<PAGE>

                                                                    EXHIBIT 13.1



<PAGE>




                          WAKE FOREST BANCSHARES, INC.







                               2006 Annual Report
















<PAGE>


                                    CONTENTS


<TABLE>
-----------------------------------------------------------------------------------------------------------------------

<S>                                                                                                              <C>
SELECTED CONSOLIDATED FINANCIAL DATA                                                                                 1

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

REPORT TO STOCKHOLDERS                                                                                               2

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

MANAGEMENT'S DISCUSSION AND ANALYSIS                                                                            3 - 15

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

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM                                                             16

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

CONSOLIDATED FINANCIAL STATEMENTS:

Consolidated statements of financial condition at September 30, 2006 and 2005                                       17

Consolidated statements of income for years ended September 30, 2006 and 2005                                       18

Consolidated statements of stockholders' equity for the years ended
September 30, 2006 and 2005                                                                                     19 -20

Consolidated statements of cash flows for the years ended
September 30, 2006 and 2005                                                                                    21 - 22
-----------------------------------------------------------------------------------------------------------------------

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                                                                     23 - 35

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

COMMON STOCK INFORMATION                                                                                            36

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

CORPORATE INFORMATION                                                                                               37

-----------------------------------------------------------------------------------------------------------------------
</TABLE>

<PAGE>

                          WAKE FOREST BANCSHARES, INC.
                      SELECTED CONSOLIDATED FINANCIAL DATA

<TABLE>
<CAPTION>
                                                                            September 30,
                                            --------------------------------------------------------------------------------
                                                   2006            2005            2004            2003            2002
                                               -------------   -------------    ------------    ------------    ------------
Financial Condition Data:                                                       (In Thousands)
<S>                                         <C>             <C>             <C>             <C>             <C>
Total assets                                $       104,279 $        99,731 $        87,650 $        85,674 $        92,985
Investments (1)                                      23,806          22,273           5,467          16,381          15,331
Loans receivable, net                                76,635          73,894          79,241          67,016          75,747
Deposits                                             83,978          80,905          69,891          68,840          76,767
Stockholders' equity                                 18,806          17,406          16,407          15,542          14,840


                                                                   Years Ended September 30,
                                                --------------------------------------------------------------------------------
                                                   2006            2005            2004            2003            2002
                                               -------------   -------------    ------------    ------------    ------------
Operating Data:                                                     (In Thousands, Except Per Share Data)
Interest and dividend income                $         7,173 $         5,752 $         4,818 $         5,325 $         6,445
Interest expense                                      2,979           2,315           1,942           2,325           3,436
                                               -------------   -------------    ------------    ------------    ------------
Net interest income                                   4,194           3,437           2,876           3,000           3,009
Provision for loan losses                               193             120              90             215             144
Noninterest income                                      109              95             129             315             350
Noninterest expense                                   1,519           1,350           1,153           1,234           1,497
                                               -------------   -------------    ------------    ------------    ------------
Income before income taxes                            2,591           2,062           1,762           1,866           1,718
Income tax expense                                      935             741             673             715             662
                                               -------------   -------------    ------------    ------------    ------------
Net income                                  $         1,656 $         1,321 $         1,089 $         1,151 $         1,056
                                               =============   =============    ============    ============    ============

Basic earnings per share                    $          1.44 $          1.14  $         0.95  $         1.01  $         0.92
Diluted earnings per share                             1.43            1.13            0.94            1.00            0.92
Dividends per share                                    0.68            0.60            0.56            0.52            0.48
Dividend payout ratio                                21.31%          23.67%          26.36%          29.68%          52.15%

Selected Other Data:
Return on average assets (3)                          1.63%           1.38%           1.26%           1.30%           1.11%
Return on average equity (3)                          9.19%           7.86%           6.89%           7.57%           7.24%
Interest rate spread (3)                              3.66%           3.24%           2.91%           2.94%           2.57%
Average equity to average assets (3)                 17.75%          17.60%          18.29%          17.15%          15.39%
Net interest margin (3)                               4.27%           3.73%           3.41%           3.48%           3.24%
Allowance for loan losses to
  nonperforming loans (2)                           156.44%         110.27%          48.99%         259.11%          44.23%
Nonperforming loans to total loans (2)                0.86%           1.03%           1.86%           0.37%           1.38%
</TABLE>

(1) Includes interest earning deposits and investment securities
(2) Nonperforming loans include mortgage loans delinquent more than 90 days
(3) Average balances are derived from month-end balances

                                       1
<PAGE>


                             REPORT TO STOCKHOLDERS


I am pleased to report that your Company reported record earnings of $1.66
million, or $1.43 per diluted share, for our fiscal year ended September 30,
2006. Our earnings for 2006 exceeded our previous best year in 2000 by more than
$325,000 and represented a 25% increase over the prior year. At the end of 2006,
the Company had also set historical records for total assets and deposits.
Earnings per share also increased by over 26% from 2005. Our positive operating
results were primarily generated due to the Company's increased interest rate
spread. Because the Company maintains loan and investment portfolios which are
rate sensitive, the Federal Reserve actions to gradually increase market rates
have had a positive impact on our revenue stream. In contrast, the Company's
cost of funds has risen at a somewhat slower rate due to the sizable amount of
fixed rate certificates in our deposit portfolio. The Company's interest rate
margin was 4.27% in 2006 as compared to 3.73% in the prior year. The Company
also reported an efficiency ratio of approximately 32% during 2006, a measure
that demonstrates the Company's ability to operate in a prudent and lean manner.
The Company's return on assets amounted to 1.63% during the current year,
considerably higher than most other community institutions in North Carolina.


The Company declared cash dividends of $0.68 per share for 2006, after having
paid dividends of $0.60 per share during the previous year. Because federal
income tax laws tax dividends at the same rate as long term capital gains,
shareholders benefit from cash dividends in a similar fashion to equities that
rely solely upon capital appreciation. We are able to continue to pay dividends
because the Company is profitable and is in a strong capital position. The
Company's stock price generally traded in a relatively narrow range throughout
most of the year but moved higher at year end. While stock movements are not
always tied to performance, I am pleased to report that if you had invested in
our Company at our initial public offering, your annualized 10 year total rate
of return would have been approximately 19% today.

Although the Company had one of its best years in terms of lending volume, heavy
construction loan payoffs during the current year limited loan growth during
2006. A significant amount of the Company's lending is due to our community's
close proximity to Raleigh and the Research Triangle Park. As a result,
construction of new homes in the Wake Forest area has continued to expand.
Assuming favorable economic conditions, the long-term fundamentals for the Wake
Forest area continue to be positive and should support continued loan growth.
The Company offers an array of competitively priced deposit products and we
intend to remain aggressive with our deposit pricing to ensure that the Company
has sufficient liquidity for continued growth and profitability.

The Board of Directors' and management's primary commitment is to maximize
shareholder value while continuing to serve our local market as a hometown
community-oriented financial institution. We appreciate your investment in Wake
Forest Bancshares, Inc. and are excited about the future prospects of the
Company. As always, we encourage your comments and suggestions, and truly
appreciate your support and business.

                                   Respectfully,




                                   Robert C. White
                                   President & Chief Executive Officer


                                       2
<PAGE>

WAKE FOREST BANCSHARES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
------------------------------------------------------------------------------

                                     GENERAL

Wake Forest Bancshares, Inc. (the "Company") was formed in 1999 for the purpose
of becoming a savings and loan holding company. The Company owns 100% of the
stock of Wake Forest Federal Savings & Loan Association ("Wake Forest Federal"
or the "Association"). The Association was founded in 1922. The Company in turn
is majority owned by Wake Forest Bancorp, M.H.C., (the "MHC") a mutual holding
company. The formation of the Company had no impact on the operations of the
Association or the MHC. The Association continues to operate at the same
location, with the same management, and subject to all the rights, obligations
and liabilities of the Association which existed immediately prior to the
formation of the Company.

The Company conducts no business other than holding stock in the Association,
investing dividends received from the Association, repurchasing its common stock
from time to time, and distributing dividends on its common stock to its
shareholders. The principal business of the Association is accepting deposits
from the general public and using those deposits and other sources of funds
primarily to make loans secured by real estate and, to a lesser extent, other
forms of collateral located in the Association's primary market area of Wake and
Franklin counties in North Carolina.

Members of the MHC consist of depositors and certain borrowers of the
Association, who have the sole authority to elect the board of directors of the
MHC for as long as it remains in mutual form. The MHC's principal asset consists
of 635,000 shares of the Company's common stock. The MHC also is eligible to
receive its proportional share of dividends declared and paid by the Company,
but has elected to waive the receipt of its quarterly dividends since the first
quarter of the 2003 year. Such funds when received are invested in deposits with
the Association. The MHC, which by law must own in excess of 50% of the stock of
the Company, currently has an ownership interest of 54.9% of the Company.

The MHC's Board of Directors, which is currently the same as the Association's
and the Company's Board of Directors, will generally be able to control the
outcome of most matters presented to the stockholders of the Company for
resolution by vote except for certain matters related to stock compensation
plans, a vote regarding conversion of the mutual holding company to stock form,
or other matters which require an affirmative vote by the minority stockholders.
The Company and the MHC are registered as savings and loan holding companies and
are subject to regulation, examination, and supervision by the Office of Thrift
Supervision ("OTS").

The Association's results of operations depend primarily on its net interest
income, which is the difference between interest income from interest-earning
assets and interest expense on interest-bearing liabilities. The Association's
operations are also affected by non-interest income, such as fees from servicing
loans, loan sales, customer deposit account service charges, and other sources
of revenue. The Association's principal operating expenses, aside from interest
expense, consist of compensation and related benefits, federal deposit insurance
premiums, office occupancy costs, and other general and administrative expenses.

The following discussion and analysis is intended to assist readers in
understanding the results of operations and changes in financial position at and
for the years ended September 30, 2006 and 2005.


                                       3
<PAGE>

WAKE FOREST BANCSHARES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
------------------------------------------------------------------------------

                               FINANCIAL CONDITION

Total assets increased by $4.6 million during 2006, from $99.7 million at
September 30, 2005 to $104.3 million at September 30, 2006. The increase in
total assets resulted primarily from a $3.1 million increase in customer
deposits during the year and from $1.3 million in retained income from current
operations.

Total investments, including short-term interest-earning deposits, increased by
$1.5 million during 2006 and amounted to $23.8 million at September 30, 2006.
The Association's investment portfolio has been heavily weighted in short term
instruments to minimize interest rate risk and to have funds available for
growth in the loan portfolio. The investment securities portfolio, which
amounted to $738,450 at September 30, 2006, contains available for sale
securities with net unrealized gains of $532,850. The net unrealized gains are
associated with the Company's investment in Federal Home Loan Mortgage
Corporation ("Freddie Mac") stock.

Net loans receivable increased by approximately $2.7 million during 2006 from
$73.9 million at September 30, 2005 to $76.6 million at September 30, 2006.
Although loan growth was not significant during 2006, the Association originated
a heavy volume of loans during the year. The Association closed $45.8 million in
loans and incurred loan payoffs of $42.6 million during 2005, primarily
construction loans. The Association originated $44.9 million in loans and had
$48.7 in loan payoffs in the prior year. Because the Association's primary
lending area is in close proximity to Raleigh and the Research Triangle Park,
population growth and demand for housing has spilled over into surrounding
communities such as Wake Forest. In addition to these geographic advantages,
relatively low mortgage interest rates and improved local economic conditions
helped spur loan originations in 2006.

Customer deposits increased by $1.5 million during 2006 and totaled $84.0
million at September 30, 2006, a record high for the Company. The increase in
deposits occurred primarily because the Association has competitively priced its
deposits to support loan demand and to provide additional liquidity to sustain
construction loan commitments.

The Company had no outstanding borrowings during 2006. The Company has borrowing
capacity through the Association's ability to borrow funds from the Federal Home
Loan Bank of Atlanta (the "FHLB"). This capacity is currently set at 12% of the
Association's total assets, subject to available collateral.

The Company and the Association are both required to meet certain capital
requirements as established by the OTS. At September 30, 2006, all capital
requirements were met. (See Note 12 to the consolidated financial statements).

The Board of Directors of the Company has approved an ongoing stock repurchase
program authorizing the Company to repurchase its outstanding common stock,
subject to regulatory approval. The repurchases are made through registered
broker-dealers from shareholders in open market purchases at the discretion of
management. The Company intends to hold the shares repurchased as treasury
shares, and may utilize such shares to fund stock benefit plans or for any other
general corporate purpose as permitted by applicable law. At September 30, 2006,
the Company had repurchased 90,445 shares of its common stock for $1,389,800.
The program continues until terminated by the Board of Directors.


                                       4
<PAGE>

WAKE FOREST BANCSHARES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
------------------------------------------------------------------------------

                              RESULTS OF OPERATIONS

Returns. The Company's return on average assets was 1.63% and 1.38% and its
return on average equity was 9.19% and 7.86% for 2006 and 2005, respectively.
The increase in the returns on average assets and average equity during 2006 was
primarily due to an increase in the Company's interest margin during the current
year.

Net Income. The Company's net income for the years ended September 30, 2006 and
2005 was $1,655,950 and $1,320,500, respectively. Net income in 2006 was
approximately 25% higher than the earnings reported in 2005 due to an improved
interest margin during the current year. The 22.0% increase in net interest
income more than offset a 12.47% increase in non-interest expense during 2006.

