate                  6           3.03%            14          3.52%
    Residential construction                   --           5.51%            --          5.07%
    Land                                       --           4.12%            --          4.88%
    Line of credit                             --           3.08%            --          2.88%
                                            -----           -----         -----          -----
          Total real estate loans             135          99.68%           123         99.69%
                                            -----           -----         -----         ------
Consumer loans:                                                                               
    Share                                      --           0.08%            --          0.23%
    Credit reserve                             --           0.24%            --          0.08%
                                            -----           -----         -----          -----                                
          Total consumer loans                 --           0.32%            --          0.31%
                                            -----           -----         -----          -----
Unallocated                                     9              --            21             --
                                            -----           -----         -----          -----
Total allowance for loan losses         $     144         100.00%       $   144        100.00% 
                                            =====         =======       =======        =======
</TABLE> 


                                      14
<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, 1996, the carrying value of the Bank's
investment securities portfolio totaled approximately $101.0 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 mortgage-backed securities consist of mortgage-
backed securities issued by the GNMA, FNMA and FHLMC.

         The investment securities portfolio includes interest-bearing deposits
of $59.3 million at September 30, 1996. Of this amount, $46.6 million relates to
deposits collected from potential subscribers to the Company's stock offering in
connection with the Conversion. After the year-end, $11.6 million was refunded
to subscribers who were unable to purchase stock because the demand for stock
exceeded the offering amount.
 
         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.
The Bank adopted SFAS 115 on September 30, 1994. The adoption affected only the
held-to-maturity and available-for-sale classifications, with the net unrealized
securities gains (loss) on the securities available-for-sale of $(220,000), net
of related deferred taxes of $114,000, reported as a separate component of
equity in its financial statements at September 30, 1994. See Note 3 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, 1996, the Bank's investment in stock of the FHLB of Atlanta was
$1.3 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.


                                      15
<PAGE>
 
         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.

                                      16
<PAGE>
 
<TABLE> 
<CAPTION> 
                                                                           At September 30,
                                      --------------------------------------------------------------------------------------------
                                                      1996                           1995                          1994     
                                              ---------------------          ---------------------         ---------------------
                                            Amortized          Market      Amortized         Market      Amortized        Market
                                                Cost            Value          Cost           Value          Cost          Value
                                                ----            -----          ----           -----          ----          -----
                                                                            (In Thousands)
<S>                                         <C>             <C>             <C>            <C>            <C>           <C> 
Interest-bearing deposits                   $  59,348       $  59,348       $  8,622       $  8,622       $  3,853      $  3,853
                                            ---------       ---------       --------       --------       --------      --------
Mortgage-backed securities, held to
maturity                                        5,496           5,511          4,529          4,642          5,325         5,271
                                                -----           -----          -----          -----          -----         -----
Investment Securities:
 Held to maturity or for investment
   U.S. Treasury and agency securities
 Available for sale:                                                              --             --             --            --
    U.S. Treasury and agency securities        34,827          34,769         30,907         30,959         25,395        25,061
 Non-marketable equity securities:
   Federal Home Loan Bank stock                 1,346           1,346          1,346          1,346          1,346         1,346
 Other                                             15              15             15             15             15            15
                                               ------          ------         ------         ------         ------        ------

                                               36,188          36,130         32,268         32,320         26,756        26,422
                                               ======          ======         ======         ======         ======        ======

Unrealized gain (loss) on securities
available for sale                               (58)              --             52             --          (334)            --
                                               ======          ======             ==         ======          =====        ======

Total                                        $100,974        $100,989        $45,471        $45,584        $35,600       $35,546
                                             ========        ========        =======        =======        =======       =======
</TABLE> 

(1)      The net unrealized gain (loss) at September 30, 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.

         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, 1996.


