<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, 1999
                                          --------------------------

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


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

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

      155 West South Street
     Albemarle, North Carolina                              28001
-----------------------------------------                ----------
(Address of principal executive office)                   (Zip Code)

Registrant's telephone number, including area code  (704) 982-9184
                                                    --------------

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

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

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

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

Indicate by check mark if disclosure of delinquent filers in response to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.            [ X ]

State the aggregate market value of the voting stock held by non-affiliates of
the registrant.  The aggregate market value shall be computed by reference to
the price at which the stock was sold, or the average bid and asked prices of
such stock, as of a specified date within 60 days prior to the date of filing.
$25,201,357.50 common stock, no par value, based on the closing price of such
-----------------------------------------------------------------------------
common stock on December 22, 1999.
----------------------------------

Indicate the number of shares outstanding of each of the registrant's classes of
common stock, as of the latest practicable date.
3,665,652 shares of common stock, no par value, outstanding at December 22,
---------------------------------------------------------------------------
1999.
-----
                      DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Annual Report to stockholders of South Street Financial Corp.
for the year ended September 30, 1999 ("1999 Annual Report"), are incorporated
by reference into Part I, Part II and Part IV.

Portions of the Proxy Statement for the 2000 Annual Meeting of Shareholders of
South Street Financial Corp. to be held on February 28, 2000, are incorporated
by reference into Part III.

================================================================================
<PAGE>

                                    PART I


ITEM 1.   BUSINESS

General

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

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

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

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

     In June 1998, Park Ridge Associates, a joint venture between the Bank and a
local real estate developer, acquired 25.6 acres of prime real estate located
within the city limits of Albemarle, North Carolina, with the intention of
developing the property into a premier residential subdivision. Eleven out of
twenty-seven of the subdivision lots have been committed to buyers, and the
property is currently being marketed; the expected completion date is December
1999. There can be no assurances that the development will be completed by the
expected completion date, or that the Bank will be successful in recovering its
investment in the joint venture, due to the uncertainty inherent in the
construction industry and in the real estate market.

     In December 1998, the Bank joined the HONOR network (which merged into the
STAR network in 1999) and the CIRRUS network for ATMs and Point of Sale ("POS")
terminals, which allows the Bank's cardholders to enjoy the convenience and
accessability of approximately 324,000 ATMs and over 400,000 POS terminals
worldwide.

     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,

                                       2
<PAGE>

Savings Institutions Division, North Carolina Department of Commerce (the
"Administrator"). Deposit flows and cost of funds are influenced by interest
rates on competing investments and general market rates of interest. Lending
activities are affected by the demand for financing of real estate and other
types of loans, which in turn are affected by the interest rates at which such
financing may be offered and other factors affecting local demand and
availability of funds.

     At September 30, 1999, the Company had total assets of $174.5 million, net
loans of $125.5 million, deposits of $144.3 million, investment securities of
$41.5 million and stockholders' equity of $26.7 million.  The Company
repurchased 578,208 shares of common stock in 1999 resulting in a decrease in
stockholders' equity of $4.5 million.

     At September 30, 1999, the Company and the Bank had a total of 39
employees, all of whom are full-time. Employees are not represented by any union
or collective bargaining group, and the Bank considers its employee relations to
be good.

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

Market Area

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

     The Bank's loans and deposits are primarily generated from the areas where
its offices are located.  It does not solicit deposits and loans outside its
primary market area and does not use brokers to obtain deposits.  Approximately
83% of the Bank's deposits are at the Albemarle office. Stanly County is largely
rural with a population of 54,000.  Its economy is diversified among
manufacturing, trade and services.  Major area employers include Wiscassett
Mills Company, Collins and Aikman Corporation, Michelin Aircraft Tire Company,
Oakwood Homes 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 98% of the Bank's loan
portfolio is secured by real estate.  As of September 30, 1999, all of the loans
in the Bank's real estate loan portfolio were secured by properties in North
Carolina.  On September 30, 1999, the Bank's largest single outstanding loan had
a balance of approximately $1.0 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 $125.5 million at September 30, 1999 representing 71.9% of the
Company's total assets at such date.  At September 30, 1999, 83.7% of the Bank's
net loan portfolio was composed of one-to-four family residential mortgage
loans.  Home equity loans, all of which have

                                       3
<PAGE>

adjustable rates, represented 2.3% of the Bank's net loan portfolio, and
nonresidential real estate loans represented 3.0% 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, 1999, fewer than 1% of the loans in the
Bank's loan portfolio, excluding home equity loans, had adjustable interest
rates.