Net Interest Income. Net interest income represents the difference between
income derived from interest-earning assets and interest expense incurred on
interest-bearing liabilities. Net interest income is affected by both (i) the
difference between the rates of interest earned on interest-earning assets and
the rates paid on interest-bearing liabilities ("interest rate spread") and (ii)
the relative amounts of interest-earning assets and interest-bearing liabilities
outstanding during the period. Net interest income increased by $757,300 to
$4,194,200 for the year ended September 30, 2006 from $3,436,900 reported in
2005. Net interest income increased primarily due to an increase in the
Company's interest rate spread, which improved from 3.24% in 2005 to 3.66% in
2006.

Interest Income. Total interest income increased to $7.2 million in 2006 from
$5.8 million in 2005, an increase of $1,421,500. The increase in interest income
during 2006 was primarily attributable to a 1.06% rise in the Company's yield on
interest earning assets in 2006 due to a rising interest rate environment. A
$6.2 million increase in the average balance of interest earning assets
outstanding between 2005 and 2006 also contributed to the increase in interest
income. The Company's overall yield on interest earning assets was 6.24% in 2005
as compared with 7.30% in 2006.

Interest Expense. Total interest expense increased from $2.3 million in 2005 to
$3.0 million in 2006, an increase of $664,200. The Association's cost of funds
increased from 3.00% in 2005 to 3.64% in 2006, an increase of 0.64% due to a
rising interest rate environment and competitive pricing considerations. The
increase in interest expense from 2005 to 2006 was due primarily to an increase
in the Association cost of funds but a $4.8 million rise in the average volume
of interest-bearing deposits between the current year and 2005 also contributed
to the increase in interest expense.

Provision for Loan Losses. The Association provided $192,500 in loan loss
provisions during 2006. In 2005, the Association provided $119,600 in loan loss
provisions. The Association had no loan charge-offs in 2006 or 2005. The
provisions, which are charged to operations, and the resulting loan loss
allowances are amounts the Association's management believes will be adequate to
absorb probable losses that are estimated to have occurred. Loans are
charged-off against the allowance when management believes that uncollectibility
is confirmed. Subsequent recoveries, if any, are credited to the allowance.

The allowance for loan losses is evaluated on a regular basis by management and
is based upon management's periodic review of the collectibility of the loans in
light of historical experience, the nature and volume of the loan portfolio,
adverse situations that may affect the borrower's ability to repay, estimated
value of any underlying collateral and prevailing economic conditions. The
Company records provisions for loan losses based upon known problem loans and
estimated deficiencies in the existing loan portfolio.

During the past five years, the Association's loan portfolio has gradually
trended towards a greater concentration of residential construction and land
loans, which generally involve a greater degree of credit risk and collection
issues. As a result, the Company has provided a relatively higher level of loan
loss provisions during the current five year period than what has historically
been deemed necessary. This evaluation is inherently subjective as it requires
estimates that are susceptible to significant revisions as more information
becomes available. In addition, regulatory examiners may require the Association
to recognize adjustments to the allowance for loan losses based on their
judgments about information available to them at the time of their examination.


                                       5
<PAGE>

WAKE FOREST BANCSHARES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
------------------------------------------------------------------------------

                        RESULTS OF OPERATIONS (CONTINUED)

Non-interest Income. Non-interest income amounted to $108,650 and $94,750 in
2006 and 2005, respectively. Non-interest income typically consists of service
charges and fees associated with the Association's loan and deposit accounts as
well as income from bank owned life insurance contracts. The Association also
receives fee income on the origination and sale of certain long-term fixed rate
mortgage loans.

Non-interest Expense. Non-interest expense consists primarily of operating
expenses for compensation and related benefits, occupancy, federal insurance
premiums, OTS operating assessments, data processing charges, and costs
associated with foreclosed assets. Non-interest expenses amounted to $1,519,000
and $1,350,550 in 2006 and 2005, respectively.

Compensation and related benefits increased from $746,600 in 2005 to $820,500 in
2006, an increase of $73,900. The increase in compensation and benefits occurred
primarily because of increased health insurance cost and because the Company
paid a higher level of bonuses associated with the greater earnings in the
current year as compared to 2005.

Data processing and outside service fees increased by $28,200 from $126,550 in
2005 to $154,750 during 2006 because the Company recently completed a computer
systems upgrade and conversion, resulting in additional travel and training cost
as well as depreciation expense on new equipment and software rights.

Expenses associated with foreclosed assets increased from $91,650 in 2005 to
$170,500 in 2006. All of the expense associated with foreclosed assets during
2005 and 2006 occurred as a result of environmental assessment activities
associated with the Company's foreclosed 3.81 acre commercial tract on highway
98 outside of Wake Forest, North Carolina. Other operating expense decreased by
$18,750 from $299,700 during 2005 to $280,950 in 2006, primarily because of a
decrease in the Company's state franchise tax expense in the current year.
Occupancy expense and federal insurance premiums and OTS operating assessments
changed nominally from 2005 to 2006. Certain administrative expenses are
allocated to the MHC as shown in Note 15 to the Consolidated Financial
Statements.

Income Taxes. The Company's effective income tax rate was 36.1% and 35.9% in
2006 and 2005, respectively. The slight difference in rates was due to changes
in the components of permanent tax differences, including nontaxable investment
income and earnings from bank owned life insurance.



                                       6
<PAGE>

                  AVERAGE BALANCES, INTEREST, YIELDS AND COSTS

The following table sets forth certain information relating to the Association's
average balance sheets and reflects the average yield on assets and average cost
of liabilities at and for the periods indicated. Such yields and costs are
derived by dividing income or expense by the average balance of assets or
liabilities, respectively, for the periods presented. Average balances are
derived from month-end balances. Management does not believe that the use of
month-end balances instead of daily average balances has caused a material
difference in the information presented.

<TABLE>
<CAPTION>
                                                                                        Year Ended September 30,
                                                                            --------------------------------------------
                                                                                               2006
                                                                            --------------------------------------------
                                               At September 30, 2006
                                             --------------------------                                      Average
                                               Actual        Yield/            Average                        Yield/
Assets:                                        Balance        Cost             Balance         Interest        Cost
                                             ------------  ------------     ---------------   ------------  ------------
     Interest-earning assets:
<S>                                       <C>                    <C>    <C>                <C>                    <C>
        Interest-earning deposits         $       23,067         5.27%  $           23,454 $        1,100         4.69%
        Investment securities                        738         3.65%                 685             25         3.65%
        Loans receivable (1)                      76,635         7.99%              74,145          6,048         8.16%
                                             ------------                   ---------------   ------------
     Total interest-earning assets               100,440         7.36%              98,284 $        7,173         7.30%
                                                                                              ------------
     Non-interest-earning assets                   3,839                             3,252
                                             ------------                   ---------------
                     Total                $      104,279                $          101,536
                                             ============                   ===============

Liabilities and stockholders' equity:
     Interest-bearing liabilities:
        Passbook accounts                          2,703         2.00%               2,859             48         1.68%
        NOW & MMDA accounts                       26,272         3.87%              25,213            809         3.21%
        Certificates of deposit                   55,003         4.38%              53,784          2,122         3.95%
                                             ------------                   ---------------   ------------
     Total interest-bearing liabilities           83,978         4.14%              81,856 $        2,979         3.64%
                                                                                              ------------
     Non-interest-bearing liabilities              1,495                             1,655
     Stockholders' equity                         18,806                            18,025
                                             ------------                   ---------------
                     Total                $      104,279                $          101,536
                                             ============                   ===============
Net interest income and
     interest rate spread (2)                                    3.22%                     $        4,194         3.66%
                                                                                              ============
Net yield on interest-earning assets (3)                         3.90%                                            4.27%
Ratio of interest-earning assets to
     interest-bearing liabilities                              119.60%                                          120.07%

<CAPTION>
                                                     Year Ended September 30,
                                              --------------------------------------------
                                                              2005
                                              --------------------------------------------
                                                                                Average
                                                 Average                         Yield/
Assets:                                          Balance        Interest         Cost
                                              --------------   ------------   ------------
     Interest-earning assets:
<S>                                        <C>              <C>                     <C>
        Interest-earning deposits          $         16,984 $          471          2.77%
        Investment securities                           712             19          2.67%
        Loans receivable (1)                         74,426          5,262          7.07%
                                              --------------   ------------
     Total interest-earning assets                   92,122 $        5,752          6.24%
                                                               ------------
     Non-interest-earning assets                      3,307
                                              --------------
                     Total                 $         95,429
                                              ==============

Liabilities and stockholders' equity:
     Interest-bearing liabilities:
        Passbook accounts                             3,069             30          0.98%
        NOW & MMDA accounts                          21,465            428          1.99%
        Certificates of deposit                      52,505          1,857          3.54%
                                              --------------   ------------
     Total interest-bearing liabilities              77,039 $        2,315          3.00%
                                                               ------------
     Non-interest-bearing liabilities                 1,592
     Stockholders' equity                            16,798
                                              --------------
                     Total                 $         95,429
                                              ==============
Net interest income and
     interest rate spread (2)                               $        3,437          3.24%
                                                               ============
Net yield on interest-earning assets (3)                                            3.73%
Ratio of interest-earning assets to
     interest-bearing liabilities                                                 119.58%

</TABLE>

(1) Balance is net of deferred loan fees and loans in process. Non-accrual loans
    are included in the balances.
(2) Interest rate spread represents the difference between the average yield on
    interest-earning assets and the average cost of interest-bearing
    liabilities.
(3) Net yield on interest-earning assets represents net interest income divided
    by average interest-earning assets.

                                       7
<PAGE>


                   RATE/VOLUME ANALYSIS OF NET INTEREST INCOME

The following table analyzes the dollar amount of changes in interest income and
interest expense for major components of the Association's interest-earning
assets and interest-bearing liabilities. The table distinquishes between (1)
changes in net interest income attributable to volume (changes in volume
multiplied by the prior period's interest rate), (2) changes in net interest
income attributable to rate (changes in interest rates multiplied by the prior
period's volume), and (3) mixed changes (changes in volume multiplied by changes
in rates).

<TABLE>
<CAPTION>
                                                      Year Ended September 30,
                                                             2006 vs. 2005
                                                  Increase (Decrease) Attributable to
                                         ----------------------------------------------------------
                                                                          Rate/
Assets:                                    Volume          Rate           Volume           Net
                                         ------------   ------------   -------------   ------------
<S>                                  <C>             <C>            <C>             <C>
    Interest-earning assets:
       Interest-earning deposits     $           179 $          326 $           124 $          629
       Investment securities                      (1)             7               -              6
       Loans receivable                          (20)           811              (5)           786
                                         ------------   ------------   -------------   ------------
                    Total                        158          1,144             119          1,421
                                         ------------   ------------   -------------   ------------

Liabilities:
    Interest-bearing liabilities:
       Passbook savings                           (2)            21              (1)            18
       NOW & MMDA accounts                        75            262              44            381
       Certificate of deposit                     45            215               5            265
                                         ------------   ------------   -------------   ------------
                    Total                        118            498              48            664
                                         ------------   ------------   -------------   ------------

    Net interest income              $            40 $          646 $            71 $          757
                                         ============   ============   =============   ============

<CAPTION>
                                                     Year Ended September 30,
                                                            2005 vs. 2004
                                                 Increase (Decrease) Attributable to
                                        ----------------------------------------------------------
                                                                          Rate/
Assets:                                   Volume           Rate          Volume           Net
                                        ------------   -------------   ------------   ------------
<S>                                 <C>             <C>             <C>            <C>
    Interest-earning assets:
       Interest-earning deposits    $            82 $           160 $          114 $          356
       Investment securities                     10              (5)            (3)             2
       Loans receivable                          37             532              7            576
                                        ------------   -------------   ------------   ------------
                    Total                       129             687            118            934
                                        ------------   -------------   ------------   ------------

Liabilities:
    Interest-bearing liabilities:
       Passbook savings                           1              15             (1)            15
       NOW & MMDA accounts                       64             126             42            232
       Certificate of deposit                    92              35             (1)           126
                                        ------------   -------------   ------------   ------------
                    Total                       157             176             40            373
                                        ------------   -------------   ------------   ------------

    Net interest income             $           (28)$           511 $           78 $          561
                                        ============   =============   ============   ============
</TABLE>


                                       8
<PAGE>

WAKE FOREST BANCSHARES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
--------------------------------------------------------------------------------

                                  ASSET QUALITY

The Company's level of non-performing loans, consisting of loans past due 90
days or more, as a percentage of loans outstanding, was 0.86% and 1.03% at
September 30, 2006 and 2005, respectively. At September 30, 2006, non-performing
loans amounted to $666,400 and were comprised of two residential property loans
and one commercial property loan totaling $457,350, which consisted of two mini
storage facilities and an office building on 3.6 acres in Wendell, N.C. At this
time, we believe that the fair market value of all these properties is higher
than the outstanding loan balances and we will not incur a loss on the ultimate
disposition of any of these loans. All of the loans have been placed on
non-accrual status.

At September 30, 2006, non-performing assets also included a foreclosed
commercial property ($1,003,800) which consisted of a convenience store and an
adjacent tract of land, in total 3.81 acres located on a major highway outside
of Wake Forest, North Carolina. While the property's location is considered
highly desirable, the Company decided that an environmental assessment was
necessary to properly market the tract due to the historical uses of the
property. As a result, site assessment reports were filed with various state
environmental agencies. Petroleum contamination and other trace elements
consistent with operating a gas station and a truck maintenance facility over an
extended period of time were found on parts of the property. The Company is in
the process of applying for brownfields status for the site which should make
the tract more attractive to prospective developers of the property. Although
the Company does not currently believe the contamination will have a detrimental
effect on the potential development of the property, the agencies are expected
to be able to assist the Company in determining the extent of any required
clean-up and ongoing monitoring steps that will be required. At this time, the
Company does not believe that the ongoing environmental costs will materially
impact the value of the property and no loss is expected on its ultimate sale.
During the current year, the Company expensed $170,500 in environmentally
related cost for this property.

