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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington D.C. 20549



FORM 10-QSB



QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934



For the quarterly period ended December 31, 2004



Commission File No: 0-24479



AF Financial Group

(Exact name of
small business issuer as specified in its charter)



|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Federally Chartered                                            |  | 56-2098545                          
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)



21 East Ashe Street

West Jefferson, North Carolina 28694

(Address of principal executive offices)



(336) 246-4344

(Issuers telephone number)



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



As of January 31, 2005 there were 1,049,835 shares of the registrants common stock outstanding, $.01 par value.



Transitional Small Business Disclosure Format: Yes ̈No x



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##### Table of Contents



AF FINANCIAL GROUP



CONTENTS



|                                                                                                                                               |  |      
|---------------------------------------------------------------------------------------------------------------------------------------------- |  | -----
|                                                                                                                                               |  | Pages
|PART I - FINANCIAL INFORMATION                                                                                                                 |  |      
|                                                                                                                                               | 
|Item 1. Financial Statements                                                                                                                   |  |      
|                                                                                                                                               | 
|Condensed Consolidated Statements of Financial Condition as of December 31, 2004 (unaudited) and June 30, 2004                                 |  | 1    
|                                                                                                                                               | 
|Condensed Consolidated Statements of Income and Comprehensive Income (unaudited) for the Three and Six Months ended December 31, 2004 and 2003 |  | 2    
|                                                                                                                                               | 
|Condensed Consolidated Statements of Cash Flows (unaudited) for the Six Months ended December 31, 2004 and 2003                                |  | 3    
|                                                                                                                                               | 
|Notes to Condensed Consolidated Financial Statements                                                                                           |  | 4  7
|                                                                                                                                               | 
|Item 2. Managements Discussion and Analysis                                                                                                   |  | 8 16
|Item 3. Controls and Procedures                                                                                                                |  | 16   
|                                                                                                                                               | 
|PART II  OTHER INFORMATION                                                                                                                    |  |      
|                                                                                                                                               | 
|Item 1. Legal Proceedings                                                                                                                      |  | 17   
|Item 2. Unregistered Sales of Equity Securities and Use of Proceeds                                                                            |  | 17   
|Item 3. Defaults Upon Senior Securities                                                                                                        |  | 17   
|Item 4. Submission of Matters to a Vote of Security Holders                                                                                    |  | 17   
|Item 5. Other Information                                                                                                                      |  | 18   
|Item 6. Exhibits                                                                                                                               |  | 18-19
|Signatures                                                                                                                                     |  | 20   





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##### Table of Contents



AF FINANCIAL GROUP AND SUBSIDIARIES



CONDENSED
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

As of December 31, 2004 and June 30, 2004



|                                                                                                                                                              |  |                  |             |   |              |   |             |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---------------- | ----------- | - | ------------ | - | ----------- | -
|                                                                                                                                                              |  | December 31,2004 |             |   | June 30,2004 |  
|                                                                                                                                                              |  | (Unaudited)      |             |   | (*)          |  
|ASSETS                                                                                                                                                        |  |                  |             |   |              |   |             |  
|Cash and cash equivalents:                                                                                                                                    |  |                  |             |   |              |   |             |  
|Interest-bearing deposits                                                                                                                                     |  | $                | 3,496,372   |   |              | $ | 2,498,878   |  
|Noninterest-bearing deposits                                                                                                                                  |  |                  | 7,274,763   |   |              |   | 5,175,174   |  
|Securities held to maturity                                                                                                                                   |  |                  | 334,000     |   |              |   | 529,000     |  
|Securities available for sale                                                                                                                                 |  |                  | 4,195,567   |   |              |   | 4,315,066   |  
|Federal Home Loan Bank stock                                                                                                                                  |  |                  | 2,051,000   |   |              |   | 1,657,200   |  
|Loans                                                                                                                                                         |  |                  | 187,809,840 |   |              |   | 182,734,177 |  
|Less allowance for loan losses                                                                                                                                |  |                  | (1,307,954  | ) |              |   | (1,245,018  | )
|Loans receivable, net                                                                                                                                         |  |                  | 186,501,886 |   |              |   | 181,489,159 |  
|                                                                                                                                                              |  |                  |             |   |              |   |             |  
|Real estate owned                                                                                                                                             |  |                  | 250,000     |   |              |   |            |  
|Office properties and equipment, net                                                                                                                          |  |                  | 13,103,902  |   |              |   | 11,515,179  |  
|Accrued interest receivable on loans                                                                                                                          |  |                  | 922,230     |   |              |   | 855,408     |  
|Accrued interest receivable on investment securities                                                                                                          |  |                  | 33,662      |   |              |   | 66,402      |  
|Prepaid expenses and other assets                                                                                                                             |  |                  | 1,585,655   |   |              |   | 1,560,688   |  
|Deferred income taxes, net                                                                                                                                    |  |                  | 258,940     |   |              |   | 280,577     |  
|Goodwill                                                                                                                                                      |  |                  | 1,648,468   |   |              |   | 1,676,446   |  
|                                                                                                                                                              |  |                  |             |   |              |   |             |  
|Total assets                                                                                                                                                  |  | $                | 221,656,445 |   |              | $ | 211,619,177 |  
|                                                                                                                                                              |  |                  |             |   |              |   |             |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                          |  |                  |             |   |              |   |             |  
|Liabilities:                                                                                                                                                  |  |                  |             |   |              |   |             |  
|Savings deposits                                                                                                                                              |  | $                | 162,971,183 |   |              | $ | 157,433,544 |  
|Short-term borrowings                                                                                                                                         |  |                  | 9,559,085   |   |              |   | 5,150,000   |  
|Long-term borrowings                                                                                                                                          |  |                  | 34,068,152  |   |              |   | 34,261,980  |  
|Accounts payable and other liabilities                                                                                                                        |  |                  | 1,690,043   |   |              |   | 1,764,907   |  
|Redeemable common stock held by the ESOP, net of unearned ESOP shares                                                                                         |  |                  | 658,631     |   |              |   | 534,750     |  
|                                                                                                                                                              |  |                  |             |   |              |   |             |  
|Total liabilities                                                                                                                                             |  |                  | 208,947,094 |   |              |   | 199,145,181 |  
|                                                                                                                                                              |  |                  |             |   |              |   |             |  
|Commitments and Contingencies                                                                                                                                 |  |                  |             |   |              |   |             |  
|                                                                                                                                                              |  |                 
|Stockholders Equity:                                                                                                                                         |  |                  |             |   |              |   |             |  
|Common stock, par value $.01 per share; authorized 5,000,000 shares; 1,053,675 issued and 1,049,835 outstanding shares at December 31, 2004
and June 30, 2004 |  |                  | 10,537      |   |              |   | 10,537      |  
|Additional paid-in capital                                                                                                                                    |  |                  | 4,671,305   |   |              |   | 4,653,933   |  
|Retained earnings, substantially restricted                                                                                                                   |  |                  | 8,058,319   |   |              |   | 7,874,017   |  
|Accumulated other comprehensive income                                                                                                                        |  |                  | 44,070      |   |              |   | 10,389      |  
|                                                                                                                                                              |  |                  |             |   |              |   |             |  
|                                                                                                                                                              |  |                  | 12,784,231  |   |              |   | 12,548,876  |  
|Less the cost of 3,840 shares of treasury stock                                                                                                               |  |                  | (74,880     | ) |              |   | (74,880     | )
|                                                                                                                                                              |  |                  |             |   |              |   |             |  
|Total stockholders equity                                                                                                                                    |  |                  | 12,709,351  |   |              |   | 12,473,996  |  
|                                                                                                                                                              |  |                  |             |   |              |   |             |  
|Total liabilities and stockholders equity                                                                                                                    |  | $                | 221,656,445 |   |              | $ | 211,619,177 |  
|                                                                                                                                                              |  |                  |             |   |              |   |             |  



See
Notes to Condensed Consolidated Financial Statements.



|* | The Condensed Consolidated Statement of Financial Condition as of June 30, 2004 has been derived from audited consolidated financial statements.
|- | ------------------------------------------------------------------------------------------------------------------------------------------------



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AF FINANCIAL GROUP AND SUBSIDIARIES



CONDENSED
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (UNAUDITED)

