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                                  UNITED STATES
                       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, 1998

                                       OR

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

     Commission file number 0-27178

                         PEEKSKILL FINANCIAL CORPORATION
             (Exact Name of Registrant as Specified in its Charter)

           Delaware                                              13-3858258
(State or other jurisdiction of                               (I.R.S. Employer
incorporation or organization)                               Identification No.)

      1019 Park Street, Peeksill, New York                10566
    (Address of principal executive offices)            (Zip Code)

Registrant's telephone number, including area code: (914) 737-2777

           Securities Registered Pursuant to Section 12(b) of the Act:

                                      None

           Securities Registered Pursuant to Section 12(g) of the Act:

                     Common Stock, par value $0.01 per share
                                (Title of Class)

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

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

     As of  September  22,  1998,  there were issued and  outstanding  2,857,569
shares of the  Registrant's  Common  Stock.  The  aggregate  market value of the
voting stock held by non-affiliates of the Registrant,  computed by reference to
the  average  of the  closing  bid and asked  prices of such stock on the Nasdaq
National  Market  System as of  September  22,  1998,  was  approximately  $40.2
million.

                       DOCUMENTS INCORPORATED BY REFERENCE

PART II of Form  10-K--Annual  Report to Stockholders  for the fiscal year ended
June 30, 1998.

PART III of Form  10-K--Proxy  Statement for the Annual Meeting of  Stockholders
for the fiscal year ended June 30, 1998.

================================================================================

<PAGE>


                        PEEKSKILL FINANCIAL CORPORATION
                           Annual Report on Form 10-K

<TABLE>
<CAPTION>
                                                                                    Page
                                                                                    ----
                                     PART I
<S>                                                                                  <C>
Item 1.   Business                                                                    3
Item 2.   Properties                                                                 35
Item 3.   Legal Proceedings                                                          37
Item 4.   Submission of Matters to a Vote of Security Holders                        37

                                     PART II

Item 5.   Market for the Registrant's Common Equity and Related Stockholder
          Matters                                                                    37
Item 6.   Selected Financial Data                                                    37
Item 7.   Management's Discussion and Analysis of Financial Condition and
          Results of Operations                                                      37
Item 7A.  Quantitative and Qualitative Disclosures About Market Risk                 37
Item 8.   Financial Statements and Supplementary Data                                37
Item 9.   Changes in and Disagreements with Accountants on Accounting and
          Financial Disclosure                                                       38

                                  PART III

Item 10.  Directors and Executive Officers of the Registrant                         38
Item 11.  Executive Compensation                                                     38
Item 12.  Security Ownership of Certain Beneficial Owners and Management             38
Item 13.  Certain Relationships and Related Transactions                             38

                                   PART IV

Item 14.  Exhibits, Financial Statement Schedules, and Reports on Form 8-K           39

          Signatures                                                                 41
</TABLE>


                                       2
<PAGE>

                                     PART I

Item 1. Business

General

     Peekskill Financial  Corporation  ("Peekskill" or the "Company") was formed
in 1995 at the direction of First Federal  Savings Bank ("First  Federal" or the
"Bank"),  formerly First Federal Savings and Loan Association of Peekskill,  for
the purpose of becoming a unitary  savings and loan  holding  company and owning
all of the  outstanding  stock  of the  Bank  issued  on  December  29,  1995 in
connection  with  the  Bank's  conversion  from  the  mutual  to  stock  form of
organization (the  "Conversion").  The Company is incorporated under the laws of
the State of Delaware and is authorized to do business in the State of New York,
and  generally is  authorized to engage in any activity that is permitted by the
Delaware General  Corporation Law. Unless the context  otherwise  requires,  all
references  herein  to the  Bank  or the  Company  include  both  entities  on a
consolidated basis.

     At June 30, 1998, the Company had total assets of $200.3 million,  deposits
of $139.9  million and  stockholders'  equity of $43.2  million.  The  Company's
Common  Stock is quoted on the Nasdaq  National  Market  System under the symbol
"PEEK."

     First Federal was  originally  organized as a state  chartered  savings and
loan association in 1924. In 1954, it converted to a federally chartered savings
and loan  association.  In December 1995, the Bank became a federally  chartered
savings bank.  First Federal  serves the financial  needs of  communities in its
market area through its main office located at 1019 Park Street,  Peekskill, New
York and branch offices located at 1961 Commerce Street in Yorktown Heights, New
York and Cortlandt Town Center on Route 6 in Mohegan Lake, New York.

     First Federal's business involves attracting deposits from customers in its
market area and investing such funds primarily in mortgage-backed securities and
one-to-four family residential  mortgages.  At June 30, 1998, the Bank had total
assets  of  $199.1   million   consisting   primarily   of  $127.5   million  of
mortgage-backed  securities  and $46.3 million of  one-to-four  family  mortgage
loans representing  95.1% of the total loan portfolio.  The Bank also held other
debt securities  (consisting primarily of U.S. Government Agency obligations) of
$16.5 million at June 30, 1998.

     The Bank has sought to enhance  its net income  through  the  adoption of a
strategy  designed to  maintain  capital in excess of  regulatory  requirements,
limit loan delinquencies and enhance net interest spread while managing interest
rate risk.  This strategy  involves (i)  maintaining a substantial  portfolio of
mortgage-backed  and other debt  securities  having  terms to repricing of seven
years or less,  (ii)  controlling  operating  expenses,  (iii)  focusing  on the
origination of one-to-four  family  residential loans, (iv) limiting other types
of loans that could  increase  credit  risk or  operating  costs,  and (v) using
customer  service to build and maintain a  substantial  level of core  depositor
accounts.

     The executive  offices of the Company and the Bank are located at 1019 Park
Street,  Peekskill,  New York 10566, and the telephone number at that address is
(914) 737-2777.


                                       3
<PAGE>


     The Company and the Bank are regulated by the Office of Thrift  Supervision
("OTS").  The Bank is a member  of the  Federal  Home Loan  Bank  System  ("FHLB
System")  and is a  stockholder  in the Federal  Home Loan Bank  ("FHLB") of New
York.  The Bank is also a  member  of the  Savings  Association  Insurance  Fund
("SAIF")  and its deposit  accounts are insured up to  applicable  limits by the
Federal Deposit Insurance Corporation ("FDIC").

Forward-Looking Statements

     The Company has made,  and may  continue to make,  various  forward-looking
statements  with respect to earnings,  credit  quality and other  financial  and
business  matters for periods  subsequent to June 30, 1998. The Company cautions
that these forward-looking statements are subject to numerous assumptions, risks
and  uncertainties,  and that  statements for subsequent  periods are subject to
greater uncertainty because of the increased likelihood of changes in underlying
factors  and   assumptions.   Actual  results  could  differ   materially   from
forward-looking statements.

     In addition to those factors previously  disclosed by the Company and those
factors  identified  elsewhere herein,  the following factors could cause actual
results  to differ  materially  from such  forward-looking  statements:  pricing
pressures on loan and deposit products; actions of competitors; changes in local
and national economic conditions; customer deposit disintermediation; changes in
customers'  acceptance  of the Company's  products and services;  the extent and
timing of legislative and regulatory actions and reforms;  and Year 2000 related
costs and issues substantially different from those now anticipated.

     The Company's forward-looking statements speak only as of the date on which
such statements are made. By making any forward-looking  statements, the Company
assumes no duty to update them to reflect new, changing or unanticipated  events
or circumstances.

Competition

     The Company faces  significant  competition for the loans it originates and
the  deposits  it  accepts.  The  Company's  market  area has a high  density of
financial  institutions,  from  small  community  banks  to  branches  of  large
non-local  institutions,  all of which  compete  with  the  Company  to  varying
degrees.  The Company's  competition  for loans comes  principally  from savings
banks,  savings  and  loan  associations,  commercial  banks,  mortgage  banking
companies and other institutional lenders. The Company successfully competes for
loans by emphasizing  the quality of its loan services and by charging loan fees
and  interest  rates that are  generally  competitive  within  its market  area.
Changes in the  demand  for loans  relative  to the  availability  of credit may
affect the level of  competition  from financial  institutions  that may be more
willing than the Company or its  competitors  to make credit  available but that
have not generally engaged in lending activities in the Company's market area in
the past. The Company's most direct  competition  for deposits has  historically
come from savings banks, savings and loan associations, and commercial banks, as
well as  money  market  funds,  stock  and  bond  mutual  funds,  and  brokerage
companies. The Company competes for deposits by emphasizing product delivery and
customer service, and offering products at generally competitive interest rates.


                                       4
<PAGE>

Market Area

     First  Federal  conducts  business  in  Northern  Westchester,  Putnam  and
Dutchess counties through its main office located in Peekskill, New York and two
branch offices located in Yorktown Heights, New York and Mohegan Lake, New York.
First Federal's primary market area consists of communities  within  Westchester
and Putnam  counties.  Peekskill is located  approximately 50 miles northwest of
the Borough of Manhattan in New York City.

     Peekskill was traditionally a small town whose inhabitants were employed in
small and medium sized businesses in the surrounding communities.  However, with
the  growth of the New York  Metropolitan  area and the  expansion  of  business
activities in the White Plains area, Peekskill, and particularly the surrounding
communities,  have evolved into suburban  bedroom  communities.  More  recently,
however,   Peekskill's   market  area  has  experienced   limited  economic  and
demographic  growth. The city of Peekskill has a significant level of low-income
housing  and has  experienced  very  limited  levels  of  single-family  housing
construction in recent decades. In contrast, other portions of the Bank's market
area such as Yorktown and Putnam Valley have recently  experienced somewhat more
growth,  both  economically  and  demographically,   with  increased  levels  of
single-family housing construction.

     The  local  communities  in  and  around  Peekskill  do not  contain  major
employers.  Generally, residents commute to other areas of Westchester county to
work.  Major  employers   located  in  Westchester   County  include  the  local
government, IBM, U.S. Postal Service, NYNEX, and Pepsico, Inc.

     The population in Westchester  County has remained stable over the last ten
years  with a 1%  increase  in  population  from  1985 to  1994.  Putnam  County
experienced  a  10.5%  increase  in  population   over  the  same  period.   The
unemployment  rate for  Westchester  and  Putnam  Counties  was  5.4% and  4.9%,
respectively,  in December 1994. These figures are  representative  of the state
and U.S. unemployment rates for the same period.

Lending Activities

     Loan Portfolio Composition. The Company's loan portfolio consists primarily
of conventional  first mortgage loans secured by one-to-four  family properties.
At June 30, 1998, the Company had net loans of $47.6 million,  which  represents
23.8% of total assets. The percentage distribution of the loan portfolio at that
date was as follows: 95.1% of one-to-four family mortgage loans, the majority of
which  are  owner  occupied;  1.4%  of  multi-family  mortgage  loans;  1.0%  of
commercial  mortgage  loans;  1.4% of construction  loans;  and 1.1% of consumer
loans.


                                       5
<PAGE>


     The following  table sets forth the  composition  of the loan  portfolio in
dollar amounts and percentages as of the dates indicated. In addition, the table
sets forth the loan portfolio by fixed- and  adjustable-rate  balances as of the
dates indicated.