                                      17
<PAGE>
 
<TABLE> 
<CAPTION> 
                                                        After One Through      After Five Through                            
                                 One Year or Less           Five Years              Ten Years            After Ten Years     
                               --------------------    -------------------    --------------------    ---------------------  
                                           Weighted               Weighted                Weighted                Weighted   
                               Carrying    Average    Carrying    Average     Carrying    Average     Carrying    Average    
                                Value       Yield      Value       Yield       Value       Yield       Value       Yield    
                               --------    --------   --------    --------    --------    --------    --------    --------
                                                                            (Dollars in Thousands)                          
<S>                           <C>         <C>        <C>         <C>          <C>        <C>         <C>         <C> 
 Interest-bearing deposits      $59,348        5.80% $       --          --   $      --          --   $      --          -- 
Mortgage-backed securities           --           --         --          --          --          --       5,496       7.71% 
U.S. Treasury securities                                                                                                    
 Available-for-sale              10,512        5.96%     23,251       5.52%       1,006       7.45%          --          -- 
Federal Home Loan Bank Stock (1)     --           --         --          --          --          --       1,346       7.48% 
Other (1)                            --           --         --          --          --          --          15          -- 
                                -------        -----    -------       -----      ------       -----      ------       ----- 
Total                           $69,860        5.82%    $23,251       5.52%      $1,006       7.45%      $6,857       7.65% 
                                =======        =====    =======       =====      ======       =====      ======       ===== 
</TABLE> 
                                
<TABLE> 
<CAPTION> 
                                          Total 
                                  ---------------------
                                               Weighted 
                                   Carrying    Average 
                                    Value       Yield 
                                   --------    --------
<S>                               <C>          <C> 
 Interest-bearing deposits        $  59,348       5.80%
Mortgage-backed securities            5,496       7.71%
U.S. Treasury securities        
 Available-for-sale                  34,769       5.71%
Federal Home Loan Bank Stock (1)      1,346       7.48%
Other (1)                                15          --
                                   --------       -----
Total                              $100,974       5.89%
                                   ========       =====
</TABLE> 

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

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 no
borrowings outstanding at September 30, 1996; however, it does maintain
borrowing capabilities through the FHLB of Atlanta.

         Deposits.   On September 30, 1996 and September 30, 1995 and 1994, the
Bank's deposits totaled $146.4 million, $137.6 million and $127.3 million,
respectively. The Bank also received deposits totaling $46.6 million from
subscribers for the Company's common stock at September 30, 1996.

         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, 
                              ----------------------------------------------------------------------------------------

                                       1996              1995              1994              1993               1992
                                       ----              ----              ----              ----               ----
                                                                       (In Thousands)
<S>                                  <C>               <C>              <C>                 <C>               <C> 
Total deposits at                    $137,647          $127,312         $139,685            $138,753          $133,524
beginning of period

Net increase (decrease)                   976             4,355          (17,346)             (5,105)           (2,813)
before interest credited

Interest credited                       7,775             5,980            4,973               6,037             8,042 
                                        -----           -------          -------             -------           -------
Total deposits at end of
period                               $146,398          $137,647         $127,312            $139,685          $138,753 
                                     ========          ========         ========            ========          ========
</TABLE> 

<PAGE>
 
         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.

         The following table sets forth certain information regarding the Bank's
savings deposits at the dates indicated.

                                                        19
<PAGE>
 
<TABLE> 
<CAPTION> 
                                                                         At September 30,

                                      1996                               1995                                   1994 
                          ----------------------------        ---------------------------           ----------------------------

                                                 Weighted                            Weighted                              Weighted
                                Amount       Average Rate           Amount       Average Rate             Amount       Average Rate
                                ------       ------------           ------       ------------             ------       ------------

<S>                         <C>              <C>                 <C>             <C>                    <C>            <C> 
Deposits, stock offering    $   46,601              3.00%        $      --                 --           $     --                 --
                             =========           ========         ========       ============           ========       ============
</TABLE> 

