NewSouth Bancorp, Inc.
and Subsidiary

Consolidated Financial Statements
Years ended September 30, 1998, 1997 and 1996

<PAGE>

                                TABLE OF CONTENTS


Letter to Stockholders                                                         1

Selected Consolidated Financial Information and Other Data                     2

Management's Discussion and Analysis of Financial Condition
     and Results of Operations                                                 3

Report of Independent Accountants                                             14

Consolidated Statements of Financial Condition                                15

Consolidated Statements of Operations                                         16

Consolidated Statements of Stockholders' Equity                               17

Consolidated Statements of Cash Flows                                         18

Notes to Consolidated Financial Statements                                    20

Board of Directors                                                            35

Executive Officers                                                            35

NewSouth Bank Office Locations                                                35

Stockholder Information                                                       36


                                MISSION STATEMENT

"Our mission is to become the premier  community bank in eastern North Carolina.
We will enhance  shareholder value by serving the personal and business needs of
our markets,  providing superior customer service,  investing in the communities
that we serve, and enriching the lives of our employees."

<PAGE>

                             LETTER TO STOCKHOLDERS

To Our Stockholders:

It is a pleasure to present the results of  operations  of NewSouth  Bancorp and
its  subsidiary,  NewSouth Bank, for the year ended September 30, 1998. The year
contained many  significant  events.  Record earnings were achieved,  the Bank's
loan portfolio increased to record levels, a 50% stock dividend was declared and
the cash dividend was increased. We are pleased with the results achieved during
1998 and are encouraged about the future of the Company.

The financial  results for our first full year were  gratifying.  Net income for
the year was $3.1 million or $0.80 per share,  representing  a 38% increase over
the $2.3 million earned in 1997. Due to our financial performance,  the Board of
Directors  declared a 50% stock dividend and increased the cash dividend rate by
5%. To enhance  shareholder value and earnings per share, we implemented a stock
repurchase program during 1998,  purchasing 218,202 shares as treasury stock. In
September 1998, the Company announced a second program to purchase an additional
5%, or 207,292  shares of its common stock.  We believe  these  purchases are an
effective means of enhancing shareholder value.

The  Bank  experienced  positive  growth  trends  in  both  loans  and  deposits
throughout  the year.  This  success  resulted in a 13% growth in assets to $281
million at year end 1998 from $249  million at year end 1997.  Net loans grew by
14% to $225 million at year end 1998 from $198 million at year end 1997.  At the
same  time,  deposits  grew by 17% to $205  million  at year end 1998  from $175
million at year end 1997. As we continue our commercial bank transition,  and to
support the growth and risk  associated  with the emphasis  placed on commercial
and consumer  lending,  our loan portfolio is supported by loan loss reserves of
$3.4 million, or 1.5% of total loans outstanding at year end.

We completed the  conversion to a new data  processing  system in 1998 that will
give us access to the very  best in  technology  and  enable us to  provide  our
customers  with a variety of new products and  services.  I want to thank all of
our  employees  who gave  unselfishly  of their  time  and  talents  to make the
transition to a new data center so  successful.  We are  extremely  fortunate to
have such a dedicated and professional staff that is committed to the success of
our Company.

We are pleased to announce that we will be opening our ninth full-service branch
office in  Chocowinity  by  mid-1999.  This  office  will  complement  our other
Beaufort  County  branches and will serve as an additional base of operation for
developing  customer  relationships and meeting the banking needs of our growing
market.  Continuing  our  commitment  to  provide  outstanding  service  to  our
customers,  we have  recently  installed new drive up ATM units in the Elizabeth
City,  New Bern and  Washington  markets.  Also,  the Bank has put in place  the
NewSouth Bank  AccessLine,  providing  customers access to their current account
information 24 hours a day, seven days a week.

Each member of your Board of Directors  along with our  officers  and  employees
join me in  thanking  you for your  continued  support of NewSouth  Bancorp.  As
always,  your comments or  suggestions  are welcomed and we look forward to your
continued support.

                                   Sincerely,

                                   /s/ Tom Vann

                                   Tom Vann
                                   President

                                        1

<PAGE>

           SELECTED CONSOLIDATED FINANCIAL INFORMATION AND OTHER DATA

<TABLE>
<CAPTION>
                                                                    September 30,
                                            ------------------------------------------------------------
                                              1998         1997         1996         1995         1994   
                                            --------     --------     --------     --------     --------
                                                               (Dollars in thousands)
Selected Financial Condition Data
---------------------------------
<S>                                         <C>          <C>          <C>          <C>          <C>     
Total assets                                $281,479     $249,281     $194,139     $177,704     $165,996
Loans receivable, net                        224,999      197,785      155,681      144,541      135,679
Cash and investment securities                20,119       18,856       16,684        4,788        5,817
Mortgage-backed securities                    27,017       24,818       14,797       22,285       18,535
Deposits                                     204,635      175,116      171,213      153,457      131,592
Borrowings                                    11,933       12,621        1,040        4,000       16,500
Stockholders' equity                          56,714       57,856       18,347       17,688       15,620

Selected Operations Data
------------------------
Interest income                             $ 21,867     $ 18,515     $ 15,349     $ 14,385     $ 11,811
Interest expense                               9,240        8,346        8,105        7,344        5,204
                                            --------     --------     --------     --------     --------
Net interest income                           12,627       10,169        7,244        7,041        6,607
Provision for loan losses                        310          931          511           20          210
Noninterest income                             2,646        1,685        1,833        1,502        1,652
Noninterest expenses                           9,940        6,941        7,295        5,660        4,801
                                            --------     --------     --------     --------     --------
Income before income taxes                     5,023        3,982        1,271        2,863        3,248
Income taxes                                   1,900        1,719          451          998        1,011
                                            --------     --------     --------     --------     --------
Net income                                  $  3,123     $  2,263     $    820     $  1,865     $  2,237
                                            ========     ========     ========     ========     ========
Earnings per share (1)(2)                   $    .80     $    .35     $     --     $     --     $     --
                                            ========     ========     ========     ========     ========
Dividends per share (2)                     $    .27     $    .13     $     --     $     --     $     --
                                            ========     ========     ========     ========     ========

Selected Financial Ratios and Other Data
----------------------------------------

Performance Ratios:
Return on average assets                        1.19%        1.00%         .45%        1.07%        1.28%
Return on average equity                        5.40         6.57         4.45        11.17        13.38
Interest rate spread                            4.03         4.10         3.72         3.84         4.25
Net interest margin                             5.05         4.67         4.12         4.21         4.48
Average earning assets to average
  interest-bearing liabilities                127.57       115.00       108.52       108.40       106.58
Noninterest expense to average assets           3.80         3.06         3.97         3.26         3.08
Dividend payout ratio                          33.75        37.14           --           --           --

Quality Ratios:
Nonperforming assets to total assets             .43%         .65%         .62%         .42%         .31%
Nonperforming loans to total loans               .36          .64          .66          .47          .25
Loan loss reserves to total loans               1.50         1.64         1.51         1.30         1.46
Loan loss reserves to nonperforming
  loans                                       419.45       257.45       227.37       275.62       583.19
Provision for loan losses to total loans         .14          .47          .32          .01          .15

Capital Ratios:
Equity to total assets, end of period          19.95%       23.23%        9.45%        9.95%        9.41%
Average equity to average assets               22.14        15.17        10.05         9.61         9.54

Other Data:
Full service offices                               8            8            8            8            6
Loans serviced for others                   $250,202     $253,647     $253,682     $229,635     $205,141
</TABLE>

---------------
(1)  Applies to net income of $1,395,900  earned for the period April 8, 1997 to
     September 30, 1997.
(2)  Adjusted for three-for-two stock split on August 19, 1998.

                                        2
<PAGE>

                      MANAGEMENT'S DISCUSSION AND ANALYSIS
                OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

GENERAL

     Prior to April 7, 1997 NewSouth Bancorp, Inc. (the "Company") had no assets
or liabilities and engaged in no business activities. The Company was formed for
the  purpose of issuing  common  stock and owning  100% of the stock of NewSouth
Bank (the "Bank") and operating through the Bank a commercial  banking business.
Subsequent to the stock  conversion,  the Company has engaged in no  significant
activity other than holding the stock of the Bank,  therefore,  this  discussion
relates to the consolidated financial condition and results of operations of the
Company and the Bank.

     The business of the Bank consists  principally of attracting  deposits from
the general public and using them to originate secured and unsecured  commercial
and  consumer  loans,  permanent  mortgage  and  construction  loans  secured by
single-family  residences,  credit  cards and other loans.  The Bank's  earnings
depend  primarily on its net interest  income,  which is the difference  between
interest earned on interest-earning assets and interest paid on interest-bearing
liabilities.  The  Bank's  earnings  are  also  affected  by  the  level  of its
noninterest income and expenses.

     The operations of the Bank are affected by prevailing  economic  conditions
as well as policies of federal and state regulatory authorities. The Bank's cost
of funds is influenced by interest  rates paid on competing  investments,  rates
offered on deposits by other  financial  institutions  in the Bank's market area
and by general market  interest  rates.  Lending  activities are affected by the
demand for financing of real estate and various types of commercial and consumer
loans,  which are  influenced by interest  rates at which such  financing may be
offered.

     The  Bank's  business  emphasis  is  to  operate  as  a   well-capitalized,
profitable and independent community oriented financial institution dedicated to
providing  quality  customer  service  and meeting  the  financial  needs of the
communities  it serves.  Management  believes the Bank can be more  effective in
serving its customers  than many larger  competitors,  because of its ability to
quickly and  effectively  respond to customer  needs and  inquiries.  The Bank's
ability to provide  these  services is enhanced by the  stability  of the Bank's
senior management team.

LIQUIDITY AND CAPITAL RESOURCES

     As a state chartered  commercial bank, the Bank must meet certain liquidity
requirements  established by the North Carolina  Office of The  Commissioner  of
Banks (the "Commissioner").  Savings banks which convert to commercial banks are
required to maintain 15% liquidity pursuant to the conversion guidelines adopted
by the  Commissioner.  The Bank's  liquidity  ratio,  as  computed  under  these
guidelines, was 15.1% at September 30, 1998 and 15.9% at September 30, 1997.

     The Bank's  primary  sources of funds are deposits,  principal and interest
payments on loans,  proceeds  from loan sales and advances from the Federal Home
Loan Bank of Atlanta (the "FHLB").  While maturities and scheduled  amortization
of  loans  are  predictable  sources  of  funds,   deposit  flows  and  mortgage
prepayments are greatly  influenced by interest rates,  economic  conditions and
local competition.

     The  primary  investing   activity  of  the  Bank  is  the  origination  of
commercial,  consumer and mortgage  loans.  During the years ended September 30,
1998 and 1997,  the Bank had loan  originations  of $173.1  million  and  $143.7
million,  respectively.  The primary  financing  activities  of the Bank are the
attraction of checking,  certificate  and savings  deposits,  and obtaining FHLB
advances.

     The Bank's most liquid assets are cash and cash equivalents.  The levels of
these  assets are  dependent  on the Bank's  operating,  financing,  lending and
investing  activities  during any given period.  At September 30, 1998 and 1997,
cash and cash equivalents totaled $17.0 million and $15.8 million, respectively.
The Bank has other sources of liquidity if a need for  additional  funds arises.
During the years ended  September 30, 1998 and 1997, the Bank sold and exchanged
real estate loans  totaling $54.1 million and $31.7  million,  respectively.  At
September  30,  1998,  the Bank had $9.5 million of FHLB  advances,  compared to
$11.0 million at September  30, 1997.  At September 30, 1998,  the Bank had $1.9
million of retail repurchase  agreements,  compared to $1.6 million at September
30, 1997.  Other sources of liquidity  include  investment  and  mortgage-backed
securities designated as

                                        3
<PAGE>

available for sale,  which totaled $30.1 million at September 30, 1998 and $27.9
million at September 30, 1997.

     At September 30, 1998  stockholders'  equity was $56.7 million  compared to
$57.8  million  at  September  30,  1997.  On April 7, 1997 the  Company  issued
2,909,500  shares of common stock and  received  net proceeds of $42.5  million,
including $3.5 million in shares  purchased by the Employee Stock Ownership Plan
("ESOP"). On August 19, 1998 the Company had a three-for-two stock split paid in
the  form of a 50%  stock  dividend.  At  September  30,  1998 the  Company  had
4,145,842  shares of common stock  outstanding,  net of 218,202 treasury shares.
Net income for the year ended  September 30, 1998 was $3.1 million,  compared to
$2.3 million for the year ended September 30, 1997.

     As a  North  Carolina  chartered  commercial  bank  and a  Federal  Deposit
Insurance Corporation (the "FDIC") insured institution,  the Bank is required to
meet various capital standards by its state and federal regulatory agencies. The
Bank's stand-alone  equity was $42.0 million at September 30, 1998,  compared to
$39.9 million at September  30, 1997,  which is  substantially  in excess of all
such regulatory requirements. The Commissioner requires the Bank at all times to
maintain a capital  surplus of not less than 50% of common  capital  stock.  The
FDIC requires the Bank to meet a minimum leverage capital  requirement of Tier I
capital (consisting of retained earnings and common  stockholders'  equity, less
any  intangible  assets) to assets  ratio of at least 4% and a total  capital to
risk-weighted  assets  ratio  of 8%,  of  which 4% must be in the form of Tier I
capital.  The Bank was in compliance  with all capital  requirements of both the
Commissioner and the FDIC at September 30, 1998 and September 30, 1997.

ASSET/LIABILITY MANAGEMENT

     The Bank strives to achieve  consistent net interest  income and reduce its
exposure to adverse changes in interest rates by matching the terms to repricing
of its  interest-sensitive  assets and  liabilities.  Factors  beyond the Bank's
control, such as market interest rates and competition,  may also have an impact
on the Bank's interest income and interest expense.

     In the  absence  of any other  factors,  the  overall  yield on the  Bank's
earning assets  generally will increase from existing levels when interest rates
rise over an  extended  period of time,  and  conversely  interest  income  will
decrease  when  interest  rates  decrease.  In general,  interest  expense  will
increase  when  interest  rates  rise  over an  extended  period  of  time,  and
conversely   interest  expense  will  decrease  when  interest  rates  decrease.
Therefore, by controlling the increases and decreases in its interest income and
interest  expense which are caused by changes in market interest rates, the Bank
can significantly influence its net interest income.

     The  President  of the Bank  reports to the Board of Directors on a regular
basis on interest rate risk and trends,  as well as liquidity and capital ratios
and  requirements.  The Board of Directors  reviews the maturities of the Bank's
assets and  liabilities  and  establishes  policies and  strategies  designed to
regulate  the  Bank's  flow of funds and to  coordinate  the  sources,  uses and
pricing of such funds.  The first priority in structuring and pricing the Bank's
assets and  liabilities is to maintain an acceptable  interest rate spread while
reducing the net effects of changes in interest rates. The Bank's  management is
responsible for  administering  the policies and  determinations of the Board of
Directors with respect to the Bank's asset and liability goals and strategies.

     A principal  strategy in managing the Bank's interest rate risk has been to
increase  interest rate sensitive  assets such as commercial  business loans and
consumer  loans. At September 30, 1998, the Bank had $20.8 million of commercial
business  loans  and  $48.4  million  of  consumer  loans,  or 8.6%  and  20.0%,
respectively,  of the Bank's gross loan portfolio, compared to $16.4 million and
$49.9 million,  respectively,  at September 30, 1997. At September 30, 1998, the
Bank had $38.4  million of loans  held for sale,  compared  to $25.1  million at
September 30, 1997. Depending on conditions existing at a given time, as part of
its  interest  rate  risk  management  strategy,  the Bank  may sell  fixed-rate
residential mortgage loans in the secondary market.

