<PAGE>
 
                      SECURITIES AND EXCHANGE COMMISSION
                            Washington, D.C. 20549

                                   FORM 10-K


[X]  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
     ACT OF 1934 [FEE REQUIRED] For the Fiscal Year Ended December 31, 1998 
                                     OR  
[_]  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
     EXCHANGE ACT OF 1934 [NO FEE REQUIRED] 
     For the transaction period from ______________ to ________________



                        Commission File Number: 0-29040
                                                -------

                           FIDELITY BANKSHARES, INC.
      -------------------------------------------------------------------
            (Exact Name of Registrant as Specified in its Charter)

           Delaware                                         65-0717085
-------------------------------                   -----------------------------
  (State or Other Jurisdiction                           (I.R.S. Employer 
of Incorporation or Organization)                     Identification Number)

218 Datura Street, West Palm Beach, Florida                    33401
-------------------------------------------                 ----------
 (Address of Principal Executive Offices)                   (Zip Code)

                                (561) 659-9900
              ---------------------------------------------------
              (Registrant's Telephone Number including area code)

          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 $.10 per share
              ---------------------------------------------------
                               (Title of Class)

     Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding twelve months (or for such shorter period that the
Registrant was required to file reports) and (2) has been subject to such
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
amendments to this Form 10-K. [X]

     As of February 26, 1999, there were issued and outstanding 6,463,735 shares
of the Registrant's Common Stock. The aggregate value of the voting stock held
by non-affiliates of the Registrant, computed by reference to the average bid
and asked prices of the Common Stock as of February 26, 1999 ($18.34) was
$44,189,130.

                      DOCUMENTS INCORPORATED BY REFERENCE

1.   Sections of Annual Report to Stockholders for the fiscal year ended
     December 31, 1998 (Parts II and IV).

2.   Proxy Statement for the 1999 Annual Meeting of Stockholders (Parts I and
     III).
<PAGE>
 
                                    PART I

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

General

     Fidelity Bankshares, Inc.

     Fidelity Bankshares, Inc. (the "Company") is a Delaware corporation which
was organized in May 1996. The only significant asset of the Company is its
investment in Fidelity Federal Savings Bank of Florida (the "Bank"). The Company
is majority owned by Fidelity Bankshares, M.H.C., a federally-chartered mutual
holding company (the "Mutual Holding Company"). On January 29, 1997 the Company
acquired all of the issued and outstanding common stock of the Bank in
connection with the Bank's reorganization into the two-tier form of mutual
holding company ownership. At that time, each share of Bank common stock was
automatically converted into one share of Company common stock, par value $.10
per share (the "Common Stock"). 3,542,000 shares of Common Stock were issued to
the Mutual Holding Company and 3,206,625 shares of Common Stock were issued to
the Bank's public stockholders.

     In December 1997 the Company incorporated Fidelity Capital Trust I, a
statutory business trust created under the laws of the State of Delaware
("Fidelity Capital"). Fidelity Capital was formed for the purpose of issuing
8.375% Cumulative Trust Preferred Securities (the "Preferred Securities") which
represent beneficial interests in Fidelity Capital. On January 21, 1998,
Fidelity Capital completed the offer and sale of $28.75 million in Preferred
Securities. In connection with the offer and sale of the Preferred Securities,
the Company issued an equivalent principal amount of 8.375% Junior Subordinated
Deferrable Interest Debentures which were sold to Fidelity Capital for the
equivalent of the net proceeds of $27.3 from the sale of the Preferred
Securities. The Junior Subordinated Deferrable Interest Debentures are scheduled
to mature on January 31, 2028.

     Fidelity Federal Savings Bank of Florida

     The Bank is a federally chartered savings bank headquartered in West Palm
Beach, Florida. The Bank's deposits are insured by the Federal Deposit Insurance
Corporation ("FDIC"). The Bank was chartered originally as a federal mutual
savings and loan association in 1952, and in 1983, amended its charter to become
a federally chartered mutual savings bank. On January 7, 1994, the Bank
completed a reorganization into a federally chartered mutual holding company.
The Bank is a member of the Federal Home Loan Bank ("FHLB") System. At 
December 31, 1998, the Bank had total assets of $1.6 billion, total deposits of
$1.1 billion, and stockholders' equity of $106 million.

     The Bank is primarily engaged in the business of attracting deposits from
the general public in the Bank's market area, and investing such deposits,
together with other sources of funds, in loans secured by one- to four-family
residential real estate. To a lesser extent, the Bank also originates
construction loans and land loans for single-family properties and invests in
mortgage-backed securities issued or guaranteed by the United States Government
or agencies thereof. In addition, the Bank invests a portion of its assets in
securities issued by the United States Government, cash and cash equivalents
including deposits in other financial institutions, and FHLB stock. The Bank's
principal sources of funds are deposits and principal and interest payments on
loans. Principal sources of income are interest received from loans and
investment securities. The Bank's principal expense is interest paid on deposits
and employee compensation and benefits.
<PAGE>
 
     The Company's and the Bank's principal executive office is located at
218 Datura Street, West Palm Beach, Florida, and its telephone number at that
address is (561) 659-9900.

Market Area

     The Bank is headquartered in West Palm Beach, Florida, and operates in
Palm Beach and Martin Counties in Florida. At December 31, 1998, the Bank had 22
offices in its market area, 3 of which are located in Martin County, and 19 of
which are located in Palm Beach County. Palm Beach and Martin Counties, located
in Southeastern Florida, have experienced considerable growth and development
since the 1960s, and had a total population of approximately one million as of
1990 and 1.1 million as of 1998. Due to significant growth controls established
at the state and local governmental levels, as well as a moderation of economic
growth and migration in the Bank's market area, management believes growth of
the local market area may be more moderate in the future.

     The Bank's business and operating results are significantly affected by the
general economic conditions prevalent in its market areas. The southeast Florida
economy is significantly dependent upon government, foreign trade, tourism, and
its attraction as a retirement area. Unemployment in Palm Beach County is higher
than the national and State of Florida averages. Major employers in the Bank's
market area include Pratt & Whitney, Motorola, St. Mary's Medical Center,
Florida Power and Light, Bell South and the Palm Beach County School Board.

Lending Activities

     General. Historically, the principal lending activity of the Bank has been
the origination of fixed and adjustable rate mortgage loans collateralized by
one- to four-family residential properties located in its market area. The Bank
currently originates adjustable rate mortgage (ARM) loans for retention in its
portfolio, and fixed rate loans, the majority of which are eligible for sale in
the secondary mortgage market. To a lesser extent, the Bank also originates
loans secured by commercial real estate and multi-family residential real
estate, construction loans, commercial business loans and consumer loans.

     In an effort to manage interest rate risk, the Bank has sought to make its
interest-earning assets more interest rate sensitive by originating adjustable
rate loans, such as ARM loans, home equity loans, and short- and medium-term
consumer loans. The Bank also purchases both fixed and adjustable rate mortgage-
backed securities. At December 31, 1998, approximately $509.5 million, or 48.0%,
of the Bank's total gross loan portfolio, and $160.2 million, or 41.2%, of the
Bank's mortgage-backed securities portfolio, consisted of loans or securities
with adjustable interest rates. The Bank originates fixed rate mortgage loans
generally with 15- to 30-year terms to maturity, collateralized by one- to four-
family residential properties. One- to four-family fixed rate residential
mortgage loans generally are originated and underwritten according to standards
that allow the Bank to resell such loans in the secondary mortgage market for
purposes of managing interest rate risk and liquidity. The Bank periodically
sells a portion of its fixed-rate loans which have terms to maturity exceeding
fifteen years. The Bank retains in its portfolio all consumer, commercial real
estate and multi-family residential real estate loans.

                                       2
<PAGE>
 
     Analysis of Loan Portfolio. Set forth below are selected data relating to
the composition of the Bank's loan portfolio by type of loan as of the dates
indicated. Also set forth below is the aggregate amount of the Bank's investment
in mortgage-backed securities at the dates indicated.

<TABLE>
<CAPTION>
                                                                                     At December 31,                             
                                                      ---------------------------------------------------------------------------
                                                               1994                      1995                      1996          
                                                      ---------------------      ---------------------      ---------------------
                                                        Amount     Percent         Amount     Percent        Amount      Percent 
                                                      ---------   ---------      ---------   ---------      ---------   ---------
                                                                                 (Dollars in Thousands)                          
                                                                                                                                 
                                                                                                               
<S>                                                   <C>             <C>        <C>             <C>         <C>             <C>  
Real estate loans:
   One- to four-family (1) .........................  $ 373,407        81.8%     $ 432,387        81.2%     $ 528,689        79.9%
   Construction loans ..............................     24,086         5.3         40,522         7.6         58,493         8.8
   Land loans ......................................     10,865         2.4         10,769         2.0         11,875         1.8
   Commercial ......................................     32,773         7.2         31,359         5.9         29,030         4.4
   Multi-family ....................................     13,081         2.8         13,748         2.6         13,781         2.1
                                                      ---------   ---------      ---------   ---------      ---------   ---------
                                                                                                                                 
      Total real estate loans ......................    454,212        99.5        528,785        99.3        641,868        97.0
                                                      ---------   ---------      ---------   ---------      ---------   ---------
                                                                                                                                 
Non-real estate loans:                                                                                                           
   Consumer (2) ....................................     18,343         4.0         26,855         5.0         39,478         6.0
   Commercial business .............................      2,776         0.6          5,834         1.1         18,585         2.8
                                                      ---------   ---------      ---------   ---------      ---------   ---------
                                                                                                                                 
      Total non-real estate loans ..................     21,119         4.6         32,689         6.1         58,063         8.8
                                                      ---------   ---------      ---------   ---------      ---------   ---------
                                                                                                                                 
      Total loans receivable .......................    475,331       104.1        561,474       105.4        699,931       105.8
                                                                                                                                 
Less:                                                                                                                            
   Undisbursed loan proceeds .......................     15,463         3.4         27,261         5.1         37,575         5.7
   Unearned discount and net deferred fees (costs)..        759         0.2           (385)       (0.1)        (1,607)       (0.2)
   Allowance for loan losses .......................      2,566         0.5          2,265         0.4          2,263         0.3
                                                      ---------   ---------      ---------   ---------      ---------   ---------
                                                                                                                                 
      Total loans receivable--net ..................  $ 456,543       100.0%     $ 532,333       100.0%     $ 661,700       100.0%
                                                      =========   =========      =========   =========      =========   =========
                                                                                                                                 
Mortgage-backed securities .........................  $ 126,807                  $ 159,761                  $ 123,599            
                                                      =========                  =========                  =========            
<CAPTION>                                                                                                                        
                                                                                                                                 
                                                                        At December 31,                                          
                                                      ------------------------------------------------                           
                                                               1997                      1998                                    
                                                      ---------------------      ---------------------                           
                                                        Amount     Percent         Amount     Percent                            
                                                      ---------   ---------      ---------   ---------                           
                                                                     (Dollars in Thousands)                                      
                                                                                                                                 
<S>                                                   <C>              <C>       <C>              <C>                            
Real estate loans:
   One- to four-family (1) .........................  $ 720,782        83.7%    $  828,929        84.8%                          
   Construction loans ..............................     38,577         4.5         53,515         5.5                           
   Land loans ......................................     12,116         1.4          8,583         0.9                           
   Commercial ......................................     26,947         3.1         62,399         6.4                           
   Multi-family ....................................     12,999         1.5         12,272         1.2                           
                                                      ---------   ---------     ----------   ---------                           
                                                                                                                                 
      Total real estate loans ......................    811,421        94.2        965,698        98.8                           
                                                      ---------   ---------     ----------   ---------                           
                                                                                                                                 
Non-real estate loans:                                                                                                           
   Consumer (2) ....................................     47,758         5.5         48,270         4.9                           
   Commercial business .............................     57,289         6.7         46,958         4.8                           
                                                      ---------   ---------     ----------   ---------                           
                                                                                                                                 
      Total non-real estate loans ..................    105,047        12.2         95,228         9.7                           
                                                      ---------   ---------     ----------   ---------                           
                                                                                                                                 
                                                                                                                                 
      Total loans receivable .......................    916,468       106.4      1,060,926       108.5                           
                                                                                                                                 
Less:                                                                                                                            
   Undisbursed loan proceeds .......................     54,471         6.3         84,155         8.6                           
   Unearned discount and net deferred fees (costs)..     (2,554)       (0.3)        (3,621)       (0.4)                          
   Allowance for loan losses .......................      3,294         0.4          3,226         0.3                           
                                                      ---------   ---------     ----------   ---------                           
                                                                                                                                 
      Total loans receivable--net ..................  $ 861,257       100.0%    $  977,166       100.0%                          
                                                      =========   =========     ==========   =========                           
                                                                                                                                 
Mortgage-backed securities .........................  $ 234,132                 $  389,263                                       
                                                      =========                 ==========                                         
</TABLE>

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

(1)  Includes participations of $6.6 million, $5.6 million, $4.3 million, $3.2
     million and $2.2 million at December 31, 1994, 1995, 1996, 1997 and 1998,
     respectively.

(2)  Includes primarily home equity lines of credit, automobile loans, boat
     loans and passbook loans. At December 31, 1998, the disbursed portion of
     equity lines of credit totaled $14.8 million.

                                       3
<PAGE>
 
     Loan and Mortgage-Backed Securities Maturity Schedule. The following table
sets forth certain information as of December 31, 1998, regarding the dollar
amount of loans and mortgage-backed securities maturing in the Bank's portfolio
based on their contractual terms to maturity. The amounts shown represent
outstanding principal balances less loans in process and are not adjusted for
premiums, discounts, reserves, and unearned fees. Demand loans, loans having no
stated schedule of repayments and no stated maturity, and overdrafts are
reported as due in one year or less. Adjustable and floating rate loans are
included in the period in which interest rates are next scheduled to adjust
rather than in which they contractually mature, and fixed rate loans and
mortgage-backed securities are included in the period in which the final
contractual repayment is due. Fixed rate mortgage-backed securities are assumed
to mature in the period in which the final contractual payment is due on the
underlying mortgage.

