1997 Annual Report

NewSouth Bancorp
----------------

<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                                    19

Board of Directors                                                            31

Executive Officers                                                            31

NewSouth Bank Office Locations                                                31

Stockholder Information                                                       32

<PAGE>

                             LETTER TO STOCKHOLDERS

To Our Stockholders:

This was a landmark year in the history of NewSouth Bank. We celebrated our 95th
anniversary and converted to a publicly-held company. The public offering of 2.9
million shares marked the beginning of NewSouth Bancorp, now the holding company
of  NewSouth  Bank.  The  enthusiastic   response  to  the  stock  offering  was
encouraging  and, as a community  bank,  the  interest  from local  investors in
eastern North  Carolina was  impressive.  We are proud to have our new investors
join our depositors, directors and employees as members of NewSouth Bank.

We converted to a public company  because your Board of Directors and management
team  recognized  that in order to be properly  positioned  in the  marketplace,
NewSouth  Bank needed to become a  community  bank.  With the  banking  industry
consolidating  more  and  more  each  day,  NewSouth  Bank  recognized  that  an
opportunity  was  unfolding to serve its customers and at the same time position
itself for future success.

While  the  conversion  to a  publicly-held  company  was  undoubtedly  our most
significant  event  of the  past  year,  our  commitment  to  community  banking
continued  unabated.  At  year-end  September  30,  1997,  our assets  were $249
million,  loans  receivable  totaled  $198  million and  deposits  totaled  $175
million. We are also proud to report that our capital exceeded $57 million.

Consumer and commercial  lending has become  increasingly  important to NewSouth
Bank.  As a community  bank,  we have focused our attention on lending and other
services  where  we  think  the  greatest   opportunities  exist  for  community
businesses.  We have  expanded the number of personnel  involved in consumer and
commercial lending in order to better serve our customers.

Total consumer and commercial loan portfolios grew this year from $79 million to
$112 million,  an increase of 42%. Again,  much of this increase is attributable
to our approach to relationship business.

New deposit product lines such as free checking for  individuals  over fifty and
expanded business  checking  accounts helped us experience  remarkable growth in
customer checking accounts. Checking accounts grew by $10 million or 37%.

As we look into the future, we believe the opportunities are vast. As we take up
the challenge of growing NewSouth Bank,  excellent  service and a broad range of
competitive  products as well as a direct  involvement in our  communities  will
continue to guide our endeavors.  The course set this past year provides a solid
foundation for the future of NewSouth Bank.

With  gratitude  for  the  support  of  investors  and  customers  as  well as a
recognition  of the  significant  commitment  of  our  employees,  officers  and
directors, we look forward with confidence and a determination to become eastern
North Carolina's premier community bank.

                                   Sincerely,

                                   /s/Tom Vann

                                   Tom Vann
                                   President

                                        1
<PAGE>

           SELECTED CONSOLIDATED FINANCIAL INFORMATION AND OTHER DATA

<TABLE>
<CAPTION>
                                                              September 30,
                                          ----------------------------------------------------
                                            1997       1996       1995       1994       1993
                                          --------   --------   --------   --------   --------
                                                             (In thousands)
Selected Financial Condition Data
---------------------------------
<S>                                       <C>        <C>        <C>        <C>        <C>     
Total assets                              $249,281   $194,139   $177,704   $165,996   $146,012
Loans receivable, net                      197,785    155,681    144,541    135,679    118,536
Cash and investment securities              18,856     16,684      4,788      5,817      6,477
Mortgage-backed securities                  24,818     14,797     22,285     18,535     16,083
Deposits                                   175,116    171,213    153,457    131,592    103,645
Borrowings                                  12,621      1,040      4,000     16,500     26,500
Stockholders' equity                        57,856     18,347     17,688     15,620     13,383

Selected Operations Data
------------------------
Interest income                           $ 18,515   $ 15,349   $ 14,385   $ 11,811   $ 10,462
                                          --------   --------   --------   --------   --------
Interest expense                             8,346      8,105      7,344      5,204      4,524
Net interest income                         10,169      7,244      7,041      6,607      5,938
Provision for loan losses                      931        511         20        210        548
Noninterest income                           1,685      1,833      1,502      1,652      3,006
Noninterest expenses                         6,941      7,295      5,660      4,801      3,738
                                          --------   --------   --------   --------   --------
Income before income taxes                   3,982      1,271      2,863      3,248      4,658
Income taxes                                 1,719        451        998      1,011      2,065
                                          --------   --------   --------   --------   --------
Net income                                $  2,263   $    820   $  1,865   $  2,237   $  2,593
                                          ========   ========   ========   ========   ========
Earnings per share (1)                    $    .53   $     --   $     --   $     --   $     --
                                          ========   ========   ========   ========   ========
Dividends declared per share              $    .20   $     --   $     --   $     --   $     --
                                          ========   ========   ========   ========   ========

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

Performance Ratios:
Return on average assets                      1.00%       .45%      1.07%      1.28%      1.93%
Return on average equity                      6.57       4.45      11.17      13.38      19.17
Interest rate spread                          4.10       3.72       3.84       4.25       4.67
Net interest margin                           4.67       4.12       4.21       4.48       4.46
Average earning assets to average
  interest-bearing liabilities              115.00     108.52     108.40     106.58     107.44
Ratio of noninterest expense to average
  total assets                                3.06       3.97       3.26       3.08       2.56

Quality Ratios:
Nonperforming assets to total assets           .53%       .62%       .42%       .31%       .62%
Nonperforming loans to total loans             .49        .66        .47        .25        .77
Loan loss reserves to total loans             1.64       1.51       1.30       1.46       1.56
Loan loss reserves to nonperforming
  loans                                     337.03     227.37     275.62     583.19     202.30
Provision for loan losses to total loans       .47        .32        .01        .15        .46

Capital Ratios:
Equity to total assets, end of period        23.23%      9.45%      9.95%      9.41%      9.17%
Average equity to average assets             15.17      10.05       9.61       9.54       9.10

Other Data:
Full service offices                             8          8          8          6          6
Loans serviced for others                 $253,647   $253,682   $229,635   $205,141   $161,674
</TABLE>

--------------------
(1)  Applies to net income of $1,395,899  earned for the period April 8, 1997 to
     September 30, 1997.

                                        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 that the Bank can be more effective
in servicing its customers than many of its nonlocal  competitors because of the
Bank's ability to quickly and  effectively  provide  responses 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  State  of  North  Carolina  Office  of  The
Commissioner  of Banks (the  "Commissioner").  Savings  banks  which  convert to
commercial  banks are  required to have at least 15%  liquidity  pursuant to the
conversion guidelines adopted by the Commissioner. The Bank's liquidity ratio at
September  30, 1997, as computed  under such  regulations,  was 16.0%.  Prior to
converting to a commercial bank, the Bank was required to maintain liquid assets
equal to at least 10% of total assets.  The Bank's liquidity ratio was 13.6% for
the year ended September 30, 1996.

     The Bank's  primary  sources of funds are deposits,  principal and interest
payments on loans, proceeds from the sale of loans 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 general interest rates,  economic
conditions and local competition.

     The primary  investing  activities of the Bank have been the origination of
loans  and the  purchase  of  investment  securities.  During  the  years  ended
September 30, 1997 and 1996,  the Bank had loan  originations  of $143.7 million
and $130.2 million, respectively.  During the years ended September 30, 1997 and
1996, the Bank purchased investment securities of $2.0 million and $6.0 million,
respectively. The primary financing activities of the Bank are the attraction of
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, 1997 and 1996,
cash and cash equivalents totaled $15.8 million and $8.6 million,  respectively.
The Bank has other sources of liquidity if a need for  additional  funds arises.
During the years ended September 30, 1997 and 1996, the Bank sold loans totaling
$31.7 million and $53.0 million,  respectively.  At September 30, 1997, the Bank
had $11.0 million

                                        3
<PAGE>

of FHLB  advances,  compared to no advances at September  30, 1996. At September
30, 1997, the Bank had $1.6 million of retail repurchase agreements, compared to
$1.0  million  at  September  30,  1996.  Other  sources  of  liquidity  include
investment  and  mortgage-backed  securities  designated  as available for sale,
which totaled $27.9 million at September 30, 1997 and $22.9 million at September
30, 1996.

     At September 30, 1997  stockholders'  equity was $57.8 million  compared to
$18.3  million at  September  30,  1996,  reflecting  current  earnings  and net
proceeds received from the stock conversion. 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").  Net income for the year ended  September  30, 1997 was $2.3  million,
compared to $820,000 for the year ended September 30, 1996.

