SECURITIES AND EXCHANGE COMMISSION
                            Washington, D.C.  20549


                                   FORM 10-K
(Mark One)

    X       ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
---------   EXCHANGE ACT OF 1934 [NO FEE REQUIRED]

For the Fiscal Year Ended December 31, 1996

|_|     TRANSITIONAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
        EXCHANGE ACT OF 1934 [NO FEE REQUIRED]

For the transition period from ________________ to ______________________

                        Commission File Number: 0-17353

                           FMS FINANCIAL CORPORATION
            ------------------------------------------------------
            (Exact name of registrant as specified in its charter)

                            New Jersey                         22-2916440
         ---------------------------------------------      -------------------
         (State or other jurisdiction of incorporation      (I.R.S. Employer
          or organization)                                  Identification No.)

        Sunset and Salem Roads, Burlington, New Jersey            08016
      ------------------------------------------------         -----------
        (Address of principal executive offices)                (Zip Code)

Registrant's telephone number, including area code:              (609) 386-2400
                                                                 ---------------

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

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

                    Common Stock, par value $.10 per share
                    --------------------------------------
                               (Title of Class)

      Indicate by check mark  whether the  registrant  (1) has filed all reports
required to be filed by Section 13 or 15(d) of the  Securities  Exchange  Act of
1934  during  the  preceding  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      .
                                               -----       ----

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

      Based on the closing  sales price of $19.75 per share of the  registrant's
common stock on March 3, 1997, as reported on the Nasdaq  National Market System
the  aggregate  market  value of  voting  stock  held by  non-affiliates  of the
registrant was approximately  $47.3 million.  On such date,  2,392,707 shares of
the registrant's Common Stock were outstanding.

                      DOCUMENTS INCORPORATED BY REFERENCE

      1.       Portions  of Annual  Report to  Stockholders  for the Fiscal Year
               Ended December 31, 1996. (Parts II and IV)

      2.       Portions  of Proxy  Statement  for the  1997  Annual  Meeting  of
               Stockholders. (Part III)


<PAGE>



                                    PART I
Item 1.  Business
-----------------

General

      The  Corporation.   FMS  Financial  Corporation  (the  "Corporation")  was
incorporated  under the laws of the State of New Jersey on September 1, 1988 for
the purpose of  becoming a savings and loan  holding  company.  On December  21,
1988,  the  Corporation  acquired  all of  the  common  stock  of  Farmers'  and
Mechanics'  Savings  Bank,  SLA,  now known as Farmers and  Mechanics  Bank (the
"Bank" or "Farmers and  Mechanics")  following the Bank's  conversion from a New
Jersey chartered mutual to a New Jersey chartered stock savings institution. The
Bank  converted  its  charter to that of a federal  savings  bank on October 15,
1993.

      Prior to the acquisition of all of the outstanding  stock of the Bank, the
Corporation had no assets or liabilities and engaged in no business  activities.
Subsequent to the acquisition of Farmers and Mechanics,  the Corporation engaged
in no  significant  activity  other  than  holding  the  stock  of the  Bank and
operating a savings and loan  business  through  the Bank,  and the  issuance in
July, 1994 of 10%  subordinated  debentures due 2004 in the aggregate  principal
amount of $10 million.  Accordingly,  the  information set forth in this report,
including  financial  statements and related data, relates primarily to the Bank
and its subsidiaries.

     The Corporation's  executive offices are located at Sunset and Salem Roads,
Burlington, New Jersey. Its telephone number is (609) 386-2400.

      The Bank.  Farmers and  Mechanics  commenced  operations in 1871 under the
name  Farmers and  Mechanics  Building and Loan  Association.  The Bank became a
member of the  Federal  Home Loan Bank  ("FHLB")  System and has had its savings
deposits federally insured by the Savings  Association  Insurance Fund ("SAIF"),
and  its  predecessor  the  Federal  Savings  and  Loan  Insurance   Corporation
("FSLIC"), since 1952. The Bank is subject to regulation by the Office of Thrift
Supervision ("OTS") and the Federal Deposit Insurance Corporation ("FDIC").  See
"Regulation."  Effective  October 26, 1994, the Bank changed its name to Farmers
and  Mechanics  Bank.  The name  change  was  approved  by the  Bank's  Board of
Directors,  the Corporation and the OTS. The Bank conducts its business  through
its main  administrative  office and eighteen branch offices located  throughout
Burlington  County,  New Jersey.  At December 31, 1996, the Bank's total assets,
deposits and stockholders' equity amounted to $541.7 million, $453.3 million and
$33.8 million, respectively.

      Farmers and  Mechanics is primarily  engaged in the business of attracting
deposits  from the  general  public and  originating  loans which are secured by
residential real estate. To a lesser extent, the Bank also originates  consumer,
commercial real estate and construction loans and invests in U.S.
government securities and mortgage-related securities.

      Farmers  and  Mechanics  considers  its  primary  market  area for savings
deposits  to be  Burlington  County,  New Jersey,  while its primary  market for
lending activities consists of Burlington County, and, to a lesser extent, other
regions of southern New Jersey.



<PAGE>



Lending Activities

      General.  The  principal  lending  activity  of  the  Bank  has  been  the
origination of conventional  fixed-rate and  adjustable-rate  mortgage loans for
the  purpose  of  financing  or  refinancing  one-to   four-family   residential
properties. To a lesser extent, the Bank also originates commercial real estate,
consumer,  construction and commercial  business loans. As of December 31, 1996,
98.14% of the Bank's loans were real estate loans, of which 82.22%  consisted of
loans secured by mortgages on one-to four-family residential properties of which
 .62% were insured or guaranteed  real estate loans,  1.28% were consumer  loans,
and .58% were commercial  business loans.  Such percentages have been calculated
before  the  deduction  of loans in  process,  deferred  loan fees and loan loss
reserves.  See "--Analysis of Loan  Portfolio".  The Bank also sells  fixed-rate
loans in the secondary mortgage market and has purchased adjustable-rate loans.


                                      2

<PAGE>



Analysis of Loan Portfolio

      The  following  table  sets  forth  the  composition  of the  Bank's  loan
portfolio and mortgage-backed and related securities portfolio in dollar amounts
and in percentages of the respective portfolios at the dates indicated.

<TABLE>
<CAPTION>

                                                                    At December 31,
                                   -----------------------------------------------------------------------------------------------
                                          1996                1995                1994              1993              1992
                                   ------------------ -------------------  ----------------- ------------------ ------------------
                                   Carrying  Percent  Carrying   Percent   Carrying Percent  Carrying  Percent  Carrying  Percent
                                    Value    of Total   Value    of Total    Value of Tota     Value  of Total   Value   of Total
                                   -------   -------- --------   --------  -------- -------  -------- --------  -------- --------
                                         (Dollars In Thousands)
Mortgage loans:
<S>                                <C>         <C>    <C>         <C>     <C>        <C>     <C>        <C>     <C>         <C>   
  One- to four-family .........    $257,608    82.22% $ 249,278   84.74%  $245,874   84.83%  $237,381   86.03%  $ 222,178   85.08%

  Commercial real estate.......      39,177    12.50     34,721   11.81     32,228   11.12     28,892   10.47      29,136   11.38

  Commercial Construction......       4,715     1.51         --      --         --      --         --      --          --      --
  Construction ................       5,989     1.91      4,063    1.38      5,699    1.97      4,157    1.51       2,760    1.06
                                   --------            --------             ------             ------              ------     
      Total mortgage loans.....     307,489             288,062            283,801            270,430             254,074
Consumer and other loans:
  Consumer ....................       4,016     1.28      4,337    1.47      4,317    1.49      4,119    1.49       4,234    1.62
  Commercial business .........       1,830      .58      1,779    0.60      1,712    0.59      1,377    0.50       2,248    0.86
                                   --------            --------             ------             ------              ------     
      Total consumer and other
        loans .................       5,846               6,116              6,029              5,496               6,482
                                   --------            --------             ------             ------              ------     
      Total loans .............     313,335   100.00%   294,178  100.00%   289,830  100.00%   275,926  100.00%    260,556  100.00%
                                              ======             ======             ======             ======              ======

Less:
  Unearned discount, premium,
    loans in process, deferred
    loan fees, net ............      (3,682)             (3,011)            (3,948)            (4,113)             (3,187)
  Allowance for loan losses....      (2,782)             (2,767)            (2,622)            (2,589)             (2,380)
                                   --------            --------             ------             ------              ------     
      Total loans, net.........    $306,871           $ 288,400           $283,260           $269,224            $254,989
                                   ========           =========           ========            ========           ========

Mortgage-backed securities
held to maturity and available
for sale:
  FHLMC .......................    $ 42,586    34.69% $  54,039   43.47% $  64,474   44.99%  $ 56,258   43.77%   $ 52,602   41.68%

  FNMA ........................      37,958    30.92     41,507   33.38     48,746   34.01     36,533   28.42      32,617   25.84
  GNMA ........................      23,216    18.91     15,225   12.25     17,522   12.23     16,879   13.13      15,425   12.22
  Real estate investment
    mortgage conduit ..........       5,830     4.75      7,291    5.86      7,577    5.29     10,187    7.93      12,564    9.96
  Collateralized mortgage
    obligations ...............      12,621    10.28      5,485    4.41      3,863    2.69      6,485    5.05      10,474    8.30
  Mortgage pass throughs ......         552      .45        784    0.63      1,131    0.79      2,190    1.70       2,525    2.00
                                   --------   ------  ---------  ------   --------  ------   --------   -----    --------  ------   
      Total mortgage-backed and
        related securities.....    $122,763   100.00% $ 124,331  100.00%  $143,313  100.00%  $128,532  100.00%   $126,207  100.00%  
                                   ========   ======  =========  ======   ========  ======   ========  ======    ========  ======   

</TABLE>



                                               3

<PAGE>



      The following table sets forth the Bank's loan  originations  and loan and
mortgage-backed and related securities  purchases,  sales and principal payments
for the periods indicated.

<TABLE>
<CAPTION>
 
                                                                            Year Ended December 31,
                                                         ---------------------------------------------------------------
                                                            1996         1995         1994         1993         1992
                                                            ----         ----         ----         ----         ----   
                                                                (In Thousands)
Total loans receivable (gross):
<S>                                                      <C>          <C>          <C>          <C>          <C>      
  At beginning of period .............................   $ 294,178    $ 289,830    $ 275,926    $ 260,556    $ 240,018

  Mortgage loans originated:
    One-to four-family ...............................      30,192       34,775       52,902       87,061       88,468
    Commercial real estate ...........................      17,751        7,144        6,806        6,509       10,902
    Commercial construction ..........................       4,715         --           --           --             --
    Construction .....................................       4,792        2,925        3,516         --            125
                                                         ---------    ---------    ---------    ---------    ---------
      Total mortgage loans originated ................      57,450       44,844       63,224       93,570       99,495

  Mortgage and consumer loans purchased:
    One to four family ...............................      14,486           --           --           --        8,072
    Consumer .........................................          --           --          127           --           --
                                                         ---------    ---------    ---------    ---------    ---------
      Total mortgage and consumer loans purchased.....      14,486           --          127           --        8,072

Total mortgage loans originated and purchased ........      71,936       44,844       63,351       93,570      107,567
Consumer loans originated ............................       1,131        1,048          475          834          710
Transfer of mortgage loans to real estate owned ......        (482)         (57)      (1,091)        (362)        (619)
Sale of loans ........................................        (950)      (1,118)      (1,739)     (12,362)     (23,125)
Principal repayments .................................     (52,478)     (40,369)     (47,092)     (66,310)     (63,995)
                                                         ---------    ---------    ---------    ---------    ---------
Total loans receivable at end of period ..............   $ 313,335    $ 294,178    $ 289,830    $ 275,926    $ 260,556
                                                         =========    =========    =========    =========    =========

Mortgage backed securities held to maturity
and available for sale:
At beginning of period ...............................   $ 124,331    $ 143,313    $ 128,532    $ 126,207    $ 107,632
Mortgage backed securities purchased (1) .............      31,927        2,755       52,051       54,697       49,827
Mortgage backed securities sold (1) ..................        (923)          --           --           --       (1,000)
Amortization and repayments ..........................     (32,646)     (22,018)     (37,270)     (52,372)     (30,252)
Charge in mark to market on available
  for sale securities ................................          74          281           --           --           --
                                                         ---------    ---------    ---------    ---------    ---------
At end of period (1) .................................   $ 122,763    $ 124,331    $ 143,313    $ 128,532    $ 126,207
                                                         =========    =========    =========    =========    =========
</TABLE>


-------------------
(1)   Includes the purchase and sale of CMO's and Remics


                                        4

<PAGE>



      Residential  Loans. One of the primary lending  activities of the Bank has
been the  origination  of  conventional  mortgage  loans to enable  borrowers to
purchase  existing  homes,  refinance  existing  mortgage loans or construct new
homes.  The Bank  generally  originates  mortgage  loans  with terms of 15 to 30
years, amortized on a monthly basis, with principal and interest due each month.
Typically,  residential real estate loans remain  outstanding for  significantly
shorter periods than their  contractual terms because borrowers may refinance or
prepay loans at their option.

