SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549


                                    FORM 10-K

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

                     For the fiscal year ended June 30, 1997

                                       OR

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

          For the transition period from __________ to _______________

                          Commission File No.: 0-27388

                              HFNC Financial Corp.
             (Exact name of registrant as specified in its charter)


         North Carolina                                        56-1937349
  (State or other jurisdiction                              (I.R.S. Employer
of incorporation or organization)                        Identification Number)

      139 South Tryon Street
    Charlotte, North Carolina                                    28202
            (Address)                                          (Zip Code)


       Registrant's telephone number, including area code: (704) 373-0400

   Securities registered pursuant to Section 12(b) of the Act: Not Applicable

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

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

Indicate by check mark whether the Registrant (1) has filed all reports required
by  Section  13 or 15(d)  of the  Securities  Exchange  Act of 1934  during  the
preceding 12 months (or 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 ]
<PAGE>
Based upon the  $16.00  closing  price of the  Registrant's  common  stock as of
September 26, 1997, the aggregate  market value of the 14,775,901  shares of the
Registrant's  common stock deemed to be held by non-affiliates of the Registrant
was: $236.4 million. Although directors and executive officers of the Registrant
and certain of its employee benefit plans were assumed to be "affiliates" of the
Registrant for purposes of this  calculation,  the  classification  is not to be
interpreted as an admission of such status.

     Number of shares of Common Stock outstanding as of September 26, 1997:
                                   17,192,500


                       DOCUMENTS INCORPORATED BY REFERENCE

         List hereunder the following  documents  incorporated  by reference and
the Part of the Form 10-K into which the document is incorporated.

(1) Portions of the Annual  Report to  Stockholders  for the year ended June 30,
1997 are incorporated into Part II, Items 5 through 8 of this Form 10-K.

(2) Portions of the  definitive  proxy  statement for the 1997 Annual Meeting of
Stockholders to be filed within 120 days of June 30, 1997 are incorporated  into
Part III, Items 9 through 13 of this Form 10-K.
<PAGE>
PART I

Item 1. Business.

General

         HFNC Financial Corp.  (the  "Company") is a North Carolina  corporation
organized in August 1995 by Home  Federal  Savings and Loan  Association  ("Home
Federal" or the  "Association")  for the  purpose of becoming a unitary  holding
company of the Association.  The Association's  conversion to stock form and the
concurrent  offer and sale of the  Company's  common  stock was  consummated  on
December 28, 1995 (the "Conversion"). The only significant assets of the Company
are  the  capital  stock  of the  Association  and  the  capital  stock  of HFNC
Investment Corp., a Delaware chartered finance subsidiary  ("Investment Corp.").
The  business  and  management  of the  Company  consists  of the  business  and
management of the Association and Investment Corp. At June 30, 1997, the Company
had $892.9  million in total assets,  $731.9  million in total  liabilities  and
$161.1 million in total equity.

         Home Federal  conducts  business  from its main office and eight branch
offices and a loan origination office, all located in Mecklenberg County,  North
Carolina. All but one of the Association's offices are located in Charlotte. The
region  has become a major  center  for  financial  services,  distribution  and
transportation.  Home Federal's deposits are insured by the Savings  Association
Insurance Fund ("SAIF"),  which is administered by the Federal Deposit Insurance
Corporation ("FDIC"), to the maximum extent permitted by law.

         The Association is a community  oriented savings  institution which has
traditionally offered a wide variety of savings products to its retail customers
while  concentrating its lending  activities on the origination of loans secured
by one- to four-family residential dwellings, including an emphasis on loans for
construction of residential  dwellings.  To a significantly  lesser extent,  the
Association's  activities  have also included  origination  of  commercial  real
estate,  land  and  consumer  loans.  In  addition,   the  Company  maintains  a
significant portfolio of investment securities, which amounted to $175.7 million
or 19.7% of total  assets  at June 30,  1997,  approximately  37% of which  have
maturities  of under five years.  In  addition  to interest  income on loans and
investments,  the Company  receives  other income  primarily  from loan fees and
various service charges.

         The  Association  currently  exceeds  all  minimum  regulatory  capital
requirements.  At  June  30,  1997,  the  Association  had  tangible,  core  and
risk-based capital ratios of 18.9%, 18.9% and 36.5%,  respectively,  as compared
to the minimum requirements of 1.5%. 3.0% and 8.0%, respectively.

         The Association is subject to examination and comprehensive  regulation
by the  Office  of  Thrift  Supervision  ("OTS"),  which  is  the  Association's
chartering authority and primary regulator. The Association is also regulated by
the FDIC,  the  administrator  of the SAIF.  The  Association is also subject to
certain reserve  requirements  established by the Federal Reserve Board and is a
member of the Federal Home Loan Bank ("FHLB") of Atlanta, which is one of the 12
regional banks comprising the FHLB System.

Lending Activities

         General.  At June 30, 1997, the  Association's  total loans  receivable
portfolio ("total loan portfolio") amounted to $704.3 million, or 78.9% of total
assets at such date. The Association has traditionally  concentrated its lending
activities  on  conventional  first  mortgage  loans  secured  by  single-family
residential properties.  Consistent with its lending orientation, $561.4 million
or 79.7% of the  Association's  total loan  portfolio  consisted of  one-to-four
family  residential  loans  at June  30,  1997.  In  addition,  the  Association
originates  residential  construction loans,  commercial real estate loans, land
loans and consumer loans.  At June 30, 1997,  such loan  categories  amounted to
$68.4 million, $30.6 million, $20.0 million and $23.9 million,  respectively, or
9.7%,  4.3%,  2.8% and  3.5% of the  total  loan  portfolio,  respectively.  The
Association  does not offer  loans  which are  insured  by the  Federal  Housing
Administration  or  partially  guaranteed  by the  Office of  Veterans  Affairs.
Virtually  all of the  Association's  mortgage  loans are secured by  properties
located in its primary market area.

                                        1
<PAGE>
         Loan  Portfolio  Composition.   The  following  table  sets  forth  the
composition  of the  Association's  loan  portfolio by type of loan at the dates
indicated.
<TABLE>
<CAPTION>
                                                                                      June 30,
                                           --------------------------------------------------------------------------------
                                                         1997                           1996                     1995      
                                           -----------------------------      ---------------------     -------------------
                                                 Amount              %          Amount         %          Amount         % 
                                           ----------------    -----------    ---------   ---------     ---------   -------
                                                                               (Dollars in Thousands)
<S>                                            <C>               <C>           <C>         <C>           <C>         <C>  
Residential real estate                        $561,352           79.7%        $416,711     75.4%        $353,801     74.7%
Construction                                     68,366            9.7           61,015     11.1           50,068     10.6 
Commercial real estate (1)                       30,631            4.3           29,343      5.3           25,403      5.4 
Land                                             19,992            2.8           22,844      4.1           19,326      4.1 
Consumer loans:                                                                                                            
   Home equity                                   14,495            2.1           13,697      2.5           15,370      3.2 
   Credit cards                                   6,198            0.9            5,644      1.0            5,349      1.1 
   Other                                          3,255            0.5            3,278      0.6            4,356      0.9 
                                               --------          -----         ---------   -----          -------    ----- 
     Total loans receivable                     704,289          100.0%          552,532   100.0%         473,673    100.0%
                                               --------          =====         ---------   =====          -------    ===== 
Less:                                                                                                                      
   Allowance for loan losses                      7,612                           7,496                     8,088          
   Loans in process                              33,030                          34,846                    24,643          
   Deferred loan fees                             5,324                           5,059                     4,934          
   Other                                             --                              --                        --          
                                               --------                        --------                  --------          
        Loans receivable, net                  $658,323                        $505,131                  $436,008          
                                               ========                        ========                  ========          

<PAGE>

<CAPTION>
                                                               June 30,
                                           ------------------------------------------------
                                                     1994                      1993
                                           --------------------      ----------------------
                                             Amount          %         Amount         %
                                           --------     ---------    --------    ----------
                                                         (Dollars in Thousands)
<S>                                        <C>            <C>          <C>         <C>  
Residential real estate                    $346,599        72.0%       $371,883     71.0%
Construction                                 51,557        10.7          53,488     10.2
Commercial real estate (1)                   30,631         6.4          37,762      7.2
Land                                         27,066         5.6          25,635      4.9
Consumer loans:                                                                 
   Home equity                               14,245         3.0          16,368      3.1
   Credit cards                               5,863         1.2           7,044      1.3
   Other                                      5,301         1.1          11,844      2.3
                                           --------       -----        --------    -----
     Total loans receivable                 481,262       100.0%        524,024    100.0%
                                           --------       =====        --------    =====
Less:
   Allowance for loan losses                  7,828                       7,181 
   Loans in process                          31,304                      28,297 
   Deferred loan fees                         5,453                       6,600 
   Other                                         35                          50 
                                           --------                    -------- 
        Loans receivable, net              $436,642                    $481,896 
                                            =======                    ======== 
</TABLE>
                                                                       

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

(1)      Includes  $134,000,   $191,000,  $640,000,  $419,000  and  $761,000  of
         commercial  business loans (i.e.,  working capital and inventory loans)
         at June 30, 1997, 1996, 1995, 1994 and 1993, respectively.


                                        2
<PAGE>
         Contractual  Principal  Repayments  and Interest  Rates.  The following
table sets forth  certain  information  at June 30,  1997  regarding  the dollar
amount of loans maturing in the Association's total loan portfolio, based on the
contractual terms to maturity. Loans having no stated schedule of repayments and
no stated maturity are reported as due in one year or less.
<TABLE>
<CAPTION>
                                                                                      Due 5 or more
                                      Due 1 year               Due 1-5 years            years after
                                        or less             after June 30, 1997        June 30, 1997          Total
                                ---------------------    -----------------------    -----------------    -------------
                                                                         (In Thousands)
<S>                                            <C>                        <C>                   <C>             <C>     
First mortgage loans:
   Residential real estate                     $ 12,467                   $ 23,975              $524,910        $561,352
   Construction                                  62,967                      4,967                   432          68,366
   Commercial real estate                        11,449                     17,610                 1,572          30,631
   Land                                           9,204                     10,788                    --          19,992
Consumer                                         22,284                      1,147                   517          23,948
                                               --------                   --------              --------        --------
  Total                                        $118,371                   $ 58,487              $527,431        $704,289
                                               ========                   ========              ========        ========
</TABLE>

         The  following  table sets forth the dollar  amount of total  loans due
after one year from June 30, 1997, as shown in the preceding  table,  which have
fixed interest rates or which have floating or adjustable interest rates.
<TABLE>
<CAPTION>
                                           Fixed rate          Floating or adjustable-rate             Total
                                    -----------------------    ---------------------------    -----------------------
                                                                      (In Thousands)
<S>                                        <C>                             <C>                       <C>     
First mortgage loans:
   Residential real estate                 $425,882                        $123,003                  $548,885
   Construction                               5,399                              --                     5,399
   Commercial real estate                    18,661                             521                    19,182
   Land                                      10,788                              --                    10,788
Consumer                                      1,664                              --                     1,664
                                           --------                        --------                  --------
    Total                                  $462,394                        $123,524                  $585,918
                                           ========                        ========                  ========
</TABLE>

         Scheduled  contractual  maturities of loans do not necessarily  reflect
the actual term of the  Association's  portfolio.  The average  life of mortgage
loans is substantially less than their average contractual terms because of loan
prepayments and enforcement of due-on-sale  clauses,  which give the Association
the right to declare a loan  immediately  due and  payable  in the event,  among
other things,  that the borrower sells the real property subject to the mortgage
and the  loan is not  repaid.  The  average  life of  mortgage  loans  tends  to
increase,  however,  when current mortgage loan rates substantially exceed rates
on existing  mortgage  loans and,  conversely,  decrease  when rates on existing
mortgage loans  substantially  exceed current  mortgage loan rates. In addition,
management  believes that a significant number of the Association's  residential
mortgage  loans are  outstanding  for a period  significantly  less  than  their
contractual  terms. The Association  attributes this to the mobile nature of the
people who reside in its market area which, over the past decade,  has developed
as a regional corporate and banking center.


                                        3
<PAGE>
         Origination,  Purchase and Sale of Loans. The lending activities of the
Association  are  subject  to  the  written,  non-discriminatory,   underwriting
standards and loan origination procedures established by the Association's Board
of Directors and management.  Loan  originations  are obtained from a variety of
sources, including builders, realtors, walk-in customers, loan officers, outside
loan  correspondents  and  advertising.   In  its  marketing,   the  Association
emphasizes its community  ties,  customized,  personal  service and an efficient
underwriting and approval process.  The Association uses its in-house  appraisal
staff for most residential  real estate loans and construction  loans secured by
property located in Mecklenberg  County,  North Carolina and outside  appraisers
for most  residential  real  estate  loans and  construction  loans  secured  by
property  located  outside of Mecklenberg  County and all commercial real estate
and land  loans.  The  Association  requires  hazard,  title and,  to the extent
applicable, flood insurance on all security property.

         Mortgage loan applications are initially processed by loan officers and
are required to be approved by the  Association's  Loan Committee,  a management
committee  consisting  of the  Association's  mortgage  lending  manager and two
additional  senior  officers  with  lending  expertise.  Mortgage  loans must be
approved by two of the three  members of the Loan  Committee.  In addition,  the
Association's  President or Executive Vice President may act in the place of one
of the existing  members of the Loan Committee.  Notwithstanding  the foregoing,
all  loans  over  $1.0  million  must be  approved  in  advance  by the Board of
Directors.  Consumer loans are initially processed by consumer loan officers and
are required to be approved by designated officers of the Association  depending
on both the  amount  and  nature of the loan.  All  loans  are  ratified  by the
Association's Board of Directors.