<TABLE> 
<CAPTION>  
                                                                       At September 30,
                               --------------------------------------------------------------------------------------------
                                            1996                           1995                          1994 
                                  -------------------------       -------------------------     ------------------------- 

                                          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:                                                                                                
  Passbook savings               $  17,953   3.00%   12.26%   $  15,490    3.00%    11.25%  $  17,711    3.00%    13.91%
  NOW accounts                       6,369   2.59%    4.35%       6,331    3.02%     4.60%      6,300    2.72%     4.95%
  Money market deposit                                                                                          
       accounts                      6,674   3.00%    4.56%       7,809    3.25%     5.67%     12,164    3.25%     9.55%
  Noninterest bearing accounts         819      --    0.56%         562       --     0.41%        647       --     0.51%
                                     -----   -----    -----      ------    -----     -----      -----    -----     -----
      Total demand deposits         31,815   2.59%   21.73%      30,192    3.01%    21.93%     36,822    2.98%    28.92%
                                    ------   -----   ------      ------    -----                         -----    ------
Certificates of Deposit            114,307   5.96%   78.08%     107,280    6.10%    77.94%     90,378    3.93%    70.99%
                                   -------   -----   ------     -------    -----    ------     ------    -----    ------
Accrued Interest                       276            0.19%         175              0.13%        112              0.09%
                                   -------            -----         ---              -----     ------              -----
Total Deposits...............     $146,398   5.21%  100.00%    $137,647    5.43%   100.00%   $127,312    3.67%   100.00%
                                  ========   =====  =======    ========    =====   =======   ========   ======   =======
</TABLE> 

         As of September 30, 1996, the aggregate amount of time certificates of
deposit in amounts greater than or equal to $100,000 was $13.9 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, 1996
                                                                                       ------------------
                                                                                         (In Thousands)
<S>                                                                                    <C> 
3 Months or less                                                                           $ 1,795
Over 3 months through 6 months                                                               3,304
Over 6 months through 12 months                                                              4,053
Over 12 months                                                                               4,754
                                                                                           -------
         Total                                                                             $13,906
                                                                                           =======
</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

<PAGE>
 
Atlanta's assessment of the institution's creditworthiness. The Bank has not had
any outstanding borrowings from the FHLB of Atlanta or any other source in the
last five years.

Subsidiaries

         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, 1996, there were at least six 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, 1996, 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

         As of September 30, 1996, the Bank had 37 full-time employees. All full
time employees of the Bank are covered as a group for basic hospitalization,
including major medical, dental, accidental death and dismemberment insurance.
Optional medical and dental insurance is available for dependents which must be
partially paid by the employee. The Bank also maintains a defined benefit
retirement plan. In addition, in connection with the Conversion, the Bank
adopted an employment stock ownership plan which will provide benefits to the
Bank's employees.

         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.

                                       21
<PAGE>
 
         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
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 1996, 1995 and 1994.

         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, 1996
includes approximately $2.9 million for which no provision for federal income
tax has been made. See Note 12 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, 1996, 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 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,

                                       22
<PAGE>
 
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 7.75% 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 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 7.50% in 1997, 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 will become 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. The BHCA generally does not place territorial
restrictions on the activities of such nonbanking related activities.

         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,
under the 1991 Banking Law, 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

                                       23
<PAGE>
 
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 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.

         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.

         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. Also, no stock repurchases may
be made for at least one year after Conversion unless approved by the
Administrator, who may approve such repurchases only upon a finding that the
safety and soundness of the Bank would not be adversely affected thereby.

         Capital Adequacy Guidelines for Holding Companies. The Federal Reserve
has adopted capital adequacy guidelines for bank holding companies. 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 and other intangible assets. 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.

                                       24
<PAGE>
 
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.

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.

                                       25
<PAGE>
 
         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) establish certain collateral requirements for loans to
affiliates; (ii) 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 (iii) 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.