     In December 1998, the Bank started a new consumer and commercial loan
department and began offering a full range of consumer and commercial products
and services.  See "- Consumer Loans" below for a further discussion of the new
department, products and services.

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

                                       4
<PAGE>

<TABLE>
<CAPTION>
                                                  Year Ended September 30,
                                           --------------------------------------
                                              1999          1998          1997
                                           ----------     ----------   ----------
                                                       (In Thousands)
<S>                                        <C>             <C>         <C>
Loans receivable, net,
 beginning of period                       $ 110,550       $ 111,990   $ 109,858
                                            --------         -------     -------
Loan originations:
   Residential 1-4 family                     26,604          16,309      17,998
   Nonresidential real estate                    513           1,303         524
   Residential construction                   11,949           2,963       9,898
   Line of credit                              1,247           1,641       1,248
   Commercial                                  5,739              --          --
   Consumer                                    1,213             343         321
                                            --------         -------     -------
     Total loan originations                  47,265          22,559      29,989
Principal repayments                        (227,948)        (27,123)    (24,763)
Other changes, net/(1)/                       (4,374)          3,124      (3,094)
                                            --------         -------     -------
Increase (decrease) in loans receivable       14,943          (1,440)      2,132
                                            --------         -------     -------
Loans receivable, net, end of period       $ 125,493       $ 110,550   $ 111,990
                                            ========         =======     =======
</TABLE>
______________________________
/(1)/  Includes changes in deferred loan fees, allowance for loan losses and
       undisbursed portion of construction loans.

     Residential Real Estate Lending.  The Bank's primary lending activity,
which it intends to continue to emphasize, is the origination of fixed-rate
mortgage loans to enable borrowers to purchase or refinance one-to-four family
residential real property.  Consistent with the Bank's emphasis on being a
community-oriented financial institution, it is and has been the Bank's strategy
to focus its lending efforts in Stanly County, North Carolina and in contiguous
counties.  On September 30, 1999, approximately 83.7% of the Bank's total net
real estate loan portfolio consisted of one-to-four family residential real
estate loans.  These include both loans secured by detached single-family
residences and condominiums and loans secured by housing containing not more
than four separate dwelling units.  Of such loans, 2.4% 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 95% 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

                                       5
<PAGE>

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, 1999, the Bank had approximately
$620,000 in outstanding loans secured by multifamily residential real estate,
comprising approximately 0.49% of its net 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, 1999, the Bank had
$11.2 million in outstanding loans secured by nonresidential real estate,
including undeveloped land, comprising approximately 8.9% 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, 1999, the largest nonresidential real estate loan in the Bank's
loan portfolio totaled $1.0 million. This loan was performing in accordance with
the original loan contract.

     Home Equity Lines of Credit.  At September 30, 1999, the Bank had
approximately $2.9 million in home equity line of credit loans, representing
approximately 2.3% of its net loan portfolio. These loans are often originated
at the time of the closing of a one-to-four family residential real estate loan
secured by the same property. The Bank's home equity lines of credit have
adjustable interest rates tied to prime interest rates plus a margin. The home
equity lines of credit require monthly payments until the loan is paid in full.
Home equity lines of credit are generally secured by subordinate liens against
residential real property. The Bank requires that fire and extended coverage
casualty insurance (and, if appropriate, flood insurance) be maintained in an
amount at least sufficient to cover its loan. Home equity loans are generally
limited so that the amount of such loans, along with any senior indebtedness,
does not exceed 80% of the value of the real estate security. Because home
equity loans involve revolving lines of credit which can be drawn over a period
of time, the Bank faces risks associated with changes in the borrower's
financial condition. Because home equity loans have adjustable interest rates
with no rate caps (other than usury limitations), increased delinquencies could
occur if interest rate increases occur and borrowers are unable to satisfy
higher payment requirements. The Bank 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, 1999 was approximately $11.2 million, representing
approximately 9.0% 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%.

                                       6
<PAGE>

     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,
automobile loans and other secured and unsecured consumer loans. As of September
30, 1999, the Bank had approximately $2.6 million in consumer loans outstanding,
representing approximately 2.1% of its net loan portfolio.