         Historically, the Association has not been an active purchaser of loans
or participation  interests in loans. The Association  purchased $4.4 million of
loans during fiscal 1997, none during 1996, and $53,000 during 1995.

         Loans have, from time to time,  been sold by the Association  primarily
to the Federal National  Mortgage  Association  ("FNMA"),  a  quasi-governmental
agency,  with servicing  retained and without recourse.  The Association did not
sell any loans during fiscal 1997,  1996 or 1995.  However,  management may sell
loans in the future to the extent that it believes the interest rate environment
is unfavorable and interest rate risk is unacceptable.

         When  loans  are  sold  to  the  FNMA,  the  Association   retains  the
responsibility  for  servicing  the loans,  including  collecting  and remitting
mortgage loan  payments,  accounting  for principal and interest and holding and
disbursing escrow or impound funds for real estate taxes and insurance premiums.
The  Association  receives a servicing  fee for  performing  these  services for
others. The Association's servicing portfolio amounted to $735.2 million at June
30, 1997, including $30.9 million of loans serviced for others.



                                        4
<PAGE>
         The following table shows total loans originated,  purchased,  sold and
repaid during the periods indicated.
<TABLE>
<CAPTION>
                                                             Year Ended June 30,
                                                     -----------------------------------
                                                        1997         1996        1995
                                                     ---------    ---------    ---------
                                                                (In Thousands)
<S>                                                  <C>          <C>          <C>      
Loan originations:
   Residential real estate                           $ 170,561    $ 107,029    $  28,100
   Construction                                         74,114       65,508       56,677
   Commercial real estate                                8,072       10,105        2,500
   Land                                                 13,624       16,071        4,145
   Consumer                                              5,494        4,117        6,332
                                                     ---------    ---------    ---------
      Total loans originated                           271,865      202,830       97,754

Loans purchased                                          4,366         --             53
                                                     ---------    ---------    ---------
      Total loans originated and
        purchased                                      276,231      202,830       97,807

Loan principal reductions                             (123,360)    (121,845)    (101,315)

Transfer of loans to real estate owned                  (1,114)      (2,127)      (4,081)
                                                     ---------    ---------    ---------

Net increase (decrease) in total loan portfolio(1)   $ 151,757    $  78,858    $  (7,589)
                                                     =========    =========    =========
</TABLE>

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

(1)      The  increase in the  Association's  loan  portfolio in fiscal 1997 and
         1996  was  due to the  use of loan  correspondents  in the  origination
         process and to the development of new mortgage loan products.

         A savings institution  generally may not make loans to one borrower and
related  entities in an amount which exceeds 15% of its  unimpaired  capital and
surplus,  although  loans in an amount equal to an additional  10% of unimpaired
capital and surplus may be made to a borrower if the loans are fully  secured by
readily  marketable  securities.  At June 30, 1997, the  Association's  limit on
loans to one borrower was  approximately  $28.0  million.  At June 30, 1997, the
Association's largest loan or groups of loans to one borrower, including persons
or  entities  related to the  borrower,  amounted to $6.2  million.  This amount
consists of $3.0 million on  construction  loans for  single-family  residences,
$2.2  million  in  acquisition  and  development  loans,  and  $1.0  million  in
miscellaneous other loans,  including land,  commercial real estate and consumer
loans.

         One-to-Four  Family  Residential Real Estate Loans. The Association has
historically  concentrated  its lending  activities on the  origination of loans
secured  by first  mortgage  liens on  existing  one-to-four  family  residences
located in its market  area.  At June 30, 1997,  $561.4  million or 79.7% of the
Association's  total loan portfolio  consisted of permanent  one-to-four  family
residential real estate loans. The Association originated $170.6 million, $107.0
million and $28.1 million of one-to-four family residential real estate loans in
fiscal  1997,  1996 and 1995,  respectively.  The increase in  residential  real
estate loan originations during fiscal 1997 and 1996 over prior years was due to
the use of loan correspondents in the origination process and to the development
of new mortgage loan products.  The Association intends to continue to emphasize
the   origination  of  permanent  loans  secured  by  first  mortgage  liens  on
one-to-four family residential properties in the future.

                                        5
<PAGE>
         The  Association's  fixed-rate loans generally have maturities  ranging
from 15 to 30 years and are fully amortizing with monthly payments sufficient to
repay the total  amount of the loan with  interest  by the end of the loan term.
Such loans are originated under terms, conditions and documentation which permit
them to be sold to U.S.  Government  sponsored  agencies  such as the FNMA.  The
Association's  fixed-rate loans customarily include "due on sale" clauses, which
give the Association the right to declare a loan  immediately due and payable in
the event the borrower sells or otherwise  disposes of the real property subject
to the mortgage and the loan is not repaid.

         The Association  also originates for its portfolio  one-to-four  family
residential  real estate loans which  provide for an interest rate which adjusts
every year or which is fixed for a three or five year period and  adjusts  every
year after the initial  period  (such  adjustable-rate  loans are referred to as
"ARMs").  The  Association's  one-year ARM adjusts every year in accordance with
the  national  monthly  median  cost of funds  index  while  the  interest  rate
adjustment  for its three and five year ARMs after the initial  fixed  period is
based on the one year U.S. Treasury  securities rate. The Association's ARMs are
typically based on a 30-year amortization  schedule.  The amount of any increase
or  decrease in rate after the  initial  term is limited to 2% per year,  with a
limit of 6% over the life of the loan. The  Association  qualifies the borrowers
on its loans which are fixed for three or five years  based on the initial  rate
and  qualifies  its  borrowers  for its one-year ARM based on the fully  indexed
rate.  The  adjustable  rate loans offered by the  Association  may generally be
converted to a  fixed-rate  loan within five years from the start of the initial
adjustment  period.  The Association  does not offer deep discount rates and its
adjustable rate loans do not provide for negative amortization.

         Adjustable-rate  loans  decrease the risks  associated  with changes in
interest  rates but involve  other risks,  primarily  because as interest  rates
rise, the payment by the borrower rises to the extent  permitted by the terms of
the loan,  thereby  increasing the potential for default.  At the same time, the
marketability  of the  underlying  property may be adversely  affected by higher
interest rates. The Association  believes that these risks, which have not had a
material adverse effect on the Association to date,  generally are less than the
risks associated with holding  fixed-rate  loans in an increasing  interest rate
environment.

         The  Association's  residential  mortgage loans typically do not exceed
80% of the appraised  value of the security  property.  Pursuant to underwriting
guidelines adopted by the Board of Directors, the Association can lend up to 95%
of the appraised value of the property securing a one-to-four family residential
loan; however,  the Association  generally obtains private mortgage insurance on
the portion of the principal  amount that exceeds 80% of the appraised  value of
the security property.

         Construction Loans. The Association  originates  primarily  residential
construction loans to local real estate builders,  generally with whom it has an
established  relationship.  To a  significantly  lesser extent,  the Association
originates  such loans to individuals who have a contract with a builder for the
construction  of their  residence.  The  Association's  construction  loans  are
secured by property located primarily in the Association's  primary market area.
At June 30, 1997,  construction  loans  amounted to $68.4 million or 9.7% of the
Association's total loan portfolio.  In addition,  at such date, the Association
had $33.0 million of undisbursed  funds for construction  loans in process.  The
Association  originated  $74.1  million,  $65.5  million  and $56.7  million  of
construction loans in fiscal 1997, 1996 and 1995, respectively.

         The  Association's  construction  loans  generally  have fixed interest
rates for a term of one year.  Construction loans to builders are typically made
with a maximum loan-to-value ratio of 75%. Construction loans to individuals are
typically made in connection with the granting of the permanent financing on the
property. Such loans convert to a fully amortizing adjustable or fixed-rate loan
at the end of the  construction  term. The Association  typically  requires that
permanent  financing with the Association or some other lender be in place prior
to origination of any construction loan to an individual.

         The  Association's  construction  loans to local  builders  are made on
either a pre-sold  or  speculative  (unsold)  basis.  However,  the  Association
generally limits the number of unsold homes under  construction to its builders,
with  the  amount  dependent  on the  Association's  prior  experience  with the
builder, the Association's present exposure to the

                                        6
<PAGE>
builder,  the  location of the  property  and the number of unsold  homes in the
development.   The   Association   originates  a  significant   portion  of  its
construction loans to builders on a speculative basis.

         Prior  to  making  a  commitment  to  fund  a  construction  loan,  the
Association requires an appraisal of the property by the Association's appraisal
staff or independent  state-licensed  and qualified  appraisers  approved by the
Board of Directors.  The Association's appraisal staff also reviews and inspects
each project at the commencement of construction and prior to every disbursement
of funds during the term of the  construction  loan. Loan proceeds are disbursed
after  inspections  of the project  based on a  percentage  of  completion.  The
Association requires monthly interest payments during the construction term. The
amount of funds available for advance under the Association's construction loans
usually  include an amount from which the borrower  can pay the stated  interest
due thereon until completion of the loan term.

         Construction  lending is generally considered to involve a higher level
of risk as compared to permanent  one-to-four family residential lending, due to
the  concentration of principal in a limited number of borrowers and the effects
of  general  economic  conditions  on  developers  and  builders.   Moreover,  a
construction  loan  can  involve   additional  risks  because  of  the  inherent
difficulty  in estimating  both a property's  value at completion of the project
and the estimated cost (including  interest) of the project. The nature of these
loans is such that they are generally more difficult to evaluate and monitor. In
addition,  speculative construction loans to a builder are not pre-sold and thus
pose a greater  potential risk to the  Association  than  construction  loans to
individuals on their personal residences.

         The Association has attempted to minimize the foregoing risks by, among
other things,  limiting the extent of its construction  lending generally and by
limiting  its  construction  lending to  primarily  residential  properties.  In
addition,  the  Association  has adopted  underwriting  guidelines  which impose
stringent loan-to-value, debt service and other requirements for loans which are
believed to involve  higher  elements of credit risk, by limiting the geographic
area in which the  Association  will do business to its  existing  market and by
working primarily with builders with whom it has established  relationships.  It
is also the Association's  general policy to obtain personal guarantees from the
principals of its corporate borrowers on its construction loans.

         Commercial Real Estate Loans. The Association originates mortgage loans
for the acquisition and  refinancing of commercial real estate  properties.  The
Association generally offers such loans to accommodate its present customers. At
June 30, 1997, $30.6 million or 4.3% of the  Association's  total loan portfolio
consisted of loans secured by existing  commercial real estate  properties.  The
majority of the Association's commercial real estate loans are secured by office
buildings,  warehouses and manufacturing facilities, all of which are secured by
property  located  in  the  Association's  market  area.   Management  does  not
anticipate that commercial real estate loans will comprise a substantial portion
of the loan portfolio in the future.

         The  Association   requires   appraisals  of  all  properties  securing
commercial  real  estate  loans.  Appraisals  are  performed  by an  independent
appraiser  designated  by  the  Association,   all  of  which  are  reviewed  by
management.  The  Association  considers  the quality  and  location of the real
estate, the credit of the borrower, the cash flow of the project and the quality
of management involved with the property.

         The Association will primarily  originate  commercial real estate loans
with fixed interest rates subject to call provisions  after three or five years.
Such  loans  are  typically  based  on a 15 or 25  year  amortization  schedule.
Loan-to-  value  ratios on the  Association's  commercial  real estate loans are
generally  limited to 75%. As part of the criteria for  underwriting  commercial
real estate loans, the Association  generally imposes a debt coverage ratio (the
ratio of net  cash  from  operations  before  payment  of debt  service  to debt
service) of not less than 1.2. It is also the  Association's  general  policy to
obtain personal guarantees from the principals of its corporate borrowers on its
commercial real estate loans.

         Commercial real estate lending entails significant  additional risks as
compared with single-family  residential property lending.  Such loans typically
involve large loan balances to single borrowers or groups of related  borrowers.
The payment  experience on such loans is typically  dependent on the  successful
operation of the real estate project. The

                                        7
<PAGE>
success of such projects is sensitive to changes in supply and demand conditions
in the market for and  commercial  real estate as well as regional  and economic
conditions  generally.  At June  30,  1997,  the  Association  had  $969,000  of
non-performing  commercial real estate loans,  which  constituted 15.3% of total
non-performing loans at such date.

         Land Loans.  The Association  originates land loans to local developers
for the purpose of developing the land (i.e.,  roads, sewer and water) for sale.
Such loans are secured by a lien on the property,  are generally  limited to 75%
of the  developed  value of the secured  property and are  typically  made for a
period of three  years  with an  interest  rate that  adjusts  every  year.  The
Association requires monthly interest payments during the term of the land loan.
The amount of funds available under the Association's land loans usually include
an amount from which the borrower can pay the stated  interest due thereon until
completion  of the loan term.  The  principal of the loan is reduced as lots are
developed,  sold and released.  The  Association's  land loans are structured so
that the Association is repaid in full upon the sale of approximately 85% of the
available lots by the borrower.  All of the Association's land loans are secured
by property  located in its primary  market area. In addition,  the  Association
attempts to obtain  personal  guarantees  from its borrowers and originates such
loans to  developers  with whom it has  established  relationships.  At June 30,
1997,  the  Association  had $3.1  million of  non-accruing  land  loans,  which
constituted  48.7%  of total  non-performing  loans at such  date.  Such  amount
primarily  consists of land loans to one borrower who has experienced  financial
difficulties  and is involved in litigation with the  Association.  See Item 3 -
Legal Proceedings.

         Consumer  Loans.  The  Association  offers  consumer  loans in order to
provide a full range of financial services to its customers.  The consumer loans
offered by the Association  primarily consist of home equity loans and unsecured
loans through both MasterCard and VISA credit cards.  Consumer loans amounted to
$23.9  million  or 3.5% of the total  loan  portfolio  at June 30,  1997,  $14.5
million and $6.2 million of which consisted of home equity loans and credit card
debt, respectively.