<TABLE>
<CAPTION>
                                                                      Over 1     Over 3     Over 5     Over 10    Beyond
                                                           Within    Year to    Years to   Years to   Years to      20
                                                           1 Year    3 Years    5 Years    10 Years    2 Years     Years     Total 
                                                          --------   --------   --------   --------   --------   --------   --------

                                                                                         (In Thousands)
<S>                                                       <C>        <C>        <C>        <C>        <C>        <C>        <C>     
Real estate loans:
  One- to four-family residential (1) .................   $320,410   $196,455   $119,406   $123,876   $ 45,222   $  3,197   $808,566
  Commercial, multi-family and land ...................     54,519      9,592      7,843      1,885        748         15     74,602
Consumer and commercial business loans (2) ............     69,369     17,598      5,655      2,807        182         --     95,611
                                                          --------   --------   --------   --------   --------   --------   --------
  Total loans receivable ..............................   $444,298   $223,645   $132,904   $128,568   $ 46,152   $  3,212   $978,779
                                                          --------   --------   --------   --------   --------   --------   --------
Mortgage-backed securities ............................   $261,387   $ 37,652   $ 26,949   $ 38,386   $ 16,126   $  1,811   $382,311
                                                          --------   --------   --------   --------   --------   --------   --------
</TABLE>

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

(1)  Includes construction loans.

(2)  Includes commercial business loans of $44.7 million.

     The following table sets forth at December 31, 1998, the dollar amount of
all fixed rate and adjustable rate loans due or repricing after December 31,
1999.

<TABLE> 
<CAPTION>
                                                                             Fixed              Adjustable             Total
                                                                            --------            ----------            -------- 
                                                                                              (In Thousands)
<S>                                                                         <C>                  <C>                  <C>     
Real estate loans:
   One- to four-family residential ..................................       $346,746             $141,410             $488,156
   Commercial, multi-family and land ................................          6,654               13,429               20,083
Consumer and commercial business loans (1) ..........................         12,531               13,711               26,242
                                                                            --------             --------             --------
      Total .........................................................       $365,931             $168,550             $534,481
                                                                            --------             --------             --------
Mortgage-backed securities ..........................................       $120,924             $     --             $120,924
                                                                            --------             --------             --------
</TABLE>

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

(1)  Includes commercial business loans of $6.3 million.

     One- to Four-Family Residential Real Estate Loans. The Bank's primary
lending activity consists of the origination of one- to four-family,
owner-occupied, residential mortgage loans secured by properties located in the
Bank's market area. During 1995, the Bank began to originate one- to four-family
residential loans on properties outside of its market area. These loans which
were originated through a network of brokers throughout Florida, are subject to
internal controls established by the Bank, as well as the Bank's customary
underwriting standards. At December 31, 1998, $842.4 million, or 83.2%, of the
Bank's total gross loan portfolio consisted of one- to four-family residential
mortgage loans, including residential construction loans of which $53.5 million
were originated outside the Bank's market area.

     The Bank currently offers one- to four-family residential mortgage loans
with terms typically ranging from 15 to 30 years, and with adjustable or fixed
interest rates. Originations of fixed rate mortgage loans versus ARM loans are
monitored on an ongoing basis and are affected significantly by the level of

                                       4
<PAGE>
 
market interest rates, customer preference, the Bank's interest rate gap
position, and loan products offered by the Bank's competitors. ARM loan
originations totaled $127.7 million during the year ended December 31, 1998.
Therefore, even if management's strategy is to emphasize ARM loans, market
conditions may be such that there is greater demand for fixed rate mortgage
loans.

     The Bank's fixed rate loans generally are originated and underwritten
according to standards that permit sale in the secondary mortgage market.
Whether the Bank can or will sell fixed rate loans into the secondary market,
however, depends on a number of factors including the yield and the term of the
loan, market conditions, and the Bank's current gap position. The Bank's fixed
rate mortgage loans are amortized on a monthly basis with principal and interest
due each month. One- to four-family residential real estate loans often remain
outstanding for significantly shorter periods than their contractual terms
because borrowers may refinance or prepay loans at their option.

     The Bank currently offers ARM loans with initial interest rate adjustment
periods of one, three, five and seven years, based on changes in a designated
market index. After the initial interest rate adjustment period, three, five and
seven year ARM loans have the option of converting to a fixed rate mortgage for
the remaining term of the loan at the prevailing interest rate for fixed rate
mortgages at the time of the conversion. The interest rate on one year ARM loans
and the three, five and seven year ARM loans that do not convert to a fixed rate
mortgage adjust annually with an annual interest rate adjustment limitation of
200 basis points and with a maximum lifetime interest rate of 600 basis points
above the initial rate. The interest rate on all non-owner-occupied one- to
four-family mortgage loans is 300 basis points above the appropriate U.S.
Treasury securities as the index for ARM originations. The Bank originates ARM
loans with initially discounted rates, which vary depending upon whether the
initial interest rate adjustment period is one, three, five or seven years. The
Bank determines whether a borrower qualifies for an ARM loan based on the fully
indexed rate of the ARM loan at the time the loan is originated. One- to
four-family residential ARM loans totaled $343.7 million, or 32.4%, of the
Bank's total gross loan portfolio at December 31, 1998.

     The primary purpose of offering ARM loans is to make the Bank's loan
portfolio more interest rate sensitive. However, as the interest income earned
on ARM loans varies with prevailing interest rates, such loans may not offer the
Bank as predictable cash flows as long-term, fixed rate loans. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations--Asset
and Liability Management-Interest Rate Sensitivity Analysis" contained in the
Bank's 1998 Annual Report to Stockholders (the "Annual Report"). ARM loans carry
increased credit risk associated with potentially higher monthly payments by
borrowers as general market interest rates increase. It is possible, therefore,
that during periods of rising interest rates, the risk of default on ARM loans
may increase due to the upward adjustment of interest costs to the borrower.

     The Bank's one- to four-family residential first mortgage loans customarily
include due-on-sale clauses, which are provisions giving the Bank the right to
declare a loan immediately due and payable in the event, among other things,
that the borrower sells or otherwise disposes of the underlying real property
serving as security for the loan. Due-on-sale clauses are an important means of
adjusting the rates on the Bank's fixed rate mortgage loan portfolio, and the
Bank has generally exercised its rights under these clauses.

     Regulations limit the amount that a savings association may lend relative
to the appraised value of the real estate securing the loan, as determined by an
appraisal at the time of loan origination. Appraisals are generally performed by
the Bank's service corporation subsidiary. Such regulations permit a maximum
loan-to-value ratio of 97% for residential property and 85% for all other real
estate loans. The Bank's lending policies generally limit the maximum
loan-to-value ratio on both fixed rate and ARM loans without 

                                       5
<PAGE>
 
private mortgage insurance to 80% of the lesser of the appraised value or the
purchase price of the property to serve as collateral for the loan.

     The Bank makes one- to four-family real estate loans with loan-to-value
ratios in excess of 80%. For one- to four-family real estate loans with
loan-to-value ratios of between 80% and 90%, the Bank generally requires the
borrower to obtain private mortgage insurance. For loans in excess of 90% the
Bank requires the borrower to obtain private mortgage insurance. The Bank
requires fire and casualty insurance, as well as a title guaranty regarding good
title, on all properties securing real estate loans made by the Bank.

     In the past, the Bank has entered into loan participations secured by one-
to four-family residences. At December 31, 1998, the Bank's loan portfolio
included $2.2 million of loan participations.

     Construction and Land Loans. The Bank currently offers fixed rate and
adjustable rate residential construction loans primarily for the construction of
owner-occupied single-family residences to builders who have a contract for sale
of the property or owners who have a contract for construction. In addition, the
Bank makes construction loans to builders for homes held for sale which totaled
$26.9 million at December 31, 1998. Construction loans are generally structured
to become permanent loans, and are originated with terms of up to 30 years with
an allowance of up to one year for construction. During the construction phase
the loans made prior to December 31, 1998 predominately had an adjustable
interest rate that adjusted annually and converted into either a fixed rate or
remained an adjustable rate mortgage loan at the end of the construction period.
The Bank also makes construction loans with fixed rates of interest. Such loans
become permanent one- to four-family loans upon completion of construction.
Advances are made as construction is completed.

     In addition, the Bank originates loans which are secured by individual
unimproved or improved lots. At December 31, 1998, $53.5 million, or 5.0%, and
$8.6 million, or less than 1.0%, of the Bank's total loan portfolio consisted of
construction loans and land loans, respectively. Land loans are currently
offered with one-year adjustable rates for terms of up to 15 years. The maximum
loan-to-value ratio for the Bank's land loans is 75%. The Bank uses the
applicable U.S. Treasury securities rate as its index on newly originated loans.
Initial interest rates may be below the fully indexed rate.

     Construction lending generally involves a greater degree of credit risk
than one- to four-family residential mortgage lending. The repayment of the
construction loan is often dependent upon the successful completion of the
construction project. Construction delays or the inability of the borrower to
sell the property once construction is completed may impair the borrower's
ability to repay the loan.

     Multi-Family Residential Real Estate Loans. Loans securing multi-family
real estate constituted approximately $15.7 million, or 1.5%, of the Bank's
total loan portfolio at December 31, 1998. At December 31, 1998, the Bank had a
total of 78 loans secured by multi-family properties. The Bank's multi-family
real estate loans are secured by multi-family residences, such as rental
properties. At December 31, 1998, substantially all of the Bank's multi-family
loans were secured by properties located within the Bank's market area. At
December 31, 1998, the Bank's multi-family real estate loans had an average
principal balance of $201,000 and the largest multi-family real estate loan had
a principal balance of $1.4 million. Multi-family real estate loans currently
are offered with adjustable interest rates, although in the past the Bank
originated fixed rate multi-family real estate loans. The terms of each
multi-family loan are negotiated on a case-by- case basis. Such loans typically
have adjustable interest rates tied to a market index with a 600 basis point
lifetime interest rate cap and an interest rate floor equal the initial rate,
and amortize over 15 to 25 years. The Bank generally makes multi-family mortgage
loans up to 80% of the appraised value of the property 

                                       6
<PAGE>
 
securing the loan. The Bank may choose to offer initial discount rates depending
on market conditions, but generally the initial interest rate on multi-family
real estate loans has been priced at the applicable U.S. Treasury securities as
its index on newly originated loans. The Bank's originations of multi-family
loans have been limited in recent years.

     Loans secured by multi-family real estate generally involve a greater
degree of credit risk than one- to four-family residential mortgage loans and
carry larger loan balances. This increased credit risk is a result of several
factors, including the concentration of principal in a limited number of loans
and borrowers, the effects of general economic conditions on income producing
properties, and the increased difficulty of evaluating and monitoring these
types of loans. Furthermore, the repayment of loans secured by multi-family and
commercial real estate is typically dependent upon the successful operation of
the related real estate property. If the cash flow from the project is reduced,
the borrower's ability to repay the loan may be impaired.

     Commercial Real Estate Loans. Loans secured by commercial real estate
constituted approximately $59.0 million, or 5.6%, of the Bank's total loan
portfolio at December 31, 1998. The Bank's commercial real estate loans are
secured by improved property such as offices, small business facilities, strip
shopping centers, warehouses and other non-residential buildings. At 
December 31, 1998, substantially all of the Bank's commercial real estate loans
were secured by properties located within the Bank's market area. At 
December 31, 1998, the Bank's commercial real estate loans had an average
principal balance of $333,000. At that date, the largest commercial real estate
loan had a principal balance of $4.6 million, secured by residential land
located in Delray Beach, Florida and was currently performing. This was the
largest commercial real estate lending relationship at the Bank and was within
the current loans-to-one borrower limits. Commercial real estate loans currently
are offered with adjustable rates, although in the past the Bank has originated
fixed rate commercial real estate loans. The terms of each commercial real
estate loan are negotiated on a case-by-case basis, although such loans
typically have adjustable interest rates tied to a market index, with a 600
basis point lifetime interest rate cap, and a 200 basis point interest rate
floor below the initial interest rate. The Bank may choose to offer initial
discount rates depending on market conditions. The Bank uses the applicable U.S.
Treasuries rate as its index on newly originated loans. Commercial real estate
loans originated by the Bank generally amortize over 15 to 25 years.

     Loans secured by commercial real estate generally involve a greater degree
of risk than one- to four-family residential mortgage loans and carry larger
loan balances. This increased credit risk is a result of several factors,
including the concentration of principal in a limited number of loans and
borrowers, the effects of general economic conditions on income producing
properties, and the increased difficulty of evaluating and monitoring these
types of loans. Furthermore, the repayment of loans secured by commercial real
estate is typically dependent upon the successful operation of the related real
estate project. If the cash flow from the project is reduced, the borrower's
ability to repay the loan may be impaired.

     Consumer Loans. As of December 31, 1998, consumer loans totaled $48.3
million, or 4.5%, of the Bank's total gross loan portfolio. The principal types
of consumer loans offered by the Bank are home equity lines of credit,
adjustable and fixed rate second mortgage loans, automobile loans, unsecured
personal loans, and loans secured by deposit accounts. Consumer loans are
offered on a fixed rate and adjustable rate basis with maturities generally of
less than ten years. The Bank's home equity lines of credit are secured by the
borrower's principal residence with a maximum loan-to-value ratio, including the
principal balances of both the first and second mortgage loans, of 80% or less
(up to 90% if the Bank has a first mortgage on the 

                                       7
<PAGE>
 
property). Such loans are offered on an adjustable rate basis with terms of up
to ten years. At December 31, 1998, the disbursed portion of home equity lines
of credit totaled $14.8 million, or 30.6% of consumer loans.

     The underwriting standards employed by the Bank for consumer loans include
a determination of the applicant's credit history and an assessment of ability
to meet existing obligations and payments on the proposed loan. The stability of
the applicant's monthly income may be determined by verification of gross
monthly income from primary employment, and additionally from any verifiable
secondary income. Creditworthiness of the applicant is of primary consideration;
however, the underwriting process also includes a comparison of the value of the
collateral in relation to the proposed loan amount, and in the case of home
equity lines of credit, the Bank obtains a title guarantee or an opinion as to
the validity of title.

     Consumer loans entail greater credit risk than do residential mortgage
loans, particularly in the case of consumer loans that are unsecured or secured
by assets that depreciate rapidly, such as automobiles, mobile homes, boats, and
recreational vehicles. In such cases, repossessed collateral for a defaulted
consumer loan may not provide an adequate source of repayment for the
outstanding loan and the remaining deficiency often does not warrant further
substantial collection efforts against the borrower. In particular, amounts
realizable on the sale of repossessed automobiles may be significantly reduced
based upon the condition of the automobiles and the lack of demand for used
automobiles. The Bank adds a general provision on a regular basis to its
consumer loan loss allowance, based on general economic conditions and prior
loss experience. See "--Delinquencies and Classified Assets--Non-Performing
Assets," and "Delinquent Loans and Non-Performing Assets--Classification of
Assets" for information regarding the Bank's loan loss experience and reserve
policy.