      Regulations  permit  thrift  institutions  to make home loans on which the
interest rate,  loan balance or term to maturity may be adjusted,  provided that
the  adjustments  are  tied to  specified  indices.  The Bank  presently  offers
mortgage  loans that adjust every year after an initial  fixed term of one, two,
five or seven years,  at an interest rate indexed higher than the  corresponding
U.S.  Treasury  Security  Index.  The interest rates on these  mortgages  adjust
annually  after the one,  two, five or seven year  anniversary  date of the loan
with an  interest  rate  adjustment  cap of 1.5% per year and  presently  not to
exceed  a rate of 11.5%  over  the  life of the  loan.  At  December  31,  1996,
adjustable-rate  residential first mortgage loans amounted to $79.9 million,  or
25.5% of the Bank's total loan portfolio.

      Fixed-rate mortgage loans are generally  underwritten according to Federal
Home  Loan  Mortgage   Corporation   ("FHLMC")  and  Federal  National  Mortgage
Association  ("FNMA")  guidelines.  The  Bank  sells  fixed-rate  loans  in  the
secondary  market  from  time to time when such  sales are  consistent  with the
Bank's  asset/liability  management goals and can be achieved on terms favorable
to the Bank. The Bank generally  charges a higher  interest rate on loans if the
property is not owner-occupied. At December 31, 1996, $150.3 million or 48.0% of
the  Bank's  total loan  portfolio,  consisted  of  long-term  fixed-rate  first
mortgage loans.

      The Bank's  lending  policies  generally  limit the maximum  loan-to-value
ratio on owner-occupied  residential  mortgage loans to 95% of the lesser of the
appraised  value or purchase  price,  with the condition  that private  mortgage
insurance  is  required  on loans  with  loan-to-value  ratios in excess of 80%.
Mortgage loans on investment  properties  are made by the Bank at  loan-to-value
ratios up to 70%. The loan-to-value ratio,  maturity and other provisions of the
loans made by the Bank have  generally  reflected the policy of making less than
the maximum loan permissible  under applicable  regulations,  in accordance with
established  lending  practices,  market  conditions and underwriting  standards
maintained by the Bank. The Bank requires title, fire and casualty  insurance on
all properties securing real estate loans made by the Bank.

      The Bank  actively  solicits  and  originates  home equity  loans and home
equity reserve lines of credit  secured by the equity in the borrower's  primary
residence. These loans generally have terms of 10 to 15 years, some of which are
fixed rates and some of which have rates that adjust  based upon the prime rate.
At December  31,  1996,  the Bank had home  equity  loans in the amount of $13.3
million or 4.26% of its total loan  portfolio.  Also at December 31,  1996,  the
Bank had approved  $31.8 million in home equity lines of credit,  of which $14.0
million was outstanding.

      Construction  Loans. The Bank originates loans to finance the construction
of one-to four-family dwellings or commercial real estate.  Generally,  the Bank
only  makes  interim  construction  loans to  individuals  if it also  makes the
permanent  mortgage  loan on the  property.  Construction  loans to builders are
generally  made only if the Bank  makes the  permanent  mortgage  loan or if the
builder  has a contract  for sale and the  purchaser  has  received a  permanent
mortgage  commitment.  At  December  31,  1996,  the Bank's  construction  loans
amounted to $8.1 million, net of loans in process.


                                      5

<PAGE>



      Interim  construction  loans to builders  generally  have terms of up to 9
months and  interest  rates  which  adjust at a positive  spread  over the prime
interest  rate.  Construction  loans  to  build  single  family  residences  are
available.  These loans are  available to borrowers  who qualify for a permanent
loan.

      Construction  financing is generally considered to involve a higher degree
of risk of loss than long-term financing on improved, occupied real estate. Risk
of loss on a  construction  loan is  dependent  largely upon the accuracy of the
initial  estimate of the  property's  value at  completion of  construction  and
development and the estimated cost (including interest) of construction.  During
the  construction  phase,  a number of factors  could  result in delays and cost
overruns.  If the estimate of  construction  costs proves to be inaccurate,  the
Bank may be required to advance funds beyond the amount originally  committed to
permit  completion  of the  development.  If the  estimate of value proves to be
inaccurate, the Bank may be confronted, at or prior to the maturity of the loan,
with a project having a value which is insufficient to assure full repayment.

      Commercial  Real Estate Loans.  Loans  secured by  commercial  real estate
(e.g.,  shopping centers,  medical  buildings,  retail offices) and multi-family
dwelling units (e.g., apartment projects with more than four units), constituted
$39.2  million,  or 12.5%,  of the Bank's  total loan  portfolio at December 31,
1996. Commercial real estate loans and multi-family  residential loans have been
made in amounts up to $3.8 million, with most of such loans ranging in size from
$100,000 to $1.0 million. Permanent loans on commercial properties are generally
originated  in amounts up to 75% of the  appraised  value of the  property.  The
Bank's permanent  commercial real estate loans are secured by improved  property
such as office buildings,  retail stores, warehouse,  church buildings and other
non-residential  buildings,  most of which are  located  in the  Bank's  primary
market area. Commercial real estate loans and multi-family residential loans are
generally  made at rates  which  adjust  at a  positive  spread  over the  prime
interest  rate or are balloon  loans with fixed  interest  rates which mature in
three to five years with principal amortization for a period of up to 25 years.

      Loans secured by commercial real estate are generally larger and involve a
greater degree of risk than one-to  four-family  residential  mortgage loans. Of
primary  concern in  commercial  and  multi-family  real  estate  lending is the
borrower's  creditworthiness  and the feasibility and cash flow potential of the
project.  Loans secured by income  properties  are generally  larger and involve
greater risks than residential  mortgage loans because payments on loans secured
by income  properties are often dependent on successful  operation or management
of the  properties.  As a result,  repayment  of such  loans may be subject to a
greater extent than residential  real estate loans to adverse  conditions in the
real  estate  market or the  economy.  In order to monitor  cash flows on income
properties,  the Bank requires borrowers and loan guarantors, if any, to provide
annual  financial  statements and rent rolls on commercial real estate loans. At
December 31, 1996, the five largest  commercial real estate loans totalled $10.0
million  with no single  loan  larger  than $3.6  million.  All such  loans were
current and were  performing  in  accordance  with their terms and the  property
securing such loans are in the Bank's market area.

      Consumer.  Regulations permit federally  chartered thrift  institutions to
make secured and unsecured consumer loans up to 35% of the institution's assets.
The Bank makes various types of secured and unsecured  consumer loans  including
education  loans,  lines of  credit,  automobile  loans (new and used) and loans
secured by deposit  accounts.  As of December 31, 1996,  consumer loans totalled
$4.0  million,  or 1.3% of the  Bank's  total  loan  portfolio.  Consumer  loans
generally have terms of six months to 5 years,  some of which are at fixed rates
and some of which have rates that adjust periodically.


                                      6

<PAGE>



      The Bank  intends to continue to  emphasize  the  origination  of consumer
loans.  The Bank believes that the shorter term and the normally higher interest
rates  available  on  various  types of  consumer  loans  have been  helpful  in
maintaining a profitable  spread  between the Bank's  average loan yield and its
cost of funds.

      Consumer loans are advantageous to the Bank because of their interest rate
sensitivity,  but they also involve more credit risk than  residential  mortgage
loans because of the higher potential of defaults and the difficulties  involved
in disposing of the collateral, if any.

      Commercial  Business Loans.  The Bank's  portfolio of commercial  business
loans amounted to $1.8 million,  or .6% of the Bank's total loan  portfolio,  at
December 31, 1996. These commercial business loans are underwritten on the basis
of the  borrower's  ability  to  service  such  debt  from  income.  The  Bank's
commercial  business loans are generally  made to small and mid-sized  companies
located within the Bank's primary lending area. In most cases, the Bank requires
additional  collateral  of  equipment,  chattel or other assets  before making a
commercial business loan.

      Loan Originations, Purchases and Sales. In the past, the Bank has retained
in its portfolio  most of the loans it originates.  However,  the Bank's general
policy is to originate  fixed-rate  mortgage  loans under terms,  conditions and
documentation  which permit sale to the FHLMC,  FNMA, or other  investors in the
secondary  market.  Adjustable-rate  mortgage loans are generally not originated
under  terms and  conditions  that  would  permit  their  sale in the  secondary
mortgage  market to FHLMC or FNMA. The Bank's policy has been to sell certain of
its fixed-rate  mortgage loan  originations.  These sales may result in gains or
losses. This policy was established to reduce the Bank's  vulnerability to rapid
interest  rate  movements  and to  provide  a  source  of  funding  for  ongoing
commitments.   Fixed-rate  mortgages  designated  for  sale  are  accounted  for
separately in accordance with applicable accounting rules. At December 31, 1996,
the Bank had no loans available-for-sale. The Bank continually monitors the loan
inventory and its commitments.

      Loan  Commitments.  The Bank issues loan  origination  commitments to real
estate  developers  and  qualified  borrowers  primarily  for the  construction,
purchase and refinancing of residential  real estate and commercial real estate.
Such  commitments are made on specified terms and conditions,  including in most
cases the payment of a  non-refundable  commitment  fee based on a percentage of
the amount of committed  funds.  At December 31, 1996, the Bank had unused lines
of credit and outstanding  loan origination  commitments of approximately  $26.2
million.

      Loan  Origination and Other Fees. In addition to interest earned on loans,
the Bank receives loan origination fees or "points" for originating  loans. Loan
points are a percentage of the  principal  amount of the mortgage loan which are
charged to the borrower for origination of the loan. The Bank's loan origination
fees generally range from 2% to 3% on conventional  residential mortgages and 1%
to 2% on  commercial  real  estate  loans.  All  loan  origination  fees  net of
incremental  direct loan origination  costs, are deferred and amortized over the
contractual life of the related loans.

      The Bank recognizes  other fees and service  charges on loans.  Other fees
and service charges consist of late fees, loan service fees, fees collected with
a change in borrower or other loan modifications. The Bank recognized other fees
and service  charges on loans of $122 thousand,  $157 thousand and $179 thousand
for the years ended December 31, 1996, 1995 and 1994, respectively.


                                      7

<PAGE>



      Residential  Mortgage Loan Servicing.  The Bank services loans retained in
its portfolio  and loans which were  originated by the Bank and sold through the
secondary  mortgage market with the servicing  rights to those loans retained by
the Bank.  The loan  servicing  activities  of the Bank include  collecting  and
remitting  loan  payments,  holding  escrow funds for the payment of real estate
taxes and insurance  premiums and generally  administering the loans.  Under the
loan  servicing  contracts,  the Bank receives  servicing fees that are withheld
from the monthly  payments  made to investors.  The  servicing  spreads on loans
serviced  are usually  based on the unpaid  principal  balance of the loan being
serviced  and  typically  range from .25  percent to .375  percent  per annum of
declining  principal  balance on the  loans.  At  December  31,  1996,  the Bank
serviced  for others 642 loans with an  outstanding  aggregate  balance of $29.3
million.  Loan servicing  income for the years ended December 31, 1996, 1995 and
1994, was $98 thousand, $113 thousand and $132 thousand, respectively.

      Collection  Procedures.  The Bank's collection  procedures  provide that a
late charge will be assessed after a loan is 15 days delinquent.  When a loan is
more than 30 days  delinquent,  the borrower  will be contacted by mail or phone
and payment requested. If the delinquency continues,  subsequent efforts will be
made to contact the  delinquent  borrower.  In certain  instances,  the Bank may
modify the loan or grant a limited  moratorium  on loan  payments  to enable the
borrower  to  reorganize  his  financial  affairs.  If the loan  continues  in a
delinquent  status  for 90  days or  more,  the  Bank  generally  will  initiate
foreclosure proceedings.