         The largest component of the  Association's  consumer loan portfolio is
home equity loans,  which are secured by the underlying equity in the borrower's
home or second  residence.  Home equity loans are revolving  loans and generally
have variable  interest  rates based on the prime rate plus a margin and maximum
terms of 15  years.  The  Association's  home  equity  loans  generally  require
loan-to-value  ratios of 80% or less after taking into  consideration  the first
mortgage loan.

         Consumer loans  generally have shorter terms and higher  interest rates
than mortgage  loans but generally  involve more credit risk than mortgage loans
because of the type and nature of the  collateral  and,  in certain  cases,  the
absence  of  collateral.  These  risks are not as  prevalent  in the case of the
Association's consumer loan portfolio, however, because a high percentage of the
portfolio is comprised of home equity loans which are secured by real estate and
underwritten  in a manner  such that they  result  in a  lending  risk  which is
substantially similar to single-family residential loans.

         Loan  Fee  Income.  In  addition  to  interest  earned  on  loans,  the
Association receives income from fees in connection with loan originations, loan
modifications,  late  payments  and for  miscellaneous  services  related to its
loans.  Income from these activities varies from period to period depending upon
the volume and type of loans made and competitive conditions.

         The  Association  charges  loan  origination  fees which are  generally
calculated  as a  percentage  of  the  amount  borrowed.  Loan  origination  and
commitment fees, as well as loan origination  costs, are deferred and recognized
over the  contractual  remaining  lives of the  related  loans on a level  yield
basis.  Discounts and premiums on loans  purchased are accreted and amortized in
the same manner.  In  accordance  with FASB  Statement  No. 91, the  Association
recognized  $1.7  million,  $2.0 million and $1.7 million of deferred  loan fees
during  fiscal  1997,  1996 and  1995,  respectively,  in  connection  with loan
refinancing, payoffs and ongoing amortization of outstanding loans.

                                        8
<PAGE>
Asset Quality

         When a  borrower  fails  to make a  required  payment  on a  loan,  the
Association  attempts to cure the  deficiency  by  contacting  the  borrower and
seeking the payment. Contacts are generally made 15 days after a payment is due.
In most cases,  deficiencies  are cured  promptly.  If a delinquency  continues,
additional  contact  is made  either  through  a notice  or other  means and the
Association will attempt to work out a payment  schedule.  While the Association
generally  prefers  to  work  with  borrowers  to  resolve  such  problems,  the
Association will institute  foreclosure or other proceedings,  as necessary,  to
minimize  any  potential   loss.  The  Association   generally   initiates  such
proceedings when a loan becomes 90 days delinquent.

         Loans  are  placed on  non-accrual  status  when,  in the  judgment  of
management,   the  probability  of  collection  of  interest  is  deemed  to  be
insufficient  to warrant further  accrual.  When a loan is placed on non-accrual
status, previously accrued but unpaid interest is deducted from interest income.
Presently,  the  Association  does not accrue interest on real estate loans past
due 90 days or more. Loans may be reinstated to accrual status when payments are
under 90 days past due and,  in the  opinion of  management,  collection  of the
remaining balance can be reasonably expected.

         Real estate  acquired by the  Association as a result of foreclosure or
by deed in lieu of  foreclosure  is  classified as other real estate owned until
sold.  Pursuant to a statement of position  ("SOP 92-3")  issued by the AICPA in
April 1992,  which provides  guidance on determining the balance sheet treatment
of foreclosed  assets in annual  financial  statements  for periods ending on or
after  December 15,  1992,  there is a rebuttable  presumption  that  foreclosed
assets are held for sale and such  assets are  recommended  to be carried at the
lower  of fair  value  minus  estimated  costs  to sell  the  property,  or cost
(generally the balance of the loan on the property at the date of  acquisition).
After the date of  acquisition,  all costs incurred in maintaining  the property
are  expensed and costs  incurred for the  improvement  or  development  of such
property are  capitalized  up to the extent of their net realizable  value.  The
Association's  accounting for its real estate  acquired by foreclosure  complies
with the guidance set forth in SOP 92-3.

         Under  generally  accepted  accounting  principles,  the Association is
required  to  account  for  certain  loan  modifications  or  restructurings  as
"troubled debt restructurings." In general, the modification or restructuring of
a debt constitutes a troubled debt restructuring if the Association for economic
or legal  reasons  related to the  borrower's  financial  difficulties  grants a
concession to the borrower that the  Association  would not otherwise  consider.
Debt  restructurings  or loan  modifications  for a borrower do not  necessarily
always  constitute  troubled  debt  restructurings,  however,  and troubled debt
restructurings do not necessarily  result in non-accrual  loans. The Association
had $643,000 of troubled debt restructurings as of June 30, 1997.

         Federal  regulations  require  that each  insured  savings  association
classify  its assets on a regular  basis.  There are three  classifications  for
problem  assets:  "substandard,"  "doubtful"  and "loss." At June 30, 1997,  the
Association had $10.9 million of classified assets.

                                        9
<PAGE>
         Non-Performing  Assets.  The following table sets forth the amounts and
categories of the Association's non-performing assets at the dates indicated.
<TABLE>
<CAPTION>
                                                                    June 30,
                                              ---------------------------------------------------
                                                1997       1996       1995       1994       1993
                                              -------    -------    -------    -------    ------- 
                                                              (Dollars in Thousands)
<S>                                           <C>        <C>        <C>        <C>        <C>     
Non-accruing loans:
    Residential real estate                   $ 1,856    $ 2,632    $ 2,365    $ 5,516    $ 6,625 
    Construction                                  130        350        149      2,026      4,622 
    Commercial real estate                        969        967      1,138      2,647      3,792 
    Land                                        3,076      4,082      4,405      6,847      7,623 
    Consumer                                      288         13        344        363      1,948 
                                              -------    -------    -------    -------    ------- 
         Total non-accruing loans               6,319      8,044      8,401     17,399     24,610 
                                              -------    -------    -------    -------    ------- 
                                                                                                  
Real estate acquired in settlement                                                                
   of loans, net of reserves                      868      2,539      2,034      2,636      6,579 
                                              -------    -------    -------    -------    ------- 
     Total non-performing assets              $ 7,187    $10,583    $10,435    $20,035    $31,189 
                                              -------    =======    =======    =======    ======= 
                                                                                                  
Troubled debt restructurings                  $   643    $   525    $ 2,422    $ 1,208    $   949 
                                              =======    =======    =======    =======    ======= 
                                                                                                  
     Total non-performing loans and                                                               
     troubled debt restructurings as                                                              
     a percentage of total net loans             1.06%      1.70%      2.48%      4.26%      5.30%
                                              =======    =======    =======    =======    ======= 
                                                                                                  
     Total non-performing assets and                                                              
     troubled debt restructurings as                                                              
     a percentage of total assets                0.87%      1.41%      2.17%      3.70%      5.46%
                                              =======    =======    =======    =======    ======= 
</TABLE>

                                       10
<PAGE>
         For the year  ended  June 30,  1997,  approximately  $472,000  in gross
interest income would have been recorded on loans accounted for on a non-accrual
basis  and  troubled  debt  restructurings  if such  loans had been  current  in
accordance  with their  original terms and had been  outstanding  throughout the
year or since  origination if held for part of the year. For the year ended June
30, 1997,  $113,000 was included in net income for these same loans prior to the
time they were placed on non-accrual  status or were  restructured as a troubled
debt restructuring.

         Total  non-performing  loans  and  troubled  debt  restructurings  as a
percentage of total net loans have decreased  significantly to 1.06% at June 30,
1997 from 5.30% at June 30, 1993.  Correspondingly,  total non-performing assets
and troubled debt  restructurings  as a percentage of total assets  decreased to
0.87% from 5.46% during the same period. As discussed below, the decrease during
this period in  non-performing  construction and land loans was primarily due to
the  resolution  or  reduction  of large  concentrations  of loans to one  local
developer  who  was  experiencing  debt  service   problems.   The  decrease  in
non-performing  residential  real  estate  loans  during  the  same  period  was
primarily due to the resolution or reduction of a large  concentration  of loans
to one borrower,  including  related  entities,  and, to a lesser extent, to the
continued improvement in the local economy.

         In fiscal  1992,  with the  down-turn  then  being  experienced  in the
economy  generally,  and in the real  estate  market  in  particular,  one local
developer  began  experiencing  debt service  problems with respect to his loans
from the Association and eventually filed for bankruptcy. At June 30, 1993, this
borrower's  non-performing  loans amounted to $1.6 million in residential loans,
$1.1 million in construction  loans, $6.3 million in land loans and $1.8 million
in  commercial  loans,  totaling more than $10.8 million of the $24.6 million in
total  non-performing  loans  at June 30,  1993.  As a  result  of  charge-offs,
repayments and transfers to real estate owned since fiscal 1993, the Association
has substantially reduced its loans to this borrower to $3.3 million at June 30,
1997,  consisting of nine  non-accruing land loans amounting to $3.1 million and
three  non-accruing  commercial  real estate loans  amounting  to  $232,000.  In
addition,  during  fiscal 1992 and 1993,  the  Association  experienced  similar
difficulties with respect to a large  concentration of  non-performing  loans to
another borrower,  including $1.6 million in residential real estate loans, $2.4
million in  construction  loans,  $1.2 million in land loans and $1.0 million in
consumer and commercial real estate loans at June 30, 1993.  These loans totaled
$6.2  million  of the $24.6  million in total  non-performing  loans at June 30,
1993.  As of June 30, 1997,  the loans  outstanding  to this  borrower have been
reduced to $1.2 million in  residential  rental real estate  properties,  all of
which are now fully performing.

         At June 30, 1997,  the $1.9 million of  non-accruing  residential  real
estate loans  consisted of 16 loans secured by  single-family  residential  real
estate  located  primarily  in  the  Association's   market  area.  The  largest
outstanding  loan  balance at such date  amounted to  $405,000,  and the average
outstanding loan balance amounted to $116,000.  Substantially  all of such loans
were made to separate borrowers.

         The $3.1 million of non-accruing  land loans at June 30, 1997 consisted
of the nine loans to the local  developer  referred to above.  All of such loans
are presently  subject to litigation  between the borrower and the  Association.
See Item 3 - Legal Proceedings.

         The $868,000 of real estate acquired in settlement of loans at June 30,
1997   consists  of  developed   and   undeveloped   residential   property  and
single-family residential properties.

         Allowance  for Loan Losses.  It is  management's  policy to maintain an
allowance for estimated  losses based on the perceived  risk of loss in the loan
portfolio and the adequacy of the allowance. Management's periodic evaluation of
the  adequacy  of the  allowance  is based on the  Association's  past loan loss
experience,  known and inherent risks in the portfolio,  adverse situations that
may  affect  the  borrower's  ability  to  repay,  the  estimated  value  of the
underlying  collateral  and  current  economic  conditions.   The  allowance  is
increased by provisions for loan losses which are charged against income.

         Although  management  uses  the  best  information  available  to  make
determinations  with  respect  to the  provisions  for loan  losses,  additional
provisions  for loan  losses may be  required  to be  established  in the future
should

                                       11
<PAGE>
economic or other conditions change substantially.  In addition, the OTS and the
FDIC, as an integral part of their examination process,  periodically review the
Association's  allowance for possible loan losses. Such agencies may require the
Association to recognize  additions to such allowance  based on their  judgments
about information available to them at the time of their examination.

         The  following  table  sets  forth  an  analysis  of the  Association's
allowance for loan losses during the periods indicated.
<TABLE>
<CAPTION>
                                                                   Year Ended June 30,
                                          ---------------------------------------------------------------------------
                                            1997             1996             1995            1994             1993
                                          -------          -------          -------          -------          -------
                                                                  (Dollars in Thousands)
<S>                                       <C>              <C>              <C>              <C>              <C>    
Balance at beginning of
   period                                 $ 7,496          $ 8,088          $ 7,828          $ 7,181          $ 4,013
                                          -------          -------          -------          -------          -------
Charge-offs:
   Residential real estate                    (16)             (16)             (63)            (368)          (1,204)
   Construction                              --               --               --               --               --
   Commercial real estate                    (233)          (1,086)            (145)            (127)            (304)
   Land                                      --               (349)             (16)            --                (27)
   Consumer                                   (95)             (41)            (171)            (247)            (142)
                                          -------          -------          -------          -------          -------
     Total charge-offs                       (344)          (1,492)            (395)            (742)          (1,677)
                                          -------          -------          -------          -------          -------
 Recoveries:
   Residential real estate                     11             --                 80             --               --
   Construction                              --               --               --               --               --
   Commercial real estate                      50             --                 85               24               42
   Land                                       450               25             --               --               --
   Consumer                                     8              538                4               13               12
                                          -------          -------          -------          -------          -------
     Total recoveries                         519              563              169               37               54
                                          -------          -------          -------          -------          -------
     Net (charge-offs) recoveries             175             (929)            (226)            (705)          (1,623)
                                          -------          -------          -------          -------          -------

Provision (recovery) for
  losses on loans                             (59)             337              486            1,352            4,791
                                          -------          -------          -------          -------          -------

Balance at end of period                  $ 7,612          $ 7,496          $ 8,088          $ 7,828          $ 7,181
                                          =======          =======          =======          =======          =======
Allowance for loan losses as a
  percent of total loans
  outstanding                                1.08%            1.36%            1.71%            1.63%            1.37%
                                          =======          =======          =======          =======          =======
Allowance for loan losses as a
  percent of nonperforming loans
  and troubled debt restructurings         109.33%           87.48%           74.73%           42.07%           28.10%
                                          =======          =======          =======          =======          =======
Ratio of net charge-offs (recoveries) 
  to average loans outstanding              (0.03)%           0.20%            0.05%            0.16%            0.33%
                                          =======          =======          =======          =======          =======
</TABLE>