<TABLE>
<CAPTION>
                                                                        June 30,
                                      ------------------------------------------------------------------------
                                              1998                        1997                    1996             
                                       --------------------       --------------------     --------------------    
                                       Amount       Percent       Amount      Percent      Amount       Percent    
                                       ------       -------       ------      -------      ------       -------    
                                                                 (Dollars in thousands)
<S>                                    <C>            <C>        <C>            <C>        <C>            <C>     
Real Estate Loans:
 One-to-four family ...............    $46,271         95.1%     $44,163         94.9%     $38,644         95.5%   
 Multi-family .....................        674          1.4          724          1.6          394          1.0    
 Commercial .......................        507          1.0          531          1.1          285          0.7    
 Construction .....................        676          1.4          670          1.4          579          1.4    
                                      --------    ---------     --------    ---------     --------    ---------    
     Total real estate loans ......     48,128         98.9       46,088         99.0       39,902         98.6    
                                      --------    ---------     --------    ---------     --------    ---------    

Other Loans:
  Passbook loans and other ........        460          1.0          341          0.8          404          1.0    
  Student .........................         63          0.1          102          0.2          143          0.4    
                                      --------    ---------     --------    ---------     --------    ---------    
     Total consumer loans .........        523          1.1          443          1.0          547          1.4    
                                      --------    ---------     --------    ---------     --------    ---------    
     Total loans ..................     48,651        100.0%      46,531        100.0%      40,449        100.0%   
                                                  =========                  ========                 =========                 
Less:
 Construction loans in process ....       (112)                     (195)                     (114)                
 Allowance for loan losses ........       (682)                     (622)                     (519)                
 Net deferred loan origination fees       (226)                     (207)                     (259)                
                                     ---------                  --------                 ---------                 
 Total loans, net .................    $47,631                   $45,507                   $39,557                 
                                     =========                  ========                 =========                 
                                                                                                                   
Fixed-Rate Loans:
  Real estate loans ...............    $47,252         97.1%     $45,015         96.7%     $38,770         95.8%   
  Other loans .....................        523          1.1          443          1.0          547          1.4    
                                      --------    ---------     --------    ---------     --------    ---------    
    Total-fixed rate loans ........     47,775         98.2       45,458         97.7       39,317         97.2    

Adjustable-Rate Loans:
  Real estate loans ...............        876          1.8        1,073          2.3        1,132          2.8    
                                      --------    ---------     --------    ---------     --------    ---------    
    Total loans ...................    $48,651        100.0%     $46,531        100.0%     $40,449        100.0%   
                                      ========    =========     ========    =========     ========    =========    

<CAPTION>
                                                          June 30,
                                         ---------------------------------------------
                                                1995                      1994
                                         --------------------     --------------------
                                         Amount      Percent      Amount       Percent
                                         ------      -------      ------       -------
                                                     (Dollars in thousands)
<S>                                     <C>            <C>       <C>             <C>  
Real Estate Loans:
 One-to-four family ...............     $40,112         95.2%    $38,979          95.8%
 Multi-family .....................         426          1.0         458           1.1
 Commercial .......................         308          0.7         329           0.8
 Construction .....................         725          1.7         165           0.4
                                       --------    ---------    --------     ---------
     Total real estate loans ......      41,571         98.6      39,931          98.1
                                       --------    ---------    --------     ---------

Other Loans:
  Passbook loans and other ........         356          0.9         524           1.3
  Student .........................         215          0.5         255           0.6
                                       --------    ---------    --------     ---------
     Total consumer loans .........         571          1.4         779           1.9
                                       --------    ---------    --------     ---------
     Total loans ..................      42,142        100.0%     40,710         100.0%

Less:
 Construction loans in process ....        (273)                     (50)
 Allowance for loan losses ........        (474)                    (336)
 Net deferred loan origination fees        (335)                    (363)
                                       --------                ---------
 Total loans, net .................     $41,060                  $39,961
                                       ========                =========
                                                        
Fixed-Rate Loans:
  Real estate loans ...............     $40,297         95.6%    $38,571          94.7%
  Other loans .....................         571          1.4         779           1.9
                                       --------    ---------    --------     ---------
    Total-fixed rate loans ........      40,868         97.0      39,350          96.6

Adjustable-Rate Loans:
  Real estate loans ...............       1,274          3.0       1,360           3.4
                                       --------    ---------    --------     ---------
    Total loans ...................     $42,142        100.0%    $40,710         100.0%
                                       ========    =========    ========     =========
</TABLE>


                                       6
<PAGE>


     Loan Maturities.  The following table shows the contractual maturity of the
loan portfolio at June 30, 1998. All loans (including adjustable-rate loans) are
shown as maturing in the period that includes the final contractual due date, as
the table does not  reflect  the  effects  of  periodic  amortization  payments,
possible prepayments or enforcement of due-on-sale clauses.

<TABLE>
<CAPTION>
                                               Due in
                                 ------------------------------------
                                              More than      
                                 Less than    1 Year to      More than              
                                  1 Year       5 Years        5 Years         Total 
                                  ------       -------        -------         ----- 
Mortgage loans:                                 (In thousands) 
<S>                             <C>            <C>            <C>            <C>    
  One-to-four family ...        $    72        $ 3,916        $42,283        $46,271
  Multi-family .........             --            322            352            674
  Commercial ...........             --            233            274            507
  Construction .........            676             --             --            676
                                -------        -------        -------        -------
    Total mortgage loans            748          4,471         42,909         48,128

Other loans ............            460             58              5            523
                                -------        -------        -------        -------
    Total loans ........        $ 1,208        $ 4,529        $42,914        $48,651
                                =======        =======        =======        =======
</TABLE>


     The  following  table sets  forth,  by type of  interest  rate,  the dollar
amounts in each loan  category  at June 30, 1998 that are  contractually  due in
more than one year.

                                          Fixed           Adjustable       Total
                                          -----           ----------       -----
                                                      (In thousands)
Mortgage loans:
  One-to-four family ...........         $45,323         $   876         $46,199
  Multi-family .................             674              --             674
  Commercial ...................             507              --             507
                                         -------         -------         -------
    Total mortgage loans .......          46,504             876          47,380

Other loans ....................              63              --              63
                                         -------         -------         -------
    Total loans ................         $46,567         $   876         $47,443
                                         =======         =======         =======


     Loans-to-One-Borrower.  Pursuant to Federal  law, the  aggregate  amount of
loans  that the  Bank is  permitted  to make to any one  borrower  is  generally
limited to 15% of  unimpaired  capital and surplus (25% if the security for such
loan  has a  "readily  ascertainable"  value  or  30%  for  certain  residential
development  loans).  At June 30, 1998, based on the 15% limitation,  the Bank's
loans-to-one  borrower  limit was $6.5  million  and the largest  dollar  amount
outstanding to one borrower, or group of related borrowers,  was $350,000.  This
loan, which is secured by a single-family  residence in Putnam Valley, New York,
was performing in accordance with its contractual terms at June 30, 1998.

     Loan Underwriting.  The Bank's lending practices are subject to its written
underwriting standards and established loan origination procedures. Decisions on
loan applications are made on


                                       7
<PAGE>


the basis of  detailed  applications  and  property  valuations  by  independent
appraisers  (consistent with the Bank's appraisal policy). The loan applications
are designed primarily to determine the borrower's ability to repay and the more
significant items on the application are verified through use of credit reports,
financial statements, tax returns and/or confirmations.

     Under the Bank's loan policy,  the employee  processing an  application  is
responsible  for  ensuring  that  all  documentation  is  obtained  prior to the
submission  of the  application  to an officer for  approval.  In  addition,  an
officer verifies that the application meets the Bank's  underwriting  guidelines
described  below.  All mortgage  loans must be approved by the Bank's  Executive
Committee  or  the  Board  of  Directors.  Various  officers  of the  Bank  have
individual loan approval authority for other loans.

     Generally,  the Bank requires title insurance on its mortgage loans as well
as fire and extended  coverage  casualty  insurance in amounts at least equal to
the principal  amount of the loan or the value of  improvements on the property,
depending on the type of loan. The Bank also requires flood insurance to protect
the  property  securing  its  interest  when the  property is located in a flood
plain.

     One-to-Four Family Residential Real Estate Lending.  The cornerstone of the
Bank's  lending  program  is the  origination  of  fixed-rate  loans  secured by
mortgages on owner-occupied  one-to-four  family  residences.  At June 30, 1998,
$46.3  million,  or 95.1%,  of the Bank's loan  portfolio  consisted of mortgage
loans  secured  by  one-to-four  family  residences.  Substantially  all  of the
residential  loans  originated by the Bank are secured by properties  located in
its primary  lending  area.  All of the  one-to-four  family  residential  loans
originated  by the Bank  are  retained  and  serviced  by it  except  for  loans
originated for the State of New York Mortgage Agency  ("SONYMA")  which are sold
to SONYMA at closing. In order to supplement one-to-four family residential loan
products,   the  Bank  from  time  to  time  has  purchased  one-to-four  family
residential  loan  participations,  although it has not done so in recent years.
However, depending on future market conditions, it may do so in the future.

     The Bank currently offers conventional  fixed-rate loans with maximum terms
of up to 30  years.  The  interest  rate on such  loans  is  generally  based on
competitive factors. The Bank does not offer adjustable-rate  residential loans,
although it may do so in the future, depending on market conditions.

     In underwriting  one-to-four family residential real estate loans, the Bank
evaluates  the  borrower's  ability  to  make  principal,  interest  and  escrow
payments, the value of the property that will secure the loan, the loan-to-value
ratio and debt-to-income  ratios. First Federal originates  residential mortgage
loans  with  loan-to-value  ratios of up to 90% for  owner-occupied  homes.  For
mortgage loans with  loan-to-value  ratios greater than 80%, the Bank originates
the loans with private  mortgage  insurance to reduce the Bank's exposure to 80%
or less.

     The Bank's  residential  mortgage  loans  customarily  include  due-on-sale
clauses  giving  the Bank the  right to  declare  the loan  immediately  due and
payable in the event that, among other things,


                                       8
<PAGE>


the borrower sells or otherwise disposes of the property subject to the mortgage
and the loan is not repaid.

     The  Bank  also  originates  home  equity  loans  secured  by a lien on the
borrower's residence. Home equity loans are generally limited to $80,000 and are
originated  using  the same  underwriting  standards  applicable  to the  Bank's
one-to-four  family  residential  mortgage loans. The Bank currently offers home
equity  loans for terms of up to 7 years.  At June 30,  1998,  the Bank had $1.9
million of  outstanding  advances  under home equity  loans  (included  in total
one-to-four family mortgage loans).

     Multi-Family and Commercial Real Estate Lending. At June 30, 1998, the Bank
had $507,000 in  commercial  real estate loans,  representing  1.0% of the total
loan portfolio,  and $674,000 in  multi-family  loans, or 1.4% of the total loan
portfolio.  The Bank's  multi-family loan portfolio  consists of a participation
interest  in a loan  secured by an  apartment  complex  and two  Bank-originated
loans.  The  Bank's  commercial  real  estate  loan  portfolio   consists  of  a
participation  interest in a loan secured by a strip  shopping  center and three
Bank-originated  loans.  At June 30, 1998, all of these loans were performing in
accordance with their contractual terms.

     Multi-family  and commercial real estate loans  generally  present a higher
level of risk than loans secured by one-to-four family residences.  This greater
risk is due to several  factors,  including  larger  outstanding  balances,  the
effects of general economic conditions on income-producing  properties,  and the
increased  difficulty  of  evaluating  and  monitoring  these  types  of  loans.
Furthermore,  the repayment of loans secured by multi-family and commercial real
estate is typically dependent upon the successful  operation of the related real
estate  project.  If the cash flow from the project is reduced (for example,  if
leases are not obtained or renewed),  the  borrower's  ability to repay the loan
may be impaired.

     While the Bank may  engage  in  multi-family  and  commercial  real  estate
lending from time to time in the future,  it anticipates that future volume will
continue to be modest.

     Construction  Lending. The Bank makes construction loans to individuals for
the  construction of their primary or secondary  residences and  occasionally to
builders for the construction of new residences.