     Commercial Business Loans. The Bank currently offers commercial business
loans to finance businesses in its market area. Historically, the Bank offered
commercial business loans as a customer service to business account holders.
However, the Bank has begun to significantly expand and aggressively market its
loans and services to commercial business enterprises. During the year, the Bank
originated a $6.0 million loan secured by accounts receivable and inventory,
which is the Bank's largest commercial business loan. At December 31, 1998, the
Bank had 350 commercial business loans outstanding with an aggregate balance of
$46.1 million. The average commercial business loan balance was approximately
$132,000. Commercial business loans are generally offered with adjustable
interest rates only, which are tied to The Wall Street Journal prime rate, plus
up to 300 basis points. The loans are offered with prevailing terms of five
years but which may range up to 15 years. In addition, the Bank offers Small
Business Administration loans.

     Underwriting standards employed by the Bank for commercial business loans
include a determination of the applicant's ability to meet existing obligations
and payments on the proposed loan for normal cash flows generated by the
applicant's business. The financial strength of each applicant also is assessed
through a review of financial statements provided by the applicant. In addition,
as part of the loan underwriting process, commercial borrowers must indicate in
writing to the Bank that they are aware of the year 2000 concerns and are either
year 2000 compliant, or are taking steps to become year 2000 compliant.

     Commercial business loans generally bear higher interest rates than
residential loans, but they also may involve a higher risk of default since
their repayment is generally dependent on the successful operation of the
borrower's business. The Bank generally obtains personal guarantees from the
borrower or a third party as a condition to originating its commercial business
loans.

                                       8
<PAGE>
 
     Loan Originations, Solicitation, Processing, and Commitments. Loan
originations are derived from a number of sources such as real estate broker
referrals, existing customers, borrowers, builders, attorneys, and walk-in
customers. Upon receiving a loan application, the Bank obtains a credit report
and employment verification to verify specific information relating to the
applicant's employment, income, and credit standing. In the case of a real
estate loan, an appraiser approved by the Bank appraises the real estate
intended to secure the proposed loan. A loan processor in the Bank's loan
department checks the loan application file for accuracy and completeness, and
verifies the information provided. All loans of up to $300,000 may be approved
by any one of the Bank's senior lending officers; loans between $300,000 and
$400,000 must be approved by any one of the Bank's designated senior officers;
loans between $400,000 and $1,000,000 must be approved by at least two of the
Bank's designated senior officers which includes the Chief Executive Officer;
and loans in excess of $1,000,000 must be approved by at least three members of
the Board of Directors acting as a loan committee. The loan committee meets as
needed to review and verify that management's approvals of loans are made within
the scope of management's authority. Fire and casualty insurance is required at
the time the loan is made and throughout the term of the loan, and upon request
of the Bank, flood insurance may be required. After the loan is approved, a loan
commitment letter is promptly issued to the borrower. At December 31, 1998, the
Bank had commitments to originate $32.8 million of loans.

     If the loan is approved, the commitment letter specifies the terms and
conditions of the proposed loan including the amount of the loan, interest rate,
amortization term, a brief description of the required collateral, and required
insurance coverage. The borrower must provide proof of fire and casualty
insurance on the property (and, as required, flood insurance) serving as
collateral, which insurance must be maintained during the full term of the loan.
Title insurance or an opinion of title, based on a title search of the property,
is required on all loans secured by real property.

     Borrowers who refinance must satisfy the Bank's underwriting criteria at
the time they apply to refinance their loan and have been current in their loan
payments for a minimum of one year. Approximately 7% of the Bank's loan
originations during the year ended December 31, 1998 represented the refinancing
of the Bank's existing loans. Refinancings have resulted in a decrease in the
Bank's interest rate spread. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations" in the 1998 Annual Report to
Stockholders.

     During 1997, the Bank in connection with local mortgage brokers began a
mortgage loan broker solicitation program to supplement the Bank's internal
originations of one- to four-family residential loans. Under this program, which
is limited to the origination of one- to four-family residential loans,
prospective borrowers complete loan applications which are provided by mortgage
brokers. The completed applications are forwarded to the Bank. All loans
obtained in this manner are reviewed in accordance with the Bank's customary
underwriting standards. Total originations from all sources under the mortgage
loan broker solicitation program during 1998 were $76.7 million and are included
as originations in the following table. The Bank may expand this program in the
future.

     During 1994, the Bank entered into an agreement with the wholly-owned
mortgage subsidiary of a major South Florida builder-developer, who has
substantial operations in the Bank's local service area. Under the terms of this
agreement, the mortgage company originates, processes and closes home mortgages
resulting from the sale of the developer's inventory of homes. The mortgage
files are sent to the Bank by the mortgage company for review and, if approved
by the Bank, it issues a commitment to purchase the loan


                                       9
<PAGE>
 
from the mortgage company. Purchases are accomplished by assignment of the
mortgage from the mortgage company to the Bank. The Bank purchased $32 million
in loans from this provider in 1998.

     The Bank's recently purchased loans are collateralized by properties
located primarily in Florida, although the Bank has in the past purchased loans
collateralized by properties located outside the State of Florida. At December
31, 1998, $82.8 million, or 7.8%, of all loans in the Bank's portfolio, were
purchased from others. Of this amount, $3.4 million represented the Bank's
interest in purchased participations. The Bank's largest loan participation was
a $1.2 million interest in a loan secured by one- to four-family residences. The
remaining loan participations consisted of loans secured by one- to four-family
residential properties with an average balance of $12,000.

     Origination, Purchase and Sale of Loans. The table below shows the Bank's
loan origination, purchase and sales activity for the periods indicated.

<TABLE>
<CAPTION>
                                                                                             Year Ended December 31,        
                                                                              ------------------------------------------------------

                                                                                  1996                 1997                  1998
                                                                              -----------          -----------          ------------

                                                                                                 (In Thousands)
<S>                                                                           <C>                  <C>                  <C>        
Loan receivable-gross, beginning of period ..........................           $ 561,474            $ 699,931           $  916,468
Originations:
      Real estate:
        One- to four-family residential (1) .........................             187,851              177,111              255,444
        Land loans ..................................................               3,207               30,908               23,089
        Commercial ..................................................                 390                5,664                9,668
        Multi-family ................................................               1,869                7,227                5,975
      Non-real estate loans:
        Consumer ....................................................              23,761               29,276               34,382
        Commercial Business .........................................              33,276               61,383               67,465
                                                                              -----------          -----------          -----------
      Total originations ............................................             250,354              311,569              396,023
Acquired as part of acquisition .....................................                  --               52,957                   --
Transfer of mortgage loans to foreclosed real estate
      and in-substance foreclosure ..................................                (593)              (2,403)              (1,542)

Loan purchases ......................................................              21,153               35,647               45,157
Repayments ..........................................................            (115,440)            (169,599)            (241,478)

Loan sales ..........................................................             (17,017)             (11,634)             (53,702)
                                                                              -----------          -----------          -----------
Net loan activity ...................................................             138,457              216,537              144,458
                                                                              -----------          -----------          -----------
Total loans receivable-gross, end of period .........................           $ 699,931            $ 916,468           $1,060,926
                                                                              ===========          ===========          ===========
</TABLE>
------------------------------------
(1)  Includes loans to finance the construction of one- to four-family
     residential properties, and loans originated for sale in the secondary
     market.
(2)  This table is being presented on a gross loan receivable basis.

     Loan Origination Fees and Other Income. In addition to interest earned on
loans, the Bank generally receives loan origination fees. To the extent that
loans are originated or acquired for the Bank's portfolio, SFAS 91 requires that
the Bank defer loan origination fees and costs and amortize such amounts as an
adjustment of yield over the life of the loan by use of the level yield method.
Fees and costs deferred under SFAS 91 are recognized into income immediately
upon prepayment or the sale of the related loan. At December 31, 1998, the Bank
had $1.6 million of deferred loan origination fees and $5.3 million of deferred
loan origination costs. Such fees vary with the volume and type of loans and
commitments made and purchased, principal repayments, and competitive conditions
in the mortgage markets, which in turn respond to the demand and availability of
money.

                                      10
<PAGE>
 
     The Bank also receives other fees, service charges, and other income that
consist primarily of deposit transaction account service charges, late charges,
credit card fees, and income from REO operations. The Bank recognized fees and
service charges of $3.2 million, $3.6 million and $4.6 million for the years
ended December 31, 1996, 1997, and 1998, respectively.

     Loans-to-One Borrower. Savings associations are subject to the same
loans-to-one borrower limits as those applicable to national banks, which under
current regulations restrict loans to one borrower to an amount equal to 15% of
unimpaired capital and unimpaired surplus on an unsecured basis, and an
additional amount equal to 10% of unimpaired capital and unimpaired surplus if
the loan is secured by readily marketable collateral (generally, financial
instruments and bullion, but not real estate). At December 31, 1998, the Bank's
largest outstanding loan balance to one borrower totaled $12 million which was
secured by residential property under development in northern Palm Beach County,
Florida. At that date, the Bank's second largest lending relationship totaled
$6.8 million and was secured by various residential properties. The Bank's third
largest lending relationship totaled $6.0 million and was secured by accounts
receivable and inventory. The Bank's fourth largest lending relationship totaled
$5.5 million and was secured by various residential properties. The Bank's fifth
largest lending relationship totaled $4.3 million and was secured by various
residential properties. The Bank's regulatory limit on loans-to-one borrower was
$15.9 million at December 31, 1998.

Mortgage-Backed Securities

     The Bank also invests in mortgage-backed securities issued or guaranteed by
the United States Government or agencies thereof. These securities consist
primarily of fixed-rate mortgage-backed securities issued or guaranteed by the
Federal National Mortgage Association ("FNMA") or the Federal Home Loan Mortgage
Corporation ("FHLMC"). Mortgage-backed securities totaled $389.3 million at
December 31, 1998 and had a market value of $389.3 million. Effective December
31, 1993, the Bank implemented SFAS 115, "Accounting for Certain Investments in
Debt and Equity Securities." As a result of the adoption of this accounting
principle, the Bank declared its investment in adjustable rate, mortgage-backed
securities as available for sale. In November 1995, FASB issued "A Guide to
Implementation of SFAS 115 on Accounting for Certain Investments in Debt and
Equity Securities - Questions and Answers" ("SFAS 115 Q & A Guide"). SFAS 115 Q
& A Guide permits an entity to conduct a one time reassessment of the
classifications of all securities held at that time. On November 28, 1995, in
conformity with the SFAS 115 Q & A Guide, management of the Bank classified all
securities as "Available for Sale". As a result, all such securities are now
presented at fair value, as determined by market quotations.


                                      11
<PAGE>
 
     The Bank's objectives in investing in mortgage-backed securities varies
from time to time depending upon market interest rates, local mortgage loan
demand, and the Bank's level of liquidity. The Bank's mortgage-backed securities
are more liquid than whole loans and can be readily sold in response to market
conditions and interest rates. Mortgage-backed securities purchased by the Bank
also have lower credit risk than mortgage loans because principal and interest
are either insured or guaranteed by the United States Government or agencies
thereof.

<TABLE>
<CAPTION>
                                                                                                  Year Ended December 31,        
                                                                                        --------------------------------------------
                                                                                           1996             1997             1998   
                                                                                        ---------        ---------        ----------

                                                                                                       (In Thousands)
<S>                                                                                     <C>              <C>              <C>      
Mortgage-backed securities at beginning of period ...............................       $ 159,761        $ 123,599        $ 234,132
Purchases .......................................................................           9,962          131,956          310,581
Acquired as part of Acquisition of BankBoynton ..................................              --              205               --
Sales ...........................................................................         (19,641)              --          (26,044)
Repayments ......................................................................         (23,608)         (22,325)        (125,105)
Discount (premium) amortization .................................................               3             (304)          (2,503)
Increase (decrease) in market value of securities held for sale in
 accordance with SFAS 115 .......................................................          (2,878)           1,001           (1,798)
                                                                                        ---------        ---------        ---------
Mortgage-backed securities at end of period .....................................       $ 123,599        $ 234,132        $ 389,263
                                                                                        =========        =========        ========= 

</TABLE>
     The following table sets forth the allocation of fixed and adjustable rate
mortgage-backed securities for the periods indicated.

<TABLE>
<CAPTION>
                                                                                       At December 31, 
                                                         --------------------------------------------------------------------------
                                                                   1996                      1997                      1998         
                                                         ----------------------    ----------------------    ----------------------
                                                             $            %             $            %            $            %   
                                                         ---------    ---------    ---------    ---------    ---------     --------
                                                                                   (Dollars In Thousands)
<S>                                                      <C>          <C>           <C>           <C>         <C>          <C>   
  Mortgage-backed securities, net:
    Adjustable:
      FHLMC .......................................      $ 15,900        12.78%     $ 48,469       20.57%     $102,756       26.27%
      FNMA ........................................        29,576        23.76        43,825       18.60        56,490       14.44
      GNMA ........................................         1,963         1.58         1,586        0.67           995         .25
                                                         --------      -------      --------      ------      --------      ------
        Total adjustable ..........................        47,439        38.12        93,880       39.84       160,241       40.96
                                                         --------      -------      --------      ------      --------      ------
    Fixed:
      FHLMC .......................................        56,245        45.20        83,326        35.36      122,463       31.30
      FNMA ........................................        11,771         9.46        26,497        11.24       86,166       22.02
      GNMA ........................................         8,144         6.54        30,429        12.91       20,393        5.22
                                                         --------      -------      --------      -------     --------      ------
        Total fixed ...............................        76,160        61.20       140,252        59.51      229,022       58.54
                                                         --------      -------      --------      -------     --------      ------
Accrued interest ..................................           842         0.68         1,530         0.65        1,941         .50
                                                         --------      -------      --------      -------     --------      ------
   Total mortgage-backed securities, net ..........      $124,441       100.00%     $235,662       100.00%    $391,204      100.00%
                                                         ========      =======      ========      =======     ========      ======

</TABLE>

Delinquencies and Classified Assets

     Delinquencies. The Bank's collection procedures provide that when a loan is
15 days past due, a computer-generated late charge notice is sent to the
borrower requesting payment, plus a late charge. If delinquency continues, at 30
days a delinquent notice is sent and personal contact efforts are attempted,
either in person or by telephone, to strengthen the collection process and
obtain reasons for the delinquency. Also, plans to arrange a repayment plan are
made. If a loan becomes 60 days past due, a collection letter is sent, personal
contact is attempted, and the loan becomes subject to possible legal action if
suitable arrangements to repay have not been made. In addition, the borrower is
given information which provides access to consumer counseling services, to the
extent required by regulations of the Department of Housing and Urban
Development ("HUD"). When a loan continues in a delinquent status for 90 days or
more, and 

                                      12
<PAGE>
 
a repayment schedule has not been made or kept by the borrower, generally a
notice of intent to foreclose is sent to the borrower, giving 30 days to cure
the delinquency. If not cured, foreclosure proceedings are initiated.