The Company had no loan charge-offs during the year ended September 30, 2006.
The Company's loan loss allowance amounted to $1,042,500 at September 30, 2006
and management believes that it has sufficient loan loss allowances established
to cover any loss associated with its loan portfolio. The allowance for loan
losses is established based upon probable losses that are estimated to have
occurred through a provision for loan losses charged to earnings. During the
past five years, the Association's loan portfolio has gradually trended towards
a greater concentration of residential construction and land loans, which
generally involve a greater degree of credit risk and collection issues. As a
result, the Company has provided relatively higher levels of loan loss
provisions and resulting allowances during this period than what has
historically been considered necessary. The allowance for loan losses is
evaluated on a regular basis by management.

The Company records provisions for loan losses based upon known problem loans
and estimated deficiencies in the existing loan portfolio. The Company's
methodology for assessing the appropriateness of the allowance for loan losses
consists of two key components which are a specific allowance for identified
problem or impaired loans under the provisions of Statement of Financial
Accounting Standards ("SFAS")No. 114, "Accounting by Creditors for Impairment of
a Loan", and a formula allowance for the remainder of the portfolio under the
provisions of SFAS No. 5, "Accounting for Contingencies." Because the Company
only originates loans secured by real estate, specific problem loans are graded
using the standard regulatory classifications and are evaluated for impairment
under SFAS No. 114 based upon the collateral's fair value less estimated cost of
disposal.

All other loans with unidentified impairment issues are pooled and segmented by
major loan types (single-family residential properties, construction loans,
commercial real estate, land, etc.). Loan loss rates for these categories are
then generated by capturing historical loan losses net of recoveries over a five
and ten year period, with added weight given to the more recent five year
period. Qualitative factors that may affect loan collectibility such as
geographical and lending concentrations, local economic conditions, and
delinquency trends are also considered in determining the Company's best
estimate of the range of credit losses. This evaluation is inherently subjective
as it requires estimates that are susceptible to significant revision as more
information becomes available.

Although management believes it has established and maintained the allowance for
loan losses at appropriate levels, future adjustments may be necessary if
economic, real estate values and other conditions differ substantially from the
current operating environment. In addition, regulatory examiners may require the
Association to recognize adjustments to the allowance for loan losses based on
their judgments about information available to them at the time of their
examination.


                                       9
<PAGE>

WAKE FOREST BANCSHARES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
--------------------------------------------------------------------------------

                         CAPITAL RESOURCES AND LIQUIDITY

The Company declared dividends of $.68 per share during 2006. Although the
Company anticipates that it will continue to declare cash dividends on a regular
basis, the Board of Directors will review its policy on the payment of dividends
on an ongoing basis, and such payment may be subject to dividends received from
the Association to the Company, future earnings, cash flows, capital needs, and
regulatory restrictions. During 2006, the MHC waived the receipt of its
quarterly dividends from the Company. The Board of Directors of the MHC will
continue to review the operating needs of the MHC and may elect to waive future
dividends.

The objective of the Company's liquidity management is to ensure the
availability of sufficient cash flows to meet all financial commitments and to
capitalize on opportunities to enhance stockholders' value. More specifically,
liquidity ensures that adequate funds are available to meet deposit withdrawals,
fund loan and capital expenditure commitments, maintain reserve requirements,
pay operating expenses, and provide funds for debt service, dividends to
stockholders, and other institutional commitments. Funds are primarily provided
through financial resources from operating activities, expansion of the deposit
base, repayments received on loans, borrowings, the sale or maturity of
investments, or the ability to raise equity capital.

During the current year, cash increased by approximately $1.5 million, and
amounted to $23.8 million at September 30, 2006. Cash flow resulting from
internal operating activities provided increases of $1.8 million in cash during
the year ended September 30, 2006. Cash flows from investing activities utilized
$3.0 million in cash during the current year, with net loan originations of $3.2
million being the primary use of cash. Because the Federal Reserve raised short
term rates on a consistent basis throughout the majority of 2006 and the bond
markets produced a relatively flat yield curve out at least ten years, the
Association elected to maintain its excess liquidity in shorter term cash
investments and was therefore not active in the securities market in 2006.

During 2006, financing activities of the Company generated $2.8 million in cash,
including net deposit increases of $3.1 million. As a result of construction
loan commitments and heavy loan originations, the Association aggressively
marketed its deposits during the current year. The Association's ability to
generate deposits has historically been sufficient to fund its loan demand and
provide for adequate liquidity without the need to access other forms of credit
availability. However, the Association has a readily available source of credit
through its borrowing capacity at the FHLB of Atlanta, currently equal to 12% of
total assets assuming eligible collateral is available. Cash provided by
operating and financing activities is used to originate new loans to customers,
to maintain the Association's liquid investment portfolios, and to meet short
term liquidity requirements.

Given its current liquidity and its ability to borrow from the FHLB of Atlanta,
the Company believes that it will have sufficient funds available to meet
anticipated future loan commitments, unexpected deposit withdrawals, and other
cash requirements.

                         OFF-BALANCE SHEET TRANSACTIONS

In the normal course of business, the Association engages in a variety of
financial transactions that, under generally accepted accounting principles,
either are not recorded on the balance sheet or are recorded on the balance
sheet in amounts that differ from the full contract or notional amounts.
Primarily the Association is a party to financial instruments with
off-balance-sheet risk in the normal course of business to meet the financing
needs of its customers. These financial instruments include commitments to
extend credit, revolving lines of credit, and the undisbursed portion of
construction loans. Those instruments involve, to varying degrees, elements of
credit and interest rate risk in excess of the amounts recognized in the
statement of financial condition. The contract or notional amounts of those
instruments reflect the extent of involvement the Association has in particular
classes of financial instruments.

The Association's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for commitments to extend credit is
represented by the contractual notional amount of those instruments. The
Association uses the same credit policies in making commitments and conditional
obligations as it does for on-balance-sheet instruments. At September 30, 2006,
the Association had outstanding loan commitments amounting to $4,992,600. The
undisbursed portion of construction loans amounted to $13,340,900 and unused
lines of credit amounted to $7,198,900 at September 30, 2006.

                                       10
<PAGE>

WAKE FOREST BANCSHARES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
--------------------------------------------------------------------------------

                    OFF-BALANCE SHEET TRANSACTIONS, CONTINUED

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

                   ASSET/LIABILITY MANAGEMENT AND MARKET RISK

Interest rate risk can have a material market risk impact on the operating
results of the Company due to the potential of economic losses associated with
future changes in interest rates. These economic losses can be reflected as a
loss of future net interest income and/or loss of current fair market values of
interest sensitive financial instruments. Interest rate risk is the most
significant market risk affecting the Company.

Other types of market risk, such as foreign currency and commodity price risk,
do not arise in the normal course of the Company's business activities. In
addition, the Company does not currently engage in trading activities or use
derivative instruments to control interest rate risk. The Company's asset and
liability management objectives are to (i) improve the rate sensitivity of its
interest-earning assets in relation to interest-bearing liabilities, and (ii)
maintain an appropriate ratio of interest-sensitive assets to interest-sensitive
liabilities with comparable maturities. Management realizes certain risks are
inherent and that the goal is to minimize interest rate risk. In the absence of
other factors, the Company's overall yield on interest-earning assets will
increase as will its cost of funds on its interest-bearing liabilities when
market rates increase over an extended period of time. Conversely, the Company's
yields and cost of funds will decrease when market rates decline. The Company is
able to manage these swings to some extent by attempting to control the
maturities or repricing adjustments of its interest-earning assets and
interest-bearing liabilities over given periods of time.

The Company's "gap" is typically described as the difference between the amounts
of such assets and liabilities which reprice within a period of time, typically
one to three years. In a declining interest rate environment, the Company's
interest earning assets tend to reprice prior to its interest-bearing
liabilities over a short period, creating an unfavorable impact on the Company's
net interest income. Conversely, an increase in general market rates will tend
to positively affect the Company's net interest income over a short period.

In order to minimize the potential effects of adverse material and prolonged
increases or decreases in market interest rates on the Company's operations,
management has implemented an asset/liability program designed to improve the
Company's interest rate gap. The program primarily emphasizes the origination of
balloon and other short term loans, or loans with rates which float with Prime
such as construction, commercial real estate, lines of credit and home equity
loans. The Company generally originates a limited number of long-term fixed rate
loans for its own portfolio and will also originate such loans for sale in the
secondary market. In addition, the program emphasizes investing in short or
intermediate term investment securities, and the solicitation of checking or
transaction deposit accounts which are less sensitive to changes in interest
rates and can be repriced rapidly. The Board of Directors is responsible for
reviewing the Company's asset and liability policies. On a quarterly basis, the
Board reviews interest rate risk and trends. Management of the Company is
responsible for administering the policies established by the Board with respect
to asset and liability goals and strategies.

The following Market Risk Analysis table reflects maturities of interest rate
sensitive assets and liabilities over the next five years.


                                       11
<PAGE>

WAKE FOREST BANCSHARES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
--------------------------------------------------------------------------------

<TABLE>
<CAPTION>
                                                               MARKET RISK ANALYSIS
                                                             YEAR ENDED SEPTEMBER 30,
                                  ----------------------------------------------------------------------------------
                                                              (DOLLARS IN THOUSANDS)
                                      2007             2008            2009             2010             2011
                                  -------------    -------------   -------------    -------------    -------------
<S>                                      <C>                <C>            <C>               <C>             <C>
Assets:
     Loans-fixed:
       Balance                           $ 180           $    -           $  32            $   -            $  36
       Interest rate                      5.50%            0.00%           8.23%            0.00%            8.83%

     Loans-variable (1):
       Balance                          47,620            5,268           5,594            4,751            3,042
       Interest rate                      8.93%            5.70%           7.19%            6.65%            6.05%

     Investments (2):
       Balance                          23,806                -               -                -                -
       Interest rate                     5.22%                -               -                -                -

Liabilities:
     Deposits (3):
       Balance                          28,975                -               -                -                -
       Interest rate                      3.69%               -               -                -                -

     Deposits-certificates:
       Balance                          35,263            9,275           2,089            7,602              774
       Interest rate                      4.31%            4.43%           4.22%            4.60%            4.89%

<CAPTION>
                                               MARKET RISK ANALYSIS
                                             YEAR ENDED SEPTEMBER 30,
                                 --------------------------------------------------
                                              (DOLLARS IN THOUSANDS)
                                   THEREAFTER          TOTAL          FAIR VALUE
                                  --------------    -------------    --------------
<S>                                     <C>              <C>               <C>
Assets:
     Loans-fixed:
       Balance                          $ 8,981          $ 9,229           $ 9,077
       Interest rate                       6.26%            6.26%                -

     Loans-variable (1):
       Balance                            1,131           67,406            67,379
       Interest rate                       7.05%            8.22%                 -

     Investments (2):
       Balance                                -           23,806            23,806
       Interest rate                          -            5.22%                 -

Liabilities:
     Deposits (3):
       Balance                                -           28,975            28,975
       Interest rate                          -             3.69%                -

     Deposits-certificates:
       Balance                                -           55,003            54,655
       Interest rate                          -             4.38%                -
</TABLE>

(1)  Maturities of variable rate loans are based on contractual maturity
     except home equity loans and commercial lines of credit which are based on
     the next repricing date
(2)  Includes interest bearing deposits and investment securities
(3)  Includes passbook accounts, NOW accounts and money market accounts


                                       12
<PAGE>


WAKE FOREST BANCSHARES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
--------------------------------------------------------------------------------

                          FUTURE REPORTING REQUIREMENTS

In December 2004, the FASB issued SFAS No. 123(R), Accounting for Stock-Based
Compensation (SFAS No. 123(R)). SFAS No. 123(R) establishes standards for the
accounting for transactions in which an entity exchanges its equity instruments
for goods or services. This Statement focuses primarily on accounting for
transactions in which an entity obtains employee services in share-based payment
transactions. Awards to most non-employee directors will be accounted for as
employee awards. SFAS No. 123(R) requires that the fair value of such equity
instruments be recognized as an expense in the historical financial statements
as services are performed. Prior to SFAS No. 123(R), only certain pro forma
disclosures of fair value were required. The provisions of this Statement are
effective for the first interim reporting period in the Company's first fiscal
year that begins after December 15, 2005. Accordingly, the Company will be
required to adopt SFAS No. 123(R) commencing with the quarter beginning October
1, 2006. The adoption of the statement will not have had an impact of the
Company's 2007 financial statements because all of the Company's stock options
were issued and vested in periods earlier than those fiscal years.

In March 2005, the SEC issued Staff Accounting Bulletin ("SAB") No. 107, which
contains guidance on applying the requirements in SFAS No. 123(R) including
valuation techniques, development of assumptions used in valuing employee stock
options and related MD&A disclosures. SAB No. 107 is effective for the period in
which SFAS No. 123(R) is adopted. The adoption of SAB No. 107 is not expected to
have an impact on the Company's 2007 financial statements.