     In December 1998, the Bank started a new consumer and commercial loan
department and began offering a full range of consumer and commercial products
and services. To oversee the new department, the Bank hired a commercial banker
with over 21 years of experience in the local market. The Bank hired another
loan officer in August 1999 to assist in the growth of this line of service.
Management of the Bank believes that introducing consumer and commercial lending
to the Bank's existing line of products and services will enhance the Bank's net
interest margin while reducing the Bank's overall exposure to interest rate
risk. Management also feels that the addition of these products will help the
Bank grow while creating stronger ties to its existing customer base. As of
September 30, 1999, commercial loans, which are classified as nonresidential
real estate loans, totaled approximately $4.9 million, representing
approximately 3.9% of the Bank's 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 $500,000 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 $500,000 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, 1999, the Bank
had $8.5 million in such unfunded mortgage loan commitments. In addition, on
such date the Bank had $3.6 million in unfunded commitments for unused lines of
credit and letters of credit.

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

                                       7
<PAGE>

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

     Nonperforming Assets and Asset Classification. When a borrower fails to
make a required payment on a loan and does not cure the delinquency promptly,
the loan is classified as delinquent. Delinquencies on all loans are reviewed
monthly by the Board of Directors. The normal procedure followed by the Bank
once a loan is classified as delinquent is to make contact with the borrower at
prescribed intervals in an effort to bring the loan to a current status, and
late charges are assessed as allowed by law. In most cases, delinquencies are
cured promptly. If a delinquency is not cured, the Bank normally, subject to any
required prior notice to the borrower, commences foreclosure proceedings. If the
loan is not reinstated within the time permitted for reinstatement, or the
property is not redeemed prior to sale, the property may be sold at a
foreclosure sale. In foreclosure sales, the Bank may acquire title to the
property through foreclosure, in which case the property so acquired is offered
for sale and may be financed by a loan involving terms more favorable to the
borrower than those normally offered. Any property acquired as a result of
foreclosure or by deed in lieu of foreclosure is classified as real estate owned
until such time as it is sold or otherwise disposed of by the Bank to recover
its investment. As of September 30, 1999, the Bank had one piece of single-
family property classified as real estate owned. The property was recorded on
the Bank's books at $18,000, the unpaid principal balance of loans secured by
such property. The appraised value of the property exceeded their its principal
balance. 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, 1999,
interest income that would have been recorded net of interest income actually
recognized on nonperforming loans under the original terms of such loans was
$12,000.

     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, 1999, the Bank had approximately $291,000 of loans
internally classified as "substandard", and no loans classified as "doubtful" or
"loss". The Bank also identifies assets which possess credit deficiencies or
potential weaknesses deserving close attention by management. These assets may
be considered "special mention" assets and do not yet warrant adverse
classification. At September 30, 1999, the Bank had approximately $791,000 of
loans in the "special mention" category.

                                       8
<PAGE>

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

     The following table sets forth at September 30, 1999, 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
                                 ------        ------   ------        ------   ------        ------   ------        ------
<S>                              <C>           <C>      <C>           <C>      <C>           <C>      <C>           <C>
                                                                   (Dollars in Thousand)

Real estate loans:
   Residential 1-4 family            30          $791       11          $222       --          $ --       --          $ --
   Residential real estate           --            --       --            --       --            --       --            --
   Nonresidential real estate        --            --       --            --       --            --       --            --
   Residential construction          --            --       --            --       --            --       --            --
   Land                              --            --       --            --       --            --       --            --
   Line of credit                    --            --        3            65       --            --       --            --
                                   ----          ----     ----          ----     ----          ----     ----          ----
      Total real estate loans        30           791       14           287       --            --       --            --
                                   ----          ----     ----          ----     ----          ----     ----          ----

Consumer loans:
   Share                             --            --       --            --       --            --       --            --
   Credit reserve                    --            --        4             4       --            --       --            --
                                   ----          ----     ----          ----     ----          ----     ----          ----
      Total consumer loans           --            --        4             4       --            --       --            --
                                   ----          ----     ----          ----     ----          ----     ----          ----
Total                                30          $791       18          $291       --          $ --       --          $ --
                                   ====          ====     ====          ====     ====          ====     ====          ====
</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, 1999, the Bank maintained its level of allowance for loan losses
which management believes is adequate based on the risks inherent in the loan
portfolio.

     For information on loans receivable, see Note 4 of "Notes to Consolidated
Financial Statements" in the 1999 Annual Report.

Investment Securities

     Interest and dividend income from investment securities generally provides
the second largest source of income to the Company after interest on loans. In
addition, the Company receives interest income from deposits in other

                                       9
<PAGE>

financial institutions. On September 30, 1999, the carrying value of the
Company's investment securities portfolio totaled approximately $41.5 million
and consisted of interest-bearing deposits, federal funds sold, U.S. government
and agency securities, mortgage-backed securities, and stock in the FHLB of
Atlanta. The investment securities portfolio includes interest-bearing deposits
and federal funds sold of $2.3 million at September 30, 1999. The mortgage-
backed securities consist of mortgage-backed securities issued by the GNMA, FNMA
and FHLMC.