     Impaired Loans. A loan is impaired when, based on current information and
events, it is probable that a creditor will be unable to collect all amounts due
according to the contractual terms of the loan agreement.

     Non-Performing Assets. Loans are reviewed on a regular basis and are placed
on a non-accrual status when, in the opinion of management, the collection of
additional interest is doubtful. Loans are placed on non-accrual status and
considered non-performing when either principal or interest is 90 days or more
past due. Interest accrued and unpaid at the time a loan is placed on a
non-accrual status is charged against interest income. At December 31, 1998, the
Bank had non-performing loans of $3.9 million, and a ratio of non-performing
loans to net loans receivable of .39%.

     Real estate acquired by the Bank as a result of foreclosure or by the deed
in lieu of foreclosure is classified as real estate owned ("REO") until such
time as it is sold. When real estate is acquired through foreclosure or by deed
in lieu of foreclosure, it is recorded at its fair value, less estimated costs
of disposal. If the value of the property is less than the loan, less any
related specific loan loss provisions, the difference is charged against the
Bank's earnings. Any subsequent write-down of REO is also charged against
earnings. At December 31, 1998, the Bank had approximately $907,000 of property
acquired as the result of foreclosure and classified as REO. At December 31,
1998, the Bank had non-performing assets of $4.8 million and a ratio of
non-performing assets to total assets of .30%.

Delinquent Loans and Non-Performing Assets

     The following table sets forth information regarding the Bank's non-accrual
mortgage loans delinquent 90 days or more, non-accrual consumer and commercial
business loans delinquent 60 days or more, and real estate acquired or deemed
acquired by foreclosure at the dates indicated. When a loan is delinquent 90
days or more, the Bank fully reserves all accrued interest thereon and ceases to
accrue interest thereafter. For all the dates indicated, the Bank did not have
any material restructured loans within the meaning of SFAS 15.

<TABLE>
<CAPTION>
                                                                                             At December 31,                      
                                                                 -------------------------------------------------------------
                                                                   1994          1995         1996         1997         1998  
                                                                 ---------    ---------    ---------    ---------     --------
                                                                                    (Dollars in Thousands)
<S>                                                              <C>          <C>          <C>          <C>           <C>   
Delinquent Loans:
  One- to four-family residential (1) ...................        $1,299         $1,513       $2,637        $2,610       $3,677
  Commercial and multi-family real estate ...............           335            201          461           140           51
  Land ..................................................           159             10           84           187           --
  Consumer and commercial business loans (3) ............           135            140          108           312          131
                                                                 ------         ------       ------        ------       ------ 
Total Delinquent loans ..................................         1,928          1,864        3,290         3,249        3,859
Total REO and loans foreclosed in-substance .............           608            643           93           967          907
                                                                 ------         ------       ------        ------       ------ 
      Total nonperforming assets (2) ....................        $2,536         $2,507       $3,383        $4,216       $4,766
                                                                 ======         ======       ======        ======       ====== 
Total loans delinquent 90 days or more to net
  loans receivable (3) ..................................          0.42%          0.35%        0.50%         0.38%        0.39%
Total loans delinquent 90 days or more to
  total assets (3) ......................................          0.27%          0.24%        0.38%         0.27%        0.25%
Total nonperforming loans, loans foreclosed
   in substance and REO to total assets .................          0.36%          0.32%        0.39%         0.35%        0.30%
</TABLE>
------------------------------------
(1)  At December 31, 1998, the Bank had no delinquent or non-performing
     construction loans.
(2)  Net of specific valuation allowances.
(3)  Includes consumer and commercial business loans delinquent 60 days or more.


                                      13
<PAGE>
 
     During the year ended December 31, 1998, gross interest income of
approximately $317,000 would have been recorded on loans accounted for on a
non-accrual basis if the loans had been current throughout the period. No
interest income on non-accrual loans was included in income during 1998.

     The following table sets forth information with respect to loans past due
60-89 days in the Bank's portfolio at the dates indicated.

<TABLE>
<CAPTION>
                                                                           At December 31,                      
                                                   -------------------------------------------------------------
                                                     1994          1995         1996         1997         1998  
                                                   ---------    ---------    ---------    ---------     --------
                                                                           (In Thousands)
<S>                                                <C>          <C>          <C>          <C>           <C>     
Loans past due 60-89 days:
      One- to four-family residential (1)........  $   1,554    $   1,272    $   2,038    $   3,014     $  2,049
      Commercial real estate and multi-family....        100          106           55           54           --
      Consumer and commercial business loans.....          7          106           19           83            8
      Land loans.................................         48            1           --           --           11
                                                   ---------    ---------    ---------    ---------     --------
        Total past due 60-89 days................  $   1,709    $   1,485    $   2,112    $   3,151     $  2,068
                                                   =========    =========    =========    =========     ========
</TABLE>
--------------------------------
(1)  (Includes construction loans)

     Classification of Assets. Federal regulations provide for the
classification of loans and other assets such as debt and equity securities
considered by the OTS to be of lesser quality as "substandard," "doubtful," or
"loss" assets. An asset is considered "substandard" if it is inadequately
protected by the current net worth and paying capacity of the obligor or of the
collateral pledged, if any. "Substandard" assets include those characterized by
the "distinct possibility" that the savings institution will sustain "some loss"
if the deficiencies are not corrected. Assets classified as "doubtful" have all
of the weaknesses inherent in those classified "substandard," with the added
characteristic that these weaknesses make "collection or liquidation in full,"
on the basis of currently existing facts, conditions, and values, "highly
questionable and improbable." Assets classified as "loss" are those considered
"uncollectible" and of such little value that their continuance as assets
without the establishment of a specific loss reserve is not warranted. Assets
that do not expose the savings institution to risk sufficient to warrant
classification in one of the aforementioned categories, but which possess some
weaknesses, are designated "special mention" by management.

     When a savings institution classifies problem assets as either substandard
or doubtful, it is required to establish general allowances for loan losses in
an amount deemed prudent by management. General allowances represent loss
allowances that have been established to recognize the inherent risk associated
with lending activities, but which, unlike specific allowances, have not been
allocated to particular problem assets. When a savings institution classifies
problem assets as "loss," it is required either to establish a specific
allowance for losses equal to 100% of the amount of the assets so classified, or
to charge off such amount. A savings institution's determination as to the
classification of its assets and the amount of its valuation allowances is
subject to review by the OTS, which can order the establishment of additional
general or specific loss allowances. The Bank regularly reviews the problem
loans in its portfolio to determine whether any loans require classification in
accordance with applicable regulations.

                                      14
<PAGE>
 
     The following table sets forth the aggregate amount of the Bank's
classified assets at the dates indicated.

                                                          At December 31, 
                                                   -----------------------------
                                                    1996       1997        1998
                                                   ------     ------      ------
                                                         (In Thousands)

Substandard assets (1)(2) ..................      $3,207      $3,961      $4,752
Doubtful assets (2) ........................          --          --          --
Loss assets (2) ............................          --          --          --
                                                  ------      ------      ------
      Total classified assets (2) ..........      $3,207      $3,961      $4,752
                                                  ======      ======      ======
------------------------------------
(1)  Includes REO and in-substance foreclosures.
(2)  Net of specific valuation allowances.

     The following table sets forth information regarding the Bank's delinquent
loans, REO and loans foreclosed in-substance at December 31, 1998.


                                                            Balance      Number
                                                            -------      ------
                                                          (Dollars In Thousands)
Residential real estate:
   Loans 60 to 89 days delinquent ....................       $2,049        26
   Loans more than 89 days delinquent ................        3,677        68
Commercial and multi-family real estate:
   Loans 60 to 89 days delinquent ....................           --        --
   Loans more than 89 days delinquent ................           51         1
Land loans:
   Loans 60 to 89 days delinquent ....................           11         1
   Loans more than 89 days delinquent ................           --        --
Consumer and commercial business loans
    60 days or more delinquent .......................          131        10
REO ..................................................          907        10
                                                             ------    ------
      Total ..........................................       $6,826       116
                                                             ======    ======

     Allowance for Loan Losses. Management's policy is to provide for estimated
losses on the Bank's loan portfolio based on management's evaluation of the
potential losses that may be incurred. The Bank regularly reviews its loan
portfolio, including problem loans, to determine whether any loans require
classification or the establishment of appropriate reserves or allowances for
losses. Such evaluation, which includes a review of all loans of which full
collectibility of interest and principal may not be reasonably assured,
considers, among other matters, the estimated net realizable value (or fair
value, where appropriate) of the underlying collateral. Other factors considered
by management include the size and risk exposure of each segment of the loan
portfolio, present indicators such as delinquency rates and the borrower's
current financial condition, and the potential for losses in future periods.
Management calculates the general allowance for loan losses in part based on
past experience, and in part based on specified percentages of loan balances.
While both general and specific loss allowances are charged against earnings,
general loan loss allowances are added back to capital in computing risk-based
capital under OTS regulations.

     Management will continue to review the entire loan portfolio to determine
the extent, if any, to which further additional loan loss provisions may be
deemed necessary. Management believes that the Bank's current allowance for loan
losses is adequate; however, there can be no assurance that the allowance for
loan losses will be adequate to cover losses that may in fact be realized in the
future or that additional provisions for loan losses will not be required.
Further, as the Bank is expanding its portfolio of commercial 

                                      15
<PAGE>
 
business loans, which are deemed to have greater credit risk than single family
mortgage loans, management of the Bank expects to provide greater allowances for
loan losses than have been considered necessary in the past.

     Analysis of the Allowance For Loan Losses. The following table sets forth
the analysis of the allowance for loan losses for the periods indicated.

<TABLE>
<CAPTION>
                                                                              At December 31,                      
                                                     ---------------------------------------------------------------- 
                                                        1994        1995          1996           1997          1998  
                                                     ---------    ---------     ---------     ---------     ---------
                                                                          (Dollars in Thousands)
<S>                                                  <C>          <C>           <C>           <C>           <C>      
Total net loans receivable outstanding ...........   $ 456,543    $ 532,333     $ 661,700     $ 861,257     $ 977,166
                                                     =========    =========     =========     =========     ========= 
Average net loans receivable outstanding .........   $ 441,573    $ 490,088     $ 605,507     $ 735,949     $ 917,647
                                                     =========    =========     =========     =========     ========= 

Allowance balance (at beginning of period) .......   $   2,865    $   2,566     $   2,265     $   2,263     $   3,294
Reclassification of valuation allowances
  on in-substance foreclosure ....................          --           --            --            --            --
Acquired as part of Acquisition of BankBoynton:
  Real estate ....................................          --           --            --           208            --
  Consumer .......................................          --           --            --           959            --
Provision for losses:
  Real estate ....................................          73         (199)          133           165           115
  Consumer and commercial business loans .........          39          (11)           31             5           (38)
Charge-offs:
  Real estate ....................................        (229)         (89)         (145)          (98)          (85)
  Consumer and commercial business loans .........        (182)          (2)          (21)         (208)          (60)
Recoveries:
  Real estate ....................................          --           --            --            --            --
  Consumer and commercial business loans .........          --           --            --            --            --
                                                     ---------    ---------     ---------     ---------     ---------
      Allowance balance (at end of period) .......   $   2,566    $   2,265     $   2,263     $   3,294     $   3,226
                                                     =========    =========     =========     =========     ========= 
Allowance for loan losses as a percent of net
   loans receivable at end of period .............        0.56%        0.43%         0.34%         0.38%         0.33%
Net loans charged-off as a percent of average
  loans outstanding ..............................        0.10%        0.02%         0.03%         0.04%         0.01%
Ratio of allowance for loan losses to total
  non-performing loans at end of period (1) ......      132.61%      121.51%        68.78%       101.39%       100.59%
Ratio of allowance for loan losses to total
  non-performing loans, REO and in-substance
  foreclosures at end of period (1) ..............      100.90%       90.35%        66.89%        78.13%        78.42%
</TABLE>
------------------------------------
(1)  Net of specific reserves.

                                      16
<PAGE>
 
     Allocation of Allowance for Loan Losses. The following table sets forth the
allocation of allowance for loan losses by loan category for the periods
indicated. Management believes that the allowance can be allocated by category
only on an approximate basis. The allocation of the allowance by 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 December 31,                       
                                                                  ------------------------------------------------------------------
                                                                          1996                    1997                  1998       
                                                                  ---------------------   --------------------    ------------------
                                                                             % of Loans             % of Loans           % of Loans
                                                                              In Each                In Each              In Each
                                                                            Category to            Category to           Category to
                                                                    Amount  Total Loans   Amount   Total Loans    Amount Total Loans
                                                                   -------  -----------   ------   -----------    ------ -----------
                                                                                        (Dollars in Thousands)
<S>                                                                <C>      <C>           <C>      <C>            <C>    <C>   
Balance at end of period applicable to:                    
  One- to four-family residential mortgage ....................     $1,095     83.89%     $1,547      82.86%      $2,128     83.18%
  Commercial real estate and multi-family residential .........        571      6.12         441       7.04          753      7.04
  Land loans ..................................................        119      1.70         209       1.32          203      0.81
  Other .......................................................        478      8.29       1,097       8.78          142      8.97
                                                                    ------    ------      ------     ------       ------    ------
     Total allowance for loan losses...........................     $2,263    100.00%     $3,294     100.00%      $3,226    100.00%
                                                                    ======    ======      ======     ======       ======    ======
</TABLE>

Investment Activities

     In prior years, the Bank increased the percentage of its assets held in its
investment portfolio as part of its strategy of maintaining higher levels of
liquidity which improve the Bank's interest rate risk position. The Bank's
investment portfolio comprises U.S. government and agency securities, corporate
debt securities, municipal bonds, FHLB Stock and interest earning deposits. The
carrying value of the Bank's investment securities totaled $111.0 million at
December 31, 1998, compared to $61.7 million at December 31, 1997. The Bank's
interest-bearing deposits due from other financial institutions with original
maturities of three months or less, totaled $32.1 million at December 31, 1998,
compared to $33.7 million at December 31, 1997.