         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 based on underwriting standards not less
stringent than those applied in comparable transactions with other persons and
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.

         Insurance of Deposit Accounts. The FDIC administers two separate
deposit insurance funds. The SAIF maintains a fund to insure the deposits of
institutions the deposits of which were insured by the Federal Savings and Loan
Insurance Corporation (the "FSLIC") prior to the enactment of FIRREA, and the
BIF maintains a fund to insure the deposits of institutions the deposits of
which were insured by the FDIC prior to the enactment of FIRREA. The Bank is a
member of the SAIF of the FDIC.

         As a SAIF-insured institution, the Bank is subject to insurance
assessments imposed by the FDIC. Effective January 1, 1993, the FDIC replaced
its uniform assessment rate with a transitional risk-based assessment schedule
issued by the FDIC pursuant to the 1991 Banking Law, which imposes assessments
ranging from 0.23% to 0.31% of an institution's average assessment base. The
actual assessment to be paid by each SAIF member is based on the institution's
assessment risk classification, which will be determined based on whether the
institution is considered "well capitalized," "adequately capitalized" or
"undercapitalized" (as such terms have been defined in federal regulations), and
whether such institution is considered by its supervisory agency to be
financially sound or to have supervisory concerns.

                                       26
<PAGE>
 
         As a result of subsequent changes to the assessment schedule, financial
institutions such as the Bank that are members of the SAIF, are currently
required to pay higher deposit insurance premiums than financial institutions
which are members of the BIF (primarily commercial banks), because the BIF has
higher reserves than the SAIF and has been responsible for fewer troubled
institutions. This had created a disparity between SAIF and BIF assessments.
Annual assessments for BIF members in the lowest risk categories are now only
$2,000. For the years ended September 30, 1996 and 1995, the Bank's federal
deposit insurance premium expense was $318,000 and $295,000, respectively, not
including a one-time special SAIF assessment totaling $838,000 for the year
ended September 30, 1996 for the years ended September 30, 1996 and 1995,
respectively. The FDIC has noted that the premium differential may have adverse
consequences for SAIF members, including reduced earnings and an impaired
ability to raise funds in capital markets. In addition, SAIF members, such as
the Bank, could be placed at a substantial competitive disadvantage to BIF
members with respect to pricing of loans and deposits and the ability to achieve
lower operating costs.

         A comprehensive continuing appropriations bill enacted on September 30,
1996 reduced this premium differential between BIF- and SAIF-insured
institutions but did not eliminate it. As a result of this legislation, it is
now anticipated that, beginning on January 1, 1997, BIF-insured institutions,
except those in higher risk categories, will pay deposit insurance premiums
equal to approximately 1.3 cents per $100 of insured domestic deposits and SAIF-
insured institutions, except those in higher risk categories, will pay deposit
insurance premiums equal to approximately 6.4 cents per $100 of insured domestic
deposits. This premium differential is expected to exist until at least 
January 1, 1999.

         The above-described comprehensive continuing appropriations bill
enacted on September 30, 1996 also provides for a one-time assessment on SAIF
members to recapitalize the SAIF. The assessment is equal to 65.7 cents per each
$100 of insured domestic deposits. Such premium will have the effect of
immediately reducing the capital of SAIF-member institutions by the amount of
the assessment. SAIF-member institutions will not be allowed to amortize the
expense of the one-time assessment over a period of years. The one-time
assessment, which will be based on the Bank's deposits as of March 31, 1995, is
approximately $838,000 on a before tax basis and be payable prior to December,
1996. This one-time assessment to recapitalize the SAIF had an adverse effect on
the operating expenses and results of operations of the Bank during the quarter
ended September 30, 1996.

         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, which was
performed by the FDIC under the old CRA regulations in January 1994, 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.

         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 quantative 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."

                                       27
<PAGE>
 
         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,
1996, the Bank had a leverage ratio of 9.59%.