     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  banking  regulatory
agencies. The Bank's stand-alone equity was $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 of the  capital  requirements  of both  the  Commissioner  and  the  FDIC at
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.

     Management's  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, 1997, the Bank had $16.4 million of
commercial business loans and $49.9 million of consumer loans, which amounted to
7.7% and 23.3%,  respectively,  of the Bank's gross loan portfolio,  compared to
6.0% and 21.5%,  respectively,  at September 30, 1996. In managing its portfolio
of  investment  and  mortgage-backed  securities,  the Bank has  emphasized  the
purchase of  short-term  securities,  to reduce it's  exposure to  increases  in
interest  rates. At September 30, 1997, the Bank had $25.1 million of loans held
for sale,  compared to $21.6 million at September  30, 1996.  The Bank had $27.9
million of investment and mortgage-backed securities classified as available for
sale at September 30, 1997, compared to $22.9 million at September 30, 1996. 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.

     The Bank has  shortened  the  average  repricing  period  of its  assets by
emphasizing  the  origination  of  short-term   fixed-rate  or   adjustable-rate
residential  mortgage loans. At September 30, 1997, the Bank held  approximately
$50.4 million of adjustable-rate  residential  mortgage loans, which represented
approximately 23.5% of the Bank's

                                        4
<PAGE>

gross loan portfolio, compared to $45.6 million at September 30, 1996. Depending
on  conditions  existing  at a given  time,  as part of its  interest  rate risk
management strategy,  the Bank may sell newly originated fixed-rate  residential
mortgage loans in the secondary market.

Interest Rate Sensitivity Analysis

     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, 1997.

Table 1 - Projected Change in NPV

                                  Net Portfolio Value
 Change                ------------------------------------------
in Rates               $ Amount        $ Change          % Change
--------               --------        --------          --------
                                 (Dollars in thousands)  
                                                         
+ 400  bp              $ 52,361        $(13,527)          (20.5)%
+ 300  bp                56,048          (9,840)          (14.9)
+ 200  bp                59,735          (6,153)           (9.3)
+ 100  bp                62,812          (3,076)           (4.7)
Base                     65,888            --               --
- 100  bp                67,682           1,794             2.7
- 200  bp                69,475           3,587             5.4
- 300  bp                71,058           5,170             7.8
- 400  bp                72,640           6,752            10.2
                                                        
     Table 1 indicates  that at September  30, 1997,  in the event of sudden and
sustained  increases in prevailing  market interest rates,  the Bank's estimated
NPV would be expected to decrease, and that in the event of sudden and sustained
decreases in prevailing market interest rates, the Bank's estimated NPV would be
expected to increase. At September 30, 1997, 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.

     Certain  shortcomings  are inherent in the method of analysis  presented in
the   computation  of  estimated  NPV.  Actual  values  may  differ  from  those
projections set forth in Table 1 should market  conditions vary from assumptions
used in preparing the table.  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

                                        5
<PAGE>

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. Finally,
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-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,
                                    -------------------------------------------------------------
                                         1997     vs.     1996           1996    vs.    1995
                                    ------------------------------  -----------------------------
                                      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 ...............  $2,509  $ 133   $  24   $2,666  $ 660   $ 246   $ 13   $  919
  Investment securities ..........       3     12      --       15    215     (19)   (28)     168
  Mortgage-backed securities .....     292    (15)     (3)     274   (184)     21     (3)    (166)
  Other interest-earning assets ..     668   (161)   (297)     210     57     (12)    (2)      43
                                    ------  -----   -----   ------  -----   -----   ----   ------
    Total interest-earning assets    3,472    (31)   (276)   3,165    748     236    (20)     964
                                    ------  -----   -----   ------  -----   -----   ----   ------
Interest expense:
  Deposits .......................   1,261   (958)   (154)     149    791     481     57    1,329
  FHLB advances ..................      74    (11)     (6)      57   (591)     32    (26)    (585)
  Other interest-bearing
    liabilities ..................      20      8       7       17     48      (2)   (29)      17
                                    ------  -----   -----   ------  -----   -----   ----   ------
     Total interest-bearing
       liabilities ...............   1,355   (961)   (153)     241    248     511      2      761
                                    ------  -----   -----   ------  -----   -----   ----   ------
Change in net interest income ....  $2,117  $ 930   $(123)  $2,924  $ 500   $(275)  $(22)  $  203
                                    ======  =====   =====   ======  =====   =====   ====   ======
</TABLE>

                                        6
<PAGE>

TABLE 3 - YIELD/COST ANALYSIS

<TABLE>
<CAPTION>
                                                                            Year Ended September 30,
                                             ------------------------------------------------------------------------------------
                                                         1997                          1996                         1995
                                             --------------------------    -------------------------    -------------------------
                                                                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                          $176,311  $16,097   9.13%     $148,538  $13,431   9.04%    $141,088  $12,511   8.87%
   Investment securities                        5,287      326   6.17         5,236      311   5.94        2,090      143   6.84
   Mortgage-backed securities                  20,832    1,521   7.30        16,881    1,247   7.39       19,404    1,413   7.28
   Other interest-earning assets               15,249      571   3.75         5,349      361   6.75        4,539      318   7.01
                                             --------  -------   ----      --------  -------   ----     --------  -------   ----
     Total interest-earning assets            217,679   18,515   8.51       176,004   15,350   8.72      167,121   14,385   8.61
                                                       -------                       -------                      -------
Non-interest-earning assets                     9,311                         7,579                        6,587
                                             --------                      --------                     --------
     Total assets                            $226,990                      $183,583                     $173,708
                                             ========                      ========                     ========
Interest-bearing liabilities:
   Deposits                                  $184,672    8,088   4.38      $159,304    7,939   4.98     $142,283    6,610   4.65
   FHLB advances                                3,400      202   5.94         2,250      145   6.44       11,833      730   6.17
   Other interest-bearing liabilities           1,218       56   4.60           629       21   3.34           48        4   8.33
                                             --------  -------   ----      --------  -------   ----     --------  -------   ----
     Total interest-bearing liabilities       189,290    8,346   4.41       162,183    8,105   5.00      154,164    7,344   4.76
                                                       -------                       -------                      -------
Non-interest-bearing liabilities                3,265                         2,958                        2,848
                                             --------                      --------                     --------
   Total liabilities                          192,555                       165,141                      157,012
   Stockholders' equity                        34,435                        18,442                       16,696
                                             --------                      --------                     --------
     Total liabilities and retained income   $226,990                      $183,583                     $173,708
                                             ========                      ========                     ========
Net interest income                                    $10,169                       $ 7,245                      $ 7,041
                                                       =======                       =======                      =======
Interest rate spread (1)                                         4.10%                         3.72%                        3.85%
                                                                 ====                          ====                         ====
Net yield on interest-earning assets (2)                         4.67%                         4.12%                        4.21%
                                                                 ====                          ====                         ====
Ratio of average interest-earning assets
   to average interest bearing liabilities                     115.00%                       108.52%                      108.40%
                                                               ======                        ======                       ======
</TABLE>

-----------------------------------------
(1)  Represents  the  difference  between the average yield on  interest-earning
     assets and the average cost of interest bearing liabilities.
(2)  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 income for the three years
ended  September  30,  1997,  1996,  and 1995 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, 1997 and 1996

     Total assets  increased  28.4% to $249.3 million at September 30, 1997 from
$194.1 million at September 30, 1996. Assets invested in mortgage,  consumer and
commercial loans (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%  between the periods,  to $27.9 million at September 30, 1997
from $22.9 million at September  30, 1996.  The increase in assets was supported
by the net proceeds  received  from the stock  conversion.  On April 7, 1997 the
Company  issued  2,909,500  shares of common stock and received  $42.5  million,
which represents the actual net proceeds from the stock offering, including $3.5
million in shares purchased by the ESOP.

     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.

     Total  residential  real estate  mortgage  loans  increased  7.8% to $102.2
million at September 30, 1997 from $94.8 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.  Commercial  real estate loans  increased  47.4% to $46.0
million at  September  30, 1997 from $31.2  million at September  30, 1996,  and
commercial business loans increased 59.2% to $16.4 million at September 30, 1997
from  $10.3  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 $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,  as the Bank  continues  to place an
emphasis on structuring itself as a commercial banking entity.

