<PAGE>

                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                   FORM 10-KSB

                 Annual Report Under Section 13 or 15(d) of the
                         Securities Exchange Act of 1934

                  For the fiscal year ended September 30, 2006

                        Commission File Number: 000-25999

                          WAKE FOREST BANCSHARES, INC.
                 (Name of small business issuer in its charter)

      UNITED STATES OF AMERICA                             56-2131079
   (State or other jurisdiction of                (IRS Employer Identification
           incorporation)                                     No.)

                             302 South Brooks Street
                        Wake Forest, North Carolina 27587
                    (Address of principal executive offices)

                                 (919) 556-5146
                           (Issuer's telephone number)

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

                     Common Stock, par value $0.01 per share
                                (Title of Class)

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

     Check if there is no disclosure of delinquent filers in response to Item
405 of Regulation S-B contained in this form, and no disclosure will be
contained, to the best of the registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this 10-KSB or
any amendment to this Form 10-KSB. / /

     Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). Yes / /  No /X/

     The revenues for the issuer's fiscal year ended September 30, 2006 were
$7,281,800.

     The issuer had 1,158,003 shares of common stock outstanding as of December
21, 2006. The aggregate market value of the common equity held by non-affiliates
of the registrant, computed by reference to the average bid and asked prices of
the common stock as of December 15, 2006 was $10,325,800

                      DOCUMENTS INCORPORATED BY REFERENCE.

      Portions of the registrant's Annual Report to Stockholders for the year
ended September 30, 2006 are incorporated by reference into Parts I and II of
this Form 10-KSB.

         Portions of the registrant's Proxy Statement for the 2007 Annual
Meeting of Stockholders are incorporated by reference into Part III of this Form
10-KSB.



<PAGE>


                                TABLE OF CONTENTS


<TABLE>
<S>                   <C>                                                                                     <C>
PART I

         ITEM 1.      Description of Business....................................................................4
         ITEM 2.      Description of Property...................................................................27
         ITEM 3.      Legal Proceedings.........................................................................27
         ITEM 4.      Submission of Matters to a Vote of Security HolderS.......................................27

PART II

         ITEM 5.      Market for Common Equity and Related Stockholder Matters..................................27
         ITEM 6.      Management's Discussion and Analysis or Plan of Operation.................................28
         ITEM 7.      Financial Statements......................................................................28
         ITEM 8.      Changes in and Disagreements with Accountants On Accounting
                      and Financial Disclosure..................................................................28
         ITEM 8A.     Controls and Procedures...................................................................29
         ITEM 8B      Other Information.........................................................................29

PART III

         ITEM 9.      Directors, Executive Officers, Promoters, Control Persons and Corporate
                      Governance; Compliance  with Section 16(a) of the Exchange Act............................29
         ITEM 10.     Executive Compensation....................................................................29
         ITEM 11.     Security Ownership of Certain Beneficial Owners and Management
                      and Related Stockholder Matters...........................................................29
         ITEM 12.     Certain Relationships and Related Transactions, and Directors
                       Independence.............................................................................29
         ITEM 13.     Exhibits..................................................................................29
         ITEM 14.     Principal Accountant Fees and Services....................................................31

SIGNATURES
</TABLE>

<PAGE>

                                     PART I

FORWARD-LOOKING STATEMENTS

         This document, including information incorporated by reference,
contains, and future filings by Wake Forest Bancshares, Inc. (the "Company") on
Form 10-QSB and Form 8-K and future oral and written statements by the Company
and its management may contain forward-looking statements about the Company and
its subsidiary which we believe are within the meaning of the Private Securities
Litigation Reform Act of 1995. These forward-looking statements include, without
limitation, statements with respect to anticipated future operating and
financial performance, growth opportunities, interest rates, cost savings and
funding advantages expected or anticipated to be realized by management. Words
such as "may," "could," "should," "would," "believe," "anticipate," "estimate,"
"expect," "intend," "plan" and similar expressions are intended to identify
these forward-looking statements. Forward-looking statements by the Company and
its management are based on beliefs, plans, objectives, goals, expectations,
anticipations, estimates and intentions of management and are not guarantees of
future performance. The Company disclaims any obligation to update or revise any
forward-looking statements based on the occurrence of future events, the receipt
of new information, or otherwise. The important factors we discuss below and
elsewhere in this document, as well as other factors discussed under the caption
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" in our Annual Report to Shareholders (attached to this document as
Exhibit 13) and identified in our filings with the SEC and those presented
elsewhere by our management from time to time, could cause actual results to
differ materially from those indicated by the forward-looking statements made in
this document:

         o     the strength of the United States economy in general and the
               strength of the local economies in which we conduct operations;

         o     the effects of, and changes in, trade, monetary and fiscal
               policies and laws, including interest rate policies of the
               Federal Reserve Board;

         o     inflation, interest rate, market and monetary fluctuations;

         o     the timely development and acceptance of our new products and
               services and the perceived overall value of these products and
               services by users, including the features, pricing and quality
               compared to competitors' products and services;

         o     the willingness of users to substitute our products and services
               for products and services of our competitors;

         o     our success in gaining regulatory approval of our products and
               services, when required;

         o     the impact of changes in financial services' laws and regulations
               (including laws concerning taxes, banking, securities and
               insurance);

         o     the impact of technological changes;

         o     changes in consumer spending and saving habits; and

         o     our success at managing the risks involved in the foregoing.


                                       3
<PAGE>


ITEM 1.  DESCRIPTION OF BUSINESS

GENERAL

         Wake Forest Bancshares, Inc. is a federally-chartered stock holding
company for Wake Forest Federal Savings & Loan Association (the "Association"),
a federally-chartered stock savings and loan association which conducts business
from its one office located in Wake Forest, North Carolina. The office is
located in Wake County, North Carolina. The Company was formed on May 7, 1999 in
connection with reorganization of the Association into the "two tier" mutual
holding company structure. The Company is a majority-owned subsidiary of Wake
Forest Bancorp, M.H.C., a federal mutual holding company (the "MHC"). The
Association was founded in 1922 as a building and loan association. In 1982, the
Association converted from a North Carolina chartered mutual savings and loan
association to a federally-chartered mutual savings and loan association. During
fiscal year 1996, the Association converted from a federally-chartered mutual
savings and loan association to a federally-chartered stock savings and loan
association. The Association is the Company's sole subsidiary. The Association's
deposits are insured by the Deposit Insurance Fund of the Federal Deposit
Insurance Corporation (the "FDIC") to the maximum extent permitted by law. At
September 30, 2006, the Company had total assets of $104.3 million, total
deposits of $84.0 million and total stockholders' equity of $18.8 million.

         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 primary focus of the Association is to provide financing for single
family housing in its market area of northern Wake County and southern Franklin
County. The Association has concentrated its lending activities on real estate
loans secured by single family residential properties and construction loans on
primarily residential properties. To a lesser extent, the Association invests in
commercial real estate, land, multi-family residential and savings account
loans. The Association also invests its excess funds primarily in Federal Home
Loan Bank stock, Federal Home Loan Mortgage Corporation ("FHLMC") stock, U.S.
Treasury and Agency obligations, and other short term interest-bearing deposits.
The Association's principal sources of funds are deposits and principal and
interest payments on loans. The principal source of income is interest on loans
and investment securities. The Association's principal expenses are interest
paid on deposits and compensation and benefits.

         The Association's results of operations are dependent primarily on net
interest income, which is the difference between the interest income earned on
its interest-earning assets, such as loans and securities, and interest expense
on its interest-bearing liabilities, such as deposits. The Association also
generates non-interest income such as service charges and other account fees,
fees from sale of loans in the secondary market, and gains from sale of
investments. The Association's non-interest expenses primarily consist of
compensation and benefits, occupancy expenses, data processing fees and other
operating expenses. The Association's results of operations are also
significantly affected by general economic and competitive conditions
(particularly changes in market interest rates), government policies, changes in
accounting standards and actions of regulatory agencies. The Association
exceeded all of its regulatory capital requirements at September 30, 2006. See
"Regulation -- Federal Banking Regulation -- Capital Requirements."

         The Association is primarily engaged in the business of attracting
retail deposits from the general public in the Association's marketing area, and
investing those deposits, together with other sources of funds, primarily in
loans secured by one- to four-family residential real estate for retention in
its loan portfolio. For further details, see below under "Lending Activities."


                                       4
<PAGE>

MARKET AREA AND COMPETITION

         The Association is a community-oriented savings institution which
primarily gathers deposits and originates one- to four-family residential
mortgage loans and construction loans within its market area. The Association's
market area for deposit gathering and lending is concentrated in northern Wake
County and southern Franklin County, North Carolina.

         The Association's market area has benefited from its close proximity to
the "Research Triangle Park" which includes the cities of Chapel Hill, Durham
and Raleigh. The commuting distance from the Research Triangle Park to the town
of Wake Forest is approximately 15 miles. While most of the commercial
development within the Research Triangle Park has been in Durham County, most of
the residential development for the employees of the Research Triangle Park has
taken place in Wake County. Northern Wake County is expected to benefit from the
continued expansion of this area. Access to the Research Triangle Park is
excellent due to the proximity of Interstate 540, which is just south of Wake
Forest. The driving time between Wake Forest and the Research Triangle Park is
about 20 minutes.

         Currently, employment within the region varies, from a more high tech
and service-oriented industry near the Research Triangle Park to a more
agricultural/manufacturing base further away from the Research Triangle Park.
The largest employers in the northern Wake County area include Embarq,
Novo-Nordisk, and Mallinckrodt. The Association's proximity to the Research
Triangle Park, to Raleigh-Durham International Airport and to the City of
Raleigh, the state capital, should result in the future growth in the
Association's market area.

         The population of the Association's market area has grown rapidly
during the last decade and is expected to continue its growth over the next ten
years. Based on information provided by the Wake Forest Chamber of Commerce, the
town of Wake Forest's population was 12,588 in 2000 and grew 63.62% to 20,596 by
2006. Residential households totaled 7,750 in Wake Forest in 2006. The median
household income in Wake Forest was $71,158 in 2006. Wake County's and Franklin
County's populations were 748,815 and 54,429 in 2005, respectively.

         The Association faces substantial competition for both the deposits it
accepts and the loans it makes. Located within the Wake Forest area are branch
offices of twelve other depository institutions, ten of which are commercial
banks and two are large credit unions. The Association also encounters
significant competition for deposits from commercial banks, savings banks,
savings and loan associations and credit unions located in the Raleigh-Durham
area. Due to the Association's size relative to its competitors, the Association
offers a more limited product line, with an emphasis on product delivery and
customer service. The Association competes for deposits by offering a variety of
customer services and deposit accounts at competitive interest rates. The
Association, as well as its competitors, is affected by general economic
conditions, particularly changes in market interest rates, real estate market
values, government policies and regulatory authorities' actions. Changes in the
ratio of the demand for loans relative to the availability of credit may affect
the level of competition from financial institutions which may have greater
resources than the Association, but which have not generally engaged in lending
activities in the Association's market area in the past. Competition may also
increase as a result of the lifting of restrictions on the interstate operations
of financial institutions. See "Regulation."

LENDING ACTIVITIES

         Loan Portfolio Composition. The Association's loan portfolio consists
primarily of conventional one- to four-family first mortgage loans and
construction loans. To a lesser extent, the Association also makes multi-family
residential loans, commercial real estate loans, land loans, and loans secured
by savings accounts at the Association.

         The types of loans that the Association may originate are subject to
federal and state laws and regulations. Interest rates charged by the
Association on loans are affected by the demand for such loans, the supply of
money available for lending purposes and the rates offered by competitors. These
factors are in turn affected by, among other things, economic conditions,
monetary policies of the federal government, including the Federal Reserve
Board, and legislative tax policies.