     Loans to individuals  for the  construction of their  residences  typically
have terms of up to 30 years and are structured to provide both construction and
"permanent"  financing.  The borrower makes  interest-only  payments  during the
construction period.  Residential  construction loans are generally underwritten
pursuant to the same  guidelines  used for  originating  conventional  permanent
residential loans. At June 30, 1998, the Bank had $436,000 of one-to-four family
residential  construction loans to borrowers intending to live in the properties
upon completion of construction.  Subject to future market conditions,  the Bank
intends to continue its construction  lending activities to persons intending to
be owner-occupants.

     On occasion,  the Bank makes loans to builders to finance the  construction
of  one-to-four  family  residences.  These  loans are made on the same terms as
loans to individuals for the


                                       9
<PAGE>


construction  of  single-family  residences.  At June 30, 1998, the Bank had one
loan of this  type for  $240,000.  While  the Bank may  engage  in this  type of
lending  from time to time in the future,  the Bank  currently  expects that its
total volume at any one time will be limited.

     Residential   construction   lending   involves   several   risks.   First,
construction loans are generally more difficult to evaluate and monitor. Second,
a lender's  risk of loss on a  construction  loan is dependent  largely upon the
accuracy of the initial  estimate of the property's value upon completion of the
project and the  estimated  cost  (including  interest) of the  project.  If the
estimate of value proves to be  inaccurate,  the Bank may be  confronted,  at or
prior  to the  maturity  of the  loan,  with a  project  with a value  which  is
insufficient  to assure full repayment  and/or the possibility of having to make
substantial investments to complete the project.

     Other Loans. The Bank offers  passbook,  home improvement and student loans
for personal and  educational  purposes.  At June 30, 1998,  other loans totaled
$523,000 or 1.1% of total loans outstanding.  In the future, the Bank may expand
its consumer lending somewhat to increase home improvement loans.

     Originations  and Repayments of Loans.  Real estate loans are originated by
First Federal's loan officers.  In addition, in the future, the Bank may utilize
outside  mortgage  loan  brokers  in an  attempt to  increase  loan  production,
although  there are no specific plans to do so at this time.  Loan  applications
are taken at each of First Federal's offices and processed at the main office.

     The Bank's  ability to originate  loans is dependent upon  competition  and
customer  demand for loans in its market  area.  Demand is  affected by both the
local economy and the interest rate  environment.  See "Competition" and "Market
Area."  Historically,  virtually all loans originated by First Federal have been
retained in the portfolio.


                                       10
<PAGE>


     The following table shows the loan origination and repayment  activities of
the Bank for the periods indicated.

                                                      Year Ended June 30,
                                               --------------------------------
                                                 1998        1997        1996
                                               --------    --------    --------
                                                          (In thousands)
Originations by type:
  Mortgage loans:
         One-to-four family .................  $  9,161    $ 11,144    $  4,355
         Multi-family .......................        --         364          --
         Commercial .........................        --         276          --
         Construction .......................       746         972         640
  Other loans ...............................       479         529         560
                                               --------    --------    --------
       Total loans originated ...............    10,386      13,285       5,555
                                               --------    --------    --------

Principal Repayments:
  Mortgage loans:
         One-to-four family .................    (6,806)     (5,405)     (5,684)
         Multi-family .......................       (50)        (34)        (32)
         Commercial .........................       (24)        (30)        (23)
         Construction .......................      (740)       (881)       (627)
  Other loans ...............................      (399)       (633)       (584)
                                               --------    --------    --------
       Total principal repayments ...........    (8,091)     (6,983)     (6,950)
                                               --------    --------    --------

Loans transferred to real estate owned ......      (247)       (220)       (139)
                                               --------    --------    --------
       Net increase (decrease) in total loans  $  2,120    $  6,082    $ (1,534)
                                               ========    ========    ========

Asset Quality

     Loan  Delinquencies.  When a borrower fails to make a required payment on a
loan, the Bank attempts to cure the  delinquency  by contacting the borrower.  A
late notice is sent on all loans over 15 days delinquent. Additional written and
verbal  contacts may be made with the borrower  between 30 and 60 days after the
due date.  If the loan is  contractually  delinquent  90 days,  the Bank usually
sends  a  30-day  demand  letter  to  the  borrower  and,   after  the  loan  is
contractually delinquent 120 days, institutes appropriate action to foreclose on
the  property.  If  foreclosed,  the  property  is  sold at  auction  and may be
purchased by the Bank.

     Real estate acquired by First Federal as a result of foreclosure or by deed
in lieu of foreclosure is classified as real estate owned until it is sold. When
a property is acquired or expected to be acquired by foreclosure or deed in lieu
of  foreclosure,  it is recorded at estimated fair value less the estimated cost
of disposition,  with the resulting write-down charged to the allowance for loan
losses.  After  acquisition,  all costs incurred in maintaining the property are
expensed.  Costs relating to the  development  and  improvement of the property,
however, are capitalized.


                                       11
<PAGE>


     The  following  table sets forth  information  concerning  the Bank's  loan
delinquencies at June 30, 1998 and 1997:

<TABLE>
<CAPTION>
                                         Loans Delinquent For:            
                                 ------------------------------------     Total Delinquent
                                     60-89 Days      90 Days and Over          Loans      
                                 ----------------    ----------------    -----------------
                                 Number    Amount    Number     Amount     Number   Amount
                                 ---------------------------------------------------------
                                                  (Dollars in thousands)
<S>                                   <C>   <C>        <C>     <C>             <C>  <C>   
One-to-four family real estate
loans:
  June 30, 1998 ..............        7     $313       16(1)   $1,491(1)       23   $1,804
                                 ------   ------   ------      ------      ------   ------
  June 30, 1997 ..............        9     $394       27(1)   $2,004(1)       36   $2,398
                                 ------   ------   ------      ------      ------   ------
</TABLE>


(1)  Includes a participation interest in certain residential mortgage loans, as
     discussed  below, of $876,000 at June 30, 1998 and $1.1 million at June 30,
     1997.

     Classification  of Assets.  Federal  regulations  require that each savings
association  classify  its own  assets  on a  regular  basis.  In  addition,  in
connection  with  examinations of savings  institutions,  OTS and FDIC examiners
have authority to identify  problem assets and, if appropriate,  require them to
be classified.  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 bank will sustain some
loss if the deficiencies are not corrected.  Doubtful assets have the weaknesses
of substandard assets, with the additional  characteristics  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 probability of loss. An
asset  classified as loss is considered  uncollectible  and of such little value
that  continuance  as an asset on the balance  sheet of the  institution  is not
warranted.  Assets classified as substandard or doubtful require the institution
to establish prudent general  allowances for loan losses. If an asset or portion
thereof is classified as loss, the institution  must either  establish  specific
allowances for loan losses equal to 100% of the portion of the asset  classified
as loss,  or charge off such amount.  If an  institution  does not agree with an
examiner's  classification of an asset, it may appeal this  determination to the
District  Director of the OTS.  On the basis of  management's  review,  the Bank
classified $1.5 million of loans and $94,000 of real estate owned as substandard
at June 30, 1998.  There were no assets  classified  as doubtful or loss at that
date. The foregoing asset  classifications  are generally  consistent with those
made by the OTS.


                                       12
<PAGE>


     Non-Performing   Assets.  The  table  below  sets  forth  the  amounts  and
categories of non-performing assets at the dates indicated.  Loans are placed on
non-accrual  status when the  collection of principal  and/or  interest  becomes
doubtful.  Real estate owned  represents  properties  acquired in  settlement of
loans.

<TABLE>
<CAPTION>
                                                                  June 30,
                                                 ----------------------------------------------
                                                  1998      1997      1996      1995      1994
                                                 ------    ------    ------    ------    ------
                                                             (Dollars in thousands)
<S>                                              <C>       <C>       <C>       <C>       <C>   
Accruing loans past due more than 90 days:
  One-to-four family mortgage loans ..........     $370      $930    $1,252    $2,096    $1,698
  Consumer loans .............................       --        --        --        --        18
Non-accrual loans:
  One-to-four family mortgage loans ..........      245        --        --        --        --
  Participation interest in one-to-four family
mortgage loans ...............................      876     1,074        --        --        --
                                                 ------    ------    ------    ------    ------
Total non-performing loans ...................    1,491     2,004     1,252     2,096     1,716

Real estate owned:
  Single-family property .....................       94       220        --        --        --
                                                 ------    ------    ------    ------    ------
Total non-performing assets ..................   $1,585    $2,224    $1,252    $2,096    $1,716
                                                 ------    ------    ------    ------    ------
Total as a percentage of total assets ........      0.8%      1.2%      0.7%      1.3%      1.1%
                                                 ======    ======    ======    ======    ======
</TABLE>


     As of June 30, 1998, other than the participation interest discussed below,
the Bank's largest non-performing loan had a carrying value of $182,000.

     During  1986 and  1987,  the Bank  purchased  from the  Thrift  Association
Service   Corporation   ("TASCO")  six  participation   interests  in  pools  of
one-to-four  family  residential  loans (the  "TASCO  Loans").  Pursuant  to the
participation  agreements,  principal  and interest  payments on the  underlying
loans within each pool were to be paid to the Bank whether or not such  payments
were collected by TASCO.

     During  1989,  TASCO  sold  the  servicing  of  the  loans  underlying  the
participation  interests to City Federal Savings Bank ("City Federal").  As part
of the purchase agreement,  City Federal agreed to assume the guarantee of TASCO
with regard to the  principal and interest  payments of the loans.  City Federal
subsequently  went into  receivership  and its  obligations  were assumed by the
Resolution Trust Corporation ("RTC").  Subsequently,  the obligations of the RTC
were assumed by the FDIC.

     The FDIC is disputing its  obligations  under the applicable  agreements to
make principal and interest payments on the underlying loans whether or not such
amounts  are  collected  from the  borrowers.  The FDIC  ceased  forwarding  all
payments to the participants (including those collected and due to participants)
during the quarter  ended  September 30, 1996, at which time the Bank placed the
TASCO Loans on non-accrual status.  Further, the FDIC is demanding reimbursement
of principal and interest payments previously made by the FDIC but not collected
by them on the participation certificates.  Its position is based on a review of
the operative documents, negotiations


                                       13
<PAGE>


with TASCO regarding the guarantee,  and a belief that servicers do not normally
act as financial  guarantors.  Settlement  negotiations  between the parties are
proceeding;  however,  no assurance can be given as to when a settlement  may be
reached.  Although the FDIC resumed making certain payments in the quarter ended
June 30, 1997, the matter has not been resolved. Accordingly, the TASCO Loans of
$876,000 remain on non-accrual status at June 30, 1998, and interest payments of
$55,000 and $21,000  received in fiscal 1998 and 1997,  respectively,  have been
deferred.  Foregone  interest income due to the non-accrual  status of the TASCO
Loans was $76,000 and $74,000 for fiscal 1998 and 1997,  respectively.  Interest
income for fiscal 1997 was also  reduced by the  reversal of $67,000 in interest
previously received on the TASCO Loans.

     See  "Management's  Discussion  and  Analysis of  Financial  Condition  and
Results of  Operations  - Asset  Quality" in the Annual  Report to  Stockholders
attached  hereto as  Exhibit  13,  for a further  discussion  of  non-performing
assets.

     Other Loans of Concern.  As of June 30,  1998,  there were no loans  (other
than  non-performing  loans) with respect to which known  information  about the
possible  credit  problems of the  borrowers  or the cash flows of the  security
properties  have  caused  management  to have  concerns as to the ability of the
borrowers to comply with present  loan  repayment  terms and which may result in
the future inclusion of such loans in the non-performing asset categories.