The guidance in Emerging Issues Task Force (EITF) 03-1, The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments, was
originally effective for other-than-temporary impairment evaluations made in
reporting periods beginning after June 15, 2004. However, the guidance contained
in paragraphs 10-20 of the Issue was delayed due to significant controversy over
its practical application by FASB Staff Position (FSP) EITF Issue 03-1-1, The
Effective Date of Paragraphs 10-20 of EITF Issue No. 03-1, posted on September
30, 2004. On November 3, 2005, the FASB issued FSP FAS 115-1 and 124-1, The
Meaning of Other Than Temporary Impairment and Its Application to Certain
Investments, which effectively nullifies the requirements of Issue No. 03-1.
This FSP provides guidance determining when an investment is considered impaired
or temporarily impaired and the measurement of an impairment loss. However, the
disclosure requirements contained in Issue No. 03-1 continue to be effective in
annual financial statements. This latest FSP does not provide any additional
guidance on whether an impairment is other than temporary. However, the most
controversial matter in Issue 03-1 regarding the sale of an available for sale
security at a loss and its automatic tainting of the remaining available for
sale securities which have deemed temporary impairment issues appears to be
resolved. The FSP does require that a loss on an impaired available for sale
security that will not fully recover prior to an expected date of sale should be
reported in earnings in the period the decision to sell is made. Additionally,
an investor must recognize an impairment loss in earnings when impairment is
deemed other than temporary even if a decision to sell has not been made. The
guidance in the FSP must be applied to reporting periods beginning after
December 15, 2005. The Company does not expect the adoption of FSP FAS 115-1 and
124-1 will have a material impact on its financial condition or results of
operations.

In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error
Corrections. This statement replaces APB Opinion No. 20, Accounting Changes and
SFAS No. 3, Reporting Accounting Changes in Interim Financial Statements. SFAS
No. 154 changes the requirements for the accounting for and reporting of a
voluntary change in accounting principle. SFAS No. 154 requires retrospective
application to prior periods' financial statements of changes in accounting
principles or error corrections, unless it is impractical to determine the
period-specific effects or when a pronouncement includes specific transition
provisions. This Statement is effective for accounting changes and corrections
of errors made in fiscal years beginning after December 15, 2005.

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, which
enhances existing guidance for measuring assets and liabilities using fair
value. SFAS No. 157 provides a single definition of fair value, together with a
framework for measuring it, and requires additional disclosures about the use of
fair value to measure assets and liabilities. SFAS No. 157 emphasizes that fair
value is a market-based measurement and establishes a fair value hierarchy with
the highest priority being quoted market prices in active markets. While SFAS
No. 157 does not add any new fair value measurements, it may change certain
current practices. SFAS No. 157 is effective for financial statements issued for
fiscal years beginning after November 15, 2007, and for interim periods within
those fiscal years. The Company has not determined the impact of adopting SFAS
No. 157 on its financial statements.


                                       13
<PAGE>

WAKE FOREST BANCSHARES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
--------------------------------------------------------------------------------

                    FUTURE REPORTING REQUIREMENTS (CONTINUED)

In September 2006, the SEC issued SAB No. 108, Considering the Effects of Prior
Year Misstatements When Quantifying Misstatements in the Current Year Financial
Statements. SAB No. 108 addresses the diversity in practice by registrants when
quantifying the effect of prior year errors on current year financial
statements. SAB No. 108 is effective for fiscal years ending after November 15,
2006. The Company does not believe that the adoption of SAB No. 108 will have a
material impact on our financial statements.

                   CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The Company's discussion and analysis of its financial condition and results of
operations are based upon its consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires the
Company to make estimates and judgments regarding uncertainties that affect the
reported amounts of assets, liabilities, revenues and expenses. On an ongoing
basis, the Company evaluates its estimates which are based upon historical
experience and on other assumptions that are believed to be reasonable under the
circumstances. Actual results may differ from these estimates under different
assumptions or conditions.

The Company's significant accounting policies are described in Note 1 to the
consolidated financial statements. The Company considers the following
accounting policies to be most critical in their potential effect on its
financial position or results of operations:

Allowance for Loan Losses:

The most critical estimate concerns the Company's allowance for loan losses. The
Company records provisions for loan losses based upon known problem loans and
estimated deficiencies in the existing loan portfolio. The Company's methodology
for assessing the appropriations of the allowance for loan losses consists of
two key components, which are a specific allowance for identified problem or
impaired loans and a formula allowance for the remainder of the portfolio.

A loan is considered impaired when, based on current information and events, it
is probable that the Association will be unable to collect the scheduled
payments of principal or interest when due according to the contractual terms of
the loan agreement. Factors considered by management in determining impairment
include payment status, collateral value, and the probability of collecting
scheduled principal and interest payments when due. Loans that experience
insignificant payment delays and payment shortfalls generally are not classified
as impaired. Management determines the significance of payment delays and
payment shortfalls on a case-by-case basis, taking into consideration all of the
circumstances surrounding the loan and the borrower, including the length of the
delay, the reasons for the delay, the borrower's prior payment record, and the
amount of the shortfall in relation to the principal and interest owed.
Impairment is measured on a loan-by-loan basis for commercial and construction
loans by either the present value of expected future cash flows discounted at
the loan's effective interest rate, the loan's obtainable market price, or the
fair value of the collateral if the loan is collateral dependent. This
evaluation is inherently subjective as it requires material estimates that may
be susceptible to significant change. Large groups of smaller balance
homogeneous loans are collectively evaluated for impairment. Accordingly, the
Association does not separately identify individual residential loans for
impairment disclosures.

The adequacy of the allowance is also reviewed by management based upon its
evaluation of then-existing economic and business conditions affecting the key
lending areas of the Company and other conditions, such as new loan products,
collateral values, loan concentrations, changes in the mix and volume of the
loan portfolio; trends in portfolio credit quality, including delinquency and
charge-off rates; and current economic conditions that may affect a borrower's
ability to repay. Although management believes it has established and maintained
the allowance for loan losses at appropriate levels, future adjustments may be
necessary if economic, real estate and other conditions differ substantially
from the current operating environment.

                                       14
<PAGE>

WAKE FOREST BANCSHARES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
--------------------------------------------------------------------------------

             CRITICAL ACCOUNTING POLICIES AND ESTIMATES (CONTINUED)

Interest Income Recognition:

Interest on loans is included in income as earned based upon interest rates
applied to unpaid principal. Interest is not accrued on loans 90 days or more
past due unless the loans are adequately secured and in the process of
collection. Interest is not accrued on other loans when management believes
collection is doubtful. All loans considered impaired are non-accruing. Interest
on non-accruing loans is recognized as payments are received when the ultimate
collectibility of interest is no longer considered doubtful. When a loan is
placed on non-accrual status, all interest previously accrued is reversed
against current-period interest income.

                     IMPACT OF INFLATION AND CHANGING PRICES

The consolidated financial statements and accompanying footnotes have been
prepared in accordance with accounting principles generally accepted in the
United States of America, which require the measurement of financial position
and operating results in terms of historical dollars without consideration for
changes in the relative purchasing power of money over time due to inflation.
The assets and liabilities of the Company are primarily monetary in nature and
changes in interest rates have a greater impact on the Company's performance
than do the effects of inflation. However, the rate of inflation can tend to
impact overall market rates, and to that extent, changes in inflation may have a
direct impact on the Company's interest rate spread and its operations.

                SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Annual Report to Stockholders contains certain forward-looking statements
regarding estimated future revenue and expense levels and other business of the
Company. Such statements are subject to certain risks and uncertainties
including changes in general and local market conditions, legislative and
regulatory conditions and an adverse interest rate environment. Undue reliance
should not be placed on this information. These estimates are based on the
current expectations of management, which may change in the future due to a
large number of potential events, including unanticipated future developments.
The Company and the Association do not undertake to update any forward-looking
statement, whether written or oral, that may be made from time to time by or on
behalf of the Company or the Association.



                                       15
<PAGE>

                               [DIXON HUGHES LOGO]


             REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM




To the Board of Directors and Stockholders
Wake Forest Bancshares, Inc. and Subsidiary
Wake Forest, North Carolina


We have audited the accompanying consolidated statements of financial condition
of Wake Forest Bancshares, Inc. and Subsidiary as of September 30, 2006 and 2005
and the related consolidated statements of income, stockholders' equity, and
cash flows for the years then ended. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. We were not engaged to perform an
audit of the Company's internal control over financial reporting. Our audit
included consideration of internal control over financial reporting as a basis
for designing audit procedures that are appropriate in the circumstances, but
not for the purpose of expressing an opinion on the effectiveness of the
Company's internal control over financial reporting. Accordingly, we express no
such opinion. An audit also includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, as
well as evaluating the overall financial statement presentation. We believe that
our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Wake Forest
Bancshares, Inc. and Subsidiary as of September 30, 2006 and 2005, and the
results of their operations and their cash flows for the years then ended in
conformity with accounting principles generally accepted in the United States of
America.

/s/ Dixon Hughes PLLC

Raleigh, North Carolina
December 21, 2006



                                       16
<PAGE>

WAKE FOREST BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
SEPTEMBER 30, 2006 AND 2005
------------------------------------------------------------------------------

<TABLE>
<CAPTION>
ASSETS                                                                              2006                  2005
                                                                              -----------------     -----------------
<S>                                                                       <C>                  <C>
Cash:

  Interest-earning deposits                                               $         23,067,150 $          21,630,700
  Noninterest-earning deposits                                                         751,750               696,700
                                                                              -----------------     -----------------
                                                                                    23,818,900            22,327,400
                                                                              -----------------     -----------------
Investment securities (Note 2):

  Available for sale, at market value                                                  540,850               460,350
  FHLB stock, at cost                                                                  197,600               182,300
Loans receivable, net of allowance for loan losses
  of $1,042,500 in 2006 and $850,000 in 2005 (Note 3)                               76,635,300            73,894,100
Accrued interest receivable                                                            230,050               136,200
Property and equipment, net (Note 4)                                                   401,800               337,850
Foreclosed assets, net (Note 5)                                                      1,003,800             1,003,800
Bank owned life insurance (Note 6)                                                   1,100,050             1,058,500
Deferred income taxes (Note 11)                                                        295,100               297,150
Prepaid expenses and other assets                                                       55,050                33,700
                                                                              -----------------     -----------------
          Total assets                                                    $        104,278,500 $          99,731,350
                                                                              =================     =================

LIABILITIES AND EQUITY

Liabilities:

  Deposits (Note 7)                                                       $         83,977,850 $          80,905,150
  Accrued interest on deposits                                                          67,950                26,950
  Accounts payable and accrued expenses                                                784,200               746,300
  Dividends payable                                                                     88,700                77,650
  Redeemable common stock held by the ESOP, net of
    unearned ESOP shares (Note 10)                                                     553,650               569,100
                                                                              -----------------     -----------------
          Total liabilities                                                         85,472,350            82,325,150
                                                                              -----------------     -----------------
Commitments and contingencies (Note 14)
Stockholders' Equity (Note 12):

  Preferred stock, authorized 1,000,000 shares, none issued                                  -                     -
  Common stock, $.01 par value, authorized 5,000,000 shares;
    issued 1,247,134 shares in 2006 and 1,237,146 in 2005                               12,450                12,350
  Additional paid-in-capital                                                         5,665,700             5,502,050
  Accumulated other comprehensive income                                               330,400               280,500
  Retained  earnings, substantially restricted (Note 12)                            14,187,400            12,868,900
  Common stock in treasury, at cost (90,445 shares in 2006
    and 84,385 shares in 2005)                                                      (1,389,800)           (1,257,600)
                                                                              -----------------     -----------------
          Total stockholders' equity                                                18,806,150            17,406,200
                                                                              -----------------     -----------------
                                                                          $        104,278,500 $          99,731,350
                                                                              =================     =================
</TABLE>

See Notes to Consolidated Financial Statements.

                                       17
<PAGE>


WAKE FOREST BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED SEPTEMBER 30, 2006 AND 2005
------------------------------------------------------------------------------

<TABLE>
<CAPTION>
                                                                                    2006                  2005
                                                                              -----------------     -----------------
Interest and dividend income:
<S>                                                                       <C>                  <C>
  Loans                                                                   $          6,047,800 $           5,262,050
  Investment securities                                                                 25,600                18,300
  Interest-earning deposits                                                          1,099,750               471,300
                                                                              -----------------     -----------------
                                                                                     7,173,150             5,751,650
                                                                              -----------------     -----------------
Interest expense:

  Deposits (Note 7)                                                                  2,978,950             2,314,750
                                                                              -----------------     -----------------
                                                                                     2,978,950             2,314,750
                                                                              -----------------     -----------------

Net interest income before provision for loan losses                                 4,194,200             3,436,900
Provision for loan losses (Note 3)                                                    (192,500)             (119,600)
                                                                              -----------------     -----------------
Net interest income after provision for loan losses                                  4,001,700             3,317,300
                                                                              -----------------     -----------------

Noninterest income:

  Service fees and other income                                                         59,100                54,100
  Gain on sale of mortgage loans                                                         8,000                 4,000
  Income from bank owned life insurance                                                 41,550                36,650
                                                                              -----------------     -----------------
                                                                                       108,650                94,750
                                                                              -----------------     -----------------
Noninterest expense:

  Compensation and benefits (Notes 8, 9, and 10)                                       820,500               746,600
  Occupancy                                                                             46,950                43,700
  Federal insurance premiums and operating assessments                                  45,350                42,350
  Data processing and outside service fees                                             154,750               126,550
  Foreclosed assets                                                                    170,500                91,650
  Other operating expense                                                              280,950               299,700
                                                                              -----------------     -----------------
                                                                                     1,519,000             1,350,550
                                                                              -----------------     -----------------

Income before income taxes                                                           2,591,350             2,061,500
                                                                              -----------------     -----------------
Income taxes (Note 11):

  Current                                                                              964,000               787,750
  Deferred                                                                             (28,600)              (46,750)
                                                                              -----------------     -----------------
                                                                                       935,400               741,000
                                                                              -----------------     -----------------
          Net income                                                      $          1,655,950 $           1,320,500
                                                                              =================     =================

Basic earnings per share                                                  $               1.44 $                1.14
Diluted earnings per share                                                $               1.43 $                1.13
Dividends paid per share                                                  $               0.68 $                0.60
</TABLE>


See Notes to Consolidated Financial Statements.

