SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                   -----------

                                    FORM 10-K

                        FOR ANNUAL AND TRANSITION REPORTS
                     PURSUANT TO SECTIONS 13 OR 15(d) OF THE
                         SECURITIES EXCHANGE ACT OF 1934

(Mark One)
[X]  ANNUAL REPORT  PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES  EXCHANGE
     ACT OF 1934

For the fiscal year ended September 30, 2000

                                       OR

[ ]  TRANSITIONAL  REPORT  PURSUANT  TO  SECTION  13 OR 15(d) OF THE  SECURITIES
     EXCHANGE ACT OF 1934

For the transition period from          to
                               --------    --------

                           Commission File No. 0-22219

                            FIRST SOUTH BANCORP, INC.
--------------------------------------------------------------------------------
             (Exact Name of Registrant as Specified in Its Charter)

           Virginia                                            56-1999749
-------------------------------                          -----------------------
(State or Other Jurisdiction of                             (I.R.S. Employer
Incorporation or Organization)                             Identification No.)

1311 Carolina Avenue, Washington, North Carolina               27889-2047
------------------------------------------------         -----------------------
(Address of Principal Executive Offices)                       (Zip Code)

       REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (252) 946-4178

          Securities registered pursuant to Section 12(b) of the Act:
                                      None

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

                     Common stock, par value $.01 per share
                     --------------------------------------
                                (Title of Class)

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

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

As of December 7, 2000,  the aggregate  market value of the 2,251,777  shares of
Common Stock of the registrant  issued and outstanding held by non-affiliates on
such date was  approximately  $52.1  million  based on the closing sale price of
$23.125  per share of the  registrant's  Common  Stock as  listed on the  Nasdaq
National Market. For purposes of this calculation, it is assumed that directors,
executive  officers and  beneficial  owners of more than 5% of the  registrant's
outstanding voting stock are affiliates.

Number of shares of Common Stock outstanding as of December 7, 2000:  3,101,559.

                       DOCUMENTS INCORPORATED BY REFERENCE

     The following lists the documents incorporated by reference and the Part of
the Form 10-K into which the document is incorporated:

     1.   Portions  of the Annual  Report to  Stockholders  for the fiscal  year
          ended September 30, 2000. (Parts II and IV)
     2.   Portions of Proxy  Statement for 2001 Annual Meeting of  Stockholders.
          (Part III)

<PAGE>

                                     PART I

ITEM 1. BUSINESS
----------------

GENERAL

     First South Bancorp,  Inc. (the "Company") is a Virginia  corporation  that
serves as the holding  company for First South Bank, a North Carolina  chartered
commercial bank (the "Bank"). The Company's principal business is overseeing the
business  of the Bank and  investing  the  portion  of the net stock  conversion
proceeds retained by it.

     First South Bank. The Bank is a North  Carolina-chartered  commercial  bank
headquartered  in Washington,  North Carolina and serves eastern North Carolina.
The Bank was chartered by the State of North Carolina in 1902 under the name The
Home Building and Loan  Association.  The Bank received federal insurance of its
deposits in 1959.  In 1992,  the Bank  converted  to a North  Carolina-chartered
savings  bank,  at which time it adopted the name Home Savings  Bank,  SSB. Upon
completion  of the bank  conversion  in  April  1997,  the  Bank  became a North
Carolina-chartered  commercial  bank and  adopted  the name  NewSouth  Bank.  In
December 1999, the Bank changed its name to First South Bank.

     The Bank's  principal  business  consists of  attracting  deposits from the
general public and investing  these funds in loans secured by first mortgages on
owner-occupied,  single-family  residences in the Bank's market area, commercial
real estate loans, commercial business loans and consumer loans.

     The Bank derives its income  principally  from interest earned on loans and
investments and, to a lesser extent,  loan servicing and other fees and gains on
the sale of loans and investments.  The Bank's  principal  expenses are interest
expense on deposits and borrowings and noninterest  expense such as compensation
and  employee  benefits,  office  occupancy  expenses  and  other  miscellaneous
expenses.  Funds for these  activities  are  provided  principally  by deposits,
repayments of outstanding loans and investments and operating revenues.

MARKET AREA

     Although the Company makes loans and obtains  deposits  throughout  eastern
North Carolina, the Company's primary market area consists of Beaufort,  Craven,
Cumberland,  Edgecombe,  Lenoir, Nash, Pasquotank,  Pitt and Robeson Counties in
North Carolina,  which are the counties in which the Bank's offices are located.
As of September 30, 2000,  management  estimates  that more than 95% of deposits
and 90% of loans came from its primary market area.

     The  economy of the  Company's  primary  market area is  diversified,  with
employment  distributed among manufacturing,  agriculture and  non-manufacturing
activities.  Major employers in the area include Weyerhaeuser  Company,  Dupont,
Abbott  Laboratories,  East Carolina University,  Pitt Memorial Hospital,  Kelly
Springfield Tire Company,  Fort Bragg, Pope Air Force Base,  Converse,  Campbell
Soup and Kaiser-Roth Hosiery. The unemployment rate in the Company's market area
is equivalent to the national average and the unemployment rate for the State of
North Carolina.

LENDING ACTIVITIES

     General.  The Company's  gross loan  portfolio  totaled  $372.3  million at
September 30, 2000,  representing  66.5% of total assets at that date. It is the
Company's policy to concentrate its lending within its market area. At September
30,  2000,  $135.6  million,  or 35.3% of the  Company's  gross loan  portfolio,
consisted  of   single-family,   residential   mortgage  loans.   The  Company's
construction  loans totaled $29.3 million,  or 7.6% of the Company's  gross loan
portfolio,  at September  30, 2000.  The Company also  originates a  significant
amount of commercial real estate loans.  At September 30, 2000,  commercial real
estate loans amounted to $103.0  million,  or 26.8% of the Company's  gross loan
portfolio.  In recent years, the Company has sought to increase  originations of
commercial business loans and consumer loans. At September 30, 2000,  commercial
business  loans  totaled  $34.9  million,  or 9.1% of the  Company's  gross loan
portfolio,  and consumer loans totaled $75.0 million,  or 19.5% of the Company's
gross  loan  portfolio.   To  a  lesser  extent,  the  Company  also  originates
multi-family residential and commercial real estate loans.

<PAGE>

     Loan Portfolio  Composition.  The following  table sets forth selected data
relating to the  composition  of the Company's loan portfolio by type of loan at
the dates indicated. At September 30, 2000, the Company had no concentrations of
loans exceeding 10% of gross loans other than as disclosed below.

<TABLE>
<CAPTION>
                                                                           At September 30,
                                   -------------------------------------------------------------------------------------------------
                                         2000                1999                1998                1997                1996
                                   ----------------    ----------------    ----------------    ----------------    -----------------
                                    Amount      %       Amount      %       Amount      %       Amount      %       Amount      %
                                   --------   -----    --------   -----    --------   -----    --------   -----    --------   -----
                                                                        (Dollars in thousands)
<S>                                <C>        <C>      <C>        <C>      <C>        <C>      <C>        <C>      <C>        <C>
Residential mortgage loans:
  Single-family residential .....  $135,572    35.3%   $ 62,422    27.2%   $ 91,546    37.8%   $ 67,959    31.7%   $ 58,576    33.7%
  Multi-family residential ......     6,747     1.7         379      .2         848      .4         946      .4         998      .6
  Construction ..................    29,332     7.6      25,809    11.3      27,817    11.5      33,249    15.5      35,240    20.3
                                   --------   -----    --------   -----    --------   -----    --------   -----    --------   -----
    Total residential mortgage
       loans ....................   171,651    44.6      88,610    38.7     120,211    49.7     102,154    47.6      94,814    54.6
                                   --------   -----    --------   -----    --------   -----    --------   -----    --------   -----

Commercial loans:
  Commercial real estate ........   103,027    26.8      68,403    29.9      51,480    21.3      45,990    21.4      31,168    17.9
  Commercial business ...........    34,914     9.1      21,106     9.2      21,823     9.0      16,449     7.7      10,328     6.0
                                   --------   -----    --------   -----    --------   -----    --------   -----    --------   -----
    Total commercial loans ......   137,941    35.9      89,509    39.1      73,303    30.3      62,439    29.1      41,496    23.9
                                   --------   -----    --------   -----    --------   -----    --------   -----    --------   -----

Consumer loans:
  Automobile ....................     5,718     1.5       4,291     1.9       4,575     1.9       4,611     2.2       4,185     2.4
  Savings account loans .........       997      .3         620      .3         470      .2         617      .3         549      .3
  Home equity loans .............    35,845     9.3      23,795    10.4      22,898     9.5      21,665    10.1      17,949    10.3
  Other .........................    32,442     8.4      22,141     9.6      20,443     8.4      22,996    10.7      14,740     8.5
                                   --------   -----    --------   -----    --------   -----    --------   -----    --------   -----
    Total consumer loans ........    75,002    19.5      50,847    22.2      48,386    20.0      49,889    23.3      37,423    21.5
                                   --------   -----    --------   -----    --------   -----    --------   -----    --------   -----
      Total .....................   384,594   100.0%    228,966   100.0%    241,900   100.0%    214,482   100.0%    173,733   100.0%
                                   --------   =====    --------   =====    --------   =====    --------   =====    --------   =====

Less:
  Loans in process ..............    12,322              13,102              12,930              12,717              15,245
  Deferred fees and discounts ...       903                 513                 606                 731                 456
  Allowance for loan losses .....     5,159               3,297               3,365               3,249               2,351
                                   --------            --------            --------            --------            --------
    Total .......................  $366,210            $212,054            $224,999            $197,785            $155,681
                                   ========            ========            ========            ========            ========
</TABLE>

<PAGE>

     Loan  Maturities.  The following  table sets forth certain  information  at
September  30,  2000  regarding  the  dollar  amount  of loans  maturing  in the
Company's  portfolio  based on their  contractual  terms to maturity,  including
scheduled repayments of principal. Demand loans, loans having no stated schedule
of repayments and no stated maturity,  and overdrafts are reported as due in one
year or less.  The table does not include  any  estimate  of  prepayments  which
significantly  shorten  the  average  life of  mortgage  loans and may cause the
Company's  repayment  experience to differ from that shown below.  Loan balances
are net of loans in process.

<TABLE>
<CAPTION>
                                          Due After           Due After
                                          1 Through           5 or More
                        Due One         5 Years After        Years After
                     Year or Less     September 30, 2000  September 30, 2000        Total
                     ------------     ------------------  ------------------        -----
                                                  (In thousands)
<S>                    <C>                 <C>                 <C>                 <C>
Real estate loans      $144,149            $103,721            $ 69,541            $317,411
Commercial ......        26,971              13,327                 387              40,685
Other ...........         7,648               6,277                 251              14,176
                       --------            --------            --------            --------
   Total ........      $178,768            $123,325            $ 70,179            $372,272
                       ========            ========            ========            ========
</TABLE>

     The  following  table sets forth at September 30, 2000 the dollar amount of
all loans due one year or more after September 30, 2000 which have predetermined
interest rates and have floating or adjustable interest rates.

                      Predetermined       Floating or
                          Rates        Adjustable Rates
                      -------------    ----------------
                               (In thousands)

Real estate loans       $148,444           $ 24,813
Commercial ......         11,958              1,758
Other ...........          6,531                 --
                        --------           --------
   Total ........       $166,933           $ 26,751
                        ========           ========

     Scheduled  contractual  principal  repayments  of loans do not  reflect the
actual life of such assets.  The average life of loans can be substantially less
than their  contractual terms because of prepayments.  In addition,  due-on-sale
clauses on loans generally give the Bank the right to declare a loan immediately
due and payable in the event,  among other things,  that the borrower  sells the
real  property  subject to the mortgage and the loan is not repaid.  The average
life of mortgage loans tends to increase when current mortgage loan market rates
are substantially  higher than rates on existing mortgage loans and, conversely,
decrease when current  mortgage loan market rates are  substantially  lower than
rates on existing mortgage loans.

     Originations,  Purchases  and  Sales  of  Loans.  The  Bank  generally  has
authority  to  originate  and  purchase  loans  secured by real  estate  located
throughout the state of North Carolina and the United  States.  Consistent  with
its  emphasis  on being a  community-oriented  financial  institution,  the Bank
concentrates its lending activities in its market area.

     The  Bank's  loan  originations  are  derived  from a  number  of  sources,
including   referrals  from   depositors  and   borrowers,   repeat   customers,
advertising,   calling  officers  as  well  as  walk-in  customers.  The  Bank's
solicitation  programs consist of  advertisements in local media, in addition to
participation in various community  organizations and events.  Real estate loans
are  originated by the Bank's loan  personnel.  All of the Bank's loan personnel
are  salaried,  and  though the Bank does not  compensate  loan  personnel  on a
commission basis for loans  originated,  it does pay an incentive  percentage of
closed  mortgage  loan volume once a defined  threshold has been achieved by the
participant. With the exception of applications for boat or recreational vehicle
loans,  which may be originated on an indirect basis through an arrangement with
dealers, loan applications are accepted at the Bank's offices. In all cases, the
Bank has final approval of the application. Historically, the Bank generally has
not purchased loans. However, the Bank may in the future consider making limited
loan purchases, including purchases of commercial loans.

<PAGE>

     In  recent  years,  the  Bank  has sold or  exchanged  for  mortgage-backed
securities a significant amount of fixed-rate, single-family mortgage loans that
it originated.  During the years ended September 30, 2000, 1999 and 1998,  these
transactions   totaled  $62.8   million,   $86.1  million  and  $54.1   million,
respectively.  Such loans are sold to or  exchanged  with the Federal  Home Loan
Mortgage  Corporation  ("FHLMC").  The Bank generally retains servicing on loans
sold or exchanged.

     Loan Underwriting  Policies.  The Bank's lending  activities are subject to
the  Bank's  written,  non-discriminatory  underwriting  standards  and to  loan
origination  procedures  prescribed  by the Bank's  Board of  Directors  and its
management.  Detailed loan applications are obtained to determine the borrower's
ability  to repay,  and the more  significant  items on these  applications  are
verified   through  the  use  of  credit  reports,   financial   statements  and
confirmations.  All loans are presented  weekly by the management loan committee
to a loan  committee  of the Board of  Directors  of the Bank,  made up of three
outside directors who serve on a rotating basis. The President does not serve on
the loan  committee of the Board of Directors.  Individual  officers of the Bank
have been granted  authority  by the Board of Directors to approve  consumer and
commercial loans up to varying specified dollar amounts, depending upon the type
of loan. In addition,  committees of loan officers have loan authorities greater
than individual authorities. These authorities are based on aggregate borrowings
of an individual or entity. All loans to a single borrower aggregating in excess
of $500,000 must be approved by the full Board of Directors. On a monthly basis,
the full Board of Directors reviews the actions taken by the loan committee.