     Deposits for the current  fiscal year  increased by 2.3%, to $175.1 million
at September 30, 1997 from $171.2 million at September 30, 1996. During the year
ended September 30, 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, and the ratio of average equity to

                                        8
<PAGE>

average  assets  increased  to 15.2% for the year ended  September  30,1997 from
10.1% for the year ended September 30, 1996. During the year ended September 30,
1997, the Company declared two quarterly cash dividends at $0.10 each,  totaling
$582,000. 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.

     The Company's note  receivable  from the ESOP was $3.1 million at September
30,  1997 and is  reported as a reduction  of  stockholders's  equity.  The note
requires an annual  $349,000  principal  payment plus interest at prime plus one
percent.  Although  repayment of the note is secured solely by 232,760 shares of
common stock of the Company  purchased  by the ESOP (8% of the shares  issued in
the stock conversion),  the Bank expects to make discretionary  contributions to
the ESOP in amounts at least equal to the principal and interest payments on the
ESOP note.

     During the year ended September 30, 1997, the Management  Recognition  Plan
Trust  ("MRP")  established  for the benefit of  directors  and  officers of the
Company and the Bank,  purchased  77,700 shares of the Company's common stock in
the open market at a $26.39 average cost per share totaling $2.1 million.  These
shares are being held in trust for future awards and are reported as a reduction
in stockholders' equity. The MRP is expected to purchase up to 116,380 shares of
the Company's common stock (4% of the shares issued in the stock  conversion) in
the open market.

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  reasons for this increase are the results of investing the
net  proceeds  of  the  stock   conversion  into  earning  assets,   as  average
interest-earning assets increased by $41.7 million, or 23.7% during fiscal 1997,
which is discussed below.

     Interest Income.  Interest income  increased by $3.2 million,  or 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 the
increase  in the volume of average  interest-earning  assets . Interest on loans
increased by $2.7 million,  or 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 the year ended September 30, 1997
increased by $241,000,  or 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 $25.4 million,  or
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.  As  previously
discussed,  approximately $11.8 million of deposits were withdrawn by depositors
to purchase shares of the Company's common stock.

     Net Interest  Income.  Net interest  income  increased by $3.0 million,  or
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  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  $931,000 and $511,000 for loan losses during the
years ended September 30, 1997 and 1996, respectively.  The increased 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
$3.2 million at  September  30, 1997  compared to $2.4 million at September  30,
1996, 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 1.6% at September 30, 1997 compared
to 1.5% at September 30, 1996.

     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

                                        9
<PAGE>

generally and delinquent loan accounts are analyzed individually, on a quarterly
basis. Consideration is given to the account status, payment history, ability to
repay and probability of repayment, and loan-to-value  percentages.  As a result
of this review and analysis,  loans are classified in the 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 0.5% at  September  30, 1997 and 0.7% at
September 30, 1996.

     Noninterest  Income.  Noninterest  income totaled $1.7 million for the year
ended September 30, 1997 and $1.8 million for the year ended September 30, 1996.
Noninterest 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  decreased  to  $124,000  for fiscal  1997 from
$423,000 for fiscal 1996,  as the volume of loans sold during 1997  decreased to
$31.7  million  for 1997 from $53.0  million for 1996.  Servicing  fee income on
loans serviced for others was $613,000 for 1997 compared to $632,000 for 1996.

     Noninterest Expense.  Noninterest expenses decreased 5.5% in fiscal 1997 to
$6.9 million,  from $7.3 million in fiscal 1996.  The ratio of these expenses to
gross income  decreased to 34.4% for fiscal 1997 from 42.4% 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 $614,000 in benefits expense incurred
with the  establishment  of 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.

Comparison of Financial Condition at September 30, 1996 and 1995

     Total assets  increased  9.2% to $194.1  million at September 30, 1996 from
$177.7 million at September 30, 1995. Assets invested in mortgage,  consumer and
commercial loans (net of loans-in-process, deferred fees and loan loss reserves)
increased by 7.7%, to $155.7  million at September 30, 1996 from $144.5  million
at September 30, 1995.  Investment  securities  and  mortgage-backed  securities
decreased by 9.5% between the periods,  to $22.9  million at September  30, 1996
from $25.3 million at September 30, 1995.

     Total  residential  real  estate  mortgage  loans  decreased  7.1% to $94.8
million at  September  30,  1996 from  $102.1  million at  September  30,  1995.
Consumer loans increased 26.1% to $37.4 million at September 30, 1996 from $29.7
million at September 30, 1995.  Commercial  real estate loans increased 42.4% to
$31.2  million at September  30, 1996 from $21.9  million at September 30, 1995,
and commercial business loans increased 179.3% to $10.3 million at September 30,
1996 from $3.7  million at  September  30, 1995.  During  fiscal 1996,  the Bank
originated $76.3 million of residential real estate mortgage loans,  compared to
$59.2  million of such  originations  during  fiscal  1995.  The Bank sold $53.0
million of real estate  loans  during  fiscal  1996,  compared to $43.6  million
during fiscal 1995.  Loans  serviced for others  increased to $253.7  million at
September 30, 1996 from $229.6  million at September 30, 1995.  Commercial  real
estate,  commercial  business and consumer loan originations  increased 57.5% to
$53.8 million during fiscal 1996 from $34.2 million during fiscal 1995.

                                       10
<PAGE>

     Deposits for the period  increased by 11.6%, to $171.2 million at September
30,  1996 from  $153.5  million at  September  30,  1995.  The number of deposit
accounts grew to 15,404 at September 30, 1996 from 13,794 at September 30, 1995.
Total  capital for the period  increased by 3.7%,  to $18.3 million at September
30, 1996 from $17.7 million at September  30, 1995.  At September 30, 1996,  the
ratio of capital to total assets was 9.5%,  compared to 10.0% at  September  30,
1995.

Comparison of Operating Results for the Years Ended September 30, 1996 and 1995

     Net Income.  Net income  decreased by $1.0 million to $820,000 for the year
ended  September  30, 1996 from $1.9  million for the year ended  September  30,
1995.  The  principal  reasons  for this  decrease  are the results of a special
assessment on deposit insurance premiums, increased provisions for possible loan
losses and accelerated  depreciation  on certain fixed assets,  all of which are
discussed below.

     Interest  Income.  Interest income  increased  $964,000,  or 6.7%, to $15.3
million  for fiscal  1996 from $14.4  million  for fiscal  1995.  This  increase
resulted from an increase in interest income on loans and investments and higher
yields due to a rising interest rate environment. Interest on loans increased by
$920,000,  or 7.2%, to $13.4 million in fiscal 1996 from $12.5 million in fiscal
1995. This increase was due to a 17 basis point increase in the average yield on
loans to 9.04% for fiscal 1996 from 8.87% for fiscal 1995.  In  addition,  there
was an increase  of $7.5  million in the  average  balance of loans  outstanding
between the two periods.  The average  yield on total  average  interest-earning
assets of $176.0  million was 8.7% for 1996 compared to an 8.6% average yield on
$167.1 million of total average interest earning assets for 1995.

     Interest  Expense.  Interest  expense for the year ended September 30, 1996
increased by $761,000,  or 10.4%, to $8.1 million,  from $7.3 million for fiscal
1995. The increase resulted from a rise in general market interest rates and was
also  influenced  by an increase  in the volume of  deposits.  Average  deposits
increased $17.0 million, or 11.9%, to $159.3 million for fiscal 1996 from $142.3
million  for fiscal  1995.  The  average  cost of  interest-bearing  liabilities
increased  to 5.0% for 1996  from 4.8% for 1995,  and  average  interest-bearing
liabilities  increased to $162.2 million for fiscal 1996 from $154.2 million for
fiscal 1995.

     Net Interest Income. Net interest income increased by $203,000, or 2.9%, to
$7.2 million for the year ended  September  30, 1996,  from $7.0 million for the
year ended September 30, 1995.

     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  $511,000 and $20,000 for loan losses during the
years ended  September 30, 1996 and 1995,  respectively.  The allowance for loan
losses was $2.4  million at  September  30,  1996  compared  to $1.9  million at
September  30, 1995.  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, 1996
compared to 1.3% at September 30, 1995. The increased  provisions were necessary
to  support  the growth  and risks  associated  with the  emphasis  placed  upon
commercial and consumer lending. The ratio of nonperforming loans to total loans
was 0.7% at September 30, 1996 and 0.5% at September 30, 1995.