     In managing its portfolio of investment securities, the Bank has emphasized
the purchase of  short-term  securities  to reduce it's exposure to increases in
interest  rates.  The Bank had $30.1 million of investment  and  mortgage-backed
securities  classified as available for sale at September 30, 1998,  compared to
$27.9 million at September 30, 1997. The Bank is holding these loans, investment
and mortgage-backed securities as available for sale so that they may be sold if
needed for liquidity or asset and liability management purposes.

                                        4
<PAGE>

MARKET RISK

     Market risk  reflects the risk of economic loss  resulting  from changes in
market  prices  and  interest  rates.  The  risk of  loss  can be  reflected  in
diminished current market values and/or reduced potential net interest income in
future periods.  The Bank's market risk arises primarily from interest rate risk
inherent  in its  lending  and  deposit  taking  activities.  The Bank  does not
maintain a trading account for any class of financial  instruments,  nor does it
engage in hedging  activities  or  purchase  high-risk  derivative  instruments.
Furthermore,  the Bank is not  subject  to  foreign  currency  exchange  risk or
commodity price risk.

     Management  measures the Bank's  interest rate risk by computing  estimated
changes in net interest  income and the net portfolio  value ("NPV") of its cash
flows from assets,  liabilities  and  off-balance  sheet items in the event of a
range of assumed  changes in market  interest  rates.  The  Bank's  exposure  to
interest  rates is reviewed on a quarterly  basis by senior  management  and the
Board of  Directors.  Exposure to interest rate risk is measured with the use of
interest rate  sensitivity  analysis to determine the change in NPV in the event
of hypothetical  changes in interest rates,  while interest rate sensitivity gap
analysis is used to determine the repricing characteristics of the Bank's assets
and  liabilities.  If estimated  changes to NPV and net interest  income are not
within the limits  established by the Board, the Board may direct  management to
adjust the Bank's asset and  liability  mix to bring  interest  rate risk within
Board approved limits.

     NPV  represents  the market value of  portfolio  equity and is equal to the
market value of assets minus the market value of liabilities,  with  adjustments
made for  off-balance  sheet items.  This analysis  assesses the risk of loss in
market risk  sensitive  instruments in the event of a sudden and sustained 1% to
4%  increases  and  decreases  in market  interest  rates.  The Bank's  Board of
Directors  has adopted an interest  rate risk policy which  establishes  maximum
increases in NPV of 17%,  36%, 56% and 83% and decreases in NPV of 15%, 36%, 61%
and 90% in the event of sudden and  sustained 1% to 4% increases or decreases in
market interest rates. Table 1 below presents the Bank's projected change in NPV
for the various rate shock levels at September 30, 1998.

TABLE 1 - PROJECTED CHANGE IN NPV AND NET INTEREST INCOME

                  Net Portfolio Value                  Net Interest Income
 Change      -----------------------------     ------------------------------
in Rates     $ Amount  $ Change   % Change     $ Amount   $ Change   % Change
--------     --------  --------   --------     --------   --------   --------

                                  (Dollars in thousands)

+ 400  bp    $50,867   $(14,939)   (22.7)%     $ 12,094   $   (19)     (.16)%
+ 300  bp     55,000    (10,806)   (16.4)        12,134        21       .17
+ 200  bp     59,133     (6,673)   (10.1)        12,174        61       .50
+ 100  bp     62,470     (3,336)    (5.1)        12,144        31       .25
Base          65,806         --       --         12,113        --        --
- 100  bp     67,289      1,483      2.2         11,998      (115)     (.95)
- 200  bp     68,772      2,966      4.5         11,883      (230)    (1.90)
- 300  bp     70,354      4,548      6.9         11,751      (362)    (2.99)
- 400  bp     71,935      6,129      9.3         11,619      (494)    (4.08)

     Table 1 indicates  that at September  30, 1998,  in the event of sudden and
sustained  increases in market interest rates, the Bank's estimated net interest
income would be expected to increase and NPV would be expected to decrease,  and
that in the event of sudden and sustained  decreases in market  interest  rates,
estimated  net  interest  income  would be expected to decrease and NPV would be
expected to increase. At September 30, 1998, the Bank's estimated changes in NPV
were within the targets established by the Board of Directors.

     Computations of prospective  effects of hypothetical  interest rate changes
are based on numerous assumptions,  including relative levels of market interest
rates,  loan  prepayments and deposit decay rates, and should not be relied upon
as indicative of actual results.  Further,  the  computations do not contemplate
any actions the Bank may undertake in response to changes in interest rates. The
NPV  calculation  is based on the net  present  value of  discounted  cash flows
utilizing market prepayment assumptions and market rates of interest provided by
surveys performed during each quarterly period, with adjustments made to reflect
the shift in the  Treasury  yield curve  between the survey date and the quarter
end date.

                                        5
<PAGE>

     Certain  shortcomings  are inherent in the method of analysis  presented in
Table 1. For example,  although  certain assets and liabilities may have similar
maturities  to  repricing,  they may react in  differing  degrees  to changes in
market  interest  rates.  The  interest  rates on  certain  types of assets  and
liabilities may fluctuate in advance of changes in market interest rates,  while
interest  rates on other types may lag behind  changes in market rates.  Certain
assets such as  adjustable-rate  loans have features which  restrict  changes in
interest  rates  on a  short-term  basis  and over  the  life of the  asset.  In
addition,  the proportion of adjustable-rate loans in the Bank's portfolio could
decrease in future periods if market  interest rates remain at or decrease below
current levels due to refinance  activity.  Further, in the event of a change in
interest rates, prepayment and early withdrawal levels would likely deviate from
those assumed in the table.  Also,  the ability of many borrowers to repay their
adjustable-rate debt may decrease in the event of an increase in interest rates.

     In  addition,  the Bank uses  interest  rate  sensitivity  gap  analysis to
monitor  the   relationship   between  the   maturity   and   repricing  of  its
interest-earning assets and interest-bearing  liabilities,  while maintaining an
acceptable interest rate spread. Interest rate sensitivity gap is defined as the
difference between the amount of  interest-earning  assets maturing or repricing
within a specific  time  period and the amount of  interest-bearing  liabilities
maturing or repricing within that time period. A gap is considered positive when
the   amount  of   interest-rate-sensitive   assets   exceeds   the   amount  of
interest-rate-sensitive  liabilities, and is considered negative when the amount
of     interest-rate-sensitive     liabilities    exceeds    the    amount    of
interest-rate-sensitive  assets.  Generally,  during a period of rising interest
rates,  a negative  gap would  adversely  affect net  interest  income,  while a
positive  gap would result in an increase in net  interest  income.  Conversely,
during a period of falling  interest  rates,  a negative  gap would result in an
increase in net interest income,  while a positive gap would  negatively  affect
net interest income. The Bank's goal is to maintain a reasonable balance between
exposure to interest rate fluctuations and earnings.

RATE/VOLUME ANALYSIS

     Net interest income can also be analyzed in terms of the impact of changing
interest rates on average  interest-earning assets and average  interest-bearing
liabilities and the changing  volume or amount of these assets and  liabilities.
Table 2 below  represents  the  extent to which  changes in  interest  rates and
changes  in  the  volume  of  average   interest-earning   assets  and   average
interest-bearing  liabilities  have  affected  the  Bank's  interest  income and
interest  expense  during the periods  indicated.  For each  category of average
interest-earning asset and average  interest-bearing  liability,  information is
provided on changes  attributable  to: (i) changes in volume  (changes in volume
multiplied by old rate);  (ii) changes in rate (change in rate multiplied by old
volume); (iii) changes in rate-volume (changes in rate multiplied by the changes
in volume); and (iv) net change (total of the previous columns).

TABLE 2 - RATE/VOLUME ANALYSIS

<TABLE>
<CAPTION>
                                                                       Year Ended September 30,
                                      -----------------------------------------------------------------------------------------
                                           1998          vs.          1997                  1997         vs.         1996     
                                      ------------------------------------------      -----------------------------------------
                                                   Increase (Decrease) Due to                  Increase (Decrease) Due to
                                      ------------------------------------------      -----------------------------------------
                                                               Rate/                                          Rate/
                                      Volume       Rate       Volume       Total      Volume      Rate       Volume       Total
                                      ------       ----       ------       -----      ------      ----       ------       -----
                                                                             (In thousands)
Interest income:
<S>                                   <C>         <C>         <C>         <C>         <C>        <C>         <C>         <C>    
  Loans receivable                    $ 2,670     $   104     $    17     $ 2,791     $ 2,509    $   133     $    24     $ 2,666
  Investment securities                   (54)         47          (8)        (15)          3         12          --          15
 Mortgage-backed securities               784         (10)         (5)        769         292        (15)         (3)        274
  Other interest-earning assets          (250)        101         (44)       (193)        668       (161)       (297)        210
                                      -------     -------     -------     -------     -------    -------     -------     -------
    Total interest-earning assets       3,150         242         (40)      3,352       3,472        (31)       (276)      3,165
                                      -------     -------     -------     -------     -------    -------     -------     -------

Interest expense:
  Deposits                                369         610          29       1,008       1,261       (958)       (154)        149
  FHLB advances                          (138)          1          (1)       (138)         74        (11)         (6)         57
  Other interest-bearing
    liabilities                            33          (6)         (3)         24          20          8           7          17
                                      -------     -------     -------     -------     -------    -------     -------     -------
     Total interest-bearing
       liabilities                        264         605          25         894       1,355       (961)       (153)        241
                                      -------     -------     -------     -------     -------    -------     -------     -------
Change in net interest income         $ 2,886     $  (363)    $   (65)    $ 2,458     $ 2,117    $   930     $  (123)    $ 2,924
                                      =======     =======     =======     =======     =======    =======     =======     =======
</TABLE>

                                        6
<PAGE>

TABLE 3 - YIELD/COST ANALYSIS

<TABLE>
<CAPTION>
                                                                             Year Ended September 30,
                                             ---------------------------------------------------------------------------------------
                                                        1998                           1997                           1996
                                             -------------------------      -------------------------      -------------------------
                                                               Average                        Average                        Average
                                             Average            Yield/      Average            Yield/      Average            Yield/
                                             Balance   Interest  Cost       Balance   Interest  Cost       Balance   Interest  Cost

Interest-earning assets:
<S>                                          <C>       <C>       <C>        <C>       <C>       <C>        <C>       <C>       <C>  
   Loans receivable (1)                      $205,587  $18,888   9.19%      $176,311  $16,097   9.13%      $148,538  $13,431   9.04%
   Investment securities                        4,410      311   7.05          5,287      326   6.17          5,236      311   5.94
   Mortgage-backed securities                  31,565    2,290   7.25         20,832    1,521   7.30         16,881    1,247   7.39
   Other Interest-earning assets                8,570      378   4.41         15,249      571   3.75          5,349      361   6.75
                                             --------  -------   ----        -------   ------   ----       --------  -------   ----

     Total interest-earning assets            250,132   21,867   8.74        217,679   18,515   8.51        176,004   15,350   8.72
                                                        ------   ----                  ------   ----                  ------   ----
Non-interest-earning assets                    11,278                          9,311                          7,579
                                             --------                       --------                       --------
     Total assets                            $261,410                       $226,990                       $183,583
                                             ========                       ========                       ========

Interest-bearing liabilities:
   Deposits                                  $193,061    9,096   4.71       $184,672    8,088   4.38       $159,304    7,939   4.98
   FHLB advances                                1,071       64   5.98          3,400      202   5.94          2,250      145   6.44
   Other interest-bearing liabilities           1,944       80   4.12          1,218       56   4.60            629       21   3.34
                                              -------   ------   ----       --------  -------   ----       --------   ------   ----
Total interest-bearing liabilities            196,076    9,240   4.71        189,290    8,346   4.41        162,183    8,105   5.00
                                                         -----   ----                 -------   ----                   -----   ----
Non-interest-bearing liabilities                7,445                          3,265                          2,958
                                              -------                        -------                       --------
   Total liabilities                          203,521                        192,555                        165,141
   Stockholders' equity                        57,889                         34,435                         18,442
                                              -------                        -------                        -------
     Total liabilities and retained income   $261,410                       $226,990                       $183,583
                                             ========                       ========                       ========
Net interest income                                    $12,627                        $10,169                         $7,245
                                                       =======                        =======                         ======
Interest rate spread (2)                                         4.03%                          4.10%                          3.72%
                                                                 ====                           ====                           ====
Net yield on interest-earning assets (3)                         5.05%                          4.67%                          4.12%
                                                                 ====                                                          ====
Ratio of average interest-earning assets
   to average interest bearing liabilities                     127.57%                        115.00%                        108.52%
                                                               ======                         ======                         ======
</TABLE>

---------------
(1)  Includes non-performing loans.
(2)  Represents  the  difference  between the average yield on  interest-earning
     assets and the average cost of interest bearing liabilities.
(3)  Represents  the net  interest  income  divided by average  interest-earning
     assets.

                                        7
<PAGE>

ANALYSIS OF NET INTEREST INCOME

     Net interest income  represents the difference  between income derived from
interest-earning   assets  and  the   interest   expense   on   interest-bearing
liabilities.  Net  interest  income is affected by both the  difference  between
rates  of  interest  earned  on  interest-earning   assets  and  rates  paid  on
interest-bearing liabilities ("interest rate spread") and the relative volume of
interest-earning assets and interest-bearing liabilities.

     Table 3  above  sets  forth  certain  information  relating  to the  Bank's
statements  of financial  condition and  statements of operations  for the three
years ended September 30, 1998, 1997, and 1996 and reflects the yield on average
interest-earning assets and the cost of average interest-bearing liabilities for
the periods indicated.  Average balances are derived from month end balances and
the Bank does not believe that the use of month end balances  instead of average
daily balances has caused any material difference in the information presented.

RESULTS OF OPERATIONS

Comparison of Financial Condition at September 30, 1998 and 1997

     Total assets  increased 12.9% to $281.5 million at September 30, 1998, from
$249.3 million at September 30, 1997. Loans receivable (net of loans-in-process,
deferred fees and loan loss  reserves)  increased by 13.8% to $225.0  million at
September  30,  1998,  from $197.8  million at September  30,  1997.  Investment
securities and mortgage-backed  securities increased by 8.0% to $30.1 million at
September 30, 1998, from $27.9 million at September 30, 1997.

     In order to take  advantage  of  generally  higher  loan  yields as well as
shorter  terms,  the Bank has increased its emphasis on the  origination of both
secured and unsecured  commercial and consumer loans.  Prior to 1994, a majority
of the loans originated by the Bank were mortgage loans secured by single-family
residences.  From time to time,  the Bank sells  selected  mortgage loans in the
secondary  market  in order to  reduce  interest  rate and  credit  risk,  while
retaining servicing to generate additional fee income.

     Commercial  real estate loans increased 12.0% to $51.5 million at September
30, 1998,  from $46.0 million at September 30, 1997.  Commercial  business loans
increased  26.8% to $20.8 million at September  30, 1998,  from $16.4 million at
September  30, 1997,  while  consumer  loans  declined  3.0% to $48.4 million at
September 30, 1998 from $49.9 million at September  30, 1997.  Residential  real
estate  mortgage loans  increased 17.6% to $120.2 million at September 30, 1998,
from  $102.2  million at  September  30,  1997.  During  fiscal  1998,  the Bank
originated $95.7 million of residential real estate mortgage loans,  compared to
$66.9 million during fiscal 1997.  The Bank sold and exchanged  $54.1 million of
real estate loans during fiscal 1998,  compared to $31.7  million  during fiscal
1997.  Loans  serviced  for others was $250.2  million at  September  30,  1998,
compared to $253.6  million at  September  30,  1997.  Commercial  real  estate,
commercial  business and consumer loan  originations  increased to $77.4 million
during fiscal 1998, from $76.8 million during fiscal 1997, as the Bank continues
to emphasize structuring itself as a commercial banking entity.