     The Bank is required under federal regulations to maintain a minimum amount
of liquid assets that may be invested in specified short term securities and
certain other investments. See "Regulation--Federal Regulations--Liquidity
Requirements" below and "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Liquidity and Capital Resources" in the
Annual Report. The Bank generally has maintained a portfolio of liquid assets
that exceeds regulatory requirements. Liquidity levels may be increased or
decreased depending upon the yields on investment alternatives and upon
management's judgment as to the attractiveness of the yields then available in
relation to other opportunities and its expectation of the level of yield that
will be available in the future, as well as management's projections as to the
short term demand for funds to be used in the Bank's loan origination and other
activities.


                                      17
<PAGE>
 
     Investment Portfolio. The following tables set forth the carrying value of
the Bank's investments at the dates indicated. At December 31, 1998, the market
value of the Bank's investments was approximately $111.0 million. As allowed by
SFAS 115, "Accounting for Certain Investments in Debt and Equity Securities,"
the Bank declared its investment in U.S. Government and agency obligations as
available for sale. As a result, such securities are now presented at fair
value, as determined by market quotations. The market value of investments
includes interest-earning deposits and FHLB stock at book value, which
approximates market value.

<TABLE>
<CAPTION>
                                                                                                      At December 31,            
                                                                                ----------------------------------------------------
                                                                                  1996                  1997                  1998
                                                                                --------              --------              --------
                                                                                                  (In Thousands)
<S>                                                                             <C>                   <C>                   <C>     
U.S. Government and agency obligations ...........................              $  8,035              $ 13,861              $ 15,924

Corporate debt securities ........................................                    --                    --                44,488

Municipal bonds ..................................................                   430                 2,216                 2,900

Interest-earning deposits ........................................                27,127                33,688                32,075

FHLB stock .......................................................                 6,148                11,955                15,658
                                                                                --------              --------              --------
      Total investments ..........................................              $ 41,740              $ 61,720              $111,045
                                                                                ========              ========              ========

</TABLE>

     During 1998, the Bank began to diversify its investments in mortgage-backed
securities by purchasing investment grade rated, floating rate trust preferred
securities of other financial institutions. In doing so, the Bank was relying on
regulations which permit an investment of up to 35% of its assets in "commercial
paper and corporate debt securities." In November of 1998, the Office of Thrift
Supervision ("OTS") issued TB-73, which among other matters stated concerns over
institutions' investment in trust preferred securities, citing increased
interest rate risks as a result of the predominant fixed rate nature of such
securities and that some of these securities could have their maturities
extended at the issuer's option. As a result, the OTS adopted limitations on the
investment of such securities to 15% of a regulated institution's equity, but
adopted a method by which an institution could appeal the limitation.

     At December 31, 1998, the Bank's investment in trust preferred securities
was 2.8% of its assets and 42.7% of its regulatory capital. Most issues of trust
preferred securities appear to be fixed rate and unrated as to credit risk
including Fidelity Bankshares, Inc.'s issue of "Guaranteed Preferred Beneficial
Interests in Company's Debentures." However, the Bank's investment policy
specifically restricts its investment in such securities to $50 million,
investment grade and floating rate to improve its interest rate risk. The Bank
has appealed to the OTS to permit it to continue its investment at current
levels and noted in its appeal that its investments had floating interest rates
and the issuers did not have the option to extend the maturities. Management of
the Bank is unable to predict the outcome of its appeal.


                                      18
<PAGE>
 
     Investment Portfolio Maturities. The following table sets forth the
scheduled maturities, amortized cost, market values and average yields for the
Bank's investment securities at December 31, 1998.

<TABLE>
<CAPTION>

                                                                            At December 31, 1998 
                                                      ----------------------------------------------------------------- 
                                                        One Year or Less     One to Three Years   Three to Five Years    
                                                      --------------------  --------------------- ---------------------  
                                                                 Annualized            Annualized            Annualized   
                                                                 Weighted              Weighted              Weighted     
                                                      Amortized   Average   Amortized   Average   Amortized   Average     
                                                        Cost       Yield      Cost       Yield      Cost       Yield      
                                                      ---------  ---------- ---------  ---------- ---------  ----------  
<S>                                                    <C>       <C>        <C>        <C>        <C>        <C> 
Debt securities:
U.S. Government agency securities .............        $ 11,796      6.1%    $  3,999     5.8%    $     --        --%
Corporate debt Securities .....................          46,000      6.3           --      --           --        -- 
Municipal bonds ...............................           1,101      4.6          980     4.0          444      3.90
FHLB stock ....................................          15,658      7.5           --      --           --        -- 
Interest-earning deposits .....................          32,075      4.9           --      --           --        -- 
                                                      ---------  ---------- ---------  ---------- ---------  ----------  
      Total ...................................        $106,630      6.0%    $  4,979     5.5%    $    444      3.90%
                                                      =========  ========== =========  ========== =========  ==========
<CAPTION>
                                                       Over Five Years                  Total            
                                                   -----------------------      ------------------------
                                                                Annualized                                               Annualized 
                                                                 Weighted                                      Average    Weighted
                                                   Amortized      Average       Amortize        Market         Life in     Average
                                                      Cost         Yield          Cost           Value         Years(1)     Yield
                                                   ---------    ----------      --------        --------       --------  -----------

                                                                                 (Dollars in Thousands) 
<S>                                                <C>          <C>             <C>             <C>            <C>       <C>  
Debt securities:
U.S. Government agency securities ..............    $     --         --%        $ 15,795        $ 15,924            .8        6.0%
Corporate debt Securities ......................          --         --           46,000          44,488          29.1        6.3
Municipal bonds ................................         358        3.8            2,883           2,900           2.4        4.2
FHLB stock .....................................          --         --           15,658          15,658            --        7.5
Interest-earning deposits ......................          --         --           32,075          32,075            --        4.9
                                                    --------        ---         --------        --------         -----       ----
      Total ....................................    $    358        3.8%        $112,411        $111,045          21.0        6.0%
                                                    ========        ===         ========        ========         =====       ====
</TABLE>
---------------------------
(1)  Total weighted average life in years calculated only on United States
     Government agency securities, corporate debt securities and municipal
     bonds.

                                      19
<PAGE>
 
Sources of Funds

      General. Deposits are the major source of the Bank's funds for lending and
other investment purposes. In addition to deposits, the Bank derives funds from
the amortization and prepayment of loans and mortgage-backed securities, the
maturity of investment securities, operations and, if needed, advances from the
FHLB. Scheduled loan principal repayments are a relatively stable source of
funds, while deposit inflows and outflows and loan prepayments are influenced
significantly by general interest rates and market conditions. Borrowings may be
used on a short-term basis to compensate for reductions in the availability of
funds from other sources or on a longer term basis for general business
purposes.

      Deposits. Consumer and commercial deposits are attracted principally from
within the Bank's market area through the offering of a broad selection of
deposit instruments including non-interest-bearing demand accounts, NOW
accounts, passbook savings, money market deposits, term certificate accounts and
individual retirement accounts. Deposit account terms vary according to the
minimum balance required, the period of time during which the funds must remain
on deposit, and the interest rate, among other factors. The Bank regularly
evaluates its internal cost of funds, surveys rates offered by competing
institutions, reviews the Bank's cash flow requirements for lending and
liquidity, and executes rate changes when deemed appropriate. The Bank does not
obtain funds through brokers.

      Deposit Portfolio. The following table sets forth information regarding
interest rates, terms, minimum amounts and balances of the Bank's deposit
portfolio as of December 31, 1998.

<TABLE>
<CAPTION>

       Weighted                                                                                              Percentage
        Average                                                                   Minimum                     of Total
     Interest Rate        Minimum Term        Checking and Savings Deposits       Amount        Balances      Deposits
     -------------        ------------        -----------------------------       ------        --------      --------
                                                                                             (In Thousands)
     <S>                  <C>                 <C>                                <C>         <C>             <C>     
         0.00  %              None              Non-interest-bearing demand      $     0        $  57,002          5.1%
         1.01                 None              NOW accounts                         100           94,848          8.5
         2.00                 None              Passbooks                            100          127,494         11.4
         2.50                 None              Money market accounts              2,500           44,481          4.0

                                                Certificates of Deposit
                                                -----------------------

         4.19             0 - 3 months          Fixed term, fixed rate             1,000        $  11,239          1.0%
         4.75             3 - 6 months          Fixed term, fixed rate             1,000           40,323          3.6
         5.26             6 - 12 months         Fixed term, fixed rate             1,000          296,224         26.4
         5.66            12 - 36 months         Fixed term, fixed rate             1,000          358,856         32.0
         6.10            36 - 60 months         Fixed term, fixed rate             1,000           90,279          8.0
                                                                                               ----------       ------
                                                                        Total                  $1,120,746        100.0%
                                                                                               ==========       =======
</TABLE>

                                      20
<PAGE>
 
     The following table sets forth the change in dollar amount of savings
deposits in the various types of savings accounts offered by the Bank between
the dates indicated.

<TABLE>
<CAPTION>
                                                     Balance     Increase      Balance     Deposit  Increase     Balance    Deposit
                                                    12/31/94     Decrease     12/31/95        %     Decrease     12/31/96      %
                                                  -----------    --------     --------     -------  --------     --------     ----
                                                                                 (Dollars in Thousands)
<S>                                               <C>            <C>          <C>          <C>      <C>          <C>        <C> 
Noninterest bearing demand accounts ..............   $ 19,551    $  1,879     $ 21,430        3.6%  $  4,976     $ 26,406      3.8%
NOW, Super NOW and funds
  transfer accounts ..............................     65,025       2,861       67,886       11.4      2,672       70,558     10.2
Passbook and statement accounts ..................     99,198     (12,727)      86,471       14.5      1,063       87,534     12.6
Variable rate money market accounts ..............     55,516     (10,839)      44,677        7.5       (665)      44,012      6.3
Time Deposits:
  Maturing within 12 months ......................    243,557      38,676      294,202       47.4     64,710      358,912     51.7
  Maturing within 12-36 months ...................     34,405      41,018       57,236       12.7     22,658       79,894     11.5
  Maturing beyond 36 months ......................     20,983      (3,923)      23,278        2.9      4,124       27,402      3.9
                                                     --------    --------     --------     ------   --------     --------    ----- 

    Total ........................................   $538,235    $ 56,945     $595,180      100.0%  $ 99,538     $694,718    100.0%
                                                     ========    ========     ========     ======   ========     ========    =====
<CAPTION>

                                                           Increase     Balance       Deposit   Increase       Balance      Deposit 
                                                           Decrease     12/31/97         %      Decrease       12/31/98        %  
                                                          ----------   ----------     -------  ----------     ----------    -------
                                                                                    (Dollars in Thousands)
<S>                                                       <C>          <C>            <C>      <C>            <C>           <C>   
Noninterest bearing demand accounts ..................    $    9,482   $   35,888        4.1%  $   21,114     $   57,002        5.1%
NOW, Super NOW and funds
  transfer accounts ..................................        11,594       82,152        9.4       12,696         94,848        8.5
Passbook and statement accounts ......................        17,548      105,082       12.1       22,412        127,494       11.4
Variable rate money market accounts ..................        (1,877)      42,135        4.8        2,346         44,481        4.0
Time Deposits:
  Maturing within 12 months ..........................        28,599      387,511       44.4     (133,230)       254,281       22.7
  Maturing within 12-36 months .......................        89,334      169,228       19.4      263,897        433,125       38.6
  Maturing beyond 36 months ..........................        22,942       50,344        5.8       59,171        109,515        9.7
                                                          ----------   ----------     ------   ----------     ----------      -----

    Total ............................................    $  177,622   $  872,340      100.0%  $  248,406     $1,120,746      100.0%
                                                          ==========   ==========     ======   ==========     ==========      =====
</TABLE>


                                      21
<PAGE>
 
     The following table sets forth the certificates of deposit in the Bank
classified by rates as of the dates indicated.

                                                   At December 31,            
                                      ------------------------------------------
                                        1996             1997             1998
                                      --------         --------         --------
Rate                                               (In Thousands)
----
1.01 - 2.00% ................         $    949         $    895         $  1,018
2.01 - 3.00% ................                2              301               --
3.01 - 4.00% ................               20                6                6
4.01 - 5.00% ................           34,308           11,225          125,019
5.01 - 6.00% ................          333,998          441,810          564,002
6.01 - 7.00% ................           93,788          152,453          106,719
7.01 - 8.00% ................            3,079              353              157
8.01 - 9.00% ................               64               40               --
                                      --------         --------         --------
                                      $466,208         $607,083         $796,921
                                      ========         ========         ========

     The following table sets forth the amount and maturities of certificates of
deposit at December 31, 1998.

<TABLE>
<CAPTION>
                                                                        Amount Due                                 
                                        ---------------------------------------------------------------------------
                                        Less Than     1-2        2-3        3-4        4-5      After 5
                                        One Year     Years      Years      Years      Years      Years      Total  
                                        ---------    -----      -----      -----      -----     -------     -----
                                                                      (In Thousands)
<S>                                     <C>        <C>        <C>        <C>        <C>        <C>        <C>      
Rate
   1.01 - 2.00%.....................    $   1,018  $      --  $      --  $      --  $      --  $      --  $   1,018
   2.01 - 3.00%.....................           --         --         --         --         --         --         --
   3.01 - 4.00%.....................            6         --         --         --         --         --          6
   4.01 - 5.00%.....................       81,319     35,628      7,529        314         36        193    125,019
   5.01 - 6.00%.....................      136,525    187,695    150,103      1,851     86,896        932    564,002
   6.01 - 7.00%.....................       35,413     34,508     17,539     16,008      3,188         63    106,719
   7.01 - 8.00%.....................           --        123         --         34         --         --        157
                                        ---------  ---------  ---------  ---------  ---------  ---------  ---------
                                        $ 254,281  $ 257,954  $ 175,171  $  18,207  $  90,120  $   1,188  $ 796,921
                                        =========  =========  =========  =========  =========  =========  =========
</TABLE>

     The following table indicates the amount of the Bank's negotiable
certificates of deposit of $100,000 or more by time remaining until maturity as
of December 31, 1998.