                                       18
<PAGE>

WAKE FOREST BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED SEPTEMBER 30, 2006 AND 2005
------------------------------------------------------------------------------


<TABLE>
<CAPTION>
                                                             Outstanding
                                                              Shares of                               Additional
                                                                Common               Common             Paid in
                                                                Stock                Stock              Capital
                                                           -----------------    -----------------   ----------------

<S>                                                            <C>                <C>                <C>
Balance at September 30, 2004                                  1,149,792          $   12,200         $5,257,650
Comprehensive income:
  Net income for 2005                                                                    --                 --
  Net change in unrealized gain on securities                                            --                 --
     Total comprehensive income
Market value adjustment for redeemable
  common stock held by ESOP                                                              --                 --
Cash dividends ($0.60 per share)                                                         --                 --
Exercise of stock options                                         15,963                 150            203,400
Acquisition of 12,994 shares of common
  stock for the treasury                                         (12,994)                --                 --
Tax effect of exercise of nonqualifying stock options                                    --              41,000
                                                              ----------          ----------         ----------
Balance at September 30, 2005                                  1,152,761              12,350          5,502,050
Comprehensive income:
  Net income for 2006                                                                    --                 --
  Net change in unrealized gain on securities                                            --                 --
     Total comprehensive income
Market value adjustment for redeemable
  common stock held by ESOP                                                              --
Cash dividends ($0.68 per share)                                                         --                 --
Exercise of stock options                                          9,988                 100            127,250
Acquisition of 6,060 shares of common
  stock for the treasury                                          (6,060)                --                 --
Tax effect of exercise of nonqualifying stock options                                                    36,400
                                                              ----------          ----------         ----------
Balance at September 30, 2006                                  1,156,689          $   12,450         $5,665,700
                                                              ==========          ==========         ==========
</TABLE>

See Notes to Consolidated Financial Statements.

                                       19
<PAGE>

WAKE FOREST BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED SEPTEMBER 30, 2006 AND 2005
------------------------------------------------------------------------------


<TABLE>
<CAPTION>
         Accumulated
            Other                                         Treasury
        Comprehensive              Retained                Stock
            Income                 Earnings               Acquired                 Total
     ---------------------    -------------------    -------------------     -------------------

<S>                               <C>                   <C>                   <C>
      $    324,900                $ 11,788,750          $   (976,800)         $ 16,406,700

              --                     1,320,500                  --               1,320,500
           (44,400)                       --                    --                 (44,400)
                                                                              ------------
                                                                                 1,276,100
                                                                              ------------

              --                        72,150                  --                  72,150
              --                      (312,500)                 --                (312,500)
                                                                                   203,550

              --                          --                (280,800)             (280,800)
              --                          --                    --                  41,000
      ------------                ------------          ------------          ------------
           280,500                  12,868,900            (1,257,600)           17,406,200

              --                     1,655,950                  --               1,655,950
            49,900                        --                    --                  49,900
                                                                              ------------
                                                                                 1,705,850
                                                                              ------------
              --                        15,400                  --                  15,400
              --                      (352,850)                 --                (352,850)
                                                                                   127,350

              --                          --                (132,200)             (132,200)
              --                          --                    --                  36,400
      ------------                ------------          ------------          ------------
      $    330,400                $ 14,187,400          $ (1,389,800)         $ 18,806,150
      ============                ============          ============          ============
</TABLE>

                                       20
<PAGE>

WAKE FOREST BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED SEPTEMBER 30, 2006 AND 2005
------------------------------------------------------------------------------

<TABLE>
<CAPTION>
                                                                                   2006                   2005
                                                                             ------------------     -----------------
<S>                                                                        <C>                    <C>
CASH FLOWS FROM OPERATING ACTIVITIES

Net income                                                                 $         1,655,950    $        1,320,500
Adjustments to reconcile net income to net
 cash provided by operating activities:
   Depreciation                                                                         33,500                23,550
   Provision for loan losses                                                           192,500               119,600
   Deferred income taxes                                                               (28,600)              (46,750)
   Increase in cash surrender value of life insurance                                  (41,550)              (36,650)
   Gain on sale of loans of mortgage loans                                              (8,000)               (4,000)
Loans orignated for sale                                                                     -              (221,800)
Proceeds from loans sold                                                                     -               225,800
Changes in assets and liabilities:
  (Increase) decrease in:

    Accrued interest receivable                                                        (93,850)              (14,650)
    Prepaid expenses and other assets                                                  (21,350)               49,650
Increase (decrease) in:

    Accounts payable and accrued expenses                                               78,900               135,000
                                                                             ------------------     -----------------
          Net cash provided by operating activities                                  1,767,500             1,550,250
                                                                             ------------------     -----------------

CASH FLOWS FROM INVESTING ACTIVITIES

Principal collected on loans                                                        42,629,550            48,665,000
Mortgage loans purchased                                                                     -               (30,000)
Redemption of participation loans                                                      273,750                     -
Loans originated                                                                   (45,829,000)          (44,898,650)
Proceeds from sale of foreclosed assets                                                      -               500,000
Capital additions to foreclosed assets                                                       -               (12,500)
Purchase of FHLB of Atlanta Stock                                                      (15,300)                    -
Redemption of FHLB of Atlanta stock                                                          -                31,500
Purchases of property and equipment                                                    (97,450)                    -
                                                                             ------------------     -----------------
          Net cash provided by (used in) investing activities                       (3,038,450)            4,255,350
                                                                             ------------------     -----------------
</TABLE>


See Notes to Consolidated Financial Statements.


                                       21
<PAGE>

WAKE FOREST BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED SEPTEMBER 30, 2006 AND 2005
------------------------------------------------------------------------------

<TABLE>
<CAPTION>
                                                                                  2006                  2005
                                                                            ------------------    ------------------
<S>                                                                        <C>                   <C>
CASH FLOWS FROM FINANCING ACTIVITIES

Cash dividends paid                                                        $         (341,800)   $         (306,900)
Proceeds from stock options exercised                                                 127,350               203,550
Additions to paid in capital from tax effect of exercise of
  nonqualifying stock options                                                          36,400                41,000
Purchase of treasury stock                                                           (132,200)             (280,800)
Net increase in deposits                                                            3,072,700            11,013,700
                                                                            ------------------    ------------------
Net cash provided by financing activities                                           2,762,450            10,670,550
                                                                            ------------------    ------------------

          Net increase in cash                                                      1,491,500            16,476,150
                                                                            ------------------    ------------------

Cash:

  Beginning                                                                        22,327,400             5,851,250
                                                                            ------------------    ------------------
  Ending                                                                   $       23,818,900    $       22,327,400
                                                                            ==================    ==================

Supplemental Disclosures of Cash Flow Information
  Cash payments for:

     Interest                                                              $        2,937,950    $        2,302,650
     Income taxes                                                          $          965,000    $          681,750

Supplemental Schedule of Noncash Investing
 and Financing Activities:

  Fair value of ESOP shares in excess of unearned
    ESOP shares (charged) credited to retained earnings                    $           15,450    $           72,150
  Change in unrealized gain (loss) on available for sale
     securities, net of tax effect                                         $           49,900    $          (44,400)
  Loans receivable transferred to foreclosed assets                        $                -    $        1,491,300
</TABLE>

                                       22
<PAGE>

WAKE FOREST BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------------------------------------------------

NOTE 1.  NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES

Wake Forest Bancshares, Inc. (the "Company") is located in Wake Forest, North
Carolina and is the parent stock holding company of Wake Forest Federal Savings
& Loan Association (the "Association" or "Wake Forest Federal"), its only
subsidiary. The Company was formed in 1999 solely for the purpose of becoming a
savings and loan holding company and had no prior operating history. The Company
conducts no business other than holding all of the stock in the Association,
investing dividends received from the Association, repurchasing its common stock
from time to time, and distributing dividends on its common stock to its
shareholders. The Association's principal activities consist of obtaining
savings deposits and providing mortgage credit to customers in its primary
market area, the counties of Wake and Franklin, North Carolina. The Company's
and the Association's primary regulator is the Office of Thrift Supervision
(OTS) and its deposits are insured by the Federal Deposit Insurance Corporation
(FDIC).

The Company is majority owned by Wake Forest Bancorp, M.H.C., (the "MHC") a
mutual holding company. Members of the MHC consist of depositors and certain
borrowers of the Association, who have the sole authority to elect the board of
directors of the MHC for as long as it remains in mutual form. The MHC's
principal assets consist of 635,000 shares of the Company's common stock and
deposits at the Association for accumulated dividends paid on those shares. The
MHC, which by law must own in excess of 50% of the stock of the Company,
currently has an ownership interest of 54.9% of the Company. The mutual holding
company is registered as a savings and loan holding company and is subject to
regulation, examination, and supervision by the OTS.

A summary of the Company's significant accounting policies follows:

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

Consolidation: The consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiary, Wake Forest Federal. All significant
inter-company accounts and transactions have been eliminated in consolidation.

Cash and cash equivalents: For purposes of reporting cash flows, the Company
considers all interest-bearing deposits with maturities of less than three
months at acquisition and non-interest-bearing deposits to be cash and cash
equivalents. At times, the Association maintains deposits in correspondent banks
in amounts that may be in excess of the FDIC insurance limit.

Investment securities: The Company carries its investments at fair market value
or amortized cost depending on its classification of such securities.
Classification of securities and the Company's accounting policies are as
follows:

   Securities held to maturity: Securities classified as held to maturity are
   those debt securities the Company has both the intent and ability to hold to
   maturity regardless of changes in market conditions, liquidity needs or
   changes in general economic conditions. These securities are carried at
   amortized cost. The Company currently has no securities which are classified
   as held to maturity.

   Securities available for sale: Securities classified as available for sale
   are those debt securities that the Company intends to hold for an indefinite
   period of time but not necessarily to maturity and equity securities not
   classified as held for trading. Any decision to sell a security classified as
   available for sale would be based on various factors, including significant
   movements in interest rates, changes in the maturity mix of its securities,
   liquidity needs and other significant factors. Securities available for sale
   are carried at fair value. Unrealized gains and losses are reported as a
   separate component of equity, net of related tax effects. Realized gains and
   losses are included in earnings.

   Securities held for trading: Trading securities are held in anticipation of
   short-term market gains. Such securities are carried at fair value with
   realized and unrealized gains and losses included in earnings. The Company
   currently has no securities which are classified as trading.


                                       23
<PAGE>
WAKE FOREST BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------------------------------------------------

NOTE 1.  NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

Loans receivable and Fees: Loans receivable are stated at unpaid principal
balances, less the allowance for loan losses and net deferred loan origination
fees. The Association's loan portfolio consists principally of mortgage loans
collateralized by first trust deeds on single family residences, other
residential property, commercial property and land. The Association receives
fees for originating mortgage loans. The Association defers all loan fees less
certain direct costs as an adjustment to yield with subsequent amortization into
income over the life of the related loan.

Allowance for loan losses: The allowance for loan losses is established as
losses are estimated to have occurred through a provision for loan losses
charged to earnings. Loan losses are charged against the allowance when
management believes the uncollectibility of a loan balance is confirmed.
Subsequent recoveries, if any, are credited to the allowance. The allowance for
loan losses is evaluated on a regular basis by management and is based upon
management's periodic review of the collectibility of the loans in light of
historical experience, the nature and volume of the loan portfolio, adverse
situations that may affect the borrower's ability to repay, estimated value of
any underlying collateral and prevailing economic conditions. This evaluation is
inherently subjective as it requires estimates that are susceptible to
significant revision as more information becomes available. In addition,
regulatory examiners may require the Association to recognize adjustments to the
allowance for loan losses based on their judgments about information available
to them at the time of their examination.

A loan is considered impaired when, based on current information and events, it
is probable that the Association will be unable to collect the scheduled
payments of principal or interest when due according to the contractual terms of
the loan agreement. An allowance is recorded if the present value of the loan's
future cash flows, discounted using the loan's effective interest rate, is less
than the carrying value of the loan. An impaired loan can also be valued at its
fair value in the market place or on the basis of its underlying collateral if
the loan is primarily collateral dependent. If foreclosure is imminent, and the
loan is collateral dependent, the loan is valued based upon the fair value of
the underlying collateral.

Deposits: Eligible deposits are insured up to $100,000 ($250,000 for certain
retirement accounts) by the FDIC.

Interest income: The Association does not record interest on loans delinquent 90
days or more unless in the opinion of management, collectibility is assured. If
collectibility is not certain, the Association establishes a reserve for
uncollected interest. Interest collected while the loan is in such status is
credited to income in the period received. If the loan is brought to a status in
which it is no longer delinquent 90 days, the reserve for uncollected interest
is reversed and interest income is recognized. The Association accounts for
interest on impaired loans in a similar fashion. Such interest when ultimately
collected is credited to income in the period received.

Property, equipment and depreciation: Property and equipment are stated at cost
less accumulated depreciation. Depreciation is computed primarily by use of the
straight-line method over depreciable lives of 3-7 years for furniture and
equipment and up to 40 years for buildings and improvements.