     Noninterest  Income.  Noninterest  income totaled $1.8 million for the year
ended September 30, 1996 and $1.5 million for the year ended September 30, 1995.
Noninterest income consists of fees and service charges earned on loans, service
charges on deposit  accounts,  gains for sale of loans, and other  miscellaneous
income.  Gains from sales of loans  increased  to $423,000  for fiscal 1996 from
$312,000 for fiscal 1995, as the volume of loans sold increased to $53.0 million
for 1996 from $43.6 million for 1995. Servicing fee income on loans serviced for
others increased to $632,000 for fiscal 1996 from $582,000 for fiscal 1995.

     Noninterest Expense. Noninterest expenses increased 28.9% in fiscal 1996 to
$7.3 million,  from $5.7 million in fiscal 1995.  The ratio of these expenses to
gross  income was 42.4% in fiscal  1996  compared to 35.6% in fiscal  1995.  The
largest single  component of these expenses,  compensation  and fringe benefits,
increased 4.0% in fiscal 1996 to $3.6 million from $3.4 million for fiscal 1995.
These increases are a result of the growth in personnel and management  required
to support the 16.9% growth in assets from  September  30, 1994 to September 30,
1996.

                                       11
<PAGE>

     Federal deposit  insurance  premiums  increased by $995,000 to $1.3 million
for the year ended September 30, 1996 from $305,000 for the year ended September
30, 1995. During the year ended September 30, 1996, the Bank incurred a one-time
FDIC assessment of $946,000 to capitalize the SAIF insurance fund up to required
reserve  ratios.  The  assessment  was based  upon  65.7  cents per $100 of SAIF
deposits  as of March  31,  1995.  During  fiscal  1996,  the Bank has also paid
continuing  SAIF  insurance  premiums  at a rate of 23  cents  per  $100 of SAIF
deposits.  However,  that rate will drop to 6.4 cents per $100 effective January
1, 1997  through  December 31, 1999 and to 2.4 cents per $100  thereafter.  This
revised  deposit  insurance  rate  structure will enable the Bank to recognize a
substantial reduction in deposit insurance premiums going forward.

     Premises and  equipment  expense  increased by $255,000 to $798,000 for the
year ended  September 30, 1996 from $543,000 for September 30, 1995.  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  decreased to $451,000 for
fiscal 1996 from $998,000 for fiscal 1995. The Bank's  effective income tax rate
was 35.4% for the year  ended  September  30,  1996 and 34.9% for the year ended
September 30, 1995.

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.

Impact of Recent Accounting Standards

     The Company  prepares its  consolidated  financial  statements  and related
disclosures  in conformity  with  standards  established  by, among others,  the
Financial  Accounting  Standards Board ("FASB").  The FASB frequently issues new
rules  and  proposed  new  rules  for  companies  to apply  to  their  reporting
activities.  The following discussion addresses such changes as of September 30,
1997 that will affect the Company's future reporting.

     The  Accounting   Standards  Division  of  the  AICPA  approved  SOP  93-6,
"Employers'  Accounting  for Employee Stock  Ownership  Plans," which applies to
shares of capital stock of sponsoring employers acquired by ESOP plans. SOP 93-6
changed the measure of compensation  recorded by employers from the cost of ESOP
shares to the fair value of employee stock ownership plan shares.  To the extent
that the fair value of the ESOP  shares,  committed  to be released  directly to
compensate  employees,  differs  from  the  cost  of such  shares,  compensation
expenses and a related  charge or credit to additional  paid-in  capital will be
reported in the Company's financial statements.

     The FASB has issued  Statement of Financial  Accounting  Standards  No. 125
('SFAS No. 125"),  "Accounting  for Transfers and Servicing of Financial  Assets
and Extinguishments of Liabilities". SFAS No. 125 is effective for transfers and
servicing of financial assets and extinguishments of liabilities occurring after
December 31, 1996 and is applied prospectively.  This statement requires,  among
other  things,  the  Company to record at fair  value,  assets  and  liabilities
resulting from a transfer of financial  assets.  In December 1996,  SFAS No. 127
was issued which deferred the effective  date of certain  provisions of SFAS No.
125  related  to   repurchase   agreements,   securities   lending  and  similar
transactions  until January 1, 1998. The Company  adopted the provisions of SFAS
No. 125 as of January 1, 1997 and the adoption did not have a material effect on
the Company's reported financial condition or results of operations.

     The FASB has issued SFAS No. 128, "Earnings Per Share",  which is effective
for financial statements issued for periods ending after December 15, 1997. SFAS
No. 128  establishes  standards for computing and presenting  earnings per share
("EPS") and  replaces the  presentation  of primary EPS with a  presentation  of
basic EPS. It requires dual presentation of basic and diluted EPS on the face of
the consolidated statement of income and the reconciliation of the numerator and
denominator of the basic EPS computation to the numerator and denominator

                                       12
<PAGE>

of the  diluted  EPS  computation.  Earlier  application  is not  permitted  but
disclosure of pro forma EPS amounts computed using the standards  established by
SFAS No. 128 is  permitted  in the notes to  financial  statements  for  periods
ending  prior to the  effective  date.  See Note l to the Notes to  Consolidated
Financial Statements for additional information.

     The FASB  has  issued  SFAS  No.  130,  "Reporting  Comprehensive  Income",
effective  for  the  fiscal  year  ending  September  30,  1999.  SFAS  No.  130
establishes standards for reporting and displaying  comprehensive income and its
components in a full set of general-purpose financial statements. Management has
not yet determined the effect, if any, of adopting SFAS No. 130.

     The FASB has  issued  SFAS  No.  131,  "Disclosures  About  Segments  of an
Enterprise  and  Related  Information",  effective  for the fiscal  year  ending
September 30, 1999. SFAS No. 131 specifies revised guidelines for determining an
entity's operating  segments and the type and level of financial  information to
be disclosed.  Management does not expect that the adoption of SFAS No. 131 will
have a material impact on the Company's consolidated financial statements.

                                       13
<PAGE>

REPORT OF INDEPENDENT ACCOUNTANTS

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

We have audited the accompanying  consolidated statements of financial condition
of NewSouth Bancorp,  Inc. and Subsidiary as of September 30, 1997 and 1996, and
the related  consolidated  statements of operations,  stockholders'  equity, and
cash flows for each of the three years in the period ended  September  30, 1997.
These financial  statements are the responsibility of the Company's  management.
Our responsibility is to express an opinion on these financial  statements based
on our audits.

We  conducted  our  audits  in  accordance  with  generally   accepted  auditing
standards.  Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements.  An audit also includes
assessing the  accounting  principles  used and  significant  estimates  made by
management,  as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion,  the consolidated  financial  statements  present fairly, in all
material respects, the consolidated financial position of NewSouth Bancorp, Inc.
and Subsidiary at September 30, 1997 and 1996, and the  consolidated  results of
their  operations and their cash flows for each of the three years in the period
ended  September 30, 1997,  in conformity  with  generally  accepted  accounting
principles.

/s/ Coopers & Lybrand L.L.P.

Coopers & Lybrand L.L.P.
Raleigh, North Carolina
October 17, 1997

                                       14
<PAGE>

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
NewSouth Bancorp, Inc. and Subsidiary
September 30, 1997 and 1996

<TABLE>
<CAPTION>
ASSETS                                                                1997           1996
                                                                      ----           ----
<S>                                                              <C>            <C>         
Cash and due from banks                                          $  3,027,271   $  2,811,326
Interest-bearing deposits in financial institutions                12,744,980      5,765,251
Investment securities - available for sale                          3,083,422      8,106,581
Mortgage-backed securities - available for sale                    24,818,412     14,797,424
Loans receivable, net:
    Held for sale                                                  25,055,845     21,627,590
    Held for investment                                           172,729,060    134,053,705
Premises and equipment, net                                         2,818,167      2,900,421
Income taxes receivable                                                     -        385,373
Deferred income taxes                                                 821,863        223,983
Real estate owned                                                     357,503        178,509
Federal Home Loan Bank of Atlanta stock, at cost
    which approximates market                                       1,287,500      1,287,500
Accrued interest receivable                                         1,847,346      1,382,569
Prepaid expenses and other assets                                     689,828        618,921
                                                                 ------------   ------------
               Total assets                                      $249,281,197   $194,139,153
                                                                 ============   ============

LIABILITIES AND STOCKHOLDERS' EQUITY

Deposits:
    Demand                                                       $ 37,500,216   $ 27,334,469
    Savings                                                         6,455,357      7,019,797
    Time                                                          131,160,215    136,859,020
                                                                 ------------   ------------
               Total deposits                                     175,115,788    171,213,286