         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, 1996, the Bank complied with each of the capital
requirements of the FDIC and the Administrator.

         The 1991 Banking Law required each federal banking agency to revise its
risk-based capital standards to ensure that those standards 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 multi-family 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'
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 the Bank's management of interest rate risk.

         The FDIC has adopted a final rule changing its risk-based capital rules
to recognize the effect of bilateral netting agreements in reducing the credit
risk of two types of financial derivatives - interest and exchange rate
contracts. Under the rule, savings banks are permitted to net positive and
negative mark-to-market values of rate contracts with the same counterparty,
subject to legally enforceable bilateral netting contracts that meet certain
criteria. This represents a change from the prior rules which recognized only a
very limited form of netting. The Bank does not anticipate that this rule will
have a material effect upon its financial statements.

         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

                                       28
<PAGE>
 
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, 1996, 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.

         Limitations on Rates Paid for Deposits. Regulations promulgated by the
FDIC pursuant to the 1991 Banking Law place limitations on the ability of
insured depository institutions to accept, renew or roll over deposits by
offering rates of interest which are significantly higher than the prevailing
rates of interest on deposits offered by other insured depository institutions
having the same type of charter in such depository institution's normal market
area. Under these regulations, "well capitalized" depository institutions may
accept, renew or roll such deposits over without restriction, "adequately
capitalized" depository institutions may accept, renew or roll such deposits
over with a waiver from the FDIC (subject to certain restrictions on payments of
rates) and "undercapitalized" depository institutions may not accept, renew or
roll such deposits over. The definitions of "well capitalized," "adequately
capitalized" and "undercapitalized" are the same as the definitions adopted by
the FDIC to implement the corrective action provisions of the 1991 Banking Law.

         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, 1996, the Bank was in compliance with
this requirement with an investment in FHLB of Atlanta stock of $1.3 million.

         FIRREA has had the effect of reducing the dividends that the Bank
receives on its stock in the FHLB of Atlanta. During fiscal 1995 and 1996, the
Bank recorded dividend income of $94,000 and $101,000, respectively, with
respect to its FHLB of Atlanta stock. FIRREA requires each FHLB to contribute a
certain amount 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. In addition,
FIRREA requires each FHLB to transfer a percentage of its annual net earnings to
the Affordable Housing Program. That amount will increase from 5% of the annual
net income of the FHLB in 1990 to at least 10% of its annual net income in 1995
and subsequent years. As a result of these FIRREA requirements, it is
anticipated that the FHLB of Atlanta's earnings will be reduced and that the
Bank will receive reduced dividends on its FHLB of Atlanta stock in future
periods.

         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, 1996, 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 an insured institution, such as the 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 generally 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

                                       29
<PAGE>
 
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.

         For three years following completion of the Conversion, North Carolina
conversion regulations require the prior written approval of the Administrator
before any person may directly or indirectly offer to acquire or acquire the
beneficial ownership of more than 10% of any class of an equity security of the
Bank. If any person were to so acquire the beneficial ownership of more than 10%
of any class of any equity security without prior written approval, the
securities beneficially owned in excess of 10% would not be counted as shares
entitled to vote and would not be voted or counted as voting shares in
connection with any matter submitted to stockholders for a vote. Approval is not
required for (i) any offer with a view toward public resale made exclusively to
the Bank or its underwriters or the selling group acting on its behalf or (ii)
any offer to acquire or acquisition of beneficial ownership of more than 10% of
the common stock of the Bank by a corporation whose ownership is or will be
substantially the same as the ownership of the Bank, provided that the offer or
acquisition is made more than one year following the consummation of the
Conversion. The regulation provides that within one year following the
Conversion, the Administrator would approve the acquisition of more than 10% of
beneficial ownership only to protect the safety and soundness of the
institution. During the second and third years after the Conversion, the
Administrator may approve such an acquisition upon a finding that (i) the
acquisition is necessary to protect the safety and soundness of the Company and
the Bank or the Boards of Directors of the Company and the Bank support the
acquisition, (ii) the acquiror is of good character and integrity and possesses
satisfactory managerial skills, and will be a source of financial strength to
the Company and the Bank; and (iii) the public interests will not be adversely
affected.