Presold mortgages in process of settlement: The Association originates certain
residential mortgage loans that have been pre-approved by secondary investors.
The terms of the loans are set by the secondary investors and are transferred to
them at par within days of the Association initially funding the loan. The
Association receives origination fees from borrowers and servicing release
premiums from the investors. Between the initial funding of the loans by the
Association and the subsequent reimbursement by the investors, the Association
carries the loans on its balance sheet at cost.

Foreclosed assets: Foreclosed assets acquired through, or in lieu of, loan
foreclosure are 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 or recoveries to the valuation allowance are included in earnings.

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


                                       24
<PAGE>

WAKE FOREST BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------------------------------------------------

NOTE 1.  NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

Earnings per share: The Company provides for a dual presentation of basic and
diluted earnings per share (EPS) with a reconciliation of the numerator and
denominator of the EPS computations. Basic earnings per share amounts are based
on the weighted average shares of common stock outstanding. Diluted earnings per
share assume the conversion, exercise or issuance of all potential common stock
instruments such as options, warrants and convertible securities, unless the
effect is to reduce a loss or increase earnings per share. No adjustments were
required to net income for any period presented in the computation of diluted
earnings per share. The basic and diluted weighted average shares outstanding
for 2006 and 2005 are as follows:

<TABLE>
<CAPTION>
                                                                            2006                2005
                                                                      -----------------   -----------------
<S>                                                                          <C>                 <C>
Weighted average outstanding shares used for basic EPS                       1,152,765           1,154,570
Plus incremental shares from assumed issuances
     pursuant to stock options                                                   5,380              10,350
                                                                      -----------------   -----------------
Weighted average outstanding shares used for diluted EPS                     1,158,145           1,164,920
                                                                      =================   =================
</TABLE>

Off-balance-sheet risk and credit risk: The Association is a party to financial
instruments with off-balance-sheet risk such as commitments to extend credit.
Management assesses the risk related to these instruments for potential loss.
The Association lends primarily on one-to-four family residential properties
throughout its primary lending area, Wake and Franklin counties of North
Carolina.

Stock compensation plans: In 1995, the Financial Accounting Standards Board
(FASB) issued Standard No. 123, Accounting For Stock-Based Compensation, which
requires disclosures concerning the fair value of options and encourages
accounting recognition for options using the fair value method. The Company has
elected to apply the disclosure-only provisions of the Statement.

In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation - Transition and Disclosure. SFAS No. 148 amends SFAS No. 123,
Accounting for Stock-Based Compensation, to provide alternative methods of
transition for a voluntary change to the fair value based method of accounting
for stock-based employee compensation. In addition, this Statement amends the
disclosure requirements of SFAS No. 123 to require prominent disclosures in both
annual and interim financial statements about the method of accounting for
stock-based employee compensation and the effect of the method used on reported
results. Statement 148 is effective for financial statements for fiscal years
ending after December 15, 2002. The Company continues to account for its
stock-based compensation in accordance with APB 25 and has adopted the
disclosure provisions of Statement 148 effective for all periods presented
herein. Accordingly, no compensation cost has been recorded and none would have
been required in 2006 or 2005 because the five year period over which the
options vested and would have been expensed under SFAS No. 123 expired.
Effective with the Company's fiscal year ending September 30, 2007, the
voluntary change to the fair value based method of accounting for stock based
compensation becomes mandatory pursuant to SFAS No. 123 "Revised." This
Statement focuses primarily on accounting for transactions in which an entity
obtains employee services in share-based payment transactions. SFAS No. 123(R)
requires that the fair value of such equity instruments be recognized as an
expense in the historical financial statements as services are performed.

Fair value of financial instruments: Estimated fair values have been determined
by the Company using available market information and appropriate valuation
methodologies. However, considerable judgment is required to develop the
estimates of fair value. Accordingly, the estimates for the fair value of the
Company's financial instruments are not necessarily indicative of the amounts
the Company could realize in a current market exchange. The use of different
market assumptions or estimation methodologies may have a material effect on the
estimated fair value amounts. The fair value estimates are based on pertinent
information available to management as of September 30, 2006. Although
management is not aware of any factors that would significantly affect the
estimated fair value amounts, such amounts have not been comprehensively
revalued for purposes of these financial statements since that date, and
therefore, current estimates of fair value may differ significantly from the
amounts presented herein. The following methods and assumptions were used by the
Company in estimating its fair value disclosures for financial instruments:

   Cash and accrued interest receivable: The carrying amounts reported in the
   consolidated statements of financial condition approximate these assets' fair
   values.


                                       25
<PAGE>
WAKE FOREST BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------------------------------------------------

   NOTE 1.  NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

   Investment securities: The fair values of investment securities are
   determined based on quoted market values. For the Association's investment in
   Federal Home Loan Bank stock, no ready market exists and it has no quoted
   market value. For disclosure purposes, such stock is assumed to have a fair
   value which is equal to its cost.

   Loans receivable: The fair value for all loans, except short-term
   construction loans, home equity loans and prime-based commercial real estate
   loans, has been estimated by discounting projected future cash flows using
   the current rate at which loans with similar maturities would be made to
   borrowers with similar credit ratings. Certain prepayment assumptions were
   made to the Association's portfolio of long-term fixed rate mortgage loans.
   The fair value of construction loans, home equity loans, and prime-based
   commercial real estate loans are assumed to be equal to their recorded
   amounts because such loans have relatively short terms.

   Bank owned life insurance. Bank owned life insurance is not a marketable
   instrument and its fair value is considered to equal to its redeemable value,
   or its cash surrender value.

   Deposits: The fair value of deposits with no stated maturities is estimated
   to be equal to the amount payable on demand. The fair value of certificates
   of deposit is based upon the discounted value of future contractual cash
   flows. The discount rate is estimated using rates offered for deposits of
   similar remaining maturities.

   Off-balance-sheet commitments: Because the Association's commitments, which
   consist entirely of loan commitments, are either short-term in nature or
   subject to immediate repricing, no fair value has been assigned to these
   off-balance-sheet items.

   Accrued Interest Payable and Dividends Payable: The fair value of accrued
   interest payable and dividends payable is assumed to equal to its recorded
   amount because of the short term nature of the liability.

NOTE 2.  INVESTMENT SECURITIES

The amortized cost, estimated market value and gross unrealized gains and losses
of the Association's investment securities at September 30, 2006 and 2005 are as
follows:

<TABLE>
<CAPTION>
                                                                                    2006
                                                  --------------------------------------------------------------------------
                                                                             Gross             Gross           Estimated
                                                        Amortized         Unrealized        Unrealized           Market
                                                           Cost              Gains            Losses             Value
                                                      ---------------    --------------    --------------    ---------------
<S>                                               <C>                 <C>               <C>               <C>
Available for sale securities:
  FHLMC stock                                     $            8,000  $        532,850  $        -        $         540,850
Nonmarketable equity securities:

  Federal Home Loan Bank stock                               197,600           -                 -                  197,600
                                                      ---------------    --------------    --------------    ---------------
                                                  $          205,600  $        532,850  $        -        $         738,450
                                                      ===============    ==============    ==============    ===============

<CAPTION>
                                                                                    2005
                                                  --------------------------------------------------------------------------
                                                                             Gross             Gross           Estimated
                                                        Amortized         Unrealized        Unrealized           Market
                                                           Cost              Gains            Losses             Value
                                                      ---------------    --------------    --------------    ---------------
<S>                                               <C>                 <C>               <C>               <C>
Available for sale securities:
  FHLMC stock                                     $            8,000  $        452,350  $        -        $         460,350
Nonmarketable equity securities:

  Federal Home Loan Bank stock                               182,300           -                 -                  182,300
                                                      ---------------    --------------    --------------    ---------------
                                                  $          190,300  $        452,350  $        -        $         642,650
                                                      ===============    ==============    ==============    ===============
</TABLE>

                                       26
<PAGE>

WAKE FOREST BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------------------------------------------------

NOTE 2.  INVESTMENT SECURITIES (CONTINUED)

The change during 2006 and 2005 in accumulated other comprehensive income which
consists solely of net unrealized gains and losses associated with available for
sale securities is as follows:

<TABLE>
<CAPTION>
                                                                                              2006                2005
                                                                                         ----------------    ---------------
<S>                                                                                   <C>                <C>
Accumulated other comprehensive income, beginning of year                             $          280,500 $          324,900
  Change in unrealized gains, net of tax effect of $30,600 in 2006
     and $27,200 in 2005                                                                          49,900            (44,400)
                                                                                         ----------------    ---------------
Accumulated other comprehensive income, end of year                                   $          330,400 $          280,500
                                                                                         ================    ===============
</TABLE>

There were no sales of investment securities during 2006 or 2005. The
Association, as a member of the Federal Home Loan Bank (FHLB) system, maintains
an investment in capital stock of the FHLB of Atlanta. No ready market exists
for the bank stock and its market value is equal to its cost due to the
redemptive provisions of the FHLB of Atlanta. During 2006 and 2005, FHLB stock
with a cost basis of $15,300 and $31,500 was purchased and redeemed,
respectively, at par by the FHLB of Atlanta.

NOTE 3. LOANS RECEIVABLE


Loans receivable consist of the following:

<TABLE>
<CAPTION>
First mortgage loans:                                                                       2006                  2005
                                                                                      -----------------     -----------------
<S>                                                                               <C>                  <C>
Single family, one-to-four units                                                    $       24,256,050     $      24,947,600
Multifamily, residential                                                                       427,000               698,800
Commercial real estate                                                                      12,426,350            13,667,950
Land                                                                                        14,604,950            11,581,300
Residential construction                                                                    36,900,250            36,559,350
                                                                                      -----------------     -----------------
                                                                                            88,614,600            87,455,000
Equity line mortgages                                                                        2,328,150             2,494,800
Loans on savings accounts                                                                      179,500                88,300
                                                                                      -----------------     -----------------
                                                                                            91,122,250            90,038,100
                                                                                      -----------------     -----------------
Undisbursed portion of loans in process                                                    (13,340,900)          (15,179,100)
Allowance for loan losses                                                                   (1,042,500)             (850,000)
Deferred loan fees                                                                            (103,550)             (114,900)
                                                                                      -----------------     -----------------
                                                                                           (14,486,950)          (16,144,000)
                                                                                      -----------------     -----------------
                                                                                    $       76,635,300 $          73,894,100
                                                                                      =================     =================
</TABLE>

The change in the Association's allowance for loan losses is as follows for the
years ended September 30, 2006 and 2005:

<TABLE>
<CAPTION>
                                                                                             2006                 2005
                                                                                       -----------------    -----------------
<S>                                                                                   <C>                  <C>
Balance, beginning of year                                                            $         850,000    $         730,400
Provision for loan losses                                                                       192,500              119,600
Charge-offs                                                                                           -                    -
                                                                                       -----------------    -----------------
Balance, end of year                                                                  $       1,042,500    $         850,000
                                                                                       =================    =================
</TABLE>


                                       27
<PAGE>


WAKE FOREST BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------------------------------------------------

NOTE 3.  LOANS RECEIVABLE (CONTINUED)

The Association does not accrue interest on loans past due 90 days or more if,
in the opinion of management, collectibility is in doubt. Such interest is
removed from income through the establishment of a reserve for uncollected
interest. At September 30, 2006 and 2005, reserves for uncollected interest
totaling $10,500 and $24,050 were established on loans amounting to $666,400 and
$770,850, respectively. There were no accruing loans past due more than 90 days
at September 30, 2006 and 2005. Interest income that would have been recorded in
2006 and 2005 if non-accrual loans had been current was $10,500 and $24,050,
respectively. The amount of interest income recognized on these loans in 2006
and 2005 was $45,950 and $35,000, respectively.

The Association did not have any loans outstanding at September 30, 2006 and
2005 which it considered impaired.

Shareholders of the Company with 10% or more ownership and officers and
directors, including their families and companies of which they are principal
owners, are considered to be related parties. These related parties were loan
customers of, and had other transactions with the Association in the ordinary
course of business. In management's opinion, these loans and transactions were
on the same terms as those for comparable loans and transactions with
non-related parties during the years ended September 30, 2006 and 2005.
Aggregate loan transactions with related parties during the years ended
September 30, 2006 and 2005 were as follows:

<TABLE>
<CAPTION>
                                                                                  2006                 2005
                                                                            -----------------    -----------------
<S>                                                                     <C>                  <C>
Beginning balance                                                          $          16,000    $          96,350
New loans                                                                                  -               16,000
Reductions                                                                           (16,000)             (96,350)
                                                                            -----------------    -----------------
Ending balance                                                             $               -    $          16,000
                                                                            =================    =================
Maximum balance during the year                                            $          16,000    $          78,700
                                                                            =================    =================
</TABLE>

NOTE 4.  PROPERTY AND EQUIPMENT

Property and equipment at September 30, 2006 and 2005 are summarized as follows:

<TABLE>
<CAPTION>
                                                                                   2006                 2005
                                                                             -----------------    -----------------
<S>                                                                       <C>                 <C>
Land                                                                        $          20,950    $          20,950
Office buildings and improvements                                                     608,800              608,800
Furniture and fixtures                                                                303,550              206,100
                                                                             -----------------    -----------------
                                                                                      933,300              835,850
Less accumulated depreciation                                                        (531,500)            (498,000)
                                                                             -----------------    -----------------
                                                                            $         401,800    $         337,850
                                                                             =================    =================
</TABLE>


NOTE 5.  FORECLOSED ASSETS

There were no provisions or charge-offs in the allowance for loss on foreclosed
assets during 2006 or 2005. However, the Company incurred $170,500 and $91,650
in expense associated with holding foreclosed assets during 2006 and 2005,
respectively. The Company did not dispose of any foreclosed assets during 2006
or 2005.