Borrowed money                                                     12,621,120      1,039,608
Accrued interest payable                                               91,915         67,939
Income taxes payable                                                  457,498              -
Advance payments by borrowers for property taxes and insurance        182,731        383,517
Other liabilities                                                   2,956,558      3,088,232
                                                                 ------------   ------------
               Total liabilities                                  191,425,610    175,792,582

Commitments and contingencies (Notes 4, 9, 10, 13 and 16)

Common stock, $.01 par value, 8,000,000 shares authorized,
    2,909,500 shares issued and outstanding                            29,095              -
Additional paid-in capital                                         42,654,054              -
Retained earnings, substantially restricted                        20,041,635     18,306,036
Unearned ESOP shares, 207,932 shares                               (3,118,984)             -
Unawarded MRP shares, at cost                                      (2,050,531)             -
Unrealized gain on available for sale securities, net                 300,318         40,535
                                                                 ------------   ------------
               Total stockholders' equity                          57,855,587     18,346,571
                                                                 ------------   ------------
               Total liabilities and stockholders' equity        $249,281,197   $194,139,153
                                                                 ============   ============
</TABLE>

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

                                       15
<PAGE>

CONSOLIDATED STATEMENTS OF OPERATIONS
NewSouth Bancorp, Inc. and Subsidiary
years ended September 30, 1997, 1996 and 1995

<TABLE>
<CAPTION>
                                                                       1997         1996         1995
                                                                       ----         ----         ----
Interest income:
<S>                                                                <C>          <C>          <C>        
    Interest and fees on loans                                     $16,096,914  $13,430,797  $12,511,035
    Interest and dividends on investments and deposits               2,418,451    1,918,876    1,874,173
                                                                   -----------  -----------  -----------
               Total interest income                                18,515,365   15,349,673   14,385,208
                                                                   -----------  -----------  -----------

Interest expense:
    Interest on deposits                                             8,088,144    7,939,014    6,610,023
    Interest on borrowings                                             258,084      166,438      733,993
                                                                   -----------  -----------  -----------
               Total interest expense                                8,346,228    8,105,452    7,344,016
                                                                   -----------  -----------  -----------

Net interest income before provision for loan losses                10,169,137    7,244,221    7,041,192
Provision for loan losses                                              931,078      511,000       20,000
                                                                   -----------  -----------  -----------
               Net interest income                                   9,238,059    6,733,221    7,021,192
                                                                   -----------  -----------  -----------

Other income:
    Loan fees and service charges                                      752,470      552,169      402,054
    Loan servicing fees                                                613,353      631,866      581,844
    Gain on sale of real estate, net                                    32,190       33,628       64,513
    Gain on sale of mortgage loans and mortgage-backed securities      124,066      423,113      312,325
    Other income                                                       162,893      191,768      141,613
                                                                   -----------  -----------  -----------
               Total other income                                    1,684,972    1,832,544    1,502,349
                                                                   -----------  -----------  -----------

General and administrative expenses:
    Compensation and fringe benefits                                 4,603,764    3,569,144    3,431,537
    Federal insurance premiums                                          88,165      353,585      304,802
    Insurance fund special assessment                                        -      946,020            -
    Premises and equipment                                             377,468      798,119      542,840
    Advertising                                                        181,016      102,762       93,634
    Payroll and other taxes                                            311,290      286,949      259,786
    Other                                                            1,379,348    1,238,180    1,027,622
                                                                   -----------  -----------  -----------
               Total general and administrative expenses             6,941,051    7,294,759    5,660,221
                                                                   -----------  -----------  -----------

Income before income taxes                                           3,981,980    1,271,006    2,863,320

Income taxes                                                         1,719,350      450,517      998,080
                                                                   -----------  -----------  -----------
Net income                                                         $ 2,262,630  $   820,489  $ 1,865,240
                                                                   ===========  ===========  ===========
Net income per common share (1)                                    $       .53
                                                                   ===========
Weighted average shares outstanding (1)                              2,641,289
                                                                   ===========
</TABLE>

(1) Calculated from date of conversion, see Notes 1 and 2.

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

                                       16
<PAGE>

CONSOLIDATED STATEMENTS OF STOCKHOLDER EQUITY
NewSouth Bancorp, Inc. and Subsidiary
years ended September 30, 1997, 1996 and 1995

<TABLE>
<CAPTION>
                                                                                                            Unrealized
                                                                                                              gain on
                                                                    Retained                                 Available
                                                    Additional      Earnings      Unearned     Unawarded      For Sale
                                           Common     Paid-in    Substantially      ESOP          MRP        Securities
                                            Stock     Capital      Restricted      Shares        Shares          net       Total
                                           -------  -----------    -----------   -----------   -----------    --------  -----------
<S>                                        <C>      <C>            <C>           <C>           <C>            <C>       <C>        
Balance at September 30, 1994              $     -  $         -    $15,620,307   $         -   $         -    $      -  $15,620,307

Adjustment to October 1, 1994 balance for
 change in method of accounting
    for securities, net of taxes                 -            -             -              -             -      46,431       46,431
Change in unrealized gains on securities
 available-for sale, net of  taxes               -            -             -              -             -     156,091      156,091
Net income as restated                           -            -      1,865,240             -             -           -    1,865,240
                                           -------  -----------    -----------   -----------   -----------    --------  -----------

Balance at September 30, 1995                    -            -     17,485,547             -             -     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             -             -           -      820,489
                                           -------  -----------    -----------   -----------   -----------    --------  -----------

Balance at September 30, 1996                    -            -     18,306,036             -             -      40,535   18,346,571

Issuance of shares of common stock          29,095   42,423,041              -    (3,491,400)            -           -   38,960,736
Net income                                       -            -      2,262,630             -             -           -    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 ($.20 per share)                       -            -       (527,031)            -             -           -     (527,031)
Release of ESOP shares                           -      231,013              -       372,416             -           -      603,429
                                           -------  -----------    -----------   -----------   -----------    --------  -----------
Balance September 30, 1997                 $29,095  $42,654,054    $20,041,635   $(3,118,984)  $(2,050,531)   $300,318  $57,855,587
                                           =======  ===========    ===========   ===========   ===========    ========  ===========
</TABLE>

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

                                       17
<PAGE>

CONSOLIDATED STATEMENTS OF CASH FLOWS
NewSouth Bancorp, Inc. and Subsidiary
years ended September 30, 1997, 1996 and 1995

<TABLE>
<CAPTION>
                                                                        1997           1996           1995
                                                                        ----           ----           ----
Operating activities:
<S>                                                                <C>            <C>            <C>         
    Net income                                                     $  2,262,630   $    820,489   $  1,865,240
    Adjustments to reconcile net income to net cash
      provided by (used in) operating activities:
        Provision for loan losses                                       931,078        511,000         20,000
        Depreciation                                                    147,927        449,104        228,684
        ESOP compensation                                               603,429              -              -
        Accretion of discounts on securities                             24,263         19,918            123
        Provision for deferred income taxes                            (765,372)      (440,704)      (241,196)
        Gain on disposal of premises and equipment and
          real estate acquired in settlement of loans                   (33,506)       (36,293)       (64,432)
        Gain on sale of mortgage loans and
          mortgage-backed securities                                   (139,405)      (423,113)      (312,325)
        Originations of loans held for sale, net                    (35,004,100)   (55,047,196)   (47,101,448)
        Proceeds from sale of loans held for sale                    13,190,353     51,656,899     37,707,880
        Other operating activities                                     (248,415)       636,375        560,847
                                                                   ------------   ------------   ------------
               Net cash used in operating activities                (19,031,118)    (1,853,521)    (7,336,627)
                                                                   ------------   ------------   ------------
Investing activities:
        Proceeds from maturities of securities available for sale     7,000,000              -              -
        Purchases of investment securities                           (2,000,000)    (6,043,438)    (3,001,857)
        Proceeds from principal repayments and sales of
          mortgage-backed securities available-for-sale               8,914,741      8,832,521      2,877,591
        Loan originations, net of principal repayments of
          loans held for investment                                 (40,566,654)    (9,827,513)    (5,580,606)
        Proceeds from maturities of securities held-to-maturity               -      1,000,000      1,000,000
        Proceeds from disposal of premises and equipment and
          real estate acquired in settlement of loans                   815,117        238,564        282,474
        Redemptions (purchases) of FHLB stock                                 -              -        (38,400)
        Purchases of premises and equipment                             (66,057)      (351,588)      (594,301)
                                                                   ------------   ------------   ------------
               Net cash used in investing activities                (25,902,853)    (6,151,454)    (5,055,099)
                                                                   ------------   ------------   ------------
Financing activities:
        Net increase in deposit accounts                              3,902,502     17,756,258     21,864,747
        Proceeds from FHLB borrowings                                49,000,000     24,000,000     42,000,000
        Repayments of  FHLB borrowings                              (38,000,000)   (28,000,000)   (54,500,000)
        Net proceeds from issuance of stock                          38,960,736              -              -
        MRP funding                                                  (2,050,531)             -              -
        Cash dividends paid                                            (264,574)             -              -
        Net change in repurchase agreements                             581,512      1,039,608              -
                                                                   ------------   ------------   ------------
               Net cash provided by financing activities             52,129,645     14,795,866      9,364,747
                                                                   ------------   ------------   ------------