For the Three and Six Months Ended December 31, 2004 and 2003



|                                                    |  |                                |           |   |                              |   |           |      |  |   |           |   |  |   |           |  
|--------------------------------------------------- |  | ------------------------------ | --------- | - | ---------------------------- | - | --------- | ---- |  | - | --------- | - |  | - | --------- | -
|                                                    |  | Three Months EndedDecember 31, |           |   | Six Months EndedDecember 31, |  
|                                                    |  | 2004                           |           |   | 2003                         |   |           | 2004 |  |   | 2003      |  
|Interest and dividend income:                       |  |                                |           |   |                              |   |           |      |  |   |           |   |  |   |           |  
|Loans                                               |  | $                              | 2,928,697 |   |                              | $ | 2,547,386 |      |  | $ | 5,751,438 |   |  | $ | 5,157,418 |  
|Investment securities                               |  |                                | 49,750    |   |                              |   | 62,520    |      |  |   | 105,040   |   |  |   | 117,808   |  
|Interest-bearing deposits                           |  |                                | 16,230    |   |                              |   | 13,881    |      |  |   | 22,704    |   |  |   | 32,372    |  
|                                                    |  |                                |           |   |                              |   |           |      |  |   |           |   |  |   |           |  
|Total interest income                               |  |                                | 2,994,677 |   |                              |   | 2,623,787 |      |  |   | 5,879,182 |   |  |   | 5,307,598 |  
|                                                    |  |                                |           |   |                              |   |           |      |  |   |           |   |  |   |           |  
|Interest expense:                                   |  |                                |           |   |                              |   |           |      |  |   |           |   |  |   |           |  
|Savings deposits                                    |  |                                | 670,958   |   |                              |   | 683,366   |      |  |   | 1,318,478 |   |  |   | 1,416,177 |  
|Short-term borrowings                               |  |                                | 57,538    |   |                              |   | 613       |      |  |   | 83,880    |   |  |   | 613       |  
|Long-term borrowings                                |  |                                | 441,845   |   |                              |   | 449,971   |      |  |   | 882,007   |   |  |   | 862,138   |  
|                                                    |  |                                |           |   |                              |   |           |      |  |   |           |   |  |   |           |  
|Total interest expense                              |  |                                | 1,170,341 |   |                              |   | 1,133,950 |      |  |   | 2,284,365 |   |  |   | 2,278,928 |  
|                                                    |  |                                |           |   |                              |   |           |      |  |   |           |   |  |   |           |  
|Net interest income                                 |  |                                | 1,824,336 |   |                              |   | 1,489,837 |      |  |   | 3,594,817 |   |  |   | 3,028,670 |  
|Provision for loan losses                           |  |                                | (293,922  | ) |                              |   | 500,000   |      |  |   | (213,922  | ) |  |   | 544,000   |  
|                                                    |  |                                |           |   |                              |   |           |      |  |   |           |   |  |   |           |  
|Net interest income after provision for loan losses |  |                                | 2,118,258 |   |                              |   | 989,837   |      |  |   | 3,808,739 |   |  |   | 2,484,670 |  
|                                                    |  |                                |           |   |                              |   |           |      |  |   |           |   |  |   |           |  
|Noninterest income:                                 |  |                                |           |   |                              |   |           |      |  |   |           |   |  |   |           |  
|Insurance commissions                               |  |                                | 572,092   |   |                              |   | 571,968   |      |  |   | 1,248,554 |   |  |   | 1,185,473 |  
|Other                                               |  |                                | 385,372   |   |                              |   | 282,789   |      |  |   | 723,677   |   |  |   | 674,292   |  
|                                                    |  |                                |           |   |                              |   |           |      |  |   |           |   |  |   |           |  
|                                                    |  |                                | 957,464   |   |                              |   | 854,757   |      |  |   | 1,972,231 |   |  |   | 1,859,765 |  
|                                                    |  |                                |           |   |                              |   |           |      |  |   |           |   |  |   |           |  
|Noninterest expense:                                |  |                                |           |   |                              |   |           |      |  |   |           |   |  |   |           |  
|Compensation and employee benefits                  |  |                                | 1,466,282 |   |                              |   | 1,379,129 |      |  |   | 2,849,637 |   |  |   | 2,745,207 |  
|Occupancy and equipment                             |  |                                | 358,780   |   |                              |   | 312,894   |      |  |   | 670,608   |   |  |   | 617,073   |  
|Computer processing charges                         |  |                                | 169,778   |   |                              |   | 153,703   |      |  |   | 336,221   |   |  |   | 296,506   |  
|Other                                               |  |                                | 754,252   |   |                              |   | 631,041   |      |  |   | 1,307,391 |   |  |   | 1,237,801 |  
|                                                    |  |                                |           |   |                              |   |           |      |  |   |           |   |  |   |           |  
|                                                    |  |                                | 2,749,092 |   |                              |   | 2,476,767 |      |  |   | 5,163,857 |   |  |   | 4,896,587 |  
|                                                    |  |                                |           |   |                              |   |           |      |  |   |           |   |  |   |           |  
|Income (loss) before income taxes                   |  |                                | 326,630   |   |                              |   | (632,173  | )    |  |   | 617,113   |   |  |   | (552,152  | )
|Income taxes                                        |  |                                | 144,742   |   |                              |   | (225,392  | )    |  |   | 275,902   |   |  |   | (177,580  | )
|                                                    |  |                                |           |   |                              |   |           |      |  |   |           |   |  |   |           |  
|Net income (loss)                                   |  |                                | 181,888   |   |                              |   | (406,781  | )    |  |   | 341,211   |   |  |   | (374,572  | )
|                                                    |  |                                |           |   |                              |   |           |      |  |   |           |   |  |   |           |  
|Other comprehensive income (loss), net of tax:      |  |                                |           |   |                              |   |           |      |  |   |           |   |  |   |           |  
|Unrealized gain (loss) on securities, net of tax    |  |                                | 5,464     |   |                              |   | (4,426    | )    |  |   | 33,681    |   |  |   | (17,156   | )
|                                                    |  |                                |           |   |                              |   |           |      |  |   |           |   |  |   |           |  
|Comprehensive income (loss)                         |  | $                              | 187,352   |   |                              | $ | (411,207  | )    |  | $ | 374,892   |   |  | $ | (391,728  | )
|                                                    |  |                                |           |   |                              |   |           |      |  |   |           |   |  |   |           |  
|Basic Earnings (loss) per share of common stock     |  | $                              | 0.17      |   |                              | $ | (0.39     | )    |  | $ | 0.33      |   |  | $ | (0.36     | )
|                                                    |  |                                |           |   |                              |   |           |      |  |   |           |   |  |   |           |  
|Diluted Earnings (loss) per share of common stock   |  | $                              | 0.17      |   |                              | $ | (0.39     | )    |  | $ | 0.33      |   |  | $ | (0.36     | )
|                                                    |  |                                |           |   |                              |   |           |      |  |   |           |   |  |   |           |  
|Basic weighted average shares outstanding           |  |                                | 1,044,336 |   |                              |   | 1,040,636 |      |  |   | 1,043,872 |   |  |   | 1,040,172 |  
|                                                    |  |                                |           |   |                              |   |           |      |  |   |           |   |  |   |           |  
|Diluted weighted average shares outstanding         |  |                                | 1,045,886 |   |                              |   | 1,040,636 |      |  |   | 1,044,769 |   |  |   | 1,040,172 |  
|                                                    |  |                                |           |   |                              |   |           |      |  |   |           |   |  |   |           |  
|Cash dividends declared per share                   |  | $                              | 0.05      |   |                              | $ | 0.05      |      |  | $ | 0.10      |   |  | $ | 0.10      |  
|                                                    |  |                                |           |   |                              |   |           |      |  |   |           |   |  |   |           |  



See
Notes to Condensed Consolidated Financial Statements.



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AF FINANCIAL GROUP AND SUBSIDIARIES



CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

For the Six Months Ended December 31, 2004 and 2003



|                                                                                  |  |                               |            |   |      |   |            |  
|--------------------------------------------------------------------------------- |  | ----------------------------- | ---------- | - | ---- | - | ---------- | -
|                                                                                  |  | Six Months Ended December 31, |           
|                                                                                  |  | 2004                          |            |   | 2003 |  
|Cash Flows from Operating Activities                                              |  |                               |            |   |      |   |            |  
|Net income (loss)                                                                 |  | $                             | 341,211    |   |      | $ | (374,572   | )
|Adjustments to reconcile net income (loss) to net cash                            |  |                               |            |   |      |   |            |  
|provided by operating activities:                                                 |  |                               |            |   |      |   |            |  
|Provision for loan losses                                                         |  |                               | (213,922   | ) |      |   | 544,000    |  
|Depreciation                                                                      |  |                               | 437,922    |   |      |   | 430,876    |  
|ESOP Expense                                                                      |  |                               | 35,890     |   |      |   | 37,296     |  
|Change in operating assets and liabilities:                                       |  |                               |            |   |      |   |            |  
|Accrued interest receivable                                                       |  |                               | (34,082    | ) |      |   | 30,529     |  
|Accrued interest payable                                                          |  |                               | (109,227   | ) |      |   | (34,485    | )
|Prepaid expense and other assets                                                  |  |                               | 353,994    |   |      |   | 159,489    |  
|Accounts payable and other liabilities                                            |  |                               | (86,387    | ) |      |   | (354,385   | )
|                                                                                  |  |                               |            |   |      |   |            |  
|Net cash provided by operating activities                                         |  |                               | 725,399    |   |      |   | 438,748    |  
|                                                                                  |  |                               |            |   |      |   |            |  
|Cash Flows from Investing Activities                                              |  |                               |            |   |      |   |            |  
|Increase in Federal Home Loan Bank stock                                          |  |                               | (393,800   | ) |      |   |           |  
|Purchases of investments held to maturity                                         |  |                               | (285,000   | ) |      |   | (95,000    | )
|Proceeds from maturities of investments held to maturity                          |  |                               | 480,000    |   |      |   |           |  
|Purchases of securities available for sale                                        |  |                               | (1,900,000 | ) |      |   | (2,000,000 | )
|Proceeds from principal repayment and maturities of securities available for sale |  |                               | 2,065,037  |   |      |   | 3,689,260  |  
|Net originations of loans receivable                                              |  |                               | (5,278,617 | ) |      |   | (6,996,292 | )
|Recovery (investment) in insurance agency assets                                  |  |                               | 27,978     |   |      |   | (80,000    | )
|Purchases of office properties and equipment                                      |  |                               | (2,091,014 | ) |      |   | (1,779,329 | )
|Proceeds from sale of real estate owned                                           |  |                               | 80,000     |   |      |   | 22,145     |  
|                                                                                  |  |                               |            |   |      |   |            |  
|Net cash used in investing activities                                             |  |                               | (7,295,416 | ) |      |   | (7,239,216 | )
|                                                                                  |  |                               |            |   |      |   |            |  
|Cash Flows from Financing Activities                                              |  |                               |            |   |      |   |            |  
|Net increase in savings deposits                                                  |  |                               | 5,658,389  |   |      |   | 794,198    |  
|Short-term borrowings, net                                                        |  |                               | 4,409,085  |   |      |   |           |  
|Long-term borrowings, net                                                         |  |                               | (348,828   | ) |      |   | (46,236    | )
|Dividends paid                                                                    |  |                               | (51,546    | ) |      |   | (48,800    | )
|                                                                                  |  |                               |            |   |      |   |            |  
|Net cash provided by financing activities                                         |  |                               | 9,667,100  |   |      |   | 699,162    |  
|                                                                                  |  |                               |            |   |      |   |            |  
|Net increase (decrease) in cash and cash equivalents                              |  |                               | 3,097,083  |   |      |   | (6,101,306 | )
|Cash and cash equivalents:                                                        |  |                               |            |   |      |   |            |  
|Beginning                                                                         |  |                               | 7,674,052  |   |      |   | 14,072,018 |  
|                                                                                  |  |                               |            |   |      |   |            |  
|Ending                                                                            |  | $                             | 10,771,135 |   |      | $ | 7,970,712  |  
|                                                                                  |  |                               |            |   |      |   |            |  



See Notes to Condensed
Consolidated Financial Statements.