                                       5
<PAGE>

         The following table sets forth the composition of the Association's
mortgage and other loan portfolios in dollar amounts and percentages at the
dates indicated.

<TABLE>
<CAPTION>
                                                                 At September 30,
                                         ----------------------------------------------------------------
                                                    2006                                2005
                                         --------------------------         -----------------------------
                                                           % of                                 % of
                                           Amount         Total                Amount           Total
                                         -----------    -----------         -------------    ------------
                                                            (Dollars in Thousands)
<S>                                   <C>                 <C>         <C>                       <C>
Type of loans:
      One- to four-family residential       $24,256         31.65%             $24,948            33.76%
      Multi-family residential                  427          0.56                  699             0.95
      Commercial real estate                 12,426         16.21               13,668            18.50
      Land                                   14,605         19.06               11,581            15.67
      Residential construction               36,900         48.15               36,559            49.47
      Equity line mortgages                   2,328          3.04                2,495             3.38
      Savings Account                           180          0.23                   88             0.12
                                            -------        ------              -------           ------
                                             91,122        118.90%              90,038           121.85%
                                            -------        ------              -------           ------
Less:
      Deferred loan fees                        104          0.14%                 115             0.16%
      Undisbursed portion of                                                                         --
        loans in process                     13,341         17.41               15,179            20.54
      Allowance for loan losses               1,042          1.36                  850             1.15
                                            -------        ------              -------           ------
                                             14,487         18.90               16,144            21.85
                                            -------        ------              -------           ------

           Total loans receivable, net$     $76,635        100.00%             $73,894           100.00%
                                            =======        ======              =======           ======
</TABLE>

         Loan Maturity. The following table shows the contractual maturity of
the Association's loans at September 30, 2006. The table reflects the entire
unpaid principal balance in the maturity period that includes the final loan
payment date and, accordingly, does not give effect to periodic principal
repayments or possible prepayments. Principal repayments and prepayments totaled
$42.6 million and $48.7 million for the years ended September 30, 2006 and 2005,
respectively.

<TABLE>
<CAPTION>
                                                           At September 30, 2006
                      --------------------------------------------------------------------------------------------------
                                                                                                     Savings
                        Residential Residential  Commercial              Residential    Equity Line  Account
                        1-4 Family  Multi-family Real Estate    Land     Construction   Mortgages     Loans        Total
                        ----------  ------------ -----------   ---------  ------------  -----------  --------    --------
<S>                   <C>          <C>         <C>             <C>        <C>                     <C>        <C>
Contractual maturity:                                            (In Thousands)
  One year or less       $    514    $   --      $    840      $  3,481    $ 36,900       $   --      $    134    $ 41,869
                         --------    --------    --------      --------    --------       --------    --------    --------
   After one year:
      1 to 3 years            553        --         2,440         7,177        --             --            46      10,216
      3 to 5 years            397        --           566           895        --             --          --         1,858
      5 to 10 years           608        --           572           446        --              591        --         2,217
      10 to 20 years        6,897        --         3,528         2,606        --            1,737        --        14,768
      Over 20 years        15,287         427       4,480          --          --             --          --        20,194
                         --------    --------    --------      --------    --------       --------    --------    --------
Total after one year       23,742         427      11,586        11,124        --            2,328          46      49,253
                         --------    --------    --------      --------    --------       --------    --------    --------
Total amount due           24,256         427      12,426        14,605      36,900          2,328         180      91,122
Undisbursed loans            --          --          --            --       (13,341)          --          --       (13,341)
                         --------    --------    --------      --------    --------       --------    --------    --------
Loans outstanding        $ 24,256    $    427    $ 12,426      $ 14,605    $ 23,559       $  2,328    $    180    $ 77,781
                         ========    ========    ========      ========    ========       ========    ========    ========
</TABLE>


                                       6
<PAGE>

      The following table sets forth the dollar amounts in each loan category at
September 30, 2006 that are contractually due after September 30, 2007, and
whether such loans have fixed interest rates or adjustable interest rates.

<TABLE>
<CAPTION>
                                              Due After September 30, 2007
                                      ------------------------------------------
                                          Fixed     Adjustable
                                          Rates       Rates       Total
                                      ----------   -----------   ------------
                                               (Dollars in Thousands)
<S>                                    <C>             <C>             <C>
One-to-four family residential         $ 8,369         $15,373         $23,742
Multi-family residential                   427            --               427
Commercial real estate                     216          11,370          11,586
Land                                        37          11,087          11,124
Residential construction                  --              --              --
Equity line mortgages                     --             2,328           2,328
Savings account loans                       46            --                46
                                       -------         -------         -------
                                       $ 9,095         $40,158         $49,253
                                       =======         =======         =======
</TABLE>

      Origination, Purchase, Sale and Servicing of Loans. The Association's
lending activities are conducted through its office in Wake Forest, North
Carolina. The Association originates both adjustable-rate mortgage loans and
fixed-rate mortgage loans. Adjustable-rate mortgage loans and fixed-rate
mortgage loans carry maximum amortizations of 30 years. The Association's
ability to originate loans is dependent upon the relative customer demand for
fixed-rate or adjustable-rate mortgage loans, which is affected by the current
and expected future levels of interest rates. The Association currently holds
for its portfolio all the adjustable rate loans it originates. The Association
has a correspondent lending program with a large national mortgage company and
sells a portion of its longer-term fixed rate residential mortgage loans in the
secondary market. Loans sold through the program are sold servicing released and
typically will be 15 and 30 year fixed- rate loans. The Association does not
service loans for others and has no current plans to begin such activities. From
time to time, the Association purchases participations in mortgage loans
originated by other institutions or affordable housing consortiums. The
determination to purchase participations in specific loans or pools of loans is
based upon criteria substantially similar to the Association's underwriting
policies, which consider the financial condition of the borrower, the location
of the underlying property and the appraised value of the property, among other
factors.

         One- to Four-Family Mortgage Lending. The Association offers both
fixed-rate and adjustable-rate mortgage loans, with amortizations of up to 30
years. These loans are secured by one- to four-family residences, which
generally are owner-occupied. Substantially all such loans are secured by
property located in northern Wake County and southern Franklin County, North
Carolina. Loan originations are generally obtained from existing or past
customers and members of the local communities. See "-Origination, Purchase,
Sale and Servicing of Loans."

         At September 30, 2006, the Association's total loans were $76.6
million, of which $24.3 million or 31.65% were one-to four-family residential
mortgage loans. Of the one- to four-family residential mortgage loans
outstanding at that date, 34.57%, or $8.4 million, were fixed-rate loans and
65.43%, or $15.9 million, were adjustable-rate loans. The Association offers
three-, five-, and seven-year balloon loans, which are either called or modified
based on the Association's interest rates currently in effect at the balloon
date. These loans are similar to adjustable rate loans in that the loans
generally amortize over terms of up to 30 years but are not indexed to any
widely recognized rate, such as the one year U.S. Treasury securities rate, and
do not have interest rate caps or floors. Instead, the majority of such loans
are modified at the balloon date and the rate is adjusted to the Association's
current rate offered for similar loans being originated on such dates. For
purposes of the tabular presentations throughout this document, such loans are
considered to be adjustable. Such loans involve risks similar to more
traditional adjustable rate loans because the Association modifies the loan
documents at the end of the three-, five-, and seven-year terms to adjust for
rates currently offered by the Association for similar loans being originated on
such dates. The loans are not generally underwritten again at modification
unless the Association is aware of collateral or ability-to-pay issues.


                                       7
<PAGE>

         In view of its operating strategy, the Association adheres to its Board
approved underwriting guidelines for loan origination, which, though prudent in
approach to credit risk and evaluation of collateral, allow management
flexibility with respect to documentation of certain matters and certain credit
requirements. As a result, such underwriting guidelines in certain lending
situations are less rigid than comparable Federal National Mortgage Association
("Fannie Mae") or Federal Home Loan Mortgage Corporation ("FHLMC') underwriting
guidelines. The Association's loans are typically originated under terms,
conditions and documentation which permit them to be sold to U.S.
government-sponsored enterprises such as Fannie Mae or FHLMC. The Association
sells certain residential loans in the secondary market through a correspondent
lending program which requires that the Association originate such loans
utilizing the standard secondary market underwriting requirements. Unless sold
in the secondary market, the Association's policy is to originate one- to
four-family residential mortgage loans in amounts up to 80% of the lower of the
appraised value or the selling price of the property securing the loan. Mortgage
loans originated by the Association generally include due-on-sale clauses which
provide the Association with the contractual right to deem the loan immediately
due and payable in the event the borrower transfers ownership of the property
without the Association's consent. Due-on-sale clauses are an important means of
adjusting the rates on the Association's fixed-rate mortgage loan portfolio and
the Association has generally exercised its rights under these clauses.

         Construction Lending. The Association originates loans for construction
to local real estate contractors in its market area, generally with whom it has
an established relationship and to individuals for construction of one- to
four-family residences. The Association's construction loans primarily have been
made to finance the construction of one- to four-family residential properties
which will generally be owner-occupied. These loans are generally indexed to the
prime rate ("Prime") with maturities of six to nine months, and allow for
extensions with Board approval. The Association's policies provide that
construction loans may be made in amounts up to 80% of the appraised value of
the property or the cost of construction, whichever is less, for construction of
one- to four-family residences. All construction loans are subject to the
limitation on loans-to-one-borrower and the Association considers the location
of the proposed construction in order to avoid over-concentration in a single
area. Prior to making a commitment to fund a construction loan, the Association
requires an independent appraisal of the property by a state-certified appraiser
if the requested amount exceeds $125,000. The Association's Chairman of the
Board generally inspects each project at the commencement of construction and
throughout the term of the construction. Loan proceeds are disbursed in
increments as construction progresses and as inspections warrant based upon a
percentage of completion. At September 30, 2006, the Association had $23.6
million (net of undisbursed loan funds of $13.3 million) of residential
construction loans which amounted to 30.74% of the Association's net loans
outstanding. The largest residential construction loan in the Association's
portfolio at September 30, 2006 was $831,700, is secured by a single family
residence under construction and is performing according to its terms.

         Construction loans to individuals are typically made in connection with
the granting of the permanent loan on the property. Such loans convert to a
fully amortizing adjustable- or fixed-rate loan at the end of the construction
term. In most cases, the Association requires that the closing with respect to
permanent financing occur simultaneously with the closing of any construction
loan to an individual.

         The Association makes construction loans to local builders on either a
pre-sold or speculative (unsold) basis. However, the Association generally
limits the number of unsold homes under construction by its builders, with the
amount dependent on the reputation of the builder, the present exposure of the
builder, the location of the property, the size of the loan and prior sales of
homes in the development. The Association estimates that approximately 70% of
its construction loans to builders are on a speculative basis.

         The Association also originates construction loans on commercial
properties. The underwriting requirements are similar to those required for
construction loans on residential properties. However, the loan to value may not
exceed 75% of the property's appraised value, certain debt service and income
ratios are considered, and financial projections and business plans are
reviewed. At September 30, 2006, the Association had no commercial construction
loans outstanding.

                                       8
<PAGE>

          Construction loans are generally considered to involve a higher degree
of credit risk than one- to four-family residential mortgage loans because
circumstances outside the borrower's control may adversely affect the market
value of the property. The Association has attempted to minimize these risks by,
among other things, limiting the extent of its construction lending as a
proportion of lending and by limiting its construction lending to primarily
residential properties. In addition, the Association has adopted underwriting
guidelines which impose stringent loan-to-value, debt service and other
requirements for loans which are believed to involve higher elements of credit
risk, by limiting the geographic area in which the Association will do business
to its existing market and by working with builders with whom it has established
relationships. It is also the Association's general policy to obtain personal
guarantees from the principal of its corporate borrowers on its construction
loans.