Increase (decrease) in cash and cash equivalents                      7,195,674      6,790,891     (3,026,979)

Cash and cash equivalents, beginning of year                          8,576,577      1,785,686      4,812,665
                                                                   ------------   ------------   ------------

Cash and cash equivalents, end of year                             $ 15,772,251   $  8,576,577   $  1,785,686
                                                                   ============   ============   ============

Supplemental disclosures:
    Real estate acquired in settlement of loans                    $    960,221   $    296,690   $    110,636
    Exchange of loans for mortgage-backed securities               $ 18,524,209   $  1,545,859   $  6,288,164
    Transfers to securities available-for-sale                     $         -    $ 16,140,485   $          -
    Cash paid for interest                                         $  8,322,252   $  8,100,128   $  7,384,085
    Cash paid for income taxes                                     $  1,673,000   $  1,327,315   $    904,222
    Dividends declared, not paid                                   $    262,457   $          -   $          -
</TABLE>

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

                                       18
<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NewSouth Bancorp Inc. and Subsidiary

Note 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  (See Note 2).  The
Bank is regulated by the Federal Deposit Insurance Corporation and the Office of
The Commissioner of Banks of the state of North Carolina.

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.

The significant policies are summarized below:

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, 1997,  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  originated and serviced by the issuers of the
securities.  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 are deferred,  as well as certain direct loan origination
costs.  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  historical
effective interest rate, while all  collateral-dependent  loans are measured for
impairment based on the fair value of the collateral.  At September 30, 1997 and
1996 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.

                                       19
<PAGE>

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 both September 30,
1997 and 1996, the Bank owned 12,875 shares of the FHLB's $100 par value capital
stock.

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.

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.

                                       20
<PAGE>

Net Income Per Common Share

Net income per common share is computed on the basis of weighted  average number
of shares of common stock  outstanding,  excluding  unallocated  ESOP shares and
unawarded MRP shares. Net income per common share for 1997 of $.53 is calculated
by  dividing  net income for the period  April 8, 1997 to  September  30,  1997,
$1,395,900,   by  the  number  of  weighted   average  shares  of  common  stock
outstanding.

The Company will adopt Statement of Financial  Accounting Standards ("SFAS") No.
128, "Earnings Per Share", on October 1, 1997. SFAS No. 128 requires the Company
to change its method of computing,  presenting and disclosing earnings per share
information. Upon adoption, all prior periods data presented will be restated to
conform to the  provisions  of SFAS No. 128. If the Company had adopted SFAS No.
128 for the period ending September 30, 1997, there would have been no effect on
earnings  per  share,  as  the  Company  had  no  common  stock  equivalents  or
convertible securities outstanding during the period.

Reclassifications

Certain  items  included  in the 1996 and 1995  financial  statements  have been
reclassified to conform to the 1997 presentation.  These  reclassifications have
no effect on the net income or retained earnings previously reported.

New Accounting Pronouncements

The Company  adopted SFAS No. 125,  "Accounting  for  Transfers and Servicing of
Financial  Assets and  Extinguishments  of  Liabilities" on January 1, 1997. The
impact of adopting this statement is not material to the Company's  consolidated
financial statements.

The Company will adopt 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 will adopt 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.

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.

Note 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  2,909,500  shares  of  common  stock,  including  232,760  issued to the
Employee Stock  Ownership Plan ("ESOP"),  par value $.01 per share,  for $15 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.  NewSouth Bank
opened for business  the first day under that name on April 8, 1997.  The common
stock of the Company  began trading on the NASDAQ  National  Market System under
the symbol "NSBC" on April 8, 1997.

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.

                                       21
<PAGE>

Note 3 - Investment Securities

Investment securities at September 30, 1997 and 1996 are classified as available
for sale according to management's intent and summarized as follows:

                                              Gross Unrealized        Estimated
                             Amortized      ---------------------       Market
                                Cost          Gains       Losses         Value
                             ----------     --------     --------     ----------
1997:                    
    U.S. Treasury notes      $3,000,897     $ 82,525     $      -     $3,083,422
                             ==========     ========     ========     ==========
1996:                                                                
                                                                     
    U.S. Treasury notes      $5,025,160     $ 81,421     $      -     $5,106,581
    State and political                                              
      Subdivisions            3,000,000            -            -      3,000,000
                             ----------     --------     --------     ----------
                             $8,025,160     $ 81,421     $      -     $8,106,581
                             ==========     ========     ========     ==========
                                                           
All  investment  securities  at  September  30, 1997 will mature  after one year
through five years.                     
                                       
Investment securities with a carrying value of $5,000,000 were sold during 1997,
resulting in no realized gain or loss.

Note 4 - Mortgage-Backed Securities

Mortgage-backed  securities  at September  30, 1997 and 1996 are  classified  as
available for sale according to management's intent and summarized as follows:

                                               Gross Unrealized       Estimated
                               Amortized     --------------------       Market
                                 Cost         Gains      Losses         Value
                              -----------    --------    --------    -----------
1997:                       
    FHLMC participation     
    certificates, maturing  
    from years 2003 to 2027   $24,406,887    $463,942    $ 52,417    $24,818,412
                              ===========    ========    ========    ===========
1996:                       
    FHLMC participation     
    certificates, maturing  
    from years 2006 to 2022   $14,812,070    $143,156    $157,802    $14,797,424
                              ===========    ========    ========    ===========


Mortgage-backed  securities at September 30, 1997 will  contractually  mature on
the following schedule:

                                                                    Estimated
                                                 Amortized            Market
                                                    Cost              Value
                                                -----------        -----------
Due after five years through ten years          $ 4,221,949        $ 4,269,920
Due after ten years                              20,184,938         20,548,492
                                                -----------        -----------
                                                $24,406,887        $24,818,412
                                                ===========        ===========

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

Mortgage-backed  securities with a carrying value of $6,607,924,  $5,566,420 and
$776,757 were sold during the years ended  September 30, 1997,  1996,  and 1995,
respectively.  Gross gains realized on the sales of  mortgage-backed  securities
were $688, $146,723 and $6,112 during 1997, 1996 and 1995,  respectively.  Gross
realized losses on sales of mortgage-backed  securities were $15,339,  $0 and $0
during 1997, 1996 and 1995, respectively.

Mortgage-backed securities with a carrying value of approximately $1,594,000 and
$2,089,000  were  pledged as  collateral  for deposits  from public  entities at
September 30, 1997 and 1996, respectively.

                                       22
<PAGE>

Note 5 - Loans Receivable

Loans receivable at September 30, 1997 and 1996 are summarized as follows:

                                        1997                1996
                                        ----                ----
Mortgage loans                      $102,154,361        $ 94,813,285 
Consumer loans                        49,889,347          37,422,945
Commercial loans                      62,438,748          41,496,450
                                    ------------        ------------
               Total                 214,482,456         173,732,680
Less:                                                 
    Loans in process                 (12,716,819)        (15,244,463)
    Allowance for loan losses         (3,249,352)         (2,351,309)
    Deferred loan fees                  (731,380)           (455,613)
                                    ------------        ------------
Loans receivable, net               $197,784,905        $155,681,295
                                    ============        ============

At September  30, 1997,  the Bank had entered into a security  agreement  with a
blanket  floating  lien pledging its eligible real estate loans to secure actual
or potential borrowings from the Federal Home Loan Bank of Atlanta (See Note 9).

During 1997, 1996 and 1995, the Bank exchanged loans with outstanding  principal
balances of  $18,524,209,  $1,545,859  and  $6,288,164,  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, 1997 and 1996, are fixed rate mortgage loans with an estimated  market value
of approximately $25,100,000 and $21,600,000, respectively.