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AF FINANCIAL GROUP



NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS



Note 1. Nature of Business



AF Financial Group (the Company) is a federally chartered
stock holding company for AF Bank (the Bank), AF Insurance Services, Inc. (an independent insurance agency) and AF Brokerage, Inc. (a registered broker/dealer, member NASD and SIPC). AF Bank conducts business from its main office located
in West Jefferson, North Carolina, with branches in Boone, Jefferson, Sparta, Warrensville, and West Jefferson, North Carolina. Headquartered in West Jefferson, North Carolina, AF Insurance Services, Inc., has branches in Boone, Elkin, Jefferson,
Lenoir, Sparta, West Jefferson, and North Wilkesboro, North Carolina. AF Brokerage, Inc. serves Ashe, Alleghany, Wilkes and Watauga counties in North Carolina.



Note 2. Basis of Presentation



The accompanying unaudited condensed consolidated financial statements (except for the condensed consolidated statement of financial condition at June 30, 2004, which is
derived from audited consolidated financial statements) have been prepared in accordance with accounting principles generally accepted in the United States (US GAAP) for interim financial information and with the instructions to Form
10-QSB of Regulation S-B. Accordingly, they do not include all of the information and footnotes required by US GAAP for complete financial statements. In the opinion of management, all adjustments (none of which were other than normal recurring
accruals) necessary for a fair presentation of the financial position and results of operations for the periods presented have been included. The results of operations for the three and six month periods ended December 31, 2004 are not necessarily
indicative of the results of operations that may be expected for the Companys fiscal year ending June 30, 2005.



Certain amounts in the three and six month periods ended December 31, 2003 financial statements have been reclassified to conform to the three and six month periods ended
December 31, 2004 presentation. The reclassifications had no effect on net income (loss) or stockholders equity as previously reported.



The accounting policies which follow are as set forth in Note 1 of the Notes to Consolidated Financial Statements in the Companys 2004 audited consolidated
financial statements, which are included in the Companys Annual Report on Form 10-KSB for the year ended June 30, 2004. This quarterly report should be read in conjunction with such annual report.



Note 3. Earnings Per Share



Basic earnings per share amounts are based on the weighted average shares of common stock
outstanding. Diluted earnings per share assumes the exercise or issuance of all potential common stock instruments such as options, unless the effect is antidilutive (to reduce a loss or increase earnings per share). Shares owned by the
Companys ESOP that have not been committed to be released are not considered to be outstanding for the purposes of computing earnings per share. Earnings per share have been calculated in accordance with Statement of Position 93-6
Employers Accounting for Employee Stock Ownership Plans and Statement of Financial Accounting Standards Number 128.



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Earnings per share have been computed using the weighted average number of shares of common stock and potentially
dilutive common stock equivalents outstanding as follows:



|                                                                                            |  |                                |  |                              |  |           |  |          
|------------------------------------------------------------------------------------------- |  | ------------------------------ |  | ---------------------------- |  | --------- |  | ---------
|                                                                                            |  | Three Months EndedDecember 31, |  | Six Months EndedDecember 31,
|                                                                                            |  | 2004                           |  | 2003                         |  | 2004      |  | 2003     
|Weighted average shares outstanding                                                         |  | 1,044,336                      |  | 1,040,636                    |  | 1,043,872 |  | 1,040,172
|Potentially Dilutive effect of stock options                                                |  | 1,550                          |  |                             |  | 897       |  |         
|                                                                                            |  |                                |  |                              |  |           |  |          
|Weighted average shares outstanding, including potentially dilutive effect of stock options |  | 1,045,886                      |  | 1,040,636                    |  | 1,044,769 |  | 1,040,172
|                                                                                            |  |                                |  |                              |  |           |  |          



Note 4. Capital Securities



On December 31, 2004, the Company adopted FIN 46R which resulted in the
deconsolidation of the Companys trust preferred subsidiary, AF Capital Trust I (the Trust). Upon deconsolidation, the junior subordinated debentures issued by the Company to the trust were included in borrowings (instead of trust
preferred securities) and the Companys equity interests in the trust were included in other assets. As a result, other assets and borrowings increased by $155,000. Except for accounting treatment, the relationship between the Company and the
Trust has not changed. AF Capital Trust I continues to be a wholly owned trust preferred subsidiary of the Company and the full and unconditional guarantee of the Company for the repayment of the trust preferred securities remains in effect.



Note 5. Dividends Declared



On December 17, 2004, the Board of Directors of the Company declared a dividend of $0.05 a
share for stockholders of record as of December 27, 2004 and payable on January 7, 2005. The dividends declared were accrued and reported in accounts payable and other liabilities in the December 31, 2004 Consolidated Statement of Financial
Condition. AsheCo, MHC, the mutual holding company, waived the receipt of dividends declared by the Company.



Note 6. Income Taxes



Income taxes
resulted from applying normal, expected tax rates on income earned and on losses during the three and six months ended December 31, 2004 and 2003. The income tax expense was $144,742 for the three months ended December 31, 2004 compared to the
income tax credit of $225,392 for the three months ended December 31, 2003. The income tax expense was $275,902 for the six months ended December 31, 2004 compared to the income tax credit of $177,580 for the six months ended December 31, 2003. The
effective tax rate was higher than statutory tax rates, resulting primarily from the fact that North Carolina corporations may not file consolidated income tax returns. This had the effect of taxing all income in a particular member of a
consolidated group without permitting an offsetting benefit for losses incurred in another member of the same group, creating a higher than expected overall state income tax expense.



Note 7. Segment Reporting



The Company has additional reportable segments, AF Bank, AF Insurance Services, Inc. and AF
Brokerage, Inc. AF Bank is a federally chartered stock savings bank. The principal activities of the Bank consist of obtaining savings deposits and providing credit to customers in its primary



5



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##### Table of Contents

market area. AF Insurance Services, Inc. and AF Brokerage, Inc. provide insurance and noninsured investment services respectively. Information about
reportable segments and reconciliation of such information to the condensed consolidated financial statements as of the three and six month periods ended December 31, 2004 and 2003 is as follows (dollars in thousands):



|                                     |  |                  |      |   |         |   |         |                           |  |   |                 |   |  |                          |     |   |                    |   |      |   |  |   |         |  
|------------------------------------ |  | ---------------- | ---- | - | ------- | - | ------- | ------------------------- |  | - | --------------- | - |  | ------------------------ | --- | - | ------------------ | - | ---- | - |  | - | ------- | -
|                                     |  | AFFinancialGroup |      |   | AF Bank |   |         | AFInsuranceServices, Inc. |  |   | AFBrokerageInc. |   |  | Inter-segmentElimination |     |   | ConsolidatedTotals |  
|Three Months Ended December 31, 2004 |  |                  |      |   |         |   |         |                           |  |   |                 |   |  |                          |     |   |                    |   |      |   |  |   |         |  
|Interest income                      |  | $                |     |   |         | $ | 2,996   |                           |  | $ |                |   |  | $                        |    |   |                    | $ | (2   | ) |  | $ | 2,994   |  
|Interest expense                     |  |                  | 132  |   |         |   | 1,024   |                           |  |   | 16              |   |  |                          |    |   |                    |   | (2   | ) |  |   | 1,170   |  
|                                     |  |                  |      |   |         |   |         |                           |  |   |                 |   |  |                          |     |   |                    |   |      |   |  |   |         |  
|Net interest income                  |  |                  | (132 | ) |         |   | 1,972   |                           |  |   | (16             | ) |  |                          |    |   |                    |   |     |   |  |   | 1,824   |  
|Provision for loan losses            |  |                  |     |   |         |   | (294    | )                         |  |   |                |   |  |                          |    |   |                    |   |     |   |  |   | (294    | )
|                                     |  |                  |      |   |         |   |         |                           |  |   |                 |   |  |                          |     |   |                    |   |      |   |  |   |         |  
|Net interest income after provision  |  |                  | (132 | ) |         |   | 2,266   |                           |  |   | (16             | ) |  |                          |    |   |                    |   |     |   |  |   | 2,118   |  
|Non-interest income                  |  |                  |     |   |         |   | 371     |                           |  |   | 585             |   |  |                          | 87  |   |                    |   | (85  | ) |  |   | 958     |  
|Non-interest expense                 |  |                  | 93   |   |         |   | 2,030   |                           |  |   | 608             |   |  |                          | 103 |   |                    |   | (85  | ) |  |   | 2,749   |  
|                                     |  |                  |      |   |         |   |         |                           |  |   |                 |   |  |                          |     |   |                    |   |      |   |  |   |         |  
|Income (loss) before income taxes    |  |                  | (225 | ) |         |   | 607     |                           |  |   | (39             | ) |  |                          | (16 | ) |                    |   |     |   |  |   | 327     |  
|Income taxes                         |  |                  | (72  | ) |         |   | 237     |                           |  |   | (15             | ) |  |                          | (5  | ) |                    |   |     |   |  |   | 145     |  
|                                     |  |                  |      |   |         |   |         |                           |  |   |                 |   |  |                          |     |   |                    |   |      |   |  |   |         |  
|Net income (loss)                    |  | $                | (153 | ) |         | $ | 370     |                           |  | $ | (24             | ) |  | $                        | (11 | ) |                    | $ |     |   |  | $ | 182     |  
|                                     |  |                  |      |   |         |   |         |                           |  |   |                 |   |  |                          |     |   |                    |   |      |   |  |   |         |  
|Assets                               |  | $                | 346  |   |         | $ | 219,184 |                           |  | $ | 2,254           |   |  | $                        | 200 |   |                    | $ | (328 | ) |  | $ | 221,656 |  
|                                     |  |                  |      |   |         |   |         |                           |  |   |                 |   |  |                          |     |   |                    |   |      |   |  |   |         |  