         Commercial Real Estate Mortgage Lending. The Association originates
commercial real estate mortgage loans that are generally secured by properties
used for business purposes and retail facilities, such as small office
buildings, located in the Association's market area as well as a significant
number of church loans. The Association's underwriting procedures provide that
commercial real estate loans may be made in amounts up to the lesser of (i) 75%
of the lesser of the appraised value or purchase price of the property and (ii)
the Association's current loans-to-one-borrower limit. These loans are generally
originated with amortization periods of up to 30 years with (i) a three-, five-,
or seven-year balloon, or (ii) prime based loans. The Association's underwriting
standards and procedures for these loans are similar to those applicable to its
construction lending, whereby the Association considers factors such as the
borrower's expertise, credit history and profitability. At September 30, 2006,
the Association's commercial real estate mortgage portfolio was $12.4 million,
or 16.21% of total loans outstanding. The largest commercial real estate loan in
the Association's portfolio at September 30, 2006 was $1.7 million and is
secured by a local church.

         Mortgage loans secured by commercial real estate properties are
generally larger and involve a greater degree of risk than one- to four-family
residential mortgage loans. This risk is attributable to the uncertain
realization of projected income-producing cash flows which are affected by
vacancy rates, the ability to maintain rent levels against competitively-priced
properties and the ability to collect rent from tenants on a timely basis.
Because payments on loans secured by commercial real estate properties are often
dependent on the successful operation or management of the properties, repayment
of such loans may be subject to a greater extent to adverse conditions in the
real estate market or the economy. The Association seeks to minimize these risks
through its underwriting standards, which require such loans to be qualified on
the basis of the property's income and debt service ratio.

         Equity Lines and Commercial Lines of Credit. The Association originates
equity line loans on one- to four- residential properties and line of credit
loans on commercial real estate and residential land. The Association's
underwriting policies require that equity line loans on one- to four-
residential properties be secured by real estate where the Association may or
may not have the first mortgage on the property. The equity line loans on one-
to four- residential properties may be made in amounts up to 80% of the
appraised value or adjusted tax value of the property, and take into
consideration any outstanding first mortgage liens in determining the
loan-to-value ratio. Equity line loans are originated at Prime plus 1% and
adjust for changes in prime thereafter on the first day of the month following a
change in Prime. The terms on the equity line loans on one- to four- residential
properties are for a period of 15 years. At September 30, 2006, the
Association's equity line portfolio was $2.3 million, or 3.04% of total loans
outstanding.

         The risks associated with equity line loans on one- to four-
residential properties are generally similar to the risks associated with other
forms of single-family residential lending due to the loan-to value limits
placed on such loans. The lines are revolving and may or may not be fully
disbursed at any given time. The Association's underwriting policies require
that commercial lines of credit be secured by real estate where the Association
has a first mortgage position. Commercial lines of credit are made in amounts up
to 75% of the appraised value of developed real estate or 65% of the appraised
value of undeveloped land. Commercial lines of credit are made with terms of
between 3 and 30 years at generally prime plus 1%, with adjustments to Prime
made on the first day of the month following a change in Prime. The risks
associated with lines of credit on real estate are substantially the same as the
risks described above on the Association's other forms of commercial real estate
lending.


                                       9
<PAGE>


         Other Mortgage Lending. The Association also offers loans secured by
land and multi-family residences. Land loans generally consist of residential
building lots for which the borrower intends to ultimately construct residential
properties, but may also include tracts purchased for speculative purposes and a
minor amount of farm land. Multi-family loans generally consist of residential
properties with more than four units, typically apartment complexes, in which
the Association has a participating interest through an affordable housing
consortium. The Association does not solicit such loans which do not constitute
an active part of its business, and generally offers such loans to accommodate
its present customers or to fulfill commitments to affordable housing
consortiums. At September 30, 2006, the Association's total land loan portfolio
was $14.6 million or 19.06% of total loans outstanding and its multi-family loan
portfolio was $427,000 or 0.56% of total loans outstanding.

         The Association requires appraisals of all properties securing
multi-family residential loans. Appraisals are performed by an independent
appraiser designated by the Association, all of which are reviewed by
management. The Association considers the quality and location of the real
estate, the credit of the borrower, the cash flow of the project and the quality
of management involved with the property.

         The Association originates multi-family residential loans with both
fixed and adjustable interest rates which vary as to maturity. Such loans are
typically income-producing investment loans. Loan to value ratios on the
Association's multi-family residential loans are generally limited to 75%. As
part of the criteria for underwriting these loans, the Association's general
policy is to obtain personal guarantees from the principals of its corporate
borrowers.

         Multi-family residential lending entails significant additional risks
as compared with single-family residential property lending. Such loans
typically involve large loan balances to single borrowers or groups of related
borrowers. The payment experience on such loans is typically dependent on the
successful operation of the real estate project. The success of such projects is
sensitive to changes in supply and demand, conditions in the market for
multi-family residential properties as well as regional and economic conditions
generally.

         Savings Account Loans. The Association offers loans secured by savings
accounts at the Association. Interest rates charged on such loans are set at
competitive rates, taking into consideration the amount and term of the loan and
are available in amounts up to 95% of the value of the account. Savings account
loans are reviewed and approved in conformity with standards approved by the
Association's Board of Directors. At September 30, 2006, the Association's
savings account loan portfolio totaled $179,500 or 0.23% of total loans
outstanding.

         Loan Approval Procedures and Authority. The Board of Directors
establishes the lending policies of the Association and reviews properties
offered as security. The Board of Directors has established the following
lending authority: the lending officers may approve loans in amounts up to
$500,000 while loans above $500,000 require Board approval. The foregoing
lending limits are reviewed annually and, as needed, revised by the Board of
Directors. The Board ratifies all loans on a monthly basis.

         For all loans originated by the Association, upon receipt of a
completed loan application from a prospective borrower, a credit report is
ordered and certain other information is verified by an independent credit
reporting agency, and, if necessary, additional financial information is
required to be submitted by the borrower. An appraisal of any real estate
intended to secure the proposed loan is required, which appraisal currently is
performed by an independent appraiser designated and approved by the
Association. Loans of up to $125,000 may be approved by the Association's loan
officers using property tax values and drive-by appraisals. The Board annually
approves the independent appraisers used by the Association and approves the
Association's appraisal policy. It is the Association's policy to obtain title
and hazard insurance on all real estate loans. In connection with a borrower's
request for a renewal of a mortgage loan, the Association evaluates the
borrower's ability to service the renewed loan applying an interest rate that
reflects prevailing market conditions. The current value of the underlying
collateral property is considered and the Association reserves the right to
reappraise the property.

Asset Quality

         Non-Performing Loans. Loans are considered non-performing if they are
in foreclosure or are 90 or more days delinquent. Management and the Board of
Directors perform a monthly review of all delinquent loans. The actions taken by
the Association with respect to delinquencies vary depending on the nature of
the loan and period of delinquency. The Association's policies generally provide
that delinquent mortgage loans be reviewed and that a written late charge notice
be mailed no later than the 30th day of delinquency. The Association's policies
provide that telephone contact will be attempted to ascertain the reasons for
delinquency and the prospects of repayment. When contact is made with the
borrower at any time prior to foreclosure, the Association attempts to obtain
full payment or work out a repayment schedule with the borrower to avoid
foreclosure. It is the Association's general policy to place all loans which are
90 days past due on nonaccrual status through the establishment of a reserve for
uncollected interest unless collectibility of all delinquent interest is
assured. Exceptions to placing a loan on non-accrual status are made when the
loan officer or management believe that no loss will be incurred on such loan.
Any such exceptions are reported to the Board of Directors on a monthly basis.
Circumstances under which such an exception may be granted include when the
underlying property is being actively marketed for sales, when a sales contract
has been executed and is pending closing or when the Association and the
borrower are actively negotiating a work-out schedule and all such interest is
considered collectible.

                                       10
<PAGE>

         The Association, as part of its loan review process, including the
decision whether to place a loan on nonaccrual status, attempts to determine the
underlying cause of the borrower's delinquency and ability to repay the loan.
The Association has been able to take this approach because it is a relatively
small institution and its problem loans have been historically insignificant as
a percentage of the Association's total loan portfolio. As the Association
grows, it may be necessary for the Association to take a more rigid approach and
automatically place loans on non-accrual status upon becoming 90 days or more
past due and evaluate only those loans that trigger certain mechanisms that
might indicate that an exception is warranted. However, management believes that
its current approach keeps it better informed as to the progress of a problem
loan and its underlying difficulties and that its non-accrual policy results in
an accurate depiction of loans that are collectible or likely to result in a
loss. There can be no assurances that the Association will be able to maintain
its problem loans at or below historical levels.

         Non-Accrual and Other Past Due Loans. The following table sets forth
information regarding non-accrual loans, other past due loans and real estate
owned. There were no troubled debt restructurings at any of the dates presented
below.

<TABLE>
<CAPTION>
                                                                                    At or For the Year
                                                                                    Ended September 30,
                                                                            ----------------------------------
                                                                                  (Dollars in Thousands)
                                                                                 2006                2005
                                                                            --------------      -------------
<S>                                                                           <C>                   <C>
Nonaccrual loans                                                              $       666           $      771
Accruing loans past due 90 days or more                                              --                   --
                                                                              -----------           ----------
Total non-performing loans                                                    $       666           $      771
                                                                              ===========           ==========
Allowance for loan losses                                                     $     1,042           $      850
                                                                              ===========           ==========
Real estate owned, net                                                        $     1,004           $    1,004
                                                                              ===========           ==========
Ratios:
     Non-accrual loans to total loans                                               0.86%                1.03%
     Non-performing loans to total loans                                            0.86%                1.03%
     Non-performing loans and real estate owned to total assets                     1.60%                1.78%
     Allowance for loan losses to:
       Non-accrual loans                                                          156.44%              110.27%
       Non-performing loans                                                       156.44%              110.27%
       Total loans                                                                  1.34%                1.14%
Contractual interest income that would have
  been recognized on nonaccrual loans                                         $        11           $       24
Actual interest income recognized                                                    --                   --
                                                                              -----------           ----------
Interest income not recognized                                                $        11           $       24
                                                                              ===========           ==========
</TABLE>

         Classified Assets. Federal regulations and the Association's
Classification of Assets Policy require that the Association utilize an internal
asset classification system as a means of reporting problem and potential
problem assets. The Association has incorporated the OTS internal asset
classifications as a part of its credit monitoring system. The Association
currently classifies problem and potential problem assets as "Special Mention,"
"Substandard," "Doubtful" or "Loss" assets. An asset is considered "Substandard"
if it is inadequately protected by the current equity and paying capacity of the
obligor or of the collateral pledged, if any. "Substandard" assets include those
characterized by the "distinct possibility" that the insured institution will
sustain "some loss" if the deficiencies are not corrected. Assets classified as
"Doubtful" have all of the weaknesses inherent in those classified "Substandard"
with the added characteristic that the weaknesses present make "collection or
liquidation in full," on the basis of currently existing facts, conditions, and
values, "highly questionable and improbable." Assets classified as "Loss" are
those considered "uncollectible" and of such little value that their continuance
as assets without the establishment of a specific loss reserve is not warranted.
Assets which do not currently expose the insured institution to sufficient risk
to warrant classification in one of the aforementioned categories but possess
weaknesses are required to be designated "Special Mention."

                                       11
<PAGE>

         When an insured institution classifies one or more assets, or portions
thereof, as Substandard or Doubtful, it is required to establish an allowance
for loan losses in an amount deemed prudent by management. Allowance for loan
losses represent loss allowances which have been established to recognize the
inherent risk associated with lending activities, but which, unlike specific
allowances, have not been allocated to particular problem assets. When an
insured institution classifies one or more assets, or proportions thereof, as
"Loss," it is required either to establish a specific allowance for loan losses
equal to 100% of the amount of the asset so classified or to charge off such
amount.