     Deposits  increased by 16.9% to $204.6 million at September 30, 1998,  from
$175.1 million at September 30, 1997. Certificates of deposit increased 18.4% to
$155.4 million at September 30, 1998, from $131.2 million at September 30, 1997,
and the Bank continued its efforts of attracting  lower cost core  deposits,  as
checking  accounts  increased 16.8% to $42.9 million at September 30, 1998, from
$37.5  million at September  30, 1997.  Total  borrowings  were $12.0 million at
September 30, 1998  compared to $12.6 million at September 30, 1997,  supporting
the growth in earning assets and banking operations during the period.

     Stockholders'  equity was $56.7 million at September 30, 1998,  compared to
$57.9  million at  September  30,  1997.  The ratio of equity to total assets at
September 30, 1998  decreased to 19.9% from 23.2% at September 30, 1997.  During
the year ended  September 30, 1998,  the Company  declared four  quarterly  cash
dividends  totaling $1.1 million,  reflecting a dividend  payout ratio of 33.8%.
Future quarterly  dividends will be determined at the discretion of the Board of
Directors  based upon  earnings,  the capital  and  financial  condition  of the
Company and general economic conditions.

                                        8
<PAGE>

     The  Company's  note  receivable  from the ESOP declined to $2.7 million at
September  30, 1998,  from $3.1 million at September  30, 1997,  reflecting  the
release  of  43,189  shares  to ESOP  participants.  The note is  reported  as a
reduction  of  stockholders'  equity and requires an annual  $349,000  principal
payment  plus  interest  at prime plus one  percent.  Although  the ESOP note is
secured  solely by shares of common  stock of the  Company,  the Bank expects to
make  discretionary  contributions  to the ESOP in amounts at least equal to the
required  principal  and  interest  payments.  At September  30,  1998,  268,709
unallocated shares remain in the ESOP.

     During the year ended  September 30, 1998, the  stockholders of the Company
approved the Management Recognition Plan ("MRP"), established for the benefit of
directors  and  officers  of the  Company  and the Bank.  During  the year ended
September  30,1998 the Company acquired 58,020  additional  shares of its common
stock  for the  MRP,  through  open  market  purchases  totaling  $1.2  million,
completing the purchase of 4% of its outstanding shares. In addition,  58,195 of
the shares awarded to MRP participants  were vested,  totaling $1.3 million.  At
September 30, 1998, 116,374 shares totaling $2.3 million are being held in trust
for MRP  participants  vesting and are reported as a reduction in  stockholders'
equity.

     Pursuant to a stock  repurchase  program  adopted by the Company during the
year ended September 30, 1998, the Company acquired 218,202 shares of its common
stock  through open market  purchases,  or 5%,  totaling  $4.9  million.  Shares
acquired under the repurchase program are being held as treasury stock, at cost.

Comparison of Operating Results for the Years Ended September 30, 1998 and 1997

     Net  Income.  Net income  increased  by 38.0% to $3.1  million for the year
ended  September  30, 1998,  from $2.3 million for the year ended  September 30,
1997.  The  increase in net income is  attributable  to a 28.8%  increase in net
interest income and other income,  offset in part by a 43.2% increase in general
and administrative expenses.

     Interest  Income.  Interest income  increased by 18.1% to $21.9 million for
fiscal 1998, from $18.5 million for fiscal 1997. The increase in interest income
on loans and  investments  during 1998 results  principally  from the  increased
volume of average  interest-earning assets. Interest on loans increased by 17.3%
to $18.9  million  in fiscal  1998,  from  $16.1  million  in fiscal  1997,  due
primarily to a $29.3 million increase in the average balance of loans receivable
between  fiscal 1998 and 1997,  and an increase in the average yield on loans to
9.19% for fiscal 1998 from 9.13% for fiscal  1997.  The  average  yield on total
average interest-earning assets was 8.7% for 1998 compared to an 8.5% for 1997.

     Interest  Expense.  Interest  expense for the year ended September 30, 1998
increased by 10.7% to $9.2  million,  from $8.3  million for fiscal  1997.  This
resulted   principally   from  an   increase   in  the  rates  paid  on  average
interest-bearing  liabilities.  Total  deposits  increased  by 16.9%  to  $204.6
million at September 30, 1998,  from $175.1  million at September 30, 1997.  The
average cost of interest-bearing  liabilities increased to 4.7% for fiscal 1998,
from 4.4% for 1997. Total average interest-bearing liabilities increased by 3.6%
to $196.1 million for fiscal 1998, from $189.3 million for fiscal 1997.

     Net  Interest  Income.  Net  interest  income  increased  by 24.2% to $12.6
million for the year ended  September 30, 1998,  from $10.2 million for the year
ended  September  30, 1997.  This increase is primarily due to increases in both
the volume  and net yield on average  interest-earning  assets,  resulting  from
investing  the net proceeds of the stock  conversion  into earning  assets for a
full year. Average  interest-earning assets increased by 14.9% to $250.1 million
during  fiscal  1998,   from  $217.7   million  for  1997.   The  net  yield  on
interest-earning assets (net interest income divided by average interest-earning
assets)  increased to 5.1% for the year ended  September  30, 1998,  compared to
4.7% for the year ended September 30, 1997.

     Provision  for Loan Losses.  The Bank  maintains an allowance for losses on
loans based upon  management's  evaluation of risks in the loan  portfolio,  the
Bank's  past loan loss  experience,  and current and  expected  future  economic
conditions.  The Bank provided  $310,000 and $931,000 for loan losses during the
years ended  September 30, 1998 and 1997,  respectively.  These  provisions were
necessary to support the growth and risks  associated  with the emphasis  placed
upon  commercial  and consumer  lending.  The allowance for loan losses was $3.4
million at September  30, 1998  compared to $3.2 million at September  30, 1997,
which the Bank  believes  is  adequate  to absorb  potential  losses in its loan
portfolio.  The ratio of the  allowance  for loan losses to total loans,  net of
loans in process and deferred loan fees, was 1.5% at September 30, 1998 compared
to 1.6% at September 30, 1997.

                                        9
<PAGE>

     The Bank uses a systematic approach in determining the adequacy of its loan
loss  allowance  and  the  necessary  provision  for  loan  losses,   through  a
classification  of  assets  program,  whereby  the loan  portfolio  is  reviewed
generally and delinquent  loans are analyzed  individually on a quarterly basis.
Consideration is given to the loan status,  payment  history,  ability to repay,
probability of repayment,  and  loan-to-value  percentages.  As a result of this
review and analysis,  loans are classified in appropriate  categories applicable
to their circumstances.  After reviewing current economic conditions, changes in
delinquency  status,  and actual  loan losses  incurred by the Bank,  management
establishes an  appropriate  reserve  percentage  applicable to each category of
assets,  and provision  for loan losses is recorded when  necessary to bring the
allowance to a level  consistent with this analysis.  The ratio of nonperforming
loans to total loans was 0.4% at September  30, 1998 and 0.6% at  September  30,
1997.

     Other  Income.  Other income  increased  57.0% to $2.7 million for the year
ended  September  30, 1998,  from $1.7 million for the year ended  September 30,
1997. Other income consists of fees and service charges earned on loans, service
charges on deposit accounts,  gains from sales of loans, and other miscellaneous
income. Loan fees and service charges increased to $985,000 for fiscal 1998 from
$752,000 for fiscal 1997,  reflecting  the growth in the loan  portfolio  during
1998.  Gains from sales of loans and  mortgage-backed  securities  increased  to
$796,000 for fiscal 1998 from  $124,000 for fiscal 1997,  as the volume of loans
and mortgage-backed  securities sold during 1998 increased to $45.1 million from
$19.8  million  for 1997.  Servicing  fee  income on loans  serviced  for others
increased to $637,000 for 1998 from $613,000 for 1997.

     General and Administrative  Expenses.  General and administrative  expenses
increased  43.2% to $9.9  million  for fiscal  1998 from $6.9  million in fiscal
1997.  The  Company's  efficiency  ratio  (noninterest  expenses  divided by net
interest income plus noninterest income) increased to 65.1% for fiscal 1998 from
58.6% for fiscal 1997.

     The largest single  component of these  expenses,  compensation  and fringe
benefits, increased to $7.2 million for fiscal 1998 from $4.6 million for fiscal
1997.  During fiscal 1998 the Bank recorded $1.9 million of benefits expense for
the MRP plan,  compared to no MRP expense in fiscal 1997. In addition,  the Bank
recorded  $826,000 in benefits expense for the ESOP in fiscal 1998,  compared to
$603,000  in  fiscal  1997.  This  increase  is also a result  of the  growth in
personnel  and  management  required to support the 45.0%  growth in assets from
September 30, 1996 to September 30, 1998. Other noninterest  expenses  including
deposit  insurance  premiums,  premises and  equipment,  advertising  and office
expenses remained relatively constant from period to period.

     Income Taxes.  The provision for income taxes increased to $1.9 million for
fiscal 1998 from $1.7  million for fiscal 1997.  The  increase in provision  for
income taxes is the result of the increased  pretax earnings of $5.0 million for
fiscal 1998 from $4.0 million for fiscal 1997 and the effective income tax rates
then in effect.

Comparison of Financial Condition at September 30, 1997 and 1996

     Total assets  increased  28.4% to $249.3 million at September 30, 1997 from
$194.1 million at September 30, 1996. Loans receivable (net of loans-in-process,
deferred fees and loan loss reserves)  increased by 27.0%,  to $197.8 million at
September  30,  1997 from  $155.7  million at  September  30,  1996.  Investment
securities and mortgage-backed  securities  increased by 21.8%, to $27.9 million
at September 30, 1997 from $22.9 million at September 30, 1996.  The increase in
assets was supported by the stock conversion net proceeds.  On April 7, 1997 the
Company  issued $42.5 million of common stock,  which  represents the actual net
offering proceeds, including $3.5 million in shares purchased by the ESOP.

     Commercial  real estate loans increased 47.4% to $46.0 million at September
30, 1997 from $31.2 million at September  30, 1996,  commercial  business  loans
increased  59.2% to $16.4  million at September  30, 1997 from $10.3  million at
September 30, 1996. Consumer loans increased 33.4% to $49.9 million at September
30, 1997 from $37.4  million at  September  30,  1996.  Residential  real estate
mortgage loans increased 7.8% to $102.2 million at September 30, 1997 from $94.8
Million at September 30, 1996.  During fiscal 1997,  the Bank  originated  $66.9
million of residential  real estate  mortgage  loans,  compared to $76.3 million
during  fiscal 1996.  The Bank sold and  exchanged  $31.7 million of real estate
loans during fiscal 1997,  compared to $53.0 million  during fiscal 1996.  Loans
serviced for others was $253.6 million at September 30, 1997, compared to $253.7
million at September 30, 1996.  Commercial real estate,  commercial business and
consumer loan  originations  increased 42.8% to $76.8 million during fiscal 1997
from $53.8 million during fiscal 1996.

                                       10
<PAGE>

     Deposits  increased by 2.3%,  to $175.1  million at September 30, 1997 from
$171.2 million at September 30, 1996.  During fiscal 1997,  approximately  $11.8
million of deposits  were  withdrawn  by  depositors  to purchase  shares of the
Company's  common  stock  subscribed  for in the stock  conversion.  While total
deposits  experienced a marginal  increase  during the year ended  September 30,
1997,  checking accounts increased by $10.2 million,  or 37.4%, to $37.5 million
at September 30, 1997 from $27.3 million at September 30, 1996,  reflecting  the
Bank's efforts to increase lower cost core checking  accounts.  Total borrowings
increased to $12.6  million at September 30, 1997 from $1.0 million at September
30, 1996, to support the growth in earning assets and banking  operations during
the period.

     Stockholders'  equity  increased  by $39.5  million,  or  215.8%,  to $57.8
million  at  September  30,  1997 from  $18.3  million at  September  30,  1996,
reflecting  the  infusion of the net  proceeds of the stock  conversion  and the
consolidated  earnings of the Company for the year ended  September 30, 1997. At
September 30, 1997, the ratio of equity to total assets  increased to 23.2% from
9.5% at  September  30, 1996.  During the year ended  September  30,  1997,  the
Company declared two quarterly cash dividends  totaling  $582,000,  reflecting a
dividend payout ratio of 37.1%.

     The Company's note  receivable  from the ESOP was $3.1 million at September
30, 1997 and reported as a reduction of stockholders's  equity.  During the year
ended September 30, 1997, the Company acquired 77,700 shares of its common stock
for the MRP through open market purchases,  totaling $2.1 million.  These shares
are being held in trust for future  awards and are  reported as a  reduction  in
stockholders'  equity.  Subsequent to September 30, 1997, the Company  completed
purchasing 4% of its outstanding common stock for the MRP.

Comparison of Operating Results for the Years Ended September 30, 1997 and 1996

     Net Income.  Net income  increased  by $1.4 million to $2.3 million for the
year ended  September  30, 1997 from  $820,000 for the year ended  September 30,
1996.  The  principal  reason for this  increase is the  investing  of the stock
conversion net proceeds into earning assets, as average  interest-earning assets
increased by 23.7% to $217.7  million for fiscal 1997,  from $176.0  million for
fiscal 1996.

     Interest  Income.  Interest income  increased by 20.9% to $18.5 million for
fiscal 1997, from $15.3 million for fiscal 1996. The increase in interest income
on loans and investments  during 1997 is a result of increased volume of average
interest-earning  assets.  Interest on loans increased by 20.1% to $16.1 million
in fiscal  1997,  from  $13.4  million in fiscal  1996.  This  increase  was due
primarily  to  a  $27.8  million  increase  in  the  average  balance  of  loans
outstanding  between  fiscal 1997 and 1996, and an increase in the average yield
on loans to 9.13% for fiscal 1997 from 9.04% for fiscal 1996.  The average yield
on total  average  interest-earning  assets of $217.7  million was 8.5% for 1997
compared  to  an  8.7%  average  yield  on  $176.0   million  of  total  average
interest-earning assets for 1996.

     Interest  Expense.  Interest  expense for fiscal 1997  increased by 3.0% to
$8.3 million,  from $8.1 million for fiscal 1996. This resulted principally from
an  increase  in the volume of  average  interest-bearing  liabilities.  Average
deposits  increased  by 15.9% to $184.7  million  for fiscal  1997,  from $159.3
million  for fiscal  1996.  The  average  cost of  interest-bearing  liabilities
decreased to 4.4% for 1997 from 5.0% for 1996.  Total  average  interest-bearing
liabilities  increased to $189.3 million for fiscal 1997 from $162.2 million for
fiscal 1996.

     Net  Interest  Income.  Net  interest  income  increased  by 41.7% to $10.2
million for the year ended  September  30, 1997,  from $7.2 million for the year
ended September 30, 1996.

     Provision  for Loan Losses.  The Bank  maintains an allowance for losses on
loans based upon an  evaluation of risks in the loan  portfolio,  past loan loss
experience,  and current  and  expected  future  economic  conditions.  The Bank
provided  $931,000 and $511,000 for loan losses during the years ended September
30, 1997 and 1996, respectively.  The allowance for loan losses was $3.2 million
at September 30, 1997 compared to $2.4 million at September 30, 1996,  which the
Bank believes was adequate to absorb potential losses in its loan portfolio. The
ratio of the allowance  for loan losses to total loans,  net of loans in process
and  deferred  loan fees,  was 1.6% at  September  30, 1997  compared to 1.5% at
September  30, 1996.  The  increased  provisions  were  necessary to support the
growth and risks  associated with the Bank's emphasis placed upon commercial and
consumer  lending.  The ratio of nonperforming  loans to total loans was 0.5% at
September 30, 1997 and 0.7% at September 30, 1996.