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

     The FASB has issued Statement of Financial Accounting Standards No. 115
("SFAS 115"), "Accounting for Certain Investments in Debt and Equity Securities"
which addresses the accounting and reporting for investments in equity
securities that have readily determinable fair values and for all investments in
debt securities. These investments are to be classified in three categories and
accounted for as follows: (1) debt securities that the entity has the positive
intent and ability to hold to maturity are classified as held-to-maturity and
reported at amortized cost; (2) debt and equity securities that are bought and
held principally for the purpose of selling them in the near term are classified
as trading securities and reported at fair value, with net unrealized gains and
losses included in earnings; and (3) debt securities not classified as either
held-to-maturity or trading securities and equity securities not classified as
trading securities are classified as securities available-for-sale and reported
at fair value, with unrealized gains and losses excluded from earnings and
reported as a separate component of equity. The Company has no trading
securities. See Note 3 of "Notes to Consolidated Financial Statements" in the
1999 Annual Report.

     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, 1999, the Bank's investment in stock of the FHLB of Atlanta was
$1.2 million.

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

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

     See Note 3 of "Notes to Consolidated Financial Statements" in the 1999
Annual Report for further information on investment securities.

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

                                       10
<PAGE>

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 had no borrowings outstanding from
other banks at September 30, 1999.

     Deposits. On September 30, 1999, 1998 and 1997, the Bank's deposits
totaled, $144.3 million, $148.4 million, and $141.8 million, respectively.

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

<TABLE>
<CAPTION>
                             ---------------------------------------------------
                                   At or For the Year Ended September 30,
                             ---------------------------------------------------
                               1999       1998       1997       1996      1995
                             ---------  ---------  ---------  --------  --------
<S>                          <C>        <C>        <C>        <C>       <C>
                                                (In Thousands)
Total deposits at            $148,444   $141,755   $146,398   $137,647  $127,312
 beginning of period
Net increase (decrease)       (11,116)      (614)   (11,998)       976     4,355
 before interest credited
Interest credited               6,944      7,303      7,355      7,775     5,980
                             --------   --------   --------   --------  --------
Total deposits at end of
 period                      $144,272   $148,444   $141,755   $146,398  $137,647
                             ========   ========   ========   ========  ========
</TABLE>

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

     In December 1998, the Bank joined the HONOR network (which merged into the
STAR network in 1999) and the CIRRUS network for ATMs and Point of Sale ("POS")
terminals, which allows the Bank's cardholders to enjoy the convenience and
accessability of approximately 324,000 ATMs and over 400,000 POS terminals
worldwide.

     Borrowings. The FHLB system functions in a reserve credit capacity for
savings institutions. As a member, the Bank is required to own capital stock in
the FHLB of Atlanta and is authorized to apply for advances from the FHLB of
Atlanta on the security of that stock and a floating lien on certain of its real
estate secured loans and other assets. Each credit program has its own interest
rate and range of maturities. Depending on the program, limitations on the
amount of advances are based either on a fixed percentage of an institution's
net worth or on the FHLB of Atlanta's assessment of the institution's
creditworthiness. The Bank had no outstanding borrowings from the FHLB of
Atlanta at September 30, 1999. On January 8, 1998, the Company made a return of
capital distribution to its stockholders in the form of a special dividend of
$6.00 per share on all outstanding shares of Common Stock. To partially fund
this special dividend,

                                       11
<PAGE>

the Company borrowed $18.0 million from an outside bank in fiscal year 1999. The
note was paid off on October 1, 1998


     See Notes 8 and 9 of "Notes to Consolidated Financial Statements" in the
1999 Annual Report for further information on deposits and borrowings.

Subsidiaries

     The Company has no subsidiaries other than the Bank. The Bank has a wholly-
owned subsidiary, South Street Development Corp. ("SSDC"), which is a 50% owner
of Park Ridge Associates, L.L.C. ("Park Ridge"). SSDC and Park Ridge do business
in the real estate development industry.

     In June 1998, Park Ridge acquired 25.6 acres of prime real estate located
within the city limits of Albemarle, North Carolina. Park Ridge acquired the
real estate to develop it into a premier residential subdivision. The upscale
subdivision consists of 30 building lots of which 3 have been retained by the
sellers and 11 have been committed to buyers. As of December 1999 the project
was 99% completed, and was being marketed. There can be no assurances that the
development will be completed by the expected completion date, or that the Bank
will be successful in recovering its investment in the joint venture, due to the
uncertainty inherent in the construction industry and in the real estate market.