                    Remaining Maturity                            Amounts   
                    ------------------                            -------
                                                              (In Thousands)

         Three months or less..........................         $  43,908
         Three through six months......................            28,777
         Six through twelve months.....................            35,703
         Over twelve months............................           128,886
                                                                ---------
             Total.....................................         $ 237,274
                                                                =========

                                      22
<PAGE>
 
         The following table sets forth the net changes in the deposit
activities of the Bank for the periods indicated.

<TABLE>
<CAPTION>
                                                          Year Ended December 31,        
                                                   ------------------------------------
                                                      1996         1997         1998   
                                                   ----------   ----------   ----------
                                                              (In Thousands)
<S>                                                <C>          <C>          <C>       
Deposits .......................................   $2,557,621   $3,353,672   $4,359,705
Acquired as part of acquisition ................           --       41,730           --
Withdrawals ....................................    2,480,059    3,250,906    4,145,444
                                                   ----------   ----------   ----------
Net increase (decrease) before interest credited       77,562      144,496      214,261
Interest credited ..............................       21,976       33,126       34,145
                                                   ----------   ----------   ----------
Net increase (decrease) in deposits ............   $   99,538   $  177,622   $  248,406
                                                   ==========   ==========   ==========
</TABLE>

Borrowings

     Savings deposits are the primary source of funds of the Bank's lending and
investment activities and for its general business purposes. If the need arises,
the Bank, may rely upon advances from the FHLB and the Federal Reserve Bank
discount window to supplement its supply of lendable funds and to meet deposit
withdrawal requirements. Advances from the FHLB typically are collateralized by
the Bank's stock in the FHLB and a portion of the Bank's first mortgage loans.
At December 31, 1998, the Bank had $303.1 million in FHLB advances outstanding.

     The FHLB functions as a central reserve bank providing credit for the Bank
and other member savings institutions and financial institutions. As a member,
the Bank is required to own capital stock in the FHLB and is authorized to apply
for advances on the security of such stock and certain of its home mortgages and
other assets (principally, securities that are obligations of, or guaranteed by,
the United States) provided certain standards related to creditworthiness have
been met. Advances are made pursuant to several different programs. Each credit
program has its own interest rate and range of maturities. Depending on the
program, limitations on the amount of advances are based either on a fixed
percentage of a member institution's net worth or on the FHLB's assessment of
the institution's creditworthiness. All FHLB advances have fixed interest rates
and mature between two and 10 years, except for $28.3 million in such advances,
bearing interest at 8.17%, which mature in the fourth quarter, 1999..

<TABLE> 
<CAPTION> 
                                                    Year Ended December 31,        
                                              ---------------------------------
                                               1996         1997         1998   
                                              -------     --------     --------
                                                       (In Thousands)
<S>                                           <C>         <C>          <C> 
FHLB advances:
   Maximum month-end balance  ...........      91,135     $239,091     $318,527
   Balance at end of period .............      82,517      239,091      303,140
   Average balance ......................      84,351      119,759      286,094

Weighted average interest rate on:
   Balance at end of period .............        6.74%        6.41%        5.94%
   Average balance for period ...........        6.79%        6.27%        6.06%
</TABLE> 

                                      23
<PAGE>
 
Competition

     The Bank's market area in Southeast Florida has a large concentration of
financial institutions, many of which are significantly larger and have greater
financial resources than the Bank, and all of which are competitors of the Bank
to varying degrees. As a result, the Bank encounters strong competition both in
attracting deposits and in originating real estate and other loans. Its most
direct competition for deposits has come historically from commercial banks,
brokerage houses, other savings associations, and credit unions in its market
area, and the Bank expects continued strong competition from such financial
institutions in the foreseeable future. The Bank's market area includes branches
of several commercial banks that are substantially larger than the Bank in terms
of state-wide deposits. The Bank competes for savings by offering depositors a
high level of personal service and expertise together with a wide range of
financial services.

     The competition for real estate and other loans comes principally from
commercial banks, mortgage banking companies, and other savings associations.
This competition for loans has increased substantially in recent years as a
result of the large number of institutions competing in the Bank's market area
as well as the increased efforts by commercial banks to expand mortgage loan
originations.

     The Bank competes for loans primarily through the interest rates and loan
fees it charges and the efficiency and quality of services it provides
borrowers, real estate brokers, and builders. Factors that affect competition
include general and local economic conditions, current interest rate levels, and
volatility of the mortgage markets.

     Based on total assets as of $1.6 billion, the Bank was the largest savings
institution headquartered in Palm Beach County, and the Bank held approximately
5.1% of all financial institution deposits in Palm Beach County.

Subsidiary Activities

     The Bank has one active wholly owned subsidiary, Fidelity Realty and
Appraisal Service, Inc., a Florida corporation ("FRAS"). FRAS is primarily
engaged in providing appraisal services for the Bank and selling the Bank's REO.
At December 31, 1998, FRAS had a cumulative deficit of $96,000. For the year
ended December 31, 1998, FRAS had net income of $70,000.

     Under FIRREA, SAIF-insured institutions are required to provide 30 days
advance notice to the OTS and FDIC before establishing or acquiring a subsidiary
or conducting a new activity in a subsidiary. The insured institution must also
provide the FDIC and the OTS such information as may be required by applicable
regulations and must conduct the activity in accordance with the rules and
orders of the OTS. In addition to other enforcement and supervision powers, the
OTS may determine after notice and opportunity for a hearing that the
continuation of a savings association's ownership of or relation to a subsidiary
(i) constitutes a serious risk to the safety, soundness or stability of the
savings association, or (ii) is inconsistent with the purposes of FIRREA. Upon
the making of such a determination, the OTS may order the savings association to
divest the subsidiary or take other actions.


                                      24
<PAGE>
 
Personnel

     As of December 31, 1998, the Bank had 370 full-time and 45 part-time
employees. None of the Bank's employees is represented by a collective
bargaining group. The Bank believes its relationship with its employees to be
good.

Regulation

     As a federally chartered, SAIF-insured savings association the Bank is
subject to examination, supervision and extensive regulation by the OTS, and the
FDIC. The Bank is a member of and owns stock in the FHLB of Atlanta, which is
one of the twelve regional banks in the Federal Home Loan Bank System. This
regulation and supervision establishes a comprehensive framework of activities
in which an institution can engage and is intended primarily for the protection
of the insurance fund and depositors.

     The Bank also is subject to regulation by the Board of Governors of the
Federal Reserve System (the "Federal Reserve Board") governing reserves to be
maintained against deposits and certain other matters. The Holding Company will
be subject to supervision and regulation by the OTS.

     The OTS regularly examines the Bank and prepares reports for the
consideration of the Bank's Board of Directors on any deficiencies that they may
find in the Bank's operations. The FDIC also examines the Bank in its role as
the administrator of the SAIF. The Bank's relationship with its depositors and
borrowers also is regulated to a great extent by both federal and state laws
especially in such matters as the ownership of savings accounts and the form and
content of the Bank's mortgage documents. Any change in such regulation, whether
by the FDIC, OTS, or Congress, could have a material adverse impact on the
Holding Company and the Bank and their operations.

     The Federal Deposit Insurance Corporation Improvement Act of 1991. The
Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA")
primarily addresses the recapitalization of the BIF, which insures the deposits
of commercial banks and savings banks. In addition, FDICIA established a number
of new mandatory supervisory measures for savings associations and banks.

     Standards for Safety and Soundness. FDICIA requires the federal bank
regulatory agencies to prescribe regulatory standards for all insured depository
institutions and depository institution holding companies relating to: (i)
internal controls, information systems and audit systems; (ii) loan
documentation; (iii) credit underwriting; (iv) interest rate risk exposure; (v)
asset growth; and (vi) compensation, fees and benefits. The compensation
standards would prohibit employment contracts, compensation or benefit
arrangements, stock option plans, fee arrangements or other compensatory
arrangements that provide excessive compensation, fees or benefits or could lead
to material financial loss. In addition the federal banking regulatory agencies
are required to prescribe by regulation standards specifying: (i) maximum
classified assets to capital ratios; (ii) minimum earnings sufficient to absorb
losses without impairing capital; and (iii) to the extent feasible, a minimum
ratio of market value to book value for publicly traded shares of depository
institutions and depository institution holding companies.

     Financial Management Requirements. Pursuant to FDICIA, in May 1993, the
FDIC adopted rules establishing annual independent audits and financial
reporting requirements for all depository institutions with assets of more than
$500 million, their management and their independent auditors. The rules also
establish new requirements for the composition, duties, and authority of such
institutions' audit committees


                                      25
<PAGE>
 
and boards of directors, effective in fiscal years beginning after December 31,
1992. Among other things, all depository institutions with assets in excess of
$500 million are required to prepare and make available to the public annual
reports on their financial condition and management, including statements of
management's responsibility under regulations relating to safety and soundness,
and an assessment of the institution's compliance with internal controls, laws
and regulations. The institution's independent auditors are required to attest
to these management assessments. Each such institution also is required to have
an audit committee composed of independent directors. Audit Committees of large
institutions (institutions with assets exceeding $3.0 billion) must: (i) include
members with banking or related financial management experience; (ii) have the
ability to engage their own independent legal counsel; and (iii) must not
include any large customers (as defined) of the institution.

Federal Regulations

     Regulatory Capital. The capital requirements consist of a "tangible capital
requirement," a "leverage limit" and a "risk-based capital requirement."

     Under the tangible capital requirement, a savings association must maintain
tangible capital in an amount equal to at least 1.5% of adjusted total assets.
Tangible capital is defined as core capital less all intangible assets
(including supervisory goodwill), plus a specified amount of purchased mortgage
servicing rights. Further, the valuation allowance applicable to the write-down
of investments and mortgage-backed securities in accordance with SFAS 115 is
excluded from the regulatory capital calculation.

     The leverage limit adopted by the OTS requires that savings associations
maintain "core capital" in an amount equal to at least 3% of adjusted total
assets. The OTS, however, has proposed an amendment to this requirement that
would increase core capital requirements for nearly all savings associations, as
discussed below. Core capital is defined as common stockholders' equity
(including retained earnings), non-cumulative perpetual preferred stock, and
minority interests in the equity accounts of consolidated subsidiaries, plus
purchased mortgage servicing rights valued at the lower of 90% of fair market
value, 90% of original cost or the current amortized book value as determined
under generally accepted accounting principles ("GAAP"), and "qualifying
supervisory goodwill," less non-qualifying intangible assets.

     In addition, the OTS has proposed a rule that would limit the amount of
purchased mortgage servicing rights includable as core capital to 50% of such
capital. No assurance can be given as to the final form of such regulation, the
date of its effectiveness, or whether it will differ materially from the
proposal. The proposal, if adopted as proposed, is not anticipated to have any
immediate effect on the Bank.

     Savings associations receiving a CAMEL rating of "1", the best possible
rating on a scale of 1 to 5, are required to maintain a ratio of core capital to
adjusted total assets of 3%. All other savings associations are required to
maintain minimum core capital of 4% to 5% of total adjusted assets. In
determining the required minimum core capital ratio, the OTS will assess the
quality of risk management and the level of risk in each savings association on
a case-by-case basis. At December 31, 1998, the Bank's ratio of core capital to
total adjusted assets was 6.7%. The OTS prohibits savings associations from
disclosing their CAMEL ratings. (See notes to consolidated financial
statements.)

     A savings association that does not meet the minimum regulatory capital
requirements because of the failure to satisfy the core capital requirement will
be required to submit a capital restoration plan to the OTS that sets forth in
reasonable detail the steps the association will take to be in compliance. The
capital


                                      26
<PAGE>
 
plans will be required to be filed within 60 days of the effective date of the
new regulation. If the OTS rejects a savings association's capital plan, the OTS
may require an amended capital plan to be filed, or the OTS can take supervisory
action against the association.

     Under the risk-based capital requirement, a savings association must
maintain total capital (which is defined as core capital plus supplementary
capital) equal to at least 8.0% of risk-weighted assets. A savings association
must calculate its risk-weighted assets by multiplying each asset and
off-balance sheet item by various risk factors, which range from 0% for cash and
securities issued by the United States Government or its agencies to 100% for
repossessed assets or loans more than 90 days past due. Supplementary capital
may include, among other items, cumulative perpetual preferred stock, perpetual
subordinated debt, mandatory convertible subordinated debt, intermediate-term
preferred stock, and general allowances for loan losses. The allowance for loan
losses includable in supplementary capital is limited to 1.25% of risk-weighted
assets. Supplementary capital is limited to 100% of core capital.

     The OTS and the FDIC generally are authorized to take enforcement action
against a savings association that fails to meet its capital requirements, which
action may include restrictions on operations and banking activities, the
imposition of a capital directive, a cease-and-desist order, civil money
penalties or harsher measures such as the appointment of a receiver or
conservator or a forced merger into another institution. In addition, under
current regulatory policy, a savings association that fails to meet its capital
requirements is prohibited from paying any dividends. Except under certain
circumstances, further disclosure of final enforcement actions by the OTS is
required.

     Federal Home Loan Bank System. The Bank is a member of the Federal Home
Loan Bank ("FHLB") of Atlanta, which is one of the 12 regional FHLBs. As a
member of the FHLB, the Bank is required to purchase and maintain stock in the
FHLB of Atlanta in an amount equal to the greater of 1% of its aggregate unpaid
residential mortgage loans, home purchase contracts or similar obligations at
the beginning of each year, or 1/20 (or such greater fraction as established by
the FHLB) of outstanding FHLB advances. At December 31, 1998 the Bank had $15.7
million in FHLB of Atlanta stock, which was in compliance with this requirement.
In past years the Bank has received dividends on its FHLB stock. Over the past
five years such dividends have averaged 7.02%, and was 7.44% for the year ended
December 31, 1998. Certain provisions of FIRREA require all 12 FHLBs to provide
financial assistance for the resolution of troubled savings associations and to
contribute to affordable housing programs through direct loans or interest
subsidies on advances targeted for community investment and low- and
moderate-income housing projects. These contributions could cause rates on the
FHLB advances to increase and could affect adversely the level of FHLB dividends
paid and the value of FHLB stock in the future.

     Each FHLB serves as a reserve or central bank for its members within its
assigned region. It is funded primarily from proceeds derived from the sale of
consolidated obligations of the FHLB System. It makes loans to members (i.e.,
advances) in accordance with policies and procedures established by the board of
directors of the FHLB. These policies and procedures are subject to the
regulation and oversight of the Federal Housing Finance Board (the "FHFB").