NOTE 6.  BANK OWNED LIFE INSURANCE

The Company has entered into Life Insurance Endorsement Method Split Dollar
Agreements with certain employees of the Association. Under the agreement, upon
death of the employee, the Company first recovers the cash surrender value of
the contract and then shares the remaining death benefits from the insurance
contracts, which are written through two different carriers, with the designated
beneficiaries of the employee.


                                       28
<PAGE>

WAKE FOREST BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------------------------------------------------

NOTE 6.  BANK OWNED LIFE INSURANCE (CONTINUED)

The death benefit to the employee is limited to $25,000 each. The Company, as
owner of the policies, retains an interest in the life insurance proceeds and a
100% interest in the cash surrender value of the policies. The Company paid an
initial single premium of $1.0 million which is accounted for as cash surrender
value and reported as "Bank owned life insurance" (other assets) in the
Company's consolidated statement of financial condition. Increases in the
surrender value of the policies are accounted for as other non-interest income.
For 2006 and 2005, the increase amounted to $41,550 and $36,650, respectively.

NOTE 7. DEPOSITS

  Deposits at September 30, 2006 and 2005 consist of the following:

<TABLE>
<CAPTION>
                                                                                        2006                 2005
                                                                                 -------------------  -------------------

<S>                                                                            <C>                  <C>
Passbook accounts                                                              $          2,702,750 $          3,096,300
MMDA accounts                                                                            22,290,450           19,636,350
NOW accounts                                                                              2,228,550            2,449,200
Certificate of deposit accounts                                                          55,003,350           53,653,750
Noninterest-bearing accounts                                                              1,752,750            2,069,550
                                                                                 -------------------  -------------------
                                                                               $         83,977,850 $         80,905,150
                                                                                 ===================  ===================
</TABLE>

Certificate of deposit accounts by maturity at September 30, 2006 are summarized
as follows:

<TABLE>
<CAPTION>
                                                                 Maturity Period:
<S>                                                                    <C>                           <C>
                                                                       2007                          $         35,262,900
                                                                       2008                                     9,275,150
                                                                       2009                                     2,088,900
                                                                       2010                                     7,602,100
                                                                       2011                                       774,300
                                                                                                        ------------------
                                                                                                     $         55,003,350
                                                                                                        ==================
</TABLE>

The aggregate amount of certificate of deposit accounts at September 30, 2006
with a minimum denomination of $100,000 by maturity are summarized as follows:

<TABLE>
<CAPTION>
Maturity Period:

<S>                                                                                                <C>
  Within three months                                                                              $         2,017,500
  After three months but within six months                                                                   5,288,750
  After six months but within twelve months                                                                  8,767,950
  After twelve months                                                                                        8,225,700
                                                                                                    -------------------
                                                                                                   $        24,299,900
                                                                                                    ===================
</TABLE>


                                       29
<PAGE>

WAKE FOREST BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------------------------------------------------

NOTE 8.  EMPLOYEES AND DIRECTORS BENEFIT PLANS

The Association has a 401k plan which covers substantially all employees. The
Association matches employee contributions up to 7.5% and pays the
administrative cost of the Plan. Plan expenses amounted to $1,650 and $1,750
during 2006 and 2005, respectively.

The Association has a non-qualified noncontributory retirement plan covering its
directors. Retirement plan expense is computed based on the discounted present
value of expected future payments over the expected service years for the
directors. Under the plan, directors will receive upon retirement a lump sum
payment equal to the discounted present value of annual payments not to exceed
$5,000 for ten years. Other stipulations and limitations based on years of
service, death and disability, change of control, and early termination apply.
Expense associated with the plan amounted to $4,500 and $2,800 in 2006 and 2005,
respectively.

The Association has also entered into employment agreements with two key
executives. The agreements provide for a three year term, but upon each
anniversary, the agreements automatically extend so that the terms shall always
be three years, unless either party gives notice that the agreement will not be
renewed. Performance reviews by a committee of the Board will be conducted
annually and the agreements can be terminated by the Association at anytime for
cause as defined in the agreements. The agreements provide for a base salary
plus performance bonus to be determined annually. In the event of termination
other than for cause, the employees are entitled to a lump sum cash payment in
an amount equal to the present value of the base salary, bonus payments, and
other benefits as described and determined in the agreements.

NOTE 9.  STOCK OPTION PLAN

The Company has a stock option plan for the benefit of its officers, directors,
and key employees. Options totaling 54,000 at an exercise price of $12.75 were
granted on January 22, 1997. No options have been granted since that date. The
options became exercisable at the rate of 20% annually for years during periods
of service as an employee, officer, or director, and expire after ten years.
Accelerated vesting may occur in certain circumstances as disclosed in the plan
documents. Options are exercisable at the fair value on the date of grant. A
summary of the changes in the Company's options during the years ended September
30, 2006 and 2005 is presented below:

<TABLE>
<CAPTION>
                                                                                      2006                 2005
                                                                                -----------------    -----------------
<S>                                                                                       <C>                  <C>
Stock options outstanding at beginning of the year                                        16,802               32,765
Granted                                                                                        -                    -
Exercised                                                                                 (9,988)             (15,963)
Terminated                                                                                     -                    -
                                                                                -----------------    -----------------
Stock options outstanding at end of the year                                               6,814               16,802
                                                                                =================    =================
Stock options exercisable at end of the year                                               6,814               16,802
                                                                                =================    =================
</TABLE>

NOTE 10.  EMPLOYEE STOCK OWNERSHIP PLAN

The Association has an Employee Stock Ownership Plan ("ESOP") to benefit
substantially all employees. As a part of the Association's initial public
offering in April 1996, the ESOP purchased 41,200 shares of common stock with
the proceeds from a loan received from a third party financial institution. The
Association made quarterly contributions to the ESOP in amounts sufficient to
allow the ESOP to make its scheduled principal and interest payments on the
note. The note matured in March 2003. The Association recorded expense based
upon the fair value of the shares allocated to plan participants each year. The
difference between the cash contributions and the amount expensed was credited
or charged to additional paid-in capital. Because all remaining shares under the
plan were allocated to participants during 2003, the Company's current expense
is only associated with administration of the plan and amounted to $2,915 and
$1,750 for 2006 and 2005, respectively.

The ESOP has a put option which requires that the Company repurchase its common
stock from eligible participants in the ESOP who elect to receive cash in
exchange for their common stock. The Company is required to reflect as a
liability the maximum possible cash obligation to redeem the shares, which is
the fair value of such shares. The liability for the put option at September 30,
2006 was $553,650 based upon the market price of the Company's shares at that
time. The liability for the put option will fluctuate based upon the fair value
of the shares with the resulting increase or decrease reflected as change to
retained earnings.

                                       30
<PAGE>

WAKE FOREST BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------------------------------------------------

NOTE 10.  EMPLOYEE STOCK OWNERSHIP PLAN (CONTINUED)

Shares of the Company held by the ESOP at September 30, 2006 and 2005 are as
follows:

<TABLE>
<CAPTION>
                                                                               2006              2005
                                                                          ---------------   ---------------
<S>                                                                               <C>               <C>
Shares originally held by the ESOP                                                41,200            41,200
Shares released to retired participants                                          (18,602)          (15,096)
                                                                          ---------------   ---------------
Shares outstanding at year end                                                    22,598            26,104
                                                                          ---------------   ---------------
Shares released for allocation                                                    22,598            26,104
                                                                          ---------------   ---------------
Fair value of outstanding ESOP shares                                          $ 553,650         $ 569,100
                                                                          ===============   ===============
</TABLE>

NOTE 11.  INCOME TAXES

At September 30, 2006 and 2005, retained earnings contain $1,434,000 in tax
related bad debt reserves for which no deferred income taxes have been provided
because the Association does not intend to use the reserves for purposes other
than to absorb losses. The balance represents the Association's bad debt
reserves at September 30, 1988, and the unrecorded deferred income taxes amount
to approximately $545,000. If amounts which qualified as bad debt deductions are
used for purposes other than to absorb losses or adjustments arising from the
carryback of net operating losses, income taxes may be imposed at the then
existing rates.

Income tax expense differs from the federal statutory rate of 34% as follows:

<TABLE>
<CAPTION>
                                                                                     2006                  2005
                                                                               -----------------     -----------------
<S>                                                                                       <C>                   <C>
         Statutory federal income tax rate                                                34.00 %               34.00 %
         Increase (decrease) in income taxes resulting from:
           State income taxes, net of federal benefit                                      2.63                  3.40
           Other                                                                          (0.53)                (1.46)
                                                                               -----------------     -----------------
         Effective tax rate                                                               36.10 %               35.94 %
                                                                               =================     =================
</TABLE>

Deferred income taxes consist of the following components as of September 30,
2006 and 2005:

<TABLE>
<CAPTION>
                                                                                    2006                 2005
                                                                               -----------------    -----------------
<S>                                                                           <C>                  <C>
Deferred tax assets:

  Loan loss allowances                                                        $         393,300    $         323,000
  Health insurance accrual                                                               95,000               89,600
  Retirement plan accrual                                                                54,700               68,050
  Other                                                                                   4,000                9,150
                                                                               -----------------    -----------------
                                                                                        547,000              489,800
                                                                               -----------------    -----------------
Deferred tax liabilities:

  Excess accumulated tax depreciation                                                    49,400               20,800
  Unrealized net appreciation, investments                                              202,500              171,850
                                                                               -----------------    -----------------
                                                                                        251,900              192,650
                                                                               -----------------    -----------------
                                                                              $         295,100    $         297,150
                                                                               =================    =================
</TABLE>

                                       31
<PAGE>

WAKE FOREST BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------------------------------------------------

NOTE 12.  CAPITAL

Concurrent with the reorganization in 1996, the Association established a
liquidation account equal to its net worth as reflected in its statement of
financial condition used in its final offering circular. The liquidation account
is maintained for the benefit of eligible deposit account holders and
supplemental eligible deposit account holders who continue to maintain their
deposit accounts in the Association after the reorganization. Only in the event
of a complete liquidation will eligible deposit account holders and supplemental
eligible deposit account holders be entitled to receive a liquidation
distribution from the liquidation account adjusted for transactions since the
reorganization. Dividends paid by the Association to the Company subsequent to
the reorganization cannot be paid from this liquidation account.

Subject to applicable law, the Boards of Directors of the Company and the
Association may each provide for the payment of dividends. Future declarations
of cash dividends, if any, by the Company may depend upon dividend payments by
the Association to the Company. Subject to regulations promulgated by the OTS,
the Association will not be permitted to pay dividends on its common stock if
its net worth would be reduced below the amount required for the liquidation
account or its minimum regulatory capital requirements.

In addition, as an institution which is considered well capitalized under the
OTS's Prompt Corrective Action regulations, the Association may pay a cash
dividend to the Company, with prior notification to the OTS, if the total amount
of all capital distributions (including the proposed distribution) for the
applicable calendar year does not exceed the Association's net income for the
year plus retained net income (net income minus capital distributions) for the
preceding two years. However, the OTS retains the right to deny any capital
distribution if it raises safety and soundness concerns.

The Company and the Association are subject to the capital requirements
established by the OTS. Under the OTS prompt corrective action regulations, the
Company and the Association are considered well capitalized if their ratio of
total capital to risk-weighted assets is at least 10%, their ratio of core
capital (Tier 1) to risk-weighted assets is at least 6.0%, and their ratio of
core capital (Tier 1) to total average assets is at least 5.0%. Both the Company
and the Association met all of the above requirements and are considered well
capitalized.

The Company's capital requirements and ratios are presented below:

<TABLE>
                                                                       MINIMUM REQUIREMENTS TO BE:
                                               ----------------------------------------------------------------------------
In Thousands                                      ACTUAL                 ADEQUATELY CAPITALIZED       WELL CAPITALIZED
                                               ----------------------------------------------------------------------------
                                                  Amount      Ratio       Amount        Ratio        Amount       Ratio
                                               ----------------------------------------------------------------------------
<S>                                                <C>          <C>         <C>         <C>            <C>          <C>
2006

Total Capital to Risk Weighted Assets              $ 19,622     28.00%      $ 5,606     8.00%          $ 7,007      10.00%
Tier 1 Capital to Risk Weighted Assets             $ 18,507     26.41%      $ 2,803     4.00%          $ 4,204       6.00%
Tier 1 Capital to Average Assets                   $ 18,507     17.84%      $ 4,150     4.00%          $ 5,187       5.00%

2005

Total Capital to Risk Weighted Assets              $ 18,151     27.61%      $ 5,259     8.00%          $ 6,574      10.00%
Tier 1 Capital to Risk Weighted Assets             $ 17,126     26.05%      $ 2,630     4.00%          $ 3,945       6.00%
Tier 1 Capital to Average Assets                   $ 17,126     17.25%      $ 3,971     4.00%          $ 4,964       5.00%
</TABLE>

The Company has an ongoing stock repurchase program authorizing the Company to
repurchase up to an additional $151,750 of its outstanding common stock. The
repurchases are made through registered broker-dealers from shareholders in open
market purchases at the discretion of management. The Company intends to hold
the shares repurchased as treasury shares, and may utilize such shares to fund
stock benefit plans or for any other general corporate purpose as permitted by
applicable law. At September 30, 2006, the Company had repurchased 90,445 shares
of its common stock. The program continues until terminated by the Board of
Directors.