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, 1999, there were at least 7 other commercial banks,
credit unions and mortgage companies as well as numerous other financial
services providers located in the Bank's market area. At September 30, 1999, the
Bank had a deposit market share of approximately 25% 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.

Federal Income Taxation

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

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

     The percentage of taxable income method was limited to 8% of taxable
income. This method could not raise the reserve to exceed 6% of qualifying real
property loans at the end of the year. Moreover, the additions for qualifying

                                       12
<PAGE>

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 1999, 1998 and 1997.

     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. Retained earnings at September 30, 1999 includes
approximately $2.9 million for which no provision for federal income tax has
been made. See Note 12 to "Notes to Consolidated Financial Statements" in the
1999 Annual Report.


     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, 1999, the
Bank's post-1987 excess reserves amounted to approximately $852,000. A special
provision suspended recapture of post-1987 excess reserves for two years
because, during those years, the institution satisfied a "residential loan
requirement." This requirement was met because the principal amount of the
institution's residential loans exceeded the base year amount, which was
measured by the average of the institution's residential loans during the six
taxable years ending before January 1, 1996. During the year ended September 30,
1999, the Bank recaptured $171,000 of the excess reserve.

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

                                       13
<PAGE>

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 12
years.

State Taxation

     Under North Carolina law, the corporate income tax is 7.25% of federal
taxable income as computed under the Code, subject to certain prescribed
adjustments. An annual state franchise tax is imposed at a rate of 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 7.00% in 2000 and 6.90%
thereafter.

                          SUPERVISION AND REGULATION


     Bank holding companies and state savings banks are extensively regulated
under both federal and state law. The following is a brief summary of certain
statutes and rules and regulations that affect or will affect the Company and
the Bank. This summary is qualified in its entirety by reference to the
particular statutes and regulatory provisions referred to below and is not
intended to be an exhaustive description of the statutes or regulations
applicable to the business of the Company and the Bank. Supervision, regulation
and examination of the Company and the Bank by the regulatory agencies are
intended primarily for the protection of depositors rather than shareholders of
the Company.

Regulation of the Company

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

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

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

     There are a number of obligations and restrictions imposed on bank holding
companies and their depository institution subsidiaries by law and regulatory
policy that are designed to minimize potential loss to the depositors of such
depository institutions and the FDIC insurance funds in the event the depository
institution becomes in danger of default or in default. For example, to avoid
receivership of an insured depository institution subsidiary, a bank holding
company is required to guarantee the compliance of any insured depository
institution subsidiary that may become "undercapitalized" with the terms of any
capital restoration plan filed by such subsidiary with its appropriate federal
banking agency up to the lesser of (i) an amount equal to 5% of the
institution's total assets at the time the institution

                                       14
<PAGE>

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, 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.

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

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

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

     Federal Securities Law. The Company has registered its Common Stock with
the SEC pursuant to Section 12(g) 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

                                       15
<PAGE>

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.

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

     Transactions with Affiliates.  Under current federal law, transactions
between the Bank and any affiliate are governed by Sections 23A and 23B of the
Federal Reserve Act. An affiliate of the Bank is any company or entity that
controls, is controlled by or is under common control with the savings bank.
Generally, subsidiaries of a bank, other than a bank subsidiary, and certain
other types of companies are not considered to be affiliates. Generally,
Sections 23A and 23B (i) limit the extent to which the Bank or its subsidiaries
may engage in "covered transactions" with any one affiliate

                                       16
<PAGE>

to an amount equal to 10% of such the Bank's capital stock and surplus, and
contain an aggregate limit on all such transactions with all affiliates to an
amount equal to 20% of such capital stock and surplus and (ii) require that all
such transactions be on terms substantially the same, or at least as favorable,
to the Bank or the subsidiary as those provided to a nonaffiliate. The term
"covered transaction" includes the making of loans or other extensions of credit
to an affiliate, the purchase of assets from an affiliate, the purchase of, or
an investment in, the securities of an affiliate, the acceptance of securities
of an affiliate as collateral for a loan or extension of credit to any person,
or issuance of a guarantee, acceptance or letter of credit on behalf of an
affiliate.