      Non-Performing  Loans.  Loans are generally  placed on non-accrual  status
when either principal or interest is 90 days or more past due.  Interest accrued
and unpaid at the time a loan is placed on non-accrual status is charged against
interest  income.  Subsequent  payments  are either  applied to the  outstanding
principal balance or recorded as interest income, depending on the assessment of
the ultimate collectibility of the loan.

      Impaired Loans.  The Bank considers all  non-accrual  loans as well as any
loans in which it is  probable  that the Bank  will be  unable  to  collect  all
amounts  due  according  to the  contractual  terms  of the  loan  agreement  as
impaired.  Small  balances of homogeneous  loans such as delinquent  residential
mortgages and delinquent  consumer  installment loans are collectively  measured
for  impairment  and a reserve is  established  based on  historical  loss data.
Certain  larger  balance  impaired  loans and other  impaired loans are reviewed
individually  and  reserves  are  established  based on a  discounted  cash flow
analysis or as a practical expedient,  the underlying collateral value. Interest
income on impaired loans is recognized on a cash basis.

                                      8

<PAGE>



      The  following  table sets forth  information  regarding  impaired  loans,
troubled debt restructured and real estate owned assets by the Bank at the dates
indicated.

<TABLE>
<CAPTION>
                                                                  At December 31,
                                                ------------------------------------------------

                                                1996        1995        1994      1993      1992
                                                ----        ----        ----      ----      ----
Impaired loans - non-accrual:                                  (Dollars in Thousands)
Mortgage loans:
<S>                                            <C>         <C>         <C>       <C>       <C>   
  One-to four-family .......................   $2,413      $2,502      $1,446    $3,395    $2,780
  Commercial real estate ...................    1,663       1,604       1,040     1,266     1,261
  Consumer and other .......................       15           6         469        13       571
                                               ------      ------      ------    ------    ------
    Total impaired non-accrual loans .......   $4,091      $4,112      $2,955    $4,674    $4,612
                                               ======      ======      ======    ======    ======

Other impaired loans .......................   $   --         354          --        --        --
Troubled debt restructuring ................      560(1)   $  634(1)   $1,143    $  663    $  642
Real estate owned, net .....................      622         669       1,812     1,624     1,714
Other non-performing assets ................    1,228       1,228       1,428     1,453     2,203
                                               ------      ------      ------    ------    ------
Total non-performing assets ................   $6,501      $6,997      $7,338    $8,414    $9,171
                                               ======      ======      ======    ======    ======

Total non-accrual loans to net loans .......     1.33%       1.43%       1.04%     1.74%     1.81%
                                               ======      ======      ======    ======    ======
Total non-accrual loans to total assets.....       76%       0.82%       0.61%     1.05%     1.07%
                                               ======      ======      ======    ======    ======
Total non-performing assets to total assets.     1.20%       1.39%       1.52%     1.89%     2.12%
                                               ======      ======      ======    ======    ======
</TABLE>


-----------------------------
(1)  Loans  restructured  prior  to SFAS  Nos.  114 and 118  effective  date and
performing in accordance with the terms of the restructuring agreement.

      Classified  Assets.  Classified  assets generally  consist of assets which
have  possible  credit risk and/or have  sufficient  degree of risk or potential
weakness  to warrant  management's  close  attention.  Each asset is  assigned a
quality rating based on management's best judgment concerning the degree of risk
and the  likelihood  of repayment or orderly  liquidation.  Quality  ratings are
divided into the  following  groups:  Pass and Special  Mention  (unclassified),
Substandard, Doubtful and Loss.

      An asset classified  Substandard is inadequately  protected by the current
net worth and paying  capacity of the obligor or of the collateral  pledged,  if
any. Assets so classified  have  well-defined  weakness or weaknesses.  An asset
classified  Substandard has shown an inability or  unwillingness  on the part of
the borrower  and/or  guarantors  to meet their  obligations  or the  collateral
securing the obligation has  deteriorated in some condition.  Such assets have a
well-defined weakness that points to the distinct possibility that the Bank will
not be paid back in a timely  fashion and it may require  legal action to effect
payment.

      An asset  classified  Doubtful  has all the  weaknesses  inherent in those
classified  Substandard with the added  characteristic  that the weaknesses make
collection or  liquidation  in full, on the basis of currently  existing  facts,
conditions, and values, highly questionable and improbable. The possibility of a
loss on a Doubtful  asset is high.  However,  due to  important  and  reasonably
specific  pending  factors,  which may work to strengthen (or weaken) the asset,
its  classification as an estimated loss is deferred until its more exact status
can be determined.

      An asset  classified Loss is considered  uncollectible  and of such little
value that its  continuance  as an asset,  without  establishment  of a specific
valuation  allowance or charge-off,  is not warranted.  This classification does
not necessarily  mean that an asset has absolutely no recovery or salvage value;
but

                                      9

<PAGE>



rather,  it is not  practical  or  desirable  to defer  writing  off a basically
worthless asset even though partial recovery may be effected in the future.

      Federal regulations require that each insured institution classify its own
assets on a regular  basis.  In addition,  in connection  with  examinations  of
insured institutions,  OTS and FDIC examiners have authority to identify problem
assets and, if appropriate,  classify them.  Assets classified as Substandard or
Doubtful  require the  institution  to  establish  general  allowances  for loan
losses.  If an  asset  or  portion  thereof  is  classified  Loss,  the  insured
institution  must either establish  specified  allowances for loan losses in the
amount of 100 percent of the portion of the asset classified Loss, or charge off
such amount.  General  loss  allowances  established  to cover  possible  losses
related  to  assets  classified  Substandard  or  Doubtful  may be  included  in
determining  an  institution's  regulatory  capital,  while  specific  valuation
allowances  for loan losses do not qualify as regulatory  capital.  OTS and FDIC
examiners may disagree with the insured institution's classification and amounts
reserved.



                                      10

<PAGE>



      The  following  table sets forth  information  with  respect to the Bank's
classified assets for the periods  indicated.  The Bank had no assets classified
as Loss for the periods indicated.

<TABLE>
<CAPTION>

                                                      At December 31,
                                     -------------------------------------------------
                                     1996       1995        1994       1993       1992
                                     -----     ------      ------     ------     -----
Classified Assets:                                      (In Thousands)
 Substandard Loans:
<S>                                 <C>        <C>         <C>        <C>       <C>   
  One- to four-family.........      $2,413     $2,502      $1,446     $3,395    $2,234
  Commercial real estate......       3,942      4,247       3,763      5,503     5,782
  Consumer and other..........          15          6         469         13       415
                                     -----    -------      ------     ------    ------
    Total loans...............       6,370      6,755       5,678      8,911     8,431
                                     -----      -----      ------     ------    ------

 Real Estate held for 
    development, net .........       1,228      1,228       1,428      1,453     2,203
 Real estate owned, net.......         622        669       1,812      1,624     1,714
                                     -----     ------      ------     ------    ------
  Total Substandard...........      $8,220     $8,652     $ 8,918    $11,988   $12,348
                                     =====      =====      ======     ======    ======
  Doubtful loans..............      $   --     $   --     $    --    $    --   $   625
                                     -----      -----      ------     ------    ------
  Total Doubtful..............      $   --     $   --     $    --    $    --   $   625
                                     =====      =====      ======     ======    ======
Total Classified Assets.......      $8,220     $8,652     $ 8,918    $11,988   $12,973
                                     =====      =====      ======     ======    ======
</TABLE>


      At December 31, 1996, the Bank's  non-performing loans consisted primarily
of loans  secured  by  residential  and  commercial  real  estate.  The  largest
non-performing  loan consisted of a loan in the amount of $709 thousand  secured
by a first mortgage on a commercial real estate  property  operating as a retail
liquor store.

      For a full  explanation of the Bank's real estate held for  development at
December 31, 1996, see "--Subsidiary and Land Development Activities".

      Real Estate Owned.  The Bank's real estate owned classified as Substandard
at December 31, 1996,  consisted of properties  valued at $1.1  million,  gross.
These  properties  are carried at the lower of book value or fair  market  value
less estimated costs to sell and are analyzed by management on a periodic basis.
The real estate  owned is comprised of (i) one  residential  single  family home
with a net book value of $65  thousand,  (ii) 18 acres of land,  with a net book
value of $818 thousand,  which is zoned for the  construction of 109 townhouses,
(iii)  a  condominium  with a net  book  value  of $38  thousand  and  (iv)  one
commercial  condominium  located in  Burlington  County with a net book value of
$138 thousand. See "-- Provision for Loan and Real Estate Losses."

      Provision for Loan and Real Estate Losses.  A provision for loan losses is
charged to operations  based on management's  evaluation of the risk inherent in
its loan portfolio in relation to the level of the allowance for loan losses and
changes  in the  nature  and  volume of its loan  activity.  For the year  ended
December  31,  1996,  the Bank  charged  $120  thousand  and $153  thousand,  to
operations   as  a  provision  for  losses  on  loans  and  real  estate  owned,
respectively.

      The Bank provides  valuation  reserves for anticipated losses on loans and
real estate when management  determines that a significant  decline in the value
of the  collateral  has  occurred,  as a  result  of  which,  the  value  of the
collateral  is less than the amount of the unpaid  principal of the related loan
plus  estimated  costs of  acquisition  and  sale.  In  addition,  the Bank also
provides reserves based on the dollar amount and type of collateral securing its
loans, in order to protect against unanticipated losses. Although

                                      11

<PAGE>



management  believes  that it uses the best  information  available to make such
determinations,  future adjustments to reserves may be necessary, and net income
could be significantly  affected, if circumstances differ substantially from the
assumptions used in making the initial determinations. At December 31, 1996, the
Bank had an  allowance  for loan  losses of $2.8  million and an  allowance  for
losses on real estate  owned of $437  thousand.  While the Bank  believes it had
established its existing  allowance for loan losses in accordance with Generally
Accepted  Accounting  Principles  ("GAAP") at December 31, 1996, there can be no
assurance  that  regulators,  when  reviewing  the Bank's loan  portfolio in the
future,  will not request the Bank to  significantly  increase its allowance for
loan losses,  thereby  adversely  impacting the Bank's  financial  condition and
earnings.

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

<TABLE>
<CAPTION>


                                                         For the Year Ended December 31,
                                            --------------------------------------------------------
                                             1996         1995        1994        1993        1992
                                             ----         ----        ----        ----        ----
                                                            (Dollars in Thousands)
<S>                                         <C>         <C>         <C>         <C>         <C>    
Balance at beginning of period ..........   $ 2,767     $ 2,622     $ 2,589     $ 2,380     $ 1,839
Loans charged-off:
  One-to four-family ....................      (114)        (13)        (44)         --         (18)
  Commercial real estate ................        --          --          --          --          --
  Construction ..........................        --          --          --          --          --
  Consumer ..............................        (1)         (6)        (37)         (8)         (6)
  Commercial business ...................        --          --         (38)         --         (95)
                                            -------     -------     -------     -------     -------
    Total charge-offs ...................      (115)        (19)       (119)         (8)       (119)
Recoveries ..............................        10          44          86          15           8
                                            -------     -------     -------     -------     -------
Net loans charged-off ...................      (105)         25         (33)          7        (111)
                                            -------     -------     -------     -------     -------
Provision for possible loan losses ......       120         120          66         202         652
                                            -------     -------     -------     -------     -------
Balance at end of period ................   $ 2,782     $ 2,767     $ 2,622     $ 2,589     $ 2,380
                                            =======     =======     =======     =======     =======
Ratio of net charge-offs to average loans
  outstanding during the period .........      0.36%     (0.009%)     0.012%     (0.003%)     0.046%


</TABLE>

                                            12

<PAGE>




      The  following  table sets forth the  breakdown of the  allowance for loan
losses by loan category and the percent of loans in each category to total loans
receivable  for the periods  indicated.  The allocation of the allowance to each
category is not  necessarily  indicative  of future losses and does not restrict
the use of the allowances to absorb losses in any category.