         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 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, 1996, the Bank's liquidity ratio, calculated in
accordance with North Carolina regulations, was approximately 47.0%.

         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.

         Impact of the 1991 Banking Law. The 1991 Banking Law became effective
on December 19, 1991. Among other things, the 1991 Banking Law provided
increased funding for the BIF and provided for expanded regulation of depository
institutions and their affiliates, including bank holding companies.

         The 1991 Banking Law provided the federal banking agencies with broad
powers to take corrective action to resolve problems of insured depository
institutions. The extent of these powers will depend 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

                                       30
<PAGE>
 
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%.


         To facilitate the early identification of problems, the 1991 Banking
Law required the federal banking agencies to review and, under certain
circumstances, prescribe more stringent accounting and reporting requirements
than those required by generally accepted accounting principles. The FDIC issued
a final rule, effective July 2, 1993, implementing those provisions. The rule,
among other things, requires that management of institutions with $500 million
or more in assets report on the institution's responsibility for preparing
financial statements and establishing and maintaining an internal control
structure and procedures for financial reporting and compliance with designated
laws and regulations concerning safety and soundness, and that independent
auditors attest to and report separately on assertions in management's reports
concerning compliance with such laws and regulations, using FDIC-approved audit
procedures.

         The 1991 Banking Law further requires the federal banking agencies to
develop regulations requiring disclosure of contingent assets and liabilities
and, to the extent feasible and practicable, supplemental disclosure of the
estimated fair market value of assets and liabilities. The 1991 Banking Law also
requires annual examinations of all insured depository institutions by the
appropriate federal banking agency, with some exceptions for small, well-
capitalized institutions and state chartered institutions examined by state
regulators. Moreover, the 1991 Banking Law, as modified by the Federal Housing
Enterprises Financial Security and Soundness Act, requires the federal banking
agencies to set operational and managerial, asset quality, earnings and stock
valuation standards for insured depository institutions and depository
institution holding companies, as well as compensation standards (but not dollar
levels of compensation) for insured depository institutions that prohibit
excessive compensation, fees or benefits to officers, directors, employees, and
principal stockholders. The federal banking agencies have issued final
regulations, effective August 9, 1995, implementing these standards in
accordance with the 1991 Banking Law. Those agencies have also issued a joint
advance notice of proposed rulemaking soliciting comments on the addition of
asset quality and earnings guidelines to these safety and soundness standards.

         The foregoing necessarily is a general description of certain
provisions of the 1991 Banking Law and does not purport to be complete. The
effect of the 1991 Banking Law on the Bank has not yet been fully ascertained.

         Interstate Branching. A bank or savings bank holding company and its
subsidiaries are currently prohibited from acquiring any voting shares of, or
interest in, any banks or savings banks located outside of the state in which
the operations of the savings bank holding company's subsidiaries are located,
unless the acquisition is specifically authorized by the statutes of the state
in which the target bank is located. However, in September 1994, Congress passed
the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the
"Interstate Banking Act"). The Interstate Banking Act permitted adequately
capitalized bank and savings bank holding companies to acquire control of banks
and savings banks in any state beginning on September 29, 1995, one year after
the effectiveness of the Interstate Banking Act. In addition, 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

                                      31
<PAGE>
 
deposits in any one state, unless the state has specifically legislated a higher
deposit cap. States are free to legislate stricter deposit caps and, at present,
18 states have deposit caps lower than 30%.