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

     Deposit Insurance.  The Bank is required to pay assessments based on a
percentage of its insured deposits to the FDIC for insurance of its deposits by
the SAIF. Under the FDIC's risk-based deposit insurance assessment system, the
assessment rate for an insured depository institution depends on the assessment
risk classification assigned to the institution by the FDIC, which is determined
by the institution's capital level and supervisory evaluations. Based on the
data reported to regulators for the date closest to the last day of the seventh
month preceding the semi-annual assessment period, institutions are assigned to
one of three capital groups -- well capitalized, adequately capitalized or
undercapitalized -- using the same percentage criteria as in the prompt
corrective action regulations. See "--Regulation of the Bank - Prompt
Corrective Regulatory Action." Within each capital group, institutions are
assigned to one of three subgroups on the basis of supervisory evaluations by
the institution's primary supervisory authority and such other information as
the FDIC determines to be relevant to the institution's financial condition and
the risk posed to the deposit insurance fund. Subgroup A consists of financially
sound institutions with only a few minor weaknesses. Subgroup B consists of
institutions that demonstrate weaknesses which, if not corrected, could result
in significant deterioration of the institution and increased risk of loss to
the deposit insurance fund. Subgroup C consists of institutions that pose a
substantial probability of loss to the deposit insurance fund unless effective
corrective action is taken. The assessment rate for SAIF members had ranged from
0.23% of deposits for well capitalized institutions in Subgroup A to 0.31% of
deposits for undercapitalized institutions in Subgroup C while assessments for
over 90% of the BIF members had been the statutory minimum of $2,000. The Bank's
federal deposit insurance premium expense was $87,000, $89,000, and $70,000, for
the years ended September 30, 1999, 1998 and 1997, respectively.

     Under recently enacted legislation, both BIF and SAIF members are assessed
an amount for the Financing Corporation Bond payments. BIF members are assessed
approximately 1.3 basis points while the SAIF rate is approximately 6.4 basis
points until January 1, 2000. At that time, BIF and SAIF members will begin pro
rata sharing of the payment at an expected rate of 2.43 basis points.

     Community Reinvestment Act. The Bank, like other financial institutions, is
subject to the Community Reinvestment Act, as amended ("CRA"). A purpose of this
Act is to encourage financial institutions to help meet the credit needs of its
entire community, including the needs of low- and moderate-income neighborhoods.
During the Bank's last compliance examination the Bank received a "satisfactory"
rating with respect to CRA compliance. The Bank's

                                       17
<PAGE>

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 quantitative measures do not
accurately present its actual performance, or that demographics, competitive
conditions or economic or legal limitations peculiar to the service area should
be considered. The ratings received under the three tests will be used to
determine the overall composite CRA rating. The composite ratings will be the
same as those that are currently given: "outstanding," "satisfactory," "needs to
improve" or "substantial non-compliance."

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

     An institution which fails to meet minimum capital requirements may be
subject to a capital directive which is enforceable in the same manner and to
the same extent as a final cease and desist order, and must submit a capital
plan within 60 days to the FDIC. If the leverage ratio falls to 2% or less, the
bank may be deemed to be operating in an unsafe or unsound condition, allowing
the FDIC to take various enforcement actions, including possible termination of
insurance or placement of the institution in receivership. At September 30,
1999, the Bank had a leverage ratio of 14.44%.

     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, 1999, the Bank complied with each of the capital
requirements of the FDIC and the Administrator.

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

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

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

                                       18
<PAGE>

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 Bank's management of interest rate risk.

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

     As of  September 30, 1999, the largest aggregate amount of loans which the
Bank had to any one borrower was $1.3 million. The Bank had no loans outstanding
which management believes violate the applicable loans-to-one-borrower limits.
The Bank does not believe that the loans-to-one-borrower limits will have a
significant impact on its business, operations and earnings.

     Federal Home Loan Bank System.  The FHLB system provides a central credit
facility for member institutions. As a member of the FHLB of Atlanta, the Bank
is required to own capital stock in the FHLB of Atlanta in an amount at least
equal to the greater of 1% of the aggregate principal amount of its unpaid
residential mortgage loans, home purchase contracts and similar obligations at
the end of each calendar year, or 5% of its outstanding advances (borrowings)
from the FHLB of Atlanta. On September 30, 1999, the Bank was in compliance with
this requirement with an investment in FHLB of Atlanta stock of $1.2 million.

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

     Federal Reserve System.  Federal Reserve regulations require savings banks,
not otherwise exempt from the regulations, to maintain reserves against their
transaction accounts (primarily negotiable order of withdrawal accounts) and
certain nonpersonal time deposits. The reserve requirements are subject to
adjustment by the Federal Reserve. As of September 30, 1999, the Bank was in
compliance with the applicable reserve requirements of the Federal Reserve.