     Applications  for  single-family  real estate  loans are  underwritten  and
closed in accordance with the standards of FHLMC.  Generally,  upon receipt of a
loan application from a prospective  borrower, a credit report and verifications
are ordered to verify  specific  information  relating  to the loan  applicant's
employment, income and credit standing. If a proposed loan is to be secured by a
mortgage on real estate,  an appraisal of the real estate is usually  undertaken
either by an  appraiser  approved by the Bank and licensed by the State of North
Carolina  or  by  qualified  Bank  personnel.   In  the  case  of  single-family
residential  mortgage loans,  except when the Bank becomes aware of a particular
risk of environmental contamination, the Bank generally does not obtain a formal
environmental  report on the real  estate  at the time a loan is made.  A formal
environmental  report may be required in  connection  with  nonresidential  real
estate loans.

     It is the Bank's policy to record a lien on the real estate securing a loan
and to obtain title  insurance  which insures that the property is free of prior
encumbrances and other possible title defects. Borrowers must also obtain hazard
insurance  policies  prior to closing and, when the property is in a flood plain
as designated  by the  Department  of Housing and Urban  Development,  pay flood
insurance policy premiums.

     With respect to single-family  residential mortgage loans, the Bank makes a
loan  commitment  of  between  15 and 30 days for  each  loan  approved.  If the
borrower  desires a longer  commitment,  the commitment may be extended for good
cause and upon  written  approval.  Fees of between $175 and $425 are charged in
connection  with the  issuance of a  commitment  letter.  The  interest  rate is
guaranteed for the commitment period.

     If the amount of a residential loan originated or refinanced exceeds 80% of
the lessor of the appraised value or contract price, the Bank's policy generally
is to obtain  private  mortgage  insurance  at the  borrower's  expense  on that
portion of the principal amount of the loan that exceeds 80%. The Bank will make
a single-family  residential  mortgage loan with up to a 97% loan-to-value ratio
if the required  private  mortgage  insurance is  obtained.  The Bank  generally
limits the loan-to-value  ratio on commercial real estate mortgage loans to 80%,
although  the  loan-to-value  ratio on  commercial  real estate loans in limited
circumstances has been as high as 85%. The Bank limits the  loan-to-value  ratio
on multi-family residential real estate loans to 80%.

     The Bank is subject to regulations  that limit the amount the Bank can lend
to one borrower.  See " -- Depository  Institution Regulation -- Limits on Loans
to One  Borrower."  Under these limits,  the Bank's  loans-to-one-borrower  were
limited to $6.6  million at  September  30,  2000.  At that date the Bank had no
lending relationships in excess of the loans-to-one-borrower limit.

     Interest  rates  charged by the Bank on loans are affected  principally  by
competitive factors, the demand for such loans and the supply of funds available
for lending purposes.  These factors are, in turn,  affected by general economic
conditions,  monetary policies of the federal government,  including the Federal
Reserve Board, legislative tax policies and government budgetary matters.

<PAGE>

     Single-Family  Residential Real Estate Lending.  The Bank  historically has
been and continues to be an originator of single-family, residential real estate
loans in its market area.  At September  30,  2000,  single-family,  residential
mortgage loans,  excluding home improvement  loans,  totaled $135.6 million,  or
35.3% of the Company's gross loan portfolio.

     The Bank  originates  fixed-rate  mortgage  loans at  competitive  interest
rates.  At  September  30,  2000,  $74.4  million,  or 54.9%,  of the  Company's
residential  mortgage loan  portfolio  was  comprised of fixed-rate  residential
mortgage  loans.  Generally,  the  Company  retains  fixed-rate  mortgages  with
maturities 15 years or less while fixed-rate loans with longer maturities may be
retained in portfolio or sold in the secondary market.  The Bank also offers FHA
and VA mortgage loans in its market area, which are underwritten and closed by a
correspondent lender.

     The Bank  also  offers  adjustable-rate  residential  mortgage  loans.  The
adjustable-rate  loans  currently  offered by the Bank have interest rates which
adjust every one, three or five years from the closing date of the loan or on an
annual basis commencing after an initial fixed-rate period of one, three or five
years in accordance  with a designated  index (the primary index utilized by the
Bank is the weekly  average  yield on U.S.  Treasury  securities  adjusted  to a
constant  comparable  maturity  equal to the  loan  adjustment  period,  as made
available by the Federal Reserve Board (the "Treasury Rate")), plus a stipulated
margin. The Bank offers adjustable-rate loans that meet FHLMC standards, as well
as  loans  that  do  not  meet  such  standards.   The  Bank's   adjustable-rate
single-family  residential  real estate  loans that do not meet FHLMC  standards
have  a cap of  generally  2% on  any  increase  in  the  interest  rate  at any
adjustment date, and include a cap on the maximum interest rate over the life of
the loan,  which cap  generally is 3% to 4.5% above the initial  rate. In return
for providing a relatively  low cap on interest rate  increases over the life of
the loan,  the Bank's  adjustable-rate  loans provide for a floor on the minimum
interest  rate over the life of the loan,  which floor  generally is the initial
rate.  Further,  the Bank generally does not offer "teaser" rates, i.e., initial
rates below the fully indexed rate, on such loans. The adjustable-rate  mortgage
loans  offered by the Bank that do conform to FHLMC  standards  have a cap of 6%
above the initial  rate over the life of a loan but do not include a floor,  may
be offered  with a teaser rate and have a 25 basis point lower  margin above the
index on which the  interest  rate is based.  All of the Bank's  adjustable-rate
loans  require  that any  payment  adjustment  resulting  from a  change  in the
interest  rate  of an  adjustable-rate  loan be  sufficient  to  result  in full
amortization  of the loan by the end of the loan term and,  thus,  do not permit
any of the increased payment to be added to the principal amount of the loan, or
so-called negative amortization. At September 30, 2000, $61.2 million, or 45.1%,
of the Company's residential mortgage loans were adjustable-rate loans.

     The retention of  adjustable-rate  loans in the Company's  portfolio  helps
reduce the  Company's  exposure to increases or decreases in  prevailing  market
interest rates.  However,  there are unquantifiable  credit risks resulting from
potential  increases in costs to  borrowers in the event of upward  repricing of
adjustable-rate  loans.  It is possible that during  periods of rising  interest
rates,  the  risk of  default  on  adjustable-rate  loans  may  increase  due to
increases in interest  costs to  borrowers.  Further,  although  adjustable-rate
loans allow the  Company to increase  the  sensitivity  of its  interest-earning
assets to changes in interest rates, the extent of this interest  sensitivity is
limited by the initial  fixed-rate  period before the first  adjustment  and the
lifetime  interest rate  adjustment  limitations.  Accordingly,  there can be no
assurance that yields on the Company's  adjustable-rate  loans will fully adjust
to compensate for increases in the Company's cost of funds.

     Construction  Lending.  The Bank also  offers  residential  and  commercial
construction  loans, with a substantial portion of such loans originated to date
being for the  construction of  owner-occupied,  single-family  dwellings in the
Bank's primary market area. Residential construction loans are offered primarily
to  individuals  building  their primary or secondary  residence,  as well as to
selected local developers to build single-family dwellings.  Generally, loans to
owner/occupants   for  the   construction   of   owner-occupied,   single-family
residential  properties are originated in connection  with the permanent loan on
the property and have a  construction  term of six to 18 months.  Such loans are
offered on a fixed-rate or adjustable-rate  basis. Interest rates on residential
construction  loans made to the  owner/occupant  have interest  rates during the
construction  period of 1% above the rate  offered by the Bank on the  permanent
loan product  selected by the borrower.  Upon  completion of  construction,  the
permanent  loan rate will be set at the rate  then  offered  by the Bank on that
permanent  loan product,  except that if the permanent  loan rate would be above
the  construction  loan rate then the  borrower can maintain the same rate as on
the  construction  loan.  Interest  rates on residential  construction  loans to
builders  are set at the prime rate plus a margin of  between  .50% and 1% or at
the  Treasury  Rate plus a margin of between 3% and 4.5%,  and adjust  annually.
Interest rates on commercial construction loans are based on the prime rate plus
a negotiated margin of

<PAGE>

between 0% and 1% and adjust  annually,  with  construction  terms generally not
exceeding 18 months.  Advances are made on a percentage of completed  basis.  At
September  30,  2000,  $29.3  million,  or 7.6%,  of the  Company's  gross  loan
portfolio consisted of construction loans, virtually all of which was secured by
single-family residences.

     Prior to making a  commitment  to fund a loan,  the Bank  requires  both an
appraisal of the property by appraisers approved by the Board of Directors and a
study of the  feasibility  of the  proposed  project.  The Bank also reviews and
inspects each project at the  commencement of construction  and either weekly or
biweekly during the term of the construction  loan. The Bank generally charges a
 .50% to 1% construction loan fee for speculative builder loans. For construction
loans to owner-occupants,  the Bank generally charges a 1% construction loan fee
and a $425 commitment fee.

     Construction  financing  generally is considered to involve a higher degree
of risk of loss than long-term financing on improved, occupied real estate. Risk
of loss on a  construction  loan is  dependent  largely upon the accuracy of the
initial  estimate of the  property's  value at  completion  of  construction  or
development and the estimated cost (including interest) of construction.  During
the  construction  phase,  a number of factors  could  result in delays and cost
overruns.  If the estimate of construction costs proves to be inaccurate and the
borrower  is unable to meet the Bank's  requirements  of  putting up  additional
funds to cover extra costs or change orders,  then the Bank will demand that the
loan be paid  off and,  if  necessary,  institute  foreclosure  proceedings,  or
refinance the loan. If the estimate of value proves to be  inaccurate,  the Bank
may be  confronted,  at or prior to the  maturity of the loan,  with  collateral
having a value  which is  insufficient  to assure full  repayment.  The Bank has
sought to  minimize  this risk by  limiting  construction  lending to  qualified
borrowers (i.e.,  borrowers who satisfy all credit  requirements and whose loans
satisfy  all  other  underwriting  standards  which  would  apply to the  Bank's
permanent mortgage loan financing for the subject property) in the Bank's market
area. On loans to builders, the Bank works only with selected builders with whom
it has experience and carefully monitors the  creditworthiness  of the builders.
Builder  relationships  are  analyzed  and  underwritten  annually by the Bank's
credit administration department.

     Multi-Family  Residential  and  Commercial  Real Estate  Lending.  The Bank
originates  commercial  real  estate  loans,  as well  as a  limited  amount  of
multi-family residential real estate loans, generally limiting such originations
to loans secured by properties in its primary  market area and to borrowers with
whom it has other loan  relationships.  The Company's  multi-family  residential
loan portfolio consists primarily of loans secured by small apartment buildings,
and the  commercial  real estate loan  portfolio  includes  loans to finance the
acquisition of small office  buildings and commercial and industrial  buildings.
Such loans generally  range in size from $100,000 to $2.0 million.  At September
30, 2000, multi-family residential and commercial real estate loans totaled $6.7
and  $103.0   million,   respectively,   which   amounted  to  1.7%  and  26.8%,
respectively, of the Company's gross loan portfolio. Multi-family and commercial
real estate loans are  originated  either for 15 year terms with interest  rates
that  adjust  every one,  three or five years  based on either the prime rate as
quoted in THE WALL STREET JOURNAL plus a negotiated  margin of between 0% and 1%
for shorter term loans or, for longer term loans,  or the  Treasury  Rate plus a
negotiated margin of between 3% and 4.5%, or on a fixed-rate basis with interest
calculated on a 15 year  amortization  schedule with a balloon payment due after
five years.

     Multi-family   residential  and  commercial  real  estate  lending  entails
significant additional risks as compared with single-family residential property
lending.  Multi-family  residential  and commercial  real estate loans typically
involve larger loan balances to single borrowers or groups of related borrowers.
The payment  experience on such loans  typically is dependent on the  successful
operation of the real estate project,  retail  establishment or business.  These
risks can be  significantly  affected  by supply  and demand  conditions  in the
market for office, retail and residential space, and, as such, may be subject to
a greater  extent to adverse  conditions in the economy  generally.  To minimize
these risks, the Bank generally limits itself to its market area or to borrowers
with which it has prior  experience or who are  otherwise  known to the Bank. It
has been the Bank's policy to obtain annual financial statements of the business
of the borrower or the project for which commercial or multi-family  residential
real estate loans are made.  In  addition,  in the case of  commercial  mortgage
loans made to a partnership or a corporation, the Bank seeks, whenever possible,
to obtain personal guarantees and annual financial  statements of the principals
of the partnership or corporation.

     Commercial Lending. The Company's commercial loans consist of loans secured
by commercial real estate and commercial  business loans,  which are not secured
by real estate. For a discussion of the Company's commercial real estate lending
see "-- Multi-Family and Commercial Real Estate Lending."

<PAGE>

     In recent years, the Bank has emphasized  commercial business lending.  The
Bank originates  commercial  business loans to small and medium sized businesses
in its  market  area.  The  Bank's  commercial  borrowers  are  generally  small
businesses engaged in manufacturing, distribution or retailing, or professionals
in healthcare,  accounting and law. Commercial business loans are generally made
to finance the  purchase  of  inventory,  new or used  equipment  or  commercial
vehicles,  to support trading assets and for short-term  working  capital.  Such
loans  generally  are secured by  equipment  and  inventory,  and, if  possible,
cross-collateralized  by a real estate mortgage,  although  commercial  business
loans are sometimes granted on an unsecured basis. Such loans generally are made
for terms of five years or less,  depending  on the  purpose of the loan and the
collateral,  with loans to finance operating expenses made for one year or less,
with interest  rates that adjust at least  annually at a rate equal to the prime
rate as stated in The Wall  Street  Journal  plus a margin of between 0% and 2%.
Generally,  commercial  loans are made in  amounts  ranging  between  $5,000 and
$250,000.  At September  30,  2000,  commercial  business  loans  totaled  $34.9
million, or 9.1% of the Company's gross loan portfolio.

     The Bank  underwrites  its  commercial  business  loans on the basis of the
borrower's  cash flow and ability to service the debt from earnings  rather than
on the basis of  underlying  collateral  value,  and the Bank seeks to structure
such loans to have more than one source of  repayment.  The borrower is required
to provide the Bank with  sufficient  information  to allow the Bank to make its
lending determination.  In most instances, this information consists of at least
two years of financial statements,  a statement of projected cash flows, current
financial  information  on any guarantor and any  additional  information on the
collateral. For loans with maturities exceeding one year, the Bank requires that
borrowers and guarantors provide updated financial information at least annually
throughout the term of the loan.

     The Bank's commercial business loans may be structured as short-term loans,
term loans or as lines of credit.  Short-term  commercial business loans are for
periods  of 12  months or less and are  generally  self-liquidating  from  asset
conversion cycles.  Commercial business term loans are generally made to finance
the  purchase of assets and have  maturities  of five years or less.  Commercial
business  lines of credit  are  typically  made for the  purpose  of  supporting
trading assets and providing  working  capital.  Such loans are usually approved
with a term of 12 months and are  reviewed at that time to see if  extension  is
warranted.  The Bank also offers  standby  letters of credit for its  commercial
borrowers.  The terms of standby  letters of credit  generally do not exceed one
year,  and they are  underwritten  as  stringently  as any  commercial  loan and
generally are of a performance nature.

     Commercial  business  loans are often  larger and may involve  greater risk
than other types of lending.  Because payments on such loans are often dependent
on successful operation of the business involved, repayment of such loans may be
subject to a greater extent to adverse conditions in the economy. The Bank seeks
to minimize these risks through its underwriting guidelines,  which require that
the loan be supported by adequate  cash flow of the borrower,  profitability  of
the  business,  collateral  and personal  guarantees of the  individuals  in the
business.  In addition,  the Bank limits this type of lending to its market area
and to borrowers  with which it has prior  experience or who are otherwise  well
known to the Bank.