                                       12
<PAGE>
         The following table sets forth information concerning the allocation of
the  Association's  allowance  for loan  losses  by loan  category  at the dates
indicated.
<TABLE>
<CAPTION>
                                                                  June 30,
                             -------------------------------------------------------------------------------------
                                      1997                          1996                           1995           
                             -----------------------      --------------------------      ------------------------
                                         Percent of                     Percent of                      Percent of
                                          Loans in                       Loans in                        Loans in 
                                            Each                           Each                            Each   
                                         Category to                    Category to                    Category to
                             Amount      Total Loans      Amount        Total Loans       Amount       Total Loans
                             ------      -----------      ------        -----------       ------       -----------
                                                          (Dollars in Thousands)
<S>                          <C>           <C>            <C>             <C>             <C>              <C>     
Residential real estate      $4,319         79.7%         $3,474           75.4%          $3,029            74.7%  
Construction                    780          9.7             350           11.1              351            10.6   
Commercial real estate          543          4.3             444            5.3            1,068             5.4   
Land                          1,697          2.8           3,012            4.1            3,265             4.1   
Consumer                        273          3.5             216            4.1              375             5.2   
                             ------        -----          ------          -----           ------           -----   
     Total                   $7,612        100.0%         $7,496          100.0%          $8,088           100.0%  
                             ------        -----          ======          =====           ======           =====   
                                                                                                                   
<CAPTION>
                                                   June 30,
                           -------------------------------------------------------
                                    1994                           1993
                           ------------------------       ------------------------
                                         Percent of                     Percent of
                                          Loans in                       Loans in
                                            Each                           Each
                                        Category to                    Category to
                           Amount       Total Loans       Amount       Total Loans
                           ------       -----------       ------       -----------
                                          (Dollars in Thousands)
<S>                        <C>             <C>             <C>            <C>   
Residential real estate    $2,336           72.0%          $2,767          71.0%
Construction                  220           10.7              440          10.2 
Commercial real estate        760            6.4              743           7.2 
Land                        4,075            5.6            2,469           4.9 
Consumer                      437            5.3              762           6.7 
                           ------          -----           ------         ----- 
     Total                 $7,828          100.0%          $7,181         100.0%
                           ======          =====           ======         ===== 
</TABLE>

                                       13
<PAGE>
Investment Securities

         The  investment  policy of the Company,  as established by the Board of
Directors,  is designed  primarily  to provide  and  maintain  liquidity  and to
generate a favorable return on investments without incurring undue interest rate
risk, credit risk, and investment portfolio asset concentrations.  The Company's
investment policy is currently  implemented by the  Association's  President and
Chief Financial Officer within the parameters set by the Board of Directors.

         The Association is authorized to invest in obligations  issued or fully
guaranteed by the U.S. Government,  certain federal agency obligations,  certain
time deposits, negotiable certificates of deposit issued by commercial banks and
other insured financial institutions, investment grade corporate debt securities
and other specified investments.

         Securities that management has the intent and positive  ability to hold
to maturity  are  classified  as held to maturity  and are reported at amortized
cost.  Securities  classified  as available for sale are reported at fair value,
with unrealized  gains and losses,  net of deferred income taxes,  excluded from
earnings and reported as a separate  component of equity.  At June 30, 1997, all
$175.7  million  of the  Company's  investment  securities  were  classified  as
available for sale. On December 31, 1995,  management of the Company reevaluated
its  intent  with  respect  to  its  investment   portfolio  and,   accordingly,
reclassified  all  investments and  mortgage-backed  securities from the held to
maturity classification to the available for sale classification.  Prior to this
election,  the majority of the Company's securities were included in its held to
maturity  portfolio.  At June 30, 1997,  investments  in the debt and/or  equity
securities  of any one  issuer  did not  exceed  more than 10% of the  Company's
stockholders'  equity.  See  Notes  1 and 2 of the  Notes  to  the  Consolidated
Financial  Statements in the 1997 Annual Report to Stockholders filed as Exhibit
13 hereto (the "1997 Annual Report").

         During   fiscal  1997,   the  Company   also   invested  its  funds  in
mortgage-backed securities.  Mortgage-backed securities (which also are known as
mortgage  participation  certificates  or pass-through  certificates)  typically
represent a participation  interest in a pool of  single-family  or multi-family
mortgages,  the  principal  and  interest  payments on which are passed from the
mortgage originators, through intermediaries (generally U.S. Government agencies
and government sponsored  enterprises) that pool and repackage the participation
interests in the form of securities, to investors such as the Association.  Such
U.S. Government agencies and government sponsored  enterprises,  which guarantee
the payment of principal and interest to investors,  primarily include the FNMA,
the Federal Home Loan Mortgage  Corporation and the Government National Mortgage
Association.

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

      The actual  maturity of a  mortgage-backed  security  may be less than its
stated maturity due to prepayments of the underlying mortgages. Prepayments that
are faster than  anticipated  may shorten the life of the security and adversely
affect its yield to maturity.  The yield is based upon the  interest  income and
the  amortization  of any  premium or  discount  related to the  mortgage-backed
security. In accordance with generally accepted accounting principles,  premiums
and  discounts  are  amortized  over the  estimated  lives of the  loans,  which
decrease and increase interest income, respectively.  The prepayment assumptions
used to  determine  the  amortization  period for  premiums  and  discounts  can
significantly  affect  the  yield of the  mortgage-backed  security,  and  these
assumptions are reviewed  periodically to reflect actual  prepayments.  Although
prepayments of underlying  mortgages depend on many factors,  including the type
of mortgages,  the coupon rate, the age of mortgages,  the geographical location
of the underlying real estate  collateralizing  the mortgages and general levels
of market  interest  rates,  the  difference  between the interest  rates on the
underlying mortgages and the prevailing mortgage interest rates generally is the
most  significant  determinant  of the rate of  prepayments.  During  periods of
falling mortgage interest rates, if the coupon rate of the underlying  mortgages
exceeds  the  prevailing  market  interest  rates  offered for  mortgage  loans,
refinancing generally increases and accelerates the

                                       14
<PAGE>
prepayment  of the  underlying  mortgages and the related  security.  Under such
circumstances,  the Association  may be subject to reinvestment  risk because to
the extent that the Association's  mortgage-backed securities amortize or prepay
faster  than  anticipated,  the  Association  may not be able  to  reinvest  the
proceeds of such repayments and prepayments at a comparable rate.

      For  additional  information  relating  to the  Company's  mortgage-backed
securities,  see Note 2 of the Notes to the Consolidated Financial Statements in
the 1997 Annual Report.

      The  following  table  sets  forth  certain  information  relating  to the
Company's investment portfolio at the dates indicated.  At June 30, 1997, all of
the Company's investment securities were classified as available for sale.
<TABLE>
<CAPTION>
                                                                                 June 30,
                                                          -------------------------------------------------
                                                                 1997              1996              1995
                                                          ---------------    --------------    --------------
                                                                              (In Thousands)
<S>                                                          <C>               <C>               <C>     
U.S. Government and agency obligations                       $114,261          $119,805          $109,963
Mortgage-backed securities                                     53,197           123,087                --
FHLMC stock                                                     8,252             5,553             4,424
                                                             --------           -------          --------
     Total                                                   $175,710(1)       $248,445          $114,387
                                                             ========          ========          ========
</TABLE>

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

(1)      Such amount includes $8.5 million of unrealized  gains and $2.1 million
         of unrealized losses.

                                       15
<PAGE>
      The  following  table sets forth the  amount of the  Company's  investment
securities  which mature  during each of the periods  indicated and the weighted
average  yields  for each  range of  maturities  at June 30,  1997.  The  actual
maturity of the  Company's  investment  securities  may differ from  contractual
maturity  since certain of the Company's  investment  securities  are subject to
call  provisions  which allow the issuer to accelerate  the maturity date of the
security.
<TABLE>
<CAPTION>
                                                                       Contractually Maturing
                                      -------------------------------------------------------------------------------------
                                                            Weighted                             Weighted                  
                                                            Average                               Average                  
                                        Under 1 Year         Yield             1-5 Years           Yield        5-10 Years 
                                      ---------------    ------------    -------------------   -----------    -------------
                                                                       (Dollars in Thousands)
<S>                                      <C>                   <C>            <C>                 <C>            <C>       
U.S. Government and agency               $10,959               4.93%          $65,423             5.59%          $6,831    
  obligations                                                                                                          
Mortgage-backed securities                    --                 --                --              --                --    
FHLMC stock                                8,252               1.39                --              --                --    
                                         -------                              -------                            ------    
      Total                              $19,211               3.41%          $65,423             5.59%          $6,831    
                                         =======               ====           =======             ====           ======    
                                                                                                                 
<CAPTION>
                                                Contractually Maturing
                                      -----------------------------------------------
                                       Weighted                           Weighted
                                       Average        Greater Than         Average
                                        Yield           10 Years            Yield
                                      ----------    --------------    ---------------
                                                 (Dollars in Thousands)
<S>                                      <C>           <C>                    <C>  
U.S. Government and agency               6.86%         $31,049                7.39%
  obligations                         
Mortgage-backed securities                 --           53,197                7.40
FHLMC stock                                --               --                  --
                                                       -------
      Total                              6.86%         $84,246                7.40%
                                         ====          =======                ====
</TABLE>

                                       16
<PAGE>
Sources of Funds

      General.  Deposits are the primary source of the  Association's  funds for
lending and other investment purposes. In addition to deposits,  the Association
derives funds from loan principal  repayments and  prepayments,  securities sold
under  repurchase  agreements  and  advances  from  the  FHLB of  Atlanta.  Loan
repayments are a relatively  stable source of funds,  while deposit  inflows and
outflows are significantly influenced by general interest rates and money market
conditions.  Borrowings  may  be  used  to  compensate  for  reductions  in  the
availability of funds from other sources and for general business purposes.

      Deposits.  The Association's deposit products include a broad selection of
deposit instruments,  including negotiable order of withdrawal ("NOW") accounts,
money market accounts,  regular savings accounts and term certificate  accounts.
Deposit  account terms vary,  with the principal  differences  being the minimum
balance  required,  the time  periods  the funds must  remain on deposit and the
interest rate.

      The  Association  utilizes  traditional  marketing  methods to attract new
customers and savings deposits.  The Association does not advertise for deposits
outside of its primary market area and management believes that an insignificant
number of deposit  accounts were held by non-residents of North Carolina at June
30, 1997. The  Association  does accept  deposits  placed by deposit brokers but
does not pay fees to such  brokers for  obtaining  deposits.  The  Association's
management  believes  that the  amount  of  deposits  received  through  brokers
amounted to approximately $34.5 million at June 30, 1997. Although such deposits
have not been a volatile source of funds, deposits received from brokers are not
generally considered core deposits.

      The  Association  has been  competitive  in the types of  accounts  and in
interest  rates it has  offered on its  deposit  products.  Deposit  levels were
higher during fiscal 1995  primarily as a result of an increase in rates offered
by the Association  during that year as part of a special  marketing  program as
well as in response to a general  increase in market interest  rates.  While the
average rate paid during  fiscal 1995 was 4.74%,  the  weighted  average rate at
June 30, 1995 was 5.67%.  The effect of these rates  continued  in fiscal  1996,
resulting  in an average  rate paid during the year of 5.54%,  compared to 4.74%
during  fiscal  1995.  The  weighted  average rate of deposits at June 30, 1996,
however,  declined to 5.42%.  During fiscal 1997,  the downward trend in deposit
rates  continued as the  Association  sought to moderate its cost of deposits by
not  renewing  high rate  certificates  of deposit as they have  matured,  or by
renewing them at market  rates.  As a result,  the cost of deposits  declined to
5.34% for the fiscal year ended June 30, 1997, with a year end weighted  average
cost  of  5.24%.   Although  market  demand  generally  dictates  which  deposit
maturities and rates will be accepted by the public, the Association  intends to
continue  to  promote   checking  and  NOW  accounts  as  well  as  longer  term
certificates of deposit to the extent possible and consistent with its asset and
liability management goals.