|                                     |  |                  |      |   |         |   |         |                           |  |   |                 |   |  |                          |     |   |                    |   |      |   |  |   |         |  
|------------------------------------ |  | ---------------- | ---- | - | ------- | - | ------- | ------------------------- |  | - | --------------- | - |  | ------------------------ | --- | - | ------------------ | - | ---- | - |  | - | ------- | -
|                                     |  | AFFinancialGroup |      |   | AF Bank |   |         | AFInsuranceServices, Inc. |  |   | AFBrokerageInc. |   |  | Inter-segmentElimination |     |   | ConsolidatedTotals |  
|Three Months Ended December 31, 2003 |  |                  |      |   |         |   |         |                           |  |   |                 |   |  |                          |     |   |                    |   |      |   |  |   |         |  
|Interest income                      |  | $                |     |   |         | $ | 2,626   |                           |  | $ |                |   |  | $                        |    |   |                    | $ | (2   | ) |  | $ | 2,624   |  
|Interest expense                     |  |                  | 129  |   |         |   | 990     |                           |  |   | 17              |   |  |                          |    |   |                    |   | (2   | ) |  |   | 1,134   |  
|                                     |  |                  |      |   |         |   |         |                           |  |   |                 |   |  |                          |     |   |                    |   |      |   |  |   |         |  
|Net interest income                  |  |                  | (129 | ) |         |   | 1,636   |                           |  |   | (17             | ) |  |                          |    |   |                    |   |     |   |  |   | 1,490   |  
|Provision for loan losses            |  |                  |     |   |         |   | 500     |                           |  |   |                |   |  |                          |    |   |                    |   |     |   |  |   | 500     |  
|                                     |  |                  |      |   |         |   |         |                           |  |   |                 |   |  |                          |     |   |                    |   |      |   |  |   |         |  
|Net interest income after provision  |  |                  | (129 | ) |         |   | 1,136   |                           |  |   | (17             | ) |  |                          |    |   |                    |   |     |   |  |   | 990     |  
|Non-interest income                  |  |                  |     |   |         |   | 297     |                           |  |   | 583             |   |  |                          | 50  |   |                    |   | (75  | ) |  |   | 855     |  
|Non-interest expense                 |  |                  | 123  |   |         |   | 1,779   |                           |  |   | 565             |   |  |                          | 85  |   |                    |   | (75  | ) |  |   | 2,477   |  
|                                     |  |                  |      |   |         |   |         |                           |  |   |                 |   |  |                          |     |   |                    |   |      |   |  |   |         |  
|Income (loss) before income taxes    |  |                  | (252 | ) |         |   | (346    | )                         |  |   | 1               |   |  |                          | (35 | ) |                    |   |     |   |  |   | (632    | )
|Income taxes                         |  |                  | (81  | ) |         |   | (135    | )                         |  |   | 1               |   |  |                          | (10 | ) |                    |   |     |   |  |   | (225    | )
|                                     |  |                  |      |   |         |   |         |                           |  |   |                 |   |  |                          |     |   |                    |   |      |   |  |   |         |  
|Net income (loss)                    |  | $                | (171 | ) |         | $ | (211    | )                         |  | $ |                |   |  | $                        | (25 | ) |                    | $ |     |   |  | $ | (407    | )
|                                     |  |                  |      |   |         |   |         |                           |  |   |                 |   |  |                          |     |   |                    |   |      |   |  |   |         |  
|Assets                               |  | $                | 320  |   |         | $ | 189,338 |                           |  | $ | 2,412           |   |  | $                        | 294 |   |                    | $ | (435 | ) |  | $ | 191,929 |  
|                                     |  |                  |      |   |         |   |         |                           |  |   |                 |   |  |                          |     |   |                    |   |      |   |  |   |         |  



6



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##### Table of Contents

|                                    |  |                  |      |   |         |   |         |                           |  |   |                 |   |  |                          |     |   |                    |   |      |   |  |   |         |  
|----------------------------------- |  | ---------------- | ---- | - | ------- | - | ------- | ------------------------- |  | - | --------------- | - |  | ------------------------ | --- | - | ------------------ | - | ---- | - |  | - | ------- | -
|                                    |  | AFFinancialGroup |      |   | AF Bank |   |         | AFInsuranceServices, Inc. |  |   | AFBrokerageInc. |   |  | Inter-segmentElimination |     |   | ConsolidatedTotals |  
|Six Months Ended December 31, 2004  |  |                  |      |   |         |   |         |                           |  |   |                 |   |  |                          |     |   |                    |   |      |   |  |   |         |  
|Interest income                     |  | $                |     |   |         | $ | 5,882   |                           |  | $ |                |   |  | $                        |    |   |                    | $ | (3   | ) |  | $ | 5,879   |  
|Interest expense                    |  |                  | 263  |   |         |   | 1,994   |                           |  |   | 30              |   |  |                          |    |   |                    |   | (3   | ) |  |   | 2,284   |  
|                                    |  |                  |      |   |         |   |         |                           |  |   |                 |   |  |                          |     |   |                    |   |      |   |  |   |         |  
|Net interest income                 |  |                  | (263 | ) |         |   | 3,888   |                           |  |   | (30             | ) |  |                          |    |   |                    |   |     |   |  |   | 3,595   |  
|Provision for loan losses           |  |                  |     |   |         |   | (214    | )                         |  |   |                |   |  |                          |    |   |                    |   |     |   |  |   | (214    | )
|                                    |  |                  |      |   |         |   |         |                           |  |   |                 |   |  |                          |     |   |                    |   |      |   |  |   |         |  
|Net interest income after provision |  |                  | (263 | ) |         |   | 4,102   |                           |  |   | (30             | ) |  |                          |    |   |                    |   |     |   |  |   | 3,809   |  
|Non-interest income                 |  |                  |     |   |         |   | 712     |                           |  |   | 1,286           |   |  |                          | 148 |   |                    |   | (174 | ) |  |   | 1,972   |  
|Non-interest expense                |  |                  | 169  |   |         |   | 3,791   |                           |  |   | 1,177           |   |  |                          | 201 |   |                    |   | (174 | ) |  |   | 5,164   |  
|                                    |  |                  |      |   |         |   |         |                           |  |   |                 |   |  |                          |     |   |                    |   |      |   |  |   |         |  
|Income (loss) before income taxes   |  |                  | (432 | ) |         |   | 1,023   |                           |  |   | 79              |   |  |                          | (53 | ) |                    |   |     |   |  |   | 617     |  
|Income taxes                        |  |                  | (138 | ) |         |   | 399     |                           |  |   | 31              |   |  |                          | (16 | ) |                    |   |     |   |  |   | 276     |  
|                                    |  |                  |      |   |         |   |         |                           |  |   |                 |   |  |                          |     |   |                    |   |      |   |  |   |         |  
|Net income (loss)                   |  | $                | (294 | ) |         | $ | 624     |                           |  | $ | 48              |   |  | $                        | (37 | ) |                    | $ |     |   |  | $ | 341     |  
|                                    |  |                  |      |   |         |   |         |                           |  |   |                 |   |  |                          |     |   |                    |   |      |   |  |   |         |  
|Assets                              |  | $                | 346  |   |         | $ | 219,184 |                           |  | $ | 2,254           |   |  | $                        | 200 |   |                    | $ | (328 | ) |  | $ | 221,656 |  
|                                    |  |                  |      |   |         |   |         |                           |  |   |                 |   |  |                          |     |   |                    |   |      |   |  |   |         |  