     Consumer  Lending.  In recent  years,  the Bank has been  successful in its
strategy of  increasing  its  portfolio of consumer  loans.  The consumer  loans
originated by the Bank include  automobile loans,  certificate of deposit loans,
home equity loans and miscellaneous  other consumer loans,  including  unsecured
loans. At September 30, 2000,  consumer loans totaled $75.0 million, or 19.5% of
the Company's gross loan portfolio.

     The Bank's automobile loans are generally underwritten in amounts up to 90%
of the lesser of the purchase  price of the  automobile or, with respect to used
automobiles,  the loan value as  published by the  National  Automobile  Dealers
Association.  The terms of most such  loans do not  exceed 60  months.  The Bank
requires  that the  vehicles  be insured and the Bank be listed as loss payee on
the insurance policy.

     The  Bank  makes  certificate  of  deposit  loans  for  up to  90%  of  the
depositor's  account balance.  The interest rate is normally 3% above the annual
percentage  yield  paid on the  account  and the  account  must  be  pledged  as
collateral  to secure  the loan.  Interest  generally  is billed on a  quarterly
basis. At September 30, 2000, loans on certificates of deposit totaled $997,000,
or .3% of the Company's total loan portfolio.

     At September 30, 2000, the Company had approximately  $35.8 million in home
equity line of credit loans,  representing  approximately 9.3% of its gross loan
portfolio. The Company's home equity lines of credit have

<PAGE>

adjustable  interest  rates tied to the prime  interest rate plus a margin.  The
home equity lines of credit require  monthly  payments until the loan is paid in
full.  Home equity lines of credit are generally  secured by  subordinate  liens
against  residential  real  property.  The Bank  requires that fire and extended
coverage casualty insurance (and, if appropriate, flood insurance) be maintained
in an  amount at least  sufficient  to cover its  loan.  Home  equity  loans are
generally  limited  so that the  amount of such  loans,  along  with any  senior
indebtedness, does not exceed 85% of the value of the real estate security.

     The Company  offers credit card loans through its  participation  as a Visa
and MasterCard issuer.  Management  believes that providing credit card services
to its  customers  helps the Bank remain  competitive  by offering  customers an
additional service,  and the Bank does not actively solicit credit card business
beyond its customer base and market area. The rate currently charged by the Bank
on its credit card loans  ranges from 12% to 17%,  and the Bank is  permitted to
change the interest rate on 30 days notice.  Processing of bills and payments is
contracted  to an outside  servicer.  At September  30, 2000,  the Company had a
commitment  to fund an  aggregate  of $7.7  million of credit card loans,  which
represented the aggregate  credit limit on credit cards, and had $1.2 million of
credit card loans outstanding, representing .3% of its gross loan portfolio. The
Company  intends to continue and expand credit card lending,  but estimates that
at current levels of credit card loans, it makes little or no monthly profit net
of service expenses and write-offs.

     Consumer  lending affords the Company the opportunity to earn yields higher
than those obtainable on single-family  residential lending.  However,  consumer
loans entail greater risk than do residential  mortgage  loans,  particularly in
the case of loans which are unsecured (as is the case with credit card loans) or
secured  by  rapidly   depreciable  assets  such  as  automobiles.   Repossessed
collateral for a defaulted  consumer loan may not provide an adequate  source of
repayment of the outstanding loan balance as a result of the greater  likelihood
of damage, loss or depreciation. The remaining deficiency often does not warrant
further  substantial  collection  efforts  against the  borrower.  In  addition,
consumer  and credit  card loan  collections  are  dependent  on the  borrower's
continuing  financial  stability,  and  thus  are more  likely  to be  adversely
affected by events such as job loss,  divorce,  illness or personal  bankruptcy.
Further,  the application of various state and federal laws,  including  federal
and state  bankruptcy  and  insolvency  law,  may limit the amount  which may be
recovered.  In underwriting  consumer  loans,  the Bank considers the borrower's
credit  history,  an analysis of the borrower's  income and ability to repay the
loan, and the value of the collateral.

     Loan Fees and  Servicing.  The Bank receives  fees in connection  with late
payments  and for  miscellaneous  services  related to its loans.  The Bank also
charges fees in  connection  with loan  originations.  These fees can consist of
origination,  discount,  construction  and/or commitment fees,  depending on the
type of loan. The Bank generally does not service loans for others except as set
forth below and except for mortgage  loans  originated and sold by the Bank with
servicing retained.

     In  addition,  the Bank has  developed a program to  originate  loans for a
local credit union.  The Bank receives a $600  origination  fee for each loan as
well as an annual servicing fee of .375% of the loan amount.  All of these loans
are funded and closed in the name of the credit union. The Bank has explored the
possibility of developing similar arrangements with other institutions, although
none are currently planned.

     Nonperforming  Loans and Other Problem Assets. It is management's policy to
continually  monitor its loan portfolio to anticipate and address  potential and
actual  delinquencies.  When a borrower  fails to make a payment on a loan,  the
Bank takes immediate  steps to have the delinquency  cured and the loan restored
to current status. Loans which are delinquent more than 15 days incur a late fee
of 4% of the  monthly  payment of  principal  and  interest  due. As a matter of
policy, the Bank will contact the borrower after the loan has been delinquent 15
days. If payment is not promptly received,  the borrower is contacted again, and
efforts  are made to  formulate  an  affirmative  plan to cure the  delinquency.
Generally,  after any loan is  delinquent  45 days or more, a default  letter is
sent to the  borrower.  If the default is not cured after 30 days,  formal legal
proceedings are commenced to collect amounts owed.

     Loans  generally  are placed on nonaccrual  status,  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 90 days. Consumer
loans are generally  charged off, or any expected  loss is reserved  for,  after
they become more than 120 days past due. All other loans are charged off

<PAGE>

when management  concludes that they are  uncollectible.  See Note 5 of Notes to
Financial  Statements  included  in the Annual  Report to  Stockholders  for the
Fiscal Year Ended September 30, 2000 (the "Annual Report").

     Real estate  acquired by the Bank as a result of  foreclosure is classified
as real estate acquired through foreclosure until such time as it is sold and is
recorded at the lower of the estimated fair value of the underlying  real estate
or the carrying amount of the loan.  Costs relating to holding or improving such
real  estate are charged  against  income in the current  period.  Any  required
write-down  of the loan to its fair  value  less  estimated  selling  costs upon
foreclosure  is charged  against the  allowance  for loan losses.  See Note 5 of
Notes to Financial Statements in the Annual Report.

     The  following  table sets  forth  information  with  respect to the Bank's
nonperforming assets at the dates indicated. At the dates shown, the Bank had no
restructured  loans  within the meaning of  Statement  of  Financial  Accounting
Standards No. 15.

<TABLE>
<CAPTION>
                                                            At September 30,
                                             ---------------------------------------------
                                              2000      1999      1998     1997      1996
                                             ------    ------    ------   ------    ------
                                                         (Dollars in thousands)
Loans accounted for on a nonaccrual basis:
<S>                                          <C>       <C>       <C>      <C>       <C>
  Residential mortgage:
    Single-family ........................   $1,110    $  487    $  323   $  298    $  376
    Construction .........................      258        --       406      916       647
  Commercial real estate .................       --        --        --       16        --
  Commercial business ....................      139        48        25       14         8
  Consumer ...............................      139        33        48       18         3
                                             ------    ------    ------   ------    ------
    Total nonperforming loans ............   $1,646    $  567    $  802   $1,262    $1,034
                                             ======    ======    ======   ======    ======
Percentage of total loans, net ...........      .45%      .27%      .36%     .64%      .66%
                                             ======    ======    ======   ======    ======
Real estate owned ........................   $  220    $  591    $  412   $  358    $  179
                                             ======    ======    ======   ======    ======
</TABLE>

     During the year ended September 30, 2000,  additional gross interest income
of  approximately  $40,000 would have been recorded on loans  accounted for on a
nonaccrual basis if the loans had been current throughout this period.  Interest
on such loans  included in income  during the period  amounted to  approximately
$28,000.

     At September 30, 2000,  the Bank had no loans not classified as nonaccrual,
90 days past due or restructured  loans where known  information  about possible
credit problems of borrowers  caused  management to have serious  concerns as to
the ability of the borrowers to comply with present loan repayment terms and may
result in disclosure as nonaccrual, 90 days past due or restructured.

     There were no loans accruing interest which were  contractually past due 90
days or more at the end of any reported period.

     At September 30, 2000,  an analysis of the Bank's  portfolio did not reveal
any  impaired  loans that needed to be  classified  under SFAS No. 114 or 118. 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 and interest when due according to the  contractual  terms of the loan
arrangement.  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.  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 payments status, borrowers' financial data and borrowers' operating factors
such as cash flows, operating income or loss, and various other matters.

     At September 30, 2000,  the Company had $1.6 million of  nonaccrual  loans,
which consisted of 16 single-family  residential real estate loans totaling $1.1
million,  two residential  mortgage  construction loans totaling  $256,000,  two
commercial  business loans totaling $139,000,  and seven consumer loans totaling
$139,000.

<PAGE>

     At September 30, 2000,  the Bank had $220,000 of real estate  owned,  which
consisted of three single-family residences.

     Classified Assets.  Federal  regulations require that the Bank classify its
assets on a regular  basis.  In addition,  in connection  with  examinations  of
insured institutions, examiners have authority to identify problem assets and if
appropriate,  classify  them in their  reports of  examination.  There are three
classifications  for  problem  assets:  "substandard,"  "doubtful"  and  "loss."
Substandard  assets have one or more defined weaknesses and are characterized by
the distinct  possibility that the insured institution will sustain some loss if
the  deficiencies  are not  corrected.  Doubtful  assets have the  weaknesses of
substandard assets with the additional  characteristic  that the weaknesses make
collection or  liquidation  in full, on the basis of currently  existing  facts,
conditions and values, questionable, and there is a high possibility of loss. An
asset classified loss is considered  uncollectible and of such little value that
continuance as an asset of the institution is not warranted.  Assets  classified
as substandard or doubtful  require a bank to establish  general  allowances for
loan  losses.  If an asset or portion  thereof is  classified  loss, a bank must
either  establish a specific  allowance for loss in the amount of the portion of
the asset classified loss, or charge off such amount. The Bank regularly reviews
its  assets  to  determine   whether  any  assets  require   classification   or
re-classification.  At  September  30,  2000,  the Company  had $8.2  million in
classified  assets,  including  $2.7  million  in assets  classified  as special
mention,  $4.9 million in assets  classified as substandard,  $558,000 in assets
classified as doubtful and $27,000 in assets classified as loss.

     Allowance for Loan Losses.  The Company's  policy is to establish  reserves
for  estimated  losses on delinquent  loans when it  determines  that losses are
expected  to be incurred on such  loans.  The  allowance  for losses on loans is
maintained at a level believed adequate by management to absorb potential losses
in the portfolio. Management's determination of the adequacy of the allowance is
based on an evaluation of the portfolio, past loss experience,  current economic
conditions,  volume, growth and composition of the portfolio, and other relevant
factors.  The  allowance is increased  by  provisions  for loan losses which are
charged against income.

     Although management believes it uses the best information available to make
determinations  with  respect to the  allowances  for losses and  believes  such
allowances  are  adequate,  future  adjustments  may be  necessary  if  economic
conditions differ  substantially from the economic conditions in the assumptions
used in making  the  initial  determinations.  Management  anticipates  that the
Company's allowance for loan losses will increase in the future as it implements
the Board of Directors'  strategy of continuing existing lines of business while
gradually  expanding  commercial  business  and  consumer  lending,  which loans
generally entail greater risks than single-family residential mortgage loans.

<PAGE>

     The following  table sets forth an analysis of the Company's  allowance for
loan losses for the periods indicated.

<TABLE>
<CAPTION>
                                                   Year Ended September 30,
                                        ----------------------------------------------
                                         2000      1999      1998      1997      1996
                                        ------    ------    ------    ------    ------
                                                    (Dollars in thousands)
<S>                                     <C>       <C>       <C>       <C>       <C>
Balance at beginning of period ......   $3,297    $3,365    $3,249    $2,351    $1,877
                                        ------    ------    ------    ------    ------

Loans charged-off:
  Residential mortgage:
    Single-family ...................       --        --        --        --        44
  Commercial real estate ............       --        --        --        --        --
  Commercial business ...............       58       206       128        --        --
  Consumer ..........................       99        58        74        72        19
                                        ------    ------    ------    ------    ------
Total charge-offs ...................      157       264       202        72        63
                                        ------    ------    ------    ------    ------

Recoveries:
  Residential real estate mortgage:
    Single-family residential .......       --        --        --        33        25
  Commercial ........................       70        65        --        --        --
  Consumer ..........................        9        11         8         6         1
                                        ------    ------    ------    ------    ------
Total recoveries ....................       79        76         8        39        26
                                        ------    ------    ------    ------    ------

Net loans charged-off ...............       78       188       194        33        37
                                        ------    ------    ------    ------    ------

Additions:
Balance transferred in acquisition ..      963        --        --        --        --
Provision for loan losses ...........      977       120       310       931       511
                                        ------    ------    ------    ------    ------
      Total additions ...............    1,940       120       310       931       511
                                        ------    ------    ------    ------    ------

Balance at end of period ............   $5,159    $3,297    $3,365    $3,249    $2,351
                                        ======    ======    ======    ======    ======

Ratio of net charge-offs to average
  loans outstanding during the period      .02%      .08%      .09%      .02%      .02%
                                        ======    ======    ======    ======    ======
</TABLE>

<PAGE>

     The  following  table  allocates  the  allowance  for loan  losses  by loan
category  at the  dates  indicated.  The  allocation  of the  allowance  to each
category is not  necessarily  indicative  of future losses and does not restrict
the use of the allowance to absorb losses in any category.

<TABLE>
<CAPTION>
                                                                      At September 30,
                         -----------------------------------------------------------------------------------------------------------
                                2000                  1999                  1998                  1997                  1996
                         -------------------   -------------------   -------------------   -------------------   -------------------
                                  Percent of            Percent of            Percent of            Percent of            Percent of
                                   Loans in              Loans in              Loans in              Loans in              Loans in
                                 Category to           Category to           Category to           Category to           Category to
                         Amount  Total Loans   Amount  Total Loans   Amount  Total Loans   Amount  Total Loans   Amount  Total Loans
                         ------  -----------   ------  -----------   ------  -----------   ------  -----------   ------  -----------
                                                                  (Dollars in thousands)
<S>                      <C>        <C>        <C>        <C>        <C>        <C>        <C>        <C>        <C>        <C>
Residential mortgage ... $1,034      44.6%     $1,071      38.7%     $1,071      49.7%     $1,070      47.6%     $1,037      54.6%
Commercial (1) .........  3,125      35.9       1,577      39.1       1,598      30.3       1,456      29.1         879      23.9
Consumer ...............  1,000      19.5         649      22.2         696      20.0         723      23.3         435      21.5
                         ------     -----      ------     -----      ------     -----      ------     -----      ------     -----
   Total allowance for
      loan losses ...... $5,159     100.0%     $3,297     100.0%     $3,365     100.0%     $3,249     100.0%     $2,351     100.0%
                         ======     =====      ======     =====      ======     =====      ======     =====      ======     =====
</TABLE>

---------------
(1)  Includes commercial real estate and commercial business loans.