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

     Liquidity.  The Bank is subject to the Administrator's requirement that the
ratio of liquid assets to total assets equal at least 10%. The computation of
liquidity under North Carolina regulation allows the inclusion of mortgage-
backed securities and investments which, in the judgment of the Administrator,
have a readily marketable

                                       19
<PAGE>

value, including investments with maturities in excess of five years. On
September 30, 1999, the Bank's liquidity ratio, calculated in accordance with
North Carolina regulations, was approximately 32%.

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

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

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

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

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

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

                                       20
<PAGE>

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

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

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

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

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

     The Company paid regular cash dividends totaling $0.40 per share during the
year ended September 30, 1999.

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

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

     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.

                                       21
<PAGE>

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

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

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


ITEM 2.   PROPERTIES

Properties

     The following table sets forth the location of the Bank's principal office
in Albemarle, North Carolina and its full service branch office in Locust, North
Carolina, as well as certain other information relating to these offices as of
September 30, 1999. 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:                                 $632,000       $119,231
  155 West South Street
  Albemarle, North Carolina 28001

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

Locust:                                    $215,000       $ 25,041
  406 West Main Street
  Locust, North Carolina 28097
                                           $873,000       $144,272
                                            =======        =======
</TABLE>

     The Bank's management considers the property to be in good condition and is
of the opinion that it is adequately covered by insurance.  The total net book
value of the Bank's furniture, fixtures and equipment on September 30, 1999 was
$292,000.  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, 1999, the Bank had recorded $18,000 for real estate acquired in settlement
of loans.

                                       22
<PAGE>

ITEM 3.   LEGAL PROCEEDINGS

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

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

     No matter was submitted to a vote of the Company's stockholders during the
quarter ended September 30, 1999.


                                    PART II

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

     See the information under the section captioned "Common Stock Information"
on page 65 in the Company's 1999 Annual Report, which section is incorporated
herein by reference. See "Item 1. DESCRIPTION OF BUSINESS--Regulation of the
Bank--Restrictions on Dividends and Other Capital Distributions" above for
regulatory restrictions which limit the ability of the Bank to pay dividends to
the Company.

ITEM 6.   SELECTED FINANCIAL DATA

     The information required by this Item is set forth in the table captioned
"Selected Consolidated Financial Data" on the inside cover of the Company's 1999
Annual Report which is incorporated herein by reference.

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

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

<TABLE>
<CAPTION>
                                                         Year Ended September 30,
                                                -------------------------------------------
                                                 1999     1998     1997     1996     1995
                                                -------  -------  -------  -------  -------
<S>                                             <C>      <C>      <C>      <C>      <C>
Return on Average Assets (Net income divided
   by average total assets)                       0.15%    0.35%    1.24%    0.30%    1.23%

Return on Average Equity (Net income divided
   by average shareholders' equity                0.96%    1.89%    4.70%    2.45%    9.50%

Average Equity to Average Assets Ratio
   (Average shareholders' equity divided by
   average total assets)                         16.12%   18.43%   26.40%   12.23%   12.97%

Interest Rate Spread for the Period               2.48%    1.97%    2.02%    2.52%    3.59%

Average Interest-Earning Assets to Average
   Interest-Bearing Liabilities                 118.68%  123.10%  136.08%  112.00%  112.74%

Net Interest Margin                               3.24%    2.98%    3.46%    3.09%    4.11%

Loan Loss Allowance to Nonperforming Assets
   at Period End                                222.23%  135.76%   81.25%   63.69%   12.28%
</TABLE>

                                       23
<PAGE>

     See also the information set forth under Item 1 above and the information
set forth under the section captioned "Management's Discussion and Analysis of
Financial Condition and Results of Operation" on pages 4 through 21 in the
Company's 1999 Annual Report which section is incorporated herein by reference.

ITEM 7A   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     Pages 5 and 6 of the 1999 Annual Report are herein incorporated by
reference.

     Interest Rate Risk Management

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

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

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

     Consistent with the asset/liability management philosophy described above,
the Company has taken several steps to manage its interest rate risk.  First,
the Company has structured the security portfolio to shorten the lives of its
interest-earning assets.  The Company's recent purchases of securities,
including mortgage-backed securities have had short or medium terms to maturity.
At September 30, 1999, the Company had securities totaling $41.5 million, of
which $18.6 million have contractual maturities of five years or less.
Mortgage-backed securities amortize and experience prepayments of principal; the
Company has received average cash flows from principal paydowns, sales,
maturities and calls of securities of $39.9 million annually over the past three
fiscal years.  The Company also controls interest rate risk reduction by
emphasizing non-certificate depositor accounts.  The Board and management
believe that such accounts carry a lower cost than certificate accounts, and
that a material portion of such accounts may be more resistant to changes in
interest rates than are certificate accounts.  At September 30, 1999, the
Company had $14.6 million of regular savings accounts, and $14.5 million of
money market, demand and NOW accounts, representing 20.2% of total depositor
accounts.