         A savings institution's determination as to the classification of its
assets and the amount of its allowance for loan losses is subject to review by
the OTS, which can order the establishment of additional allowances. The OTS, in
conjunction with the other federal banking agencies, has adopted an interagency
policy statement on allowance for loan losses. The policy statement provides
guidance for financial institutions on both the responsibilities of management
for the assessment and establishment of adequate allowances and guidance for
banking agency examiners to use in determining the adequacy of valuation
guidelines. Generally, the policy statement recommends that institutions have
effective systems and controls to identify, monitor and address asset quality
problems; that management has analyzed all significant factors that affect the
collectibility of the portfolio in a reasonable manner; and that management has
established acceptable allowance evaluation processes that meet the objectives
set forth in the policy statement.

         While the Association believes that it has established an adequate
allowance for loan losses, there can be no assurance that regulators, in
reviewing the Association's loan portfolio as part of a future regulatory
examination, will not request the Association to materially increase its
allowance for loan losses, thereby negatively affecting the Association's
financial condition and earnings at that time. Although management believes that
adequate allowance for loan losses have been established, actual losses are
dependent upon future events and, as such, further additions to the level of
specific or allowance for loan losses may become necessary.

         The Association's management reviews and classifies the Association's
assets quarterly and reports the results to the Association's Board of Directors
on a quarterly basis. The Association classifies assets in accordance with the
management guidelines described above. The Association had $1,670,150 of assets
classified as "Substandard" at September 30, 2006. The classified assets include
three loans totaling $666,350 and a foreclosed commercial tract amounting to
$1,003,800.

The foreclosed commercial property consists 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.

                                       12
<PAGE>

         The Association also had one loan amounting to $578,750 classified as
"Special Mention". The loans classified "Substandard" at September 30, 2006 were
comprised of two residential property loans totaling $209,000 and one commercial
property loan totaling $457,350, which consists of two mini-storage facilities
and an office building on 3.6 acres in Wendell, N.C. The loan classified as
"Special Mention" consists of a 43 acre horse facility. At this time, the
Company believes that the fair market value of all these properties is higher
than the outstanding loan balances and no loss on the ultimate disposition of
any of these loans is expected. All of the loans classified as "Substandard"
have been placed on non-accrual status.

         Allowance for Loan Losses. The allowance for loan losses is established
through a provision for loan losses based on management's evaluation of the
risks inherent in the Association's loan portfolio and the general economy. The
allowance for loan losses is maintained at an amount management considers
adequate to cover loan losses which are deemed probable and estimable. The
allowance is based upon a number of factors, including asset classifications,
economic trends, industry experience and trends, geographic and lending
concentrations, estimated collateral values, management's assessment of the
credit risk inherent in the portfolio, historical loan loss experience, and the
Association's underwriting policies.

         At September 30, 2006, the Association's allowance for loan losses was
$1,042,500, or 1.34% of total loans, as compared to $850,000 or 1.14% of total
loans at September 30, 2005. The Association had non-performing loans of
$666,350 and $770,850 at September 30, 2006 and September 30, 2005,
respectively. The Association provided $192,500 in additional loan loss
provisions during 2006. During the current year, the Association did not charge
off any loans. The Association provided $119,600 in additional loan loss
provisions during 2005 and did not charge off any loans during that period. This
evaluation is inherently subjective as it requires estimates that are
susceptible to significant revisions as more information becomes available.
Various regulatory agencies, as an integral part of their examination process,
periodically review the Association's allowance for loan losses. These agencies
may require the Association to establish additional valuation allowances, based
on their judgments of the information available at the time of the examination.

         Real Estate Owned. Property acquired by the Association as a result of
foreclosure on a mortgage loan is classified as real estate owned ("REO") and is
initially recorded at the fair value of the property at the date of acquisition,
establishing a new cost basis with any resulting write-down charged to the
allowance for loan losses. Thereafter, an allowance for losses on real estate
owned is established if the cost of a property exceeds its current fair value
less estimated sales costs. The Association obtains an appraisal on a real
estate owned property as soon as practicable after it takes possession of the
real property. The Association will generally reassess the value of real estate
owned at least quarterly thereafter.

         During 2006, the Association did not report any gains or losses from
the sale of REO and incurred $170,500 in foreclosure related expenses from
holding foreclosed properties. During 2005, the Association did not report any
gains or losses from the sale of foreclosed property but incurred $91,650 in
foreclosure related expenses and losses on the sale of REO. The policy for loans
secured by real estate, which comprise the bulk of the Association's portfolio,
is to establish loss reserves in accordance with the Association's asset
classification process, based on GAAP. At September 30, 2006, the Association
had one piece of REO totaling $1,003,800 on a convenience store and adjacent
tract of land as described above.


                                       13
<PAGE>

         The following table sets forth activity in the Association's allowance
for loan losses and the allowance for losses on real estate owned at or for the
periods indicated.

<TABLE>
<CAPTION>
                                                                      For the Year Ended September 30,
                                                                     ---------------------------------
                                                                          2006              2005
                                                                     --------------     --------------
<S>                                                                     <C>              <C>
ALLOWANCE FOR LOAN LOSSES:                                                 (Dollars in Thousands)
     Balance at beginning of year                                       $     850              $730
     Provision for loan losses                                                192               120
     Charge-offs                                                             --                 --
     Recoveries                                                              --                 --
                                                                        ---------              ----
     Balance at end of year                                             $   1,042              $850
                                                                        =========              ====
     Ratio of net charge-offs to average loans outstanding                   0.00%             0.00%
                                                                        =========              ====
     Accruing loans past due 90 days or more                            $    --                $--
                                                                        =========              ====

ALLOWANCE FOR LOSSES ON REAL ESTATE OWNED:
     Balance at beginning of year                                       $    --                $--
     Provision for loan losses                                               --                 --
     Charge-offs                                                             --                 --
     Recoveries                                                              --                 --
                                                                        ---------              ----
     Balance at end of year                                             $    --                $--
                                                                        =========              ====
</TABLE>

           The following table sets forth the Association's allowance for loan
losses allocated by loan category and the percent of loans in each category to
total loans at the dates indicated.

<TABLE>
<CAPTION>
                                                        2006                                         2005
                                      -------------------------------------------    --------------------------------------------
                                                                     Percent of                                     Percent of
                                                    Percent of        Loans in                     Percent of        Loans in
                                                     Allowance          Each                       Allowance           Each
                                       Allowance     to Total       Category to       Allowance     to Total       Category to
                                        Amount       Allowance      Total Loans        Amount      Allowance       Total Loans
                                      ------------ --------------   -------------    -----------  -------------    -------------
                                                                        (Dollars in Thousands)
<S>                                    <C>                 <C>             <C>       <C>                 <C>              <C>
Mortgage loans:
    One-to-four family residential     $      150          14.40 %         31.09     $      140          16.47 %          33.22 %
    Multi-family residential                    7           0.67            0.55              5           0.59             0.93
    Commercial real estate                    155          14.88           16.00            125          14.71            18.29
    Land                                      155          14.88           18.80            120          14.12            15.49
    Residential construction                  550          52.78           30.33            450          52.94            28.61
    Equity line mortgages                      25           2.40            3.00             10           1.18             3.34
                                      ------------ --------------   -------------    -----------  -------------    -------------
Total mortgage loans                        1,042         100.00           99.77            850         100.00            99.88
Savings account loans                           -              -            0.23              -              -             0.12
                                      ------------ --------------   -------------    -----------  -------------    -------------
Total allowance for loan losses        $    1,042         100.00 %        100.00 %   $      850         100.00 %         100.00 %
                                      ============ ==============   =============    ===========  =============    =============
</TABLE>


INVESTMENT ACTIVITIES

         The Association's investment policy permits it to invest in U.S.
government obligations, certain securities of various government-sponsored
agencies, certificates of deposit of insured banks and savings institutions,
federal funds, and overnight deposits at the Federal Home Loan Bank of Atlanta.
At September 30, 2006, the Association held FHLMC stock with an amortized cost
of $8,000 and a current market value of $540,850 and Federal Home Loan Bank
stock with a cost and market value of $197,600. At September 30, 2006, the
Association held $23.8 million in investments, including short-term interest
earning deposits.

                                       14
<PAGE>

         The following table sets forth activity in the Association's
investments portfolio for the periods indicated:

<TABLE>
<CAPTION>
                                                             For the Year Ended
                                                               September 30
                                                    -------------------------------------
                                                         2006                   2005
                                                    --------------        ---------------
                                                                (In Thousands)
<S>                                                  <C>                   <C>
Amortized cost at beginning of period                $      21,821         $        5,467
Purchases/(Maturities or Sales), net                         1,452                 16,354
Premium and discount amortization, net                           -                      -
                                                     --------------        ---------------
Amortized cost at end of period                             23,273                 21,821
Net unrealized gain (1)                                        533                    452
                                                     --------------        ---------------
Total securities, net                                $      23,806         $       22,273
                                                     ==============        ===============
</TABLE>


(1) The net unrealized gain at September 30, 2006 and 2005 relates to available
for sale securities in accordance with Statement of Financial Accounting
Standards ("SFAS") No. 115. The net unrealized gain is presented in order to
reconcile the "Amortized Cost" of the Association's securities portfolio to the
"Carrying Cost," as reflected in the Statements of Financial Condition.

         Amortized cost and fair value of the Association's investments at the
dates indicated are as follows:

<TABLE>
<CAPTION>
                                                                       At September 30,
                                          ------------------------------------------------------------------------------
                                                            2006                                    2005
                                          --------------------------------------  --------------------------------------
                                              Amortized                               Amortized
                                                Cost             Fair Value             Cost             Fair Value
                                          ------------------  ------------------  ------------------  ------------------
<S>                                          <C>                  <C>                 <C>                <C>
Held to maturity:                                                         (In Thousands)
     Other debt securities                   $            -       $           -       $           -      $            -
                                             ---------------      --------------      --------------     ---------------
       Total held to maturity                             -                   -                   -                   -
                                             ---------------      --------------      --------------     ---------------
Available-for-Sale:
     Debt securities                                      -                   -                   -                   -
     Equity securities (1)                                8                 541                   8                 460
                                             ---------------      --------------      --------------     ---------------
       Total available-for-sale                           8                 541                   8                 460
                                             ---------------      --------------      --------------     ---------------
Short-term certificates of deposit                      990                 990                 990                 990
FHLB Overnight deposits                              22,077              22,077              20,641              20,641
                                             ---------------      --------------      --------------     ---------------
Federal Home Loan Bank Stock                            198                 198                 182                 182
                                             ---------------      --------------      --------------     ---------------
       Total investments, net (2)             $      23,273       $      23,806       $      21,821      $       22,273
                                             ===============      ==============      ==============     ===============
</TABLE>

(1)      Equity securities consist of FHLMC common stock.

(2)      The difference between "Amortized Cost" and "Fair Value" represents net
         unrealized gains at September 30, 2006 and 2005 on available for sale
         securities in accordance with SFAS No. 115.

Sources of Funds

         General. Deposits, loan and security repayments and prepayments and
cash flows generated from operations are the primary sources of the
Association's funds for use in lending and for other general purposes.

         Deposits. The Association offers a variety of deposit accounts with a
range of interest rates and terms. The Association's deposits consist of regular
(passbook) savings accounts, NOW accounts, checking accounts, money market
deposit accounts, IRAs and certificates of deposit. Certificates of deposit are
offered with maturities of up to 60 months. At September 30, 2006, the
Association's core deposits (which the Association considers to consist of NOW
accounts, money market deposit accounts and regular savings accounts)
constituted 34.50% of total deposits. The flow of deposits is influenced
significantly by general economic conditions, changes in money market rates,
prevailing interest rates and competition. The Association's deposits are
obtained predominantly from the areas located near its office location. The
Association relies primarily on customer service and long-standing relationships
with customers to attract and retain these deposits. However, market interest
rates and rates offered by competing financial institutions significantly affect
the Association's ability to attract and retain deposits. The Association does
not use brokers to obtain deposits.