<PAGE>

INVESTMENT ACTIVITIES

     General.  Interest  income from  mortgage-backed  securities and investment
securities generally provides the second largest source of income to the Company
after interest on loans. The Bank's Board of Directors has authorized investment
in  U.S.  Government  and  agency  securities,   state  government  obligations,
municipal  securities,  obligations  of the Federal Home Loan Bank  ("FHLB") and
mortgage-backed  securities.  The Bank's objective is to use such investments to
reduce interest rate risk,  enhance yields on assets and provide  liquidity.  At
September 30, 2000,  the Company's  mortgage-backed  securities  and  investment
securities portfolio amounted to $108.5 million and $45.2 million, respectively.
At such  date,  the  Company  had an  unrealized  loss of $1.3  million,  net of
deferred taxes,  with respect to its securities,  all of which are classified as
available for sale.

     Investment  and  aggregate   investment   limitations  and  credit  quality
parameters of each class of investment are  prescribed in the Bank's  investment
policy. The Bank performs analyses on mortgage-backed  securities and investment
securities  prior to forming mortgage pools and on an ongoing basis to determine
the  impact on  earnings  and  market  value  under  various  interest  rate and
prepayment conditions.  Securities purchases are subject to the oversight of the
Bank's Investment Committee consisting of four directors and are reviewed by the
Board of Directors on a monthly  basis.  The Bank's  President  has authority to
make specific investment decisions within the parameters determined by the Board
of Directors.

     Mortgage-Backed   Securities.   At  September   30,  2000,   the  Company's
mortgage-backed securities amounted to $108.5 million, or 19.4% of total assets.
Mortgage-backed  securities  represent  a  participation  interest  in a pool of
single-family or multi-family mortgages,  the principal and interest payments on
which are passed from the mortgage originators through  intermediaries that pool
and repackage the participation  interest in the form of securities to investors
such as the Bank. Such  intermediaries may include  quasi-governmental  agencies
such as FHLMC,  FNMA and GNMA  which  guarantee  the  payment of  principal  and
interest to investors. Mortgage-backed securities generally increase the quality
of the Bank's assets by virtue of the guarantees that back them, are more liquid
than  individual  mortgage  loans and may be used to  collaterize  borrowings or
other  obligations  of the Bank.  At September  30, 2000,  all of the  Company's
mortgage-backed  securities  were  backed  by loans  originated  by the Bank and
swapped with the FHLMC in exchange for such mortgage-backed securities.

     The FHLMC is a public  corporation  chartered  by the U.S.  Government  and
owned by the 12 FHLBs and  federally  insured  savings  institutions.  The FHLMC
issues  participation  certificates backed principally by conventional  mortgage
loans.  The FHLMC  guarantees  the timely  payment of interest  and the ultimate
return of principal on  participation  certificates.  FHLMC  securities  are not
backed by the full faith and credit of the United States,  but because the FHLMC
is not a U.S.  Government-sponsored  enterprise, these securities are considered
to be among the highest  quality  investments  with minimal  credit  risks.  The
maximum loan limit for FNMA and FHLMC currently is $252,700.

     Mortgage-backed  securities  typically  are issued  with  stated  principal
amounts,  and the  securities  are backed by pools of mortgages  that have loans
with interest rates that are within a range and having varying  maturities.  The
underlying   pool  of  mortgages  can  be  composed  of  either   fixed-rate  or
adjustable-rate  loans. As a result, the risk  characteristics of the underlying
pool of mortgages,  (i.e.,  fixed-rate or adjustable-rate) as well as prepayment
risk, are passed on to the  certificate  holder.  The life of a  mortgage-backed
pass-through security thus approximates the life of the underlying mortgages.

     Mortgage-backed  securities  generally  yield  less  than the  loans  which
underlie  such  securities   because  of  their  payment  guarantees  or  credit
enhancements  which offer  nominal  credit risk.  In  addition,  mortgage-backed
securities  are more liquid than  individual  mortgage  loans and may be used to
collateralize  borrowings  of the Bank in the event that the Bank  determined to
utilize  borrowings as a source of funds.  Mortgage-backed  securities issued or
guaranteed  by the  FHLMC  (except  interest-only  securities  or  the  residual
interests  in CMOs)  are  weighted  at no more than 20% for  risk-based  capital
purposes,  compared  to a  weight  of 50% to 100%  for  residential  loans.  See
"Depository Institution Regulation -- Capital Requirements."

     At September 30, 2000, mortgage-backed securities with an amortized cost of
$110.5 million and a carrying value of $108.5 million were held as available for
sale, and no  mortgage-backed  securities  were  classified as held to maturity.
Mortgage-backed  securities  which are held to  maturity  are  carried  at cost,
adjusted for the

<PAGE>

amortization  of premiums and the  accretion  of discounts  using a method which
approximates a level yield.  Mortgage-backed  securities classified as available
for sale are carried at fair value. Unrealized gains and losses on available for
sale mortgage-backed  securities are recognized as direct increases or decreases
in equity,  net of applicable  income  taxes.  See Notes 1 and 4 of the Notes to
Consolidated  Financial  Statements in the Annual Report. At September 30, 2000,
the Bank's mortgage-backed securities had a weighted average yield of 6.84%.

     At September 30, 2000,  the average  contractual  maturity of the Company's
fixed-rate  mortgage-backed  securities was  approximately  19 years. The actual
maturity of a mortgage-backed  security varies, depending on when the mortgagors
prepay  or  repay  the  underlying  mortgages.  Prepayments  of  the  underlying
mortgages may shorten the life of the investment,  thereby  adversely  affecting
its  yield to  maturity  and the  related  market  value of the  mortgage-backed
security.  The yield is based upon the interest  income and the  amortization of
the  premium  or  accretion  of the  discount  related  to  the  mortgage-backed
security.  Premiums and discounts on mortgage-backed securities are amortized or
accreted over the estimated term of the  securities  using a level yield method.
The  prepayment  assumptions  used to  determine  the  amortization  period  for
premiums and discounts can significantly affect the yield of the mortgage-backed
security,  and these assumptions are reviewed periodically to reflect the actual
prepayment.  The actual  prepayments of the underlying  mortgages depend on many
factors,  including  the  type of  mortgage,  the  coupon  rate,  the age of the
mortgages,   the   geographical   location   of  the   underlying   real  estate
collateralizing  the mortgages and general levels of market interest rates.  The
difference  between  the  interest  rates on the  underlying  mortgages  and the
prevailing  mortgage  interest rates is an important  determinant in the rate of
prepayments.  During periods of falling  mortgage  interest  rates,  prepayments
generally increase, and, conversely,  during periods of rising mortgage interest
rates,  prepayments  generally  decrease.  If the coupon rate of the  underlying
mortgage  significantly exceeds the prevailing market interest rates offered for
mortgage loans,  refinancing  generally increases and accelerates the prepayment
of the underlying mortgages. Prepayment experience is more difficult to estimate
for adjustable-rate mortgage-backed securities.

     Investment   Securities.   The  Company's  investment   securities  consist
primarily of securities issued by the U.S.  government and government  agencies.
At September 30, 2000, the Company's entire  portfolio of investment  securities
was  classified  available for sale and amounted to $45.2  million.  The Company
attempts to maintain a high degree of  liquidity  in its  investment  securities
portfolio by choosing  those that are readily  marketable.  As of September  30,
2000,  the  estimated  average  life  of  the  Company's  investment  securities
portfolio was  approximately  one year. In addition,  at September 30, 2000, the
Company had $2.7 million of FHLB stock.

<PAGE>

     The following table sets forth the scheduled  maturities,  carrying values,
amortized  cost and average yields for the Company's  investment  securities and
mortgage-backed securities portfolio at September 30, 2000.

<TABLE>
<CAPTION>
                             One Year or Less   One to Five Years  Five to Ten Years More than Ten Years  Total Investment Portfolio
                             -----------------  -----------------  -----------------  -----------------  ---------------------------
                             Carrying  Average  Carrying  Average  Carrying  Average  Carrying  Average  Carrying  Amortized Average
                               Value    Yield     Value    Yield     Value    Yield     Value    Yield     Value      Cost    Yield
                               -----    -----     -----    -----     -----    -----     -----    -----     -----      ----    -----
                                                                 (Dollars in thousands)
Securities available for sale:
<S>                          <C>          <C>   <C>        <C>     <C>        <C>     <C>        <C>     <C>        <C>        <C>
   U.S. government and
      agency  securities ... $     --     --%   $ 30,690   6.55%   $ 14,496   6.57%   $     --     --%   $ 45,186   $ 45,358   6.56%
   Mortgage-backed
      securities ...........       --     --       1,051   6.71       3,464   6.51     104,004   6.85     108,519    110,462   6.84

Securities held to maturity:
   FHLB stock (1) ..........       --     --          --     --          --     --       2,651   7.75       2,651      2,651   7.75
                             --------   ----    --------   ----    --------   ----    --------   ----    --------   --------   ----
      Total ................ $     --     --%   $ 31,741   6.56%   $ 17,960   6.56%   $106,655   6.87%   $156,356   $158,471   6.77%
                             ========   ====    ========   ====    ========   ====    ========   ====    ========   ========   ====
</TABLE>

---------------
(1)  As a member of the FHLB of  Atlanta,  the Bank is  required  to maintain an
     investment in FHLB stock, which has no stated maturity.

<PAGE>

     The  following  table  sets  forth  the  carrying  value  of the  Company's
investment  securities  and  mortgage-backed  securities  portfolio at the dates
indicated.

                                                      At September 30,
                                              --------------------------------
                                               2000         1999         1998
                                              ------       ------       ------
                                                       (In thousands)
Securities available for sale:
   U.S. government and agency securities     $ 45,186     $  3,024     $  3,108
   Mortgage-backed securities ..........      108,519       56,326       27,017
                                             --------     --------     --------
      Total ............................      153,705       59,350       30,125

Securities held to maturity:
   FHLB stock ..........................        2,651        1,460        1,364
                                             --------     --------     --------
      Total ............................     $156,356     $ 60,810     $ 31,489
                                             ========     ========     ========

DEPOSIT ACTIVITY AND OTHER SOURCES OF FUNDS

     General.  Deposits are the primary  source of the Bank's funds for lending,
investment activities and general operational purposes. In addition to deposits,
the Bank derives funds from loan principal and interest  repayments,  maturities
of investment  securities and  mortgage-backed  securities and interest payments
thereon.  Although  loan  repayments  are a relatively  stable  source of funds,
deposit inflows and outflows are  significantly  influenced by general  interest
rates and money market conditions.  Borrowings may be used on a short-term basis
to compensate for reductions in the  availability  of funds, or on a longer term
basis for general operational  purposes.  The Bank has access to borrow from the
FHLB of Atlanta.

     Deposits.  The Bank attracts  deposits  principally  from within its market
area by offering a variety of deposit instruments,  including checking accounts,
money market  accounts,  statement  and passbook  savings  accounts,  Individual
Retirement  Accounts,  and  certificates of deposit which range in maturity from
seven days to five years.  Deposit terms vary  according to the minimum  balance
required,  the length of time the funds must remain on deposit and the  interest
rate.  Maturities,  terms, service fees and withdrawal penalties for its deposit
accounts are established by the Bank on a periodic  basis.  The Bank reviews its
deposit  pricing on a weekly basis. In determining  the  characteristics  of its
deposit   accounts,   the  Bank   considers   the  rates  offered  by  competing
institutions,  lending  and  liquidity  requirements,  growth  goals and federal
regulations.  Management  believes it prices its  deposits  comparably  to rates
offered by its competitors. The Bank does not accept brokered deposits.

     The Bank  attempts to compete for deposits with other  institutions  in its
market  area by  offering  competitively  priced  deposit  instruments  that are
tailored  to the needs of its  customers.  Additionally,  the Bank seeks to meet
customers'  needs by providing  convenient  customer  service to the  community,
efficient  staff and  convenient  hours of  service.  Substantially,  all of the
Bank's  depositors  are  North  Carolina   residents.   To  provide   additional
convenience,  the Bank participates in the STAR Automatic Teller Machine network
at locations  throughout  the United  States,  through which  customers can gain
access to their  accounts at any time. To better serve its  customers,  the Bank
has installed automatic teller machines at seven office locations.

<PAGE>

     The  following  tables set forth the  distribution  of the  Bank's  deposit
accounts at the dates  indicated,  the weighted  average  interest rates and the
change in dollar  amounts for each  category of deposits  presented.  Management
does not believe that the use of year-end  balances  instead of average balances
resulted in any material difference in the information presented.

<TABLE>
<CAPTION>
                                     As of and for the Year Ended September 30,
                            ------------------------------------------------------------
                                   2000                 1999                 1998
                            ------------------   ------------------   ------------------
                                      Weighted             Weighted             Weighted
                                      Average              Average              Average
                             Amount     Rate      Amount     Rate      Amount     Rate
                            --------   ------    --------   ------    --------   ------
                                          (Dollars in thousands)
<S>                         <C>        <C>       <C>          <C>     <C>          <C>
Demand accounts:
  Checking ..............   $ 62,322      .26%   $ 31,151      .28%   $ 26,494      .42%
  Money market ..........     48,271     4.29      22,375     3.92      16,379     3.62
Savings accounts ........     22,069     1.49       7,220     1.50       6,398     1.78
                            --------   ------    --------   ------    --------   ------
    Total ...............    132,662     1.93      60,746     1.76      49,271     1.66

Certificate accounts:
  Less than 12 months (1)    112,553     5.99      50,671     5.05      30,155     4.89
  12 - 14 months (1) ....    121,941     6.25      82,655     5.06      66,064     5.70
  15 - 72 months (1) ....    104,786     5.73      40,546     5.44      59,145     5.71
                            --------   ------    --------   ------    --------   ------
    Total ...............    339,280     6.00     173,872     5.15     155,364     5.54
                            --------   ------    --------   ------    --------   ------
Total deposits ..........   $471,942   100.00%   $234,618     4.27%   $204,635     4.58%
                            ========   ======    ========   ======    ========   ======
</TABLE>
---------------
(1)  Original term.

<PAGE>

     The following table  indicates the amount of the Company's  certificates of
deposit of $100,000 or more (in thousands) by time  remaining  until maturity as
of September 30, 2000. At such date,  such deposits  represented  11.9% of total
deposits and had a weighted average rate of 6.1%.

                     Maturity Period
                     ---------------
                      (In thousands)

          Three months or less ...............   $ 1,102
          Over three through six months ......     3,169
          Over six through 12 months .........    36,664
          Over 12 months .....................    15,401
                                                 -------
             Total ...........................   $56,336
                                                 =======

     At September 30, 2000, mortgage-backed securities with an amortized cost of
$5.4 million were pledged as collateral for deposits from public entities.