                                       17
<PAGE>
      The  following  table  sets  forth the dollar  amount of  deposits  in the
various  types of  deposit  programs  offered  by the  Association  at the dates
indicated.
<TABLE>
<CAPTION>
                                                                        June 30,
                             --------------------------------------------------------------------------------------------
                                           1997                              1996                          1995
                             -----------------------------      --------------------------     --------------------------
                                  Amount         Percentage        Amount        Percentage       Amount      Percentage
                             --------------    -------------    ----------    --------------   ---------    -------------
                                                                 (Dollars in Thousands)
<S>                            <C>                 <C>            <C>            <C>           <C>            <C>   
Checking accounts              $  9,193              2.1%         $  9,326         2.1%        $  7,348         1.5%
NOW accounts                     15,168              3.4            13,638         3.0           13,187         2.7
Passbook accounts                14,447              3.3            15,141         3.4           16,099         3.3
Money market                     34,760              7.8            32,315         7.2           40,683         8.3
Certificates of deposit         370,272             83.4           378,151        84.3          413,249        84.2
                               --------                           --------                     --------             
                                                                                                       
  Total deposits               $443,840            100.0%         $448,571       100.0%        $490,566       100.0%
                               ========            =====          ========       =====         ========       ===== 
</TABLE>

      The following  table presents the average balance of each deposit type and
the average rate paid on each deposit type for the periods indicated.
<TABLE>
<CAPTION>
                                                                         June 30,
                                  ---------------------------------------------------------------------------------------
                                             1997                           1996                          1995
                                  ---------------------------     ------------------------     --------------------------
                                    Average         Average        Average       Average        Average         Average
                                    Balance        Rate Paid       Balance      Rate Paid       Balance        Rate Paid
                                  -------------   -----------    ----------    -----------    ------------   ------------
                                                                  (Dollars in Thousands)
<S>                                 <C>              <C>          <C>               <C>         <C>              <C>  
Checking                            $  8,451           --%        $  7,565            --%       $  7,148          --%
NOW accounts                          14,749         2.79           22,828          2.82          13,902         2.78
Passbook accounts                     14,929         2.50           16,574          2.50          17,326         2.50
Money market                          30,813         2.87           38,082          2.92          53,446         2.99
Certificates of deposit              371,957         5.90          406,016          6.17         360,675         5.28
                                    --------                      --------                      --------
  Total deposits                    $440,899         5.34%        $491,065          5.54%       $452,497         4.74%
                                    ========         ====         ========          ====        ========         ==== 
</TABLE>
<PAGE>
      The following  table sets forth the savings  activities of the Association
during the periods indicated.
<TABLE>
<CAPTION>
                                                                  Year Ended June 30,
                                                     -------------------------------------------
                                                       1997            1996               1995
                                                     --------        --------            -------
                                                                  (In Thousands)
<S>                                                  <C>             <C>                 <C>    
Net increase (decrease) before
  interest credited                                  $(19,939)       $(60,148)           $31,405
Interest credited                                      15,208          18,152             13,665
                                                     --------        --------            -------
Net increase (decrease) in
   deposits                                          $ (4,731)       $(41,996)           $45,070
                                                     ========        ========            =======
</TABLE>


                                                        18
<PAGE>
      The following  table shows the interest rate and maturity  information for
the Association's certificates of deposit at June 30, 1997.
<TABLE>
<CAPTION>
                                                                       Maturity Date
                                    -----------------------------------------------------------------------------------

                                       One Year          Over 1-2           Over 2-3          Over 3
                                       or Less             Years             Years            Years            Total
                                    ---------------    ---------------    -------------    -------------    -----------
                                                                       (In Thousands)
<S>                                  <C>               <C>               <C>              <C>              <C>     
2.00  -  4.00%                       $  3,932          $      8          $     --         $     --         $  3,940
4.01  -  6.00%                        196,403            28,513             1,849            1,660          228,425
6.01  -  8.00%                         91,280            26,052            11,146            5,830          134,308
8.01  - 10.00%                             35               991             2,373               --            3,399
10.01% - or more                           --               200                --               --              200
                                     --------          --------          --------         --------         --------
   Total                             $291,650          $ 55,764          $ 15,368         $  7,490         $370,272
                                     ========          ========          ========         ========         ========
</TABLE>

      The  following  table  sets  forth  the  maturities  of the  Association's
certificates of deposit having principal amounts of $100,000 or more at June 30,
1997.
<TABLE>
<CAPTION>
                                                           Amount
                                                           ------
                                                       (In Thousands)
<S>                                                       <C>
Certificates of deposit maturing 
  in quarter ending:             
 September 30, 1997                                       $ 51,756
 December 31, 1997                                          23,066
 March 31, 1998                                             18,700
 June 30, 1998                                              20,420
After June 30, 1998                                         31,159
                                                          --------
Total certificates of deposit with 
   balances of $100,000 or more                           $145,101
                                                          ========
</TABLE>




                                       19
<PAGE>
      Borrowings.  The  Association  may also obtain  advances  from the FHLB of
Atlanta  upon the  security of the common stock it owns in that bank and certain
of its  residential  mortgage  loans,  provided  certain  standards  related  to
creditworthiness  have been met.  Such  advances  are made  pursuant  to several
credit  programs,  each  of  which  has its  own  interest  rate  and  range  of
maturities.  Such  advances are  generally  available to meet seasonal and other
withdrawals of deposit accounts and to permit increased lending.

      The  Association  has  also  utilized  securities  sold  under  repurchase
agreements.  These are agreements to sell  securities  under terms which require
the Association to repurchase the same or substantially  similar securities by a
specified date.

      The  following   table  sets  forth   information   with  respect  to  the
Association's  FHLB advances and securities sold under repurchase  agreements at
and during the periods indicated.
<TABLE>
<CAPTION>
                                                              At or For the Year Ended June 30,
                                      -------------------------------------------------------------------------------
                                                 1997                        1996                       1995
                                      ------------------------    ------------------------    -----------------------
                                                                   (Dollars in Thousands)
<S>                                           <C>                         <C>                        <C>    
FHLB Advances:
Maximum balance                               $129,000                    $10,000                    $55,000
Average balance                                 61,093                      1,038                     46,197
Year end balance                              $129,000                    $    --                    $10,000
Weighted average interest rate:
  At end of year                                  5.90%                        --%                      6.75%
  During the year                                 5.92%                      5.89%                      5.80%


Repurchase Agreements:
Maximum balance                               $120,000                    $85,000                    $ 8,000
Average balance                                117,397                     13,385                      1,644
Year end balance                              $120,000                    $85,000                    $    --
Weighted average interest rate:
  At end of year                                  5.81%                      5.55%                        --%
  During the year                                 5.78%                      5.35%                      6.63%
</TABLE>

Employees

      The Company had 118 full-time employees and 10 part-time employees at June
30, 1997.  None of these  employees is  represented  by a collective  bargaining
agent,  and the  Company  believes  that  it  enjoys  good  relations  with  its
personnel.

                                       20
<PAGE>
Subsidiaries

         The  Company  has  two  wholly  owned  subsidiaries  consisting  of the
Association and Investment Corp. Investment Corp. was formed in December 1995 as
a Delaware-chartered finance subsidiary. In addition to funds held by Investment
Corp.  which were  contributed to Investment  Corp. by the Company in connection
with the Conversion,  Investment  Corp. also loaned $9.0 million to the Employee
Stock Ownership Plan.  Investment  Corp.  generated net income of  approximately
$2.3 million during fiscal 1997.

      The  Association  is  permitted  to invest  up to 2% of its  assets in the
capital  stock of, or secured or unsecured  loans to,  subsidiary  corporations,
with an additional investment of 1% of assets when such additional investment is
utilized primarily for community  development  purposes.  The Association's only
subsidiary,  Home Federal Savings Service Corporation  ("Service  Corporation"),
was formed in 1972. Service Corporation is involved in the sale of annuities and
various insurance  products to the Association's  customers and others.  Service
Corporation generated net income of approximately $129,000 during fiscal 1997.

Competition

      Charlotte is the third  largest  financial  center in the nation after New
York and San Francisco.  The Association  faces strong  competition in its local
market area both in attracting  deposits and making real estate loans.  Its most
direct  competition for deposits has historically come from commercial banks and
other savings  associations,  including many large financial  institutions which
have greater financial and marketing  resources  available to them. In addition,
during  times of low  interest  rates,  the  Association  has  faced  additional
significant  competition  for  investors'  funds from  short-term  money  market
securities,  mutual funds and other  corporate and  government  securities.  The
ability of the Association to attract and retain savings deposits depends on its
ability to generally provide a rate of return,  liquidity and risk comparable to
that offered by competing investment opportunities.  The Association experiences
strong  competition for real estate loans  principally from commercial banks and
mortgage companies.  The Association  competes for loans principally through the
interest  rates and loan fees it  charges  and the  efficiency  and  quality  of
services it provides borrowers.

                                   REGULATION

      Set forth below is a brief description of those laws and regulations which
relate to the  Company  and the  Association.  The  description  of the laws and
regulations hereunder, as well as descriptions of laws and regulations contained
elsewhere  herein,  does not  purport to be  complete  and is  qualified  in its
entirety by reference to applicable laws and regulations.

The Company

      General.  The Company is a savings  and loan  holding  company  within the
meaning of the Home Owners Loan Act ("HOLA") and is subject to OTS  regulations,
examinations,  supervision  and  reporting  requirements.  As a subsidiary  of a
savings  and loan  holding  company,  the  Association  is  subject  to  certain
restrictions in its dealings with the Company and affiliates thereof.

      Activities  Restrictions.  There  are  generally  no  restrictions  on the
activities of a savings and loan holding company which holds only one subsidiary
savings  institution.  However, if the Director of the OTS determines that there
is  reasonable  cause to believe  that the  continuation  by a savings  and loan
holding  company of an  activity  constitutes  a serious  risk to the  financial
safety,  soundness or  stability  of its  subsidiary  savings  institution,  the
Director may impose such  restrictions as deemed necessary to address such risk,
including  limiting (i) payment of dividends  by the savings  institution;  (ii)
transactions  between the savings institution and its affiliates;  and (iii) any
activities of the savings  institution that might create a serious risk that the
liabilities  of the  holding  company and its  affiliates  may be imposed on the
savings institution.  Notwithstanding the above rules as to permissible business
activities of unitary savings and


                                       21
<PAGE>
loan holding companies,  if the savings institution subsidiary of such a holding
company  fails to meet the QTL test,  as discussed  under "- The  Association  -
Qualified  Thrift Lender  Test",  then such unitary  holding  company also shall
become subject to the activities restrictions applicable to multiple savings and
loan holding companies and, unless the savings institution  requalifies as a QTL
within  one year  thereafter,  shall  register  as,  and  become  subject to the
restrictions  applicable to, a bank holding  company.  See "- The  Association -
Qualified Thrift Lender Test."

      If the Company  were to acquire  control of another  savings  institution,
other than through merger or other business  combination  with the  Association,
the Company would thereupon  become a multiple savings and loan holding company.
Except where such acquisition is pursuant to the authority to approve  emergency
thrift  acquisitions and where each subsidiary savings institution meets the QTL
test,  as set  forth  below,  the  activities  of  the  Company  and  any of its
subsidiaries   (other  than  the   Association  or  other   subsidiary   savings
institutions) would thereafter be subject to further  restrictions.  Among other
things, no multiple savings and loan holding company or subsidiary thereof which
is not a savings  institution shall commence or continue for a limited period of
time after  becoming a multiple  savings and loan holding  company or subsidiary
thereof any  business  activity,  upon prior  notice to, and no objection by the
OTS,  other  than:  (i)  furnishing  or  performing  management  services  for a
subsidiary  savings  institution;  (ii) conducting an insurance agency or escrow
business;  (iii) holding,  managing,  or liquidating assets owned by or acquired
from a subsidiary savings institution;  (iv) holding or managing properties used
or occupied by a subsidiary  savings  institution;  (v) acting as trustee  under
deeds of trust;  (vi) those  activities  authorized by regulation as of March 5,
1987 to be engaged in by multiple savings and loan holding  companies;  or (vii)
unless the Director of the OTS by regulation prohibits or limits such activities
for savings and loan  holding  companies,  those  activities  authorized  by the
Federal  Reserve  Board  as  permissible  for  bank  holding  companies.   Those
activities described in (vii) above also must be approved by the Director of the
OTS prior to being engaged in by a multiple savings and loan holding company.

      Limitations on Transactions with Affiliates.  Transactions between savings
institutions  and any  affiliate  are  governed by  Sections  23A and 23B of the
Federal  Reserve Act. An affiliate  of a savings  institution  is any company or
entity which  controls,  is  controlled  by or is under common  control with the
savings institution. In a holding company context, the parent holding company of
a  savings  institution  (such  as the  Company)  and any  companies  which  are
controlled  by  such  parent  holding  company  are  affiliates  of the  savings
institution.  Generally,  Sections 23A and 23B (i) limit the extent to which the
savings  institution or its  subsidiaries  may engage in "covered  transactions"
with any one affiliate to an amount equal to 10% of such  institution's  capital
stock and surplus,  and contain an aggregate limit on all such transactions with
all  affiliates  to an amount equal to 20% of such capital stock and surplus and
(ii) require that all such  transactions be on terms  substantially the same, or
at least as favorable,  to the  institution or subsidiary as those provided to a
non-affiliate.  The term  "covered  transaction"  includes  the making of loans,
purchase of assets,  issuance of a guarantee and other similar transactions.  In
addition  to the  restrictions  imposed  by  Sections  23A and 23B,  no  savings
institution may (i) loan or otherwise extend credit to an affiliate,  except for
any affiliate  which engages only in activities  which are  permissible for bank
holding companies, or (ii) purchase or invest in any stocks, bonds,  debentures,
notes or similar  obligations of any affiliate,  except for affiliates which are
subsidiaries of the savings institution.

      In  addition,  Sections  22(h) and (g) of the  Federal  Reserve Act places
restrictions   on  loans  to  executive   officers,   directors   and  principal
stockholders. Under Section 22(h), loans to a director, an executive officer and
to a  greater  than  10%  stockholder  of a  savings  institution,  and  certain
affiliated  interests  of  either,  may not  exceed,  together  with  all  other
outstanding  loans  to  such  person  and  affiliated  interests,   the  savings
institution's  loans  to  one  borrower  limit  (generally  equal  to 15% of the
institution's unimpaired capital and surplus).  Section 22(h) also requires that
loans to directors,  executive  officers and principal  stockholders  be made on
terms  substantially  the same as offered in  comparable  transactions  to other
persons and also requires prior board  approval for certain loans.  In addition,
the aggregate  amount of extensions  of credit by a savings  institution  to all
insiders  cannot  exceed  the  institution's  unimpaired  capital  and  surplus.
Furthermore,  Section 22(g) places additional restrictions on loans to executive
officers.  At June 30, 1997, the  Association  was in compliance  with the above
restrictions.

                                       22
<PAGE>
      Restrictions on Acquisitions. Except under limited circumstances,  savings
and loan holding companies are prohibited from acquiring, without prior approval
of the  Director of the OTS,  (i) control of any other  savings  institution  or
savings and loan holding company or substantially all the assets thereof or (ii)
more than 5% of the voting shares of a savings  institution  or holding  company
thereof  which is not a  subsidiary.  Except  with  the  prior  approval  of the
Director  of the OTS,  no  director  or  officer of a savings  and loan  holding
company or person owning or  controlling  by proxy or otherwise more than 25% of
such company's stock, may acquire control of any savings institution, other than
a  subsidiary  savings  institution,  or of any other  savings and loan  holding
company.