     Allowance for Loan Losses.  The  allowance  for loan losses is  established
through a provision for loan losses  charged to earnings  based on  management's
evaluation  of the  risk  inherent  in the  loan  portfolio.  The  allowance  is
established  as an amount that  management  believes  will be adequate to absorb
probable  losses on existing  loans.  The allowance for loan losses  consists of
amounts  specifically  allocated to  non-performing  loans and potential problem
loans (if any) as well as allowances  determined  for each major loan  category.
Loan categories such as single-family  residential  mortgages and consumer loans
are generally evaluated on an aggregate or "pool" basis by applying loss factors
to the current  balances of the various  loan  categories.  The loss factors are
determined by management  based on an evaluation of historical loss  experience,
delinquency  trends,  volume  and type of  lending  conducted,  and the  current
economic conditions in the Bank's market area.

     While management  believes that it uses the best  information  available to
determine the  allowance for loan losses,  unforeseen  market  conditions  could
result in adjustments  to the allowance for loan losses,  and net earnings could
be  significantly  affected,  if  circumstances  differ  substantially  from the
assumptions  used in  making  the  final  determination.  In  addition,  various
regulatory  agencies,   as  an  integral  part  of  their  examination  process,
periodically  review the Bank's  allowance  for loan losses.  Such  agencies may
require  the  Bank to  recognize  additions  to the  allowance  based  on  their
judgments of information available to them at the time of examination.


                                       14
<PAGE>


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

                                               Year Ended June 30,
                                     -------------------------------------------
                                     1998      1997     1996      1995      1994
                                     -------------------------------------------
                                              (Dollars in thousands)

Balance at beginning of year .....   $622      $519     $474      $336     $276
Provision for loan losses ........     60       143       45       160       60
Charge-offs:
  One-to-four family loans .......     --       (40)      --       (22)      --
                                     ----    ------     ----    ------     ----
Balance at end of year ...........   $682      $622     $519      $474     $336
                                     ----    ------     ----    ------     ----

Allowance for loan losses to:
  Non-performing loans ...........   45.7%       31.0%  41.5%       22.6%  19.6%
  Total loans, net ...............    1.4         1.4    1.3         1.2    0.8

Net charge-offs to:
  Average loans outstanding ......     --%        0.1%    --%        0.1%    --%

  Average non-performing loans ...     --         2.0     --         1.2     --


                                       15
<PAGE>



     The following  table sets forth the allowance for loan losses  allocated by
loan category,  the total loan amounts by category,  and the percent of loans in
each category to total loans at the dates indicated.

<TABLE>
<CAPTION>
                                                                           June 30,
                      --------------------------------------------------------------------------------------------------------------
                                     1998                                  1997                                 1996          
                      -----------------------------------   -----------------------------------   ----------------------------------
                                                  Percent                               Percent                              Percent
                                                  of Loans                             of Loans                             of Loans
                                     Loan         in Each                  Loan         in Each                   Loan       in Each
                      Amount of     Amounts       Category   Amount of   Amounts       Category    Amount of     Amounts    Category
                      Loan Loss       by          to Total   Loan Loss      by         to Total    Loan Loss       by       to Total
                                                    Loans                                Loans                                Loans 
                                  Allowance Category                 Allowance Category                    Allowance Category
                                  ------------------                 ------------------                    ------------------
                                                                    (Dollars in thousands)
<S>                    <C>          <C>            <C>       <C>         <C>            <C>       <C>          <C>            <C>   
One-to-four family     $   682      $46,271         95.1%    $   622     $44,163         94.9%    $   519      $38,644         95.5%
Multi-family .....          --          674          1.4          --         724          1.6          --          394          1.0 
Commercial .......          --          507          1.0          --         531          1.1          --          285          0.7 
Construction .....          --          676          1.4          --         670          1.4          --          579          1.4 
Other ............          --          523          1.1          --         443          1.0          --          547          1.4 
                       -------      -------        -----     -------     -------        -----     -------      -------        ----- 
    Total ........     $   682      $48,651        100.0%    $   622     $46,531        100.0%    $   519      $40,449        100.0%
                       =======      =======        =====     =======     =======        =====     =======      =======        ===== 

<CAPTION>
                                                      June 30,
                      --------------------------------------------------------------------------
                                     1995                                  1994                 
                      -----------------------------------   ----------------------------------- 
                                                  Percent                               Percent 
                                                  of Loans                             of Loans 
                                     Loan         in Each                  Loan         in Each 
                      Amount of     Amounts       Category   Amount of   Amounts       Category 
                      Loan Loss       by          to Total   Loan Loss      by         to Total 
                                                    Loans                                Loans  
                                  Allowance Category                 Allowance Category         
                                  ------------------                 ------------------         
                                                                    (Dollars in thousands)
<S>                    <C>          <C>            <C>       <C>         <C>            <C>      
One-to-four family     $   474      $40,112         95.2%    $   336      $38,979         95.8%
Multi-family .....          --          426          1.0          --          458          1.1
Commercial .......          --          308          0.7          --          329          0.8
Construction .....          --          725          1.7          --          165          0.4
Other ............          --          571          1.4         779          1.9
                       -------      -------        -----     -------      -------        ----- 
    Total ........     $   474      $42,142        100.0%    $   336      $40,710        100.0%
                       =======      =======        =====     =======      =======        ===== 
</TABLE>



                                       16
<PAGE>


Investment Activities

     General.  The Bank utilizes  mortgage-backed  and other debt  securities in
virtually  all aspects of its  asset/liability  management  strategy.  In making
investment decisions, management considers, among other things, the Bank's yield
and interest rate  objectives,  its interest rate risk and credit risk position,
and its liquidity and cash flow. All investment transactions are ratified by the
Bank's Board of Directors or Executive Committee.

     First Federal must maintain  minimum levels of investments  that qualify as
liquid  assets  under  OTS  regulations.  Liquidity  may  increase  or  decrease
depending upon the  availability of funds and comparative  yields on investments
in relation  to the return on loans.  Cash flow  projections  are  reviewed  and
updated  regularly to assure that adequate  liquidity is maintained.  The Bank's
level of liquidity is a result of  management's  asset/liability  strategy.  See
"Management's  Discussion  and  Analysis of Financial  Condition  and Results of
Operations - Interest Rate Risk Management" in the Annual Report to Stockholders
attached hereto as Exhibit 13 and "Regulation - Liquidity."

     Federally  chartered  savings  institutions have the authority to invest in
various types of liquid assets,  including  United States Treasury  obligations,
securities of various federal agencies,  certain savings certificates of insured
banks  and  savings  institutions,  certain  bankers'  acceptances,   repurchase
agreements  and  federal  funds.  Subject  to  various  restrictions,  federally
chartered savings institutions may also invest their assets in commercial paper,
investment  grade  corporate  debt  securities,  and mutual  funds whose  assets
conform to the investments  that a federally  chartered  savings  institution is
otherwise authorized to make directly.

     Securities  Portfolio  Composition.  The  following  table  sets  forth the
composition of the Bank's securities portfolio at the dates indicated.

<TABLE>
<CAPTION>
                                                                          June 30,
                                      ------------------------------------------------------------------------------
                                              1998                         1997                       1996
                                      ---------------------      -----------------------     -----------------------
                                      Amortized       Fair        Amortized      Fair        Amortized        Fair
                                        Cost          Value         Cost         Value          Cost          Value
                                      ---------    ---------     ---------     ---------     ---------     ---------
                                                                     (In thousands)
<S>                                   <C>           <C>           <C>           <C>           <C>           <C>     
Held-to-Maturity:
Mortgage-backed securities:
  Pass-through securities:
     Freddie Mac ...............      $ 43,258      $ 43,806      $ 57,834      $ 57,910      $ 64,437      $ 64,221
     Ginnie Mae ................        40,767        41,392        32,526        33,360        36,240        35,937
     Fannie Mae ................         7,370         7,429         8,056         8,030         7,096         6,956
  CMOs .........................        36,065        36,267        18,049        18,144        10,448        10,261
                                      --------      --------      --------      --------      --------      --------
                                       127,460       128,894       116,465       117,444       118,221       117,375
U.S. Government Agency and other
  debt securities ..............         7,986         7,989         9,985         9,904        10,979        10,714
                                      --------      --------      --------      --------      --------      --------
   Total held-to-maturity ......       135,446       136,883       126,450       127,348       129,200       128,089

Available-for-sale:
U.S. Government Agency and other
  debt securities ..............         8,500         8,498         2,999         2,983         2,500         2,459
                                      --------      --------      --------      --------      --------      --------
  Total securities .............      $143,946      $145,381      $129,449      $130,331      $131,700      $130,548
                                      ========      ========      ========      ========      ========      ========
</TABLE>


                                       17
<PAGE>



     Mortgage-Backed   Securities.   The   Bank   invests   in   mortgage-backed
pass-through  securities in order to supplement  loan production and achieve its
asset/liability  management goals. All of these securities owned by the Bank are
issued,  insured or guaranteed either directly or indirectly by a Federal agency
or are rated "AA" or higher.  However,  it should be noted that, while a Federal
guarantee  (direct or  indirect)  or a high  credit  rating may  indicate a high
degree of protection against default, such guarantees and ratings do not protect
the  securities  from  declines in value  based on changes in interest  rates or
prepayment speeds.  Reflecting its policy of maintaining a substantial portfolio
of investments having short to medium terms to repricing or maturity, the Bank's
mortgage-backed  pass-through securities portfolio at June 30, 1998 included (i)
$36.1 million of securities with remaining contractual  maturities of five years
or less and (ii) $41.4 million of  adjustable-rate  mortgage-backed  securities.
See "Management's  Discussion and Analysis of Financial Condition and Results of
Operations-  Interest Rate Risk Management" in the Annual Report to Stockholders
attached hereto as Exhibit 13.

     In addition to mortgage-backed pass-through securities, the Bank invests in
collateralized  mortgage obligations  ("CMOs").  Unlike pass-through  securities
which have a single-class  structure resulting in pro-rata  distributions to all
security  holders,  CMOs are securities  derived by reallocating  the cash flows
from  mortgage-backed  securities or pools of mortgage  loans in order to create
multiple classes, or tranches, of securities with coupon rates and average lives
that differ from the underlying  collateral as a whole.  The term to maturity of
any particular  tranche is dependent upon the prepayment speed of the underlying
collateral as well as the structure of the particular  CMO. As a result of these
factors,  the  estimated  average  lives of the CMOs could be  shorter  than the
contractual  maturities as shown on the table on page 20. Although a significant
proportion  of the  Bank's  CMOs are  interests  in  tranches  which  have  been
structured  (through the use of cash flow  priority and  "support"  tranches) to
give somewhat more  predictable  cash flows, the cash flows and hence the values
of CMOs are subject to change.

     The  Bank  invests  in  CMOs  as  an  alternative  to  mortgage  loans  and
mortgage-backed   pass-through   securities  as  part  of  its   asset/liability
management   strategy.   Management  believes  that  CMOs  represent  attractive
investment alternatives relative to other investments due to the wide variety of
maturity  and  repayment  options   available   through  such  investments.   In
particular, the Bank has from time to time concluded that short and intermediate
duration CMOs (with an expected  average life of five years or less) represent a
better  combination  of rate and duration than  adjustable-rate  mortgage-backed
securities.  Because the Bank's CMOs are purchased as an alternative to mortgage
loans and because the Bank has the ability and intent to hold such securities to
maturity,  all CMOs are  classified as  held-to-maturity.  At June 30, 1998, the
Bank held CMOs with a  carrying  value of $36.1  million,  substantially  all of
which were of expected short and intermediate duration.