         The Interstate Banking Act also provides for interstate branching. The
McFadden Act of 1927 established state lines as the ultimate barrier to
geographic expansion of a banking network by branching. The Interstate Banking
Act withdraws these barriers, 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 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. In addition, there can be no assurance as to
whether, or in what form, legislation may be enacted in North Carolina in
reaction to the Interstate Banking Act or what impact such legislation or the
Interstate Banking Act might have upon the Bank.

         The Interstate Banking Act also modifies the controversial safety and
soundness provisions contained in Section 39 of the 1991 Banking Law which
required the banking regulatory agencies to write regulations governing such
topics as internal controls, loan documentation, credit underwriting, interest
rate exposure, asset growth, compensation and fees and whatever else those
agencies determined to be appropriate. The legislation exempts bank holding
companies from these provisions and requires the agencies to write guidelines,
as opposed to regulations, dealing with these areas. It also gives more
discretion to the banking regulatory agencies with regard to prescribing
standards for banks' asset quality, earnings and stock valuation.

         The Interstate Banking Act also expands current exemptions from the
requirement that banks be examined on a 12-month cycle. Exempted banks will be
inspected every 18 months. Other provisions address paperwork reduction and
regulatory improvements, small business and commercial real estate loan
securitization, truth-in-lending amendments on high cost mortgages,
strengthening of the independence of certain financial regulatory agencies,
money laundering, flood insurance reform and extension of certain statutes of
limitations.

         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.


                                      32
<PAGE>
 
         In connection with the Conversion, the Company and the Bank have agreed
with the FDIC that, during the first year after the Conversion, the Bank will
not pay any dividend or make any other distribution to its stockholder which
represents, is characterized as or is treated for federal tax purposes as, a
return of capital.

         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 annual 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.

         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.


                                      33
<PAGE>
 
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, 1996. 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:                                    $625,000                $126,861
155 West South Street
Albemarle, North Carolina 28001

Two (2) Vacant Lots                            $26,000
South Second Street
Albemarle, North Carolina 28001

Locust:                                       $213,000                 $19,537
406 West Main Street
Locust, North Carolina 28097
</TABLE> 

         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, 1996 was $374,000.

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

         Prior to October 2, 1996, the Bank was organized as a mutual
institution. On September 17, 1996, the members of the Bank approved the Amended
and Restated Plan of Holding Company Conversion, dated as of July 19, 1996,
pursuant to which (i) the Bank would convert from a North Carolina chartered
savings bank organized in mutual form to a North Carolina chartered savings bank
organized in stock form and would sell its capital stock to the Company and (ii)
the Company would offer and sell shares of its Common Stock in a subscription
offering and, if necessary, in a community and syndicated community offering.
The Conversion was consummated, all shares of the converted bank were purchased
by the Company using a portion of the proceeds from the sale of its Common Stock
in the subscription offering, and subscriptions for 4,496,500 shares of the
Company's Common Stock were accepted on October 2, 1996.


                                      34
<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" in the Company's 1996 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 Financial Data" in the Company's 1996 Annual Report which is
incorporated herein by reference.

ITEM 7.           MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
                  OPERATING RESULTS

         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 Operating Results" on pages 3 through 14 in
the Company's 1996 Annual Report which section is incorporated herein by
reference.

ITEM 8.           FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

         The financial statements of the Bank set forth on pages 15 through 42
of the Company's 1996 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 and "- Executive Officers" contained in 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" in the Proxy
Statement, which is incorporated herein by reference.


ITEM 11.          EXECUTIVE COMPENSATION AND TRANSACTIONS

         The information required by this Item is set forth under the sections
captioned "Proposal 1 - Election of Directors - Directors Fees" and 
" - Management Compensation" contained in the Proxy Statement, which sections 
are incorporated herein by reference.