                                       32
<PAGE>

WAKE FOREST BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------------------------------------------------

NOTE 13.  CONCENTRATION OF CREDIT RISK AND OFF-BALANCE-SHEET RISK

The Association is a party to financial instruments with off-balance-sheet risk
in the normal course of business to meet the financing needs of its customers.
These financial instruments include commitments to extend credit and the
undisbursed portion of construction loans. Those instruments involve, to varying
degrees, elements of credit and interest rate risk in excess of the amounts
recognized in the statement of financial condition. The contract or notional
amounts of those instruments reflect the extent of involvement the Association
has in particular classes of financial instruments. The Association's exposure
to credit loss in the event of nonperformance by the other party to the
financial instrument for commitments to extend credit is represented by the
contractual notional amount of those instruments.

The Association uses the same credit policies in making commitments and
conditional obligations as it does for on-balance-sheet instruments. At
September 30, 2006, the Association had outstanding loan commitments amounting
to $4,992,600. The undisbursed portion of construction loans amounted to
$13,340,900 and unused lines of credit amounted to $7,198,900 at September 30,
2006.

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

NOTE 14.  FAIR VALUE OF FINANCIAL INSTRUMENTS

The following table presents the carrying amounts and estimated fair values of
the Company's financial instruments at September 30, 2006 and 2005. See Note 1
for a description of the Company's accounting policies and the limitations of
its disclosures in reporting on the fair value of its financial instruments.

<TABLE>
<CAPTION>
                                                                            September 30,
                                             -------------------------------------------------------------------------------
                                                              2006                                      2005
                                             --------------------------------------    -------------------------------------
                                                 Carrying               Fair               Carrying              Fair
                                                  Amount               Value                Amount              Value
                                             -----------------    -----------------    -----------------   -----------------
<S>                                      <C>                   <C>                 <C>                   <C>
Financial assets:

 Cash and cash equivalents               $         23,818,900  $        23,818,900 $         22,327,400  $       22,327,400
 Investment securities                                540,850              540,850              460,350             460,350
 FHLB stock                                           197,600              197,600              182,300             182,300
 Loans receivable                                  76,635,300           76,455,750           73,894,100          73,868,450
 Bank owned life insurance                          1,100,050            1,100,050            1,058,500           1,058,500
 Accrued interest receivable                          230,050              230,050              136,200             136,200
Financial liabilities:

Deposits                                           83,977,850           83,630,200           80,905,150          78,461,850
Accrued interest payable                               67,950               67,950               26,950              26,950
Dividends payable                                      88,700               88,700               77,650              77,650
</TABLE>



                                       33
<PAGE>

WAKE FOREST BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------------------------------------------------

NOTE 15.  MUTUAL HOLDING COMPANY FINANCIAL DATA

The MHC owns approximately 55% of the Company's common stock. Members of the MHC
consist of depositors and certain borrowers of the Association, who have the
sole authority to elect the board of directors of the MHC. The MHC is registered
as a savings and loan holding company and is subject to regulation, examination,
and supervision by the OTS. A summary of the condensed financial statements of
Wake Forest Bancorp, M.H.C. follows:

                            Condensed Balance Sheets
                          September 30, 2006 and 2005

<TABLE>
<CAPTION>
                                                                                           2006                 2005
                                                                                     -----------------    -----------------
Assets:

<S>                                                                              <C>                  <C>
 Cash and cash equivalents                                                          $       1,028,600   $       1,127,750
 Investment in Wake Forest Bancshares, Inc.                                                 8,531,850           7,621,050
                                                                                     ----------------    -----------------
                                 Total assets                                       $       9,560,450   $       8,748,800
                                                                                     ================    =================
Liabilities:

 Accounts payable and accrued expenses                                              $          29,250   $           6,700
                                                                                     ----------------    -----------------
Equity:

 Capitalization by Wake Forest Federal                                                        106,350             106,350
 Equity in Wake Forest Bancshares, Inc.                                                     3,854,700           3,854,700
 Retained earnings                                                                          5,570,150           4,781,050
                                                                                     ----------------    -----------------
                               Total equity                                                 9,531,200           8,742,100
                                                                                     ----------------    -----------------
                               Total liabilities and equity                         $       9,560,450   $       8,748,800
                                                                                     ================    =================
</TABLE>

                         Condensed Statements of Income
                 For the Years Ended September 30, 2006 and 2005

<TABLE>
<CAPTION>
Revenues:                                                                                  2006                 2005
                                                                                     ------------------   -----------------
<S>                                                                               <C>                   <C>
  Interest income                                                                   $           38,300   $          33,000
  Equity in earnings of subsidiary                                                             910,800             726,550
                                                                                     ------------------   -----------------
                             Total income                                                      949,100             759,550
                                                                                     ------------------   -----------------
Expenses:

  Accounting and tax expense                                                                    29,450              21,650
  Attorney Fees                                                                                 19,900              16,150
  Director's fees                                                                               84,750              80,200
  Other                                                                                         25,900              25,850
                                                                                     ------------------   -----------------
                            Total expense                                                      160,000             143,850
                                                                                     ------------------   -----------------
                            Net income                                              $          789,100   $         615,700
                                                                                     ==================   =================
</TABLE>


                       Condensed Statements of Cash Flows
                 For the Years Ended September 30, 2006 and 2005

<TABLE>
<CAPTION>
Cash Flows from Operating Activities:                                                      2006                 2005
                                                                                     -----------------    -----------------
<S>                                                                               <C>                 <C>
 Net income                                                                         $         789,100    $         615,700
  Equity in earnings of Wake Forest Federal                                                  (910,800)            (726,550)
  Increase (decrease) in accounts payable                                                      22,550              (12,450)
                                                                                     -----------------    -----------------
          Net cash provided by operating activities                                           (99,150)            (123,300)
Cash and cash equivalents- beginning                                                        1,127,750            1,251,050
                                                                                     -----------------    -----------------
Cash and cash equivalents- ending                                                   $       1,028,600    $       1,127,750
                                                                                     =================    =================
</TABLE>

                                       34
<PAGE>

WAKE FOREST BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------------------------------------------------


NOTE 16.  PARENT COMPANY ONLY FINANCIAL DATA

The condensed financial statements of Wake Forest Bancshares, Inc. for the
periods indicated follows:

                        Condensed Balance Sheets
                       September 30, 2006 and 2005

<TABLE>
<CAPTION>
Assets:                                                                            2006                 2005
                                                                             -----------------    -----------------
<S>                                                                       <C>                  <C>
 Cash and cash equivalents                                                $           151,750  $           154,600
 Accrued dividends receivable, Wake Forest Federal                                     88,700               77,650
 Investment in Wake Forest Federal                                                 18,653,800           17,250,550
 Other assets                                                                             600                1,050
                                                                             -----------------    -----------------
          Total assets:                                                   $        18,894,850  $        17,483,850
                                                                             =================    =================
Liabilities and Equity:

 Accrued dividends payable                                                $            88,700  $            77,650
                                                                             -----------------    -----------------
 Common stock                                                                          12,450               12,350
 Additional paid-in capital                                                        13,938,450           13,774,800
 Accumulated other comprehensive income                                               330,400              280,500
 Retained earnings                                                                  5,914,650            4,596,150
 Treasury stock acquired                                                           (1,389,800)          (1,257,600)
                                                                             -----------------    -----------------
          Total equity                                                             18,806,150           17,406,200
                                                                             -----------------    -----------------
          Total liabilities and equity                                    $        18,894,850  $        17,483,850
                                                                             =================    =================
</TABLE>


                     Condensed Statements of Income
             For the Years Ended September 30, 2006 and 2005

<TABLE>
<CAPTION>
                                                                                    2006                 2005
                                                                              -----------------    -----------------
<S>                                                                       <C>                   <C>
Interest income                                                           $              4,450  $             6,250
Equity in earnings of Wake Forest Federal                                            1,654,400            1,317,900
Other expense                                                                           (2,900)              (3,650)
                                                                              -----------------    -----------------
                                     Net income                           $          1,655,950  $         1,320,500
                                                                              =================    =================
</TABLE>


                    Condensed Statement of Cash Flows
             For the Years Ended September 30, 2006 and 2005

<TABLE>
<CAPTION>
Cash Flows from Operating Activities:                                              2006                 2005
                                                                             -----------------    -----------------
<S>                                                                       <C>                  <C>
 Net income                                                               $         1,655,950  $         1,320,500
  Equity in earnings of Wake Forest Federal                                        (1,654,400)          (1,317,900)
  Dividends received from Wake Forest Federal                                         341,800              306,900
  (Increase) decrease in accrued dividends receivable                                 (11,050)              (5,600)
  (Increase) decrease in other assets                                                     450                  900
                                                                             -----------------    -----------------
          Net cash provided by operating activities                                   332,750              304,800
                                                                             -----------------    -----------------
Cash Flows from Financing Activities:

Treasury stock acquired                                                              (132,200)            (280,800)
 Proceeds from exercise of stock options                                              127,350              203,550
 Increase (decrease) in accrued dividends payable                                      11,050                5,600
 Dividends paid                                                                      (341,800)            (306,900)
                                                                             -----------------    -----------------
          Net cash provided from financing activities                                (335,600)            (378,550)
                                                                             -----------------    -----------------
Decrease in cash                                                                       (2,850)             (73,750)
Cash and cash equivalents- beginning                                                  154,600              228,350
                                                                             -----------------    -----------------
Cash and cash equivalents- ending                                         $           151,750  $           154,600
                                                                             =================    =================
</TABLE>


                                       35
<PAGE>

                          WAKE FOREST BANCSHARES, INC.
                            COMMON STOCK INFORMATION
------------------------------------------------------------------------------


The Company's stock (previously as Wake Forest Federal Savings & Loan
Association) began trading on April 3, 1996. There are 1,156,689 shares of
common stock outstanding (net of treasury shares) of which approximately 43%
were held by individual stockholders at September 30, 2006. The MHC and the ESOP
hold approximately 57%. There were approximately 225 stockholders of record as
of September 30, 2006. The Company's stock is not actively traded, although the
stock is quoted on the OTC Electronic Bulletin Board under the symbol "WAKE.OB"
The table below reflects the stock trading and dividend payment frequency of the
Company's stock for the years ended September 30, 2006 and 2005, based upon
information provided to management of the Company by certain securities firms
effecting transactions in the Company's stock on an agency basis.

<TABLE>
<CAPTION>
                                                                                                   Stock Price
                                                                                      ---------------------------------
                                                                        Dividends          High              Low
                                                                       ------------   ---------------  ----------------
2006
<S>                                                                      <C>          <C>                <C>
First Quarter                                                            $    0.17    $       24.000     $      20.400
Second Quarter                                                                0.17            22.750            20.700
Third Quarter                                                                 0.17            22.500            20.550
Fourth Quarter                                                                0.17            24.500            21.300

2005

First Quarter                                                            $    0.15    $       29.000     $      22.000
Second Quarter                                                                0.15            26.500            22.000
Third Quarter                                                                 0.15            25.000            20.000
Fourth Quarter                                                                0.15            23.000            20.000
</TABLE>



                                       36
<PAGE>

                          WAKE FOREST BANCSHARES, INC.
                              CORPORATE INFORMATION

<TABLE>
<CAPTION>
                                                  OFFICERS
                                                  --------

<S>                                         <C>                                    <C>
Robert C. White                             Susan S. Carter                        Billy B. Faulkner
President, Chief Executive Officer          Vice President and                     Vice President, Secretary
 & Chief Financial Officer                  Assistant Treasurer                      & Treasurer

<CAPTION>
                                                  DIRECTORS
                                                  ---------

<S>                                         <C>                                    <C>
Howard Brown                                John D. Lyon                           Rodney M. Privette
Chairman of the Board                       Real Estate Management                 Owner of Insurance Agency
Former Owner of
Oil Distribution Company                    Harold R. Washington                   R. W. Wilkinson III
                                            Former Owner of                        Vice Chairman of the Board
Anna O. Sumerlin                            Automobile Distributorship             Former Managing Officer
Former CEO of the Company                                                          of Wake Forest Federal
                                            William S. Wooten
Robert C. White                             Dentist                                Leelan A. Woodlief
CEO of the Company                                                                 Retired Owner of Farm Supply
                                                                                   Company

STOCK TRANSFER AGENT                        SPECIAL LEGAL COUNSEL                  INDEPENDENT AUDITORS

Mellon Investor Services LLC                Thacher Proffitt & Wood LLP            Dixon Hughes PLLC
Newport Office Center VII                   Suite 800                              Suite 200
480 Washington Blvd.                        1700 Pennsylvania Ave., N.W.           2501 Blue Ridge Road
Jersey City, NJ 07310                       Washington, DC  20006                  Raleigh, NC 27607
1-800-756-3353

<CAPTION>
                                               CORPORATE OFFICE
                                               ----------------
<S>                                         <C>                                    <C>
                                            302 S. Brooks St.
                                            Wake Forest, NC  27587
</TABLE>

                                 ANNUAL MEETING

The 2007 annual meeting of stockholders of Wake Forest Bancshares, Inc. will be
held at 2:00 pm on Tuesday, February 20, 2007 at the Wake Forest Police and
Justice Center at 401 Elm Avenue, Wake Forest, N.C.

                                   FORM 10-KSB

A COPY OF THE ANNUAL REPORT ON FORM 10-KSB AS FILED WITH THE SECURITIES AND
EXCHANGE COMMISSION WILL BE FURNISHED WITHOUT CHARGE TO STOCKHOLDERS UPON
WRITTEN REQUEST TO WAKE FOREST BANCSHARES, INC., PO BOX 1167, WAKE FOREST, N.C.
27588.


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