|                                    |  |                  |      |   |         |   |         |                           |  |   |                 |   |  |                          |     |   |                    |   |      |   |  |   |         |  
|----------------------------------- |  | ---------------- | ---- | - | ------- | - | ------- | ------------------------- |  | - | --------------- | - |  | ------------------------ | --- | - | ------------------ | - | ---- | - |  | - | ------- | -
|                                    |  | AFFinancialGroup |      |   | AF Bank |   |         | AFInsuranceServices, Inc. |  |   | AFBrokerageInc. |   |  | Inter-segmentElimination |     |   | ConsolidatedTotals |  
|Six Months Ended December 31, 2003  |  |                  |      |   |         |   |         |                           |  |   |                 |   |  |                          |     |   |                    |   |      |   |  |   |         |  
|Interest income                     |  | $                |     |   |         | $ | 5,312   |                           |  | $ |                |   |  | $                        |    |   |                    | $ | (4   | ) |  | $ | 5,308   |  
|Interest expense                    |  |                  | 261  |   |         |   | 1,989   |                           |  |   | 33              |   |  |                          |    |   |                    |   | (4   | ) |  |   | 2,279   |  
|                                    |  |                  |      |   |         |   |         |                           |  |   |                 |   |  |                          |     |   |                    |   |      |   |  |   |         |  
|Net interest income                 |  |                  | (261 | ) |         |   | 3,323   |                           |  |   | (33             | ) |  |                          |    |   |                    |   |     |   |  |   | 3,029   |  
|Provision for loan losses           |  |                  |     |   |         |   | 544     |                           |  |   |                |   |  |                          |    |   |                    |   |     |   |  |   | 544     |  
|                                    |  |                  |      |   |         |   |         |                           |  |   |                 |   |  |                          |     |   |                    |   |      |   |  |   |         |  
|Net interest income after provision |  |                  | (261 | ) |         |   | 2,779   |                           |  |   | (33             | ) |  |                          |    |   |                    |   |     |   |  |   | 2,485   |  
|Non-interest income                 |  |                  |     |   |         |   | 697     |                           |  |   | 1,203           |   |  |                          | 98  |   |                    |   | (138 | ) |  |   | 1,860   |  
|Non-interest expense                |  |                  | 236  |   |         |   | 3,515   |                           |  |   | 1,124           |   |  |                          | 160 |   |                    |   | (138 | ) |  |   | 4,897   |  
|                                    |  |                  |      |   |         |   |         |                           |  |   |                 |   |  |                          |     |   |                    |   |      |   |  |   |         |  
|Income (loss) before income taxes   |  |                  | (497 | ) |         |   | (39     | )                         |  |   | 46              |   |  |                          | (62 | ) |                    |   |     |   |  |   | (552    | )
|Income taxes                        |  |                  | (162 | ) |         |   | (15     | )                         |  |   | 18              |   |  |                          | (18 | ) |                    |   |     |   |  |   | (177    | )
|                                    |  |                  |      |   |         |   |         |                           |  |   |                 |   |  |                          |     |   |                    |   |      |   |  |   |         |  
|Net income (loss)                   |  | $                | (335 | ) |         | $ | (24     | )                         |  | $ | 28              |   |  | $                        | (44 | ) |                    | $ |     |   |  | $ | (375    | )
|                                    |  |                  |      |   |         |   |         |                           |  |   |                 |   |  |                          |     |   |                    |   |      |   |  |   |         |  
|Assets                              |  | $                | 320  |   |         | $ | 189,338 |                           |  | $ | 2,412           |   |  | $                        | 294 |   |                    | $ | (435 | ) |  | $ | 191,929 |  
|                                    |  |                  |      |   |         |   |         |                           |  |   |                 |   |  |                          |     |   |                    |   |      |   |  |   |         |  



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AF FINANCIAL GROUP



|Item 2. | Managements Discussion and Analysis
|------- | ------------------------------------



This Form 10-QSB contains certain forward-looking statements consisting of estimates with respect to the financial condition, results of operations and other business
of the Company, that are subject to various factors which could cause actual results to differ materially from the estimates. These factors include: changes in general, economic and market conditions; the development of an interest rate environment
that adversely affects the interest rate spread or other income anticipated from the Companys operations and investments; our ability to offer new products and increase lower cost core deposits; and depositor and borrower preferences. The
Company disclaims any obligation to publicly announce future events or developments that may affect the forward-looking statements contained herein.



Overview



AF Financial Group is a financial services company that provides banking, insurance and investment services to residents in the northwest corner of North Carolina. Our bank subsidiary, AF Bank, was chartered in 1939
and the historical operations of AF Bank have been to provide fixed rate loans for the residents of Ashe County, North Carolina. Over the past several years, we have expanded our market area to include Alleghany, Caldwell, Surry, Watauga and Wilkes
counties and have diversified our product lines by engaging in non-residential mortgage and non-mortgage lending and offering insurance and brokerage products. In July 1997, we started offering traditional property and casualty, life and health
insurance products through AF Insurance Services, Inc., a wholly-owned subsidiary of AF Financial Group, headquartered in West Jefferson, North Carolina and operating in Boone, Elkin, Jefferson, Lenoir, Sparta, West Jefferson and Wilkesboro, North
Carolina. We also have a broker/dealer subsidiary, AF Brokerage, Inc., which serves Ashe, Alleghany, Wilkes and Watauga counties. AF Brokerage offers a full array of uninsured investment products, including fixed-rate and variable annuities and
mutual funds.



We believe we have the foundation in place to successfully
compete in our established markets. In all AF Bank markets, we have the capability to deliver comprehensive insurance services through our insurance subsidiary and the potential to deliver securities services through AF Brokerage, Inc. The challenge
facing us is to provide the most economical, efficient  and most importantly  desirable platform to offer AF customers, clients and prospects these services. It is a challenge we are working hard to meet.



We are committed to the long-term profitability and success of AF Financial Group. Management
and the board of directors are placing major emphasis upon improving our net earnings and return on equity in the year ended June 30, 2005 and beyond. This will be accomplished by increasing the overall productivity of AF Financial Group and its
operating subsidiaries, controlling costs, and reducing or eliminating unprofitable activities whenever and wherever possible.



There are a number of positive factors and recent events, which reflect our progress toward our long-term goals during the six months ended December 31, 2004:



| |  |  | An increase in net loans of $5.0 million or 2.8%;
| | - |  | -------------------------------------------------



| |  |  | Asset growth of $9.9 million or 4.7%;
| | - |  | -------------------------------------



8



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| |  |  | An increase in stockholders equity of $235,355, or 1.9%;
| | - |  | ---------------------------------------------------------



| |  |  | An increase in net income of $715,783 during the six months ended December 31, 2004 as compared to the six months ended December 31, 2003;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | An increase in noninterest income of $112,466, or 6.1% during the six months ended December 31, 2004 as compared to the six months ended December 31, 2003;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Our new Financial Center in Boone, North Carolina opened on October 4, 2004. The Financial Center combines banking, insurance and investments into one convenient highly visible
location serving the Watauga County market.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Our operating
results are primarily dependent upon net interest income, fees and charges and insurance commissions. Net interest income is the difference between interest earned on loans and investments and the interest paid on savings deposits and our
borrowings. Our primary interest-earning asset is our loan portfolio representing 84.1% of total assets. Our net interest income is affected by changes in economic conditions that influence market interest rates and to a large extent by the monetary
actions by the Federal Reserve. We have reduced the exposure to rising rates by limiting the term or the time to reprice the loans that we retain in our portfolio.



Net income increased $588,669 to $181,888 for the three months ended December 31, 2004 from a net loss of $406,781 for the three-month
period ended December 31, 2003. Net income increased $715,783 to $341,211 for the six-month period ended December 31, 2004 from a net loss of $374,572 for the six-month period ended December 31, 2003. This change is primarily due to an increase in
interest income due to the 100 basis point interest rate hike by the Federal Reserve during the six months ended December 31, 2004; from the reduction in the provision for loan losses due to a recovery of a charged off loan during the six months
ended December 31, 2004; and a $112,466 increase in noninterest income during the six months ended December 31, 2004 partially offset by an increase in noninterest expense. We believe that a positive upturn in economic indicators will continue to
have a positive impact on our net income. At December 31, 2004 we had approximately $65.1 million in loans priced at prime or a margin thereto which provides for adjusting rates immediately when market rates change. In a rising rate environment, our
ability to make immediate rate adjustments serves to protect the interest margin against increases in rates at a more rapid speed than the increase in funding costs.



Critical Accounting Policies and Estimates



The notes to our audited consolidated financial statements for the year ended June 30, 2004 included in the AF Financial Group 2004 Annual Report on Form 10-KSB
contain a summary of our significant accounting policies. We believe that our policies with respect to the methodology for our determination of the allowance for loan losses, the fair value of mortgage servicing assets and asset impairment
judgments, including the recoverability of goodwill, involve a higher degree of complexity and require management to make difficult and subjective judgments which often require assumptions or estimates about highly uncertain matters. Changes in
these judgments, assumptions or estimates could cause reported results to differ materially. These critical policies and their application are periodically reviewed with the Audit Committee and our Board of Directors. We consider the following
accounting policies to be most critical in their potential effect on our financial position or results of operations:



Allowance for Loan Losses



The Allowance for Loan Losses (ALL) is established through a provision for loan losses based on our evaluation of the risks inherent in AF Banks loan
portfolio, prior loss history and the general



9



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##### Table of Contents

economy. The ALL is maintained at an amount we consider adequate to cover loan losses which are deemed probable and estimable. The allowance is based upon a
number of factors, including asset classifications, economic trends, industry experience and trends, industry and geographic concentrations, estimated collateral values, our assessment of the credit risk inherent in the portfolio, historical loan
loss experience, and AF Banks underwriting policies. Our methodology for assessing the ALL consists of two components, which are specific allowance for identified problem or impaired loans and a formula allowance for the remainder of the
portfolio. Although we believe we have established and maintained the ALL at appropriate levels, future adjustments may be necessary if economic, real estate and other conditions differ substantially from the current operating environment. We will
continue to monitor and modify our ALL as conditions dictate.



Mortgage
Servicing Assets



Mortgage servicing assets represent the present value of
the future net servicing fees from servicing mortgage loans sold to the secondary market. The most critical accounting policy associated with mortgage servicing is the methodology used to determine the fair value of mortgage servicing assets, which
requires the development of a number of assumptions, including anticipated loan principal amortization and prepayments of principal. The value of mortgage servicing rights is significantly affected by mortgage interest rates available in the
marketplace that influence the speed of mortgage loan prepayments. During periods of declining interest rates, the value of mortgage servicing assets generally declines due to increasing prepayments attributable to increased mortgage refinance
activity. Conversely, during periods of rising interest rates, the value of servicing assets generally increases due to reduced refinance activity. We amortize mortgage servicing assets over the estimated period that servicing income is expected to
be received based on estimates of the amount and timing of future cash flows. The amount and timing of servicing asset amortization is adjusted quarterly based on actual results and updated projections.