<TABLE>
<CAPTION>

                                                                        At December 31,
                               -----------------------------------------------------------------------------------------------------
                                    1996                  1995                1994                 1993                1992
                               ---------------------  -------------------  ------------------- ------------------ ------------------

                                         Percent of           Percent of           Percent of         Percent of         Percent of
                                          Loans to             Loans to             Loans to           Loans to           Loans to
                               Amount    Total Loans  Amount  Total Loans  Amount  Total Loans Amount Total Loans Amount Total Loans
                               -----     -----------  ------  -----------  ------  ----------- ------  ---------- ------ ----------

  Loans:                                                  (Dollars in Thousands)

<S>                          <C>      <C>   <C>     <C>         <C>      <C>        <C>       <C>        <C>   <C>          <C>   
One-to four-family ......... $1,716(1)(2)   82.22%  $1,718(3)   84.74%   $1,656     84.83     $1,613     86.00%$    927     85.08%
Commercial real estate .....    877(2)      12.50      819(4)   11.81       757     11.12        757     10.47      897     11.38
Commercial construction ....     44          1.51       --         --        --        --         --        --       --        --
Construction ...............     37          1.91       21       1.38        29      1.97         13      1.51       10      1.06
Consumer and other .........     76(1)       1.28       68(3)    1.47        70      1.49         66      1.52      286      1.62
Commercial business ........     32           .58      141(4)    0.60       110      0.59        140      0.50      260      0.86
                             ------        ------   ------     ------    ------    ------     ------    ------   ------    ------ 

    Total allowance for 
      loan losses........... $2,782        100.00%  $2,767     100.00%   $2,622    100.00%    $2,589    100.00%  $2,380    100.00%
                             ======        ======   ======     ======    ======    ======     ======    ======   ======    ====== 

</TABLE>

--------------------------------
(1)  Includes reserves for impaired loans  collectively  measured for impairment
     of  residential  real estate and  consumer  loans of $115  thousand and $15
     thousand, respectively.
(2)  Includes reserves for impaired loans  individually  measured for impairment
     of residential  real estate and commercial  real estate of $12 thousand and
     $262 thousand, respectively.
(3)  Includes reserves for impaired loans  collectively  measured for impairment
     of  residential  real estate and  consumer  loans of $144  thousand  and $6
     thousand, respectively.
(4)  Includes reserves for impaired loans  individually  measured for impairment
     of commercial real estate and commercial business of $241 thousand and $109
     thousand, respectively.



                                       13

<PAGE>



      Changes in the allowance for losses on real estate owned are as follows:

<TABLE>
<CAPTION>



                                                    Year Ended December 31,
                                      ------------------------------------------------- 
                                      1996       1995         1994       1993      1992
                                      ----       ----         ----       ----      ----
                                                    (In Thousands)
<S>                                   <C>       <C>          <C>        <C>       <C>  
Balance at beginning of year..        $313      $  79        $  --      $  --     $  16
Provisions charged to operations       153        354          158         29       729
Charge-offs...................         (30)      (120)         (79)       (29)     (745)
Recoveries....................           1         --           --         --        --
                                      ----      -----        -----      -----     -----  
  Balance at end of year......        $437      $ 313        $  79      $  --     $  --
                                      ====      =====        =====      =====     =====  
</TABLE>




Mortgage-Backed Securities

      The Bank purchases mortgage-backed securities guaranteed by the Government
National   Mortgage   Association   ("GNMA")  and  the  FNMA  and  participation
certificates   issued  by  the  FHLMC.  GNMA   mortgage-backed   securities  are
certificates issued and backed by the GNMA and are secured by interests in pools
of  mortgages  which are fully  insured by the  Federal  Housing  Administration
("FHA") or partially  guaranteed by the Veterans'  Administration  ("VA"). FHLMC
mortgage-backed  securities are participation certificates issued and guaranteed
by the  FHLMC  and  secured  by  interests  in pools of  conventional  mortgages
originated   by   financial   institutions.   At  December   31,   1996,   these
mortgage-backed  securities held to maturity,  consisting of GNMA, FHLMC,  FNMA,
and private  pass-through  certificates  amounted to $104.3 million or 19.26% of
total assets.

Investment Securities Held to Maturity and Securities Available for Sale

      Farmers and Mechanics investment policy is to ensure safety and soundness,
provide and maintain the liquidity ratios required under regulations of the OTS,
optimize  the  Bank's  return on  investments,  provide  low-risk,  high-quality
assets,  manage the overall interest rate sensitivity of the portfolio and serve
as a vehicle to absorb  excess funds when loan demand is low and to infuse funds
when loan demand is high. The amount of the Bank's  investment  portfolio at any
time  will  depend in part  upon the  Bank's  loan  origination  volume  and the
availability of attractive long-term investments. Investment decisions are based
on a thorough  analysis of each investment to determine  quality,  prospects for
yield and appreciation and any inherent risks. See "Regulation."

      At December 31, 1996, Farmers and Mechanics had an investment portfolio of
$93.0  million,  of which  $25.4  million  was  available  for sale,  consisting
primarily of U.S.  Government  securities  and  obligations  of U.S.  Government
agencies.  For more information on the Bank's investment  activities see Notes 2
and 3 of the Notes to the Consolidated  Financial  Statements.  Other investment
activities of the Bank, which are not reported as part of the Bank's  investment
portfolio,  include  an  investment  of $3.6  million  in FHLB  stock,  which is
required as part of its  membership  in the  Federal  Home Loan Bank system (see
"--Regulation -- Federal Home Loan Bank System"),  and $347 thousand in interest
bearing deposits and overnight investments.

                                      14

<PAGE>



      The following  table sets forth the carrying value and market value of the
Bank's investment securities held to maturity and securities available for sale,
FHLB stock, and interest bearing deposits and overnight investments at the dates
indicated.

<TABLE>
<CAPTION>

                                                              At December 31,
                                         ------------------------------------------------------------
                                               1996                 1995                 1994
                                         -------------------  -------------------  ------------------

                                                   Estimated            Estimated           Estimated
                                         Carrying   Market    Carrying    Market   Carrying  Market
                                          Value      Value      Value      Value    Value     Value
                                         --------  ---------  --------  ---------  -------- ---------
Investment securities held to maturity:                             (In Thousands)

<S>                                      <C>        <C>       <C>        <C>      <C>        <C>    
  U.S. government and agency securities  $46,792    $46,156   $34,086    $34,110  $20,964    $19,726
  Reverse Repurchase Agreements.......... 20,000     20,000     9,000      9,000       --         --
  Municipal bonds........................    795        800       464        464      240        235
  U.S. Treasuries........................     15         14        15         14       --         --
Investment securities available for sale:
  U.S. Agencies..........................  4,997      4,997     7,928      7,928       --         --
  U.S. Treasuries........................  1,999      1,999     1,980      1,980       --         --
  REMIC's................................  5,830      5,830     7,291      7,291    7,577      7,577
  CMO's.................................. 12,621     12,621     5,485      5,485    3,863      3,863
  Common Stock...........................     --         --        84         84       26         26
                                         -------    -------   -------    -------  -------    -------
      Total investment securities........ 93,049     92,417    66,333     66,356   32,670     31,427
                                         -------    -------   -------    -------  -------    -------
  Federal Home Loan Bank of New York
    stock................................  3,621      3,621     4,058      4,058    3,728      3,728
  Interest bearing deposits and overnight
    investments..........................    347        347       181        181    1,955      1,955
                                         -------    -------   -------    -------  -------    -------
     Total investments...................$97,017    $96,385   $70,572    $70,595  $38,353    $37,110
                                         =======    =======   =======    =======  =======    =======
</TABLE>




                                       15

<PAGE>



      The following table sets forth the scheduled maturities,  carrying values,
market  values  and  average  yields  for the Bank's  investment  securities  at
December 31, 1996.

<TABLE>
<CAPTION>

                                                                                       More than
                      One Year or Less   One to Five Years     Five to Ten Years        Ten Years        Total Investment Securities
                      -----------------  -------------------  -------------------  ------------------   ----------------------------
                      Carrying  Average  Carrying    Average   Carrying   Average  Carrying   Average   Carrying    Market   Average
                       Value    Yield     Value      Yield      Value     Yield     Value     Yield      Value      Value     Yield
                      -------  --------  -------    --------   --------   -------  --------   -------   --------   -------   -------

Investment securities 
 held to maturity                           (Dollars in Thousands)
 U.S. government and
<S>                    <C>       <C>       <C>        <C>      <C>        <C>      <C>         <C>      <C>        <C>        <C>  
  agency obligations   $2,000    5.60%     $2,994     5.74%    $16,250    7.49%    $25,548     7.59%    $46,792    $46,156    7.36%
 Municipal Bond.....      465     4.08        103      5.60         --       --        227      5.60        795        800     4.71
 Reverse Repurchase
  Agreements........   20,000     6.05         --        --         --       --         --        --     20,000     20,000     6.05
 U.S. Treasury......       --      --          15      3.50         --       --         --        --         15         14     3.50
 MBS................      630     7.46      9,621      7.30      7,440     7.72     86,622      7.54    104,313    105,558     7.53
Investment securities 
 available for sale:
 U.S. Treasury......    1,999     5.70         --        --         --       --         --        --      1,999      1,999     5.70
 U.S. Government....      996     4.95      4,001      5.98         --       --         --        --      4,997      4,997     5.98
 CMOs...............      259     7.00      3,186      6.52        822     8.31      8,354      7.08     12,621     12,621     7.02
 REMICs.............       --       --         --        --      1,973     5.15      3,857      5.28      5,830      5,830     5.25
                      -------    -----    -------     -----    -------    -----   --------     -----   --------   --------    -----
   Total............  $26,349     5.88%   $19,920      6.66%   $26,485     7.40%  $124,608      7.43%  $197,362   $197,975     7.17%
                      =======             =======              =======            ========             ========   ========   
</TABLE>






                                       16

<PAGE>



Subsidiary and Land Development Activities

      Farmers and Mechanics is generally  permitted to invest an amount equal to
3% of its total assets in subsidiary  service  corporations  with at least 1% of
that investment in community reinvestment activities.  Under such 3% limitation,
at December 31,  1996,  Farmers and  Mechanics  was  authorized  to invest up to
approximately  $16.2 million in the stock of or loans to its subsidiary  service
corporations.  As of  December  31,  1996,  the net  book  value  of the  Bank's
investment in stock,  unsecured  loans, and conforming loans in its subsidiaries
was $1.3  million,  all of which had been  invested in the Bank's  wholly  owned
subsidiary  corporations,   which  were  organized  to  engage  in  real  estate
development activities.

      Under  FIRREA,  savings  associations  are required to deduct from capital
their investments in, and extensions of credit to, service  corporations engaged
in activities  which are not  permissible  for national  banks.  The real estate
development activities of the Bank's service corporation are not permissible for
national  banks,  as  promulgated  by FIRREA.  At December 31, 1996,  the Bank's
investment in and advances to subsidiaries engaged in non-permissible activities
amounted  to $1.3  million  was  deducted  from  tangible,  core and  risk-based
capital.

      Real estate held for  development  represents a high degree of credit risk
because  of the  relatively  long  period of time  needed  to  obtain  necessary
developmental approvals and the uncertainty of future market conditions.  During
recent periods, conditions in the real estate market deteriorated as a result of
unfavorable interest rates, the general unavailability of credit, a slow down in
home sales and  construction,  and a surplus of  available  real  estate.  These
conditions have contributed to many project failures throughout the industry and
have reduced the demand for land. As a result, property values have declined and
substantial  losses  have been  incurred by many  institutions.  During the year
ended December 31, 1996,  and 1995,  the Bank recorded  provisions for losses on
real estate held for development  totalling $0 and $200 thousand,  respectively.
There can be no assurance  that  conditions in the economy or real estate market
will not deteriorate further.

      The Board of Directors of Land  Financial  Services,  Inc., a wholly owned
subsidiary  of the Bank,  passed a resolution  in February 1991 to cease all new
direct  real  estate  investment  activities.  In  addition,  the Board  further
resolved that there shall be no new real estate  investment  in connection  with
existing  assets  except those  investments  which are necessary to preserve and
protect the  existing  assets so that such assets can be  liquidated  as soon as
practical. Management believes that divesture of its present land investment may
take several years, depending on market conditions.