     Borrowings.  Savings deposits  historically have been the primary source of
funds for the Bank's lending,  investment and general operating activities.  The
Bank is  authorized,  however,  to use  advances  from  the FHLB of  Atlanta  to
supplement  its  supply  of  lendable  funds  and  to  meet  deposit  withdrawal
requirements.  The FHLB of Atlanta functions as a central reserve bank providing
credit for savings institutions and certain other member financial institutions.
As a member of the FHLB System, the Bank is required to own stock in the FHLB of
Atlanta  and is  authorized  to apply for  advances.  Advances  are  pursuant to
several different programs, each of which has its own interest rate and range of
maturities.  The Bank has a Blanket  Agreement  for advances with the FHLB under
which the Bank may borrow up to 25% of assets  subject to normal  collateral and
underwriting requirements.  Advances from the FHLB of Atlanta are secured by the
Bank's stock in the FHLB of Atlanta and other eligible assets.  During the years
ended September 30, 2000, 1999 and 1998, the Bank's borrowings consisted of FHLB
advances  and  retail  repurchase   agreements.   Retail  repurchase  agreements
represent  agreements to sell  securities  under terms which require the Bank to
repurchase the same or substantially similar securities by a specified date.

     The following  table sets forth certain  information  regarding  short-term
borrowings by the Company at the dates and for the periods indicated:

<TABLE>
<CAPTION>
                                                                   At or for the Year Ended
                                                                         September 30,
                                                               ----------------------------------
                                                                 2000        1999          1998
                                                                 ----        -----         ----
                                                                     (Dollars in thousands)
<S>                                                            <C>          <C>          <C>
Amounts outstanding at end of period:
  FHLB advances ..........................................     $24,000      $    --      $ 9,500
  Federal funds purchased and securities
    sold under repurchase agreements .....................       6,388      $ 1,318      $ 2,432
Weighted average rate paid on:
  FHLB advances ..........................................        6.94%        0.00%        6.00%
  Federal funds purchased and securities sold under
    agreements to repurchase .............................        4.38%        3.13%        3.33%
Maximum amount of borrowings outstanding at any month end:
  FHLB advances ..........................................     $60,200      $19,000      $10,000
  Federal funds purchased and securities
    sold under repurchase agreements .....................       6,388        2,374        2,652

<PAGE>

<CAPTION>
                                                                   At or for the Year Ended
                                                                         September 30,
                                                               ----------------------------------
                                                                 2000        1999          1998
                                                                 ----        -----         ----
                                                                     (Dollars in thousands)
<S>                                                            <C>          <C>          <C>
Approximate average short-term borrowings
  outstanding with respect to:
  FHLB advances ..........................................     $ 9,168      $10,558      $ 1,071
  Federal funds purchased and securities
    sold under repurchase agreements .....................       3,306        1,773        1,918
Approximate weighted average rate paid on: (1)
  FHLB advances ..........................................        6.09%        5.19%        5.90%
  Federal funds purchased and securities
    sold under repurchase agreements .....................        4.30%        2.69%        3.98%
</TABLE>

------------
(1)  Based on month-end balances.

COMPETITION

     The Company faces strong competition in originating real estate, commercial
business and consumer  loans and in attracting  deposits.  The Bank competes for
real estate and other loans  principally  on the basis of  interest  rates,  the
types of loans it originates,  the deposit products it offers and the quality of
services it provides to borrowers.  The Bank also competes by offering  products
which are tailored to the local  community.  Its competition in originating real
estate loans comes primarily from other commercial banks, savings  institutions,
mortgage  bankers and mortgage  brokers.  Commercial  banks,  credit  unions and
finance companies provide vigorous competition in consumer lending.  Competition
may  increase  as a  result  of the  recent  reduction  of  restrictions  on the
interstate operations of financial institutions.

     The Bank attracts its deposits  through its branch  offices  primarily from
the local  communities.  Consequently,  competition  for deposits is principally
from other commercial banks, savings institutions,  credit unions and brokers in
the Bank's  primary  market  area.  The Bank  competes for deposits and loans by
offering  what it  believes to be a variety of deposit  accounts at  competitive
rates,  convenient business hours, a commitment to outstanding  customer service
and  a  well-trained   staff.   The  Bank  believes  it  has  developed   strong
relationships with local realtors and the community in general.

     Management  considers its primary  market area for  gathering  deposits and
originating  loans to be Beaufort,  Craven,  Lenoir,  Nash,  Pasquotank and Pitt
Counties in eastern North  Carolina,  which are the counties in which the Bank's
offices  are  located.  The  Bank  originates  loans  throughout  eastern  North
Carolina.

EMPLOYEES

     As of  September  30,  2000,  the Bank had 184  full-time  and 14 part-time
employees,  none of whom were represented by a collective  bargaining agreement.
Management considers the Bank's relationships with its employees to be good.

DEPOSITORY INSTITUTION REGULATION

     General.  The Bank is a North  Carolina-chartered  commercial  bank and its
deposit accounts are insured by the Savings Association  Insurance Fund ("SAIF")
of the FDIC. The Bank is subject to  supervision,  examination and regulation by
the  Commissioner  and the FDIC and to North Carolina and federal  statutory and
regulatory  provisions  governing  such matters as capital  standards,  mergers,
subsidiary  investments and  establishment of branch offices.  The FDIC also has
the  authority  to conduct  special  examinations.  The Bank is required to file
reports  with  the  Commissioner  and the FDIC  concerning  its  activities  and
financial  condition and will be required to obtain regulatory approval prior to
entering into certain transactions,  including mergers with, or acquisitions of,
other depository institutions.

<PAGE>

     As a  federally  insured  depository  institution,  the Bank is  subject to
various regulations promulgated by the Board of Governors of the Federal Reserve
System  ("Federal  Reserve  Board"),   including   Regulation  B  (Equal  Credit
Opportunity),  Regulation D (Reserve  Requirements),  Regulations  E (Electronic
Fund Transfers), Regulation Z (Truth in Lending), Regulation CC (Availability of
Funds and Collection of Checks) and Regulation DD (Truth in Savings).

     The system of regulation and supervision applicable to the Bank establishes
a  comprehensive  framework  for the  operations  of the Bank,  and is  intended
primarily for the protection of the FDIC and the depositors of the Bank. Changes
in the  regulatory  framework  could have a material  effect on the Bank that in
turn, could have a material effect on the Company.

     Financial  Modernization  Legislation.  On  November  12,  1999,  President
Clinton  signed  legislation  which  could  have a  far-reaching  impact  on the
financial services  industry.  The  Gramm-Leach-Bliley  ("G-L-B") Act authorizes
affiliations between banking, securities and insurance firms and authorizes bank
holding  companies  and national  banks to engage in a variety of new  financial
activities.  Among the new  activities  that will be  permitted  to bank holding
companies are  securities  and  insurance  brokerage,  securities  underwriting,
insurance  underwriting  and merchant  banking.  The Federal  Reserve Board,  in
consultation  with  the  Secretary  of  the  Treasury,  may  approve  additional
financial activities.  The G-L-B Act, however,  prohibits future acquisitions of
existing  unitary savings and loan holding  companies by firms which are engaged
in  commercial  activities  and limits  the  permissible  activities  of unitary
savings and loan holding companies formed after May 4, 1999.

     The G-L-B Act imposes  new  requirements  on  financial  institutions  with
respect to customer  privacy.  The G-L-B Act generally  prohibits  disclosure of
customer information to nonaffiliated third parties unless the customer has been
given  the  opportunity  to  object  and has not  objected  to such  disclosure.
Financial  institutions  are further required to disclose their privacy policies
to customers  annually.  Financial  institutions,  however,  will be required to
comply  with state law if it is more  protective  of customer  privacy  than the
G-L-B Act.  The G-L-B Act directs the federal  banking  agencies,  the  National
Credit Union Administration,  the Secretary of the Treasury,  the Securities and
Exchange  Commission and the Federal Trade Commission,  after  consultation with
the National Association of Insurance Commissioners,  to promulgate implementing
regulations  within six  months of  enactment.  The  privacy  provisions  became
effective in November 2000, with full compliance required by July 1, 2001.

     The G-L-B Act contains significant  revisions to the FHLB System. The G-L-B
Act imposes new capital  requirements  on the FHLBs and authorizes them to issue
two classes of stock with differing dividend rates and redemption  requirements.
The G-L-B Act deletes the current requirement that the FHLBs annually contribute
$300 million to pay interest on certain government obligations in favor of a 20%
of net  earnings  formula.  The G-L-B Act expands the  permissible  uses of FHLB
advances by community  financial  institutions (under $500 million in assets) to
include   funding   loans  to  small   businesses,   small   farms   and   small
agri-businesses.  The G-L-B  Act  makes  membership  in the FHLB  voluntary  for
federal savings associations.

     The  G-L-B  Act  contains  a  variety  of  other  provisions   including  a
prohibition  against ATM surcharges  unless the customer has first been provided
notice of the  imposition  and  amount of the fee.  The  G-L-B Act  reduces  the
frequency of Community  Reinvestment Act  examinations for smaller  institutions
and imposes certain reporting requirements on depository  institutions that make
payments  to   nongovernmental   entities  in  connection   with  the  Community
Reinvestment  Act.  The  G-L-B  Act  eliminates  the SAIF  special  reserve  and
authorizes a federal  savings  association  that converts to a national or state
bank charter to continue to use the term "federal" in its name and to retain any
interstate branches.

     The  Company  is  unable  to  predict  the  impact  of the G-L-B Act on its
operations at this time.

     Capital  Requirements.   The  Federal  Reserve  Board  and  the  FDIC  have
established  guidelines with respect to the maintenance of appropriate levels of
capital by bank holding  companies with  consolidated  assets of $150 million or
more and state nonmember banks, respectively. The regulations impose two sets of
capital  adequacy  requirements:  minimum  leverage  rules,  which  require bank
holding  companies  and state  nonmember  banks to maintain a specified  minimum
ratio of capital to total assets,  and risk-based  capital rules,  which require
the

<PAGE>

maintenance of specified  minimum ratios of capital to  "risk-weighted"  assets.
The  regulations of the FDIC and the Federal  Reserve Board require bank holding
companies  and  state  nonmember  banks,  respectively,  to  maintain  a minimum
leverage  ratio of "Tier 1 capital" to total  assets of 3.0%.  Tier 1 capital is
the sum of common stockholders' equity,  noncumulative perpetual preferred stock
(including  any  related  surplus),   and  minority  interests  in  consolidated
subsidiaries; minus all intangible assets (other than certain purchased mortgage
servicing rights and purchased credit card  receivables),  identified losses and
investments in certain  subsidiaries.  As a SAIF-insured,  state-chartered bank,
the Bank must also deduct from Tier 1 capital an amount equal to its investments
in, and extensions of credit to, subsidiaries engaged in activities that are not
permissible  for  national  banks,  other  than debt and equity  investments  in
subsidiaries  engaged in  activities  undertaken  as agent for  customers  or in
mortgage banking  activities or in subsidiary  depository  institutions or their
holding  companies.  Although setting a minimum 3.0% leverage ratio, the capital
regulations state that only the strongest bank holding companies and banks, with
composite  examination  ratings of 1 CAMELS under the rating  system used by the
federal bank regulators,  are permitted to operate at or near such minimum level
of capital.  All other bank holding companies and banks must maintain a leverage
ratio of at  least  4%.  Any  bank or bank  holding  companies  experiencing  or
anticipating significant growth would be expected to maintain capital well above
the minimum  levels.  In addition,  the Federal Reserve Board has indicated that
whenever  appropriate,  and  in  particular  when  a  bank  holding  company  is
undertaking  expansion,  seeking to engage in new activities or otherwise facing
unusual or abnormal risks, it will consider,  on a case-by-case basis, the level
of an organization's  ratio of tangible Tier 1 capital to total assets in making
an overall assessment of capital.

     In addition to the leverage  ratio,  the regulations of the Federal Reserve
Board and the FDIC require bank holding companies and state-chartered  nonmember
banks to maintain a minimum ratio of qualifying  total capital to  risk-weighted
assets  of at  least  8.0% of  which  at  least  4.0%  must  be Tier 1  capital.
Qualifying   total   capital   consists  of  Tier  1  capital  plus  Tier  2  or
"supplementary  capital,  items which include  allowances  for loan losses in an
amount of up to 1.25% of risk-weighted  assets,  cumulative  preferred stock and
preferred  stock  with a maturity  of 20 years or more,  certain  other  capital
instruments  and  up to  45% of  unrealized  gains  of  equity  securities.  The
includible  amount of Tier 2 capital  cannot  exceed  the  institution's  Tier 1
capital. Qualifying total capital is further reduced by the amount of the bank's
investments in banking and finance  subsidiaries  that are not  consolidated for
regulatory  capital purposes,  reciprocal  cross-holdings of capital  securities
issued by other banks and  certain  other  deductions.  The  risk-based  capital
regulations  assign  balance sheet assets and the credit  equivalent  amounts of
certain off-balance sheet items to one of four broad risk weight categories. The
aggregate  dollar  amount of each  category  is  multiplied  by the risk  weight
assigned  to that  category  based  principally  on the  degree of  credit  risk
associated  with the obligor.  The sum of these weighted  values equals the bank
holding company or the bank's risk-weighted assets.

     In addition to FDIC  regulatory  capital  requirements,  the North Carolina
Bank Commissioner  requires that the Bank have adequate  capitalization which is
determined based upon each Bank's particular set of  circumstances.  The Bank is
subject  to  the  Commissioner's   capital  surplus  regulation  which  requires
commercial  banks to  maintain  a  capital  surplus  of at least  50% of  common
capital. Common capital is defined as the total of the par value of shares times
the number of shares outstanding.

     Prompt  Corrective  Regulatory  Action.  Under FDICIA,  the federal banking
regulators  are  required  to  take  prompt  corrective  action  if  an  insured
depository  institution  fails to satisfy certain minimum capital  requirements,
including a leverage  limit,  a risk-based  capital  requirement,  and any other
measure deemed  appropriate by the federal banking  regulators for measuring the
capital  adequacy  of  an  insured  depository  institution.  All  institutions,
regardless  of their  capital  levels,  are  restricted  from making any capital
distribution or paying any management fees if the institution  would  thereafter
fail to satisfy  the  minimum  levels for any of its  capital  requirements.  An
institution  that  fails to meet the  minimum  level  for any  relevant  capital
measure (an  "undercapitalized  institution")  may be: (i) subject to  increased
monitoring by the appropriate federal banking regulator; (ii) required to submit
an acceptable  capital  restoration  plan within 45 days; (iii) subject to asset
growth  limits;  and (iv)  required  to obtain  prior  regulatory  approval  for
acquisitions,  branching and new lines of  businesses.  The capital  restoration
plan must  include a guarantee  by the  institution's  holding  company that the
institution  will comply with the plan until it has been adequately  capitalized
on average for four consecutive quarters,  under which the holding company would
be liable up to the lesser of 5% of the institution's total assets or the amount
necessary to bring the  institution  into capital  compliance  as of the date it
failed  to  comply  with  its  capital   restoration   plan.  A   "significantly
undercapitalized"  institution, as well as any undercapitalized institution that
does not  submit an  acceptable  capital  restoration  plan,  may be  subject to
regulatory demands for recapitalization, broader application of restrictions on

<PAGE>

transactions  with  affiliates,  limitations on interest rates paid on deposits,
asset  growth  and other  activities,  possible  replacement  of  directors  and
officers,  and restrictions on capital distributions by any bank holding company
controlling the institution. Any company controlling the institution may also be
required  to divest the  institution  or the  institution  could be  required to
divest   subsidiaries.   The  senior  executive   officers  of  a  significantly
undercapitalized   institution   may  not  receive   bonuses  or   increases  in
compensation  without prior  approval and the  institution  is  prohibited  from
making  payments of principal  or interest on its  subordinated  debt.  In their
discretion,  the  federal  banking  regulators  may also  impose  the  foregoing
sanctions on an  undercapitalized  institution if the regulators  determine that
such actions are  necessary  to carry out the purposes of the prompt  corrective
provisions.  If an institution's ratio of tangible capital to total assets falls
below the  "critical  capital  level"  established  by the  appropriate  federal
banking  regulator,  the  institution  will be  subject  to  conservatorship  or
receivership within specified time periods.