Net  gains on sales of loans  receivable  held for sale  amounted  to  $138,717,
$276,390 and $306,213  during the years ended September 30, 1997, 1996 and 1995,
respectively.

The changes in the allowance  for loan losses for the years ended  September 30,
1997, 1996 and 1995 are as follows:

                                        1997            1996            1995
                                        ----            ----            ----
Balance at beginning of year        $2,351,309      $1,876,954      $1,977,327
Provisions for loan losses             931,078         511,000          20,000
Loans charged off                      (71,904)        (62,559)       (122,000)
Recoveries                              38,869          25,914           1,627
                                    ----------      ----------      ----------
Balance at end of year              $3,249,352      $2,351,309      $1,876,954
                                    ==========      ==========      ==========

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

                                                       1997            1996
                                                       ----            ----
Loans contractually past due 90 days or more
  and/or on nonaccrual status:
Residential                                         $1,214,189      $1,022,521
Consumer and commercial                                 48,233          11,358
                                                    ----------      ----------
Balance at end of year                              $1,262,422      $1,033,879
                                                    ==========      ==========

During the years ended  September 30, 1997,  1996 and 1995,  interest  income of
approximately  $48,000,  $44,000 and  $23,000,  respectively,  was not  recorded
related to loans accounted for on a nonaccrual basis.

                                       23
<PAGE>

Note 6 - Premises and Equipment

Premises and equipment at September 30, 1997 and 1996 consist of the following:

                                                   1997              1996
                                                   ----              ----
Land                                           $  935,560        $  935,560
Office buildings                                2,488,976         2,488,976
Furniture, fixtures and equipment               1,067,858         1,073,120
Vehicles                                          225,041           174,343
                                               ----------        ----------
                                                4,717,435         4,671,999
Less accumulated depreciation                   1,899,268         1,771,578
                                               ----------        ----------
               Total                           $2,818,167        $2,900,421
                                               ==========        ==========

Note 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,  1997,  1996  and  1995  were  $96,000,  $137,000  and  $123,154,
respectively.

Effective  July 1, 1995, 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.  Prior to
July 1, 1995, the Company  maintained a profit sharing 401(k) plan. The expenses
related  to the  Company's  contributions  to these  plans for the  years  ended
September  30,  1997,   1996  and  1995  were  $52,253,   $46,171  and  $37,074,
respectively.

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, 1997,  1996 and 1995  aggregated  $515,435,
$463,250 and $582,022,  respectively. The plans generally include provisions for
forfeitures of unvested portions of payments,  and vesting in the event of death
or disability.  During 1996 it was  discovered  that the accrual for these plans
was understated as of September 30, 1995. The effect of this  understatement was
that other  liabilities were  understated by $270,000,  deferred tax assets were
understated  by $100,000,  income taxes  payable were  overstated by $30,000 and
income was  overstated  by $140,000 as of  September  30, 1995.  The  previously
reported  financial  results  for the year ended  September  30,  1995 have been
restated for the effect of this error.

In  conjunction  with  the  initial  public  offering,  the  Company's  Board of
directors approved a Management Recognition Plan for director and key employees.
The Company is  authorized  to fund the  acquisition  and award of up to 116,380
shares  (4% of  shares  issued  in the  stock  conversion)  to be  awarded  by a
committee of the board of directors.  Compensation  expense will be based on the
fair  market  value of the  shares at the award date and  recognized  during any
vesting period. As of September 30, 1997, 77,700 shares have been acquired at an
aggregate cost of $2,050,531, and no shares have been awarded.

Note  8 - Employee Stock Ownership Plan

The Company's  Board of Directors has 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  232,760  shares of the  Company's  common  stock
financed by $3,491,400  in  borrowings  by the ESOP from the Company.  This loan
will be secured by the shares of Common Stock purchased and earnings thereon. At
September 30, 1997, 24,828 shares have been allocated to participants'  accounts
and  207,932  shares,  with an  estimated  market  value of  $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.

                                       24
<PAGE>

The principal balance of the ESOP loan was $3,118,984 at September 30, 1997. 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, 1997 include compensation expense of $603,429 related to the ESOP.

Note 9 - 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  6.17%  and  0.0% and  totaled  $11,000,000  and $0 at
September 30, 1997 and 1996, respectively.

At September 30, 1997 and 1996, repurchase agreements  outstanding had a rate of
4.67% and 4.31% and totaled $1,621,120 and $1,039,608, respectively.

Repurchase  agreements are collateralized by U.S.  government agency obligations
with a principal balance of $2,000,000.

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,
1997,  the Company had an additional  $14,000,000  of credit  available with the
Federal Home Loan Bank of Atlanta.

Note 10 - Income Taxes

The components of income taxes for the years ended  September 30, 1997, 1996 and
1995 are as follows:

                                      1997            1996           1995
                                      ----            ----           ----
Current:
    Federal                       $1,908,576      $ 766,558      $1,034,106
    State                            576,146        124,663         205,170
                                  ----------      ---------      ----------
    Total current                  2,484,722        891,221       1,239,276
                                  ----------      ---------      ----------
Deferred:
    Federal                         (617,976)      (360,903)       (211,224)
    State                           (147,396)       (79,801)        (29,972)
                                  ----------      ---------      ----------
    Total deferred                  (765,372)      (440,704)       (241,196)
                                  ----------      ---------      ----------
Total                             $1,719,350      $ 450,517      $  998,080
                                  ==========      =========      ==========

Reconciliations of expected income tax at the statutory Federal rate of 34% with
income tax expense for the years ended  September 30, 1997, 1996 and 1995 are as
follows:

                                                  1997       1996       1995
                                                  ----       ----       ----
Expected income tax expense                   $1,353,873  $432,142   $973,529
State income taxes net of federal
  income tax benefit                             147,000    26,671    115,631
Non-deductible ESOP and other expenses           206,000         -          -
Rehabilitation credit                                  -         -    (28,666)
Other                                             12,477    (8,296)   (62,414)
                                              ----------  --------   --------
                                              $1,719,350  $450,517   $998,080
                                              ==========  ========   ========

                                       25
<PAGE>

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

                                                           1997          1996
                                                           ----          ----
Deferred income tax assets:
    Deferred directors' fees                           $  346,328     $ 317,186
    Bad debt reserve                                      782,302       331,007
    Deferred employee benefits                            363,925       263,009
    Other                                                  26,382             -
                                                       ----------     ---------
                                                        1,518,937       911,202
                                                       ----------     ---------
Deferred income tax liabilities:                                    
    Loans mark-to-market adjustment                      (235,757)     (405,771)
    Depreciation and amortization                         (91,306)      (85,354)
    Unrealized gains on securities available-for-sale    (193,732)      (26,240)
    Deferred loan origination fees and costs              (76,929)      (47,519)
    FHLB stock                                            (99,350)      (99,434)
    Other                                                       -       (22,901)
                                                       ----------     ---------
                                                         (697,074)     (687,219)
                                                       ----------     ---------
Net deferred income tax asset (liability)              $  821,863     $ 223,983
                                                       ==========     =========

Retained  income at September 30, 1997,  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,  however 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.

Note 11 - 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, 1997,  that the Bank meets all capital  adequacy
requirements to which it is subject.

As of September 30, 1997, 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.

                                       26
<PAGE>

The  Company's  actual  capital  amounts and ratios as of September 30, 1997 and
1996 are also presented in the table below (dollars in thousands).

<TABLE>
<CAPTION>
                                                                          To Be Well Capitalized
                                                            For Capital        Under Prompt
                                           Actual        Adequacy Purposes  Action Provisions
                                      ---------------    -----------------  -----------------
                                       Amount   Ratio      Amount   Ratio     Amount   Ratio
                                      -------   -----     -------   -----    -------   -----
1997:
Total Capital (to Risk Weighted
<S>                                   <C>        <C>      <C>        <C>     <C>        <C>  
    Weighted Assets)                  $59,684    34.8%    $13,719    8.0%    $17,149    10.0%
Tier I Capital (to Risk Weighted                                             
    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%
                                                                             
1996:                                                                        
Total Capital (to Risk Weighted                                              
    Weighted Assets)                  $19,954    15.2%    $10,484    8.0%    $13,155    10.0%
Tier I Capital (to Risk Weighted                                             
    Weighted Assets)                   18,306     9.6%      7,625    4.0%      7,893     6.0%
Tier I Capital (to Average                                                   
    Assets)                            18,306    14.0%      5,242    4.0%      9,534     5.0%
</TABLE>
                                                                     
Note 12 - Mortgage Banking Activities

Mortgage  loans  serviced  for  others  are  not  included  in the  accompanying
consolidated statements of condition.  The unpaid principal balances of mortgage
loans serviced for others was  $253,646,909  and  $253,681,978  at September 30,
1997 and 1996,  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.