      The  Director of the OTS may only  approve  acquisitions  resulting in the
formation of a multiple  savings and loan holding company which controls savings
institutions in more than one state if (i) the multiple savings and loan holding
company involved controls a savings  institution which operated a home or branch
office  located in the state of the  institution  to be  acquired as of March 5,
1987;  (ii) the  acquiror  is  authorized  to  acquire  control  of the  savings
institution  pursuant to the  emergency  acquisition  provisions  of the Federal
Deposit Insurance Act ("FDIA");  or (iii) the statutes of the state in which the
institution to be acquired is located  specifically  permit  institutions  to be
acquired  by the  state-chartered  institutions  or  savings  and  loan  holding
companies  located in the state where the  acquiring  entity is located (or by a
holding company that controls such state-chartered savings institutions).

      Under the Bank  Holding  Company  Act of 1956,  the FRB is  authorized  to
approve an application by a bank holding company to acquire control of a savings
institution.  In  addition,  a bank  holding  company  that  controls  a savings
institution  may merge or consolidate  the assets and liabilities of the savings
institution  with, or transfer  assets and  liabilities  to, any subsidiary bank
which is a member of the Bank  Insurance  Fund  ("BIF") with the approval of the
appropriate federal banking agency and the FRB. As a result of these provisions,
there have been a number of acquisitions of savings institutions by bank holding
companies in recent years.

The Association

      General.  The OTS has extensive authority over the operations of federally
chartered savings institutions.  As part of this authority, savings institutions
are required to file  periodic  reports with the OTS and are subject to periodic
examinations  by the OTS and the FDIC. The  investment and lending  authority of
savings  institutions are prescribed by federal laws and  regulations,  and such
institutions  are  prohibited  from engaging in any  activities not permitted by
such laws and regulations.  Those laws and regulations  generally are applicable
to  all  federally  chartered  savings   institutions  and  may  also  apply  to
state-chartered  savings  institutions.   Such  regulation  and  supervision  is
primarily intended for the protection of depositors.

      The OTS'  enforcement  authority over all savings  institutions  and their
holding  companies  includes,  among other  things,  the ability to assess civil
money  penalties,  to issue  cease and desist or removal  orders and to initiate
injunctive actions.  In general,  these enforcement actions may be initiated for
violations  of laws and  regulations  and  unsafe or  unsound  practices.  Other
actions or inactions  may provide the basis for  enforcement  action,  including
misleading or untimely reports filed with the OTS.

      Insurance of Accounts.  The deposits of the Association are insured to the
maximum extent permitted by the SAIF, which is administered by the FDIC, and are
backed by the full faith and credit of the U.S. Government. As insurer, the FDIC
is  authorized  to  conduct  examinations  of,  and  to  require  reporting  by,
FDIC-insured  institutions.  It also may prohibit any  FDIC-insured  institution
from engaging in any activity the FDIC determines by regulation or order to pose
a serious  threat  to the FDIC.  The FDIC  also has the  authority  to  initiate
enforcement  actions  against  savings  institutions,  after  giving  the OTS an
opportunity to take such action.

      The BIF fund met its target reserve level in September  1995, but the SAIF
was not  expected  to meet  its  target  reserve  level  until  at  least  2002.
Consequently,  in late 1995,  the FDIC approved a final rule  regarding  deposit
insurance  premiums  which,  effective  with respect to the  semiannual  premium
assessment beginning January 1, 1996, reduced


                                       23
<PAGE>
deposit  insurance  premiums  for BIF member  institutions  in the  lowest  risk
category.  Deposit insurance  premiums for SAIF members were maintained at their
existing levels (23 basis points for institutions in the lowest risk category).

      On September 30, 1996,  President  Clinton signed into law  legislation to
eliminate  the  premium  differential  between  SAIF-insured   institutions  and
BIF-insured  institutions by recapitalizing  the SAIF's reserves to the required
ratio of 1.25% of insured deposits. The legislation provided that the holders of
SAIF-assessable  deposits pay a one-time special  assessment to recapitalize the
SAIF. The legislation also provided for the merger of the BIF and the SAIF, with
such merger being  conditioned upon the prior elimination of the thrift charter.
Effective  October  8,  1996,  FDIC  regulations   imposed  a  one-time  special
assessment  equal to 65.7 basis  points for all  SAIF-assessable  deposits as of
March 31, 1995, which was collected on November 27, 1996.

      Following the  imposition  of the one-time  special  assessment,  the FDIC
lowered  assessment  rates for SAIF  members  to  reduce  the  disparity  in the
assessment  rates  paid by BIF and SAIF  members.  Beginning  October  1,  1996,
effective  BIF and SAIF rates  both  range  from zero  basis  points to 27 basis
points.   From  1997  through  1999,   FDIC-  insured   institutions   will  pay
approximately  1.3 basis points of their  BIF-assessable  deposits and 6.4 basis
points of their SAIF-assessable deposits to fund the Financing Corporation.

      The FDIC may  terminate  the deposit  insurance of any insured  depository
institution,  including the  Association,  if it determines after a hearing that
the institution has engaged or is engaging in unsafe or unsound practices, is in
an unsafe or unsound  condition  to continue  operations,  or has  violated  any
applicable law, regulation,  order or any condition imposed by an agreement with
the FDIC. It also may suspend deposit insurance  temporarily  during the hearing
process for the permanent  termination of insurance,  if the  institution has no
tangible  capital.  If insurance of accounts is terminated,  the accounts at the
institution at the time of the termination,  less subsequent withdrawals,  shall
continue to be insured for a period of six months to two years, as determined by
the FDIC. Management is aware of no existing circumstances which would result in
termination of the Association's deposit insurance.

      Regulatory Capital  Requirements.  Federally insured savings  institutions
are  required to maintain  minimum  levels of  regulatory  capital.  The OTS has
established  capital  standards  applicable to all savings  institutions.  These
standards generally must be as stringent as the comparable capital  requirements
imposed  on  national  banks.  The OTS  also is  authorized  to  impose  capital
requirements  in excess  of these  standards  on  individual  institutions  on a
case-by-case basis.

      Current OTS capital  standards  require  savings  institutions  to satisfy
three  different   capital   requirements.   Under  these   standards,   savings
institutions must maintain "tangible" capital equal to at least 1.5% of adjusted
total assets, "core" capital equal to at least 3.0% of adjusted total assets and
"total" capital (a combination of core and "supplementary"  capital) equal to at
least 8.0% of  "risk-weighted"  assets.  For  purposes of the  regulation,  core
capital generally consists of common  stockholders'  equity (including  retained
earnings), noncumulative perpetual preferred stock and related surplus, minority
interests in the equity  accounts of fully  consolidated  subsidiaries,  certain
nonwithdrawable  accounts  and  pledged  deposits  and  "qualifying  supervisory
goodwill."  Tangible  capital is given the same  definition  as core capital but
does not include qualifying supervisory goodwill and is reduced by the amount of
all the savings  institution's  intangible assets, with only a limited exception
for purchased  mortgage  servicing  rights.  The  Association had no goodwill or
other  intangible  assets at June 30, 1997.  Both core and tangible  capital are
further  reduced by an amount equal to a savings  institution's  debt and equity
investments in  subsidiaries  engaged in activities not  permissible to national
banks (other than  subsidiaries  engaged in  activities  undertaken as agent for
customers  or  in  mortgage   banking   activities  and  subsidiary   depository
institutions or their holding  companies).  These  adjustments do not materially
affect the Association's regulatory capital.

      In determining  compliance  with the  risk-based  capital  requirement,  a
savings  institution  is allowed to include both core capital and  supplementary
capital in its total capital,  provided that the amount of supplementary capital
included does not exceed the savings  institution's core capital.  Supplementary
capital generally consists of hybrid capital  instruments;  perpetual  preferred
stock which is not eligible to be included as core  capital;  subordinated  debt
and

                                       24
<PAGE>
intermediate-term  preferred stock; and general allowances for loan losses up to
a maximum of 1.25% of risk-1eighted  assets.  In determining the required amount
of risk-based capital, total assets,  including certain off-balance sheet items,
are  multiplied  by a risk  weight  based on the risks  inherent  in the type of
assets. The risk weights assigned by the OTS for principal  categories of assets
are  (i)  0%  for  cash  and  securities  issued  by  the  U.S.   Government  or
unconditionally backed by the full faith and credit of the U.S. Government; (ii)
20%  for   securities   (other   than   equity   securities)   issued   by  U.S.
Government-sponsored agencies and mortgage-backed securities issued by, or fully
guaranteed  as to principal  and interest by, the FNMA or the FHLMC,  except for
those  classes  with  residual  characteristics  or  stripped   mortgage-related
securities;  (iii) 50% for prudently  underwritten permanent one- to four-family
first  lien  mortgage  loans  not  more  than 90 days  delinquent  and  having a
loan-to-value  ratio of not more than 80% at origination  unless insured to such
ratio by an insurer  approved by the FNMA or the FHLMC,  qualifying  residential
bridge  loans  made  directly  for  the  construction  of  one-  to  four-family
residences and qualifying multi-family  residential loans; and (iv) 100% for all
other loans and investments,  including  consumer loans,  commercial  loans, and
one- to four-family  residential real estate loans more than 90 days delinquent,
and for repossessed assets.

      In  August  1993,   the  OTS  adopted  a  final  rule   incorporating   an
interest-rate risk component into the risk-based capital  regulation.  Under the
rule, an  institution  with a greater than "normal"  level of interest rate risk
will be subject to a deduction of its interest  rate risk  component  from total
capital for purposes of calculating its risk-based capital. As a result, such an
institution will be required to maintain  additional  capital in order to comply
with the risk-based  capital  requirement.  An  institution  with a greater than
"normal"  interest  rate risk is defined as an  institution  that would suffer a
loss of net portfolio  value  exceeding 2.0% of the estimated  economic value of
its assets in the event of a 200 basis point  increase or decrease (with certain
minor  exceptions) in interest  rates.  The interest rate risk component will be
calculated,  on a quarterly  basis,  as one-half  of the  difference  between an
institution's  measured  interest rate risk and 2.0%  multiplied by the economic
value of its assets.  The rule also  authorizes  the Director of the OTS, or his
designee,  to waive or defer an institution's  interest rate risk component on a
case-by-case  basis.  The final rule was  originally  effective as of January 1,
1994,  subject however to a two quarter "lag" time between the reporting date of
the data used to calculate an institution's interest rate risk and the effective
date of each quarter's  interest rate risk component.  However,  in October 1994
the Director of the OTS indicated that it would waive the capital deductions for
institutions  with a greater  than  "normal"  risk  until the OTS  publishes  an
appeals  process.  On August 21, 1995, the OTS released Thrift Bulletin 67 which
established (i) an appeals process to handle  "requests for  adjustments" to the
interest  rate risk  component  and (ii) a process  by which  "well-capitalized"
institutions may obtain  authorization to use their own interest rate risk model
to  determine  their  interest  rate risk  component.  The  Director  of the OTS
indicated,  concurrent with the release of Thrift Bulletin 67, that the OTS will
continue to delay the  implementation of the capital deduction for interest rate
risk pending the testing of the appeals process set forth in Thrift Bulletin 67.

      Any  savings  institution  that fails any of the capital  requirements  is
subject to possible  enforcement  actions by the OTS or the FDIC.  Such  actions
could  include a  capital  directive,  a cease and  desist  order,  civil  money
penalties,  the establishment of restrictions on the  institution's  operations,
termination of federal deposit insurance and the appointment of a conservator or
receiver.  The OTS'  capital  regulation  provides  that such  actions,  through
enforcement proceedings or otherwise,  could require one or more of a variety of
corrective actions.

      Liquidity Requirements.  All savings institutions 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  institutions.  At the present time,  the required  minimum
liquid asset ratio is 5%. At June 30, 1997, the Association' liquidity ratio was
10.8%.

      Capital  Distributions.  OTS regulations  govern capital  distributions by
savings  institutions,  which  include  cash  dividends,  stock  redemptions  or
repurchases, cash-out mergers, interest payments on certain convertible debt and
other  transactions  charged to the capital account of a savings  institution to
make capital distributions.  Generally, the regulation creates a safe harbor for
specified levels of capital  distributions  from  institutions  meeting at least
their minimum capital requirements,  so long as such institutions notify the OTS
and receive no objection to the distribution

                                       25
<PAGE>
from the OTS. Savings institutions and distributions that do not qualify for the
safe harbor are required to obtain prior OTS approval  before making any capital
distributions.

      Generally,  a savings  institution  that  before  and  after the  proposed
distribution  meets or exceeds its fully phased-in capital  requirements (Tier 1
institutions) may make capital  distributions  during any calendar year equal to
the higher of (i) 100% of net income for the calendar  year-to-date  plus 50% of
its "surplus capital ratio" at the beginning of the calendar year or (ii) 75% of
net income over the most recent four-quarter period. The "surplus capital ratio"
is  defined to mean the  percentage  by which the  institution's  ratio of total
capital to assets exceeds the ratio of its fully phased-in  capital  requirement
to  assets.  "Fully  phased-in  capital  requirement"  is  defined  to  mean  an
institution's  capital requirement under the statutory and regulatory  standards
applicable  on  December  31,  1994,  as  modified  to  reflect  any  applicable
individual minimum capital requirement imposed upon the institution.  Failure to
meet fully  phased-in  or minimum  capital  requirements  will result in further
restrictions on capital  distributions,  including possible  prohibition without
explicit OTS approval. See "- Regulatory Capital Requirements."