                                       15
<PAGE>

         The following table presents the deposit activity of the Association
for the periods indicated.

<TABLE>
<CAPTION>
                                                           For the Year Ended September 30,
                                                      --------------------------------------------
                                                            2006                       2005
                                                      -----------------           ----------------
                                                                     (In Thousands)
<S>                                                   <C>                         <C>
Total deposits at beginning of period                 $         80,905            $        69,891
Net (decrease) before interest credited                            704                      9,256
Interest credited                                                2,369                      1,758
                                                      -----------------           ----------------
Total deposits at end of period                       $         83,978            $        80,905
                                                      =================           ================
</TABLE>

At September 30, 2006, the Association had $24.3 million in jumbo certificate of
deposits (accounts in amounts over $100,000) maturing as follows:

<TABLE>
<CAPTION>
                                                                                     Weighted
                                                           Amount                  Average Rate
                                                      -----------------           ----------------
Maturity Period:                                                   (Dollars in Thousands)
<S>                                                   <C>                                    <C>
      Within three months                             $          2,017                       3.91 %
      After three but within six months                          5,289                       4.53
      After six but within twelve months                         8,768                       4.78
      After twelve months                                        8,226                       4.64
                                                      -----------------
         Total                                        $         24,300                       4.61 %
                                                      =================
</TABLE>


         The distribution of the Association's deposits and the related weighted
average interest rates are as follows:

<TABLE>
<CAPTION>
                                                                   At September 30,
                               -------------------------------------------------------------------------------------
                                                2006                                       2005
                               --------------------------------------     ------------------------------------------
                                              Percent      Weighted                       Percent        Weighted
                                             of Total      Average                        of Total       Average
                                 Amount      Deposits        Rate           Amount        Deposits         Rate
                               -----------  ------------  -----------     ------------  -------------  -------------
                                                             (Dollars in Thousands)
<S>                            <C>                <C>          <C>        <C>                  <C>            <C>
Passbook accounts              $    2,703         3.22%        2.00%      $     3,096          3.83%          1.25%
MMDA accounts                      22,290        26.54%        4.38%           19,636         24.27%          2.96%
NOW accounts                        2,229         2.65%        1.80%            2,449          3.03%          0.25%
Noninterest-bearing accounts        1,753         2.09%        0.00%            2,070          2.56%          0.00%
Certificate accounts               55,003        65.50%        4.38%           53,654         66.32%          3.70%
                               -----------  ------------                  ------------  -------------
     Totals                    $   83,978       100.00%        4.14%      $    80,905        100.00%          3.22%
                               ===========  ============                  ============  =============
</TABLE>



                                       16
<PAGE>

<TABLE>
<CAPTION>
                                                  September 30,
                                   -----------------------------------------
        Maturity Period                   2006                  2005
--------------------------------   -----------------------------------------
                                               Dollars in Thousands
<S>                                <C>                   <C>
             2006                  $                 -   $           26,911
             2007                               35,263               13,595
             2008                                9,275                3,303
             2009                                2,089                1,968
             2010                                7,602                7,877
             2011                                  774                    -
                                   --------------------  -------------------
                                   $            55,003   $           53,654
                                   ====================  ===================
</TABLE>


         Borrowings. The Association historically has not used borrowings as a
source of funds. However, the Association may obtain advances from the Federal
Home Loan Bank as an alternative to retail deposit funds and may do so in the
future as part of its operating strategy. These advances would be collateralized
primarily by certain of the Association's mortgage loans and secondarily by the
Association's investment in capital stock of the Federal Home Loan Bank. See
"Regulation--Federal Banking Regulation--Federal Home Loan Bank System." Such
advances may be made pursuant to several different credit programs, each of
which has its own interest rate and range of maturities. The maximum amount that
the Federal Home Loan Bank will advance to member institutions, including the
Association, fluctuates from time to time in accordance with the policies of the
OTS and the Federal Home Loan Bank. At September 30, 2006, neither the Company
nor the Association had any borrowings outstanding.

PERSONNEL

         As of September 30, 2006, the Company had no employees who were
compensated through the Company.

         As of September 30, 2006, the Association had 11 employees, nine of
which were full-time employees. In the last three years, the Association has
experienced a low turnover rate among its employees and, as of September 30,
2006, ten of the eleven employees had been with the Association for more than 5
years and 6 had been with the Association more than 10 years. The employees are
not represented by a collective bargaining unit and the Association considers
its relationship with its employees to be good. See Part III, Item 10 "Executive
Compensation" for a description of certain compensation and benefit programs
offered to the Association's employees.

REGULATION

GENERAL

         The Company and the MHC are regulated as savings and loan holding
companies by the OTS. The Association, as a federal stock savings bank, is
subject to regulation, examination and supervision by the OTS and the FDIC. The
Association must file reports with the OTS concerning its activities and
financial condition. The Company and the MHC are also required to file reports
with, and otherwise comply with the rules and regulations of the OTS. The
Company is also required to file reports with, and otherwise comply with, the
rules and regulations of the SEC under the federal securities laws.

         Any change in such laws and regulations, whether by the OTS, the FDIC,
or through legislation, could have a material adverse impact on the Company and
the Association and their operations and stockholders.


                                       17
<PAGE>

FEDERAL BANKING REGULATION

         Activity Powers. The Association derives its lending and investment
powers from the Home Owners' Loan Act, as amended (the "HOLA"), and the
regulations of the OTS. Under these laws and regulations, the Association may
invest in mortgage loans secured by residential and commercial real estate;
commercial and consumer loans; certain types of debt securities; and certain
other assets. The Association may also establish service corporations that may
engage in activities not otherwise permissible for the Association, including
certain real estate equity investments and securities and insurance brokerage.
The Association's authority to invest in certain types of loans or other
investments is limited by federal law and regulation.

         Loans-to-One-Borrower Limitations. The Association is generally subject
to the same limits on loans to one borrower as a national bank. With specified
exceptions, the Association's total loans or extensions of credit to a single
borrower cannot exceed 15% of the Association's unimpaired capital and surplus.
The Association may lend additional amounts up to 10% of its unimpaired capital
and surplus, if the loans or extensions of credit are fully-secured by
readily-marketable collateral. The Association currently complies with
applicable loans-to-one-borrower limitations.

         QTL Test. Under federal law, the Association must comply with the
qualified thrift lender, or "QTL" test. Under the QTL test, the Association is
required to maintain at least 65% of its "portfolio assets" in certain
"qualified thrift investments" in at least nine months of the most recent
12-month period. "Portfolio assets" means, in general, the Association's total
assets less the sum of:

         o     liquid assets up to 20% of total assets;

         o     goodwill and other intangible assets; and

         o     office property.

         The Association may also satisfy the QTL test by qualifying as a
"domestic building and loan association" as defined in the Internal Revenue Code
of 1986. The Association met the QTL test at September 30, 2006, and in each of
the prior 12 months, and therefore is a "qualified thrift lender." For purposes
of calculating compliance with the QTL test, we use the cost basis of our
investment in our Freddie Mac common stock, rather than the current market value
of the stock.

         If the Association fails the QTL test and is unable to correct that
failure for a period of time, it must either operate under certain restrictions
on its activities or convert to a bank charter.

         Capital Requirements. OTS regulations require the Association to meet
three minimum capital standards:

         (1)   a tangible capital ratio requirement of 1.5% of tangible capital
               to adjusted total assets;

         (2)   a leverage ratio requirement of 3% of core capital to such
               adjusted total assets, if a savings association has been assigned
               the highest composite rating of 1 under the Uniform Financial
               Institutions Ratings System or 4% or more if the savings
               association has not been assigned the highest composite rating;
               and

         (3)   a risk-based capital ratio requirement of 8% of core and
               supplementary capital to total risk-weighted assets; provided
               that the amount of supplementary capital used to satisfy this
               requirement may not exceed 100% of core capital.

         In determining compliance with the risk-based capital requirement, the
Association must compute its risk-weighted assets by multiplying its assets and
certain off-balance sheet items by risk-weights, which range from 0% for cash
and obligations issued by the United States Government or its agencies to 100%
for consumer and commercial loans, as assigned by the OTS capital regulation
based on the risks that the OTS believes are inherent in the type of asset.


                                       18
<PAGE>

         Tangible capital is defined, generally, as common stockholders' equity
(including retained earnings), certain non-cumulative perpetual preferred stock
and related earnings, non-withdrawable accounts and pledged deposits that
qualify as core capital and minority interests in equity accounts of fully
consolidated subsidiaries, and certain investments in and loans to
non-includable subsidiaries engaged in activities not permissible for a national
bank. Core capital is defined similarly to tangible capital, but core capital
also includes certain qualifying supervisory goodwill and certain purchased
credit card relationships. Supplementary capital includes cumulative and other
perpetual preferred stock mandatory convertible subordinated debt, mandatorily
redeemable preferred stock, perpetual subordinated debt, income certificates,
net worth certificates, mutual capital certificates, non-withdrawable accounts
and pledged deposits included in core capital and allowance for loan and ease
losses, as defined. In addition, up to 45% of unrealized gains on
available-for-sale equity securities with a readily determinable fair value may
be included in tier 2 capital. The allowance for loan and lease losses, as
defined, is includable in tier 2 capital to a maximum of 1.25% of risk-weighted
assets, and the amount of supplementary capital that may be included as total
capital cannot exceed the amount of core capital.

         At September 30, 2006, the Association met each of its capital
requirements.

         Community Reinvestment Act. Under the Community Reinvestment Act
("CRA"), as implemented by OTS regulations, the Association has a continuing and
affirmative obligation to help meet the credit needs of its entire community,
including low and moderate income neighborhoods. The CRA does not establish
specific lending requirements or programs for the Association nor does it limit
its discretion to develop the types of products and services that it believes
are best suited to its particular community, consistent with the CRA. The CRA
requires the OTS, in connection with its examination of the Association, to
assess the Company's record of meeting the credit needs of its community and to
take the record into account in its evaluation of certain applications by the
Association. The CRA also requires all institutions to make public disclosure of
their CRA ratings. The Association received a "Satisfactory" CRA rating in its
most recent examination.

         CRA regulations rate an institution based on its actual performance in
meeting community needs. In particular, the system focuses on three tests:

         o     a lending test, to evaluate the institution's record of making
               loans in its assessment areas;

         o     an investment test, to evaluate the institution's record of
               investing in community development projects, affordable housing,
               and programs benefiting low or moderate income individuals and
               businesses in its assessment area or a broader area that includes
               its assessment areas; and

         o     a service test, to evaluate the institution's delivery of
               services through its retail banking channels and the extent and
               innovativeness of its community development service.

         Transactions with Affiliates. The Association's authority to engage in
transactions with its "affiliates" is limited by the OTS regulations and by
Sections 23A and 23B of the Federal Reserve Act (the "FRA"). In general, these
transactions must be on terms which are as favorable to the Association as
comparable transactions with non-affiliates. In addition, certain types of these
transactions are restricted to an aggregate percentage of the Association's
capital. Collateral in specified amounts must usually be provided by affiliates
in order to receive loans from the Association. In addition, the OTS regulations
prohibit a savings association from lending to any of its affiliates that is
engaged in activities that are not permissible for bank holding companies and
from purchasing the securities of any affiliate, other than a subsidiary.

         The Federal Reserve Board's ("FRB's") Regulation W as made applicable
to federal savings banks by the OTS regulations.