Deposit Activities and Other Sources of Funds

      General.  Deposits are the major source of Farmers and Mechanics funds for
lending and other  investment  purposes.  In addition to  deposits,  Farmers and
Mechanics  derives  funds  from  loan  principal  and  interest  repayments  and
prepayments,  principal and interest payments on mortgage-backed  securities and
other  investment  securities,  advances  from the  FHLB of New  York and  other
borrowings (see  "Borrowings"  below).  Loan repayments are a relatively  stable
source of funds,  while deposit  inflows and outflows and loan  prepayments  are
significantly  influenced by general interest rates and money market conditions.
Borrowings may be used on a short term basis to compensate for reductions in the
availability of funds from other sources. They may also be used on a longer term
basis for general business purposes.


                                      17

<PAGE>



     Deposits. Deposits are attracted from within the Bank's primary market area
of Burlington County,  New Jersey,  through the offering of a broad selection of
deposit instruments  including regular checking accounts,  non-interest checking
accounts,  money market  accounts,  regular passbook  accounts,  certificates of
deposit and IRA accounts.  Deposit account terms vary,  according to the minimum
balance  required,  the time  periods  the funds must  remain on deposit and the
interest rate, among other factors.  The Bank is a member of an automated teller
machine network.

      The Bank  regularly  evaluates the internal  cost of funds,  surveys rates
offered by competing institutions, reviews the Bank's cash flow requirements for
lending and  liquidity and executes  rate changes when deemed  appropriate.  The
Bank does not have any brokered  deposits and has no present intention to accept
or solicit such deposits.

      Certificates of Deposit Maturity Schedule.  The following table sets forth
the amount and maturities of the Bank's  certificates of deposit at December 31,
1996.

                       Less than     1 to       2 to       After
                         1 year     2 years   3 years     3 years     Total
                        --------    -------   -------     -------    ------
                                           (In Thousands)
 2.01 -  4.00%........  $  14,778   $      3  $     --    $    --   $  14,781
 4.01 -  6.00%........    116,916     38,634    13,444     19,931     188,925
 6.01 -  8.00%........      9,498      2,634     8,946     12,815      33,893
 8.01 - 10.00%........        187      1,099     1,923         77       3,286
10.01 - 12.00%........          3         --        12         54          69
                        ---------  ---------   -------    -------    --------

     Total............   $141,382    $42,370   $24,325    $32,877    $240,954




      Certificates  of  Deposit  in  Excess of  $100,000.  The  following  table
indicates the amount of the Bank's  certificates  of deposit of $100,000 or more
by time remaining until maturity as of December 31, 1996.

Maturity Period of Deposits                            Certificates of
---------------------------                            ---------------
                                                           Deposit
                                                           -------
                                                       (In Thousands)
Three months or less.............................           $3,722
Three through six months.........................            3,777
Six through twelve months........................            2,867
Over twelve months...............................            7,726
                                                           -------
     Total.......................................          $18,092





                                      18

<PAGE>



      Deposit  Rate.  The  following  table sets forth the  distribution  of the
Bank's deposit  accounts at the dates indicated and the weighted average nominal
interest rates on each category of deposits presented.

<TABLE>
<CAPTION>

                                                                       At December 31,
                             ---------------------------------------------------------------------------------------------------

                                         1996                               1995                             1994
                             -------------------------------    ------------------------------   -------------------------------
                                                   Weighted                          Weighted                          Weighted
                                       Percent of   Average                Percent    Average                Percent    Average
                             Average     Total      Nominal     Average   of Total    Nominal    Average    of Total    Nominal
                             Balance    Deposits     Rate       Balance   Deposits     Rate      Balance    Deposits     Rate
                             -------    --------    -------     -------   --------    -------    -------    ---------   -------

                                                                      (In Thousands)
<S>                          <C>           <C>         <C>      <C>         <C>         <C>      <C>         <C>         <C>  
Passbook and regular 
  savings.................   $ 69,666      16.22%      2.52%    $66,798     15.93%      2.54%    $66,608     15.52%      2.50%
Checking accounts.........     72,427      16.87        .96      63,607     15.17       1.11     60,226      14.03       1.09
Money market deposit 
  accounts................     57,399      13.37       2.65      58,990     14.06       2.66     71,423      16.64       2.67
Certificates of deposit...    228,974      53.32       5.30     229,103     54.63       5.21    221,990      51.70       4.44

Surrogate statement.......        947        .22       6.12         896      0.21       6.10      9,094       2.11       4.81
                             --------     ------       ----    --------    ------       ----   --------     ------       ---- 

  Total Deposits..........   $429,413     100.00%      3.77%   $419,394    100.00%      3.81%  $429,341     100.00%      3.39%
                              =======     ======       ====     =======    ======     ======    =======     ======     ======

</TABLE>





                                       19

<PAGE>



      Borrowings.  Savings  deposits are the primary source of funds for Farmers
and Mechanics  lending and investment  activities  and for its general  business
purposes.  From time to time, however, the Bank has relied upon other borrowings
to  supplement  its  supply of  lendable  funds and to meet  deposit  withdrawal
requirements.

      The FHLB functions as a central reserve bank providing  credit for savings
and loan  associations  and certain other member  financial  institutions.  As a
member,  Farmers and  Mechanics is required to own capital  stock in the FHLB of
New York and is  authorized  to apply for advances on the security of such stock
and certain of its home  mortgages  and other  assets  (principally,  securities
which are obligations of, or guaranteed by, the United States), provided certain
standards  related to credit  worthiness have been met. Under its current credit
policies,  the FHLB of New York limits advances to 30% of a member's assets.  At
December 31, 1996, the Bank had $32.6 million in FHLB advances  outstanding at a
weighted-average interest rate of 6.09%. The advances are collateralized by FHLB
stock and certain first mortgage loans.

      On July 28, 1994 the  Corporation  issued $10 million of 10%  Subordinated
Debentures (the  "Debentures")  due 2004.  Interest is payable on the Debentures
semi-annually  on February 1 and August 1 of each year. The Corporation made its
first interest  payment on the  Debentures on February 1, 1995. The  Corporation
used the proceeds for expansion of the Corporation's  operations  through branch
acquisitions and general corporate purposes. The Debentures were issued under an
Indenture  which provides that the  Corporation  cannot declare or pay dividends
on, or  purchase,  redeem or acquire  for value its  capital  stock,  return any
capital to holders of capital stock as such, or make any  distribution of assets
to capital  stockholders  as such,  unless,  from and after the date of any such
dividend  declaration or the date of any such purchase,  redemption,  payment or
distribution  specified above,  the Corporation  retains at all times cash, cash
equivalents  (as  determined in accordance  with generally  accepted  accounting
principles)  or  marketable  securities  (with a market value as measured on the
applicable Declaration Date or Redemption Date) in an amount sufficient to cover
the two consecutive semi-annual interest payments that will be due and payable.

Personnel

     As of December 31, 1996 the Corporation,  including its  subsidiaries,  had
170  full-time  employees  and 115  part-time  employees.  The employees are not
represented  by  a  collective   bargaining   unit.   Management   believes  its
relationship with its employees is good.

Competition

      The Bank faces strong  competition in its  attraction of savings  deposits
and in the  origination of real estate loans.  Its most direct  competition  for
savings  deposits  has  historically  come from other  thrift  institutions  and
commercial banks located in Burlington County and the contiguous  counties.  The
Bank's  competition  for real  estate  loans is  principally  from other  thrift
institutions, commercial banks, and mortgage banking companies.

      The Bank  competes for loans  principally  through the interest  rates and
loan fees it charges and the  efficiency and quality of the services it provides
borrowers,  real  estate  brokers,  and home  builders.  The Bank  competes  for
deposits by offering  depositors  a wide variety of savings  accounts,  checking
accounts,   convenient  office  locations  and  hours,  tax-deferred  retirement
programs and other miscellaneous services.

                                      20

<PAGE>




Regulation

      Set forth below is a brief  description  of certain laws which are related
to the  regulation of the Bank and the  Corporation.  The  description  does not
purport  to be  complete  and is  qualified  in its  entirety  by  reference  to
applicable laws and regulations.

Regulation of the Corporation

      General.  The  Corporation is a unitary  savings and loan holding  company
subject to regulatory oversight by the OTS. As such, the Corporation is required
to  register  and file  reports  with the OTS and is subject to  regulation  and
examination by the OTS. In addition,  the OTS has enforcement authority over the
Corporation and its non-savings association  subsidiaries which also permits the
OTS to restrict or prohibit  activities that are determined to be a serious risk
to the subsidiary savings association. This regulation and oversight is intended
primarily  for  the  protection  of the  depositors  of the  Bank  and  not  for
stockholders of the Corporation.

      Restrictions  on  Acquisitions.  If the  Corporation  acquires  control of
another savings  institution as a separate  subsidiary (other than a financially
troubled  institution  acquired  pursuant to special  provisions  of the Federal
Deposit Insurance Act), the Corporation would become a multiple savings and loan
holding company whose activities and those of its  subsidiaries  (other than the
Bank or any other  savings  association)  would become  subject to  restrictions
under the Home  Owners' Loan Act  ("HOLA").  No such  multiple  savings and loan
holding  company or  subsidiary  thereof that is not a savings  association  may
commence,  or continue for more than 180 days after becoming a multiple  savings
and loan holding company or subsidiary thereof, any business activity other than
(i)  furnishing  or  performing  management  services for a  subsidiary  savings
association;  (ii) conducting an insurance agency or an escrow  business;  (iii)
holding  or  managing  properties  used  or  occupied  by a  subsidiary  savings
association;  or (iv)  acting as a trustee  under deeds of trust.  In  addition,
unless  prohibited  or limited  by the OTS,  such a  multiple  savings  and loan
holding  company  may  engage in  non-banking  activities  permissible  for bank
holding companies,  including,  but not limited to, investment advice,  leasing,
underwriting credit insurance,  management  consulting services,  and securities
brokerage  activities,  as the Federal  Reserve Board  determines  under section
4(c)(8) of the Bank  Holding  Company  Act of 1956  ("BHCA"),  and may engage in
those activities authorized by the OTS. Such a multiple savings and loan holding
company must obtain prior OTS  approval  before it may engage in any  particular
activity  permissible  for bank holding  companies  under section 4(c)(8) of the
BHCA.

      Federal  law  generally  provides  that no  "person,"  acting  directly or
indirectly or through or in concert with one or more other persons,  may acquire
"control"  as that term is defined in OTS  regulations,  of a  federally-insured
savings  institution  without giving at least 60 days' written notice to the OTS
and providing the OTS an  opportunity  to disapprove  the proposed  acquisition.
Such acquisitions of control may be disapproved if it is determined, among other
things,  that (i) the acquisition would substantially  lessen competition;  (ii)
the financial  condition of the acquiring  person might jeopardize the financial
stability  of  the  savings  institution  or  prejudice  the  interests  of  its
depositors;  or (iii) the  competency,  experience or integrity of the acquiring
person or the proposed  management  personnel  indicates that it would not be in
the  interest  of the  depositors  or the public to permit the  acquisitions  of
control by such person.


                                      21

<PAGE>



      Payment of  Dividends.  The  Corporation's  principal  source of income is
dividends to the extent declared and paid by the Bank.  Therefore,  restrictions
on the Bank's ability to pay dividends may impact on the  Corporation's  ability
to pay dividends to stockholders.

Regulation of the Bank

      General. As a federally-chartered,  SAIF-insured savings bank, the Bank is
subject to extensive  regulation by the OTS and the FDIC. Lending activities and
other  investments  must comply with various  federal  statutory and  regulatory
requirements.   The  Bank  is  also  subject  to  certain  reserve  requirements
promulgated by the Federal Reserve Board.

      The OTS, in  conjunction  with the FDIC,  regularly  examines the Bank and
prepares  reports for the  consideration of the Bank's Board of Directors on any
deficiencies that they find in the Bank's  operations.  The Bank's  relationship
with its depositors and borrowers is also regulated to a great extent by federal
law,  especially  in such matters as the  ownership of savings  accounts and the
form and content of the Bank's mortgage documents.

      The Bank  must  file  reports  with the OTS and the  FDIC  concerning  its
activities  and  financial  condition,   in  addition  to  obtaining  regulatory
approvals  prior to entering into certain  transactions  such as mergers with or
acquisitions  of other savings  institutions.  This  regulation and  supervision
establishes a comprehensive  framework of activities in which an institution can
engage and is intended  primarily for the protection of the SAIF and depositors.
The  regulatory  structure  also  gives  the  regulatory  authorities  extensive
discretion in connection with their  supervisory and enforcement  activities and
examination  policies,  including policies with respect to the classification of
assets and the  establishment  of adequate  loan loss  reserves  for  regulatory
purposes.  Any change in such  regulations,  whether by the OTS, the FDIC or the
Congress could have a material adverse impact on the  Corporation,  the Bank and
their operations.