Goodwill



On July 1, 2002, we adopted the provisions of Financial Accounting Standards Board Statement 142, Goodwill and Other Intangible Assets.
Under the provisions of the Statement, on July 1, 2002, we ceased to amortize goodwill. We will reevaluate the carrying value of goodwill annually by comparing the market value of each reporting segment to the respective total equity at that level.
Impairment would then be determined if the equity exceeds the fair value of the reporting unit. This evaluation is subjective as it requires material estimates that may be susceptible to significant change.



Comparison of Financial Condition at December 31, 2004 and June 30, 2004:



Total assets increased by $9.9 million, or 4.7%, to $221.7 million at December 31, 2004
from $211.8 million at June 30, 2004. The increase in assets was primarily the result of an increase of $5.0 million, or 2.8%, in net loans receivable, an increase of $3.1 million in cash and cash equivalents and an increase of $1.6 million, or
13.8%, in net office properties and equipment from June 30, 2004 to December 31, 2004. The increase in net loans receivable is typical for AF Bank, which operates in lending markets that have had sustained loan demand over the last several years.
The increase in net office properties and equipment was primarily due to the costs to construct the new Financial Services Center in Boone, North Carolina, which opened on October 4, 2004.



Securities available for sale decreased $119,499, or 2.8%, to $4.2 million at December 31,
2004 from $4.3 million at June 30, 2004. This decrease was due to maturing investments. At



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December 31, 2004, our investment portfolio had approximately $72,382 in net unrealized gains as compared to net unrealized gains of $17,064 at June 30,
2004.



Net loans increased $5.0 million, or 2.8%, to $186.5 million at December
31, 2004 from $181.5 million at June 30, 2004. The following table sets forth the composition of our mortgage and other loan portfolios in dollar amounts and percentages at the dates indicated.



|                                              |  |                     |         |                        |                 |   |        |   |            |  |        |  
|--------------------------------------------- |  | ------------------- | ------- | ---------------------- | --------------- | - | ------ | - | ---------- |  | ------ | -
|                                              |  | At December 31,2004 |         |                        | At June 30,2004 |  
|                                              |  | Amount              |         | % of Total             |                 |   | Amount |   | % of Total | 
|                                              |  |                     |         | (Dollars in thousands) |                 |   |       
|Mortgage loans:                               |  |                     |         |                        |                 |   |        |   |            |  |        |  
|One-to four-family                            |  | $                   | 98,148  |                        | 52.62           | % |        | $ | 96,024     |  | 52.90  | %
|Multi-family                                  |  |                     | 5,275   |                        | 2.83            | % |        |   | 5,728      |  | 3.16   | %
|Non-residential                               |  |                     | 25,306  |                        | 13.57           | % |        |   | 28,958     |  | 15.96  | %
|Land                                          |  |                     | 17,728  |                        | 9.51            | % |        |   | 13,906     |  | 7.66   | %
|Construction                                  |  |                     | 13,276  |                        | 7.12            | % |        |   | 14,203     |  | 7.83   | %
|                                              |  |                     |         |                        |                 |   |        |   |            |  |        |  
|Total mortgage loans                          |  | $                   | 159,733 |                        | 85.65           | % |        | $ | 158,819    |  | 87.51  | %
|                                              |  |                     |         |                        |                 |   |        |   |            |  |        |  
|Other loans:                                  |  |                     |         |                        |                 |   |        |   |            |  |        |  
|Commercial                                    |  | $                   | 16,771  |                        | 8.99            | % |        | $ | 12,626     |  | 6.96   | %
|Consumer loans                                |  |                     | 11,522  |                        | 6.18            | % |        |   | 11,512     |  | 6.34   | %
|                                              |  |                     |         |                        |                 |   |        |   |            |  |        |  
|Total other loans                             |  | $                   | 28,293  |                        | 15.17           | % |        | $ | 24,138     |  | 13.30  | %
|                                              |  |                     |         |                        |                 |   |        |   |            |  |        |  
|Gross loans                                   |  | $                   | 188,026 |                        | 100.82          | % |        | $ | 182,957    |  | 100.81 | %
|                                              |  |                     |         |                        |                 |   |        |   |            |  |        |  
|Less:                                         |  |                     |         |                        |                 |   |        |   |            |  |        |  
|Unearned discounts and net deferred loan fees |  | $                   | 216     |                        | 0.12            | % |        | $ | 223        |  | 0.12   | %
|Allowance for loan losses                     |  |                     | 1,308   |                        | 0.70            | % |        |   | 1,245      |  | 0.69   | %
|                                              |  |                     |         |                        |                 |   |        |   |            |  |        |  
|                                              |  |                     | 1,524   |                        | 0.82            | % |        |   | 1,468      |  | 0.81   | %
|                                              |  |                     |         |                        |                 |   |        |   |            |  |        |  
|Loans, net                                    |  | $                   | 186,502 |                        | 100.00          | % |        | $ | 181,489    |  | 100.00 | %
|                                              |  |                     |         |                        |                 |   |        |   |            |  |        |  



Savings deposits increased by $5.5
million, or 3.5%, from $157.4 million at June 30, 2004 to $163.0 million at December 31, 2004. We believe the increase in deposits is attributable to our continuing efforts directed towards increasing balances in savings and transaction accounts and
in smaller, stable certificates of deposits. We intend to further focus our marketing efforts and to offer new products to increase lower cost core deposits.



Short-term borrowings increased $4.4 million, or 85.6%, to $9.6 million at December 31, 2004 from $5.2 million at June 30, 2004. The increase in short-term borrowings was
used to provide the funding for the $5.0 million increase in net loans receivable.



Total stockholders equity increased $235,355, or 1.9%, to $12.7 million at December 31, 2004 from $12.5 million at June 30, 2004. The increase in stockholders equity was the primarily the result of net income of $341,211, the
increase in other comprehensive income of $33,681 and ESOP expenses of $35,890. These increases were partially offset by the increase in the value of redeemable common stock held by the ESOP of $123,881, or 23.2%, and dividends of $51,546. At
December 31, 2004, AF Banks regulatory capital amounted to $17.6 million compared to $17.0 million at June 30, 2004, which was in excess of regulatory capital requirements at both such dates.



AF Banks level of non-performing loans, defined as loans past due 90 days or more,
decreased to $219,670 at December 31, 2004 compared to $518,801 at June 30, 2004. The decrease is primarily the result of the Bank foreclosing on a real estate loan during the six-month period ended December 31, 2004, where the borrower lost his
employment and was not able to keep his



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payments current. This transaction resulted in moving the amount from a delinquent loan to REO. The Bank recognized net recoveries of $276,907 during the
six-month period ended December 31, 2004 compared to net charge-offs of $547,400 for the comparable period ended December 31, 2003.



The following table sets forth activity in the Banks ALL at or for the dates indicated.



|                                                                          |  |                                           |         |   |                                            |   |         |  
|------------------------------------------------------------------------- |  | ----------------------------------------- | ------- | - | ------------------------------------------ | - | ------- | -
|                                                                          |  | For the SixMonths Ended December 31, 2004 |         |   | For the Six Months Ended December 31, 2003 |  
|                                                                          |  | (Dollars in thousands)                    |        
|Balance at beginning of year                                              |  | $                                         | 1,245   |   |                                            | $ | 1,111   |  
|Provision for loan losses                                                 |  |                                           | (214    | ) |                                            |   | 544     |  
|                                                                          |  |                                           |         |   |                                            |   |         |  
|Charge-offs:                                                              |  |                                           |         |   |                                            |   |         |  
|One- to four-family residential                                           |  |                                           | (16     | ) |                                            |   | (84     | )
|Multi-family residential                                                  |  |                                           |        |   |                                            |   |        |  
|Non-residential and land                                                  |  |                                           |        |   |                                            |   | (18     | )
|Construction                                                              |  |                                           |        |   |                                            |   |        |  
|Commercial                                                                |  |                                           |        |   |                                            |   | (399    | )
|Consumer loans                                                            |  |                                           | (90     | ) |                                            |   | (70     | )
|                                                                          |  |                                           |         |   |                                            |   |         |  
|Total charge-offs                                                         |  |                                           | (106    | ) |                                            |   | (571    | )
|                                                                          |  |                                           |         |   |                                            |   |         |  
|Recoveries:                                                               |  |                                           |         |   |                                            |   |         |  
|One- to four-family residential                                           |  |                                           | 13      |   |                                            |   | 7       |  
|Multi-family residential                                                  |  |                                           |        |   |                                            |   |        |  
|Non-residential and land                                                  |  |                                           |        |   |                                            |   |        |  
|Construction                                                              |  |                                           |        |   |                                            |   |        |  
|Commercial                                                                |  |                                           | 309     |   |                                            |   |        |  
|Consumer loans                                                            |  |                                           | 61      |   |                                            |   | 16      |  
|                                                                          |  |                                           |         |   |                                            |   |         |  
|Total recoveries                                                          |  |                                           | 383     |   |                                            |   | 23      |  
|                                                                          |  |                                           |         |   |                                            |   |         |  
|Balance at end of period                                                  |  | $                                         | 1,308   |   |                                            | $ | 1,107   |  
|                                                                          |  |                                           |         |   |                                            |   |         |  
|                                                                          |  |                                          
|Total loans outstanding at end of period                                  |  | $                                         | 188,025 |   |                                            | $ | 164,009 |  
|                                                                          |  |                                           |         |   |                                            |   |         |  
|                                                                          |  |                                          
|Allowance for loan losses to total loans at end of period                 |  |                                           | 0.70    | % |                                            |   | 0.67    | %
|                                                                          |  |                                           |         |   |                                            |   |         |  
|                                                                          |  |                                          
|Allowance for loan losses to total non-performing assets at end of period |  |                                           | 278.30  | % |                                            |   | 319.94  | %
|                                                                          |  |                                           |         |   |                                            |   |         |  
|                                                                          |  |                                          
|Allowance for loan losses to total non-performing loans at end of period  |  |                                           | 594.55  | % |                                            |   | 344.86  | %
|                                                                          |  |                                           |         |   |                                            |   |         |  



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Comparison of Operating Results for the Three and Six Months Ended December 31, 2004 and 2003:



Net income for the three-month period ended December 31, 2004 increased $588,669 to $181,888
compared to a net loss of $406,781 during the same period in 2003. Net income for the six-month period ended December 31, 2004 increased $715,783 to $341,211 compared to a net loss of $374,572 for the six-month period ended December 31, 2003. The
increases in net income during the three and six-month periods were attributable to an increase in interest income and noninterest income and a decrease in the provision for loan losses, partially offset by an increase in noninterest expense.