                                      35
<PAGE>
 
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"
contained in 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" contained in 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.           Financial Statements are contained in the Bank's 1996 Annual 
                  Report attached hereto as Exhibit (13) and incorporated 
                  herein by reference

                  (a)      Independent Auditors' Report

                  (b)      Statements of Financial Condition as of September 30,
                           1996 and 1995

                  (c)      Statements of Income for the Years Ended 
                           September 30, 1996, 1995 and 1994

                  (d)      Statements of Equity for the Years Ended 
                           September 30, 1996, 1995 and 1994

                  (e)      Statements of Cash Flows for the Years Ended 
                           September 30, 1996, 1995 and 1994

                  (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 Financial
                  Statements.

14(a)3.           Exhibits

                  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.

                                                        36
<PAGE>
 
                  Exhibit (10)(ii)          Employment Agreement between R.
                                            Ronald Swanner and Home Savings Bank
                                            of Albemarle, Inc., S.S.B.

                  Exhibit (10)(iii)         1985 Retirement Payment Agreements
                                            with Carl M. Hill, R. Ronald
                                            Swanner, Caldwell A. Holbrook, Jr.
                                            and Joel A. Huneycutt

                  Exhibit (10)(iv)          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

                  Exhibit (10)(v)           Directors Retirement Plan Agreement

                  Exhibit (10)(vi)          1985 Supplemental Income Agreements
                                            with Carl M. Hill and R. Ronald
                                            Swanner

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

                  Exhibit (11)              Statement Regarding Computation of
                                            Per Share Earnings

                  Exhibit (12)              Statement Regarding Computation of 
                                            Ratios

                  Exhibit (13)              Portions of the 1996 Annual Report 
                                            to Stockholders

                  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, 1996.




                                      37
<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 20, 1996      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:

Signature                           Title                        Date

/s/ Carl M.  Hill               President, Chief Executive  December 20, 1996
-----------------------------   Officer and Director
Carl M.  Hill                   
                                                            
/s/ R.  Ronald Swanner          Executive Vice President,   December 20, 1996
-----------------------------   Secretary and Director
R.  Ronald Swanner                   
                                                            
/s/ Christopher F.  Cranford    Controller and Treasurer    December 20, 1996
----------------------------- 
Christopher F.  Cranford                                   
                                                            
/s/ Caldwell A. Holbrook, Jr.   Director                    December 20, 1996
----------------------------- 
Caldwell A. Holbrook, Jr.                                   
                                                            
/s/ Joel A. Huneycutt           Director                    December 20, 1996
----------------------------- 
Joel A. Huneycutt                                           
                                                            
/s/ Douglas Dwight Stokes       Director                    December 20, 1996
----------------------------- 
Douglas Dwight Stokes           
                                
/s/ Greg E. Underwood           Director                    December 20, 1996
----------------------------- 
Greg E. Underwood




                                      38
<PAGE>
 
                               INDEX TO EXHIBITS



Exhibit No.                                 Description
-----------                                 -----------

Exhibit (10)(i)       Employment Agreement between Carl M. Hill and Home Savings
                      Bank of Albemarle, Inc., S.S.B.
                      
Exhibit (10)(ii)      Employment Agreement between R. Ronald Swanner and Home
                      Savings Bank of Albemarle, Inc., S.S.B.
                      
Exhibit (10)(iii)     1985 Retirement Payment Agreements with Carl M. Hill, R.
                      Ronald Swanner, Caldwell A. Holbrook, Jr. and Joel A.
                      Huneycutt
                      
Exhibit (10)(iv)      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
                       
Exhibit (10)(v)       Directors Retirement Plan Agreement
                      
Exhibit (10)(vi)      1985 Supplemental Income Agreements with Carl M. Hill and
                      R. Ronald Swanner
                      
Exhibit (10)(vii)     1995 Supplemental Income Agreements with Carl M. Hill and
                      R. Ronald Swanner
                      
Exhibit (11)          Statement Regarding Computation of Per Share Earnings
                      
Exhibit (12)          Statement Regarding Computation of Ratios
                      
Exhibit (13)          Portions of the 1996 Annual Report to Stockholders
                      
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, 1996.


                                      39