      The  Federal  Deposit  Insurance  Corporation   Improvement  Act  of  1991
("FDICIA")  imposes  a number  of  mandatory  supervisory  measures  on  savings
associations,  such as the Bank. The FDICIA requires  financial  institutions to
take certain actions relating to their internal operations, including: providing
annual reports on financial  condition and management to the appropriate federal
banking regulators;  having an annual independent audit of financial  statements
performed by an independent public  accountant;  and establishing an independent
audit committee  comprised solely of outside directors.  The FDICIA also imposes
certain operational and managerial standards on financial  institutions relating
to internal controls,  loan documentation,  credit  underwriting,  interest rate
exposure,  asset  growth,  compensation,  fees and  benefits.  The  FDICIA  also
requires the FDIC to assess  deposit  insurance  premiums  based on risk.  As of
December 31, 1996  management of the Bank believes it is in compliance  with the
regulations adopted pursuant to FDICIA.

      Insurance of Deposit Accounts.  The Bank's deposit accounts are insured by
the SAIF to a maximum of $100,000 for each insured member (as defined by law and
regulation).  FIRREA  gives  the FDIC  the  authority  to  suspend  the  deposit
insurance of any savings  association  without tangible capital.  However,  if a
savings association has positive capital when it includes qualifying  intangible
assets,  the FDIC cannot  suspend  deposit  insurance  unless  capital  declines
materially, the institution fails to enter into and remain in compliance with an
approved  capital plan or the  institution  is operating in an unsafe or unsound
manner.


                                      22

<PAGE>



      Regardless of an institution's capital level, insurance of deposits may be
terminated by the FDIC upon a finding that the institution has engaged in unsafe
or  unsound  practices,  is  in an  unsafe  or  unsound  condition  to  continue
operations  or has violated  any  applicable  law,  regulation,  rule,  order or
condition  imposed  by the  FDIC or the  institution's  primary  regulator.  The
management of the Bank is unaware of any practice,  condition or violation  that
might lead to termination of its deposit insurance.

      The FDIC charges an annual  assessment for the insurance of deposits based
on the risk a particular  institution  poses to its deposit insurance fund. This
risk  classification is based on an institution's  capital group and supervisory
subgroup  assignment.  In  addition,  the FDIC is  authorized  to increase  such
deposit  insurance  rates,  on a semi-annual  basis,  if it determines  that the
reserve  ratio of the SAIF will be less  than the  designated  reserve  ratio of
1.25% of SAIF-insured deposits. In setting these increased assessments, the FDIC
must seek to restore and preserve the ratio to that designated reserve level, or
such higher  reserve ratio as  established  by the FDIC. In addition,  under the
FDICIA, the FDIC may impose special assessments on SAIF members to repay amounts
borrowed from the U.S.  Treasury or for any other reason deemed necessary by the
FDIC. The Bank's federal  deposit  insurance  premium expense for the year ended
December 31, 1996, amounted to $947 thousand.

      Effective  September  30,  1996,  federal  law was  revised  to  mandate a
one-time  special  assessment on SAIF members such as the Bank of  approximately
 .657% of  deposits  held on March 31,  1995.  The Bank  recorded a $2.7  million
pre-tax  expense for this  assessment at September 30, 1996, and such assessment
was paid on November  27, 1996.  Effective  January 1, 1997,  deposit  insurance
assessments  for SAIF members were reduced on an annual basis through the end of
1999.  Thereafter,  assessments  for BIF and SAIF members are expected to be the
same and the SAIF and BIF may be merged.  It is expected  that these  continuing
assessments for both the SAIF and BIF members will be used to repay  outstanding
Financing Corporation bond obligations.  As a result of these changes, beginning
January 1, 1997, the rate of deposit insurance  assessed the Bank is expected to
decline.

      Examination  Fees.  In addition  to federal  deposit  insurance  premiums,
savings  institutions  like the  Bank are  required  by OTS  regulations  to pay
assessments to the OTS to fund the operations of the OTS. The general assessment
is paid on a  semi-annual  basis and is  computed  based on total  assets of the
institution, including subsidiaries.

      Regulatory Capital  Requirements.  OTS capital regulations require savings
institutions to meet three capital standards: (1) tangible capital equal to 1.5%
of total  adjusted  assets,  (2) a leverage  ratio (core capital) equal to 3% of
total adjusted assets and (3) a risk-based capital  requirement equal to 8.0% of
total risk-weighted assets.

      Tangible  capital is defined as core  capital less all  intangible  assets
(including  supervisory  goodwill),  plus purchased  mortgage  servicing  rights
valued  at the lower of the  maximum  percentage  established  by the OTS or the
amount   includable  in  core  capital.   Core  capital  is  defined  as  common
stockholders'  equity  (including  retained  income),   noncumulative  perpetual
preferred  stock and minority  interests in the equity  accounts of consolidated
subsidiaries,  plus purchased  mortgage  servicing rights valued at the lower of
90% of fair market value, 90% of original cost or 100% of the current  amortized
book value as determined under GAAP, and qualifying  supervisory goodwill,  less
nonqualifying intangible assets.

      The OTS leverage ratio  regulation  establishes a core capital ratio of at
least  3%  for  those  savings  associations  in  the  strongest  financial  and
managerial condition based on the "CAMEL" rating system in

                                      23

<PAGE>



use by the OTS at December  31, 1996.  Those  savings  associations  receiving a
CAMEL rating of "1", the best possible rating on a scale of 1 to 5, are required
to maintain a ratio of core  capital to adjusted  total  assets of 3%. All other
savings  associations  are required to maintain minimum core capital of at least
4% of total adjusted assets,  with a maximum core capital ratio  requirement 5%.
In determining the required  minimum core capital ratio, the OTS will assess the
quality of risk management and the level of risk in each savings  association on
a case-by-case  basis.  The OTS did not indicate in the proposed  regulation the
standards it will use in establishing the appropriate  core capital  requirement
for  savings  associations  not rated "1" under  the  CAMEL  rating  system.  At
December 31, 1996,  the Savings  Bank's ratio of core capital to total  adjusted
assets was 7.23%.

      The OTS  regulations  also  require  savings  associations  to deduct from
capital,  for purposes of meeting the leverage  tangible and risk-based  capital
requirements,  their  investments  in  and  loans  to a  subsidiary  engaged  in
activities not permissible for a national bank ("nonconforming subsidiaries") in
increasing amounts until fully deducted after June 30, 1994 (or June 30, 1996 if
the OTS specifically  permits such extended  period).  At December 31, 1996, the
Bank had $1.3 million  invested in  nonconforming  subsidiaries all of which was
deducted from the Bank's regulatory capital.

      On  January  20,  1993,  the  OTS  issued  a  statement  imposing  certain
limitations on the inclusion of net deferred tax assets calculated under FAS 109
in regulatory capital.  Deferred tax assets that are dependent on future taxable
income or the  institution's  tax planning  strategies  may only be counted as a
component  of Tier 1 capital to the extent they do not exceed the lesser of: (i)
10% of Tier 1 capital, or (ii) the amount of such benefits which may be realized
based on one year's projected earnings.

      The  risk-based  capital  standard for savings  institutions  requires the
maintenance of total  risk-based  capital (which is defined as core capital plus
supplementary  capital)  of 8.0% of  risk-weighted  assets.  The  components  of
supplementary capital include, among other items, cumulative perpetual preferred
stock,  perpetual  subordinated debt, mandatory  convertible  subordinated debt,
intermediate-term  preferred stock and the allowance for loan losses.  Allowance
for loan and lease losses  includable in  supplementary  capital is limited to a
maximum of 1.25% of  risk-weighted  assets.  Overall,  supplementary  capital is
limited  to 100% of core  capital.  A savings  association  must  calculate  its
risk-weighted  assets by multiplying  each asset and  off-balance  sheet item by
various risk factors as determined  by the OTS,  which range from 0% for cash to
100% for delinquent  loans,  property acquired through  foreclosure,  commercial
loans and other assets.

      OTS Regulations set forth the methodology for calculating an interest rate
risk ("IRR") component which is added to the risk-based capital requirements for
OTS regulated thrift institutions.  Under the Regulations,  savings associations
with a greater than "normal"  level of interest rate exposure will be subject to
a deduction  from total  capital for purposes of  calculating  their  risk-based
capital  requirement.  Specifically,  interest rate exposure will be measured as
the decline in net portfolio  value due to a 200 basis point  decrease in market
interest rates.  The IRR component to be deducted from total capital is equal to
one-half  the  difference  between an  institution's  measured  exposure and the
"normal"  level of  exposure  which is defined as two  percent of the  estimated
economic value of its assets.

      Prompt Corrective  Action.  The FDICIA also establishes a system of prompt
corrective  action to resolve  the  problems of  undercapitalized  institutions.
Under  this  system,  the  banking  regulators  are  required  to  take  certain
supervisory actions against undercapitalized institutions, the severity of which
depends upon the  institution's  degree of  capitalization.  Under the OTS final
rule implementing the prompt corrective action provisions,  an institution shall
be deemed to be (i) "well capitalized" if it has

                                       24

<PAGE>



total risk-based capital of 10.0% or more, has a Tier I risk-based capital ratio
(core or  leverage  capital  to  risk-weighted  assets)  of 6.0% or more,  has a
leverage  capital  of 5.0% or more  and is not  subject  to any  order  or final
capital  directive to meet and maintain a specific capital level for any capital
measure,  (ii)  "adequately  capitalized" if it has a total  risk-based  capital
ratio  of  8.0% or  more,  a Tier I  risked-based  ratio  of 4.0% or more  and a
leverage  capital ratio of 4.0% or more (3.0% under certain  circumstances)  and
does not meet the definition of "well capitalized," (iii)  "undercapitalized" if
it has a  total  risk-based  capital  ratio  that is less  than  8.0%,  a Tier I
risk-based capital ratio that is less than 4.0% or a leverage capital ratio that
is  less  than  4.0%  (3.0%  in  certain  circumstances),   (iv)  "significantly
undercapitalized"  if it has a total risk-based  capital ratio that is less than
6.0%,  a Tier I  risk-based  capital  ratio that is less than 3.0% or a leverage
capital ratio that is less than 3.0% and (v) "critically undercapitalized" if it
has a ratio of  tangible  equity to total  assets  that is equal to or less than
2.0% In addition,  under certain  circumstances,  a federal  banking  agency may
reclassify a well  capitalized  institution  as adequately  capitalized  and may
require an adequately capitalized institution or an undercapitalized institution
to comply  with  supervisory  actions as if it were in the next  lower  category
(except  that the  FDIC  may not  reclassify  a  significantly  undercapitalized
institution as critically undercapitalized).

      Dividend  and Other  Capital  Distribution  Limitations.  OTS  regulations
require  the  Bank to give  the OTS 30  days'  advance  notice  of any  proposed
declaration of dividends to the Corporation, and the OTS has the authority under
its supervisory  powers to prohibit the payment of dividends to the Corporation.
In  addition,  the Bank may not  declare or pay a cash  dividend  on its capital
stock if the effect  thereof  would be to reduce the  regulatory  capital of the
Bank below the amount required for the liquidation account established  pursuant
to the Bank's Conversion.

      OTS  regulations  impose  limitations  upon all capital  distributions  by
savings  institutions,  such  as  cash  dividends,  payments  to  repurchase  or
otherwise acquire its shares, payments to shareholders of another institution in
a cash-out  merger and other  distributions  charged against  capital.  The rule
establishes  three tiers of  institutions,  based primarily on an  institution's
capital level. An institution that exceeds all  requirements  before and after a
proposed capital distribution ("Tier 1 institution") and has not been advised by
the OTS that it is in need of more than the normal  supervision can, after prior
notice but without the approval of the OTS, make capital  distributions during a
calendar  year equal to the greater of (i) 100% of its net income to date during
the  calendar  year plus the amount that would  reduce by one-half  its "surplus
capital  ratio" (the excess over its capital  requirements)  at the beginning of
the  calendar  year,  or (ii) 75% of its net income  over the most  recent  four
quarter period.  Any additional capital  distributions  require prior regulatory
approval.  As of December 31, 1996,  the Bank was a Tier 1  institution.  In the
event the Bank's capital fell below its fully  phased-in  requirement or the OTS
notified  it that it was in need of more than  normal  supervision,  the  Bank's
ability to make capital distributions could be restricted.  In addition, the OTS
could prohibit a proposed capital  distribution by any institution,  which would
otherwise  be  permitted  by the  regulation,  if the OTS  determines  that such
distribution would constitute an unsafe or unsound practice.