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

ITEM 8.   FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

                                       24
<PAGE>

     The consolidated financial statements of the Company and supplementary data
set forth on pages 23 through 65 of the Company's 1999 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 of the Proxy Statement
captioned "Proposal 1 - Election of Directors - General" of the Proxy Statement
and "Proposal - Election of Directors - Executive Officers," 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 Proxy
Statement section captioned "Section 16(a) Beneficial Ownership Reporting
Compliance," which is incorporated herein by reference.

ITEM 11.  EXECUTIVE COMPENSATION

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

ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

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

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 Proxy Statement section captioned "Proposal 1 -Election
of Directors - Certain Indebtedness and Transactions of Management," which
section is incorporated herein by reference.


                                    PART IV

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

14(a)1.   Consolidated Financial Statements (contained in the Bank's 1999
          Annual Report attached hereto as Exhibit (13) and incorporated herein
          by reference)

          (a)  Independent Auditor's Report

          (b)  Statements of Financial Condition as of September 30, 1999 and
               1998

          (c)  Statements of Income and Comprehensive Income for the Years Ended
               September 30, 1999, 1998 and 1997

                                       25
<PAGE>

          (d)  Statements of Stockholders' Equity for the Years Ended September
               30, 1999, 1998 and 1997

          (e)  Statements of Cash Flows for the Years Ended September 30, 1999,
               1998 and 1997

          (f)  Notes to Consolidated Financial Statements

14(a)2.   Financial Statement Schedules

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

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.,
                             incorporated herein by reference to the Form 10-K
                             dated September 30, 1996

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

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

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

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

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


                                       26
<PAGE>

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

          Exhibit (10)(ix)   South Street Financial Corp. Stock Option Plan,
                             incorporated herein by reference to the Form 10-K
                             dated September 30, 1997

          Exhibit (10)(x)    Home Savings Bank of Albemarle, Inc., SSB
                             Management Recognition Plan and Trust Agreement,
                             incorporated herein by reference to the Form 10-K
                             dated September 30, 1997

          Exhibit (11)       Statement Regarding Computation of Per Share
                             Earnings

          Exhibit (12)       Statement Regarding Computation of Ratios

          Exhibit (13)       Portions of the 1999 Annual Report to Security
                             Holders

          Exhibit (21)       See Item 1. Business for discussion of subsidiaries

          Exhibit (23)       Consent of Independent Certified Public Accountants

          Exhibit (27)       Financial Data Schedule

14(b)     The Company filed a report on Form 8-K on July 14, 1999, to disclose
          that, on June 14, 1999, the Company's Board of Directors authorized
          Management to repurchase up to 10% of  common stock currently issued
          and outstanding stock, which totaled 378,784 shares.

                                       27
<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 28, 1999            By:  /s/ Carl M. Hill
                                        -------------------------------------
                                        Carl M. Hill
                                        President and Chief Executive Officer

     Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated:

<TABLE>
<CAPTION>
Signature                                Title                   Date
-----------------------------  --------------------------  -----------------
<S>                            <C>                         <C>

/s/ Carl M. Hill               President, Chief Executive  December 28, 1999
-----------------------------
Carl M. Hill                   Officer and Director

/s/ R. Ronald Swanner          Executive Vice President,   December 28, 1999
-----------------------------
R.  Ronald Swanner             Secretary and Director

/s/ Christopher F. Cranford    Controller and Treasurer    December 28, 1999
-----------------------------
Christopher F. Cranford

/s/ Caldwell A. Holbrook,      Director                    December 28, 1999
-----------------------------
Caldwell A. Holbrook, Jr.

/s/ Joel A. Huneycutt          Director                    December 28, 1999
-----------------------------
Joel A. Huneycutt

/s/ Douglas Dwight Stokes      Director                    December 28, 1999
-----------------------------
Douglas Dwight Stokes

/s/ Greg E. Underwood          Director                    December 28, 1999
-----------------------------
Greg E. Underwood
</TABLE>

                                       28
<PAGE>

                               INDEX TO EXHIBITS


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

Exhibit (11)        Statement Regarding Computation of Per Share Earnings

Exhibit (12)        Statement Regarding Computation of Ratios

Exhibit (13)        1999 Annual Report

Exhibit (23)        Consent of Independent Certified Public Accountants

Exhibit (27)        Financial Data Schedule

                                       29