     To assess price volatility,  the Federal Financial Institutions Examination
Council  ("FFIEC")  adopted a policy in 1992 which  requires an annual  "stress"
test of mortgage derivative  securities.  This policy, which has been adopted by
the OTS, requires the Bank to annually test its CMOs and other  mortgage-related
securities to determine  whether they are high-risk or nonhigh-risk  securities.
Mortgage  derivative products with an average life or price volatility in excess
of a benchmark  30-year  mortgage-backed  pass-through  security are  considered
high-risk mortgage securities. Under


                                       18
<PAGE>


the policy, savings institutions may generally only invest in high-risk mortgage
securities in order to reduce  interest rate risk. As of June 30, 1998, the Bank
had no high-risk securities.

     The market  values of a significant  portion of the Bank's  mortgage-backed
securities held-to-maturity have been from time to time significantly lower than
their carrying values.  However, for financial reporting purposes, such declines
in value are  considered  to be  temporary in nature since they have been due to
changes in interest  rates rather than credit  concerns.  At June 30, 1998,  the
total market value of the Bank's mortgage-backed securities held-to-maturity was
$128.9 million, or $1.4 million greater than total amortized cost. See Note 2 of
the Notes to Consolidated Financial Statements.

     In contrast to mortgage-backed  pass-through  securities in which cash flow
is received (and,  hence,  prepayment risk is shared) pro-rata by all securities
holders,  the  cash  flows  from the  mortgages  or  mortgage-backed  securities
underlying  CMOs are  segmented  and  paid in  accordance  with a  predetermined
priority  to  investors   holding   various   tranches  of  such  securities  or
obligations.  A particular  tranche of a CMO may therefore carry prepayment risk
that differs from that of both the underlying  collateral and other tranches. It
is the Bank's  strategy to purchase  tranches  of CMOs that are  categorized  as
"planned  amortization   classes,"  "targeted  amortization  classes"  or  "very
accurately defined  maturities" and are intended to produce stable cash flows in
different interest rate environments.


                                       19
<PAGE>


     The following  table sets forth  mortgage-backed  securities  purchases and
principal  repayments  for  the  periods  indicated.  There  were  no  sales  of
mortgage-backed securities during these periods.

                                                    Year Ended June 30,
                                           ------------------------------------
                                             1998          1997          1996
                                           --------      --------      --------
                                                     (In thousands)
Purchases:
  Adjustable-rate pass-throughs ......     $ 17,414      $  2,000      $ 20,475
  Fixed-rate pass-throughs ...........        5,015         8,139        17,747
  CMOs ...............................       26,985         7,794            --
                                           --------      --------      --------
         Total purchases .............       49,414        17,933        38,222

Principal repayments .................      (38,419)      (19,689)      (20,087)
                                           --------      --------      --------
  Net increase (decrease) ............     $ 10,995      $ (1,756)     $ 18,135
                                           ========      ========      ========


     Portfolio  Maturities  and  Yields.  The  following  table  sets  forth the
contractual  maturities and weighted average yields of the Company's  securities
portfolio at June 30, 1998.  Mortgage-backed  securities  are  anticipated to be
repaid in  advance  of their  contractual  maturities  as a result of  projected
mortgage  loan  prepayments.  In  addition,  under the  structure of some of the
Bank's CMOs, the Bank's short- and intermediate-tranche interests have repayment
priority over the longer term tranches of the same underlying mortgage pool.

<TABLE>
<CAPTION>
                                                     Principal Balances Due in    
                                 ------------------------------------------------------------------
                                               More than                               
                                 Less than     1 Year to       More than 5      More than         
                                   1 Year       5 Years     Years to 10 Years   10 Years      Total
                                   ------       -------     -----------------   --------      -----
                                                         (Dollars in thousands)
<S>                              <C>            <C>            <C>            <C>            <C>     
Mortgage-backed securities:
  Pass-through securities:
     Freddie Mac ..........      $  8,362       $ 24,792       $  4,900       $  5,606       $ 43,660
     Ginnie Mae ...........            --             43            911         39,728         40,682
     Fannie Mae ...........            --          2,864          1,873          2,634          7,371
  CMOs ....................           638             --          1,698         33,708         36,044
                                 --------       --------       --------       --------       --------
     Total ................      $  9,000       $ 27,699       $  9,382       $ 81,676       $127,757
                                 --------       --------       --------       --------       --------
     Weighted average yield          6.19%          6.05%          6.83%          6.63%          6.48%

U.S. Government Agency and
  other debt securities ...      $  1,500       $  4,000       $  9,500       $  1,500       $ 16,500
                                 ========       ========       ========       ========       ========
     Weighted average yield          4.63%          6.18%          6.53%          7.19%          6.33%
</TABLE>


                                       20
<PAGE>


     The Bank's holdings of mortgage-backed  securities have increased in recent
years as a result of increased  competition  for  mortgage  loans and the Bank's
increased   focus  on  its   asset/   liability   management.   Federal   agency
mortgage-backed  securities  carry  a yield  generally  lower  than  that of the
corresponding  type  of  residential  loan  due to the  implied  Federal  agency
guarantee fee and the retention of a servicing spread by the loan servicer.  The
Bank's other debt  securities also carry lower yields due to the implied Federal
agency  guarantee  and  because  such  securities  tend to have  shorter  actual
durations  than 30 year  loans.  Accordingly,  if the  proportion  of the Bank's
assets consisting of mortgage-backed  and other debt securities  increases,  the
Bank's asset yields would likely be somewhat adversely  affected.  The Bank will
evaluate  mortgage-backed  securities  purchases  in  the  future  based  on its
asset/liability   objectives,   market  conditions  and  alternative  investment
opportunities.

     Other Debt  Securities.  To date, the Bank's  investment  strategy has been
directed  toward  high-quality  assets  (primarily  U.S.  Government  and Agency
obligations)  with short and intermediate  terms (ten years or less) to maturity
and  liquidity  investments.  At June  30,  1998,  the Bank did not own any debt
securities of a single  issuer which  exceeded 10% of the Bank's  equity,  other
than U.S. Government or Federal Agency obligations.

     The  following  table sets forth the  composition  of the Bank's other debt
securities and other interest-earning assets at the dates indicated.

<TABLE>
<CAPTION>
                                                                                        June 30,
                                                    -------------------------------------------------------------------------------
                                                              1998                        1997                        1996
                                                    -----------------------     ------------------------     ----------------------
                                                    Amortized         % of      Amortized         % of       Amortized       % of
                                                      Cost            Total       Cost            Total        Cost          Total
                                                     -------        --------     -------        --------     -------      ---------
                                                                                 (Dollars in Thousands)
<S>                                                  <C>                <C>      <C>               <C>       <C>              <C>  
Other debt securities:
  Held-to-maturity ............................      $ 7,986            48.4%    $ 9,985            76.9%    $10,979           81.5%
  Available-for-sale(1) .......................        8,500            51.6       2,999            23.1       2,500           18.5
                                                     -------        --------     -------        --------     -------      ---------
     Total ....................................      $16,486           100.0%    $12,984           100.0%    $13,479          100.0%
                                                     -------        --------     -------        --------     -------      ---------
Average remaining life of other debt securities      74 mos.                     81 mos.                     79 mos.

Other interest-earning assets:
  FHLB stock ..................................      $ 1,463                     $ 1,463                    $ 1,319
                                                     -------                     -------                    -------- 
  Interest-bearing deposits with banks ........      $ 2,010                     $ 3,680                    $16,300
                                                     -------                     -------                    -------- 
</TABLE>



(1)  The fair value of available-for-sale  securities at June 30, 1998, 1997 and
     1996 was $8.5 million, $3.0 million and $2.5 million, respectively.

Sources of Funds

     General.  The  Bank's  primary  sources  of funds are  depositor  accounts,
payments  (including  prepayments)  of loan  principal,  interest and  dividends
earned on loans and securities, repayments of securities,  borrowings, and funds
provided by operations.


                                       21
<PAGE>


     Depositor  Accounts.  First  Federal  offers  various  types  of  depositor
accounts with a variety of interest rates and terms.  These accounts  consist of
regular  savings and club accounts,  money market and NOW accounts,  and savings
certificates.  The Bank relies  primarily on  competitive  pricing  policies and
customer service to attract and retain these depositor accounts.

     The  variety of deposit  accounts  offered by the Bank has allowed it to be
competitive  in obtaining  funds and to respond with  flexibility  to changes in
customer demand.  As certain customers have become more interest rate conscious,
the Bank has become  more  susceptible  to  short-term  fluctuations  in deposit
flows.  The Bank manages the pricing of its  depositor  accounts in keeping with
its asset/liability management, profitability and growth objectives.

     Based on its experience, the Bank believes that substantial portions of its
regular  savings,  club,  money market and NOW accounts  are  relatively  stable
sources of funds. The Bank has used customer  service and marketing  initiatives
in an effort to maintain and increase the volume of these accounts. However, the
ability of the Bank to attract and maintain  these  accounts (as well as savings
certificates)   has  been  and  will  be  affected  by  competition  and  market
conditions. In particular,  the Bank believes that it would be very difficult to
increase rapidly the "core" portion of its regular  savings,  club, money market
and NOW accounts.  In total,  these account  types  decreased by $872,000,  $4.8
million and $7.3 million in fiscal 1998, 1997 and 1996, respectively. Management
believes  that a  large  portion  of  these  amounts  transferred  into  savings
certificates as a result of interest rate increases on alternate investments. In
the future, the Bank will continue to stress, subject to market conditions,  the
retention of non-certificate accounts.


                                       22
<PAGE>



     The following table sets forth the  distribution of depositor  accounts and
the related weighted average interest rates as of the dates indicated.

<TABLE>
<CAPTION>
                                                                                          June 30,
                                                           -------------------------------------------------------------------------
                                                                   1998                     1997                       1996
                                                           -----------------------  -----------------------   ----------------------
                                                                           Average                  Average                  Average
                                                           Amount           Rate     Amount          Rate      Amount         Rate
                                                           ------           ----     ------          ----      ------         ----
                                                                                    (Dollars in thousands)
<S>                                                        <C>              <C>     <C>              <C>     <C>              <C>  
Money market and NOW ................................      $ 13,196         2.85%   $ 10,989         2.85%   $ 12,090         2.45%
Regular savings .....................................        50,928         2.75      54,000         3.00      57,664         3.00
Club accounts .......................................           710         2.75         717         3.00         725         3.00
                                                           --------                 --------                 --------              
                                                             64,834         2.77      65,706         2.97      70,479         2.91
                                                           --------                 --------                 --------              
Savings certificates by remaining period to maturity:
   Less than 1 year .................................        58,118         5.53      53,825         5.53      48,026         5.38
   More than 1 year to 3 years ......................        11,889         6.43       9,707         6.26       5,464         5.54
   More than 3 years ................................         5,017         6.25       3,180         6.17       4,335         6.94
                                                           --------            -    --------                 --------              
                                                             75,024         5.72      66,712         5.66      57,825         5.51
                                                           --------                 --------                 --------              
Total ...............................................      $139,858         4.35%   $132,418         4.33%   $128,304         4.08%
                                                           --------                 --------                 --------              
</TABLE>

     The following table sets forth the deposit  activity at the Bank during the
periods indicated.