      Tier 2  institutions,  which are  institutions  that  before and after the
proposed  distribution  meet or exceed their minimum capital  requirements,  may
make  capital  distributions  up to a specified  percentage  of their net income
during  the  most  recent  four  quarter  period,  depending  on how  close  the
institution  is to meeting  its fully  phased-in  capital  requirements.  Tier 3
institutions,  which are  institutions  that do not meet current minimum capital
requirements,  or which have been otherwise  notified by the OTS that it will be
treated as a Tier 3  institution  because  they are in need of more than  normal
supervision, cannot make any capital distribution without obtaining OTS approval
prior to making such distributions.

      In order to make distributions under these safe harbors, Tier 1 and Tier 2
institutions  must submit 30 days written  notice to the OTS prior to making the
distribution.  The OTS may object to the distribution  during that 30-day period
based on safety and soundness concerns.  At June 30, 1997, the Association was a
Tier 1 institution for purposes of this regulation.

      Loans to One Borrower. The permissible amount of loans to one borrower now
generally  follows  the  national  bank  standard  for all loans made by savings
institutions.  The national bank standard generally does not permit loans to one
borrower  to exceed the greater of  $500,000  or 15% of  unimpaired  capital and
surplus. Loans in an amount equal to an additional 10% of unimpaired capital and
surplus also may be made to a borrower if the loans are fully secured by readily
marketable securities.

      Classified Assets.  Federal  regulations require that each insured savings
institution  classify its assets on a regular basis. In addition,  in connection
with examinations of insured  institutions,  federal examiners have authority to
identify  problem assets and, if  appropriate,  classify  them.  There are three
classifications  for  problem  assets:  "substandard,"  "doubtful"  and  "loss."
Substandard  assets have one or more defined weaknesses and are characterized by
the distinct  possibility that the insured institution will sustain some loss if
the  deficiencies  are not  corrected.  Doubtful  assets have the  weaknesses of
substandard assets, with the additional  characteristic that the weaknesses make
collection  or  liquidation  in full on the basis of currently  existing  facts,
conditions and values questionable,  and there is a high possibility of loss. An
asset classified loss is considered  uncollectible and of such little value that
continuance as an asset of the  institution is not warranted.  Another  category
designated  "special mention" also must be established and maintained for assets
which do not currently expose an insured  institution to a sufficient  degree of
risk  to  warrant  classification  as  substandard,  doubtful  or  loss.  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 specific allowances for loan
losses in the amount of 100% 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 up to certain  amounts,  while
specific  valuation  allowances  for loan  losses do not  qualify as  regulatory
capital.   Federal   examiners  may  disagree  with  an  insured   institution's
classifications and amounts reserved.

                                       26
<PAGE>
      Branching by Federal Savings  Institutions.  OTS policy permits interstate
branching  to the  full  extent  permitted  by  statute  (which  is  essentially
unlimited).  Generally,  federal law prohibits federal savings institutions from
establishing,  retaining  or  operating a branch  outside the state in which the
federal  institution has its home office unless the  institution  meets the IRS'
domestic  building and loan test  (generally,  60% of a thrift's  assets must be
housing-related) ("IRS Test"). The IRS Test requirement does not apply if, among
other  things,  the law of the state  where the branch  would be  located  would
permit the branch to be  established  if the federal  savings  institution  were
chartered by the state in which its home office is located. Furthermore, the OTS
will evaluate a branching  applicant's  record of compliance  with the Community
Reinvestment Act of 1977 ("CRA").  An unsatisfactory CRA record may be the basis
for denial of a branching application.

      Qualified  Thrift Lender Test.  All savings  institutions  are required to
meet a QTL test to avoid certain  restrictions  on their  operations.  A savings
institution  that  does  not meet the QTL test  must  either  convert  to a bank
charter or comply with the following  restrictions  on its  operations:  (i) the
institution  may not  engage  in any new  activity  or make any new  investment,
directly or indirectly,  unless such activity or investment is permissible for a
national bank; (ii) the branching powers of the institution  shall be restricted
to those of a national  bank;  (iii) the  institution  shall not be  eligible to
obtain  any  advances  from its  FHLB;  and (iv)  payment  of  dividends  by the
institution  shall be subject to the rules  regarding  payment of dividends by a
national  bank.  Upon the  expiration  of three  years from the date the savings
institution  ceases to be a QTL, it must cease any  activity  and not retain any
investment  not  permissible  for a  national  bank and  immediately  repay  any
outstanding FHLB advances (subject to safety and soundness considerations).

      Currently,  the QTL test requires that 65% of an institution's  "portfolio
assets" (as defined) consist of certain housing and consumer-related assets on a
monthly  average  basis  in nine out of every 12  months.  Assets  that  qualify
without  limit for  inclusion as part of the 65%  requirement  are loans made to
purchase,  refinance,  construct, improve or repair domestic residential housing
and manufactured housing; home equity loans;  mortgage-backed  securities (where
the  mortgages  are  secured by  domestic  residential  housing or  manufactured
housing);  stock  issued  by  the  FHLB  of  Atlanta;  and  direct  or  indirect
obligations of the FDIC. In addition, the following assets, among others, may be
included in meeting the test  subject to an overall  limit of 20% of the savings
institution's portfolio assets: 50% of residential mortgage loans originated and
sold within 90 days of  origination;  100% of  consumer  and  educational  loans
(limited to 10% of total portfolio assets); and stock issued by the FHLMC or the
FNMA. Portfolio assets consist of total assets minus the sum of (i) goodwill and
other  intangible  assets,  (ii)  property  used by the savings  institution  to
conduct its  business,  and (iii) liquid  assets up to 20% of the  institution's
total  assets.  At June  30,  1997,  the  qualified  thrift  investments  of the
Association were approximately 88.3% of its portfolio assets.

      Accounting   Requirements.   Applicable  OTS  accounting  regulations  and
reporting  requirements  apply the following  standards:  (i) regulatory reports
will  incorporate  GAAP  when GAAP is used by  federal  banking  agencies;  (ii)
savings  institution  transactions,  financial  condition and regulatory capital
must be reported  and  disclosed in  accordance  with OTS  regulatory  reporting
requirements that will be at least as stringent as for national banks; and (iii)
the Director of the OTS may prescribe  regulatory  reporting  requirements  more
stringent than GAAP whenever the Director  determines that such requirements are
necessary  to ensure  the safe and sound  reporting  and  operation  of  savings
institutions.

      The  accounting  principles  for  depository  institutions  are  currently
undergoing review to determine whether the historical cost model or market-based
measure of valuation is the appropriate measure for reporting the assets of such
institutions  in their  financial  statements.  Such  proposal is  controversial
because any change in applicable accounting principles which requires depository
institutions  to carry  mortgage-backed  securities  and mortgage  loans at fair
market  value  could  result  in  substantial  losses to such  institutions  and
increased volatility in their liquidity and operations.  Currently, it cannot be
predicted  whether  there may be any changes in the  accounting  principles  for
depository  institutions  in this regard beyond those imposed by SFAS No. 115 or
when any such changes might become effective.

         Federal Home Loan Bank System.  The Association is a member of the FHLB
of  Atlanta,  which  is one of 12  regional  FHLBs  that  administers  the  home
financing credit function of savings institutions. Each FHLB serves as a

                                       27
<PAGE>
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. At
June 30, 1997, the  Association  had FHLB advances  amounting to $129.0 million.
See "Business - Sources of Funds - Borrowings."

      As a member, the Association is required to purchase and maintain stock in
the FHLB of Atlanta in an amount equal to 1% of its aggregate unpaid residential
mortgage loans, home purchase contracts or similar  obligations at the beginning
of each year or 5% of FHLB advances, whichever is greater. At June 30, 1997, the
Association  had $6.5 million in FHLB stock,  which was in compliance  with this
requirement.

      The FHLBs are  required to provide  funds for the  resolution  of troubled
savings  institutions  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 in the  past and  could
continue to do so in the future.  These contributions also could have an adverse
effect on the value of FHLB stock in the future.

      Federal  Reserve System.  The FRB requires all depository  institutions to
maintain  reserves against their transaction  accounts  (primarily NOW and Super
NOW checking  accounts) and non-personal time deposits.  As of June 30, 1997, no
reserves were required to be maintained on the first $4.3 million of transaction
accounts,  reserves of 3% were required to be maintained  against the next $52.0
million  of net  transaction  accounts  (with  such  dollar  amounts  subject to
adjustment by the FRB),  and a reserve of 10% (which is subject to adjustment by
the FRB to a level  between 8% and 14%) against all  remaining  net  transaction
accounts. Because required reserves must be maintained in the form of vault cash
or a  noninterest-bearing  account at a Federal Reserve Bank, the effect of this
reserve requirement is to reduce an institution's earning assets.


                                    TAXATION

Federal Taxation

      General.  The  Company  and  Association  are  subject  to  the  generally
applicable  corporate tax provisions of the Code, and  Association is subject to
certain additional  provisions of the Code which apply to thrift and other types
of financial  institutions.  The  following  discussion  of federal  taxation is
intended only to summarize certain pertinent federal income tax matters material
to the taxation of the Company and the  Association  and is not a  comprehensive
discussion of the tax rules applicable to the Company and Association.

         Year. The Company and  Association  file a federal income tax return on
the basis of a fiscal year ending on June 30.

      Bad Debt Reserves.  Savings institutions,  such as the Association,  which
meet  certain  definitional  tests  primarily  relating to their  assets and the
nature of their  businesses,  historically  have been  permitted  to establish a
reserve  for bad  debts  and to make  annual  additions  to the  reserve.  These
additions may, within specified  formula limits,  be deducted in arriving at the
institution's  taxable income. For purposes of computing the deductible addition
to its bad debt reserve,  the institution's loans are separated into "qualifying
real property loans" (i.e.,  generally those loans secured by certain  interests
in real property) and all other loans  ("non-qualifying  loans").  The deduction
with  respect to  non-qualifying  loans must be  computed  under the  experience
method,  while,  prior to fiscal  1997, a deduction  with respect to  qualifying
loans may be computed  using a percentage  based on actual loss  experience or a
percentage of taxable income.

      Recently  enacted  legislation  will  affect the  Association's  method of
establishing  a tax  reserve  for bad  debts  and  its  ability  to make  annual
additions  thereto.  Pursuant to such  legislation,  the  percentage  of taxable
income method has been repealed.  In addition,  the  Association is permitted to
deduct bad debts only as they occur and is required to

                                       28
<PAGE>
recapture  (i.e.  take into  income)  over a  six-year  period the excess of the
balance of its bad debt  reserves  as of June 30,  1996 over the balance of such
reserves  as of June 30,  1988.  It is  anticipated  that any  recapture  of the
Association's bad debt reserves accumulated after 1987 would not have a material
adverse effect on the Company's financial condition and results of operations.

      Under the  previous  percentage  of taxable  income  method,  the bad debt
deduction  equals  8% of  taxable  income  determined  without  regard  to  that
deduction and with certain  adjustments.  The  availability of the percentage of
taxable income method permits a qualifying savings  institution to be taxed at a
lower effective  federal income tax rate than that applicable to corporations in
general. This resulted generally in an effective federal income tax rate payable
by a  qualifying  savings  institution  fully able to use the maximum  deduction
permitted under the percentage of taxable income method, in the absence of other
factors  affecting  taxable  income,  of 32.2%  exclusive  of any minimum tax or
environmental tax (as compared to 35% for corporations  generally).  Any savings
institution at least 60% of whose assets are qualifying  assets, as described in
the Code, was generally eligible for the full deduction of 8% of taxable income.

      At June 30, 1997, the federal income tax reserves of the Company  included
$16.9  million  for which no federal  income tax has been  provided.  Because of
these  federal  income tax reserves the  stockholders'  equity of the Company is
substantially restricted.

      Distributions.  If the Association  were to distribute cash or property to
its sole  stockholder,  and the  distribution  was  treated  as  being  from its
accumulated bad debt reserves,  the distribution  would cause the Association to
have additional  taxable income. A distribution is deemed to have been made from
accumulated  bad debt  reserves to the extent that (a) the  reserves  exceed the
amount that would have been  accumulated on the basis of actual loss experience,
and (b) the distribution is a "non-qualified  distribution." A distribution with
respect to stock is a non-qualified distribution to the extent that, for federal
income tax purposes, (i) it is in redemption of shares, (ii) it is pursuant to a
liquidation of the institution,  or (iii) in the case of a current distribution,
together with all other such  distributions  during the taxable year, it exceeds
the institution's  current and post-1951  accumulated  earnings and profits. The
amount of additional  taxable income created by a non-qualified  distribution is
an amount that when reduced by the tax attributable to it is equal to the amount
of the distribution.

      Minimum Tax. The Code imposes an alternative minimum tax at a rate of 20%.
The  alternative  minimum  tax  generally  applies to a base of regular  taxable
income plus certain tax  preferences  ("alternative  minimum  taxable income" or
"AMTI")  and is  payable to the  extent  such AMTI is in excess of an  exemption
amount.  The Code provides  that an item of tax  preference is the excess of the
bad debt  deduction  allowable for a taxable year pursuant to the  percentage of
taxable income method over the amount  allowable  under the  experience  method.
Other items of tax  preference  that  constitute  AMTI  include  (a)  tax-exempt
interest on newly issued (generally,  issued on or after August 8, 1986) private
activity bonds other than certain  qualified bonds and (b) 75% of the excess (if
any) of (i)  adjusted  current  earnings as defined in the Code,  over (ii) AMTI
(determined  without  regard to this  preference  and prior to  reduction by net
operating losses).

      Net Operating Loss Carryovers.  A financial institution may carry back net
operating  losses  ("NOLs") to the preceding  three taxable years and forward to
the succeeding 15 taxable years.  This provision  applies to losses  incurred in
taxable years  beginning  after 1986.  At June 30, 1997,  the Company had no NOL
carryforwards for federal income tax purposes.