Effective  January 1, 1997,  the Company  adopted SFAS No. 125  "Accounting  for
Transfers   and   Servicing  of  Financial   Assets  and   Extinguishements   of
Liabilities".  At September 30, 1997,  mortgage servicing rights reported in the
consolidated  statements  of  condition,  net of  amortization,  were  equal  to
$57,525.

Note 13 - Financial  Instruments  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  nonperformance  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.

A summary of the  contractual  amounts of the Company's  exposure to off-balance
sheet risk as of September 30, 1997 and 1996 is as follows:

<TABLE>
<CAPTION>
                                                                1997           1996
                                                                ----           ----
Commitments to extend credit:
<S>                                                         <C>            <C>        
    Commitments to originate loans                          $13,070,715    $ 9,179,693
    Undrawn balances on lines of credit and undrawn
      balances on credit reserves (overdraft protection)     19,889,495     16,899,367
                                                            -----------    -----------
                                                            $32,960,210    $26,079,060
                                                            ===========    ===========
</TABLE>

                                       27
<PAGE>

Included in the commitments to originate loans as of September 30, 1997 and 1996
are  fixed  interest  rate  loan   commitments  of  $6,722,340  and  $7,367,788,
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.

Note 14 - Parent Company Financial Data

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

Condensed Balance Sheet

Cash                                                           $     23,383 
Due from subsidiary                                              18,220,854
Investment in wholly-owned subsidiary                            39,941,603
                                                               ------------
               Total assets                                    $ 58,185,840
                                                               ============
Deferred income taxes                                          $     57,800
Other liabilities                                                   300,946
Shareholders' equity                                             57,827,094
                                                               ------------
               Total liabilities and shareholders' equity      $ 58,185,840
                                                               ============
Condensed Statement of Income                                  
                                                               
Interest income, net                                           $    159,006
Other income                                                      1,570,050
Miscellaneous expenses                                              333,156
                                                               ------------
               Net income                                      $  1,395,900
                                                               ============
Condensed Statement of Cash Flows                              
                                                               
    Operating activities:                                      
       Net income                                              $  1,395,900
       Adjustments to reconcile net income to                  
          net cash provided by operating activities:           
          Deferred income taxes                                      57,800
          ESOP compensation                                         603,429
          Increase in other liabilities                             300,946
                                                               ------------
               Net cash provided by operating activities          2,358,075
                                                               ------------
    Investing activities:                                      
       Investment in, and advances to, subsidiary               (38,980,323)
                                                               ------------
               Net cash used by investing activities            (38,980,323)
                                                               ------------
    Financing activities:                                      
       Net proceeds from issuance of stock                       38,960,736
       MRP funding                                               (2,050,531)
       Dividends                                                   (264,574)
                                                               ------------
               Net cash provided by financing activities         36,645,631
                                                               ------------
    Net increase in cash                                             23,383
                                                               
    Cash at beginning of the year                                         0
                                                               ------------
    Cash at the end of year                                    $     23,383
                                                               ============

                                       28
<PAGE>

Note 15 - Quarterly Financial Data (Unaudited)

Summarized  unaudited  quarterly financial data for the year ended September 30,
1997 is as follows:

                                                       1997
                                  ----------------------------------------------
                                    Fourth      Third       Second      First
                                  ----------  ----------  ----------  ----------
Interest income                   $5,165,935  $4,910,713  $4,355,804  $4,082,913
Interest expense                   2,149,529   1,985,807   2,123,907   2,086,985
Provision for loan losses            183,500     541,000     100,000     106,578
Noninterest income                   458,623     484,603     366,550     370,209
Noninterest expense                1,960,736   1,642,952   1,864,310   1,468,066
Income tax expense                   613,650     546,800     248,600     310,300
                                  ----------  ----------  ----------  ----------
Net income                        $  717,143  $  678,757  $  385,537  $  481,193
                                  ==========  ==========  ==========  ==========
Net income per common share       $     0.27  $     0.25         N/A         N/A
                                  ==========  ==========

Note 16 - 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.   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  considered 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, 1997 and 1996, were as
follows:

     Cash and cash  equivalents are by definition  short-term and do not present
     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 2 and 3 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:

                                     1997                        1996
                          --------------------------  --------------------------
                            Estimated     Carrying      Estimated     Carrying
                           Fair Value      Amount      Fair Value      Amount
                          ------------  ------------  ------------  ------------
1 - 4 family mortgages    $ 92,301,373  $ 90,080,092  $ 80,982,405  $ 80,190,043
Consumer                    48,442,139    48,942,499    36,263,680    36,595,184
Non-residential             58,762,314    58,762,314    38,896,068    38,896,068
                          ------------  ------------  ------------  ------------
                          $199,505,826  $197,784,905  $156,142,153  $155,681,295
                          ============  ============  ============  ============

     The fair value of deposit  liabilities  with no stated  maturities has been
     estimated  to equal the  carrying  amount (the  amount  payable on demand),
     totaling $43,955,573 and $34,354,266 in 1997 and 1996, respectively.  Under
     Statement 107, the fair value of deposits with no stated  maturity is equal
     to the amount payable on demand.  Therefore,  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.

                                       29
<PAGE>

     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, 1997 and 1996 are as follows:

                                                       1997             1996
                                                       ----             ----
     Certificates of deposits:
       Carrying amount                             $131,160,215     $136,859,020
       Estimated fair value                         131,780,748      137,735,084
     
     Advances from Federal Home Loan Bank:
       Carrying amount                             $ 11,000,000                -
       Estimated fair value                          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  $32,962,010  in 1997 and
     $26,079,060  in 1996,  which  are  primarily  comprised  of  unfunded  loan
     commitments.

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

                                       30
<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

<CAPTION>
                               EXECUTIVE OFFICERS
<S>                                 <C>                         <C>
Thomas A. Vann                      John B. Burgess             William L. Wall
President                           Executive Vice President    Executive Vice President
                                    Credit Administration       Chief Financial Officer/Secretary

Jack L. Ashley                      Mary R. Boyd                Sherry L. Correll
Vice President                      Vice President              Vice President
Branch Administration and           Loan Servicing              Deposit Administration
Operations

Kristie W. Hawkins                  Walter P. House             William R. Outland
Treasurer                           Vice President              Vice President
Controller                          Mortgage Operations         Consumer Lending

<CAPTION>
                         NEWSOUTH BANK OFFICE LOCATIONS

<S>                                 <C>                         <C>
Corporate Office                    Kinston                     Washington
1311 Carolina Avenue                827 Hardee Road             1311 Carolina Avenue
Washington,  NC  27889              919-522-9466                919-946-4178
919-946-4178
                                    New Bern                    300 North Market Street
Full-Service Branch Offices         202 Craven Street           919-946-4178
                                    919-636-2997
Elizabeth City                                                  Operations Center
604 East Ehringhaus Street          1725 Glenburnie Road        239 West Main Street
919-335-0848                        919-636-2997                919-946-4178

Greenville                          Rocky Mount                 Mortgage Origination Office
301 East Arlington Blvd.            300 Sunset Avenue
919-321-2600                        919-972-9661                Wilmington
                                                                6800 Wrightsville Avenue
                                                                910-256-3626
</TABLE>
                                       31
<PAGE>
                             STOCKHOLDER INFORMATION

Corporate Headquarters
         NewSouth Bancorp, Inc.
         1311 Carolina Avenue
         Washington,  NC  27889

         Telephone: (919) 946-4178
               Fax: (919) 946-3873

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          $25.00      $20.00          $.10
         September 30, 1997     $31.125     $24.50          $.10

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 12, 1998 at 10:00 a.m. at the main office of NewSouth  Bank,
1311 Carolina Avenue, Washington, North Carolina.

<TABLE>
<S>                                 <C>                                        <C>
General Counsel                     Special Counsel                            Independent Auditors
Rodman, Holscher, Francisco &       Housley, Kantarian & Bronstein, P.C.       Coopers & Lybrand L.L.P.
  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>
                                       32
<PAGE>


     NewSouth Bancorp
     ----------------
     1311 Carolina Avenue
     P.O. Box 2047
     Washington, North Carolina  27889
     (919) 946-4178  Fax (919) 946-3873