     FHLB advances must be fully secured by sufficient collateral as determined
by the FHLB. Eligible collateral consists of mortgage loans less than 90 days
delinquent or securities evidencing interests therein, securities (including
mortgage-backed securities) issued, insured, or guaranteed by the federal
government or any agency thereof, FHLB deposits, and to a limited extent, real
estate with readily ascertainable value in which a perfected security interest
may be obtained. Other forms of collateral may be accepted as


                                      27
<PAGE>
 
collateralization under certain circumstances. All long-term advances are
required to be used to provide funds for residential home financing. In
addition, the FHFB has established standards of community service that members
must meet to maintain access to long-term advances. FHLBs are authorized to make
short-term liquidity advances to solvent associations in poor financial
condition but with prospects of improving, upon the request of the OTS. In
addition, pursuant to FHLB regulations, each FHLB is required to establish
programs for affordable housing that involve interest subsidies from the FHLBs
on advances to members engaged in lending at subsidized interest rates for low-
and moderate-income, owner-occupied housing and affordable housing, and certain
other community purposes.

     Qualified Thrift Lender Test. The qualified thrift lender ("QTL") test
requires that a savings institution maintain at least 65% of its total portfolio
assets in "qualified thrift investments" on an average basis in nine out of
every twelve months. For purposes of the test, portfolio assets are defined as
the total assets of the savings institution minus: goodwill and other intangible
assets, the value of property used by the savings institution to conduct its
business and liquid assets not to exceed 20% of the savings institution's total
assets.

     Under the QTL's statutory and regulatory provisions, all forms of home
mortgages, home improvement loans, home equity loans and loans on the security
of other residential real estate and mobile homes as well as a designated
percentage of consumer loans are "qualified thrift investments," as are shares
of stock of the FHLB, investments or deposits in other insured institutions,
securities issued by the FNMA, FHLMC or GNMA and other mortgage-related
securities. Investments in nonsubsidiary corporations or partnerships whose
activities include servicing mortgages or real estate development are also
considered qualified thrift investments in proportion to the amount of primary
revenue such entities derive from housing-related activities. Also included in
qualified thrift investments are mortgage servicing rights, whether such rights
are purchased by the insured institution or created when the institution sells
loans and retains the right to service such loans.

     A savings institution that fails to become, or maintain its status as, a
qualified thrift lender must either become a bank (other than a savings bank) or
be subject to certain restrictions. A savings institution that fails to meet the
QTL test and does not convert to a bank will be: (i) prohibited from making an
investment or engaging in activities that would not be permissible for national
banks; (ii) prohibited from establishing any new branch office where a national
bank located in the savings institution's home state would not be able to
establish a branch office; (iii) ineligible to obtain new advances from any
Federal Home Loan Bank; and (iv) subject to limitations on the payment of
dividends comparable to the statutory and regulatory dividend restrictions
applicable to national banks. Also, beginning three years after the date on
which the savings institution ceases to be a qualified thrift lender, the
savings institution would be prohibited from retaining any investment or
engaging in any activity not permissible for a national bank and would be
required to repay any outstanding advances to any FHLB. A savings institution
may requalify as a qualified thrift lender if it thereafter complies with the
QTL test.

     As of December 31, 1998, the Bank was in compliance with the QTL
requirement. At December 31, 1998, 87.5% of the Bank's assets were "qualified
thrift investments."

     Liquidity Requirements. Federally insured savings associations are required
to maintain an average daily balance of liquid assets equal to a certain
percentage of the sum of average daily balances of net withdrawable deposit
accounts and borrowings payable in one year or less. The liquidity requirement
may


                                      28
<PAGE>
 
vary from time to time (between 4.0% and 10.0%) depending upon economic
conditions and savings flows of all savings associations. At the present time,
the required liquid asset ratio is 4.0%.

     For purposes of this ratio, liquid assets include specified short-term
assets (such as cash, certain time deposits, certain bankers' acceptances and
short-term United States Treasury obligations), and long-term assets such as
United States Treasury obligations of more than one and less than five years and
federal agency obligations with a minimum term of 18 months. The regulations
governing liquidity requirements include as liquid assets debt securities hedged
with forward commitments obtained from dealers in United States Government
securities or Associations whose accounts are insured by the FDIC, debt
securities directly hedged with a short financial futures position, and debt
securities that provide the holder with a right to redeem the security at par
value, regardless of the stated maturities of such securities. FIRREA also
authorizes the OTS to designate as liquid assets certain mortgage-related
securities and certain mortgage loans (qualifying as backing for certain
mortgage-backed securities) with less than one year to maturity. Short-term
liquid assets currently must constitute at least 1% of an association's average
daily balance of net withdrawable deposit accounts and current borrowings.
Penalties may be imposed upon associations for violations of the liquidity
requirements. The monthly average liquidity ratio of the Bank for December 1998
was 7.12% and exceeded the then applicable requirement of 4.0%.

     Insurance of Accounts and Regulation by the FDIC. The Bank's deposits are
insured up to $100,000 per insured member (as defined by law and regulation) by
the SAIF. This insurance is backed by the full faith and credit of the United
States Government. The SAIF is administered and managed by the FDIC. As insurer,
the FDIC is authorized to conduct examinations of and to require reporting by
SAIF-insured associations. It also may prohibit any SAIF-insured association
from engaging in any activity the FDIC determines by regulation or order to pose
a serious threat to the SAIF. The FDIC also has the authority to initiate
enforcement actions against savings associations, after first giving the OTS an
opportunity to take such action.

     The minimum annual deposit insurance premiums are currently assessed at the
rate of .065% of deposits for all SAIF-insured members. The FDIC, however, is
authorized to raise premiums in certain circumstances related to fund losses and
severe economic circumstances and has exercised this authority several times
with respect to premiums paid to the BIF by commercial banks and BIF-member
savings associations.

     Limitations on Capital Distributions. OTS regulations impose limitations on
all capital distributions by savings institutions. Capital distributions include
cash dividends, payments to repurchase or otherwise acquire the savings
association's shares, payments to stockholders of another institution in a
cash-out merger, and other distributions charged against capital. The rule
establishes three tiers of institutions. An institution that exceeds all fully
phased-in capital requirements before and after a proposed capital distribution
("Tier 1 Association") may, after prior notice but without the approval of the
OTS, make capital distributions during a calendar year up to (i) 100% of its net
income to date during the calendar year plus the amount that would reduce by
one-half its surplus capital at the beginning of the calendar year or (ii) 75%
of its net income over the most recent four-quarter period. Any additional
capital distributions would require prior regulatory approval. An institution
that meets its regulatory capital requirement, but not its fully phased-in
capital requirement before or after its capital distribution ("Tier 2
Association") may, after prior notice but without the approval of the OTS, make
capital distributions of: up to 75% of its net income over the most recent four
quarter period if it satisfies the risk-based capital requirement that would be
applicable to it on January 1, 1993, computed based on its current portfolio; up
to 50% of its net income over the most recent four quarter

                                       29
<PAGE>
 
period if it satisfies the risk based capital standard that was applicable to it
on January 1, 1991, computed based on its current portfolio; and up to 25% of
its net income over the most recent four quarter period if it satisfies its
current risk-based capital requirement. In computing the institution's
permissible percentage of capital distributions, previous distributions made
during the prior four quarter period must be included. A savings institution
that does not meet its current regulatory capital requirement before or after
payment of a proposed capital distribution ("Tier 3 Association") may not make
any capital distributions without the prior approval of the OTS. In addition,
the OTS would prohibit a proposed capital distribution by any institution, which
would otherwise be permitted by the regulation, if the OTS determines that such
distribution would constitute an unsafe or unsound practice. In addition, FDICIA
provides that, as a general rule, a financial institution may not make a capital
distribution if it would be undercapitalized after making the capital
distribution. Also, an institution meeting the Tier 1 capital criteria which has
been notified that it needs more than normal supervision will be treated as a
Tier 2 or Tier 3 Association unless the OTS deems otherwise. A recently proposed
OTS rule would amend the capital distribution regulation to provide that a Tier
1 Association would be permitted to make capital distributions under the Tier 1
standard or, consistent with the highest Tier 2 standard, at 75% of its net
income to date over the most recent four quarter period.
As of December 31, 1998, the Bank was a Tier 1 Association.

     Investment Limitations. FIRREA generally provides that state-chartered
savings associations may not engage as principal in any type of activity, or in
any activity in any amount not permitted for federally-chartered associations,
or directly acquire or retain any equity investment of a type or amount not
permitted for federally-chartered associations. The FDIC has authority to grant
exceptions from these prohibitions (other than with respect to non-service
corporation equity investments) if it determines no significant risk to the
insurance fund is posed by the amount of the investment or the activity to be
engaged in if the Bank is and continues to be in compliance with fully phased-in
standards. Among activity restrictions applicable to federally-chartered
institutions that are also applicable to the Bank is the prohibition on
investing directly in equity securities or real estate (other than that used for
offices and related facilities or acquired through, or in lieu of, foreclosure).
In addition, the Bank is authorized to invest directly in service corporation to
a maximum of 2% of the Bank's assets, plus an additional 1% of assets if the
amount over 2% is used for specified community or intercity development
purposes. Federal laws and regulations also impose certain limitations on
operations, including restrictions on loans to one borrower, transactions with
affiliates and affiliated persons and liability growth.

     FIRREA also imposed investment and lending restrictions that are applicable
to all federally- or state-chartered associations. FIRREA provides that no
savings association may invest in corporate debt securities not rated in one of
the four highest rating categories by a nationally recognized rating
organization. FIRREA and FDICIA amend the authority of savings associations to
engage in transactions with affiliates or to make loans to certain insiders, by
making such transactions subject to Sections 23A, 23B, 22(g) and 22(h) of the
Federal Reserve Act. Among other things, these provisions generally require that
these transactions with affiliates be on terms and conditions comparable to
those for similar transactions with non-affiliates. In addition, these affiliate
transactions may be regulated further by the OTS to address safety and soundness
concerns.

     Holding Company Regulation. The Company and the Mutual Holding Company are
holding companies within the meaning of the Home Owners' Loan Act of 1933
("HOLA"). As such, the Company and the Mutual Holding Company are registered
with and is subject to OTS examination and supervision as well as certain
reporting requirements. In addition, the operations of the Company and the
Mutual Holding Company are subject to the Regulations as well as other
regulations promulgated by the OTS from

                                       30
<PAGE>
 
time to time. As a SAIF-insured subsidiary of a savings and loan holding
company, the Bank is subject to certain restrictions in dealing with the Company
and Mutual Holding Company and with other persons affiliated with the Company
and the Mutual Holding Company and will continue to be subject to examination
and supervision by the OTS and the FDIC.

     Transactions with Affiliates. Section 11 of HOLA provides that transactions
between an insured subsidiary of a holding company and an affiliate thereof will
be subject to the restrictions that apply to transactions between banks that are
members of the Federal Reserve System and their affiliates pursuant to Sections
23A and 23B of the Federal Reserve Act. Generally, Sections 23A and 23B: (i)
limit the extent to which a financial institution or its subsidiaries may engage
in "covered transactions" with an "affiliate," to an amount equal to 10% of the
institution's capital and surplus, and limit all "covered transactions" in the
aggregate with all affiliates to an amount equal to 20% of such capital and
surplus; and (ii) require that all transactions with an affiliate, whether or
not "covered 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 types of transactions. Management believes
that the Bank is in compliance with the requirements of Sections 23A and 23B. In
addition to the restrictions that apply to financial institutions generally
under Sections 23A and 23B, Section 11 of the HOLA places three other
restrictions on savings associations, including those that are part of a holding
company organization. First, savings associations may not make any loan or
extension of credit to an affiliate unless that affiliate is engaged only in
activities permissible for bank holding companies. Second, savings associations
may not purchase or invest in affiliate securities except for those of a
subsidiary. Finally, the Director is granted authority to impose more stringent
restrictions when justifiable for reasons of safety and soundness.

     Extensions of credit by the Bank to executive officers, directors, and
principal stockholders and related interests of such persons are subject to
Sections 22 (g) and 22(h) of the Federal Reserve Act and Subpart A of the
Federal Reserve Board's Regulation O. These rules prohibit loans to any such
individual where the aggregate amount exceeds an amount equal to 15% of an
institution's unimpaired capital and surplus plus an additional 10% of
unimpaired capital and surplus in the case of loans that are fully secured by
readily marketable collateral, and/or when the aggregate amount outstanding to
all such individuals exceeds the institution's unimpaired capital and unimpaired
surplus. These rules also provide that no institution shall make any loan or
extension of credit in any manner to any of its executive officers or directors,
or to any person who directly or indirectly, or acting through or in concert
with one or more persons, owns, controls, or has the power to vote more than 10%
of any class of voting securities of such institution ("Principal Stockholder"),
or to a related interest (i.e., any company controlled by such executive
officer, director, or Principal Stockholder), or to any political or campaign
committee the funds or services of which will benefit such executive officer,
director, or Principal Stockholder or which is controlled by such executive
officer, director, or Principal Stockholder, unless such loan or extension of
credit is made on substantially the same terms, including interest rates and
collateral, as those prevailing at the time for comparable transactions with
other persons, does not involve more than the normal risk of repayment or
present other unfavorable features, and the institution follows underwriting
procedures that are not less stringent than those applicable to comparable
transactions by the institution with persons who are not executive officers,
directors, Principal Stockholders, or employees of the institution. A savings
association is therefore prohibited from making any new loans or extensions or
credit to the savings association's executive officers, directors, and 10%
stockholders at different rates or terms than those offered to employees of the
Bank generally. The rules identify limited circumstances in which an institution
is permitted to extend credit to executive officers. Management believes that
the Bank is in compliance with

                                       31
<PAGE>
 
Sections 22(g) and 22(h) of the Federal Reserve Act and Subpart A of the Federal
Reserve Board's Regulation O.

     The Federal Reserve System. Federal Reserve Board regulations require all
depository institutions to maintain non-interest earning reserves against their
transaction accounts (primarily NOW and Super NOW checking accounts) and
non-personal time deposits. Reserves of 3% must be maintained against total
transaction accounts of $54.0 million or less (after a $4.0 million exemption),
and an initial reserve of 10% (subject to adjustment by the Federal Reserve
Board to a level between 8% and 14%) must be maintained against that portion of
total transaction accounts in excess of such amount. At December 31, 1998, the
Bank was in compliance with these reserve requirements. The balances maintained
to meet the reserve requirements imposed by the Federal Reserve Board may be
used to satisfy liquidity requirements that may be imposed by the OTS. See
"--Federal Regulations--Liquidity Requirements."