                                            Year Ended June 30,
                                 -------------------------------------------
                                   1998             1997              1996
                                 ---------        ---------        ---------
                                           (Dollars in thousands)
Opening balance ...........      $ 132,418        $ 128,304        $ 130,933
Deposits(1) ...............        118,362          112,066          107,874
Withdrawals(1) ............       (115,748)        (112,514)        (115,005)
Interest credited .........          4,826            4,562            4,502
                                 ---------        ---------        ---------
Ending balance ............      $ 139,858        $ 132,418        $ 128,304
                                 ---------        ---------        ---------
Net increase (decrease) ...      $   7,440        $   4,114        $  (2,629)
                                 ---------        ---------        ---------

Percent increase (decrease)            5.6%             3.2%            (2.0)%
                                 ---------        ---------        ---------

(1)  Includes transfers of funds within the Bank.

            The following table sets forth information about the Bank's savings
certificates greater than $100,000 by remaining period to maturity as of June
30, 1998:

                                                                      Weighted
                                                         Amount     Average Rate
                                                         ------     ------------
                                                         (Dollars in thousands)
Within three months ........................            $ 1,881         5.48%
After 3 but within 6 months ................              2,883         5.53
After 6 but within 12 months ...............              2,181         5.44
After 12 months ............................              3,133         6.41
                                                        -------         ----
  Total ....................................            $10,078         5.77%
                                                        -------       


                                       23
<PAGE>


     Borrowings.  First  Federal's  other  available  sources  of funds  include
advances from the FHLB of New York and other borrowings. As a member of the FHLB
of New York,  the Bank is required to own capital  stock in the FHLB of New York
and is  authorized  to apply for advances  from the FHLB of New York.  Each FHLB
credit  program has its own interest rate,  which may be fixed or variable,  and
range of maturities.  The FHLB of New York may prescribe the acceptable uses for
these advances, as well as limitations on the size of the advances and repayment
provisions. See Note 10 of the Notes to Consolidated Financial Statements.

     The Bank has used  FHLB  advances  from time to time to  provide  funds for
investment  opportunities  and to fund deposit  outflows.  The Bank may also use
advances to extend the  maturity of its  liabilities  if deemed  appropriate  in
connection with its asset/liability management efforts.

     The Company began  utilizing  repurchase  agreements as a funding source in
fiscal 1998 to supplement  retail deposit  growth.  Proceeds from the borrowings
were  invested  in   fixed-rate   government   agency   bonds,   adjustable-rate
mortgage-backed securities and fixed-rate collateralized mortgage obligations at
an anticipated  average spread of approximately 90 basis points.  The spread was
conservatively achieved by closely matching the maturities of the securities and
borrowings.  During fiscal 1998, the Bank entered into the following  securities
repurchase agreements with the FHLB of New York (dollars in thousands):

   Agreement  with a final  maturity in January 2008,  callable
   quarterly at the FHLB's  option  beginning in January  2003,
   and bearing interest at 5.42%                                        $ 10,000
                                                                                
   Agreement  with a  final  maturity  in June  2005,  callable                 
   quarterly at the FHLB's option  beginning in June 1999,  and          
   bearing interest at 5.20%                                               3,000
                                                                         -------
              Total outstanding at June 30, 1998                        $ 13,000
                                                                        ========
                                                                        

     The above securities repurchase agreements were collateralized by
securities  included in the Company's portfolio with an amortized cost
of $13.1 million and a fair value of $13.2 million at June 30, 1998.

     The  following  table  sets  forth  information   concerning  the
balances  and  interest  rates  on FHLB  borrowings  for  the  periods
indicated.  Amounts in fiscal  1998  represent  securities  repurchase
agreements, while amounts in fiscal 1996 represent FHLB advances.

                                                 Year Ended June 30,
                                             -----------------------------
                                             1998        1997        1996
                                             ----        ----        ----
                                                (Dollars in thousands)

Maximum balance .........................   $13,000    $  --       $15,500
Average balance .........................     4,567       --           150
Year-end balance ........................    13,000       --           500
Interest rate at year end ...............    5.37 %       -- %        5.63%
Average interest rate during the year ...    5.36 %       -- %        7.33%


                                  24
<PAGE>


Service Corporations

     As a federally  chartered  savings bank,  First Federal is permitted by OTS
regulations  to  invest  up to 2% of its  assets  in the  stock of, or loans to,
service corporation subsidiaries,  and may invest an additional 1% of its assets
in service  corporations  where such additional funds are used for inner-city or
community  development  purposes. At June 30, 1998, First Federal had no service
corporations.

Employees

     At June 30,  1998,  the Bank had a total of 25  full-time  and 3  part-time
employees.  None of the  Bank's  employees  are  represented  by any  collective
bargaining agreement. Management considers its employee relations to be good.

Regulation

     General.  First Federal is a federally chartered savings bank, the deposits
of which are  federally  insured  and backed by the full faith and credit of the
United States Government. Accordingly, First Federal is subject to broad Federal
regulation  and oversight  extending to all its  operations.  First Federal is a
member of the FHLB of New York and is subject to certain  limited  regulation by
the Board of Governors of the Federal Reserve System ("Federal  Reserve Board").
As the savings and loan holding  company of First  Federal,  the Company also is
subject to federal  regulation and  oversight.  The purpose of the regulation of
the  Company  and other  holding  companies  is to  protect  subsidiary  savings
associations.  First Federal's  deposits are insured by the Savings  Association
Insurance Fund ("SAIF"), which together with the Bank Insurance Fund ("BIF") are
the two  deposit  funds  administered  by the FDIC.  As a  result,  the FDIC has
certain  regulatory and  examination  authority  over First Federal.  Certain of
these regulatory  requirements and restrictions are discussed below or elsewhere
in this document.

     Federal Regulation of Savings Associations. The OTS has extensive authority
over the operations of savings  associations.  As part of this authority,  First
Federal is  required  to file  periodic  reports  with the OTS and is subject to
periodic  examinations by the OTS and the FDIC. The last regular OTS examination
of First  Federal was as of  December  31,  1997.  When these  examinations  are
conducted by the OTS and the FDIC,  the  examiners  may require First Federal to
provide  for  higher  general  or  specific  loan  loss  reserves.  All  savings
associations  are subject to a  semi-annual  assessment,  based upon the savings
association's  total assets,  to fund the operations of the OTS. First Federal's
OTS  assessment  for the  fiscal  year  ended  June 30,  1998 was  approximately
$60,000.


                                       25
<PAGE>


     The  OTS  also  has  extensive   enforcement  authority  over  all  savings
institutions  and their  holding  companies,  including  First  Federal  and the
Company. This enforcement authority 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 for unsafe or unsound
practices.  Other  actions or  inactions  may provide the basis for  enforcement
action,  including  misleading or untimely  reports  filed with the OTS.  Except
under certain  circumstances,  public disclosure of final enforcement actions by
the OTS is required.

     In  addition,  the  investment,  lending and  branching  authority of First
Federal is  prescribed  by Federal laws which  prohibit it from  engaging in any
activities not permitted by such laws. For instance,  no savings institution may
invest in  non-investment  grade  corporate debt  securities.  In addition,  the
permissible  level of  investment  by Federal  associations  in loans secured by
non-residential real property may not exceed 400% of total capital,  except with
approval of the OTS.  First  Federal is in compliance  with these  restrictions.
Federal savings associations are generally authorized to branch nationwide.

     First Federal's general permissible lending limit for loans-to-one-borrower
is equal to the  greater of $500,000  or 15% of  unimpaired  capital and surplus
(except for loans fully secured by certain  readily  marketable  collateral,  in
which case this limit is increased to 25% of unimpaired capital and surplus). At
June 30, 1998,  First Federal's  lending limit under the 15% limitation was $6.5
million.   First  Federal  is  in  compliance  with  the  loans-to-one  borrower
limitation.

     The  OTS,  as well as the  other  Federal  banking  agencies,  has  adopted
guidelines  establishing  safety and soundness standards on such matters as loan
underwriting and  documentation,  asset quality,  earnings  standards,  internal
controls and audit systems,  interest rate risk exposure,  and  compensation and
other  employee  benefits.  Any  institution  that  fails to comply  with  these
standards must submit a compliance plan. A failure to submit a plan or to comply
with an  approved  plan will  subject  the  institution  to further  enforcement
action.

     Insurance of Accounts and Regulation by the FDIC. First Federal is a member
of the SAIF,  which is  administered  by the FDIC.  Deposits  are  insured up to
applicable  limits by the FDIC,  and such  insurance is backed by the full faith
and credit of the United States Government. As insurer, the FDIC imposes deposit
insurance  premiums and 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 risk to the SAIF or BIF. The FDIC also has the authority
to initiate enforcement actions against savings  associations,  after giving the
OTS an opportunity to take such action,  and may terminate the deposit insurance
if it determines that the institution has engaged in unsafe or unsound practices
or is in an unsafe or unsound condition.

     The FDIC's  deposit  insurance  premiums are assessed  through a risk-based
system under which all insured  depository  institutions  are placed into one of
nine  categories  and  assessed  insurance  premiums  based upon their  level of
capital and supervisory evaluation. Under the system, institutions classified as
well  capitalized  (i.e., a core capital ratio of at least 5%, a ratio of Tier 1
or


                                       26
<PAGE>


core capital to risk-weighted  assets ("Tier 1 risk-based  capital") of at least
6% and a total risk-based  capital ratio of at least 10%) and considered healthy
pay the lowest premium.  Institutions that are less than adequately  capitalized
(i.e.,  core or Tier 1  risk-based  capital  ratios  of less  than 4% or a total
risk-based  capital  ratio  of less  than  8%)  and  considered  of  substantial
supervisory concern pay the highest premium. Risk classifications of all insured
institutions are made by the FDIC for each semi-annual assessment period.

     The FDIC is authorized to increase assessment rates, on a semiannual basis,
if it  determines  that the  reserve  ratio of the  SAIF  will be less  than the
designated  reserve  ratio of 1.25% of SAIF insured  deposits.  In setting these
increased  assessments,  the FDIC must seek to restore the reserve ratio to that
designated  reserve  level,  or such higher  reserve ratio as established by the
FDIC.  The FDIC may also impose  special  assessments  on SAIF  members to repay
amounts  borrowed from the United States Treasury or for any other reason deemed
necessary by the FDIC.

     Effective  January 1, 1997,  the premium  schedule for BIF and SAIF insured
institutions   ranged  from  0  to  27  basis  points.   However,   SAIF-insured
institutions are required to pay a Financing Corporation ("FICO") assessment, in
order to fund the  interest on bonds  issued to resolve  thrift  failures in the
1980's,  equal to  approximately  6.48 basis  points  for each $100 in  domestic
deposits,   while   BIF-insured   institutions   pay  an  assessment   equal  to
approximately  1.52  basis  points  for  each  $100 in  domestic  deposits.  The
assessment  is expected to be reduced to 2.43 basis points no later than January
1, 2000,  when BIF insured  institutions  fully  participate in the  assessment.
These  assessments,  which may be  revised  based upon the level of BIF and SAIF
deposits will continue until the bonds mature in the year 2017.

     Regulatory Capital  Requirements.  Federally insured savings  associations,
such as First  Federal,  are required to maintain a minimum  level of regulatory
capital. The OTS has established capital standards, including a tangible capital
requirement,  a leverage  ratio (or core capital)  requirement  and a risk-based
capital  requirement  applicable  to such savings  associations.  These  capital
requirements   must  be  generally  as  stringent  as  the  comparable   capital
requirements  for national  banks.  The OTS is also authorized to impose capital
requirements  in excess  of these  standards  on  individual  associations  on a
case-by-case basis.