      Capital Gains and Corporate  Dividends-Received  Deduction.  Corporate net
capital   gains   are   taxed  at  a  maximum   rate  of  35%.   The   corporate
dividends-received  deduction  is 80% in the  case of  dividends  received  from
corporations  with which a corporate  recipient does not file a consolidated tax
return,  and corporations  which own less than 20% of the stock of a corporation
distributing a dividend may deduct only 70% of dividends  received or accrued on
their behalf.  However, a corporation may deduct 100% of dividends from a member
of the same affiliated group of corporations.

                                       29
<PAGE>
      Other Matters.  Federal  legislation is introduced  from time to time that
would  limit the  ability of  individuals  to deduct  interest  paid on mortgage
loans.  Individuals  are currently not permitted to deduct  interest on consumer
loans.  Significant  increases  in tax  rates  or  further  restrictions  on the
deductibility of mortgage interest could adversely affect the Association.

      The Association's  federal income tax returns for the tax years ended June
30, 1995  forward are open under the statute of  limitations  and are subject to
review by the IRS.

State Taxation

      Unless  authorized  under  special  circumstances  by the  North  Carolina
Department of Revenue,  the filing of a consolidated  state income tax return is
not permitted. Accordingly, each of the Company and its subsidiaries,  including
the  Association,  but  excluding  Investment  Corp.,  is  subject  to an annual
corporate  income tax of 7.75% of its federal  taxable  income as computed under
the Code,  subject to certain prescribed  adjustments.  In addition to the state
corporate  income tax,  the Company  and the  Association  will be subject to an
annual state  franchise  tax,  which is imposed at a rate of .15% applied to the
greatest of each institution's (i) capital stock, surplus and undivided profits,
(ii)  investment in property in North Carolina or (iii)  appraised  valuation of
property in North Carolina.

      Investment  Corp.  is  subject  to  a  Delaware  franchise  tax  based  on
Investment  Corp.'s  authorized  capital  stock or on its assumed par and no-par
capital,  whichever yields a lower result.  Under the authorized capital method,
each share is taxed at a graduated rate based on the number of authorized shares
with a maximum  aggregate tax of $150,000 per year. Under the assumed  par-value
capital  method,  Delaware taxes each  $1,000,000 of assumed  par-capital at the
rate of $200.

                                       30
<PAGE>
PART II.

Item 2.  Properties.

      At June 30, 1997,  the Company  conducted  its business from its executive
office in Charlotte,  North Carolina, nine full service offices and one mortgage
loan  office.  The  following  table sets  forth the net book  value  (including
leasehold improvements and equipment) and certain other information with respect
to the offices and other properties of the Company at June 30, 1997.
<TABLE>
<CAPTION>
                                                       Leased/            Net Book Value
               Description/Address                      Owned               of Property          Amount of Deposits
----------------------------------------------    ---------------    -----------------------   ---------------------
                                                                                      (In Thousands)
<S>                                                    <C>                     <C>                   <C>
Main Office:
139 South Tryon Street
Charlotte, North Carolina                               Owned                  $1,531                 $116,961


Branch Offices:
6342 Carmel Road
Charlotte, North Carolina  28226                        Owned                     386                   24,092


4400 Randolph Road
Charlotte, North Carolina  28211                        Owned                     249                   68,140


5601 Reddman Road
Charlotte, North Carolina  28212                        Owned                     559                   71,088

I-77 and Route 73
Cornelius, North Carolina  28031                        Owned                     344                   26,199

4323 Park Road
Charlotte, North Carolina  28209                      Leased(1)                    --                   80,500

4519 Sharon Road
Charlotte, North Carolina  28211                      Leased(2)                   166                   37,916

8601 John Maynard Keynes Drive
Charlotte, North Carolina  28262                        Owned                   1,527                   18,046

Mortgage Loan Office:
6310 Fairview Road
Charlotte, North Carolina  28211(3)                     Owned                   4,475                      898
</TABLE>

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

(1)      This property is subject to a lease that expires in 1999.

(2)      This  property  is  subject  to a lease  that  expires  in 2002 and the
         Association has an option to renew the lease for one additional  period
         of five years.

(3)      This property is also used as a branch office.

                                       31
<PAGE>
Item 3.  Legal Proceedings.

         In June 1995,  a lawsuit was  initiated  against the  Association  by a
borrower's  affiliated  companies  in  which  the  plaintiffs  alleged  that the
Association  wrongfully  set-off  certain  funds in an  account  being  held and
maintained by the  Association.  In addition,  the plaintiffs  alleged that as a
result of the wrongful set-off, the Association wrongfully dishonored a check in
the amount of $270,000. Plaintiffs further alleged that the actions on behalf of
the  Association  constituted  unfair and  deceptive  trade  practices,  thereby
entitling  plaintiffs  to  recover  treble  damages  and  attorneys'  fees.  The
Association denied any wrongdoing and filed a motion for summary judgment.  Upon
consideration  of the  motion,  the United  States  Bankruptcy  Judge  entered a
Recommended Order Granting Summary  Judgment,  recommending the dismissal of all
claims asserted against the Association. The Recommended Order is now before the
United States District Court for the Western  District of North Carolina and the
parties are awaiting the Federal  District  Court's decision of whether to enter
an Order Granting Summary  Judgment in accordance with the Recommended  Order by
the United States Bankruptcy Judge.

         In December 1996, the Association filed a suit against the borrower and
his company and against the borrower's wife, daughter and a company owned by his
wife and daughter, alleging transfers of assets to the wife, daughter, and their
company in fraud of creditors,  and asking that the fraudulent  transfers be set
aside.  The  objective of the lawsuit is to recover  assets which may be used to
satisfy a portion of the judgments obtained in favor of the Association in prior
litigation.  The borrower's  wife filed a counterclaim  against the  Association
alleging that she borrowed $750,000 from another financial institution,  secured
by a deed of trust on her principal  residence,  the proceeds of which were paid
to the  Association  for  application  on  debt  owed  by  one of her  husband's
corporations,  claiming  that  officers  of the  Association  promised to resume
making loans to her husband's  corporation  after the payment.  Home Federal and
its officers  vigorously deny all of her allegations.  The case is scheduled for
discovery  in  September  1997,  after which the  Association  intends to file a
motion for summary judgment for dismissal of the counterclaim.

         In February  1997, two companies  affiliated  with those referred to in
the first  paragraph  above filed an  additional  action  against two  executive
officers  of the  Association  and  against  an  officer  of  another  financial
institution.  The  action  was  removed  from the state  court and is  presently
pending in the United States  Bankruptcy Court for the Western District of North
Carolina.  At the same time, the borrower,  who is affiliated  with all of these
companies,  also  filed an action  against  the two  executive  officers  of the
Association  and  against  an  officer of  another  financial  institution.  The
Complaints in both actions assert virtually  identical claims. The plaintiffs in
both lawsuits allege that the officers of both financial institutions engaged in
a conspiracy  to  wrongfully  declare  loans to be in default so as to eliminate
those   companies   as   borrowers  of  the   Association.   Plaintiffs   allege
misrepresentation,  breach of fiduciary duty,  constructive fraud,  interference
with  business  expectancy,  wrongful  bank  account  set-off,  and  unfair  and
deceptive acts and practices.  Plaintiffs  claim actual damages,  treble damages
and punitive  damages  together with interest,  attorneys' fees and other costs.
The  Association  has agreed to indemnify  both of its officers  with respect to
costs,  expense and liability which might arise in connection with both of these
cases.

         In July 1997,  the above  borrower and  affiliated  companies  filed an
additional  action against HFNC Financial Corp., the Association,  and the other
financial institution referred to in the paragraph above, alleging that previous
judgments in favor of Home Federal and the other financial  institution obtained
in prior litigation were obtained by the perpetration of fraud on the Bankruptcy
Court, U.S. District Court, and the 4th Circuit Court of Appeals. The plaintiffs
are seeking to have the judgments set aside on that basis.  Home Federal has not
yet filed a responsive  pleading.  The  Association  vehemently  denies that any
fraud was  perpetrated  upon the courts and intends to  vigorously  contest this
matter.

         The Association and its officers  continue to deny any liability in the
above  described  cases and continue to  vigorously  defend  against the claims.
However, based on the advice of legal counsel, the Association is unable to give
an opinion as to the likely  outcome of the litigation or estimate the amount or
range of potential  loss,  if any. See Note 11 of the Notes to the  Consolidated
Financial Statements.

                                       32
<PAGE>
         Except as set forth above, the Association is not involved in any legal
proceedings  other than those  occurring  in the  ordinary  course of  business.
Management  believes that such other legal  proceedings will not have a material
adverse  impact  on  the  Association's   financial   condition  or  results  of
operations.

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

         Not applicable.

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

         The  information   required  herein,  to  the  extent  applicable,   is
incorporated  by  reference  from page 45 of the  Company's  1997 Annual  Report
("1997 Annual Report").

Item 6.  Selected Financial Data.

         The information  required herein is incorporated by reference from page
1 of the 1997 Annual Report.

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

         The information required herein is incorporated by reference from pages
2 to 15 of the 1997 Annual Report.

Item 8.  Financial Statements and Supplementary Data.

         The information required herein is incorporated by reference from pages
16 to 44 of the 1997 Annual Report.

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

         Not applicable.


PART III.

Item 10.  Directors and Executive Officers of the Registrant.

         The information required herein is incorporated by reference from pages
3 to 7 of the definitive  proxy  statement of the Company for the Annual Meeting
of  Stockholders  to be held on October 24, 1997,  which was filed on October 3,
1997 ("Definitive Proxy Statement").

Item 11.  Executive Compensation.

         The information required herein is incorporated by reference from pages
11 to 16 of the Definitive Proxy Statement.

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

         The information required herein is incorporated by reference from pages
8 to 10 of the Definitive Proxy Statement.

Item 13.  Certain Relationships and Related Transactions.

         The information  required herein is incorporated by reference from page
16 of the Definitive Proxy Statement.

                                       33
<PAGE>
PART IV.

Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.

         (a)  Documents Filed as Part of this Report

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

                  Report of Independent Auditors.

                  Consolidated Balance Sheets as of June 30, 1997 and 1996.

                  Consolidated Statements of Income for the Fiscal Periods Ended
                     June 30, 1997, 1996 and 1995.

                  Consolidated Statements of Changes in Shareholders' Equity for
                     the Fiscal Periods Ended June 30, 1997, 1996 and 1995.

                  Consolidated  Statements of Cash Flows for the Fiscal  Periods
                     ended June 30, 1997, 1996 and 1995.

                  Notes to Consolidated Financial Statements.

         (2) All  schedules  for  which  provision  is  made  in the  applicable
accounting  regulation  of  the  SEC  are  omitted  because  of the  absence  of
conditions under which they are required or because the required  information is
included in the consolidated financial statements and related notes thereto.

         (3) The  following  exhibits  are filed as part of this Form 10-K,  and
this list includes the Exhibit Index:
<TABLE>
<CAPTION>
                                       Exhibit Index
                                       -------------
                                                                               Page
                                                                               ----
<S>    <C>                                                                     <C>
 2.0   Plan of Conversion                                                        *
 3.1   Articles of Incorporation of HFNC Financial Corp.                         *
 3.2   Bylaws of HFNC Financial Corp.                                            *
 4.0   Specimen Stock Certificate of HFNC Financial Corp.                        **
10.1   Employment Agreement among HFNC Financial Corp.,
         Home Federal Savings and Loan Association and H. Joe King, Jr.          *
10.2   Employment Agreement among HFNC Financial Corp.,
         Home Federal Savings and Loan Association and J. Harold Barnes, Jr.     *
13.0   1997 Annual Report to Stockholders                                       E-1
21.0   Subsidiaries of the Registrant - Reference is made to "Item 2.
         Business" for the required information

(*)      Incorporated  herein  by  reference  from  the  Company's  Registration
         Statement on Form S-1  (Registration No. 33-97497) filed by the Company
         with the SEC on September 20, 1995, as subsequently amended.

(**)     Incorporated  herein by reference  from the Company's  Annual Report on
         Form 10-K for the year ended June 30, 1996.
</TABLE>

                                       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.

                                     HFNC FINANCIAL CORP.


                                     By:   /s/H. Joe King, Jr.
                                         ---------------------------------------
                                              H. Joe King, Jr.
                                              President, Chief Executive Officer
                                                and Chairman of the Board
<PAGE>
        Pursuant to the  requirements  of the  Securities  Exchange Act of 1934,
this  report has been  signed  below by the  following  persons on behalf of the
Registrant in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
Name                                         Title                                           Date
----                                         -----                                           ----
<S>                                          <C>                                             <C>

/s/H. Joe King, Jr.                          President, Chief Executive Officer              September 29, 1997
------------------------------                 and Chairman of the Board   
H. Joe King, Jr.                               



/s/J. Harold Barnes, Jr.                     Executive Vice President and                    September 29, 1997
------------------------------                 Director
J. Harold Barnes, Jr.                          


/s/Ray W. Bradley, Jr.
------------------------------               Director                                        September 29, 1997
Ray W. Bradley, Jr.


/s/Joe M. Logan
------------------------------               Director                                        September 29, 1997
Joe M. Logan


/s/John M. McCaskill
------------------------------               Director                                        September 29, 1997
John M. McCaskill


/s/Lewis H. Parham, Jr.
-----------------------------                Director                                        September 29, 1997
Lewis H. Parham, Jr.


/s/Willie E. Royal
-----------------------------                Director                                        September 29, 1997
Willie E. Royal



/s/A. Burton Mackey, Jr.                     Vice President and Treasurer                    September 29, 1997
-----------------------------                  (principal financial officer)
A. Burton Mackey, Jr.                          
</TABLE>