                                       11
<PAGE>

     Other  Income.  Other  income  totaled  $1.7  million  for the  year  ended
September 30, 1997 and $1.8 million for the year ended September 30, 1996. Other
income consists of fees and service charges earned on loans,  service charges on
deposit  accounts,  gains from sales of loans, and other  miscellaneous  income.
Loan fees and  service  charges  increased  to  $752,000  for  fiscal  1997 from
$552,000 for fiscal 1996,  reflecting  the growth in the loan  portfolio  during
1997.  Gains from sales of loans and  mortgage-backed  securities  decreased  to
$124,000 for fiscal 1997 from  $423,000 for fiscal 1996,  as the volume of loans
and  mortgage-backed  securities sold during 1997 decreased to $19.8 million for
1997 from $57.4  million for 1996.  Servicing  fee income on loans  serviced for
others was $613,000 for 1997 compared to $632,000 for 1996.

     General and Administrative  Expenses.  General and administrative  expenses
decreased 5.5% in fiscal 1997 to $6.9 million, from $7.3 million in fiscal 1996.
The Company's  efficiency  ratio  decreased to 58.6% for fiscal 1997, from 80.4%
for fiscal 1996.

     The largest single  component of these  expenses,  compensation  and fringe
benefits, increased to $4.6 million for fiscal 1997 from $3.6 million for fiscal
1996. This increase is a result of  approximately  $603,000 in benefits  expense
incurred for the ESOP and growth in personnel and management required to support
the 28.4% growth in assets from September 30, 1996 to September 30, 1997.

     Federal deposit insurance  premiums decreased to $88,000 for the year ended
September  30, 1997 from $1.3  million for the year ended  September  30,  1996.
During  1996,  the Bank  incurred a one-time  FDIC  assessment  of  $946,000  to
capitalize the SAIF insurance fund.  Pursuant to the Deposit Insurance Funds Act
of 1996, the Bank's deposit insurance premium rate has declined to 6.4 cents per
$100 of  deposits  for 1997 from 23 cents per $100 of  deposits  for 1996.  This
revised  deposit  insurance  rate  structure has enabled the Bank to recognize a
substantial reduction in deposit insurance premiums.

     Premises and equipment  expense  decreased to $377,000 for fiscal 1997 from
$798,000  for fiscal  1996.  During the year ended  September  30, 1996 the Bank
recognized accelerated  depreciation of $225,000 on certain fixed assets with no
future value due to obsolescence or excessive use.

     Income Taxes.  The provision for income taxes increased to $1.7 million for
fiscal 1997 from $451,000 for fiscal 1996.  The increase in provision for income
taxes is the result of the increased  pretax earnings to $4.0 million for fiscal
1997 from $1.3 million for fiscal 1996 and the  effective  income tax rates then
in effect.

IMPACT OF INFLATION AND CHANGING PRICES

     The financial  statements of the Bank and accompanying  footnotes have been
prepared in accordance  with generally  accepted  accounting  principles,  which
require the measurement of financial  position and operating results in terms of
historical  dollars without  considering  the change in the relative  purchasing
power of money  over  time and due to  inflation.  The  impact of  inflation  is
reflected in the increased cost of the Bank's operations. Unlike most industrial
companies,  nearly all the assets and liabilities of the Bank are monetary. As a
result,  interest rates have a greater impact on the Bank's  performance than do
the effects of general levels of inflation.  Interest  rates do not  necessarily
move in the same  direction  or to the same  extent  as the  price of goods  and
services.

YEAR 2000

     A great deal of information has been disseminated about the global computer
crash  that may occur in the year 2000.  Many  computer  programs  that can only
distinguish  the final  two  digits of the year  entered  (a common  programming
practice in earlier years) are expected to read entries for the year 2000 as the
year 1900 and compute payment,  interest or delinquency  based on the wrong date
or are expected to be unable to compute payment, interest or delinquency.  Rapid
and accurate data  processing is essential to the  operations of the Bank,  most
other financial institutions and many other companies.

     In compliance with regulatory  guidelines,  the Bank has formed a Year 2000
("Y2K")  committee  to review the  effects  the  century  change may have on all
current systems and to assess the potential risks associated with the Y2K issue.
A formal Y2K strategic plan and contingency  plan have been developed to address
the necessary steps to insure that problems and  disruptions  related to the Y2K
issue are minimized. An inventory of all systems, both

                                       12
<PAGE>

computer and  non-computer  related,  was  completed  in the process.  Potential
weaknesses  were then  documented and prioritized as to their effect on critical
business  functions.  All of the material data processing  functions of the Bank
that could be impacted by the Y2K issue are  provided by a national  third party
service bureau, Bisys, Inc. Bisys has dedicated tremendous resources in assuring
its systems are Y2K  compliant  and in  developing a  comprehensive  testing and
verification  program. The Bisys client test facility is providing the Bank with
end-to-end  testing  capabilities  of all its  hardware,  software  and  related
interfaces.

     The recently released  remediated version of the Bisys client test facility
has undergone  extensive beta testing.  All Bank user  departments are currently
involved  in an  extensive  Y2K  testing  program  to assure  validation  of the
changes.  Bisys has  advised  us that our  testing  through  their  client  test
facility  is expected to reveal any  potential  problems  well in advance of the
impending year 2000 deadline. Additional testing is also scheduled to take place
with all other external mission critical  information  systems and relationships
with which the Bank  exchanges  data or  information.  It is believed  that this
readiness will increase the likelihood of uninterrupted operations of the Bank.

     In  addressing  the Y2K  issue,  the Bank has  used  its  current  internal
staffing with little reliance on outside resources. The Bank's major vendor, the
Bisys  service  bureau,  has provided  remediated  software at no expense to the
Bank.  No major  system is expected to be  replaced  in the coming  years.  As a
result,  Y2K  related  expenses  were less than  $5,000 in fiscal  year 1998 and
expenses for fiscal 1999 are estimated at less than $25,000.  These expenses are
in the areas of customer  awareness and additional  software  testing.  The Bank
believes the cost of  addressing  the Y2K issue will have no material  impact on
its results of operations,  liquidity,  capital  resources,  or uncertainty that
would cause its reported financial condition not to be necessarily indicative of
future operating results or financial condition.

FORWARD LOOKING STATEMENTS

     The  Private  Securities  Litigation  Reform  Act of 1995  states  that the
disclosure  of forward  looking  information  is  desirable  for  investors  and
encourages  such  disclosure  by  providing a safe  harbor for  forward  looking
statements by corporate management.  This Annual Report, including the Letter to
Stockholders and Management's Discussion and Analysis of Financial Condition and
Results of Operations, contains forward looking statements that involve risk and
uncertainty.  In order to comply with the terms of the safe harbor,  the Company
notes  that a variety  of risk  factors  could  cause  its  actual  results  and
experience  to  differ   materially  from  the  anticipated   results  or  other
expectations  expressed in the Company's forward looking  statements.  The risks
and  uncertainties  that may affect the  operations,  performance,  development,
growth  projections and results of the Company's  business include,  but are not
limited to,  economic  growth,  interest rate movements,  timely  development of
technology enhancements for products, services and operating systems, the impact
of competitive products, services and pricing, customer requirements, regulatory
changes and similar  matters.  Readers of this report are cautioned not to place
undue reliance on forward  looking  statements  that are subject to influence by
these risk factors and  unanticipated  events.  Accordingly,  actual results may
differ materially from management's expectations.

                                       13
<PAGE>

                        REPORT OF INDEPENDENT ACCOUNTANTS


November 5, 1998

To the Board of Directors
NewSouth Bancorp, Inc.
Washington, North Carolina

In our opinion, the accompanying  consolidated statements of financial condition
and the related consolidated statements of operations,  stockholders' equity and
cash flows present fairly, in all material  respects,  the financial position of
NewSouth  Bancorp,  Inc. and  Subsidiary  at September 30, 1998 and 1997 and the
results of their  operations and their cash flows for each of the three years in
the period ended  September  30, 1998,  in conformity  with  generally  accepted
accounting principles.  These financial statements are the responsibility of the
Company's  management;  our  responsibility  is to  express  an opinion on these
financial  statements  based on our  audits.  We  conducted  our audits of these
statements  in accordance  with  generally  accepted  auditing  standards  which
require that we plan and perform the audit to obtain reasonable  assurance about
whether the financial  statements are free of material  misstatements.  An audit
includes  examining,  on a test  basis,  evidence  supporting  the  amounts  and
disclosures in the financial  statements,  assessing the  accounting  principles
used and  significant  estimates made by management,  and evaluating the overall
financial  statement  presentation.   We  believe  that  our  audits  provide  a
reasonable basis for the opinion expressed above.

/s/ PricewaterhouseCoopers LLP

                                       14
<PAGE>

<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
NEWSOUTH BANCORP, INC. AND SUBSIDIARY
SEPTEMBER 30, 1998 AND 1997
-------------------------------------------------------------------------------------------------

ASSETS                                                                 1998              1997
<S>                                                               <C>               <C>          
Cash and due from banks                                           $   5,243,853     $   3,027,271
Interest-bearing deposits in financial institutions                  11,767,988        12,744,980
Investment securities - available for sale                            3,107,545         3,083,422
Mortgage-backed securities - available for sale                      27,016,679        24,818,412
Loans receivable, net:
   Held for sale                                                     38,406,628        25,055,845
   Held for investment                                              186,592,403       172,729,060
Premises and equipment, net                                           3,558,836         2,818,167
Deferred income taxes                                                   569,604           821,863
Real estate owned                                                       411,938           357,503
Federal Home Loan Bank of Atlanta stock, at cost
   which approximates market                                          1,363,800         1,287,500
Accrued interest receivable                                           1,935,490         1,847,346
Prepaid expenses and other assets                                     1,504,689           689,828
                                                                  -------------     -------------

           Total assets                                           $ 281,479,453     $ 249,281,197
                                                                  =============     =============

LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
   Demand                                                         $  42,873,230     $  37,500,216
   Savings                                                            6,397,856         6,455,357
   Large denomination certificates of deposit                        25,587,798        17,097,175
   Other time                                                       129,776,201       114,063,040
                                                                  -------------     -------------
           Total deposits                                           204,635,085       175,115,788
Borrowed money                                                       11,932,919        12,621,120
Accrued interest payable                                                 62,707            91,915
Income taxes payable                                                         --           457,498
Advance payments by borrowers for property taxes and insurance          451,860           182,731
Other liabilities                                                     7,682,912         2,956,558
                                                                  -------------     -------------
           Total liabilities                                        224,765,483       191,425,610
Commitments and contingencies (Notes 10 and 14)
Common stock, $.01 par value, 8,000,000 shares authorized,
   4,364,044 shares issued and outstanding                               43,640            29,095
Additional paid-in capital                                           43,801,987        42,654,054
Retained earnings, substantially restricted                          22,091,243        20,041,635
Treasury stock at cost, 218,202 shares                               (4,895,754)               --
Unearned ESOP shares, 268,709 and 311,898 shares                     (2,687,093)       (3,118,984)
Deferred stock awards                                                (2,126,299)       (2,050,531)
Unrealized gain on available for sale securities, net                   486,246           300,318
                                                                  -------------     -------------
           Total stockholders' equity                                56,713,970        57,855,587
                                                                  -------------     -------------

           Total liabilities and stockholders' equity             $ 281,479,453     $ 249,281,197
                                                                  =============     =============
</TABLE>

The  accompanying  notes are an integral  part of these  consolidated  financial
statements.

                                       15
<PAGE>

<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF OPERATIONS
NEWSOUTH BANCORP, INC. AND SUBSIDIARY
YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996
--------------------------------------------------------------------------------------------------

                                                             1998           1997           1996
Interest income:
<S>                                                      <C>            <C>            <C>        
   Interest and fees on loans                            $18,888,253    $16,096,914    $13,430,797
   Interest and dividends on investments and deposits      2,978,655      2,418,451      1,918,876
                                                         -----------    -----------    -----------
           Total interest income                          21,866,908     18,515,365     15,349,673
                                                         -----------    -----------    -----------

Interest expense:
   Interest on deposits                                    9,096,290      8,088,144      7,939,014
   Interest on borrowings                                    143,342        258,084        166,438
                                                         -----------    -----------    -----------
           Total interest expense                          9,239,632      8,346,228      8,105,452
                                                         -----------    -----------    -----------

Net interest income before provision for loan losses      12,627,276     10,169,137      7,244,221
Provision for loan losses                                    310,000        931,078        511,000
                                                         -----------    -----------    -----------
           Net interest income                            12,317,276      9,238,059      6,733,221
                                                         -----------    -----------    -----------
Other income:
   Loan fees and service charges                             985,439        752,470        552,169
   Loan servicing fees                                       637,480        613,353        631,866
   Gain on sale of real estate, net                           28,478         32,190         33,628
   Gain on sale of mortgage loans and mortgage-backed
      securities                                             796,004        124,066        423,113
   Other income                                              198,647        162,893        191,768
                                                         -----------    -----------    -----------
           Total other income                              2,646,048      1,684,972      1,832,544
                                                         -----------    -----------    -----------
General and administrative expenses:
   Compensation and fringe benefits                        7,239,911      4,603,764      3,569,144
   Federal insurance premiums                                113,646         88,165        353,585
   Insurance fund special assessment                              --             --        946,020
   Premises and equipment                                    356,550        377,468        798,119
   Advertising                                               134,978        181,016        102,762
   Payroll and other taxes                                   417,140        311,290        286,949
   Other                                                   1,677,841      1,379,348      1,238,180
                                                         -----------    -----------    -----------
           Total general and administrative expenses       9,940,066      6,941,051      7,294,759
                                                         -----------    -----------    -----------

Income before income taxes                                 5,023,258      3,981,980      1,271,006

Income taxes                                               1,899,900      1,719,350        450,517
                                                         -----------    -----------    -----------

Net income                                               $ 3,123,358    $ 2,262,630    $   820,489
                                                         ===========    ===========    ===========

Net income per common share:
Basic                                                    $       .80            .35(1)
                                                         ===========    ===========

Assuming dilution                                        $       .80            .35(1)
                                                         ===========    ===========
</TABLE>

(1)  Calculated from date of conversion, see Note 2

The  accompanying  notes are an integral  part of these  consolidated  financial
statements.