      Finally, under the FDICIA, a savings association is prohibited from making
a  capital   distribution  if,  after  making  the  distribution,   the  savings
association would be "undercapitalized".

      Qualified Thrift Lender Test. HOLA requires savings institutions to meet a
QTL  test.  If the Bank  maintains  an  appropriate  level of  Qualified  Thrift
Investments (primarily residential mortgages and related investments,  including
certain  mortgage-backed  securities) ("QTIs") and otherwise qualifies as a QTL,
it will continue to enjoy full borrowing  privileges  from the FHLB of New York.
The  required  percentage  of QTIs is 65% of  portfolio  assets  (defined as all
assets minus intangible assets, property used

                                      25

<PAGE>



by the  institution in conducting its business and liquid assets equal to 10% of
total assets).  Certain assets are subject to a percentage  limitation of 20% of
portfolio assets. In addition,  savings associations may include shares of stock
of the FHLBs,  FNMA and FHLMC as  qualifying  QTIs.  The  method  for  measuring
compliance  with  the QTL  test is on a  monthly  basis  in nine out of every 12
months.  As of  December  31,  1996,  the  Bank was in  compliance  with its QTL
requirement with 79.72% of its assets invested in QTIs.

      Community  Reinvestment.  Under the Community Reinvestment Act ("CRA"), as
implemented  by OTS  regulations,  a savings  association  has a continuing  and
affirmative obligation consistent with its safe and sound operation to help meet
the credit needs of its entire  community,  including  low and  moderate  income
neighborhoods.  The CRA does not  establish  specific  lending  requirements  or
programs  for  financial   institutions  nor  does  it  limit  an  institution's
discretion  to develop the types of products and  services  that it believes are
best  suited  to its  particular  community,  consistent  with the CRA.  The CRA
requires the OTS, in connection with its  examination of a savings  institution,
to assess the institution's  record of meeting the credit needs of its community
and to take such record into account in its  evaluation of certain  applications
by such  institution.  The Bank received an "Outstanding"  rating as a result of
its last community reinvestment evaluation in October 1995.

      Loans-to-One  Borrower.  Under the HOLA, as amended,  savings institutions
are subject to the national bank limits on loans-to-one  borrower.  Generally, a
savings  association may not make a loan or extend credit to a single or related
group of borrowers in excess of 15% of the association's  unimpaired capital and
surplus.  An additional  amount may be lent, equal to 10% of unimpaired  capital
and surplus, if such loan is secured by readily-marketable  collateral, which is
defined to include  certain  securities  and  bullion,  but  generally  does not
include  real  estate.  The Bank does not have any loans to one  borrower  which
exceed these limits.

      Transactions With Related Parties. Generally, restrictions on transactions
with affiliates require that transactions  between a savings  association or its
subsidiaries  and  its  affiliates  be on  terms  as  favorable  to the  Bank as
transactions with non-affiliates. In addition, certain of these transactions are
restricted to a percentage of the Bank's capital. Affiliates of the Bank include
the  Corporation  and any company  which would be under common  control with the
Bank. In addition,  a savings  association may not lend to any affiliate engaged
in  activities  not  permissible  for a bank  holding  company  or  acquire  the
securities  of any  affiliate  which  is  not a  subsidiary.  The  OTS  has  the
discretion  to treat  subsidiaries  of savings  associations  as affiliates on a
case-by-case basis.

      Liquidity Requirements.  All savings associations are required to maintain
an average daily  balance of liquid assets equal to a certain  percentage of the
sum of its  average  daily  balance of net  withdrawable  deposit  accounts  and
borrowings payable in one year or less. The liquidity  requirement may vary from
time to time (between 4% and 10%) depending upon economic conditions and savings
flows of all savings  associations.  At the present  time,  the required  liquid
asset ratio is 5%. The Bank's  liquidity  ratio  equalled  11.6% at December 31,
1996.

      Liquid  assets for  purposes of this ratio  include  specified  short-term
assets (e.g.,  cash,  certain time deposits,  certain  banker's  acceptances and
short-term  U.S.  Government  obligations),  and long-term  assets  (e.g.,  U.S.
Government  obligations  of more  than one and less  than  five  years and state
agency obligations with a minimum term of 18 months). The regulations  governing
liquidity  requirements  include as liquid  assets debt  securities  hedged with
forward  commitments  obtained  from, or debt  securities  subject to repurchase
agreements  with,  members of the  Association of Primary  Dealers in the United
States  Government  Securities or banks whose  accounts are insured by the FDIC,
debt securities directly hedged with a short financial future position, and debt
securities that provide the holder with a right to redeem

                                      26

<PAGE>



the  security  at  par  value,  regardless  of  the  stated  maturities  of  the
securities. FIRREA also authorized the OTS to designate as liquid assets certain
mortgage-related  securities  with  less than one year to  maturity.  Short-term
liquid assets currently must constitute at least 1% of an association's  average
daily  balance of net  withdrawable  deposit  accounts  and current  borrowings.
Monetary  penalties may be imposed upon associations for violations of liquidity
requirements.

      Federal  Home  Loan Bank  System.  The Bank is a member of the FHLB of New
York,  which is one of 12 regional  FHLBs that  administers  the home  financing
credit  function  of  savings  associations.  Each FHLB  serves as a reserve  or
central bank for its members within its assigned region.  It is funded primarily
from  proceeds  derived from the sale of  consolidated  obligations  of the FHLB
System.  It makes loans to members (i.e.,  advances) in accordance with policies
and procedures established by the Board of Directors of the FHLB.

      As a member,  the Bank is required to purchase and  maintain  stock in the
FHLB of New York in an  amount  equal to at  least  1% of its  aggregate  unpaid
residential  mortgage loans, home purchase  contracts or similar  obligations at
the beginning of each year.  At December 31, 1996,  the Bank had $3.6 million in
FHLB stock, which was in compliance with this requirement.

      The FHLB is  required  to provide  funds for the  resolution  of  troubled
savings  associations  and to contribute to affordable  housing programs through
direct loans or interest subsidies on advances targeted for community investment
and  low-  and  moderate-income  housing  projects.   These  contributions  have
adversely  affected the level of FHLB dividends paid and could continue to do so
in the future. For the year ended December 31, 1996,  dividends paid by the FHLB
of New York to the Bank totalled $253 thousand.

      Federal Reserve System.  The Federal Reserve Board requires all depository
institutions  to maintain  non-interest  bearing  reserves at  specified  levels
against  their  transaction  accounts  (primarily   non-interest   checking  and
interest-bearing checking accounts) and non-personal time deposits. The balances
maintained to meet the reserve requirements imposed by the Federal Reserve Board
may be used to satisfy the liquidity requirements that are imposed by the OTS.

      Savings  associations  have  authority to borrow from the Federal  Reserve
Bank "discount  window," but Federal Reserve policy  generally  requires savings
associations  to exhaust  all OTS  sources  before  borrowing  from the  Federal
Reserve System. The Bank had no such borrowings at December 31, 1996.


                                      27

<PAGE>



Item 2.  Properties

      The following table sets forth the location of the Bank's offices, the net
book value of each facility,  including  furniture,  fixtures and equipment,  as
well as certain additional  information relating to these offices as of December
31, 1996.  The net book value of the Bank's  investment  in office  property and
equipment,  including  electronic  data  processing  equipment,  totalled  $14.8
million at December 31, 1996.

<TABLE>
<CAPTION>

                                  Year Facility
                                    Opened or                           Square   
                                    Acquired     Total      Net Book  Footage of    Owned/
                                    in Merger  Investment    Value(1)  Building     Leased
                                    ---------  ----------    --------  --------     ------
                                                 (Dollars    in Thousands)
                                                            
<S>                                   <C>        <C>         <C>      <C>           <C>      
Burlington Township..............     1962       $3,536      $1,525    6,624        Owned
  Administrative Building                                   
  811 Sunset Road & Salem Road                              
  Burlington, NJ  08016                                     
                                                            
Burlington Township..............     1992        2,819       2,131   24,315        Owned
  Administrative Building                                   
  3 Sunset Road & Route 541                                 
  Burlington, NJ  08016                                     
                                                            
Burlington Township Branch.......     1984        1,209         852    3,512        Owned
  809 Sunset Road & Salem Road                              
  Burlington, NJ  08016                                     
                                                            
City of Burlington Branch........     1958          358         149    3,575        Owned
  352 High Street                                           
  Burlington, NJ 08016                                      
                                                            
Medford Lakes Branch.............     1967          519         178    1,848        Owned
  Lakes Shopping Center                                     
  712 Stokes Road                                           
  Medford, NJ 08055                                         
                                                            
Moorestown Branch................     1979        1,061         601    5,473        Owned
  53 East Main Street                                       
  Moorestown, NJ 08057                                      
                                                            
Edgewater Park Branch............     1975          774         545    2,600        Owned
  1149 Cooper Street & Elm Street                           
  Edgewater, NJ 08010                                       
                                                            
Mt. Laurel Branch................     1973        1,590       1,109    4,700        Owned
  4522 Church Road & Church Street                          
  Mt. Laurel, NJ 08054                                      
                                                            
Lumberton Branch.................     1991          764         550    2,856       Leased (2)
  Lumberton Plaza                                       
  1636-61 Route 38                                          
  Lumberton, NJ 08048                                       
                                                            
Willingboro Branch...............     1991          418         338    1,617        Owned
  399 Charleston Road & JFK Way                             
  Willingboro, NJ 08046                                  

</TABLE>


                                       28

<PAGE>

<TABLE>
<CAPTION>
                                    Year Facility
                                      Opened or                           Square   
                                      Acquired       Total     Net Book  Footage of   Owned/
                                      in Merger    Investment  Value(1)  Building     Leased
                                      ---------  ----------    --------  --------     ------



<S>                                      <C>           <C>      <C>      <C>          <C>      
Medford Branch................           1991          117       32       2,500       Leased
  Taunton Forge Shopping Center          
  200 Tuckerton Road & Taunton Road      
  Medford, NJ 08055                      
                                         
Southampton Branch............           1992          656      528       2,250        Owned
  1841 Route 70 & Red Lion Circle        
  Southampton, NJ  08088                 
                                         
Eastampton Branch.............           1994          565      452       2,266        Owned
  1191 Woodlane Road                     
  Eastampton, NJ  08060                  
                                         
Willingboro East Branch.......           1994          625      521       3,200        Owned
  611 Beverly-Rancocas Road              
  Willingboro, NJ 08046                  
                                         
Willingboro West Branch.......           1994          405      363       2,130        Owned
  1 Rose Street & Beverly-Rancocas Road    
  Willingboro, NJ 08046                  
                                         
Delran Branch.................           1995          630      606       2,891        Owned
  3002 North Route 130                   
  Delran, NJ 08075                       
                                         
Bordentown Branch.............           1995(5)       486      460       3,600        Owned
  335 Farnsworth Avenue                  
  Bordentown, NJ 08505                   
                                         
Main Branch...................           1996(6)        89       75       3,600        Owned
  3 Sunset Road & Route 541              
  Burlington, NJ 08016                   
                                         
Riverton Branch...............           1996(7)       530      524       7,600        Owned
  604 Main and Harrison Streets          
  Riverton, NJ 08077                     
                                         
Larchmont Branch..............           1996(8)       488      486       3,450        Owned
  3320 Route 38                          
  Mt. Laurel, NJ 08054                   
                                      
Voorhees Land.................           1990          373      373         N/A        Owned
  Evesham Road & Main Street             
  Voorhees, NJ 08043                     
                                         
Cinnaminson Building..........           1994(3)       545      541      32,200        Owned
  2601 & 2603 Route 130               
  Cinnaminson, NJ 08077

Medford 541 Land..............           1994(4)       262      262         N/A        Owned
  7 Wilkins Station Road
  Medford, NJ 08055

</TABLE>


                                       29

<PAGE>
<TABLE>
<CAPTION>

                              Year Facility
                                Opened or                                 Square   
                                Acquired       Total       Net Book     Footage of    Owned/
                                in Merger    Investment    Value(1)      Building     Leased
                                ---------    ----------    --------      --------     ------



<S>                              <C>         <C>        <C>              <C>           <C>
Cinnaminson Land..............     1995          182        182            N/A         Owned
  1703 Highland Avenue
  Cinnaminson, NJ 08077

Medford 541-2 Land............     1995          267        267            N/A         Owned
  Church Road & Route 541
  Medford, NJ 08055

Medford Lakes Property........   1996(9)         794        794          6,570         Owned
  700 Stokes Road
  Medford, NJ 08055

Burlington Land...............   1996(10)        312        312            N/A         Owned
  Neck Road
  Burlington, NJ 08016
                                             -------    -------
    Total.....................               $20,374    $14,756
                                             =======    =======
</TABLE>


--------------------
(1)  As of December 31, 1996.  Represents the net book value of land,  building,
     furniture, fixtures and equipment owned by the Bank.
(2)  Lease expires August 20, 2021.
(3)  Purchased in April 1994, a future location for retail banking.
(4)  Medford 541 land  purchased in September  1994,  will be put up for sale in
     lieu of another parcel of land.
(5)  Branch opened in February 1996.
(6)  Branch opened in April 1996.
(7)  Branch opened in September 1996.
(8)  Branch opened in November 1996.
(9)  Purchased in May 1996 and is a future location for retail banking.
(10) Purchased in December 1996 and is a future location for retail banking.