     Under  the  implementing  regulations,   the  federal  banking  regulators,
including the FDIC,  generally measure an institution's  capital adequacy on the
basis of its total  risk-based  capital ratio (the ratio of its total capital to
risk-weighted  assets),  Tier 1 risk-based  capital ratio (the ratio of its core
capital  to  risk-weighted  assets)  and  leverage  ratio (the ratio of its core
capital to adjusted total assets).  The following table shows the capital ratios
required for the various prompt corrective action categories.

<TABLE>
<CAPTION>
                                          Adequately                             Significantly
                     Well Capitalized    Capitalized      Undercapitalized     Undercapitalized
                     ----------------    -----------      ----------------     ----------------
<S>                   <C>               <C>                <C>                  <C>
Total risk-based
   capital ratio      10.0% or more     8.0% or more       Less than 8.0%       Less than 6.0%
Tier 1 risk-based
   capital ratio       6.0% or more     4.0% or more       Less than 4.0%       Less than 3.0%
Leverage ratio         5.0% or more     4.0% or more*      Less than 4.0%*      Less than 3.0%
</TABLE>

-----------
*    3.0% if institution has a composite 1 CAMELS rating.

     A  "critically  undercapitalized"  savings  institution  is  defined  as an
institution  that has a ratio of "tangible  equity" to total assets of less than
2.0%.  Tangible  equity is defined as core  capital  plus  cumulative  perpetual
preferred stock (and related surplus) less all intangibles other than qualifying
supervisory  goodwill and certain purchased  mortgage servicing rights. The FDIC
may reclassify a well capitalized savings institution as adequately  capitalized
and may require an adequately  capitalized  or  undercapitalized  institution to
comply with the supervisory actions applicable to institutions in the next lower
capital  category  (but  may not  reclassify  a  significantly  undercapitalized
institution as critically undercapitalized) if the FDIC determines, after notice
and an opportunity for a hearing,  that the savings  institution is in an unsafe
or unsound  condition or that the  institution  has received and not corrected a
less-than-satisfactory rating for any CAMELS rating category.

     Safety and Soundness  Guidelines.  Under  FDICIA,  as amended by the Riegle
Community  Development and Regulatory  Improvement Act of 1994 (the "CDRI Act"),
each  federal  banking  agency was required to  establish  safety and  soundness
standards for  institutions  under its  authority.  The  interagency  guidelines
require  depository  institutions to maintain  internal controls and information
systems and internal audit systems that are appropriate for the size, nature and
scope of the institution's business. The guidelines also establish certain basic
standards  for loan  documentation,  credit  underwriting,  interest  rate  risk
exposure,  and asset growth.  The  guidelines  further  provide that  depository
institutions  should maintain safeguards to prevent the payment of compensation,
fees and benefits  that are  excessive or that could lead to material  financial
loss,  and should take into  account  factors  such as  comparable  compensation
practices at comparable institutions.  If the appropriate federal banking agency
determines  that a depository  institution is not in compliance  with the safety
and soundness guidelines, it may require the institution to submit an acceptable
plan to achieve  compliance with the guidelines.  A depository  institution must
submit an acceptable  compliance plan to its primary federal regulator within 30
days of receipt of a request for such a plan.  Failure to submit or  implement a
compliance plan may subject the institution to regulatory sanctions.  Management
believes that the Bank already  substantially meets all the standards adopted in
the interagency guidelines.

<PAGE>

     Community Reinvestment Act. The Bank, like other financial institutions, is
subject to the Community  Reinvestment Act ("CRA"). The purpose of the CRA is to
encourage  financial  institutions to help meet the credit needs of their entire
communities,  including  the  needs of  low-and  moderate-income  neighborhoods.
During  the  Bank's  last   compliance   examination,   the  Bank   received  an
"outstanding"  rating with  respect to CRA  compliance.  The Bank's  rating with
respect to CRA  compliance  would be a factor to be  considered  by the  Federal
Reserve Board and the FDIC in considering  applications submitted by the Bank to
acquire branches or to acquire or combine with other financial  institutions and
take other  actions  and,  if such  rating was less than  "satisfactory,"  could
result in the denial of such applications.

     The federal banking  regulatory  agencies have issued a revision of the CRA
regulations,  which  became  effective  on January 1, 1996,  to  implement a new
evaluation system that rates  institutions  based on their actual performance in
meeting  community  credit needs.  Under the  regulations,  a bank will first be
evaluated and rated under three  categories:  a lending test, an investment test
and a service  test.  For each of these three  tests,  the savings  bank will be
given a rating of either "outstanding," "high satisfactory," "low satisfactory,"
"needs to improve," or "substantial  non-compliance." A set of criteria for each
rating has been developed and is included in the  regulation.  If an institution
disagrees with a particular  rating, the institution has the burden of rebutting
the presumption by clearly  establishing  that the quantitative  measures do not
accurately present its actual  performance,  or that  demographics,  competitive
conditions or economic or legal limitations  peculiar to its service area should
be  considered.  The  ratings  received  under the three  tests  will be used to
determine the overall  composite CRA rating.  The composite  ratings will be the
same as those that are currently given: "outstanding," "satisfactory," "needs to
improve" or "substantial non-compliance."

     Federal  Home Loan Bank  System.  The FHLB  System  consists of 12 district
FHLBs subject to supervision and regulation by the Federal Housing Finance Board
("FHFB").  The FHLBs  provide a central  credit  facility  primarily  for member
institutions.  As a member  of the FHLB of  Atlanta,  the  Bank is  required  to
acquire and hold shares of capital  stock in the FHLB of Atlanta in an amount at
least equal to 1% of the aggregate  unpaid principal of its home mortgage loans,
home purchase contracts,  and similar obligations at the beginning of each year,
or 1/20 of its  advances  (borrowings)  from the FHLB of Atlanta,  whichever  is
greater.  The Bank was in compliance  with this  requirement  with investment in
FHLB of Atlanta  stock at  September  30,  2000,  of $2.7  million.  The FHLB of
Atlanta serves as a reserve or central bank for its member  institutions  within
its assigned  district.  It is funded  primarily from proceeds  derived from the
sale of  consolidated  obligations  of the FHLB  System.  It offers  advances to
members in accordance  with policies and procedures  established by the FHFB and
the Board of  Directors of the FHLB of Atlanta.  Long-term  advances may only be
made for the purpose of providing funds for residential  housing finance,  small
businesses, small farms and small agribusinesses.

     Reserves.  Pursuant to regulations of the Federal  Reserve Board,  the Bank
must  maintain  average  daily  reserves  against  their  transaction  accounts.
Reserves  equal to 3% must be maintained on  transaction  accounts  between $4.9
million and $42.8 million, plus 10% on the remainder. This percentage is subject
to adjustment by the Federal Reserve Board.  Because  required  reserves must be
maintained  in the form of vault cash or in a noninterest  bearing  account at a
Federal  Reserve Bank,  the effect of the reserve  requirement  is to reduce the
amount of the institution's  interest-earning  assets. As of September 30, 2000,
the Bank met its reserve requirements.

     The Bank is also  subject to the  reserve  requirements  of North  Carolina
commercial banks. North Carolina law requires state nonmember banks to maintain,
at all times, a reserve fund in an amount set by the State Banking Commission.

     Deposit  Insurance.  The Bank is  required  to pay  assessments  based on a
percentage of its insured  deposits to the FDIC for insurance of its deposits by
the SAIF. Under the FDIC's risk-based  deposit insurance  assessment system, the
assessment rate for an insured depository  institution depends on the assessment
risk classification assigned to the institution by the FDIC, which is determined
by the  institution's  capital level and supervisory  evaluations.  Based on the
data reported to regulators  for the date closest to the last day of the seventh
month preceding the semi-annual assessment period,  institutions are assigned to
one of three  capital  groups -- well  capitalized,  adequately  capitalized  or
undercapitalized  --  using  the  same  percentage  criteria  as in  the  prompt
corrective action  regulations.  See "-- Prompt Corrective  Regulatory  Action."
Within each capital group,  institutions  are assigned to one of three subgroups
on the basis of supervisory evaluations by the institution's primary supervisory
authority and such other  information  as the FDIC  determines to be relevant to
the institution's financial

<PAGE>

condition and the risk posed to the deposit insurance fund.  Subgroup A consists
of financially sound  institutions with only a few minor weaknesses.  Subgroup B
consists of institutions  that demonstrate  weaknesses  which, if not corrected,
could result in significant  deterioration of the institution and increased risk
of loss to the deposit insurance fund.  Subgroup C consists of institutions that
pose a  substantial  probability  of loss to the deposit  insurance  fund unless
effective  corrective  action is taken.  The  assessment  rate for SAIF  members
ranges  from zero for well  capitalized  institutions  in Subgroup A to 0.27% of
deposits  for  undercapitalized  institutions  in  Subgroup C. Both BIF and SAIF
members are assessed an amount for Financing  Corporation  bond payments.  Until
December 31,  1999,  BIF members were  assessed  approximately  1.3 basis points
while the SAIF rate was  approximately  6.4 basis points. As of January 1, 2000,
BIF and SAIF  members  began pro rata  sharing of the  payment at a rate of 2.43
basis points.

     Although the Bank, as a North Carolina  commercial  bank, would qualify for
insurance of deposits by the BIF of the FDIC, substantial entrance and exit fees
apply to  conversions  from  SAIF to BIF  insurance.  Accordingly,  the Bank has
remained  a member of the SAIF,  which  insures  the  deposits  of the Bank to a
maximum of $100,000 for each depositor.

     Liquidity Requirements. FDIC policy requires that banks maintain an average
daily  balance  of  liquid  assets  (cash,   certain  time  deposits,   bankers'
acceptances  and specified  United States  government,  state, or federal agency
obligations)  in an  amount  which it  deems  adequate  to  protect  safety  and
soundness  of the  bank.  The FDIC  currently  has no  specific  level  which it
requires. Under the FDIC's calculation method,  management calculated the Bank's
liquidity ratio as 27.9% of total assets at September 30, 2000, which management
believes is adequate.

     North Carolina banks must maintain a reserve fund in an amount and/or ratio
set by the Banking Commission to account for the level of liquidity necessary to
assure the safety and soundness of the State banking system. As of September 30,
2000,  the  Bank's   liquidity  ratio  was  in  excess  of  the  North  Carolina
regulations.

     Dividend Restrictions.  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 ratio of less
than 4.0%.

     Earnings of the Bank  appropriated  to bad debt  reserves  and deducted for
federal  income tax purposes are not available for payment of cash  dividends or
other distributions to stockholders without payment of taxes at the then current
tax  rate by the Bank on the  amount  of  earnings  removed  from  the  pre-1988
reserves  for such  distributions.  The Bank  intends  to make  full use of this
favorable tax treatment and does not contemplate use of any earnings in a manner
which would create federal tax liabilities.

     Limits on Loans to One Borrower. The Bank generally is subject to both FDIC
regulations  and  North  Carolina  law  regarding  loans  to any  one  borrower,
including  related   entities.   Under  applicable  law,  with  certain  limited
exceptions,  loans and extensions of credit by a state chartered  nonmember bank
to a person outstanding at one time and not fully secured by collateral having a
market  value at least  equal to the amount of the loan or  extension  of credit
shall not exceed 15% of the unimpaired capital of the bank. Loans and extensions
of credit fully secured by readily  marketable  collateral having a market value
may comprise  shall not exceed 10% of the  unimpaired  capital fund of the bank.
Under  these  limits,  the Bank's  loans to one  borrower  were  limited to $6.6
million  at  September  30,  2000.  At  that  date,  the  Bank  had  no  lending
relationships in excess of the loans-to-one-borrower  limit. Notwithstanding the
statutory  loans-to-one-borrower  limitations,  the  Bank  has  a  self  imposed
loans-to-one-borrower  limit, which currently is $4.3 million.  At September 30,
2000, the Bank's largest lending  relationship  was a $3.4 million  relationship
consisting of six commercial real estate loans and one unsecured loan. All loans
within this  relationship  were current and performing in accordance  with their
terms at September 30, 2000.

     Transactions with Related Parties.  Transactions  between a state nonmember
bank and any  affiliate  are  governed  by  Sections  23A and 23B of the Federal
Reserve  Act. An affiliate  of a state  nonmember  bank is any company or entity
which  controls,  is  controlled  by or is under  common  control with the state
nonmember  bank. In a holding company  context,  the parent holding company of a
state  nonmember  bank  (such  as the  Company)  and  any  companies  which  are
controlled  by  such  parent  holding  company  are  affiliates  of the  savings
institution or state nonmember bank.  Generally,  Sections 23A and 23B (i) limit
the extent to which an  institution or its  subsidiaries  may engage in "covered
transactions"  with  any  one  affiliate  to an  amount  equal  to 10%  of  such
institution's capital

<PAGE>

stock and surplus,  and contain an aggregate limit on all such transactions with
all  affiliates  to an amount equal to 20% of such capital stock and surplus and
(ii) require that all such  transactions be on terms  substantially the same, or
at least as favorable,  to the  institution or subsidiary as those provided to a
non-affiliate.  The term  "covered  transaction"  includes  the making of loans,
purchase  of  assets,  issuance  of a  guarantee  and  similar  other  types  of
transactions.  In addition to the restrictions  imposed by Sections 23A and 23B,
no state nonmember bank may (i) loan or otherwise extend credit to an affiliate,
except for any affiliate which engages only in activities  which are permissible
for bank holding  companies,  or (ii)  purchase or invest in any stocks,  bonds,
debentures, notes or similar obligations of any affiliate, except for affiliates
which are subsidiaries of the state nonmember bank.