                                       16
<PAGE>

<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
NEWSOUTH BANCORP, INC. AND SUBSIDIARY
YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996
------------------------------------------------------------------------------------------------------------

                                                                                 RETAINED
                                                               ADDITIONAL        EARNINGS,
                                                Common          Paid-in        Substantially     Treasury
                                                 Stock          Capital         Restricted         Stock
                                             ------------     ------------     ------------     ------------
<S>                                          <C>              <C>              <C>              <C>          
BALANCE AT SEPTEMBER 30, 1995                $         --     $         --     $ 17,485,547     $         -- 
Change in unrealized gains on securities
   available-for sale, net of  taxes                   --               --               --               -- 
Net income                                             --               --          820,489               -- 
                                             ------------     ------------     ------------     ------------
BALANCE, SEPTEMBER 30, 1996                            --               --       18,306,036               -- 
Issuance of shares of common stock                 29,095       42,423,041               --       (3,491,400)
Net income                                             --               --        2,262,630               -- 
Change in unrealized gains on securities
   available-for-sale, net of taxes                    --               --               --               -- 
Acquisition of shares for MRP                          --               --               --               -- 
Dividends ($.13 per share)                             --               --         (527,031)              -- 
Release of ESOP shares                                 --          231,013               --          372,416
                                             ------------     ------------     ------------     ------------
BALANCE, SEPTEMBER 30, 1997                        29,095       42,654,054       20,041,635               -- 
Three for two stock split effected in the
   form of a 50% stock dividend                    14,545               --          (14,545)              -- 
Net income                                             --               --        3,123,358               -- 
Fractional shares paid                                 --               --           (4,652)              -- 
Change in unrealized gains on securities
   available-for-sale, net of taxes                    --               --               --               -- 
Acquisition of shares for MRP                          --               --               --               -- 
Change in market value of deferred stock               --          753,959               --               -- 
MRP amortization                                       --               --               --               -- 
Acquisition of treasury shares                         --               --               --       (4,895,754)
Dividends ($.27 per share)                             --               --       (1,054,553)              -- 
Release of ESOP shares                                 --          393,974               --          431,891
                                             ------------     ------------     ------------     ------------
BALANCE, SEPTEMBER 30, 1998                  $     43,640     $ 43,801,987     $ 22,091,243     $ (4,895,754)
                                             ============     ============     ============     ============

<CAPTION>
                                                                                UNREALIZED
                                                                                 GAIN ON
                                                                                AVAILABLE
                                               UNEARNED         DEFERRED         FOR SALE
                                                 ESOP            Stock          Securities,
                                                Shares           Awards            Net              Total
                                             ------------     ------------     ------------     ------------
<S>                                          <C>              <C>              <C>              <C>          
BALANCE AT SEPTEMBER 30, 1995                $         --     $         --     $    202,522     $ 17,688,069
Change in unrealized gains on securities
   available-for sale, net of  taxes                   --               --         (161,987)        (161,987)
Net income                                             --               --               --          820,489
                                             ------------     ------------     ------------     ------------
BALANCE, SEPTEMBER 30, 1996                            --               --           40,535       18,346,571
Issuance of shares of common stock                     --               --       38,960,736
Net income                                             --               --               --        2,262,630
Change in unrealized gains on securities
   available-for-sale, net of taxes                    --               --          259,783          259,783
Acquisition of shares for MRP                          --       (2,050,531)              --       (2,050,531)
Dividends ($.13 per share)                             --               --               --         (527,031)
Release of ESOP shares                                 --               --          603,429
                                             ------------     ------------     ------------     ------------
BALANCE, SEPTEMBER 30, 1997                    (3,118,984)      (2,050,531)         300,318       57,855,587
Three for two stock split effected in the
   form of a 50% stock dividend                        --               --               --               --
Net income                                             --               --               --        3,123,358
Fractional shares paid                                 --               --               --           (4,652)
Change in unrealized gains on securities
   available-for-sale, net of taxes                    --               --          185,928          185,928
Acquisition of shares for MRP                          --       (1,224,768)              --       (1,224,768)
Change in market value of deferred stock               --         (753,959)              --               --
MRP amortization                                       --        1,902,959               --        1,902,959
Acquisition of treasury shares                         --               --               --       (4,895,754)
Dividends ($.27 per share)                             --               --               --       (1,054,553)
Release of ESOP shares                                 --               --          825,865
                                             ------------     ------------     ------------     ------------
BALANCE, SEPTEMBER 30, 1998                  $ (2,687,093)    $ (2,126,299)    $    486,246     $ 56,713,970
                                             ============     ============     ============     ============
</TABLE>

The  accompanying  notes are an integral  part of these  consolidated  financial
statements.

                                       17
<PAGE>

<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF CASH FLOWS
NEWSOUTH BANCORP, INC. AND SUBSIDIARY
YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996
------------------------------------------------------------------------------------------------------------

                                                                   1998            1997             1996
Operating activities:
<S>                                                           <C>              <C>              <C>         
   Net income                                                 $  3,123,358     $  2,262,630     $    820,489
   Adjustments to reconcile net income to net cash
     used in operating activities:
       Provision for loan losses                                   310,000          931,078          511,000
       Depreciation                                                172,844          147,927          449,104
       ESOP compensation                                           825,865          603,429               --
       MRP compensation                                          1,902,959               --               --
       Accretion of discounts on securities                            372           24,263           19,918
       Provision for (benefit of) deferred income taxes            132,438         (765,372)        (440,704)
       Gain on disposal of premises and equipment and
         real estate acquired in settlement of loans               (34,259)         (33,506)         (36,293)
       Gain on sale of mortgage loans and  mortgage-
         backed securities                                        (796,004)        (139,405)        (423,113)
       Originations of loans held for sale, net                (66,892,933)     (35,004,100)     (55,047,196)
       Proceeds from sale of loans held for sale                36,106,871       13,190,353       51,656,899
       Other operating activities                                3,327,998          (50,297)         562,728
                                                              ------------     ------------     ------------
           Net cash used in operating activities               (21,820,491)     (18,833,000)      (1,927,168)
                                                              ------------     ------------     ------------
Investing activities:
   Proceeds from maturities of securities available for                 --        7,000,000               --
     sale
   Purchases of investment securities                                   --       (2,000,000)      (6,043,438)
   Proceeds from principal repayments and sales of
     mortgage-backed securities available-for-sale              16,314,270        8,914,741        8,832,521
   Loan originations, net of principal repayments of
     loans held for investment                                 (14,631,404)     (40,566,654)      (9,827,513)
   Proceeds from maturities of securities held-to-maturity              --               --        1,000,000
   Proceeds from disposal of premises and equipment
     and real estate acquired in settlement of loans               441,237          815,117          238,564
   Purchases of FHLB stock                                         (76,300)              --               --
   Purchases of premises and equipment                            (916,865)         (66,057)        (351,588)
                                                              ------------     ------------     ------------
           Net cash provided by (used in) investing
             activities                                          1,130,938      (25,902,853)      (6,151,454)
                                                              ------------     ------------     ------------
</TABLE>

The  accompanying  notes are an integral  part of these  consolidated  financial
statements.

                                       18
<PAGE>

<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
NEWSOUTH BANCORP, INC. AND SUBSIDIARY
YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996
------------------------------------------------------------------------------------------------------

                                                             1998             1997             1996
Financing activities:
<S>                                                       <C>               <C>             <C>       
   Net increase in deposit accounts                       29,519,297        3,902,502       17,756,258
   Proceeds from FHLB borrowings                          46,000,000       49,000,000       24,000,000
   Repayments of  FHLB borrowings                        (47,500,000)     (38,000,000)     (28,000,000)
   Net proceeds from issuance of stock                            --       38,960,736               --
   Purchase of treasury shares                            (4,895,754)              --               --
   MRP funding                                            (1,224,768)      (2,050,531)              --
   Cash paid for fractional shares                            (4,652)              --               --
   Cash dividends paid                                    (1,045,908)        (264,574)              --
   Net change in escrow accounts                             269,129         (198,118)          73,647
   Net change in repurchase agreements                       811,799          581,512        1,039,608
                                                        ------------     ------------     ------------
           Net cash provided by financing activities      21,929,143       51,931,527       14,869,513
                                                        ------------     ------------     ------------

Increase in cash and cash equivalents                      1,239,590        7,195,674        6,790,891
Cash and cash equivalents, beginning of year              15,772,251        8,576,577        1,785,686
                                                        ------------     ------------     ------------
Cash and cash equivalents, end of year                  $ 17,011,841     $ 15,772,251     $  8,576,577
                                                        ============     ============     ============

Supplemental disclosures:
   Real estate acquired in settlement of loans          $    458,061     $    960,221     $    296,690
   Exchange of loans for mortgage-backed securities     $ 17,958,559     $ 18,524,209     $  1,545,859
   Transfers to securities available-for-sale           $         --     $         --     $ 16,140,485
   Cash paid for interest                               $  9,268,840     $  8,322,252     $  8,100,128
   Cash paid for income taxes                           $  2,637,000     $  1,673,000     $  1,327,315
   Dividends declared, not paid                         $    271,102     $    262,457     $         --
</TABLE>

The  accompanying  notes are an integral  part of these  consolidated  financial
statements.

                                       19
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NEWSOUTH BANCORP, INC. AND SUBSIDIARY
--------------------------------------------------------------------------------

1.   BASIS OF PRESENTATION AND ACCOUNTING POLICIES

ORGANIZATION AND NATURE OF OPERATIONS

NewSouth Bancorp, Inc. (the "Company") is a bank holding company incorporated in
October,  1996  under  the laws of the  State of  Delaware.  NewSouth  Bank (the
"Bank"),   the  wholly-owned   subsidiary  of  the  Company,  is  organized  and
incorporated  under  the  laws of the  state  of  North  Carolina.  The  Bank is
regulated by the Federal  Deposit  Insurance  Corporation and the North Carolina
Office of The Commissioner of Banks.

The consolidated  financial  statements  include the accounts of the Company and
its wholly-owned subsidiary, the Bank. All significant intercompany balances and
transactions have been eliminated in consolidation.

The  accounting  and  reporting  policies  of the  Company  and the Bank  follow
generally  accepted  accounting  principles  and  general  practices  within the
financial services industry as summarized below.

CASH AND CASH EQUIVALENTS

Cash and cash  equivalents  include  demand and time  deposits  (with  remaining
maturities  of  ninety  days or less at time of  purchase)  at  other  financial
institutions and federal funds sold. Generally,  federal funds are purchased and
sold for one-day periods.

INVESTMENTS AND MORTGAGE-BACKED SECURITIES

Investments  in certain  securities  are  classified  into three  categories and
accounted for as follows:  (1) debt  securities that the entity has the positive
intent and the ability to hold to maturity are  classified  as  held-to-maturity
and reported at amortized  cost; (2) debt and equity  securities that are bought
and held  principally  for the  purpose  of  selling  them in the near  term are
classified as trading  securities  and reported at fair value,  with  unrealized
gains and  losses  included  in  earnings;  (3) debt and equity  securities  not
classified  as either  held-to-maturity  securities  or trading  securities  are
classified as  available-for-sale  securities  and reported at fair value,  with
unrealized  gains and losses  excluded  from earnings and reported as a separate
component of equity.  As of  September  30, 1998,  the Bank has  classified  all
investments as available-for-sale.

Premiums and discounts on debt  securities are recognized in interest  income on
the level interest yield method over the period to maturity.

Mortgage-backed   securities  represent  participating  interests  in  pools  of
long-term first mortgage  loans.  Premiums and discounts are amortized using the
interest method over the remaining period to contractual maturity,  adjusted for
anticipated prepayments.

Gains and losses on the sale of securities  are determined by using the specific
identification method.

LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES

Loans  receivable  held for  investment  are  stated  at the  amount  of  unpaid
principal,  reduced by an allowance for loan losses and net deferred origination
fees. Interest on loans is accrued based on the principal amount outstanding and
is recognized on a level yield method.  The accrual of interest is discontinued,
and accrued but unpaid interest is reversed when, in management's  judgment,  it
is  determined  that  the  collectibility  of  interest,   but  not  necessarily
principal,  is doubtful.  Generally,  this occurs when payment is  delinquent in
excess of ninety days.

Loan  origination  fees,  as well certain  direct loan  origination  costs,  are
deferred.  Such costs and fees are recognized as an adjustment to yield over the
contractual lives of the related loans utilizing the interest method.

Commitment  fees  to  originate  or  purchase  loans  are  deferred,  and if the
commitment is exercised,  recognized  over the life of the loan as an adjustment
of yield. If the commitment expires unexercised,  commitment fees are recognized
in income upon  expiration of the  commitment.  Fees for  originating  loans for
other financial institutions are recognized as loan fee income.

A loan is considered impaired, based on current information and events, if it is
probable  that the Bank will be unable to  collect  the  scheduled  payments  of
principal or interest  when due according to the  contractual  terms of the loan
agreement.  Uncollateralized  loans are  measured  for  impairment  based on the
present value of expected future cash flows discounted at the

                                       20
<PAGE>

historical  effective  interest rate, while all  collateral-dependent  loans are
measured for impairment based on the fair value of the collateral.  At September
30, 1998 and 1997 and during the years then ended  there were no loans  material
to the consolidated financial statements which were defined as impaired.

The Bank uses several factors in determining if a loan is impaired. The internal
asset  classification  procedures include a thorough review of significant loans
and lending  relationships  and include the  accumulation  of related data. This
data includes loan payment  status,  borrowers'  financial  data and  borrowers'
operating factors such as cash flows, operating income or loss, etc.

The allowance for loan losses is increased by charges to income and decreased by
charge-offs  (net  of  recoveries).  Management's  periodic  evaluation  of  the
adequacy  of the  allowance  is based on the Bank's  past loan loss  experience,
known and inherent risks in the portfolio,  adverse  situations  that may affect
the  borrower's  ability  to  repay,  the  estimated  value  of  any  underlying
collateral,  and current economic conditions.  While management believes that it
has established the allowance in accordance with generally  accepted  accounting
principles  and has  taken  into  account  the views of its  regulators  and the
current economic  environment,  there can be no assurance that in the future the
Bank's regulators or its economic environment will not require further increases
in the allowance.

LOANS HELD FOR SALE

Loans  originated  and  intended  for sale are  carried  at the lower of cost or
aggregate  estimated  market value.  Net  unrealized  losses are recognized in a
valuation allowance by charges to income.  Gains and losses on sales of whole or
participating  interests in real estate loans are recognized at the time of sale
and are determined by the  difference  between net sales proceeds and the Bank's
basis of the loans sold,  adjusted for the  recognition of any servicing  assets
retained.

INCOME RECOGNITION ON IMPAIRED AND NONACCRUAL LOANS

Loans,  including impaired loans, are generally classified as nonaccrual if they
are past due as to maturity or payment of  principal or interest for a period of
more than 90 days,  unless  such loans are  well-secured  and in the  process of
collection.  If a loan or a portion of a loan is  classified  as  doubtful or is
partially  charged off, the loan is generally  classified as  nonaccrual.  Loans
that are on a current  payment  status or past due less than 90 days may also be
classified as nonaccrual if repayment in full of principal and/or interest is in
doubt.

Loans may be returned to accrual status when all principal and interest  amounts
contractually  due (including  arrearages)  are reasonably  assured of repayment
within  an  acceptable  period  of time,  and  there is a  sustained  period  of
repayment  performance  (generally a minimum of six months) by the borrower,  in
accordance with the contractual terms of interest and principal.

While a loan is classified as nonaccrual  and the future  collectibility  of the
recorded  loan balance is doubtful,  collections  of interest and  principal are
generally applied as a reduction to principal outstanding, except in the case of
loans with scheduled  amortization where the payment is generally applied to the
oldest payment due. When the future  collectibility of the recorded loan balance
is expected,  interest  income may be recognized on a cash basis limited to that
which would have been recognized on the recorded loan balance at the contractual
interest  rate.  Receipts in excess of that amount are recorded as recoveries to
the allowance for loan losses until prior charge-offs have been fully recovered.

PREMISES AND EQUIPMENT

Premises and  equipment  are stated at cost less  accumulated  depreciation  and
amortization.  Depreciation and  amortization are computed by the  straight-line
and accelerated methods based on estimated service lives of assets. Useful lives
range from 10 to 40 years for  substantially all premises and from 3 to 20 years
for equipment and fixtures.