Interest Income. Interest income increased by $370,890, or 14.1%, from
$2,623,787 for the three-month period ended December 31, 2003 to $2,994,677 for the three-month period ended December 31, 2004. Interest income increased by $571,584, or 10.8%, from $5,307,598 for the six-month period ended December 31, 2003 to
$5,879,182 for the six-month period ended December 31, 2004. Interest income from loans increased $381,311, or 15.0%, from $2,547,386 for the three-month period ended December 31, 2003 to $2,928,697 for the three-month period ended December 31,
2004. Interest income from loans increased $594,020, or 11.5%, from $5,157,418 for the six-month period ended December 31, 2003 to $5,751,438 for the six-month period ended December 31, 2004. The increase in interest income from loans for the three
and six month periods was attributable to an increase in volume of outstanding loan balances and by the increase in the weighted average rate on portfolio loans. Net loans increased $24.0 million from $164.0 million at December 31, 2003 to $188.0
million at December 31, 2004. The weighted average rate on portfolio loans increased .10% from 6.03% at December 31, 2003 to 6.13% at December 31, 2004.



Interest Expense. Interest expense increased by $36,391, or 3.2%, to $1,170,341 for the three-month period ended December 31, 2004 from $1,133,950 for the three
months ended December 31, 2003. Interest expense increased by $5,437, or 0.2%, to $2,284,365 for the six-month period ended December 31, 2004 from $2,278,928 for the six months ended December 31, 2003. Interest expense on savings deposits decreased
$12,408 from $683,366 for the three months ended December 31, 2003 to $670,958 for the three months ended December 31, 2004. Interest expense on savings deposits decreased $97,699 from $1,416,177 for the six months ended December 31, 2003 to
$1,318,478 for the six months ended December 31, 2004. These decreases were primarily attributable to the decrease of the weighted average rate paid on deposits from 1.73% at December 31, 2003 to 1.69% at December 31, 2004. The decreases in interest
expense on savings deposits were partially offset by the increase in interest expense on short-term borrowings. Interest expense on short-term borrowings increased $56,925 from $613 for the three months ended December 31, 2003 to $57,538 for the
three months ended December 31, 2004. Interest expense on short-term deposits increased $83,267 from $613 for the six months ended December 31, 2003 to $83,880 for the six months ended December 31, 2004. The increase in interest expense on
short-term deposits is the result of the $4.0 million increase in Federal Home Loan Bank (FHLB) advances during the six months ended December 31, 2004. These advances were used to fund loan demand.



Net Interest Income. Net interest income increased by $334,499, or 22.5%, from
$1,489,837 for the three-month period ended December 31, 2003 to $1,824,336 for the three-month period ended December 31, 2004. Net interest income increased by $566,147, or 18.7%, from $3,028,670 for the six-month period ended December 31, 2003 to
$3,594,817 for the six-month period ended December 31, 2004. The increase in net interest income is the result of a drop in the weighted average rate paid for deposits and the increase in outstanding loan balances, partially offset by the increase
in FHLB borrowings. In a rising rate environment, we have the ability to make immediate rate



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adjustments which allows us to increase loan rates at a more rapid speed than the increase in funding costs. We believe that a positive upturn in economic
indicators will have a positive impact on our net income. We do not believe that there has been a material change in interest rate risk from the end of our most recent fiscal year.



Provision for Loan Losses. We reversed provisions in the amount of $293,922 from the
allowance for loan losses during the three-month period ended December 31, 2004, compared to a $500,000 provision for loan losses made during the three-month period ended December 31, 2003. We reversed provisions in the amount of $213,922 from the
allowance for loan losses during the six-month period ended December 31, 2004, compared to a $544,000 provision for loan losses made during the six-month period ended December 31, 2003. Provisions for loan losses, which are charged to operations and
resulting loan loss allowances, are amounts that the we believe will be adequate to absorb probable losses on existing loans that may become uncollectible. Loans are charged off against the allowance when we believe collection is unlikely. The
evaluation to increase or decrease the provisions for loan losses and resulting allowances is based both on prior loan loss experience and other factors, such as changes in the nature and volume of the loan portfolio, overall portfolio quality and
current economic conditions.



During the six-month period ended December 31,
2004 we had net recoveries of $276,907 primarily due to a $309,080 recovery from a commercial loan that was previously charged off. We reversed provisions for loan loss allowances during the three and six month period ended December 31, 2004 based
upon an analysis of the quality of our loan portfolio. While future loan loss provision requirements are uncertain, management believes that similar recoveries are unlikely. At December 31, 2004, our level of allowance for loan losses amounted to
$1,307,954, or 0.70% of total loans, as compared to $1,107,285 of allowance for loan losses, or 0.67% of total loans at December 31, 2003, which we believe is adequate to absorb any probable losses inherent in our loan portfolio.



Noninterest Income. Noninterest income increased by $102,707, or 12.0%, from $854,757
for the three-month period ended December 31, 2003 to $957,464 for the three months ended December 31, 2004. Noninterest income increased by $112,466, or 6.1%, from $1,859,765 for the six-month period ended December 31, 2003 to $1,972,231 for the
six months ended December 31, 2004. The changes in noninterest income during the three and six month period ended December 31, 2004 were primarily attributable to increases in insurance commissions and in transaction fees on deposit accounts. The
increase in insurance commissions is primarily due to an increase in number of sales due to increased emphasis on training and monitoring the sales activities of insurance producers. The increase in transaction fees on deposit accounts is primarily
attributable to an increase in the number of transaction accounts. These trends are expected to continue to produce growth in non-interest income.



Non-Interest Expense. Non-interest expense increased by $272,325, or 11.0%, from $2,476,767 for the three months ended December 31, 2003 to $2,749,092 for the
three months ended December 31, 2004. Non-interest expense increased by $267,270, or 5.5%, from $4,896,587 for the six months ended December 31, 2003 to $5,163,857 for the six months ended December 31, 2004. The increase in non-interest expense for
the three and six month period ended December 31, 2004 is primarily attributable to an increase in professional services expense due to attorney fees associated with a personnel issue and an increase in expenses on real estate owned. While future
increases in attorney fees and expenses on real estate owned are uncertain, management believes that similar expenses are unlikely.



Capital Resources and Liquidity:



The term liquidity generally refers to an organizations ability to generate adequate amounts of funds to meet its needs for cash. More specifically, for
financial institutions, liquidity ensures that



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adequate funds are available to meet deposit withdrawals, fund loan demand and capital expenditure commitments, maintain reserve requirements, pay operating
expenses, and provide funds for debt service, dividends to stockholders, and other institutional commitments. The Companys primary sources of funds consist of deposits, borrowings, repayment and prepayment of loans, sales and participations of
loans, maturities of securities and interest-bearing deposits, and funds provided from operations. While scheduled repayments of loans and maturities of securities are predictable sources of funds, deposit flows and loan prepayments are greatly
influenced by the general level of interest rates, economic conditions, and competition. The Company uses its liquid resources primarily to fund existing and future loan commitments, to fund net deposit outflows, to invest in other interest-earning
assets, to maintain liquidity, and to meet operating expenses. For additional information about cash flows from the Companys operating, financing and investing activities, see Condensed Consolidated Statements of Cash Flow.



Liquidity management is both a daily and long-term function of management. If
we require funds beyond our ability to generate them internally, we believe we could borrow additional funds from the FHLB and use the wholesale deposit markets. At December 31, 2004, we had borrowings of $37.1 million from the FHLB. The Bank also
maintains borrowing agreements with the Federal Reserve Bank of Richmond, VA.



The Company anticipates that it will have sufficient funds available to meet its current loan origination commitments. Certificates of deposit scheduled to mature in one year or less totaled $58.7 million at December 31, 2004. Based upon
historical experience, we believe that a significant portion of such deposits will remain with the Bank.



As of December 31, 2004, cash and cash equivalents, a significant source of liquidity, totaled $10.8 million. The Office of Thrift Supervision regulations require the Company to maintain sufficient liquidity to ensure
its safe and sound operation. Given our level of liquidity and our ability to borrow from the FHLB, we believe that we will have sufficient funds available to meet anticipated future loan commitments, unexpected deposit withdrawals, and other cash
requirements.



Capital management is another important daily and long-term
function of management. While we currently meet all regulatory capital levels, we monitor this level on an ongoing basis. Our principal goals related to capital management are to provide an adequate return to shareholders while retaining a
sufficient foundation from which to support future growth and to comply with all regulatory guidelines.