     The  capital  regulations  require  tangible  capital  of at least  1.5% of
adjusted total assets (as defined by  regulation).  Tangible  capital  generally
includes  common  stockholders'  equity  and  retained  earnings,   and  certain
noncumulative  perpetual preferred stock and related surplus.  In addition,  all
intangible  assets,  other than a limited amount of purchased mortgage servicing
rights and credit card relationships, must be deducted from tangible capital for
calculating compliance with the requirement. At June 30, 1998, First Federal had
no intangible assets.

     The OTS  regulations  establish  special  capitalization  requirements  for
savings associations that own subsidiaries.  In determining  compliance with the
capital requirements,  all subsidiaries engaged solely in activities permissible
for national  banks or engaged in certain other  activities  solely as agent for
its customers are  "includable"  subsidiaries  that are consolidated for capital
purposes in proportion to the association's level of ownership.  Debt and equity
investments in


                                       27
<PAGE>


excludable  subsidiaries are deducted from assets and capital. At June 30, 1998,
First Federal had no subsidiaries.

     At June 30, 1998, First Federal had tangible  capital of $43.5 million,  or
21.8% of adjusted total assets,  which is approximately  $40.5 million above the
minimum requirement of 1.5% of adjusted total assets in effect on that date.

     The capital  standards  also require  core capital  equal to at least 3% of
adjusted total assets.  Core capital generally consists of tangible capital plus
certain  intangible  assets,  including a limited  amount of purchased  mortgage
servicing  rights  and  credit  card  relationships.  As a result of the  prompt
corrective action provisions  discussed below,  however,  a savings  association
must maintain a core capital  ratio of at least 4% to be  considered  adequately
capitalized  unless its supervisory  condition is such to allow it to maintain a
3% ratio.

     At June 30, 1998, First Federal had core capital equal to $43.5 million, or
21.8% of  adjusted  total  assets,  which is $37.5  million  above  the  minimum
leverage  ratio  requirement  of 3% of adjusted  total  assets in effect on that
date.

     The OTS risk-based capital regulations require savings associations to have
total capital of at least 8% of risk-weighted  assets. Total capital consists of
core capital, as defined above, and supplementary capital. Supplementary capital
consists of certain  permanent  and  maturing  capital  instruments  that do not
qualify as core capital, and general valuation loan and lease loss allowances up
to a maximum of 1.25% of risk-weighted assets. Supplementary capital may be used
to satisfy  the  risk-based  capital  requirement  only up to the amount of core
capital. The OTS is also authorized to require a savings association to maintain
an  additional  amount of total capital to account for  concentration  of credit
risk and the risk of non-traditional activities. Certain exclusions from capital
and assets are required to be made for the purpose of calculating total capital.
Such  exclusions  consist of equity  investments  (as defined by regulation) and
that portion of land loans and nonresidential construction loans in excess of an
80%  loan-to-value   ratio  and  reciprocal   holdings  of  qualifying   capital
instruments.

     In determining the amount of risk-weighted  assets,  all assets,  including
credit equivalent amounts for certain off-balance sheet items, are multiplied by
a risk weight,  ranging from 0% to 100%,  based on the risk inherent in the type
of asset.  For example,  the OTS has assigned a risk weight of 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 Fannie Mae or
Freddie Mac.

     OTS  regulations  also require savings  associations  with more than normal
interest  rate risk  exposure  to deduct  from total  capital,  for  purposes of
determining compliance with the risk-based capital requirement,  an amount equal
to  50% of the  association's  interest-rate  risk  exposure  multiplied  by the
present value of its assets. This exposure is a measure of the potential decline
in the net  portfolio  value of a savings  association,  greater  than 2% of the
present value of its assets,  based upon a hypothetical 200 basis point increase
or decrease in interest  rates  (whichever  results in a greater  decline).  Net
portfolio  value is the  present  value of  expected  cash  flows  from  assets,

                                       28
<PAGE>


liabilities and off-balance sheet contracts.  Any savings  association with less
than $300 million in assets and a total  risk-based  capital  ratio in excess of
12% (such as First  Federal)  is exempt  from this  requirement  unless  the OTS
determines otherwise.  The OTS has indefinitely  deferred  implementation of the
interest rate risk component of the risk-based capital requirements.

     At June 30,  1998,  First  Federal  had total  risk-based  capital of $44.1
million  (including  $43.5  million in core capital and  $623,000 in  qualifying
supplementary  capital)  and  risk-weighted  assets of $49.9  million,  or total
capital of 88.6% of  risk-weighted  assets.  This amount was $40.1 million above
the 8% requirement in effect on that date.

     The OTS and the  FDIC  are  authorized  and,  under  certain  circumstances
required, to take certain actions against savings associations that fail to meet
their  capital  requirements.  The OTS is  generally  required to take action to
restrict the activities of an "undercapitalized  association" (generally defined
to be  one  with  less  than  either  a 4%  core  capital  ratio,  a 4%  Tier  1
risked-based  capital ratio or an 8% total risk-based  capital ratio).  Any such
association  must  submit a capital  restoration  plan and,  until  such plan is
approved by the OTS, may not increase its assets,  acquire another  institution,
establish a branch or engage in any new  activities,  and generally may not make
capital   distributions.   The  OTS  is  authorized  to  impose  the  additional
restrictions that are applicable to significantly undercapitalized associations.

     As a condition to the approval of the capital restoration plan, any company
controlling an undercapitalized association must agree that it will enter into a
limited  capital  maintenance   guarantee  with  respect  to  the  institution's
achievement of its capital requirements.

     Any savings  association  that fails to comply with its capital  plan or is
"significantly undercapitalized" (i.e., Tier 1 risk-based or core capital ratios
of less  than 3% or a total  risk-based  capital  ratio of less than 6%) must be
made  subject  to  one  or  more  additional  specified  actions  and  operating
restrictions  which may cover all aspects of its operations and include a forced
merger  or  acquisition  of  the   association.   An  association  that  becomes
"critically  undercapitalized" (i.e., a tangible capital ratio of 2% or less) is
subject to further mandatory restrictions on its activities in addition to those
applicable to significantly  undercapitalized associations. In addition, the OTS
must appoint a receiver (or conservator  with the concurrence of the FDIC) for a
savings  association,  with certain limited exceptions,  within 90 days after it
becomes critically  undercapitalized.  Any undercapitalized  association is also
subject to the general enforcement  authority of the OTS and the FDIC, including
the appointment of a conservator or a receiver.

     The OTS is also generally  authorized to reclassify an  association  into a
lower capital category and impose the  restrictions  applicable to such category
if the institution is engaged in unsafe or unsound  practices or is in an unsafe
or unsound condition.

     The  imposition  by the OTS or the FDIC of any of these  measures  on First
Federal may have a substantial adverse effect on First Federal's  operations and
profitability.  Stockholders of the Company do not have preemptive  rights,  and
therefore, if the Company is directed by the OTS or the FDIC to issue additional
shares of  common  stock,  such  issuance  may  result  in the  dilution  in the
percentage ownership of present shareholders.


                                       29
<PAGE>


     Limitations on Dividends and Other Capital  Distributions.  OTS regulations
impose  various  restrictions  on  savings  associations  with  respect to their
ability  to make  distributions  of  capital,  which  include  dividends,  stock
redemptions or repurchases,  cash-out mergers and other transactions  charged to
the capital account.  OTS regulations  also prohibit a savings  association from
declaring or paying any dividends or from repurchasing any of its stock if, as a
result,  the regulatory  capital of the  association  would be reduced below the
amount  required to be maintained  for the  liquidation  account  established in
connection with its mutual-to-stock conversion.

     Generally, savings associations that meet their capital requirements before
and after the proposed  distribution,  may make capital distributions during any
calendar  year  equal  to  the  greater  of  (i)  100%  of net  income  for  the
year-to-date  plus 50% of the  amount by which the  lesser of the  association's
tangible,  core or risk-based  capital exceeds its capital  requirement for such
capital  component,  as measured at the beginning of the calendar  year, or (ii)
75% of its net income  for the most  recent  four-quarter  period.  However,  an
association  deemed to be in need of more than normal supervision by the OTS may
have its  dividend  authority  restricted  by the  OTS.  First  Federal  may pay
dividends in accordance with this general authority.

     Savings  associations  proposing to make any capital distribution need only
submit  written  notice to the OTS 30 days prior to such  distribution.  Savings
associations  that do not,  or would not,  meet their  current  minimum  capital
requirements following a proposed capital distribution, however, must obtain OTS
approval  prior  to  making  such  distribution.  The  OTS  may  object  to  the
distribution  during that 30-day  notice  period  based on safety and  soundness
concerns. See "- Regulatory Capital Requirements."

     The OTS has  proposed  regulations  that would  revise the current  capital
distribution restrictions.  Under the proposal, a savings association may make a
capital  distribution  without notice to the OTS (unless it is a subsidiary of a
holding  company)  provided that it has a CAMELS rating of "1" or "2", is not of
supervisory concern, and would remain adequately  capitalized (as defined in the
OTS prompt corrective action regulations)  following the proposed  distribution.
Savings  associations  that would remain  adequately  capitalized  following the
proposed  distribution but do not meet the other noted  requirements must notify
the OTS 30 days prior to  declaring  a capital  distribution.  The OTS stated it
will generally regard as permissible that amount of capital  distributions  that
do not exceed 50% of the institution's excess regulatory capital plus net income
to date during the calendar year. A savings  association  may not make a capital
distribution  without  prior  approval  of  the  OTS  and  the  FDIC  if  it  is
undercapitalized  before,  or as a result of, such a distribution.  As under the
current  rule,  the  OTS  may  object  to a  capital  distribution  if it  would
constitute  an unsafe  or  unsound  practice.  No  assurance  may be given as to
whether or in what form the regulations may be adopted.


                                       30
<PAGE>


     Liquidity. All savings associations,  including First Federal, 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.  This liquid asset ratio
requirement  may vary  from time to time  (between  4% and 10%)  depending  upon
economic  conditions  and  savings  flows of all  savings  associations.  At the
present  time,  the minimum  liquid asset ratio is 4%.  Penalties may be imposed
upon associations for violations of the liquid asset ratio requirement.  At June
30, 1998, First Federal was in compliance with this  requirement,  with a liquid
asset ratio of 34.4%.

     Qualified  Thrift Lender Test. All savings  associations,  including  First
Federal,  are required to meet a qualified  thrift lender  ("QTL") test to avoid
certain  restrictions  on  their  operations.   This  test  requires  a  savings
association  to have  at  least  65% of its  portfolio  assets  (as  defined  by
regulation) in qualified thrift investments on a monthly average for nine out of
every 12 months on a rolling basis. Such assets primarily consist of residential
housing related loans and  investments.  At June 30, 1998, First Federal met the
test and has always met the test since its effectiveness.

     Any savings  association  that fails to meet the QTL test must convert to a
national bank charter unless it  requalifies  as a QTL and thereafter  remains a
QTL. If an  association  does not  requalify  and  converts  to a national  bank
charter,  it must remain  SAIF-insured  until the FDIC permits it to transfer to
the BIF.  If such an  association  has not yet  requalified  or  converted  to a
national  bank,  its  new  investments  and  activities  are  limited  to  those
permissible  for both a  savings  association  and a  national  bank,  and it is
limited to national bank branching  rights in its home state.  In addition,  the
association is immediately  ineligible to receive any new FHLB borrowings and is
subject to national  bank limits for payment of dividends.  If such  association
has not requalified or converted to a national bank within three years after the
failure,  it must  divest  of all  investments  and  cease  all  activities  not
permissible  for a  national  bank.  In  addition,  it must repay  promptly  any
outstanding FHLB borrowings,  which may result in prepayment  penalties.  If any
association  that fails the QTL test is  controlled by a holding  company,  then
within one year after the failure,  the holding  company must register as a bank
holding  company  and  become  subject  to  all  restrictions  on  bank  holding
companies. See "- Holding Company Regulation."