Item 3.  Legal Proceedings
--------------------------

      The Bank is  periodically  involved as a plaintiff or defendant in various
legal  actions,  such as actions to enforce liens,  condemnation  proceedings on
properties in which the Bank holds  mortgage  interests,  matters  involving the
making and servicing of mortgage loans and other matters  incident to the Bank's
business. In the opinion of management, none of these actions individually or in
the aggregate is believed to be material to the  financial  condition or results
of operations of the Bank.

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

     No matters were  submitted to a vote of security  holders during the fourth
quarter of the fiscal year ended December 31, 1996.

                                    Part II

Item 5.  Market  for the  Registrant's  Common  Equity and  Related  Stockholder
-------------------------------------------------------------------------------
         Matters
         -------

     The  information  contained  under  the  section  captioned  "Stock  Market
Information" in the  Corporation's  Annual Report to Stockholders for the Fiscal
Year Ended  December 31, 1996 (the "Annual  Report") is  incorporated  herein by
reference.


                                       30

<PAGE>



Item 6.  Selected Financial Data
--------------------------------

     The information contained in the table captioned "Financial  Highlights" in
the Annual Report is incorporated herein by reference.

Item 7. Management's  Discussion and Analysis of Financial Condition and Results
--------------------------------------------------------------------------------
        of Operations
        -------------

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

Item 8.  Financial Statements and Supplementary Data
----------------------------------------------------

      The  Corporation's  financial  statements are listed in Item 14 herein are
incorporated herein by reference.

Item  9.  Changes  in and  Disagreements  with  Accountants  on  Accounting  and
          ----------------------------------------------------------------------
          Financial Disclosure
          --------------------


      None.

                                   Part III

Item 10.  Directors and Executive Officers of the Registrant

     The  information  contained  under the  section  captioned  "Proposal  I --
Election of Directors" in the  Corporation's  definitive proxy statement for the
Corporation's  1997 Annual Meeting of  Stockholders  (the "Proxy  Statement") is
incorporated herein by reference.

      The executive officers of the Corporation are as follows:

Name                         Age(1)    Position
----                         ------    --------

Charles B. Yates..........     57      Chairman of the Board

Craig W. Yates............     54      President and Chief Executive Officer

Channing L. Smith.........     53      Vice President and Chief Financial
                                       Officer

James E. Igo..............     40      Senior Vice President and Chief
                                       Lending Officer

Thomas M. Topley..........     36      Senior Vice President and Corporate
                                       Secretary



                                      31

<PAGE>



--------------
(1)  At December 31, 1996.

      The principal office of each executive officer is set forth below.

      Charles B. Yates is Chairman of the Board of the Corporation and the Bank.
Mr.  Yates has been a  private  investor  for seven  years.  He  previously  was
president  of  Yates  Industries,   Inc.,  a  New  York  Stock  Exchange  listed
manufacturing  company from 1967 to 1982.  He was also Vice Chairman of Square D
Corporation from 1982 to 1983 and served as Assemblyman and State Senator in the
New Jersey Legislature from 1972 to 1982.

      Craig W. Yates serves as President and Chief Executive Officer.  He became
a director of the Bank in January 1990 and President of the  Corporation and the
Bank on December 31, 1990. For the previous five years,  Mr. Yates was a private
investor.  In his  capacity  as  President,  Mr.  Yates is  responsible  for the
operations of the Corporation pursuant to the policies and procedures adopted by
the Board of Directors.

      Channing L. Smith serves as Vice  President  and Chief  Financial  Officer
since October 1994. In this capacity he is responsible for the management of the
accounting,  treasury,  investment,  and human resources of the Bank. From April
1994 to October 1994, he served as  controller.  From January 1990 to April 1993
he served as corporate Controller for Circuit Foil USA.

      James E. Igo has  served as Vice  President  and Senior  Mortgage  Lending
Officer since November 1991. In that capacity he is responsible for overall loan
production, credit quality, product development, loan servicing and the creation
of lending  policies and  procedures.  From  September 1990 to November 1991, he
served as the Vice  President,  Commercial  Lending.  Prior to 1990, Mr. Igo was
Senior Vice President and Senior Lending Officer for a commercial bank.

      Thomas M. Topley has served as Vice  President of  Operations  since April
1993 and as  Corporate  Secretary  since April  1992.  In that  capacity,  he is
responsible for corporate records, retail branch administration, data processing
and accounting operations. From June 1990 to April 1993, Mr.
Topley served as Vice President and Controller for the Bank.

Item 11.  Executive Compensation
--------------------------------

      The  information  contained  under the  section  captioned  "Proposal I --
Election  of  Directors  Executive  Compensation"  in  the  Proxy  Statement  is
incorporated herein by reference.

Item 12.  Security Ownership of Certain Beneficial Owners and Management
------------------------------------------------------------------------

      (a)   Security Ownership of Certain Beneficial Owners

            Information   required  by  this  item  is  incorporated  herein  by
            reference to the Section captioned "Voting  Securities and Principal
            Holders Thereof" of the Proxy Statement.

      (b)   Security Ownership of Management


                                      32

<PAGE>



            Information   required  by  this  item  is  incorporated  herein  by
            reference  to the  section  captioned  "Proposal  I --  Election  of
            Directors" of the Proxy Statement.

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

Item 13.  Certain Relationships and Related Transactions
--------------------------------------------------------

      The information  required by this item is incorporated herein by reference
to the section  captioned  "Proposal I --  Election  of  Directors"  and "Voting
Securities and Principal Holders Thereof" of the Proxy Statement.

                                    Part IV

Item 14.  Exhibits, Financial Statements, and Reports on Form 8-K*
-----------------------------------------------------------------

      (a)   The following documents are filed as part of this report:

            1.    The  following   financial   statements   and  the  report  of
                  independent   auditors  of  the  Registrant  included  in  the
                  Registrant's   1996   Annual   Report  to   Stockholders   are
                  incorporated herein by reference and also in Item 8 hereof.

                  (a)   Report of Coopers & Lybrand L.L.P.

                  (b)   Consolidated  Statements  of  Financial  Condition as of
                        December 31, 1996 and 1995

                  (c)   Consolidated  Statements  of  Operations  for the  years
                        ended December 31, 1996, 1995 and 1994

                  (d)   Consolidated  Statements  of Cash  Flows  for the  years
                        ended December 31, 1996, 1995 and 1994

                  (e)   Consolidated  Statements  of  Changes  in  Stockholders'
                        Equity for the years ended  December 31, 1996,  1995 and
                        1994

                  (f)   Notes to Consolidated Financial Statements

            2.    No financial  statement  schedules are provided herein because
                  the  required  information  is either  not  applicable  or not
                  required or is shown in the consolidated  financial statements
                  or in the notes thereto.

            3.    Exhibits

                  3.1   Certificate of Incorporation  (Incorporated by reference
                        to the Registrant's Form S-1 Registration  Statement No.
                        33-24340).

                  3.2   Bylaws  (Incorporated  by reference to the  Registrant's
                        Form S-1 Registration Statement No. 33-24340).

                                      33

<PAGE>




                  4     Agreement  to furnish  copy to  Securities  and Exchange
                        Commission  upon  request  of  Indenture  dated July 28,
                        1994,  relating to 10% Subordinated  Debentures due 2004
                        in   aggregate   principal   amount   of  $10   million.
                        (Incorporated by reference to Registrant's Annual Report
                        on Form 10-K for the  fiscal  year  ended  December  31,
                        1994).

                  10.1  Stock  Option  and  Incentive  Plan   (Incorporated   by
                        reference  to the  Registrant's  Form  S-8  Registration
                        Statement No. 33-24340).

                  11    Statement regarding computation of per share earnings.

                  13    Annual Report to Stockholders  for the Fiscal Year Ended
                        December 31, 1996.

                  21    Subsidiaries of the Registrant

                  23    Consent of Independent Auditors


      (b)   No  Reports on Form 8-K were  filed  during the last  quarter of the
            fiscal year covered by this Report.

-------------------
*     Incorporated  by reference  from the  Registrant's  1996 Annual  Report to
      Stockholders attached hereto as Exhibit 13.


                                      34

<PAGE>




                                  SIGNATURES

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

                                             FMS FINANCIAL CORPORATION

Date: March 28, 1997                     By: /s/ Craig W. Yates
      -----------------                  --------------------------------
                                         Craig W. Yates, President and
                                         Chief Executive Officer
                                         (Duly Authorized Representative)

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

        Signatures                                                 Dated


/s/ Charles B. Yates                                           March 28, 1997 
------------------------------------------------          ----------------------
Charles B. Yates
Chairman of the Board


/s/ Craig W. Yates                                             March 28, 1997 
------------------------------------------------          ----------------------
Craig W. Yates
President, Chief Executive Officer and Director
(Principal Executive Officer)


/s/ George J. Barber                                           March 28, 1997 
------------------------------------------------          ---------------------
George J. Barber, Director


/s/ Channing L. Smith                                          March 28, 1997 
------------------------------------------------          ---------------------
Channing L. Smith
Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)


/s/ Edward J. Staats, Jr.                                      March 28, 1997 
------------------------------------------------          ---------------------
Edward J. Staats, Jr., Director


/s/ Wayne H. Page                                              March 28, 1997 
------------------------------------------------          ---------------------
Wayne H. Page, Director


/s/ James C. Lignana                                           March 28, 1997  
------------------------------------------------          ---------------------
James C. Lignana, Director


/s/ Dominic W. Flamini                                         March 28, 1997 
------------------------------------------------          ---------------------
Dominic W. Flamini, Director


/s/ Vincent R. Farias                                          March 28, 1997 
------------------------------------------------          ----------------------
Vincent R. Farias, Director



<PAGE>




                               INDEX TO EXHIBITS




EXHIBIT

3.1       Certificate  of  Incorporation   (Incorporated  by  reference  to  the
          Registrant's Form S-1 Registration Statement No. 33-24340).

3.2       Bylaws  (Incorporated  by  reference  to  the  Registrant's  Form  S-1
          Registration Statement No. 33-24340).

4         Agreement to furnish copy to Securities and Exchange  Commission  upon
          request of Indenture dated July 28, 1994, relating to 10% Subordinated
          Debentures  due 2004 in  aggregate  principal  amount of $10  million.
          (Incorporated by reference to Registrant's  Annual Report on Form 10-K
          for the fiscal year ended December 31, 1994).

10.1      Stock  Option and  Incentive  Plan  (Incorporated  by reference to the
          Registrant's Form S-8 Registration Statement No. 33-24340).

11        Statement regarding computation of per share earnings.

13        Annual Report to  Stockholders  for the Fiscal Year Ended December 31,
          1996.

21        Subsidiaries of the Registrant.

23        Consent of Independent Auditors

27        Financial Data Schedule