         Loans to Insiders. The Association's authority to extend credit to its
directors, executive officers and principal shareholders, as well as to entities
controlled by such persons, is currently governed by the requirements of
Sections 22(g) and 22(h) of the FRA and Regulation O of the FRB. Among other
things, these provisions require that extensions of credit to insiders (a) be
made on terms that are substantially the same as, and follow credit underwriting
procedures that are not less stringent than, those prevailing for comparable
transactions with unaffiliated persons and that do not involve more than the
normal risk of repayment or present other unfavorable features, and (b) not
exceed certain limitations on the amount of credit extended to such persons,
individually and in the aggregate, which limits are based, in part, on the
amount of the Association's capital. In addition, extensions of credit in excess
of certain limits must be approved by the Association's Board of Directors.

                                       19
<PAGE>

         Section 402 of the Sarbanes-Oxley Act of 2002, or Sarbanes-Oxley,
prohibits the extension of personal loans to directors and executive officers of
issuers (as defined in Sarbanes-Oxley). The prohibition, however, does not apply
to mortgages advanced by an insured depository institution, such as the
Association that are subject to the insider lending restrictions of Section
22(h) of the FRA.

         Enforcement. The OTS has primary enforcement responsibility over
federal savings associations, including the Association. This enforcement
authority includes, among other things, the ability to assess civil money
penalties, to issue cease and desist orders and to remove directors and
officers. In general, these enforcement actions may be initiated in response to
violations of laws and regulations and to unsafe or unsound practices.

         Standards for Safety and Soundness. As required by federal law, the OTS
has adopted a set of guidelines prescribing safety and soundness standards.
These guidelines establish general standards relating to internal controls,
information systems, internal audit systems, loan documentation, credit
underwriting, interest rate risk exposure, asset growth, asset quality, earnings
standards, and compensation, fees and benefits. In general, the guidelines
require appropriate systems and practices to identify and manage the risks and
exposures specified in the guidelines.

         In addition, the OTS adopted regulations that authorize, but do not
require, the OTS to order an institution that has been given notice that it is
not satisfying these safety and soundness standards to submit a compliance plan.
If, after being notified, an institution fails to submit an acceptable plan or
fails in any material respect to implement an accepted plan, the OTS must issue
an order directing action to correct the deficiency, may issue an order
directing corrective actions and may issue an order directing other actions of
the types to which an undercapitalized association is subject under the "prompt
corrective action" provisions of federal law. If an institution fails to comply
with such an order, the OTS may seek to enforce such order in judicial
proceedings and to impose civil money penalties.

         Limitation on Capital Distributions. The OTS imposes various
restrictions or requirements on the Association's ability to make capital
distributions, including cash dividends. A savings institution that is the
subsidiary of a savings and loan holding company must file a notice with the OTS
at least 30 days before making a capital distribution. The Association must file
an application for prior approval if the total amount of its capital
distributions, including the proposed distribution, for the applicable calendar
year would exceed an amount equal to the Association's net income for that year
plus the Association's retained net income for the previous two years.

         The   OTS may disapprove of a notice or application if:

         o     the Association would be undercapitalized following the
               distribution;

         o     the proposed capital distribution raises safety and soundness
               concerns; or

         o     the capital distribution would violate a prohibition contained in
               any statute, regulation or agreement.

         Liquidity. The Association is required to maintain a sufficient amount
of liquid assets to ensure its safe and sound operation.


                                       20
<PAGE>

         Prompt Corrective Action Regulations. Under the OTS prompt corrective
action regulations, the OTS is required to take certain, and is authorized to
take other, supervisory actions against undercapitalized savings associations.
For this purpose, a savings association would be placed in one of the following
four categories based on the association's capital:

         o     well-capitalized;

         o     adequately capitalized;

         o     undercapitalized; or

         o     critically undercapitalized.

         At September 30, 2006, the Association met the criteria for being
considered "well-capitalized."

         When appropriate, the OTS can require corrective action by a savings
association holding company under the "prompt corrective action" provisions of
federal law.

         Insurance of Deposit Accounts. The FDIC merged the Bank Insurance Fun
and the Savings Association Insurance Fund (the "SAIF") to form the Deposit
Insurance Fund (the "DIF") on March 31, 2006. The Association is a member of the
DIF and pays its deposit insurance assessments to the DIF.

         Effective January 1, 2007, the FDIC established a risk-based assessment
system for determining the deposit insurance assessments to be paid by insured
depository institutions. Under the assessment system, the FDIC assigns an
institution to one of four risk categories, with the first category having two
sub-categories, based on the institutions most recent supervisory and capital
evaluations, designed to measure risk. Assessment rates currently range from
0.005% of deposits for an institution in the highest sub-category of the highest
category to 0.43% of deposits for an institution in the lowest category. The
FDIC is authorized to raise the assessment rates as necessary to maintain the
required reserve ratio of 1.25%. The FDIC allows the use of credits for
assessments previously. We believe that we have credit that will offset the
assessment for calendar 2007 and possibly 2008.

         In addition, all FDIC insured institutions are required to pay
assessments to the FDIC at an annual rate of approximately 0.0124% of insured
deposits to fund interest payments on bonds issued by the Financing Corporation,
an agency of the federal government established to recapitalize the predecessor
to the SAIF. These assessments will continue until the Financing Corporation
bonds mature in 2017 through 2019.

         Federal Home Loan Bank System. The Association is a member of the
Federal Home Loan Bank (the "FHLB") of Atlanta, which is one of the regional
FHLBs making up the FHLB System. Each member of the FHLB of Atlanta must
maintain a minimum investment in FHLB of Atlanta stock in an amount equal to the
sum of (i) approximately 0.25% of the member's total assets, up to a maximum of
$25 million, (ii) 4.5% of the member's outstanding advances, (iii) 4.5% of the
outstanding assets purchased from the member and held by the FHLB under master
commitments, and (iv) 8.0% of any Affordable Multi-Family Participation Program
loans purchased from the member. Any advances from a FHLB must be secured by
specified types of collateral, and all long-term advances may be obtained only
for the purpose of providing funds for residential housing finance.

         FHLBs are required to provide funds for the resolution of insolvent
thrifts and to contribute funds for affordable housing programs. These
requirements could reduce the amount of earnings that the FHLBs can pay as
dividends to their members and also could result in the FHLBs imposing a higher
rate of interest on advances to their members. If dividends were reduced or
interest on future FHLB advances were increased, the Association's net interest
income would be adversely affected.

                                       21
<PAGE>

         Federal Reserve System. Under regulations of the FRB, the Association
is required to maintain noninterest-earning reserves against its transaction
accounts. FRB regulations generally require that reserves of 3% must be
maintained against aggregate transaction accounts of over $8.5 million and up to
$45.8 million, subject to adjustment by FRB in excess of $42.1 million. The
first $8.5 million of otherwise reservable balances, subject to adjustments by
FRB, are exempted from the reserve requirements. The Association is in
compliance with these requirements. Because required reserves must be maintained
in the form of either vault cash, a noninterest-bearing account at a Federal
Reserve bank or a pass-through account as defined by FRB, the effect of this
reserve requirement is to reduce the Association's interest-earning assets, to
the extent the requirement exceeds vault cash.

         For aggregate transaction accounts over $45.8 million, an initial
reserve of $1,119,000 is required plus 10% of that portion of the aggregate
transaction accounts over $45.8 million.

         Prohibitions Against Tying Arrangements. Federal savings banks are
subject to the prohibitions of 12 U.S.C. ss. 1972 on certain tying arrangements.
A depository institution is prohibited, subject to some exceptions, from
extending credit to or offering any other service, or fixing or varying the
consideration for such extension of credit or service, on the condition that the
customer obtain some additional service from the institution or its affiliates
or not obtain services of a competitor of the institution.

         USA Patriot Act. The Association is subject to the Bank Secrecy Act, as
amended by the USA PATRIOT Act which gives the federal government powers to
address money laundering and terrorist threats through enhanced domestic
security measures, expanded surveillance powers, and increased information
sharing and broadened anti-money laundering requirements. Title III of the USA
PATRIOT Act takes measures intended to encourage information sharing among
financial institutions, bank regulatory agencies and law enforcement bodies.
Further, certain provisions of Title III impose affirmative obligations on a
broad range of financial institutions, including banks, thrifts, brokers,
dealers, credit unions, money transfer agents and parties registered under the
Commodity Exchange Act.

         Among other requirements, the USA PATRIOT Act imposes the following
         obligations on financial institutions:

         o     All financial institutions must establish risk-based anti-money
               laundering programs that include, at minimum: (i) internal
               policies, procedures, and controls, (ii) specific designation of
               an anti-money laundering compliance officer, (iii) ongoing
               employee training programs, and (iv) an independent audit
               function to test the anti-money laundering program.

         o     Any financial institutions must implement a written customer
               identification program appropriate for issuer, location and type
               of business.

         o     Financial institutions that establish, maintain, administer, or
               manage private banking accounts or correspondent accounts in the
               United States for non-United States persons or their
               representatives (including foreign individuals visiting the
               United States) must establish appropriate, specific, and, where
               necessary, enhanced due diligence policies, procedures, and
               controls designed to detect and report money laundering.

         o     Financial institutions are prohibited from establishing,
               maintaining, administering or managing correspondent accounts for
               foreign shell banks (foreign banks that do not have a physical
               presence in any country), and are subject to certain
               recordkeeping obligations with respect to correspondent accounts
               of foreign banks.

         Bank regulators are directed to consider a holding company's
effectiveness in combating money laundering when ruling on BHCA and Bank Merger
Act applications.


                                       22
<PAGE>

HOLDING COMPANY REGULATION

         The Company and the MHC are savings and loan holding companies
regulated by the OTS. As such, the Company and the MHC are registered with and
are subject to OTS examination and supervision, as well as certain reporting
requirements. In addition, the OTS has enforcement authority over the Company
and the MHC and any of their non-savings institution subsidiaries. Among other
things, this authority permits the OTS to restrict or prohibit activities that
are determined to be a serious risk to the financial safety, soundness or
stability of a subsidiary savings institution. Unlike bank holding companies,
federal savings and loan holding companies are not subject to any regulatory
capital requirements or to supervision by the Federal Reserve System.

         Restrictions Applicable to the Company. Because the Company was
organized after May 4, 1999, under the Gramm-Leach-Bliley Act (the "GLB Act"),
it is prohibited from engaging in non-financial activities. The Company's
activities are generally restricted to:

         o     furnishing or performing management services for a savings
               institution subsidiary of such holding company;

         o     conducting an insurance agency or escrow business;

         o     holding, managing, or liquidating assets owned or acquired from a
               savings institution subsidiary of such company;

         o     holding or managing properties used or occupied by a savings
               institution subsidiary of such company;

         o     acting as trustee under a deed of trust;

         o     any other activity (a) that the FRB, by regulation, has
               determined to be permissible for bank holding companies under
               Section 4(c) of the Bank Holding Company Act of 1956 ("BHCA"),
               unless the Director of the OTS, by regulation, prohibits or
               limits any such activity for savings and loan holding companies,
               or (b) in which multiple savings and loan holding companies were
               authorized by regulation to directly engage on March 5, 1987;

         o     purchasing, holding, or disposing of stock acquired in connection
               with a qualified stock issuance if the purchase of such stock by
               such holding company is approved by the Director of the OTS; and

         o     any activity permissible for financial holding companies under
               section 4(k) of the BHCA.

         Permissible activities which are deemed to be financial in nature or
incidental thereto under section 4(k) of the BHCA include:

         o     lending, exchanging, transferring, investing for others or
               safeguarding money or securities;

         o     insurance activities or providing and issuing annuities, and
               acting as principal, agent or broker;

         o     financial, investment or economic advisory services;

         o     issuing or selling instruments representing interests in pools of
               assets that a bank is permitted to hold directly;

         o     underwriting, dealing in, or making a market in securities;

         o     activities previously determined by the FRB to be closely related
               to banking;

         o     activities that bank holding companies are permitted to engage in
               outside of the U.S.;

                                       23
<PAGE>

         o     merchant banking activities; and

         o     portfolio investments made by an insurance company.