REAL ESTATE OWNED

Assets  acquired  through  loan  foreclosure  are  recorded as real estate owned
("REO") at the lower of the estimated  fair value of the property less estimated
costs to sell at the date of foreclosure or the carrying amount of the loan plus
unpaid  accrued  interest.  The  carrying  amount  is  subsequently  reduced  by
additional  allowances which are charged to earnings if the estimated fair value
declines below its initial value plus any  capitalized  costs.  Costs related to
the  improvement  of the  property are  capitalized,  whereas  costs  related to
holding the property are expensed.

INVESTMENT IN FEDERAL HOME LOAN BANK STOCK

The Bank is required to invest in stock of the Federal Home Loan Bank of Atlanta
(FHLB)  in  the  amount  of  1% of  its  outstanding  home  loans  or 5% of  its
outstanding  advances from the FHLB, whichever is greater. At September 30, 1998
and 1997,  respectively  the Bank owned  13,638 and 12,875  shares of the FHLB's
$100 par value capital stock.

                                       21
<PAGE>

INCOME TAXES

Deferred tax asset and  liability  balances are  determined  by  application  to
temporary  differences  of the tax rate expected to be in effect when taxes will
become payable or receivable.  Temporary differences are differences between the
tax basis of assets and liabilities and their reported  amounts in the financial
statements  that will result in taxable or  deductible  amounts in future years.
The effect on deferred taxes of a change in tax rates is recognized in income in
the period that includes the enactment date.

STOCK SPLIT

On July 16, 1998 the Company declared at three-for-two  stock split, in the form
of a 50% stock dividend,  payable August 19, 1998 to stockholders of record July
31, 1998.  Stockholders  received one additional share of common stock for every
two shares held on the record  date.  All prior  period share and per share data
have been adjusted for the split.

RECLASSIFICATIONS

Certain items included in the 1997 financial  statements have been  reclassified
to conform to the 1998 presentation.  These  reclassifications have no effect on
the net income or stockholders' equity previously reported.

NEW ACCOUNTING PRONOUNCEMENTS

The Company adopted SFAS No. 130, "Reporting Comprehensive Income" on October 1,
1998.  SFAS  No.  130   establishes   standards  for  reporting  and  displaying
comprehensive  income  and  its  components  in a full  set  of  general-purpose
financial statements.

The Company  adopted SFAS No. 131,  "Disclosure  About Segments of an Enterprise
and Related  Information"  on October 1, 1998.  SFAS No. 131  specifies  revised
guidelines for determining an entity's operating segments and the type and level
of financial  information  to be disclosed.  The adoption of SFAS No. 131 is not
expected to have a material effect on the Company's financial statement.

The Company will adopt the provisions of Financial Accounting Standards No. 132,
"Employers  Disclosures  about  Pensions  and  Other  Postretirement  benefits",
effective for fiscal years  beginning  after  December 15, 1997.  This Statement
revises employees'  disclosures about pension and other  postretirement  benefit
plans.  It does not change the  measurement or  recognition of those plans.  The
adoption  of SFAS No.  132 is not  expected  to have a  material  effect  on the
Company's financial statement.

The Company will adopt the provisions of SFAS No. 133 "Accounting for Derivative
Instruments and Hedging Activities"  effective with the fiscal quarter beginning
July 1, 1999. This Statement establishes  accounting and reporting standards for
derivative instruments and for hedging activities.  It requires that derivatives
be  recognized  as either  assets or  liabilities  in the statement of financial
position and be measured at fair value.  The  accounting for changes in the fair
value of a derivative  depends on the intended use of the derivative and whether
or not the derivative is designated as a hedging instrument. SFAS No. 133 is not
expected to have a material effect on the Company's financial statements.

Statement  of  Financial   Accounting   Standards  No.  134,   "Accounting   for
Mortgage-Backed  Securities  Retained after the Securitization of Mortgage Loans
Held for Sale by a Mortgage  Banking  Enterprise",  was issued in October  1998.
This  Statement  amends  existing  classification  and  accounting  treatment of
mortgage-backed  securities,  retained  after  mortgage  loans held for sale are
securitized,   for  entities  engaged  in  mortgage  baking  activities.   These
securities  previously  were classified and accounted for as trading and now may
be classified as held-to-maturity or available-for-sale, also. This Statement is
effective for the first fiscal quarter  beginning  after December 15, 1998. SFAS
No. 134 is not  expected  to have  material  effect on the  Company's  financial
statements.

USE OF ESTIMATES

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

                                       22
<PAGE>

2.   CONVERSION TO COMMERCIAL BANK

NewSouth Bancorp,  Inc. was incorporated in October, 1996 under the laws for the
State of  Delaware  for the purpose of  becoming  the  holding  company for Home
Savings Bank,  SSB. On April 7, 1997,  Home Savings Bank,  SSB converted  from a
North Carolina-chartered mutual savings bank to a North Carolina-chartered stock
savings bank to be known as Home Savings Bank, Inc., SSB, ("Converted Bank"), in
connection  with  an  initial  public  offering  of  common  stock.  Immediately
following completion of the stock conversion,  the Converted Bank converted from
a North  Carolina-chartered  stock savings bank to a North  Carolina  commercial
bank known as "NewSouth  Bank." In connection with the  conversion,  the Company
issued  4,364,250  shares of $.01 par value per share  common  stock,  including
349,140 issued to the Employee Stock Ownership Plan ("ESOP"), for $10 per share.
The sale of common stock generated  proceeds of  $38,960,736,  net of conversion
costs of $1,190,364 and ESOP shares of $3,491,400.

At the time of the conversion,  the Bank established a liquidation account in an
amount  equal to the Bank's net worth,  or  approximately  $19,200,000,  for the
benefit of eligible  account holders at that time. The liquidation  account will
be reduced  annually to the extent that  eligible  account  holders have reduced
their eligible deposits, shall cease upon the closing of the accounts, and shall
never be increased.  In the event of the  liquidation of the Bank, all remaining
eligible  deposit  account  holders  shall be  entitled,  after all  payments to
creditors,   to  a  distribution   from  the  liquidation   account  before  any
distribution to stockholders.  Dividends paid by the Company cannot be paid from
the liquidation account.

3.   INVESTMENT SECURITIES

Investment securities at September 30, 1998 and 1997 are classified as available
for sale according to management's intent and summarized as follows:

                                             Gross Unrealized         Estimated
                            Amortized      ---------------------       Market
                               Cost          Gains        Losses        Value
                           -----------     --------      -------     -----------
1998:
     U. S. Treasury notes  $        --     $     --      $    --     $        --
                           ===========     ========      =======     ===========
1997:
     U.S. Treasury notes   $ 3,000,897     $ 82,525      $    --     $ 3,083,422
                           ===========     ========      =======     ===========

U.S.  Treasury notes at September 30, 1998 with amortized cost of $3,000,526 and
estimated market value of $3,107,545 are contractually scheduled to mature after
one through five years.

4.   MORTGAGE-BACKED SECURITIES

Mortgage-backed  securities  at September  30, 1998 and 1997 are  classified  as
available for sale according to management's intent and summarized as follows:

<TABLE>
<CAPTION>
                                                          Gross Unrealized         Estimated
                                          Amortized     --------------------        Market
                                             Cost         Gains      Losses          Value
                                         -----------    ---------   --------      -----------
<S>                                      <C>            <C>         <C>           <C>
1998:
   FHLMC participation certificates,
   maturing from years 2003 to 2028      $26,323,899    $ 692,780   $     --      $27,016,679
                                         ===========    =========   ========      ===========
1997:
   FHLMC participation certificates,
   maturing from years 2006 to 2022      $24,406,887    $ 463,942   $ 52,417      $24,818,412
                                         ===========    =========   ========      ===========
</TABLE>

                                       23
<PAGE>

Mortgage-backed  securities at September 30, 1998 are contractually scheduled to
mature as follows:

                                                                      Estimated
                                                     Amortized          Market
                                                        Cost            Value
                                                    -----------      -----------

Due after five years through ten years              $ 4,757,078      $ 4,858,150
Due after ten years                                  21,566,821       22,158,529
                                                    -----------      -----------

                                                    $26,323,899      $27,016,679
                                                    ===========      ===========

Expected  maturities may differ from contractual  maturities  because  borrowers
have the right to call or prepay  obligations with or without call or prepayment
penalties.

Mortgage-backed  securities with a carrying value of $9,016,982,  $6,607,924 and
$5,566,420 were sold during the years ended September 30, 1998,  1997, and 1996,
respectively.  Gross realized gains on the sales of  mortgage-backed  securities
were $272,724, $688 and $146,723 during 1998, 1997 and 1996, respectively. Gross
realized losses on sales of  mortgage-backed  securities were $0, $15,339 and $0
during 1998, 1997 and 1996, respectively.

Mortgage-backed securities with a carrying value of approximately $3,619,011 and
$1,594,000  were  pledged as  collateral  for deposits  from public  entities at
September 30, 1998 and 1997, respectively.

5.   LOANS RECEIVABLE

Loans receivable at September  30, 1998 and 1997 are summarized as follows:

                                                  1998                 1997
                                             -------------        -------------
Mortgage loans                               $ 120,211,101        $ 102,154,361
Consumer loans                                  48,385,965           49,889,347
Commercial loans                                73,303,016           62,438,748
                                             -------------        -------------
         Total                                 241,900,082          214,482,456
Less:
   Loans in process                            (12,930,301)         (12,716,819)
   Allowance for loan losses                    (3,364,588)          (3,249,352)
   Deferred loan fees                             (606,162)            (731,380)
                                             -------------        -------------

Loans receivable, net                        $ 224,999,031        $ 197,784,905
                                             =============        =============

The Bank has pledged its eligible real estate loans to  collateralize  actual or
potential borrowings from the Federal Home Loan Bank of Atlanta (See Note 10).

During 1998, 1997 and 1996, the Bank exchanged loans with outstanding  principal
balances of  $17,958,559,  $18,524,209 and  $1,545,859,  respectively,  with the
Federal Home Loan Mortgage Corporation ("FHLMC") for mortgage-backed  securities
of equal value.

The Bank  originates  mortgage  loans for  portfolio  investment  or sale in the
secondary  market.  During  the  period  of  origination,   mortgage  loans  are
designated  as either held for sale or investment  purposes.  Transfers of loans
held for sale to the  investment  portfolio are recorded at the lower of cost or
market value on the transfer date.  Loans  receivable held for sale at September
30, 1998 and 1997, are fixed rate mortgage loans with an estimated  market value
of approximately $ 38,400,000 and $25,100,000, respectively.

Net  gains on sales of loans  receivable  held for sale  amounted  to  $523,280,
$138,717 and $276,390  during the years ended September 30, 1998, 1997 and 1996,
respectively.

                                       24
<PAGE>

The changes in the allowance  for loan losses for the years ended  September 30,
1998, 1997 and 1996 are as follows:

                                        1998            1997            1996

Balance at beginning of year        $ 3,249,352     $ 2,351,309     $ 1,876,954
Provisions for loan losses              310,000         931,078         511,000
Loans charged off                      (202,543)        (71,904)        (62,559)
Recoveries                                7,779          38,869          25,914
                                    -----------     -----------     -----------

Balance at end of year              $ 3,364,588     $ 3,249,352     $ 2,351,309
                                    ===========     ===========     ===========

The  following  is a summary of the  principal  balances of loans on  nonaccrual
status and loans past due ninety days or more:

                                                           1998          1997
Loans contractually past due 90 days or more
 and/or on nonaccrual status:
     Residential                                       $  728,856     $1,214,189
     Consumer and commercial                               73,544         48,233
                                                       ----------     ----------
                                                       $  802,400     $1,262,422
                                                       ==========     ==========

During the years ended  September 30, 1998,  1997 and 1996,  interest  income of
approximately  $18,000,  $48,000 and  $44,000,  respectively,  was not  recorded
related to loans accounted for on a nonaccrual basis.

6.   PREMISES AND EQUIPMENT

Premises and equipment at September  30, 1998 and 1997 consist of the following:

                                                       1998              1997

Land                                                $1,081,952        $  935,560
Office buildings                                     2,499,579         2,488,976
Furniture, fixtures and equipment                    1,706,207         1,067,858
Vehicles                                               249,748           225,041
                                                    ----------        ----------
                                                     5,537,486         4,717,435
Less accumulated depreciation                        1,978,650         1,899,268
                                                    ----------        ----------

         Total                                      $3,558,836        $2,818,167
                                                    ==========        ==========

7.   EMPLOYEE BENEFIT PLANS

The Company  participates in a multiemployer  defined benefit pension plan which
covers  substantially  all  employees.  Expenses of the plan for the years ended
September  30,  1998,  1997  and  1996  were  $168,500,  $96,000  and  $137,000,
respectively.

The Company  participates in a  multiemployer  defined  contribution  plan which
covers  substantially  all employees.  Under the plan,  employees may contribute
from 1% to 15% of  compensation,  subject to an annual  maximum as determined by
the Internal  Revenue Code. The Company makes matching  contributions  of 50% of
employees'  contributions up to 6% of the employees' salaries. The plan provides
that  employees'  contributions  are 100%  vested at all  times  and the  Bank's
contributions  vest 25% for each year of service.  The  expenses  related to the
Company's  contributions  to these plans for the years ended September 30, 1998,
1997 and 1996 were $76,386, $52,253 and $46,171, respectively.

                                       25
<PAGE>

Directors and certain officers participate in deferred compensation plans. These
plans  generally  provide for fixed  payments  beginning  at  retirement.  These
payments  are earned over  service  periods of up to ten years,  and can include
provisions for deferral of current payments.  The expense related to these plans
during the years ended September 30, 1998,  1997 and 1996  aggregated  $562,478,
$515,435 and $463,250,  respectively. The plans generally include provisions for
forfeitures of unvested portions of payments,  and vesting in the event of death
or disability.

On April 8, 1998, the Company's  Stockholders approved a Management  Recognition
Plan ("MRP") for directors and key employees.  The Company is authorized to fund
the  acquisition  and award of up to 174,570  shares (4% of shares issued in the
stock  conversion)  to be awarded by a committee of the Board of Directors.  The
Company  completed the acquisition of MRP shares during fiscal 1998. On April 8,
1998,  174,570  shares  (market  value  of  $4,029,258  and  aggregate  cost  of
$3,275,299) were awarded to certain officers and employees. The vesting schedule
provides  that 33-1/3% of the shares shall be earned and become  non-forfeitable
on April 30, 1998, 1999 and 2000.

The shares issued to the MRP plan have been recorded as outstanding  shares, and
the unvested portion has been recorded as unearned compensation through a contra
equity  account.  The  consolidated  statement of operations  for the year ended
September 30, 1998 include  compensation  expense of $1,902,959  relating to the
scheduled vesting of MRP shares.

8.   EMPLOYEE STOCK OWNERSHIP PLAN

The  Company's  Board of  Directors  adopted an Employee  Stock  Ownership  Plan
("ESOP"),   effective  October  1,  1996.  Employees  of  the  Company  and  its
subsidiaries  who have  attained  age 21 and  completed  one year of service are
eligible to participate in the ESOP, provided that any employee who was employed
full-time on the closing  date of the Stock  Conversion  automatically  became a
participant on October 1, 1996. The ESOP is to be funded by  contributions  made
by the  Company or the Bank in cash or shares of Common  Stock.  Allocations  to
participants'  accounts  occur annually on September 30. Shares are committed to
be released  for  financial  statement  purposes  when the Bank makes  scheduled
payments  on the ESOP  note  payable  and will be  allocated  to  employees  for
services  rendered in the current  accounting  period.  Employees  vest in their
allocated ESOP shares over three years.  The number of shares  legally  released
and allocated is based on the ratio of the actual  principal  payments amount to
the  remaining  total  principal  payments for the ESOP note  payable.  The Bank
expects to  contribute  sufficient  funds to the ESOP to repay the note  payable
over a ten-year  period,  plus such  other  amounts  as the  Company's  Board of
Directors may determine in its discretion.