     State  nonmember  banks also are subject to the  restrictions  contained in
Section 22(h) of the Federal Reserve Act and the Federal Reserve's  Regulation O
thereunder on loans to executive officers, directors and principal stockholders.
Under Section  22(h),  loans to a director,  executive  officer and to a greater
than 10% stockholder of a state nonmember bank and certain affiliated  interests
of such persons,  may not exceed,  together with all other  outstanding loans to
such person and affiliated  interests,  the institution's  loans-to-one-borrower
limit and all loans to such persons may not exceed the institution's  unimpaired
capital and  unimpaired  surplus.  Section  22(h) also  prohibits  loans,  above
amounts  prescribed by the appropriate  federal  banking  agency,  to directors,
executive  officers and greater than 10% stockholders of a savings  institution,
and their  respective  affiliates,  unless such loan is approved in advance by a
majority of the board of  directors  of the  institution  with any  "interested"
director not  participating  in the voting.  Regulation  O  prescribes  the loan
amount (which includes all other  outstanding  loans to such person) as to which
such prior  board of  director  approval  is  required  as being the  greater of
$25,000 or 5% of capital and surplus (up to  $500,000).  Further,  Section 22(h)
requires that loans to directors,  executive officers and principal stockholders
be made on terms substantially the same as offered in comparable transactions to
other persons.  Section 22(h) also generally prohibits a depository  institution
from paying the overdrafts of any of its executive officers or directors.

     State nonmember banks also are subject to the requirements and restrictions
of Section 22(g) of the Federal  Reserve Act on loans to executive  officers and
the  restrictions  of 12  U.S.C.  ss.1972  on  certain  tying  arrangements  and
extensions  of credit  by  correspondent  banks.  Section  22(g) of the  Federal
Reserve Act requires loans to executive officers of depository  institutions not
be made on terms more favorable than those afforded to other borrowers, requires
approval by the board of directors of a depository  institution for extension of
credit  to  executive  officers  of  the  institution,   and  imposes  reporting
requirements  for and additional  restrictions on the type,  amount and terms of
credits to such  officers.  Section 1972 (i) prohibits a depository  institution
from extending  credit to or offering any other  services,  or fixing or varying
the consideration for such extension of credit or service, on the condition that
the customer obtain some  additional  service from the institution or certain of
its  affiliates  or not obtain  services  of a  competitor  of the  institution,
subject  to  certain  exceptions,  and (ii)  prohibits  extensions  of credit to
executive officers, directors, and greater than 10% stockholders of a depository
institution  by  any  other  institution  which  has  a  correspondent   banking
relationship  with the  institution,  unless  such  extension  of  credit  is on
substantially  the same  terms as those  prevailing  at the time for  comparable
transactions  with other  persons and does not involve more than the normal risk
of repayment or present other unfavorable features.

     Additionally,  North Carolina  statutes set forth  restrictions on loans to
executive  officers of  state-chartered  banks,  which  provide that no bank may
extend  credit to any of its  executive  officers nor a firm or  partnership  of
which such executive officers is a member, nor a company in which such executive
officer owns a controlling  interest,  unless the extension of credit is made on
substantially the same terms, including interest rates and collateral,  as those
prevailing at the time for comparable  transactions by the bank with persons who
are not employed by the bank, and provided  further that the extension of credit
does not involve more than the normal risk of repayment.

     Restrictions on Certain Activities. Under FDICIA, state-chartered nonmember
banks with deposits insured by the FDIC are generally  prohibited from acquiring
or  retaining  any  equity  investment  of a type  or in an  amount  that is not
permissible  for a national bank. The foregoing  limitation,  however,  does not
prohibit  FDIC-insured  state  banks  from  acquiring  or  retaining  an  equity
investment   in  a   subsidiary   in  which  the  bank  is  a  majority   owner.
State-chartered banks are also prohibited from engaging as principal in any type
of activity  that is not  permissible  for a national bank and  subsidiaries  of
state-chartered,  FDIC-insured  state banks may not engage as  principal  in any
type of activity  that is not  permissible  for a subsidiary  of a national bank
unless  in either  case the FDIC  determines  that the  activity  would  pose no
significant risk to the appropriate  deposit insurance fund and the bank is, and
continues to be, in compliance with applicable capital standards.

<PAGE>

     The FDIC has adopted  regulations to clarify the foregoing  restrictions on
activities of FDIC-insured  state-chartered banks and their subsidiaries.  Under
the regulations,  the term activity refers to the authorized conduct of business
by an insured  state bank and includes  acquiring or  retaining  any  investment
other than an equity  investment.  An activity  permissible  for a national bank
includes  any activity  expressly  authorized  for national  banks by statute or
recognized as permissible in regulations,  official circulars or bulletins or in
any order or written  interpretation  issued by the Office of the Comptroller of
the Currency  ("OCC").  In its regulations,  the FDIC indicates that it will not
permit  state banks to  directly  engage in  commercial  ventures or directly or
indirectly  engage in any  insurance  underwriting  activity  other  than to the
extent such  activities are  permissible  for a national bank or a national bank
subsidiary or except for certain  other limited forms of insurance  underwriting
permitted under the regulations.  Under the regulations,  the FDIC permits state
banks that meet applicable  minimum capital  requirements to engage as principal
in certain  activities  that are not  permissible  to national  banks  including
guaranteeing  obligations of others,  activities which the Federal Reserve Board
has found by  regulation  or order to be closely  related to banking and certain
securities activities conducted through subsidiaries.

REGULATION OF THE COMPANY

     General.  The  Company,  as the sole  shareholder  of the  Bank,  is a bank
holding company and is registered  with the Federal Reserve Board.  Bank holding
companies are subject to  comprehensive  regulation by the Federal Reserve Board
under the Bank Holding  Company Act of 1956,  as amended (the  "BHCA"),  and the
regulations of the Federal Reserve Board. As a bank holding company, the Company
is required  to file with the  Federal  Reserve  Board  annual  reports and such
additional  information as the Federal Reserve Board may require, and is subject
to regular  examinations by the Federal Reserve Board. The Federal Reserve Board
also has extensive enforcement authority over bank holding companies, including,
among other things, the ability to assess civil money penalties,  to issue cease
and  desist or  removal  orders and to  require  that a holding  company  divest
subsidiaries (including its bank subsidiaries).  In general, enforcement actions
may be initiated  for  violations of law and  regulations  and unsafe or unsound
practices.

     Under the BHCA, a bank holding  company must obtain  Federal  Reserve Board
approval before: (i) acquiring, directly or indirectly,  ownership or control of
any  voting  shares of  another  bank or bank  holding  company  if,  after such
acquisition,  it would own or  control  more than 5% of such  shares  (unless it
already owns or controls the majority of such  shares);  (ii)  acquiring  all or
substantially  all of the assets of another  bank or bank  holding  company;  or
(iii) merging or consolidating with another bank holding company,  (satisfactory
financial  condition,  particularly  with  respect  to capital  adequacy,  and a
satisfactory  CRA  rating  generally  are  prerequisites  to  obtaining  federal
regulatory approval to make acquisitions).

     The BHCA also prohibits a bank holding  company,  with certain  exceptions,
from  acquiring  direct or indirect  ownership or control of more than 5% of the
voting  shares of any company  which is not a bank or bank holding  company,  or
from engaging  directly or indirectly in activities other than those of banking,
managing or controlling banks, or providing  services for its subsidiaries.  The
principal  exceptions to these prohibitions  involve certain non-bank activities
which,  by statute or by Federal  Reserve Board  regulation or order,  have been
identified as activities  closely related to the business of banking or managing
or controlling  banks.  The list of activities  permitted by the Federal Reserve
Board includes,  among other things,  operating a savings institution,  mortgage
company,  finance company, credit card company or factoring company;  performing
certain data processing  operations;  providing certain investment and financial
advice;  underwriting  and acting as an  insurance  agent for  certain  types of
credit-related  insurance;  leasing  property  on a  full-payout,  non-operating
basis; selling money orders,  travelers' checks and United States Savings Bonds;
real  estate and  personal  property  appraising;  providing  tax  planning  and
preparation services; and, subject to certain limitations,  providing securities
brokerage services for customers.  The Company has no present plans to engage in
any of these activities.

     The Federal  Reserve  Board has adopted  guidelines  regarding  the capital
adequacy of bank holding  companies,  which  require  bank holding  companies to
maintain  specified  minimum  ratios of capital to total  assets and  capital to
risk-weighted  assets.  See " --  Depository  Institution  Regulation -- Capital
Requirements."

     Acquisition  of Bank  Holding  Companies  and  Banks.  Under the BHCA,  any
company  must obtain  approval of the Federal  Reserve  Board prior to acquiring
control of the  Company or the Bank.  For  purposes  of the BHCA,  "control"  is
defined as ownership of more than 25% of any class of voting  securities  of the
Company or the Bank,

<PAGE>

the ability to control  the  election  of a majority  of the  directors,  or the
exercise of a controlling  influence over  management or policies of the Company
or the Bank.  In  addition,  the  Change  in Bank  Control  Act and the  related
regulations of the Federal Reserve Board require any person or persons acting in
concert (except for companies  required to make application  under the BHCA), to
file a written  notice  with the  Federal  Reserve  Board  before such person or
persons  may  acquire  control of the  Company  or the Bank.  The Change in Bank
Control Act defines "control" as the power, directly or indirectly,  to vote 25%
or more of any voting  securities  or to direct the  management or policies of a
bank holding company or an insured bank.

     Interstate  Banking.  The  Riegle-Neal  Interstate  Banking  and  Branching
Efficiency  Act of  1994  (the  "Act")  was  enacted  to  ease  restrictions  on
interstate  banking.  Effective  September 29, 1995,  the Act allows the Federal
Reserve  Board to  approve  an  application  of an  adequately  capitalized  and
adequately managed bank holding company to acquire control of, or acquire all or
substantially  all of the assets of, a bank  located in a state  other than such
holding  company's  home state,  without  regard to whether the  transaction  is
prohibited by the laws of any state.  The Federal  Reserve Board may not approve
the  acquisition  of bank that has not been in  existence  for the minimum  time
period (not  exceeding  five years)  specified by the  statutory law of the host
state.  The Act also  prohibits  the Federal  Reserve  Board from  approving  an
application  if  the  applicant  (and  its  depository  institution  affiliates)
controls or would  control  more than 10% of the insured  deposits in the United
States or 30% or more of the deposits in the target  bank's home state or in any
state in which the target bank  maintains a branch.  The Act does not affect the
authority of states to limit the  percentage  of total  insured  deposits in the
state which may be held or controlled  by a bank or bank holding  company to the
extent such limitation does not discriminate  against out-of-state banks or bank
holding  companies.   Individual  states  may  also  waive  the  30%  state-wide
concentration limit contained in the Act.

     Additionally,  the Act authorizes the federal  banking  agencies to approve
interstate  merger  transactions  without regard to whether such  transaction is
prohibited  by the law of any  state,  unless the home state of one of the banks
opted out of the Act by  adopting a law after the date of  enactment  of the Act
and prior to June 1, 1997 that  applies  equally to all  out-of-state  banks and
expressly  prohibits merger  transactions  involving  out-of-state  banks. North
Carolina has enacted  legislation  permitting  interstate banking  transactions.
Interstate  acquisitions  of branches  will be permitted  only if the law of the
state in which the  branch is  located  permits  such  acquisitions.  Interstate
mergers  and branch  acquisitions  will also be subject  to the  nationwide  and
statewide insured deposit concentration amounts described above.

     The Act  authorizes  the FDIC to approve  interstate  branching  de novo by
state banks only in states which specifically allow for such branching. Pursuant
to the Act, the appropriate  federal banking agencies adopted  regulations which
prohibit any  out-of-state  bank from using the interstate  branching  authority
primarily  for the  purpose of deposit  production.  These  regulations  include
guidelines to ensure that interstate  branches  operated by an out-of-state bank
in a host  state  are  reasonably  helping  to  meet  the  credit  needs  of the
communities which they serve.

     Dividends.  The Federal Reserve Board has issued a policy  statement on the
payment of cash dividends by bank holding companies, which expresses the Federal
Reserve  Board's view that a bank holding company should pay cash dividends only
to the extent that the  company's  net income for the past year is sufficient to
cover both the cash dividends and a rate of earning retention that is consistent
with the company's capital needs, asset quality and overall financial condition.
The Federal  Reserve Board also indicated that it would be  inappropriate  for a
company   experiencing  serious  financial  problems  to  borrow  funds  to  pay
dividends.  Furthermore,  under the prompt corrective action regulations adopted
by the Federal  Reserve Board pursuant to FDICIA,  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".   See  "--
Depository Institution Regulation -- Prompt Corrective Regulatory Action."

     Bank holding companies are required to give the Federal Reserve Board prior
written  notice  of  any  purchase  or  redemption  of  its  outstanding  equity
securities  if the gross  consideration  for the  purchase or  redemption,  when
combined with the net  consideration  paid for all such purchases or redemptions
during  the  preceding  12  months,  is  equal  to 10%  or  more  of  the  their
consolidated retained earnings.  The Federal Reserve Board may disapprove such a
purchase or redemption if it determines  that the proposal  would  constitute an
unsafe or unsound practice or would violate any law, regulation, Federal Reserve
Board order, or any condition imposed by, or written agreement with, the Federal
Reserve Board.

<PAGE>

     The Federal  Reserve  Board has adopted  guidelines  regarding  the capital
adequacy of bank holding  companies,  which  require  bank holding  companies to
maintain  specified  minimum  ratios of capital to total  assets and  capital to
risk-weighted  assets.  See "--  Depository  Institution  Regulation  -- Capital
Requirements."

TAXATION - GENERAL

     The Bank files a federal  income tax return  based on a fiscal  year ending
September 30.

FEDERAL INCOME TAXATION

     The Bank is subject to the provisions of the Internal Revenue Code of 1986,
as amended (the  "Internal  Revenue  Code") in the same general  manner as other
corporations.  In its form as a savings bank until April 1997, through tax years
beginning  before  December  31, 1995,  institutions  such as the Bank which met
certain  definitional  tests and other  conditions  prescribed  by the  Internal
Revenue  Code  benefited  from  certain  favorable  provisions  regarding  their
deductions  from taxable income for annual  additions to their bad debt reserve.
For  purposes  of the bad debt  reserve  deduction,  loans  are  separated  into
"qualifying real property loans," which generally are loans secured by interests
in certain real property,  and "nonqualifying loans", which are all other loans.
The bad debt reserve deduction with respect to nonqualifying loans must be based
on actual loss  experience.  The amount of the bad debt reserve  deduction  with
respect  to  qualifying  real  property  loans  may be based  upon  actual  loss
experience  (the  "experience   method")  or  a  percentage  of  taxable  income
determined  without regard to such deduction (the  "percentage of taxable income
method"). Under the experience method, the bad debt deduction for an addition to
the reserve for qualifying real property loans was an amount  determined under a
formula  based  generally  on the bad  debts  actually  sustained  by a  savings
institution  over a period of years.  Under the  percentage  of  taxable  income
method,  the bad debt reserve  deduction for qualifying  real property loans was
computed  as  8%  of  a  savings  institution's  taxable  income,  with  certain
adjustments.  The Bank generally elected to use the method which has resulted in
the greatest deductions for federal income tax purposes in any given year.

     Legislation  that became  effective for tax years  beginning after December
31, 1995  requiring the Bank to recapture into taxable income over a six taxable
year period the portion of the tax loan  reserve  that  exceeds the pre-1988 tax
loan loss reserve.  The Bank will no longer be allowed to use the reserve method
for tax loan loss provisions,  but would be allowed to use the experience method
of accounting  for bad debts.  There will be no future effect on net income from
the  recapture  because the taxes on these bad debts  reserves  has already been
accrued as a deferred tax liability.