Off Balance-Sheet Arrangements:



The
Company does not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on the Companys financial condition, revenues or expenses, results of operations, liquidity, capital resources or
expenditures that is material to investors.



New Accounting Pronouncements:



In December 2004, the FASB issued SFAS No. 123(R), Accounting for
Stock-Based Compensation (SFAS No. 123(R)). SFAS No. 123(R) establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services. This Statement focuses primarily on accounting for
transactions in which an entity obtains employee services in share-based payment transactions. SFAS No. 123(R) requires that the fair value of such equity instruments be recognized as an expense in the historical financial statements as services are
performed. Prior to SFAS No. 123(R), only certain pro forma disclosures of fair value were required. The provisions of this Statement are effective for the first interim reporting period that begins after December 15, 2005. Accordingly, we
will adopt SFAS No. 123(R) commencing with the



15



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##### Table of Contents

quarter ending March 31, 2006. Since all options granted were fully vested on December 8, 2001 there would be no cost of employee stock option
compensation in our consolidated financial statements for the three and six months ended December 31, 2004 and 2003. Accordingly, the adoption of SFAS No. 123(R) is not expected to have a material effect on our consolidated financial statements.



|Item 3. | Controls and Procedures
|------- | -----------------------



The Company maintains a system of internal controls and procedures designed to provide reasonable assurance as to the reliability of our published financial statements
and other disclosures included in this report. The Companys Board of Directors, operating through its Audit Committee, which is composed entirely of independent outside directors, provides oversight of the Companys financial reporting
process.



Management, including the Companys President and Chief
Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Companys disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this report.
Based upon that evaluation, the President and Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures were effective, in all material respects, to ensure that information required to be disclosed in
the reports the Company files and submits under the Exchange Act is recorded, processed, summarized and reported as and when required.



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



16



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##### Table of Contents

Part II. OTHER INFORMATION



|Item 1. | Legal Proceedings
|------- | -----------------



The Company is not a party to, and its property is not the subject of, any pending legal proceedings at the present time other than routine litigation
that is incidental to the business.



|Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds
|------- | -----------------------------------------------------------



(a) Not applicable



(b) Not applicable



(c) During the three and six month periods ended December 31, 2004, the Company did not repurchase any of its common stock. The Company does not have a
stock repurchase program in place at the present time.



|Item 3. | Defaults Upon Senior Securities
|------- | -------------------------------



None



|Item 4. | Submission of Matters to a Vote of Security Holders
|------- | ---------------------------------------------------



The Company held its Annual Meeting of Shareholders (Meeting) on November 1, 2004. All of the proposals submitted to the shareholders at the
Meeting were approved. The proposals submitted to shareholders and the tabulation of votes for each proposal is as follows:



| | 1. | Election of three candidates to the Board of Directors, each to serve for a term of three years.
| | -- | ------------------------------------------------------------------------------------------------



The number of votes cast with respect to this matter was as follows:



|                   |  |         |  |          |  |                
|------------------ |  | ------- |  | -------- |  | ---------------
|Nominee            |  | For     |  | Withheld |  | BrokerNon-Votes
|Jimmy D. Reeves    |  | 936,004 |  | 1,730    |  | 112,101        
|Jerry L. Roten     |  | 936,034 |  | 1,700    |  | 112,101        
|Michael M. Sherman |  | 935,934 |  | 1,800    |  | 112,101        



The following seven
directors were not up for reelection, however, they remain on the board to serve their existing term: Wayne R. Burgess, Jan R. Caddell Kenneth R. Greene, Claudia L. Kelley, Donald R. Moore, Robert E. Washburn and John D. Weaver.



| | 2. | Ratification of the appointment of Dixon Hughes PLLC as independent auditors for fiscal year ending June 30, 2005.
| | -- | ------------------------------------------------------------------------------------------------------------------



The number of votes cast with respect to this matter was as follows:



|        |  |         |  |           |  |                 
|------- |  | ------- |  | --------- |  | ----------------
|For     |  | Against |  | Abstained |  | Broker Non-Votes
|937,684 |  | 0       |  | 50        |  | 112,101         



17



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##### Table of Contents

|Item 5. | Other Information
|------- | -----------------



(a) Not applicable

(b) Not applicable

(c) Not applicable

(d) Not
applicable



|Item 6. | Exhibits
|------- | --------



|     |  |                                                                                                                                                                                                                                                                                               
|---- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|2.1  |  | Agreement and Plan of Reorganization dated September 15, 1997 by and among Ashe Federal Bank, AF Bankshares, Inc. and Ashe Interim Savings Bank (Incorporated by reference to Exhibit 2.1 of
the Registration Statement on Form 8-A, as filed with the SEC on June 16, 1998 (the Form 8-A)).
|     | 
|3.1  |  | Federal Stock Charter of the Company (Incorporated by reference to Exhibit 3.1 of the Form 8-A).                                                                                                                                                                                              
|     | 
|3.2  |  | Bylaws of the Company (Incorporated by reference to Exhibit 3.2 of the Form 8-A).                                                                                                                                                                                                             
|     | 
|4.1  |  | Common Stock Certificate of the Company (Incorporated by reference to Exhibit 4.3 of the Form 8-A).                                                                                                                                                                                           
|     | 
|4.2  |  | Indenture dated July 16, 2001 by and between AF Bankshares, Inc. and The Bank of New York (Incorporated by reference to Exhibit 4.2 of the Annual Report on Form 10-KSB, as filed with the SEC
on September 29, 2003 (the 2003 Form 10-KSB)).                                               
|     | 
|4.3  |  | Guarantee Agreement of AF Bankshares, Inc. dated July 16, 2001 (Incorporated by reference to Exhibit 4.3 of the 2003 Form 10-KSB).                                                                                                                                                            
|     | 
|10.1 |  | Employment Agreement between AF Bank and James A. Todd dated November 18, 2002 (Incorporated by reference to Exhibit 10.1 of the 2003 Form 10-KSB).                                                                                                                                           
|     | 
|10.2 |  | Employment Agreement between AF Bank and Melanie Paisley Miller dated November 18, 2002 (Incorporated by reference to Exhibit 10.2 of the 2003 Form 10-KSB).                                                                                                                                  
|     | 
|10.3 |  | Employment Agreement with Martin G. Little, Senior Vice President and Chief Lending Officer (Incorporated by reference to Exhibit 10.3 of the Annual Report on Form 10-KSB, as filed with the
SEC on September 29, 1998 (the 1998 Form 10-KSB).                                             
|     | 
|10.4 |  | Employee Stock Ownership Plan of Ashe Federal Bank (Incorporated by reference to Exhibit 10.4 of the 1998 Form 10-KSB).                                                                                                                                                                       
|     | 
|10.5 |  | Amendment No. 1 to the Employee Stock Ownership Plan of AF Bank (Incorporated by reference to Exhibit 10.5 of the 2003 Form 10-KSB).                                                                                                                                                          
|10.6 |  | Amendment No. 2 to the Employee Stock Ownership Plan of AF Bank (Incorporated by reference to Exhibit 10.6 of the 2003 Form 10-KSB).                                                                                                                                                          



18



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|      |  |                                                                                                                                                                                                                              
|----- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|      | 
|10.7  |  | Amendment No. 3 to the Employee Stock Ownership Plan of AF Bank (Incorporated by reference to Exhibit 10.7 of the 2003 Form 10-KSB).                                                                                         
|      | 
|10.8  |  | Amendment No. 4 to the Employee Stock Ownership Plan of AF Bank (Incorporated by reference to Exhibit 10.7 of the 2003 Form 10-KSB).                                                                                         
|      | 
|10.9  |  | Salary Continuation Agreement between AF Bankshares, Inc. and Melanie Paisley Miller dated April 15, 2002 (Incorporated by reference to Exhibit 10.10 of the 2003 Form
10-KSB).                                              
|      | 
|10.10 |  | Employment Agreement between AF Financial Group and James A. Todd dated November 18, 2002 (Incorporated by reference to Exhibit 10.11 of the 2003 Form 10-KSB).                                                              
|      | 
|10.11 |  | Employment Agreement between AF Financial Group and Melanie Paisley Miller dated November 18, 2002 (Incorporated by reference to Exhibit 10.13 of the 2003 Form 10-KSB).                                                     
|      | 
|10.12 |  | Settlement Agreement dated September 24, 2004 by and between James A. Todd and AF Financial Group (Incorporated by reference to Exhibit 99.1 of the Current Report on Form 8-K, as filed with
the SEC on September 24, 2004).
|      | 
|31.1  |  | Rule 13a-14(a)/15d-14(a) Certification                                                                                                                                                                                       
|      | 
|31.2  |  | Rule 13a-14(a)/15d-14(a) Certification                                                                                                                                                                                       
|      | 
|32.1  |  | Section 1350 Certification                                                                                                                                                                                                   
|      | 
|32.2  |  | Section 1350 Certification                                                                                                                                                                                                   



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##### Table of Contents

SIGNATURES



In accordance with the requirements of
the Exchange Act, the registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.



|                        |  |  |  |                    |  |                                                                         |  | 
|----------------------- |  |  |  | ------------------ |  | ----------------------------------------------------------------------- |  | 
|                        |  |  |  | AF Financial Group
|                        |  |  | 
|Dated February 14, 2005 |  |  |  | By:                |  | /s/ Melanie Paisley Miller                                             
|                        |  |  |  |                    |  | Melanie Paisley Miller                                                 
|                        |  |  |  |                    |  | Chief Financial Officer, Executive Vice President, Secretary, Treasurer



20