         In addition, the Company cannot be acquired or acquire a company unless
the acquirer or target (as the case may be) is engaged solely in financial
activities.

         Restrictions Applicable to Activities of Mutual Holding Companies.
Under federal law, a mutual holding company, such as the MHC, may engage only in
the following activities:

         o     investing in the stock of a savings institution;

         o     acquiring a mutual association through the merger of such
               association into a savings institution subsidiary of such holding
               company or an interim savings institution subsidiary of such
               holding company;

         o     merging with or acquiring another holding company, one of whose
               subsidiaries is a savings institution;

         o     investing in a corporation the capital stock of which is
               available for purchase by a savings institution under federal law
               or under the law of any state where the subsidiary savings
               institution or association is located; and

         o     the permissible activities described above for non-grandfathered
               savings and loan holding companies.

         If a mutual holding company acquires or merges with another holding
company, the holding company acquired or the holding company resulting from such
merger or acquisition may only invest in assets and engage in activities listed
above, and it has a period of two years to cease any non conforming activities
and divest any non-conforming investments.

         Restrictions Applicable to All Savings and Loan Holding Companies.
Federal law prohibits a savings and loan holding company, including the Company
and the MHC, directly or indirectly, from acquiring:

         o     control as defined under HOLA of another savings institution (or
               a holding company parent) without prior OTS approval;

         o     through merger, consolidation, or purchase of assets, another
               savings institution or a holding company thereof, or acquiring
               all or substantially all of the assets of such institution (or a
               holding company) without prior OTS approval; or

         o     control of any depository institution not insured by the FDIC
               (except through a merger with and into the holding company's
               savings institution subsidiary that is approved by the OTS).

         A savings and loan holding company may not acquire as a separate
subsidiary an insured institution that has a principal office outside of the
state where the principal office of its subsidiary institution is located,
except:

         o     in the case of certain emergency acquisitions approved by the
               FDIC;

         o     if such holding company controls a savings institution subsidiary
               that operated a home or branch office in such additional state as
               of March 5, 1987; or

         o     if the laws of the state in which the savings institution to be
               acquired is located specifically authorize a savings institution
               chartered by that state to be acquired by a North Carolina
               savings institution.

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

                                       24
<PAGE>

         The Sarbanes-Oxley Act. The Company is subject to the Sarbanes-Oxley
Act of 2002 ("SOX") which implements a broad range of corporate governance and
accounting measures for public companies designed to promote honesty and
transparency in corporate America and better protect investors from corporate
wrongdoing. As previously noted, Section 402 of the SOX prohibits the extension
of personal loans to directors and officers or issuers (as defined in SOX). The
prohibition, however, does not apply to mortgages advanced by an insured
depository institution, which is subject to the insider lending restrictions in
Section 22(h) of the FRA. The Sarbanes-Oxley Act's principal legislation and the
derivative legislation and rule making promulgated by the SEC includes:

         o     the creation of an independent accounting oversight board;

         o     auditor independence provisions which restrict non-audit services
               that accountants may provide to their audit clients;

         o     additional corporate governance and responsibility measures,
               including the requirement that the chief executive officer and
               chief financial officer certify financial statements;

         o     the forfeiture of bonuses or other incentive-based compensation
               and profits from the sale of an issuer's securities by directors
               and senior officers in the twelve month period following initial
               publication of any financial statements that later require
               restatement;

         o     an increase the oversight of, and enhancement of certain
               requirements relating to audit committees of public companies and
               how they interact with the company's independent auditors.

         o     requirement that audit committee members must be independent and
               are absolutely barred from accepting consulting, advisory or
               other compensatory fees from the issuer;

         o     requirement that companies disclose whether at least one member
               of the committee is a "financial expert" (as such term will be
               defined by the Securities and Exchange Commission) and if not,
               why not;

         o     expanded disclosure requirements for corporate insiders,
               including accelerated reporting of stock transactions by insiders
               and a prohibition on insider trading during pension blackout
               periods;

         o     a prohibition on personal loans to directors and officers, except
               certain loans made by insured financial institutions;

         o     disclosure of a code of ethics and filing a Form 8-K for a change
               or waiver of such code;

         o     mandatory disclosure by analysts of potential conflicts of
               interest; and

         o     a range of enhanced penalties for fraud and other violations.

         Although we anticipate that we will incur additional expense in
complying with the provisions of the Sarbanes-Oxley Act and the resulting
regulations, management does not expect that such compliance will have a
material impact on our results of operations or financial condition.


                                       25
<PAGE>

FEDERAL AND STATE TAXATION

FEDERAL TAXATION

         General. The following discussion of tax matters is intended only as a
summary and does not purport to be a comprehensive description of the tax rules
applicable to the Company, the Association or the MHC. The Association was last
audited for its taxable year ended September 30, 1993.

         For federal income tax purposes, the Company and the Association report
their income using a taxable year ending September 30 and the accrual method of
accounting. The Company, the Association and the MHC file separate income tax
returns and each reports its income on the same basis as the Association now
reports its income. Because the MHC owns less than 80% of the outstanding common
stock of the Company, the MHC and the Company are not permitted to file such
returns on a consolidated basis. The Company and the Association may file their
returns on a consolidated basis, but have elected to file separately. The
Company and the Association have entered into a tax sharing agreement which
governs the apportionment of taxable income between the entities. The Company,
the MHC and the Association are subject to federal income taxation in the same
manner as other corporations with some exceptions, including particularly the
Association's tax reserve for bad debts discussed below.

         Bad Debt Reserves. The Association, as a "small bank" (one with assets
having an adjusted tax basis of $500 million or less) is permitted to maintain a
reserve for bad debts with respect to "qualifying loans," which, in general, are
loans secured by certain interests in real property, and to make, within
specified formula limits, annual additions to the reserve which are deductible
for purposes of computing the Association's taxable income. Pursuant to the
Small Business Job Protection Act of 1996, the Association recaptured (took into
income) over a multi-year period a portion of the balance of its bad debt
reserve as of September 30, 1988.

         Distributions. To the extent that the Association makes "non-dividend
distributions" to the Company, such distributions will be considered to have
been made from the Association's "base year reserve," i.e., its reserve as of
September 30, 1988, and then from the Association's supplemental reserve for
losses on loans, to the extent thereof, and an amount based on the amount
distributed (but not in excess of the amount of such reserves) will be included
in the Association's income. Non-dividend distributions include distributions in
excess of the Association's current and accumulated earnings and profits, as
calculated for federal income tax purposes, distributions in redemption of
stock, and distributions in partial or complete liquidation. Dividends paid out
of the Association's current or accumulated earnings and profits will not be so
included in the Association's income.

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

         Corporate Alternative Minimum Tax. The Code imposes an alternative
minimum tax ("AMT") on alternative minimum taxable income ("AMTI") at a rate of
20%. Only 90% of AMTI can be offset by net operating loss carryovers of which
the Association currently has none. AMTI is adjusted by determining the tax
treatment of certain items in a manner that negates the deferral of income
resulting from the regular tax treatment of those items. Thus, the Association's
AMTI is increased by an amount equal to 75% of the amount by which the
Association's adjusted current earnings exceeds its AMTI (determined without
regard to this adjustment and prior to reduction for net operating losses). The
Association does not expect to be subject to the AMT.

         Although the corporate environmental tax of 0.12% of the excess of AMTI
(with certain modifications) over $2.0 million has expired, under current
Administration proposals, such tax will be retroactively reinstated for taxable
years beginning after December 31, 1997 and before January 2009.

         Dividends Received Deduction. As the owner of more than 20% of the
stock of the Company, the MHC may deduct from its income 80% of dividends
received from the Company. (A 70% dividends received deduction generally applies
with respect to dividends received by a corporation if such corporation owns
less than 20% of the stock of the corporation paying the dividend).

                                       26
<PAGE>

STATE TAXATION

         Under North Carolina law, the corporate income tax is 6.90% of federal
taxable income as computed under the Code, subject to certain prescribed
adjustments. An annual state franchise tax is imposed at a rate of .0015 applied
to the greatest of the institution's (i) capital stock, surplus and undivided
profits, (ii) investment in tangible property in North Carolina or (iii) 55% of
the appraised valuation of property in North Carolina.

ITEM 2. DESCRIPTION OF PROPERTY

         The Company conducts its business through its sole office, located in
Wake Forest, North Carolina. The Company owns the main office with net book
value for property and equipment of $401,800 as of September 30, 2006.
Management believes that the Company's current facilities are adequate to meet
the present and immediately foreseeable needs of the Company, the Association
and the MHC. However, the Company may consider opening a branch office in the
future. In the opinion of management, the Company's main office is adequately
covered by insurance.

<TABLE>
<CAPTION>
                                                                                             Net Book
                                                  Leased or              Date                Value at
                                                    Owned              Acquired         September 30, 2006
                                                    -----              --------         ------------------
                                                                                          (In Thousands)
<S>                                                <C>                   <C>                   <C>
             Main Office................           Owned                 1961                  $312
             302 S. Brooks Street
             Wake Forest, NC  27587
</TABLE>


ITEM 3. LEGAL PROCEEDINGS

         At September 30, 2006, there were no legal proceedings to which the
Company was a party or to which any of its property was subject, other than
routine litigation that is incidental to the business of the Company.

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

         None.

                                    PART II


ITEM 5.  MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

         Information relating to the market for Company's common equity and
related stockholder matters appears under "Common Stock Information" in the
Company's 2006 Annual Report to Stockholders, and is incorporated herein by
reference.

         Information relating to the payment of dividends by the Company appears
under "Common Stock Information" in the Company's 2006 Annual Report to
Stockholders, and is incorporated herein by reference. A dividend declared by
the Board of Directors of the Company is considered a capital distribution from
the Company to the stockholders, including the MHC, its mutual holding company.
Under the requirements of the OTS, there are certain restrictions on the ability
of the Company to pay a capital distribution. See Part 1, Item 1--"Description
of Business--Regulation--Limitation on Capital Distributions."

         The Association's dividend payout ratios were 21.31% and 23.67% and the
average equity to average asset ratios were 17.75% and 17.60% for years ended
September 30, 2006 and 2005, respectively. For all of 2006 and 2005, the MHC
elected to forego the receipt of its dividends from the Company.

                                       27
<PAGE>

         The following table sets forth the aggregate information of our equity
compensation plans in effect as of September 30, 2006.

<TABLE>
<CAPTION>
                                     Number of securites
                                      to be issued upon              Weighted-average            Number of securities
                                         exercise of                exercise price of           remaining available for
                                    outstanding options,           outstanding options,          future issuance under
Plan Category                        warrants and rights           warrants and rights         equity compensation plans
                                 ----------------------------   ---------------------------  ------------------------------

<S>                                                    <C>                    <C>                            <C>
Equity compensation
  plans approved by
  security holders                                     6,814                  $ 12.75                        14,030

Equity compensation
  plans not approved by
  security holders                                         -                        -                             -
                                 ----------------------------   ---------------------------  ------------------------------

     Total                                              6,814                 $ 12.75                    (1) 14,030
                                 ============================   ===========================  ==============================
</TABLE>

         (1)   Reflects 13,500 shares reserved for future grant under the
               Company's Option Plan. This also reflects 530 shares reserved for
               future awards under the Company's Recognition and Retention Plan
               which are held by the RRP Trust.

ITEM 6.  MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION

         The information required for this item is incorporated herein by
reference to the information under the caption "Management's Discussion and
Analysis" in our 2006 Annual Report to Stockholders.

ITEM 7.  FINANCIAL STATEMENTS

         The following financial statements are incorporated by reference to the
indicated pages of our 2006 Annual Report to Stockholders.