     The Bank's  federal  income tax returns have been audited  through the year
ended September 30, 1992.

STATE INCOME TAXATION

     Under North  Carolina law, the  corporate  income tax currently is 7.25% of
federal taxable income as computed under the Internal  Revenue Code,  subject to
certain  prescribed  adjustments.  For the tax years beginning in 1998, 1999 and
2000,  this rate will be reduced to 7.25%,  7.00% and  6.90%,  respectively.  An
annual state  franchise tax is imposed at a rate of .15% applied to the greatest
of the  institutions  (i) capital  stock,  surplus and undivided  profits,  (ii)
investment in tangible  property in North Carolina or (iii) appraised  valuation
of property in North Carolina.

     For additional  information regarding taxation, see Notes 1 and 11 of Notes
to Consolidated Financial Statements in the Annual Report.

<PAGE>

ITEM 2. PROPERTIES
------------------

     The  following  table  sets  forth  the  location  and  certain  additional
information regarding the Bank's offices at September 30, 2000.

                                                    Book Value at
                                  Year    Owned or  September 30,  Approximate
                                 Opened    Leased       2000      Square Footage
                                 ------    ------      ------     --------------
                                               (Dollars in thousands)
     MAIN OFFICE:
     1311 Carolina Avenue
     Washington, NC               1986      Owned      $  734         10,200

     BRANCH OFFICES:
     300 North Market Street
     Washington, NC               1959      Owned         201          4,680

     301 E. Arlington Blvd.
     Greenville, NC               1993      Owned         375          2,600

     604 E. Ehringhaus Street
     Elizabeth City, NC           1980      Owned         393          2,500

     827 Hardee Road
     Kinston, NC                  1996      Leased         53          2,000

     1725 Glenburnie Road
     New Bern, NC                 1990      Owned         392          2,600

     202 Craven Street
     New Bern, NC                 1995      Leased         41          2,500

     300 Sunset Avenue
     Rocky Mount, NC              1994      Owned         372          4,948

     241 Green Street
     Fayetteville, NC             1999      Owned         633         10,000

     3107 Raeford Road
     Fayetteville, NC             1999      Owned         440          2,400

     600 N. Chestnut Street
     Lumberton, NC                1999      Owned         393          6,100

     2999 Hwy. 17S.
     Chocowinity, NC              1999      **            347          2,530

     3635 North Halifax Road
     Dortches, NC                 2000      Leased         67            396

     1378 Benvenue Road
     Rocky Mount, NC              2000      **            441          5,376

     2901 Sunset Avenue
     Rocky Mount, NC              2000      Owned       1,215          5,635

<PAGE>

                                                    Book Value at
                                  Year    Owned or  September 30,  Approximate
                                 Opened    Leased       2000      Square Footage
                                 ------    ------      ------     --------------
                                               (Dollars in thousands)
     450 North Winstead Avenue
     Rocky Mount, NC              2000      Leased          5          2,845

     100 East Hope Lodge Street
     Tarboro, NC                  2000      Leased         48          1,350

     OPERATIONS CENTER:
     239 West Main Street
     Washington, NC  27889        1994      Owned         460          7,600

     FUTURE EXPANSION SITES:

     Creekside Drive
     Washington, NC                         Owned         113

     Cypress Landing
     Chocowinity, NC                        Owned         126

     Taberna
     New Bern, NC                           Owned         176

     -----------
     **   Lease land, own building.

     The book value of the Bank's  investment in premises and equipment was $7.0
million at September 30, 2000. See Note 6 to Consolidated Financial Statements.

ITEM 3. LEGAL PROCEEDINGS.
-------------------------

     From time to time,  the Company and/or the Bank is a party to various legal
proceedings  incident to their  business.  At September 30, 2000,  there were no
legal  proceedings to which the Company or the Bank was a party, or to which any
of their property was subject,  which were expected by management to result in a
material  loss to the  Company  or the  Bank.  There are no  pending  regulatory
proceedings  to which the  Company or the Bank is a party or to which  either of
their properties is subject which are currently expected to result in a material
loss.

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

     Not applicable.


                                     PART II

ITEM 5. MARKET FOR THE  REGISTRANT'S  COMMON  EQUITY AND  RELATED  STOCKHOLDERS'
--------------------------------------------------------------------------------
        MATTERS
        -------

     The information  contained in the section captioned "Market Information" in
the Company's  Annual Report to Stockholders for the Fiscal Year Ended September
30, 2000 (the "Annual Report") filed as Exhibit 13 hereto is incorporated herein
by reference.

<PAGE>

ITEM 6. SELECTED FINANCIAL DATA
-------------------------------

     The  information  contained in the table captioned  "Selected  Consolidated
Financial and Other Data" on page 2 in the Annual Report is incorporated  herein
by reference.

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

     The information contained in the section captioned "Management's Discussion
and  Analysis  of  Financial  Condition  and Results of  Operations"  on pages 3
through 13 in the Annual Report is incorporated herein by reference.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
-------------------------------------------------------------------

     The information  contained in the section captioned "Market Risk" on page 5
in the Annual Report is incorporated herein be reference.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
---------------------------------------------------

     The Independent Auditors' Report, Consolidated Financial Statements,  Notes
to Consolidated  Financial  Statements and Selected  Financial Data contained on
pages 14 through 38 in the Annual Report, which are listed under Item 14 herein,
are incorporated herein by reference.

ITEM 9.  CHANGES  IN  AND  DISAGREEMENTS  WITH  ACCOUNTANTS  ON  ACCOUNTING  AND
--------------------------------------------------------------------------------
         FINANCIAL DISCLOSURE
         --------------------

     Not applicable.

                                    PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
-----------------------------------------------------------

     The  information  contained  under the  sections  captioned  "Proposal I --
Election  of  Directors"  and  "Section  16(a)  Beneficial  Ownership  Reporting
Compliance" in the Company's  definitive  proxy statement for the Company's 2001
Annual Meeting of Stockholders (the "Proxy Statement") is incorporated herein by
reference.

ITEM 11. MANAGEMENT REMUNERATION
--------------------------------

     The  information  contained  under the  sections  captioned  "Proposal I --
Election  of  Directors,"  "--   Compensation   Committee  Report  on  Executive
Compensation,"  " --  Comparative  Stock  Performance  Graph,"  "  --  Executive
Compensation"  and  "--  Director  Compensation"  " in the  Proxy  Statement  is
incorporated herein by reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
-----------------------------------------------------------------------

     (a)  Security Ownership of Certain Beneficial Owners.  Information required
          by this  item is  incorporated  herein  by  reference  to the  section
          captioned  "Voting  Securities  and Security  Ownership"  in the Proxy
          Statement.

     (b)  Security Ownership of Management. Information required by this item is
          incorporated  herein by reference to the  sections  captioned  "Voting
          Securities  and  Security  Ownership"  and  "Proposal I -- Election of
          Directors" in the Proxy Statement.

     (c)  Changes  in  Control.   Management   of  the   Company   knows  of  no
          arrangements,  including any pledge by any person of securities of the
          Company,  the operation of which may at a subsequent  date result in a
          change in control of the registrant.

<PAGE>

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
-------------------------------------------------------

     The information  required by this item is incorporated  herein by reference
to the section  captioned  "Proposal I -- Election of Directors --  Transactions
with Management" in the Proxy Statement.

                                     PART IV

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

     (a)  LIST OF DOCUMENTS FILED AS PART OF THIS REPORT
     ---------------------------------------------------

     (1)  Financial Statements.  The following consolidated financial statements
are incorporated by reference from Item 8 hereof (see Exhibit 13):

     Independent Auditors' Report
     Consolidated Statements of Financial Condition as of September 30, 2000 and
     1999
     Consolidated  Statements  of Operations  for the Years Ended  September 30,
     2000, 1999 and 1998
     Consolidated   Statements  of  Stockholders  Equity  for  the  Years  Ended
     September 30, 2000, 1999 and 1998
     Consolidated  Statements  of Cash Flows for the Years Ended  September  30,
     2000, 1999 and 1998
     Notes to Consolidated Financial Statements

     (2)  Financial  Statement  Schedules.  All schedules for which provision is
made in the  applicable  accounting  regulations  of the Securities and Exchange
Commission are omitted because of the absence of conditions under which they are
required or because the  required  information  is included in the  consolidated
financial statements and related notes thereto.

     (3)  Exhibits.  The  following is a list of exhibits  filed as part of this
Annual Report on Form 10-K and is also the Exhibit Index.

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

     3.1       Certificate  of  Incorporation  of  First  South  Bancorp,   Inc.
               (Incorporated  herein  by  reference  from  Exhibit  3.1  to  the
               Company's   Registration   Statement   on  Form  S-1   (File  No.
               333-16335))
     3.2       Bylaws of First South Bancorp, Inc.
     4         Form of Common Stock  Certificate  of First South  Bancorp,  Inc.
               (Incorporated herein by reference from Exhibit 1 to the Company's
               Registration Statement on Form 8-A))
     10.1(a)   Employment  Agreement  between  First  South  Bancorp,  Inc.  and
               Thomas A. Vann  (Incorporated  herein by  reference  from Exhibit
               10.3(a) to the Company's Registration Statement on Form S-1 (File
               No. 333-16335))
     10.1(b)   Employment  Agreement  between  Home Savings Bank, SSB and Thomas
               A. Vann (Incorporated herein by reference from Exhibit 10.3(b) to
               the  Company's  Registration  Statement  on Form  S-1  (File  No.
               333-16335))
     10.2      Change in Control  Protective  Agreements  between  Home  Savings
               Bank, SSB, First South Bancorp,  Inc. and Mary R. Boyd, Sherry L.
               Correll,  Kristie  W.  Hawkins,  Walter P.  House and  William R.
               Outland  (Incorporated  herein by reference  from Exhibit 10.4 to
               the  Company's  Registration  Statement  on Form  S-1  (File  No.
               333-16335))
     10.3      Supplemental  Income  Agreements as Amended and Restated December
               14, 1995 between Home Savings  Bank,  SSB and Sherry L.  Correll,
               William  R.  Outland  and  Thomas A. Vann and the 1996  Amendment
               Thereto  (Incorporated  herein by reference  from Exhibit 10.5 to
               the  Company's  Registration  Statement  on Form  S-1  (File  No.
               333-16335))
     10.4      Supplemental  Income  Plan  Agreements  as Amended  and  Restated
               December 14, 1995 between  Home  Savings  Bank,  SSB and James F.
               Buckman, Walter P. House, Thomas A. Vann and

<PAGE>

               William  L.  Wall and the 1996  Amendment  Thereto  (Incorporated
               herein  by  reference   from   Exhibit  10.6  to  the   Company's
               Registration Statement on Form S-1 (File No. 333-16335))
     10.5      Home Savings Bank,  SSB  Director's  Deferred  Compensation  Plan
               Agreements as Amended and Restated  December 14, 1995 with Edmund
               T. Buckman,  Jr.,  Linley H. Gibbs,  Jr.,  Frederick N. Holscher,
               Frederick H. Howdy, Charles E. Parker, Jr., Marshall T. Singleton
               and Thomas A. Vann and the 1996 Amendment  Thereto  (Incorporated
               herein  by  reference   from   Exhibit  10.7  to  the   Company's
               Registration Statement on Form S-1 (File No. 333-16335))
     10.6      Home Savings Bank, SSB Director's  Retirement  Plan Agreements as
               Amended and Restated  December  14, 1995 with Edmund T.  Buckman,
               Jr., Linley H. Gibbs,  Jr.,  Frederick N. Holscher,  Frederick H.
               Howdy,  Charles  E.  Parker,  Jr. and Thomas A. Vann and the 1996
               Amendment Thereto  (Incorporated herein by reference from Exhibit
               10.8 to the  Company's  Registration  Statement on Form S-1 (File
               No. 333-16335))
     10.7      Home Savings Bank, SSB Director's  Retirement  Payment Agreements
               as Amended and Restated December 14, 1995 with Edmund T. Buckman,
               Jr., Linley H. Gibbs,  Jr.,  Frederick N. Holscher,  Frederick H.
               Howdy,  Charles E.  Parker,  Jr., and Thomas A. Vann and the 1996
               Amendment Thereto  (Incorporated herein by reference from Exhibit
               10.9 to the  Company's  Registration  Statement on Form S-1 (File
               No. 333-16335))
     10.8      Home Savings Bank, SSB Directors  Retirement  Plan Agreement with
               Marshall Singleton (Incorporated herein by reference from Exhibit
               10.10 to the Company's  Registration  Statement on Form S-1 (File
               No. 333-16335))
     10.9      First South  Bancorp,  Inc.  1997 Stock Option  Plan,  as amended
               (Incorporated  herein  by  reference  from  Exhibit  10.10 to the
               Company's Annual Report on Form 10-K for the Year Ended September
               30, 1999 (File No. 0-22219).
     10.10     Employment Agreement between NewSouth Bank and H.D. Reaves, Jr.
     13        Annual Report to Stockholders
     21        Subsidiaries of the Registrant
     23        Consent of PricewaterhouseCoopers, LLP
     27        Financial Data Schedule

     (b)  REPORTS ON FORM 8-K.  There were no Current  Reports on Form 8-K filed
by the Company during the fourth quarter of fiscal year 2000.

     (c)  EXHIBITS.  The  exhibits  required by Item 601 of  Regulation  S-K are
either  filed as part of this  Annual  Report  on Form 10-K or  incorporated  by
reference herein.

     (d)  FINANCIAL  STATEMENTS AND SCHEDULES EXCLUDED FROM ANNUAL REPORT. There
are no other financial  statements and financial  statement schedules which were
excluded from the Annual Report to Stockholders  pursuant to Rule 14a-3(b) which
are required to be included herein.

<PAGE>

                                   SIGNATURES

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

                                         FIRST SOUTH BANCORP, INC.
December 20, 2000
                                         By: /s/ Thomas A. Vann
                                             -----------------------------------
                                             Thomas A. Vann
                                             President

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

/s/ Thomas A. Vann                                       December 20, 2000
--------------------------------------------
Thomas A. Vann
President and Director
(Principal Executive Officer)

/s/ William L. Wall                                      December 20, 2000
--------------------------------------------
William L. Wall
Executive Vice President, Chief Financial
   Officer and Secretary
(Principal Financial and Accounting Officer)

/s/ Edmund T. Buckman, Jr.                               December 20, 2000
--------------------------------------------
Edmund T. Buckman, Jr.
Director

/s/ Linley H. Gibbs, Jr.                                 December 20, 2000
--------------------------------------------
Linley H. Gibbs, Jr.
Director

/s/ Frederick N. Holscher                                December 20, 2000
--------------------------------------------
Frederick N. Holscher
Director

/s/ Frederick H. Howdy                                   December 20, 2000
--------------------------------------------
Frederick H. Howdy
Director

/s/ Charles E. Parker, Jr.                               December 20, 2000
--------------------------------------------
Charles E. Parker, Jr.
Director

/s/ Marshall T. Singleton                                December 20, 2000
--------------------------------------------
Marshall T. Singleton
Director

/s/ H. D. Reaves, Jr.                                    December 20, 2000
--------------------------------------------
H. D. Reaves, Jr.
Director