Initially,  the ESOP  acquired  349,140  shares of the  Company's  common  stock
financed by $3,491,400 in borrowings by the ESOP from the Company.  This loan is
secured  by the  shares of Common  Stock  purchased  and  earnings  thereon.  At
September  30, 1998 and 1997,  80,431 and 37,242 shares  respectively  have been
allocated  to  participants'  accounts and 268,709 and 311,898  shares,  with an
estimated  market value of $5,844,420 and $6,237,960,  remain  unallocated.  All
allocated  shares are  considered  outstanding  for earning per share  purposes,
while the unallocated shares are not included in the calculation.

The  principal  balance  of the  ESOP  loan was  $2,687,093  and  $3,118,984  at
September  30,  1998 and 1997,  respectively.  The Bank is using  the  dividends
declared on shares held by the ESOP to reduce the outstanding debt. Dividends on
allocated shares are treated as a reduction of retained  earnings.  Dividends on
unallocated  shares are treated only as debt service,  and there is no reduction
of retained earnings.  Compensation  expense related to the ESOP is based on the
average fair market value of shares during the period since the prior allocation
date  through the dates  shares are  committed  to be  released.  The  financial
statements for the years ended September 30, 1998 and 1997, include compensation
expense of $825,865 and $603,429, respectively, related to the ESOP.

9.   STOCK OPTION PLAN

On April 8, 1998, the Shareholders of the Company approved the NewSouth Bancorp,
Inc.  1997  stock  option  plan.  The  purpose  of this Plan is to  advance  the
interests of the Company through providing  selected key employees and Directors
of the Bank and the Company with the  opportunity to purchase  shares.  The Plan
reserves  436,425  shares for grant within ten years of the effective  date. The
option price is required to be 100% of the stock's fair market value as defined,
with an exception for any shareholder with more than a 10% ownership interest in
the  Company.  The  exercise  price is required  to be 110% of the stock's  fair
market value for these  options  holders.  Options  vesting is determined on the
date of the grant.  Options have a 10 year life,  however,  there are additional
limitation's  for  shareholders  with more than a 10% ownership  interest in the
Company.  The Plan also has a change of control provision under which all shares
immediately vest if a change of control, as defined, occurs.

                                       26
<PAGE>

During the year ended September 30, 1998, 398,303 options were granted at market
value on the date of award,  (233,603 to a group of 13 officers and 164,700 to a
group of six directors).  The weighted average grant price was $23.08 No options
were exercised  during the year ended  September 30, 1998. No options expired or
were forfeited  during the year ended  September 30, 1998. On November 19, 1998,
the Board of Directors  approved a plan to recall the outstanding  stock options
and regrant the same number of options at an exercise price of $18.25 per share.

The Company has adopted SFAS No. 123, "Accounting for Stock Based Compensation".
As  permitted  by SFAS No. 123,  the Company has chosen to apply APB Opinion No.
25,  "Accounting  for Stock Issued to  Employees"  and related  interpretations.
Accordingly,  no compensation cost has been recognized for options granted under
the Option  Plan.  Had  compensation  cost for the  Company's  Option  Plan been
determined  based on the fair  value at the  grant  dates for  awards  under the
Option Plan  consistent  with the method of SFAS No. 123,  the Plan's net income
and net  income  per share  would  have been  reduced  to the pro forma  amounts
indicated  below.  The Company did not grant any options  during the years ended
September 30, 1997 or 1996, therefore,  there are no pro forma amounts for those
periods.

                                                         For the Year Ended
                                                         September 30, 1998
                                                    ----------------------------
                                                         as
                                                      Reported        Pro Forma
                                                    ------------    ------------
Net income                                          $  3,123,358    $  1,829,801
Earnings per common share - basic                   $        .80    $        .47
Earnings per common share - assuming dilution       $        .80    $        .47

The fair value of each option  grant is estimated on the date of grant using the
Black-Scholes   option-pricing   model  with  the   following   weighted-average
assumptions  used for  grants  in 1998:  dividend  growth  rate of 0%,  expected
volatility of 6.1%;  risk-free  interest  rates of 5.3%; and expected lives of 7
years. The weighted average fair value of options granted in 1998 is $5.59.

The following table summarizes  additional  information about the Option Plan at
September 30, 1998:
      
                                     Number        Remaining      Number
                                  Outstanding     Contractual   Exercisable
      Exercise Price               At 9/30/98       Life At       9/30/98
      --------------               ----------       -------       -------
      
      $23.08                        395,303         9 years       344,303
      $22.63                          3,000         9 years         1,000

10.  BORROWED MONEY

Borrowed  money  represents  advances from the Federal Home Loan Bank of Atlanta
and  repurchase  agreements.  Advances  from the  Federal  Home  Loan Bank had a
weighed average rate of 6.00% and 6.17% and totaled,  $9,500,000 and $11,000,000
at September 30, 1998 and 1997, respectively.

At September 30, 1998 and 1997, repurchase agreements  outstanding had a rate of
3.33% and 4.67% and totaled $2,432,919 and $1,621,120, respectively.

Repurchase  agreements are collateralized by U.S.  government agency obligations
with a principal balance of $3,000,000. The Company has pledged all of its stock
in the Federal  Home Loan Bank of Atlanta and  certain  loans  secured by one to
four  family  residential  mortgages  as  collateral  for  actual  or  potential
borrowings  from the FHLB. At September 30, 1998,  the Company had an additional
$15,500,000 of credit available with the Federal Home Loan Bank of Atlanta.

                                       27
<PAGE>

11.  INCOME TAXES

The components of income taxes for the years ended  September 30, 1998, 1997 and
1996 are as follows:

                                      1998              1997             1996
Current:
   Federal                        $1,422,845       $ 1,908,576        $ 766,558
   State                             344,617           576,146          124,663
                                  ----------       -----------        ---------
   Total current                   1,767,462         2,484,722          891,221
                                  ----------       -----------        ---------

Deferred:
   Federal                           115,458          (617,976)        (360,903)
   State                              16,980          (147,396)         (79,801)
                                  ----------       -----------        ---------
   Total deferred                    132,438          (765,372)        (440,704)
                                  ----------       -----------        ---------

Total                             $1,899,900       $ 1,719,350        $ 450,517
                                  ==========       ===========        =========

Reconciliations of expected income tax at the statutory Federal rate of 34% with
income tax expense for the years ended  September 30, 1998, 1997 and 1996 are as
follows:

<TABLE>
<CAPTION>
                                                    1998            1997         1996

<S>                                             <C>             <C>           <C>      
Expected income tax expense                     $ 1,707,908     $1,353,873    $ 432,142
State income taxes net of federal income tax        239,220        147,000       26,671
Non-deductible ESOP, other expenses and
   other adjustments                                (47,228)       218,477       (8,296)
                                                -----------     ----------    ---------

                                                $ 1,899,900     $1,719,350    $ 450,517
                                                ===========     ==========    =========
</TABLE>

The  components  of the net  deferred  income  tax  liability  and  asset are as
follows:

                                                            1998          1997
Deferred income tax assets:
   Deferred directors' fees                             $  365,384    $  346,328
   Bad debt reserve                                        931,514       782,302
   Deferred employee benefits                              483,382       363,925
   Other                                                   108,765        26,382
                                                        ----------    ----------
                                                         1,889,045     1,518,937
                                                        ----------    ----------
Deferred income tax liabilities:
   Loans mark-to-market adjustment                         665,254       235,757
   Depreciation and amortization                           134,905        91,306
   Unrealized gains on securities available-for-sale       313,553       193,732
   Deferred loan origination fees and costs                106,379        76,929
   FHLB stock                                               99,350        99,350
                                                        ----------    ----------
                                                         1,319,441       697,074
                                                        ----------    ----------

Net deferred income tax asset                           $  569,604    $  821,863
                                                        ==========    ==========

                                       28
<PAGE>

Retained  income at September 30, 1998,  includes  approximately  $1,850,000 for
which no  deferred  income  tax  liability  has  been  recognized.  This  amount
represents  an  allocation  of  income to bad debt  deductions  for  income  tax
purposes only. Reductions of the amount so allocated for purposes other than tax
bad debt losses or adjustments  arising from  carryback of net operating  losses
would create  income for tax purposes  only,  which would be subject to the then
current corporate income tax rate.

During 1996,  Congress  enacted  certain tax  legislation  that exempted  thrift
institutions  from being taxed on pre-1987 bad debt  reserves.  The Bank will be
recapturing  a portion of its  post-1987  bad debt reserve  created by using the
percentage of taxable income method.  The Bank has previously  recorded deferred
tax liabilities related to these excess reserves.  Additionally, the Bank is now
required to use the experience method.

12.  REGULATORY CAPITAL REQUIREMENTS

Dividend  payments  made by the Company are subject to  regulatory  restrictions
under Federal  Reserve Board policy as well as to limitations  under  applicable
provisions of Delaware  corporate law. The Federal  Reserve Board may prohibit a
bank holding  company from paying any  dividends if the holding  company's  bank
subsidiary is classified as  "undercapitalized".  Under Delaware law,  dividends
may be paid out of surplus  or, if there is no  surplus,  out of net profits for
the fiscal year in which the dividend is declared and for the  preceding  fiscal
year.  Furthermore,  under FDIC regulations,  the Bank is prohibited from making
any capital distributions if after making the distribution, the Bank would have:
(i) a total risk-based capital ratio of less than 8.0%; (ii) a Tier 1 risk-based
capital ratio of less than 4.0%; or (iii) a leverage ratios of less than 4.0%.

The Bank is subject to various regulatory capital  requirements  administered by
the  federal  and  state  banking  agencies.  Failure  to meet  minimum  capital
requirements   can  initiate   certain   mandatory,   and  possibly   additional
discretionary,  actions by regulators  that, if undertaken,  could have a direct
material  effect  on the  Bank's  financial  statements.  Quantitative  measures
established  by  regulation  to  ensure  capital  adequacy  require  the Bank to
maintain minimum amounts and ratios, as set forth in the table below. Management
believes,  as of September  30, 1998,  that the Bank meets all capital  adequacy
requirements to which it is subject.

As of September 30, 1998, the most recent notification from the FDIC categorized
the  Bank  as  well  capitalized  under  the  regulatory  framework  for  prompt
corrective  action. To be categorized as well capitalized the Bank must maintain
minimum  amounts  and  ratios,  as set  forth in the table  below.  There are no
conditions  or events since that  notification  that  management  believes  have
changed the Bank's category.

The  Company's  actual  capital  amounts and ratios as of September 30, 1998 and
1997 are also presented in the table below (dollars in thousands).

<TABLE>
<CAPTION>
                                                                                To Be Well Capitalized
                                                                   For Capital       Under Prompt
                                                  Actual        Adequacy Purpose   Action Provisions
                                             ---------------     --------------     ---------------
                                             Amount    Ratio     Amount   Ratio     Amount    Ratio
                                             ------    -----     ------   -----     ------    -----
1998:
<S>                                         <C>        <C>      <C>        <C>     <C>        <C>  
Total Capital (to Risk Weighted Assets)     $58,169    28.9%    $16,125    8.0%    $20,156    10.0%
Tier I Capital (to Risk Weighted Assets)     55,650    27.6%      8,063    4.0%     12,094     6.0%
Tier I Capital (to Average Assets)           55,650    20.2%     11,066    4.0%     13,758     5.0%
                                                                                   
1997:                                                                              
Total Capital (to Risk Weighted Assets)     $59,684    34.8%    $13,719    8.0%    $17,149    10.0%
Tier I Capital (to Risk Weighted Assets)     57,527    33.6%      6,859    4.0%     10,289     6.0%
Tier I Capital (to Average Assets)           57,527    23.8%      9,679    4.0%     12,099     5.0%
</TABLE>

13.      EARNING PER SHARE

The Company  adopted SFAS No. 128  "Earnings  Per Share" on October 1, 1997.  As
required, all prior period earnings per share have been restated to conform with
the provisions of the statement.

                                       29
<PAGE>

The following  table  provides a  reconciliation  of income  available to common
stockholders  and the average number of shares  outstanding  (less unearned ESOP
shares)  for the  years  ended  September  31,  1998 and  1997.  As the  Company
converted  from mutual form during fiscal 1997,  there are no reported  earnings
per share for fiscal 1996.

                                                     1998              1997

Net income (numerator)                            $3,123,358       $1,395,900(1)
                                                  ==========       ==========

Shares for basic EPS (denominator)                 3,876,813        3,961,933(1)
Dilutive effect of stock options                          --               --
                                                  ----------       ----------

Adjusted shares for diluted EPS                    3,876,813        3,961,933
                                                  ==========       ==========

(1)  Calculated from date of conversion, April 7, 1997.

14.  MORTGAGE BANKING ACTIVITIES

Mortgage  loans  serviced  for  others  are  not  included  in the  accompanying
consolidated statements of financial condition. The unpaid principal balances of
mortgage  loans  serviced  for  others  was  $250,202,000  and  $253,647,000  at
September 30, 1998 and 1997, respectively.  Servicing loans for others generally
consists  of  collecting   mortgage   payments,   maintaining  escrow  accounts,
disbursing  payment to investors  and  foreclosure  processing.  Loan  servicing
income is  recorded  on the  accrual  basis  and  includes  servicing  fees from
investors and certain  charges  collected from  borrowers,  such as late payment
fees.

The Company  accounts for its mortgage  banking  transactions in accordance with
SFAS No. 125  "Accounting  for Transfers  and Servicing of Financial  Assets and
Extinguishements  of  Liabilities".  At  September  30, 1998 and 1997,  mortgage
servicing rights reported in the consolidated statements of financial condition,
net of amortization, were $184,433 and $57,525, respectively.

Impairments of servicing assets are evaluated  through an assessment of the fair
value of those assets using a disaggregated,  discounted cash-flows method under
which the assets are  disaggregated  into various stratum,  based on predominant
risk  characteristics.  The  net  carrying  value  of  each  stratum,  based  on
predominant risk characteristics, is compared to its discounted estimated future
net cash  flows to  determine  whether  adjustments  should be made to  carrying
values or amortization schedules.  Impairment of a servicing asset is recognized
through a valuation  allowance and a charge to current-period  earnings if it is
considered to be temporary,  or, through a direct  write-down of the asset and a
charge to current-period earnings if it is considered other than temporary.  The
predominant  risk  characteristics  of the  underlying  loans  that  are used to
satisfy the servicing assets and liabilities for measurement  purposes generally
include the (1) loan origination date, (2) loan rate, (3) loan type and size and
(4) loan maturity date.

15.  FINANCIAL  INSTRUMENT WITH  OFF-BALANCE  SHEET RISK AND  SIGNIFICANT  GROUP
     CONCENTRATION OF CREDIT RISK

The Company is a party to financial  instruments with off-balance  sheet risk in
the normal course of business to meet the  financing  needs of its customers and
to reduce its own exposure to fluctuations  in interest  rates.  These financial
instruments  include  commitments  to extend  credit  and  involve,  to  varying
degrees,  elements  of credit  and  interest  rate risk in excess of the  amount
recognized in the balance sheet.

The  Company's  exposure to credit loss in the event of  non-performance  by the
other party to the  financial  instrument  for  commitments  to extend credit is
represented by the contractual amount of those instruments. The Company uses the
same credit policies in making  commitments  and  conditional  obligations as it
does for on-balance sheet instruments.