     Savings associations are authorized to borrow from the Federal Reserve Bank
"discount window," but Federal Reserve Board regulations require savings
associations to exhaust other reasonable alternative sources of funds, including
FHLB advances, before borrowing from the Federal Reserve Bank.

Federal and State Taxation

     Federal Taxation. For federal income tax purposes, the Company files a
federal income tax return on a calendar year basis. Because the Mutual Holding
Company owns less than 80% of the outstanding common stock of the Bank, it is
not permitted to file a consolidated federal income tax return with the Bank.
Because the Mutual Holding Company has nominal assets other than the stock of
the Bank, it will initially have no material federal income tax liability.

     Under recently enacted legislation, the percentage of taxable income method
has been repealed for years beginning after December 31, 1995, and "large"
associations, i.e., the quarterly average of the association's total assets or
of the consolidated group of which it is a member, exceeds $500 million for the
year, may no longer be entitled to use the experience method of computing
additions to their bad debt reserve. A "large" association must use the direct
write-off method for deducting bad debts, under which charge-offs are deducted
and recoveries are taken into taxable income as incurred. If the Bank is not a
"large" association, the Bank will continue to be permitted to use the
experience method. The Bank will be required to recapture (i.e., take into
income) over a six-year period its applicable excess reserves, i.e, the balance
of its reserves for losses on qualifying loans and nonqualifying loans, as of
the close of the last tax year beginning before January 1, 1996, over the
greater of (a) the balance of such reserves as of December 31, 1987 (pre-1988
reserves) or (b) in the case of a bank which is not a "large" association, an
amount that would have been the balance of such reserves as of the close of the
last tax year beginning before January 1, 1996, had the Bank always computed the
additions to its reserves using the experience method. Postponement of the
recapture is possible for a two-year period if an association meets a minimum
level of mortgage lending for 1996 and 1997.

     If an association ceases to qualify as a "bank" (as defined in Code Section
581) or converts to a credit union, the pre-1988 reserves and the supplemental
reserve are restored to income ratably over a six-year period, beginning in the
tax year the association no longer qualifies as a bank. The balance of the
pre-1988 reserves are also subject to recapture in the case of certain excess
distributions to (including distributions on liquidation and dissolution), or
redemptions of, shareholders.

                                       32
<PAGE>
 
     Delaware Taxation. As a Delaware holding company doing business in another
state, the Company is exempted from Delaware corporate income tax but is
required to file an annual report with and pay an annual fee to the State of
Delaware. The Company is also subject to an annual franchise tax imposed by the
State of Delaware.

     Florida Taxation. Foreign corporations, like the Company, pay a 5 1/2% tax
on the portion of their net taxable income which is allocable to the State of
Florida.

     The Company has not been audited by the Internal Revenue Service, the State
of Delaware or the State of Florida within the past five years. See Notes 1 and
13 to the Financial Statements.

Executive Officers of the Registrant                                            

     Listed below is information, as of December 31, 1998, concerning the
Registrant's executive officers. There are no arrangements or understandings
between the Registrant and any of persons named below with respect to which he
or she was or is to be selected as an officer.

<TABLE>
<CAPTION>

         Name                      Age                               Position and Term                          
         ----                      ---             ------------------------------------------------------  
<S>                                 <C>           <C>                                   
Vince A. Elhilow                    59             President since 1987 and Chief Executive Officer since
                                                   1992; Director of the Bank since 1984

Richard D. Aldred                   54             Executive Vice President as of December 31, 1994;
                                                   Treasurer and Chief Financial Officer since 1985

Joseph C. Bova                      54             Executive Vice President as of December 31, 1994; Lending
                                                   Operations Manager

Robert L. Fugate                    50             Executive Vice President as of December 31, 1994; Banking
                                                   Operations Manager since 1982

Christopher H. Cook                 55             Executive Vice President as of December 31, 1996;
                                                   Corporate Counsel since 1996


Patricia C. Clager                  63             Vice President since 1990; Corporate Secretary since 1987;
                                                   Assistant to the Chairman of the Board
</TABLE>

                                       33
<PAGE>
 
ITEM 2. PROPERTIES

     The Bank conducts its business through its main office located in West Palm
Beach, Florida, and 20 additional full service branch offices located in Palm
Beach and Martin counties and two loan production offices located in Palm Beach
and Broward counties. The following table sets forth certain information
concerning the main office and each branch office of the Bank at December 31,
1998. The aggregate net book value of the Bank's premises and equipment was
$37.7 million at December 31, 1998.

<TABLE>
<CAPTION>

LOCATION                               OPENING DATE                    OWNERSHIP                       ANNUAL RENT
--------                               ------------                    ---------                       -----------
<S>                                       <C>                          <C>                              <C>
     
Main Office                               12/22/52                     Fee Simple/                      $  7,420
218 Datura St.                                                         Ground Lease
West Palm Beach, Florida

45th St.                                  10/23/60                     Fee Simple                             --
4520 45th St.
West Palm Beach, Florida

Northlake                                 11/15/65                     Fee Simple                              --
950 Northlake Blvd
Lake Park, Florida

Forest Hill                                4/05/71                     Fee Simple                              --
399 Forest Hill Blvd
West Palm Beach, Florida

Palm Beach                                 6/18/73                     Fee Simple                              --
245 Royal Poinciana
Palm Beach, Florida

Century Corners                            6/25/73                     Fee Simple                              --
4835 Okeechobee Blvd
West Palm Beach, Florida

Singer Island                              2/04/74                     Fee Simple                              --
1200 E. Blue Heron
Riviera Beach, Florida

Jupiter/Tequesta                           1/26/76                     Ground Lease                     $ 13,250
171 Tequesta Dr
Tequesta, Florida

Royal Palm Beach                           3/15/76                     Fee Simple                              --
100 Royal Palm Beach Blvd
Royal Palm Beach, Florida

Boynton Beach                             12/19/77                     Lease                            $136,872
1501 Corporate Dr
Boynton Beach, Florida


West Lake Worth                           12/03/79                     Fee Simple                              --
6535 Lake Worth Rd
Lake Worth, Florida

Wellington                                 6/02/80                     Fee Simple                              --
12000 W. Forest Hill Blvd
Wellington, Florida
</TABLE> 

                                       34
<PAGE>
 
<TABLE>
<CAPTION>

LOCATION                               OPENING DATE                    OWNERSHIP                       ANNUAL RENT
--------                               ------------                    ---------                       -----------
<S>                                       <C>                          <C>                              <C>    
Delray Beach                              10/20/80                     Ground Lease                     $ 69,121
5017 W. Atlantic Ave
Delray Beach, Florida

Jensen Beach                               9/14/81                     Fee Simple                              --
1021 NE Jensen Beach Blvd
Jensen Beach, Florida

Bear Lakes                                 5/15/89                     Lease                            $197,808
701 Village Blvd
West Palm Beach, Florida

Palm Beach Gardens                         5/20/91                     Lease                            $156,185
10973 N. Military Tr
Palm Beach Gardens, Florida

Kanner/Monterey                            7/06/93                     Fee Simple                              --
2401 S. Kanner Highway
Stuart, Florida

Stuart                                    12/13/93                     Fee Simple                              --
2980 South Federal Highway
Stuart, Florida

West Boynton Beach                         4/24/95                     Fee Simple                              --
9875 Jog Road
Boynton Beach, Florida

Boynton Beach Loan Production Office       1/02/96                     Lease                            $ 51,988
2240 Woolbright Road, Suite 350
Boynton Beach, Florida

West Forest Hill                           9/30/96                     Fee Simple                             --
3989 Forest Hill Blvd.
West Palm Beach, Florida

Coral Springs Loan Production Office       6/03/96                     Lease                            $ 14,357
4641 University Drive
Coral Springs, Florida

Jupiter
1240 W. Indiantown Road                    6/23/97                     Fee Simple                              --
Jupiter, Florida

Jupiter Farms
10058 Indiantown Road                      3/16/98                     Fee Simple                              --
Jupiter, Florida

Vero Beach Loan Production Office
1701 Highway AIA                           6/15/98                     Lease                            $  7,280
Vero Beach, Florida
</TABLE> 

     The Bank's accounting and record keeping activities are maintained on the
Fiserv Solutions, Inc. (Fiserv) service bureau system. The Bank also owns data
processing equipment it uses for its internal processing needs. The net book
value of such data processing equipment and related software at December 31,
1998, was approximately $2,527,000.

                                       35
<PAGE>
 
ITEM 3.  LEGAL PROCEEDINGS
--------------------------

     There are various claims and lawsuits in which the Bank is periodically
involved incident to the Bank's business. In the opinion of management, no
material loss is expected from any of such pending claims or lawsuits.

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

     No matters were submitted during the fourth quarter of the year ended
December 31, 1998 to a vote of securityholders.

                                    PART II

ITEM 5.  MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED
         STOCKHOLDER MATTERS                             
---------------------------------------------------------

     For information concerning the market for the Company's common stock, the
section captioned "Stockholder Information" in the Company's Annual Report to
Stockholders for the Year Ended December 31, 1998 (the "Annual Report to
Stockholders") is incorporated herein by reference.

ITEM 6.  SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
-------------------------------------------------------

     The "Selected Consolidated Financial and Other Data" section of the
Company's Annual Report to Stockholders is incorporated herein by reference.

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

     The "Management's Discussion and Analysis of Financial Condition and
Results of Operations" section of the Company's Annual Report to Stockholders is
incorporated herein by reference.

ITEM 8.  FINANCIAL STATEMENTS
-----------------------------

     The financial statements identified in Item 14(a)(1) hereof are
incorporated by reference hereunder.

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

     There were no changes in or disagreements with accountants in the Company's
accounting and financial disclosure during 1998.

                                       36
<PAGE>
 
                                   PART III

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

     Information concerning Directors of the Company is incorporated herein by
reference from the Company's definitive Proxy Statement dated March 19, 1999
(the "Proxy Statement"), specifically the section captioned "Proposal
I--Election of Directors." In addition, see Item 1. "Executive Officers of the
Registrant" for information concerning the Company's executive officers.

ITEM 11. EXECUTIVE COMPENSATION
-------------------------------

     Information concerning executive compensation is incorporated herein by
reference from the Registrant's Proxy Statement, specifically the sections
captioned "Proposal I--Election of Directors--Executive Compensation,"
"--Directors' Compensation," and "--Benefits."

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

     Information concerning security ownership of certain owners and management
is incorporated herein by reference from the Company's Proxy Statement.

ITEM 13. CERTAIN TRANSACTIONS
-----------------------------

     Information concerning relationships and transactions is incorporated
herein by reference from the Company's Proxy Statement.

                                     PART IV

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

         The exhibits and financial statement schedules filed as a part of this
         Form 10-K are as follows:

  (a)(1) Financial Statements
         --------------------
  
         .    Independent Auditors' Report

         .    Consolidated Statements of Financial Condition, 
                     December 31, 1997 and 1998

         .    Consolidated Statements of Operations,
                     Years Ended December 31, 1996, 1997 and 1998 
   
         .    Consolidated Statements of Changes in Stockholders' equity,
                     Years Ended December 31, 1996, 1997 and 1998 

         .    Consolidated Statements of Cash Flows,
                     Years Ended December 31, 1996, 1997 and 1998 

         .    Notes to Consolidated Financial Statements.

                                       37
<PAGE>
 
         (a)(2) Financial Statement Schedules
                -----------------------------

                No financial statement schedules are filed because the
                required information is not applicable or is included in the
                consolidated financial statements or related notes.

         (a)(3) Exhibits
                --------

                3.1  Certificate of Incorporation of Fidelity Bankshares, Inc.**
  
                3.2  Bylaws of Fidelity Bankshares, Inc.**

                4.1 Form of Indenture with respect to Fidelity Bankshares,
                    Inc.'s 8.375% Junior Subordinated Deferrable Interest*

                10.1 Employment Agreement with Vince A. Elhilow**

                10.2 Severance Agreement with Richard D. Aldred**

                10.3 Severance Agreement with Robert Fugate**

                10.4 Severance Agreement with Joseph Bova**

                10.5 1994 Stock Option Plan for Outside Directors**

                10.6 1994 Incentive Stock Option Plan**

                10.7 Recognition and Retention Plan for Employees**

                10.8 Recognition Plan for Outside Directors**

                13   1997 Annual Report to Stockholders

                21   Subsidiaries of the Registrant

                27   Financial Data Schedule

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

                *    Filed as exhibits to the Company's Registration Statement
                     on Form S-2 under the Securities Act of 1933, filed with
                     the SEC on December 15, 1997 (Registration No. 333-42227).

                **   Filed as exhibits to the Company's Registration Statement
                     on Form S-4 under the Securities Act of 1933, filed with
                     the Securities and Exchange Commission on December 12, 1996
                     (Registration No. 333-17737).

                ***  Filed with the Securities and Exchange Commission on May
                     13, 1997.

                                       38
<PAGE>
 
          **** Filed with the Securities and Exchange Commission on August 14,
               1997.

     (b)  Reports on Form 8-K:
          --------------------
  
          None

     (c)  The exhibits listed under (a)(3) above are filed herewith.

     (d)  Not applicable.

                                       39
<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.

                                FIDELITY BANKSHARES, INC.



Date: March 23, 1999            By:  /s/Vince A. Elhilow 
                                     -------------------------------------------
                                     Vince A. Elhilow
                                     President and Chief Executive Officer

     Pursuant to the requirements of the Securities Exchange 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.


<TABLE>
<CAPTION> 

<S>                                                     <C> 
By: /s/Vince A. Elhilow                                 By: /s/Richard D. Aldred 
    -------------------------------------------------       ----------------------------------------------------
    Vince A. Elhilow, President and Chief                   Richard D. Aldred, Executive Vice President, Chief
      Executive Officer                                       Financial Officer and Treasurer
    (Principal Executive Officer)                           (Principal Financial and Accounting Officer)

Date: March 23, 1999                                    Date: March 23, 1999



By: /s/Joseph B. Shearouse, Jr.                         By: /s/Keith D. Beaty 
    -------------------------------------------------       ----------------------------------------------------
    Joseph B. Shearouse, Jr., Chairman of the Board         Keith D. Beaty, Director

Date: March 23, 1999                                    Date: March 23, 1999


By: /s/F. Ted Brown, Jr.                                By: /s/Donald E. Warren 
    -------------------------------------------------       ----------------------------------------------------
     F. Ted Brown, Jr., Director                             Donald E. Warren, Director

Date: March 23, 1999                                    Date: March 23, 1999
</TABLE>

                                       40