<TABLE>
<CAPTION>
                                                                                              Page(s) in
                                                                                             Annual Report
                                                                                             -------------
<S>                                                                                                <C>
  o      Report of Independent Registered Public Accounting Firm................................      16
  o      Consolidated Statements of Financial Condition,
                  September 30, 2006 and 2005...................................................      17
  o      Consolidated Statements of Income, Years Ended
                  September 30, 2006 and 2005...................................................      18
  o      Consolidated Statements of Stockholders' Equity,
                  Years Ended September 30, 2006 and 2005.......................................   19-20
  o      Consolidated Statements of Cash Flows,
                  Years Ended September 30, 2006 and 2005.......................................   21-22
  o      Notes to Consolidated Financial Statements.............................................   23-35
</TABLE>


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

         None.

                                       28
<PAGE>

ITEM 8A. CONTROLS AND PROCEDURES

         Management, including the Company's President and Chief Executive
Officer and Principal Executive and Financial Officer, has evaluated the
effectiveness of the Company's disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered
by this report. Based upon that evaluation, the Company's President and Chief
Executive Officer and Principal Executive and Financial Officer concluded that
the disclosure controls and procedures were effective to ensure that information
required to be disclosed in the reports the Company files and submits under the
Exchange Act is (i) recorded, processed, summarized and reported as and when
required and (ii) accumulated and communicated to the Company's management,
including the Company's Principal Executive and Financial Officer, as
appropriate to allow timely decisions regarding required disclosure.

         There have been no changes in the Company's internal control over
financial reporting identified in connection with the evaluation that occurred
during the Company's last fiscal quarter that has materially affected, or that
is reasonably likely to materially affect, the Company's internal control over
financial reporting.

ITEM 8B. OTHER INFORMATION

           None.

                                    PART III

ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS, CONTROL PERSONS AND
        CORPORATE GOVERNANCE; COMPLIANCE WITH SECTION 16(A) OF THE ACT

         The information relating to directors and executive officers of the
Company is incorporated herein by reference to the information in the Company's
2007 Proxy Statement under the headings: "Election of Directors"; "Committees of
the Board-Audit Committee", "Section 16(a) Beneficial Ownership and Reporting
Compliance" and "Code of Ethics".

ITEM 10. EXECUTIVE COMPENSATION

         The information relating to executive compensation is incorporated
herein by reference to the information in the Company's 2007 Proxy Statement
under the headings: "Executive Compensation"; "Stock Options"; "Employment
Agreements"; "Directors' Compensation"; and "Benefits".

ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
         AND RELATED STOCKHOLDER MATTERS

         The information relating to security ownership of certain beneficial
owners and management is incorporated herein by reference to the information in
the Company's 2007 Proxy Statement under the heading "Security Ownership of
Certain Beneficial Owners and Management".

ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR
         INDEPENDENCE

         The information relating to certain relationships and related
transactions is incorporated herein by reference to the information in the
Company's 2007 Proxy Statement under the headings "Transactions with Certain
Related Persons".

ITEM 13. EXHIBITS

                  2.1      Plan of Reorganization (Incorporated by reference to
                           Exhibit 2.1 of the Company's Registration Statement
                           on Form 8-A, filed with the SEC on May 7, 1999).

                                       29
<PAGE>

                  3.1      Federal Stock Charter of the Company (Incorporated by
                           reference to Exhibit 3.1 of the Company's
                           Registration Statement on Form 8-A filed with the SEC
                           on May 7, 1999).

                  3.2      Bylaws of the Company (Incorporated by reference to
                           Exhibit 3.2 of the Company's Registration Statement
                           on Form 8-A filed with the SEC on May 7, 1999 ).

                  4.3      Common Stock Certificate of the Company (Incorporated
                           by reference to Exhibit 4.3 of the Company's
                           Registration Statement on Form 8-A filed with the SEC
                           on May 7, 1999).

                  10.2     Employment Agreement with Robert C. White, President
                           and Chief Executive Officer, December 26, 2002
                           (Incorporated by reference to Exhibit 10.2 of the
                           Company's Form 10-KSB for the fiscal year ended
                           September 30, 2002, filed with the SEC on December
                           26, 2002).

                  10.3     Employment Agreement with Billy B. Faulkner, Vice
                           President (Incorporated by reference to Exhibit 10.3
                           of the Company's Form 10-KSB for the fiscal year
                           ended September 30, 2002, filed with the SEC on
                           December 26, 2002).

                  10.4(a)  Employee Stock Ownership Plan of Wake Forest Federal
                           Savings & Loan Association (Incorporated by reference
                           to Exhibit 10.4 of the Company's Form 10-KSB for the
                           fiscal year ended September 30, 1999 filed with the
                           SEC on December 28, 1999).

                  10.4(b)  Amendment No. 1 to the Employee Stock Ownership Plan
                           of Wake Forest Federal Savings & Loan Association
                           (Incorporated by reference to Exhibit 10.4(b) of the
                           Company's Form 10-KSB for the fiscal year ended
                           September 30, 2003 filed with the SEC on December 29,
                           2003).

                  10.4(c)  Amendments No. 2 to the Employee Stock Ownership Plan
                           of Wake Forest Federal Savings & Loan Association
                           (Incorporated by reference to Exhibit 10.4(c) of the
                           Company's Form 10-KSB for the fiscal year ended
                           September 30, 2003 filed with the SEC on December 29,
                           2003).

                  10.4(d)  Amendment No. 3 to the Employee Stock Ownership Plan
                           of Wake Forest Federal Savings & Loan Association
                           (Incorporated by reference to Exhibit 10.4(d) of the
                           Company's Form 10-KSB for the fiscal year ended
                           September 30, 2003 filed with the SEC on December 29,
                           2003).

                  10.4(e)  Amendment No.4 to the Employee Stock Ownership Plan
                           of Wake Forest Federal Savings & Loan Association
                           (Incorporated by reference to Exhibit 10.4(e) of the
                           Company's Form
                           8-K filed with the SEC on August 19, 2005.)

                  10.5     Wake Forest Federal Savings & Loan Association 1997
                           Recognition and Retention Plan (Incorporated by
                           reference to the Company's Form S-8 filed with the
                           SEC on July 27, 1999).

                  10.6     Wake Forest Federal Savings & Loan Association 1997
                           Stock Option Plan (Incorporated by reference to the
                           Company's Form S-8 filed with SEC on July 27, 1999).

                  10.7     Amended and Restated Retirement Plan for Board
                           Members of Wake Forest Federal Savings & Loan
                           Association (incorporated by reference to the
                           Company's Form 8-K filed with the SEC on December 22,
                           2005).

                  13.1     2006 Annual Report to Stockholders.

                  14.1     Code of Ethics.

                  21.1     Subsidiaries of the Registrant (Incorporated by
                           reference to Part 1 - "General" and
                           "Reorganization").

                  23.1     Independent Auditor's Consent.

                                       30
<PAGE>

                  31.1     Rule 13a-14(a) / 15d-14(a) Certifications.

                  32.1     Section 1350 Certifications.



ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

                  The information relating to the Company's principal accountant
                  fees and services is incorporated by references to the
                  information in the Company's 2007 Proxy Statement under the
                  heading "Principal Accountant Fees and Services".




                                       31
<PAGE>

                                   SIGNATURES

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

                                         WAKE FOREST BANCSHARES, INC.
                                         (Registrant)



 Date: December 21, 2006                 By:      /s/ Robert C. White
       --------------------------                 --------------------------
                                         Robert C. White
                                         President and Chief Executive Officer



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


<TABLE>
<S>                                                                             <C>
 /s/ Robert C. White                                                            December 21, 2006
 -----------------------------------------------------                          -----------------------------------
 Robert C. White                                                                Date
 President , Chief Executive Officer and Director
 (Principal Executive and Financial Officer)


 /s/ Howard L. Brown                                                            December  21,  2006
 -----------------------------------------------------                          ----------------------------------
 Howard L. Brown -Chairman of the Board                                         Date
 and Director


 /s/  John D. Lyon                                                              December 21, 2006
 --------------------------------------------                                   -----------------------------------
 John D. Lyon - Director                                                        Date


 /s/ Rodney M. Privette                                                         December 21, 2006
 -----------------------------------------------------                          ----------------------------------
 Rodney M. Privette - Director                                                  Date


 /s/ Anna O. Sumerlin                                                           December 21, 2006
 -----------------------------------------------------                          -----------------------------------
 Anna O. Sumerlin - Director                                                    Date
</TABLE>



<PAGE>




<TABLE>
<S>                                                                    <C>
 /s/ Harold R. Washington                                              December 21, 2006
 --------------------------------------------                          -----------------------------------
 Harold R. Washington - Director                                       Date


 /s/  R.W. Wilkinson, III                                              December  21, 2006
 -----------------------------------------------------                 ----------------------------------
 R.W. Wilkinson, III - Vice-Chairman and Director                      Date


 /s/ Leelan A. Woodlief                                                December 21, 2006
 -----------------------------------------------------                 ----------------------------------
 Leelan A. Woodlief - Director                                         Date


 /s/ William S. Wooten                                                 December 21, 2006
 -----------------------------------------------------                 -----------------------------------
 William S. Wooten - Director                                          Date
</TABLE>


<PAGE>


                                  EXHIBIT INDEX

<TABLE>
<C>                                                                                               <C>
2.1         Plan of Reorganization                                                                *

3.1         Federal Stock Charter of the Company                                                  *

3.2         Bylaws of the Company                                                                 *

4.3         Common Stock Certificate of the Company                                               *

10.2        Employment Agreement with Robert C. White, President and Chief Executive Officer      +

10.3        Employment Agreement with Billy B. Faulkner, Vice President                           +

10.4(a)     Employee Stock Ownership Plan of Wake Forest Federal Savings & Loan Association       **

10.4(b)     Amendment No. 1 to the Employee Stock Ownership Plan of Wake Forest Federal           +++
            Savings & Loan Association

10.4(c)     Amendment No. 2 to the Employee Stock Ownership Plan of Wake Forest Federal           +++
            Savings & Loan Association

10.4(d)     Amendment No. 3 to the Employee Stock Ownership Plan of Wake Forest Federal           +++
            Savings & Loan Association

10.4(e)     Amendment No. 4 to the Employee Stock Ownership Plan of Wake Forest Federal           ++++
            Savings & Loan Association

10.5        Wake Forest Federal Savings & Loan Association 1997 Recognition and Retention Plan    ***

10.6        Wake Forest Federal Savings & Loan Association 1997 Stock Option Plan                 ***

10.7        Amended and restated Retirement Plan for Board Members of Wake Forest Federal
            Savings & Loan Association                                                            +++++

13.1        2006 Annual Report to Stockholders                                                    Filed herewith

14.1        Code of Ethics

21.1        Subsidiaries of the Registrant                                                        ++

23.1        Independent Auditor's Consent                                                         Filed herewith

31.1        Rule 13a-14(a) / 15d-14(a) Certifications                                             Filed herewith

32.1        Section 1350 Certifications                                                           Filed herewith
</TABLE>




<PAGE>



      *        Incorporated by reference to the Company's Registration Statement
               on Form 8-A, filed with the SEC on May 7, 1999.

      **       Incorporated by reference the Company's Form 10-KSB for the
               fiscal year ended September 30, 1999 filed with the SEC on
               December 28, 1999.

      ****     Incorporated by reference to the Company's Form S-8 filed with
               the SEC on July 27, 1999.

      +        Incorporated by reference to the Company's Form 10-KSB for the
               fiscal year ended September 30, 2002, filed with the SEC on
               December 26, 2002.

      ++       Incorporated by reference to Part 1 - "General" and
               "Reorganization".

      +++      Incorporated by reference to the Company's Form 10-KSB for the
               fiscal year ended September 30, 2003, filed with the SEC on
               December 29, 2003.

      ++++     Incorporated by reference to the Company's Form 8-K filed with
               the SEC on August 19, 2005.

      +++++    Incorporated by reference to the Company's Form 8-K filed the
               SEC on December 22, 2005.