Commitments  to extend  credit are  agreements  to lend to a customer as long as
there is no violation of any condition established in the contract.  Commitments
generally  have fixed  expiration  dates or other  termination  clauses  and may
require payment of a fee. The Company evaluates each customer's creditworthiness
on a case-by-case basis. The amount of collateral obtained,  if deemed necessary
by the  Company  upon  extension  of  credit,  is based on  management's  credit
evaluation of the borrower.

                                       30
<PAGE>

A summary of the  contractual  amounts of the Company's  exposure to off-balance
sheet risk as of September 30, 1998 and 1997 is as follows:

<TABLE>
<CAPTION>
                                                              1998           1997
Commitments to extend credit:
<S>                                                        <C>            <C>        
   Commitments to originate loans                          $14,887,234    $13,070,715
   Undrawn balances on lines of credit and undrawn
     balances on credit reserves (overdraft protection)     18,626,163     19,889,495
                                                           -----------    -----------

                                                           $33,513,397    $32,960,210
                                                           ===========    ===========
</TABLE>

Included in the commitments to originate loans as of September 30, 1998 and 1997
are  fixed  interest  rate  loan   commitments  of  $5,821,488  and  $6,722,340,
respectively.  The shorter duration of  interest-sensitive  liabilities,  to the
extent they are used to fund these fixed-rate loans,  indicates that the Company
is  exposed  to  interest  rate  risk  because,  in a rising  rate  environment,
liabilities will be repricing faster at higher interest rates,  thereby reducing
the market value of fixed-rate long-term assets and net interest income.

The  Company's  lending is  concentrated  primarily in Beaufort,  Craven,  Nash,
Lenoir, Pasquotank,  Pitt and surrounding counties in North Carolina. Credit has
been extended to certain of the Company's  customers  through  multiple  lending
transactions.

Since many of the  commitments  are expected to expire without being drawn upon,
amounts reported do not necessarily represent future cash requirements.

16.  PARENT COMPANY FINANCIAL INFORMATION

The Company's principal asset is its investment in the Bank. Condensed financial
statements  of the parent  company as of September 30, 1998 and 1997 and for the
two years ended September 30, 1998 are as follows:

<TABLE>
<CAPTION>
                                                            1998             1997
                                                        ------------     ------------
CONDENSED BALANCE SHEET
<S>                                                     <C>              <C>         
Cash                                                    $    959,617     $     23,383
Due from subsidiary                                       13,485,534       18,220,854
Investment in wholly-owned subsidiary                     41,960,610       39,941,603
Other assets                                                 579,311               --
                                                        ------------     ------------
       Total assets                                     $ 56,985,072     $ 58,185,840
                                                        ============     ============

Deferred income taxes                                   $         --     $     57,800
Other liabilities                                            271,102          272,453
Shareholders' equity                                      56,713,970       57,855,587
                                                        ------------     ------------
       Total liabilities and shareholders' equity       $ 56,985,072     $ 58,185,840
                                                        ============     ============
CONDENSED STATEMENT OF INCOME
Interest income, net                                    $    291,950     $    159,006
Other income                                               3,007,978        1,570,050
Miscellaneous expenses                                       176,570          333,156
                                                        ------------     ------------
       Net income                                       $  3,123,358     $  1,395,900
                                                        ============     ============
</TABLE>

                                       31
<PAGE>

<TABLE>
<CAPTION>
CONDENSED STATEMENT OF CASH FLOWS
Operating activities:
<S>                                                     <C>              <C>         
   Net income                                           $  3,123,358     $  1,395,900
   Adjustments to reconcile net income to net cash
     provided by operating activities:
   Equity in undistributed earnings of subsidiary         (3,007,978)      (1,570,050)
   Deferred income taxes                                     (57,800)          57,800
   ESOP compensation                                         825,865          603,429
   MRP compensation                                        1,902,959               --
   Other operating activities                               (589,308)       1,870,996
                                                        ------------     ------------
         Net cash provided by operating activities         2,197,096        2,358,075
                                                        ------------     ------------
Investing activities:
   Investment in, and advances to, subsidiary                     --      (38,980,323)
   Repayments of advances to subsidiary                    5,910,220               --
                                                        ------------     ------------
         Net cash used by investing activities             5,910,220      (38,980,323)
                                                        ------------     ------------
Financing activities:
   Net proceeds from issuance of stock                            --       38,960,736
   MRP funding                                            (1,224,768)      (2,050,531)
   Purchase of treasury shares                            (4,895,754)              --
   Cash paid for fractional shares                            (4,652)              --
   Dividends paid                                         (1,045,908)        (264,574)
                                                        ------------     ------------
         Net cash provided by provided by (used in )
           financing activities                           (7,171,082)      36,645,631
                                                        ------------     ------------

Net increase in cash                                         936,234           23,383
Cash at beginning of the year                                 23,383               --
                                                        ------------     ------------
Cash at the end of year                                 $    959,617     $     23,383
                                                        ============     ============
</TABLE>

17.  QUARTERLY FINANCIAL DATA (UNAUDITED)

Summarized  unaudited quarterly financial data for the years ended September 30,
1998 and 1997 is as follows (in thousands):

                                            Fourth    Third     Second    First
                                            ------    ------    ------    ------
1998:
Interest income                             $5,694    $5,603    $5,330    $5,240
Interest expense                             2,417     2,357     2,262     2,204
Provision for loan losses                      100       110        --       100
Noninterest income                             647       678       732       589
Noninterest expense                          2,524     2,564     2,558     2,294
Income tax expense                             483       467       476       474
                                            ------    ------    ------    ------

Net income                                  $  817    $  783    $  766    $  757
                                            ======    ======    ======    ======

Net income per common share:
   Basic and assuming dilution              $  .21    $  .20    $  .20    $  .19
                                            ======    ======    ======    ======

                                       32
<PAGE>

                                            Fourth    Third     Second    First
                                            ------    ------    ------    ------
1997:                                 
Interest income                             $5,166    $4,911    $4,356    $4,083
Interest expense                             2,149     1,986     2,124     2,087
Provision for loan losses                      184       541       100       107
Noninterest income                             459       485       366       370
Noninterest expense                          1,961     1,643     1,864     1,468
Income tax expense                             614       547       249       310
                                            ------    ------    ------    ------
                                      
Net income                                  $  717    $  679    $  385    $  481
                                            ======    ======    ======    ======
                                      
Net income per common share           
   Basic and assuming dilution              $  .18    $  .17       N/A       N/A
                                            ======    ======    ======    ======

18.  FAIR VALUES OF FINANCIAL INSTRUMENTS

Statement of Financial  Accounting  Standards No. 107,  "Disclosures  about Fair
Value of Financial  Instruments"  (SFAS No. 107),  requires  the  disclosure  of
estimated  fair values for  financial  instruments.  Quoted  market  prices,  if
available,  are  utilized  as  an  estimate  of  the  fair  value  of  financial
instruments. Because no quoted market prices exist for a significant part of the
Company  financial  instruments,  the fair  value of such  instruments  has been
derived  based on  management's  assumptions  with  respect  to future  economic
conditions,  the amount and timing of future cash flows and  estimated  discount
rates  with  respect  to future  economic  conditions,  the amount and timing of
future cash flows and estimated  discount  rates.  Different  assumptions  could
significantly  affect these  estimates.  Accordingly,  the net realizable  value
could be materially  different from the estimates  presented below. In addition,
the estimates are only indicative of individual  financial  instruments'  values
and should not be  considered  an  indication  of the fair value of the  Company
taken as a whole.

Fair values have been  estimated  using data which  management  considers as the
best available,  and estimation  methodologies deemed suitable for the pertinent
category of financial instrument.  The estimation methodologies,  resulting fair
values,  and recorded  carrying  amounts at September 30, 1998 and 1997, were as
follows:

Cash and cash  equivalents  are by definition  short-term and do not prevent any
unanticipated  credit  issues.  Therefore,  the carrying  amount is a reasonable
estimate of fair value.  The estimated fair values of investment  securities and
mortgage  backed  securities  are  provided  in  Notes 3 and 4 to the  financial
statements. These are based on quoted market prices, when available. If a quoted
market  price is not  available,  fair value is estimated  using  quoted  market
prices for similar securities.

The fair value of the net loan  portfolio has been  estimated  using the present
value of  expected  cash flows,  discounted  at an interest  rate  adjusted  for
servicing costs and giving consideration to estimated prepayment risk and credit
loss factors, as follows:

<TABLE>
<CAPTION>
                               1998                             1997
                             Estimated        Carrying        Estimated        Carrying
                            Fair Value         Amount        Fair Value         Amount
                          --------------   -------------   --------------   -------------

<S>                       <C>              <C>             <C>              <C>          
1 - 4 family mortgages    $  107,101,833   $ 105,059,149   $   92,301,373   $  90,080,092
Consumer                      47,905,877      48,414,917       48,442,139      48,942,499
Non-residential               71,524,965      71,524,965       58,762,314      58,762,314
                          --------------   -------------   --------------   -------------

                          $  226,532,675   $ 224,999,031   $  199,505,826   $ 197,784,905
                          ==============   =============   ==============   =============
</TABLE>

                                       33
<PAGE>

The  fair  value of  deposit  liabilities  with no  stated  maturities  has been
estimated to equal the carrying amount (the amount payable on demand),  totaling
$50,271,086  and  $43,955,573 at September 30 1998 and 1997,  respectively.  The
fair value  estimates  for these  products do not reflect the benefits  that the
Bank receives from the low-cost,  long-term funding they provide. These benefits
are considered significant.

The fair value of  certificates  of deposits and advances  from the Federal Home
Loan Bank is  estimated by  discounting  the future cash flows using the current
rates  offered  for  similar  deposits  and  advances  with the  same  remaining
maturities.  The carrying  value and estimated  fair values of  certificates  of
deposit and Federal Home Loan Bank  advances at September  30, 1998 and 1997 are
as follows:

                                                      1998              1997
                                                  ------------      ------------
Certificates of deposits:
   Carrying amount                                $155,363,999      $131,160,215
   Estimated fair value                           $156,426,259      $131,780,748

Advances for Federal Home Loan Bank:
   Carrying amount                                $  9,500,000      $ 11,000,000
   Estimated fair value                           $  9,500,000      $ 11,000,595

The carrying amount of repurchase  agreements  approximates  the fair value. The
interest rate on these  agreements is a floating rate based on the Federal funds
daily rate.

There is no material  difference  between the carrying amount and estimated fair
value of off-balance sheet items totaling $33,513,397 in 1998 and $32,962,010 in
1997, which are primarily comprised of unfunded loan commitments.

The Company's  remaining  assets and  liabilities  are not considered  financial
instruments.

                                       34
<PAGE>

<TABLE>
<CAPTION>
                               BOARD OF DIRECTORS
<S>                               <C>                          <C>
DR. FREDERICK H. HOWDY            LINLEY H. GIBBS, JR.         EDMUND T. BUCKMAN, JR.
CHAIRMAN                          VICE CHAIRMAN                Retired
President                         Retired                      Washington, NC
Drs. Freshwater and Howdy, P.A.   Washington, NC
Washington, NC

FREDERICK N. HOLSCHER             CHARLES E. PARKER, JR.       MARSHALL T. SINGLETON
Partner                           Vice President               Co-Owner
Rodman, Holscher, Francisco &     Robinson Insurance Agency    B. E. Singleton & Sons
  Peck, P.A.                      New Bern, NC                 Washington, NC
Washington, NC
                                  THOMAS A. VANN
                                  President
                                  NewSouth Bank
                                  Washington, NC


                               EXECUTIVE OFFICERS

THOMAS A. VANN                    JACK L. ASHLEY               JOHN B. BURGESS
President                         Executive Vice President     Executive Vice President
                                  Branch Administration and    Credit Administration
                                  Operations

WILLIAM L. WALL                   JOSEPH C. DUNN               MARY R. BOYD
Executive Vice President          Senior Vice President        Vice President
Chief Financial Officer and       Commercial Lending           Loan Servicing
Secretary

SHERRY L. CORRELL                 KRISTIE W. HAWKINS           WALTER P. HOUSE
Vice President                    Treasurer                    Vice President
Deposit Administration            Controller                   Mortgage Operations

                                  WILLIAM R. OUTLAND
                                  Vice President
                                  Consumer Lending

                         NEWSOUTH BANK OFFICE LOCATIONS
 
CORPORATE OFFICE                  KINSTON                      WASHINGTON
1311 Carolina Avenue              827 Hardee Road              1311 Carolina Avenue
Washington,  NC  27889            252-522-9466                 252-946-4178
252-946-4178
                                  NEW BERN                     300 North Market Street
FULL-SERVICE BRANCH OFFICES       202 Craven Street            252-946-4178
                                  252-636-2997
ELIZABETH CITY                                                 Operations Center
604 East Ehringhaus Street        1725 Glenburnie Road         239 West Main Street
252-335-0848                      252-636-2997                 252-946-4178

GREENVILLE                        ROCKY MOUNT
301 East Arlington Blvd.          300 Sunset Avenue
252-321-2600                      252-972-9661
</TABLE>

                                       35
<PAGE>

                             STOCKHOLDER INFORMATION

CORPORATE HEADQUARTERS
   NewSouth Bancorp, Inc.                               Telephone:  252-946-4178
   1311 Carolina Avenue                                       Fax:  252-946-3873
   Washington,  NC  27889

STOCK LISTING INFORMATION
The  Company's  common  stock trades on the Nasdaq Stock Market under the symbol
NSBC.

STOCK PRICE INFORMATION
The  following  table sets forth the high and low trade  price  information  and
dividends  declared per share for the periods  indicated.  The Company's  common
stock began trading on April 8, 1997.

         Quarter Ended                 High        Low       Dividends Declared
         -------------                 ----        ---       ------------------
         June 30, 1997        (1)    $16.667     $13.333          $.067
         September 30, 1997   (1)     20.75       16.167           .067

         December 31, 1997    (1)     22.417      19.25            .067
         March 31, 1998       (1)     23.167      19.333           .067
         June 30, 1998        (1)     23.667      21.333           .067
         September 30, 1998   (1)     23.333      21.25            .07
         ---------------
         (1) Adjusted for three-for-two stock split on August 19, 1998.

REGISTRAR AND TRANSFER AGENT
Inquiries regarding stock transfer,  registration,  lost certificates or changes
in name and  address  should be  directed to the stock  registrar  and  transfer
agent:

         Registrar and Transfer Company
         10 Commerce Drive
         Cranford,  New Jersey  07016
         (800) 866-1340

FORM 10-K
The Company's annual report on Form 10-K, filed with the Securities and Exchange
Commission,  is available to shareholders without charge by writing:  William L.
Wall,  Chief  Financial  Officer,  NewSouth  Bancorp,  Inc.,  P.  O.  Box  2047,
Washington, NC 27889.

INVESTOR INFORMATION
Shareholders,  investors,  and analysts interested in additional information may
contact William L. Wall, Chief Financial Officer, NewSouth Bancorp, Inc.

ANNUAL MEETING
The Annual  Meeting of  shareholders  of  NewSouth  Bancorp,  Inc.  will be held
Thursday,  February  18, 1999 at 1:00 p.m. at the main office of NewSouth  Bank,
1311 Carolina Avenue, Washington, North Carolina.

<TABLE>
<CAPTION>
<S>                              <C>                                    <C>
GENERAL COUNSEL                  SPECIAL COUNSEL                        INDEPENDENT ACCOUNTANTS
Rodman, Holscher, Francisco &    Housley, Kantarian & Bronstein, P.C.   PricewaterhouseCoopers LLP
  Peck, P.A.                     Suite 700                              Suite 2300
320 North Market Street          1220 19th Street, N.W.                 150 Fayetteville Street Mall
Washington,  NC  27889           Washington,  DC  20036                 Raleigh,  NC  27601
</TABLE>

                                       36