     Community  Reinvestment Act. Under the Community  Reinvestment Act ("CRA"),
every  FDIC-insured  institution  has a continuing  and  affirmative  obligation
consistent  with safe and sound banking  practices to help meet the credit needs
of its entire community,  including low and moderate income  neighborhoods.  The
CRA does not establish  specific lending  requirements or programs for financial
institutions nor does it limit an institution's  discretion to develop the types
of products  and  services  that it believes  are best suited to its  particular
community, consistent with the CRA. The CRA requires the OTS, in connection with
the examination of First Federal, to assess the institution's  record of meeting
the credit  needs of its  community  and to take such record into account in its
evaluation of certain  applications,  such as a merger or the establishment of a
branch, by the institution.  An  unsatisfactory  rating may be used as the basis
for the denial of an application by the OTS.

     In 1995 the Federal banking agencies,  including the OTS, adopted revisions
to the CRA regulations  and the  methodology  for  determining an  institution's
compliance with the CRA. Due


                                       31
<PAGE>


to the heightened  attention  being given to the CRA in the past few years,  the
Bank may be required to devote  additional  funds for  investment and lending in
its local  community.  The Bank was examined for CRA  compliance in May 1998 and
received a rating of satisfactory.

     Transactions  with Affiliates.  Generally,  transactions  between a savings
association or its  subsidiaries  and its affiliates are required to be on terms
as  favorable  to  the  association  as  transactions  with  non-affiliates.  In
addition,  certain of these  transactions,  such as loans to an  affiliate,  are
restricted to a percentage  of the  association's  capital.  Affiliates of First
Federal  include the Company and any company which is under common  control with
First Federal. In addition,  a savings association may not lend to any affiliate
engaged in activities not  permissible for a bank holding company or acquire the
securities  of  most  affiliates.  Subsidiaries  of a  savings  association  are
generally not deemed  affiliates;  however,  the OTS has the discretion to treat
subsidiaries of savings associations as affiliates on a case-by-case basis.

     Certain  transactions with directors,  officers or controlling  persons are
also  subject to  conflict of interest  regulations  enforced by the OTS.  These
conflict of interest  regulations and other statutes also impose restrictions on
loans to such persons and their  related  interests.  Among other  things,  such
loans must be made on terms  substantially the same as for loans to unaffiliated
individuals.

     Holding  Company  Regulation.  The  Company is a unitary  savings  and loan
holding company subject to regulatory oversight by the OTS. As such, the Company
is  required  to  register  and  file  reports  with the OTS and is  subject  to
regulation  and  examination  by the OTS. In addition,  the OTS has  enforcement
authority over the Company and its non-savings association subsidiaries (if any)
which  also  permits  the  OTS to  restrict  or  prohibit  activities  that  are
determined to be a serious risk to the subsidiary savings association.

     As a  unitary  savings  and  loan  holding  company,  the  Holding  Company
generally  is not  subject to  activity  restrictions.  If the  Holding  Company
acquires  control of another savings  association as a separate  subsidiary,  it
would become a multiple savings and loan holding company,  and the activities of
the Holding Company and any of its subsidiaries (other than First Federal or any
other   SAIF-insured   savings   association)   would  become  subject  to  such
restrictions  unless  such  other  associations  each  qualify as a QTL and were
acquired in a supervisory acquisition.

     If First Federal  fails the QTL test,  the Company must obtain the approval
of the OTS prior to continuing after such failure, directly or through its other
subsidiaries,  any business  activities  other than those  approved for multiple
savings and loan holding companies or their  subsidiaries.  In addition,  within
one year of such failure,  the Company must register as, and will become subject
to, the  restrictions  applicable  to bank  holding  companies.  The  activities
authorized  for a bank holding  company are more limited than are the activities
authorized for a unitary or multiple  savings and loan holding  company.  See "-
Qualified Thrift Lender Test."

     The Company must obtain approval from the OTS before  acquiring  control of
any other SAIF-insured  association.  Such acquisitions are generally prohibited
if they  result in a  multiple  savings  and loan  holding  company  controlling
savings associations in more than one state.


                                       32
<PAGE>


However,  such  interstate  acquisitions  are permitted  based on specific state
authorization or in a supervisory acquisition of a failing savings association.

     Federal Securities Law. The stock of the Company is registered with the SEC
under the Securities  Exchange Act of 1934, as amended (the "Exchange Act"). The
Company is subject  to the  information,  proxy  solicitation,  insider  trading
restrictions and other requirements of the SEC under the Exchange Act.

     Company  stock  held by persons  who are  affiliates  (generally  officers,
directors and principal  stockholders)  of the Company may not be resold without
registration or unless sold in accordance with certain resale  restrictions.  If
the Company  meets  specified  current  public  information  requirements,  each
affiliate  of the  Company  is  able  to  sell  in the  public  market,  without
registration, a limited number of shares in any three-month period.

     Federal Reserve  System.  The Federal Reserve Board requires all depository
institutions  to maintain  non-interest  bearing  reserves at  specified  levels
against  their  transaction  accounts  (primarily  checking,  NOW and  Super NOW
checking accounts). At June 30, 1997, First Federal was in compliance with these
reserve  requirements.  The balances maintained to meet the reserve requirements
imposed  by  the  Federal  Reserve  Board  may  be  used  to  satisfy  liquidity
requirements that may be imposed by the OTS. See "- Liquidity."

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

     Federal Home Loan Bank System. First Federal is a member of the FHLB of New
York,  which is one of 12 regional  FHLBs,  that  administers the home financing
credit  function  of  savings  associations.  Each FHLB  serves as a reserve  or
central bank for its members within its assigned region.  It is funded primarily
from  proceeds  derived from the sale of  consolidated  obligations  of the FHLB
System.  It makes loans to members (i.e.,  advances) in accordance with policies
and  procedures,  established  by the board of directors of the FHLB,  which are
subject to the oversight of the Federal Housing Finance Board. All advances from
the FHLB are required to be fully secured by sufficient collateral as determined
by the FHLB. In addition,  all long-term  advances are required to provide funds
for residential home financing.

     As a member,  First  Federal is required to purchase and maintain  stock in
the FHLB of New York.  At June 30, 1998,  First Federal had $1.5 million in FHLB
stock,  which  was in  compliance  with  this  requirement.  Over the past  five
calendar years,  dividends  received by the Bank on its FHLB stock have averaged
7.80% (including 6.59% for calendar year 1997).

     Under  federal  law,  the  FHLBs  are  required  to  provide  funds for the
resolution  of  troubled  savings  associations  and to  contribute  to low- and
moderately-priced housing programs through direct loans or interest subsidies on
advances targeted for community investment and low- and moderate-income  housing
projects.  These  contributions  have  affected  adversely  the  level  of  FHLB

                                       33
<PAGE>


dividends  paid and could continue to do so in the future.  These  contributions
could also have an adverse  effect on the value of FHLB stock in the  future.  A
reduction in value of First  Federal's FHLB stock may result in a  corresponding
reduction in First Federal's capital.

Federal and State Taxation

     Federal Taxation.  The Bank and the Company currently file separate Federal
income tax returns.  These returns are filed on a calendar-year  basis using the
accrual method of accounting.

     Savings  associations such as the Bank are permitted to establish  reserves
for bad debts and to make annual  additions  thereto which may, within specified
formula limits,  be deducted in computing  taxable income for Federal income tax
purposes.  The amount of the bad debt deduction is presently  computed under the
experience  method,  although  a  percentage-of-taxable-income  method  was also
available in computing the deduction for tax years ended on or prior to December
31, 1995.  Under the  experience  method,  the bad debt reserve  deduction is an
amount  determined  under a formula based  generally upon the bad debts actually
sustained by the savings association over a period of years.

     Tax  legislation  enacted in 1996 imposes a requirement  to recapture  into
taxable  income the  portion of the tax bad debt  reserves  for  qualifying  and
non-qualifying  loans in excess of the "base-year"  balances.  For the Bank, the
base-year  reserves are the  balances as of December 31, 1987.  Recapture of the
excess  reserves  will  occur  over  a  six-year  period.  The  Bank  previously
established,  and will  continue to  maintain,  a deferred  tax  liability  with
respect  to its  Federal  tax bad  debt  reserves  in  excess  of the  base-year
balances;  accordingly,  the recapture  requirement will have no effect on total
income tax expense for financial reporting purposes.

     Also, under the 1996 legislation, the Bank's base-year Federal tax bad debt
reserves  are  "frozen"  and subject to current  recapture  only in very limited
circumstances.  Generally,  recapture  of all  or a  portion  of  the  base-year
reserves  will be  required if the Bank pays a dividend in excess of its current
or accumulated earnings and profits,  redeems any of its stock or is liquidated.
The Bank has not established a deferred Federal tax liability under Statement of
Financial  Accounting  Standards  ("SFAS") No. 109 for its base-year Federal tax
bad debt reserves, as it does not anticipate engaging in any of the transactions
that would cause such reserves to be recaptured.  The unrecognized  deferred tax
liability was $1.5 million at June 30, 1998.

     In addition to the regular  income  tax,  corporations,  including  savings
associations such as the Bank,  generally are subject to the alternative minimum
tax.  This tax is imposed at a tax rate of 20% on  alternative  minimum  taxable
income, which is the sum of a corporation's regular taxable income (with certain
adjustments)  and tax  preference  items,  less  any  available  exemption.  The
alternative  minimum tax is imposed to the extent it exceeds  the  corporation's
regular  income  tax,  and net  operating  losses can offset no more than 90% of
alternative minimum taxable income. The Company and the Bank do not expect to be
subject to the alternative minimum tax.

     The Bank has been  audited by the IRS with  respect  to Federal  income tax
returns through December 31, 1993, and all deficiencies have been satisfied.  In
the opinion of management, any


                                       34
<PAGE>


examination  of still open returns  would not result in a deficiency  that could
have a material adverse effect on the financial condition of the Bank.

     New York Taxation.  The Bank and the Company  currently file a combined New
York state tax return on a calendar-year  basis.  The Bank is subject to the New
York State  Franchise Tax on Banking  Corporations  in an annual amount equal to
the greater of (i) 9% of "entire net income"  allocable to New York State during
the  taxable  year,  or  (ii)  the  applicable   alternative  minimum  tax.  The
alternative  minimum tax is  generally  the greater of (a) 0.01% of the value of
assets  allocable  to New  York  State  with  certain  modifications,  (b) 3% of
"alternative entire net income" allocable to New York State, or (c) $250. Entire
net  income  is  similar  to  Federal   taxable   income,   subject  to  certain
modifications  (including  the fact that net operating  losses cannot be carried
back or  carried  forward).  New  York  also  imposes  a  Metropolitan  Commuter
Transportation  District surcharge of 17% that is assessed on the New York State
Franchise Tax.

     In July 1996, New York State enacted legislation to preserve the use of the
percentage-of- taxable-income bad debt deduction for thrift institutions such as
the Bank. In general,  the legislation  provides for a deduction equal to 32% of
the Bank's New York State taxable income,  which is comparable to the deductions
permitted under the prior law. The legislation also provides for a floating base
year,  which  allows  the Bank to switch  from the  percentage-of-taxable-income
method to the experience  method without  recapture of any reserve.  Previously,
the Bank had  established a deferred New York State tax liability for the excess
of its New York State tax bad debt reserves over the amount of its base-year New
York State  reserves.  Since the 1996  legislation  effectively  eliminated  the
reserves in excess of the base-year balances,  the Bank reduced its deferred tax
liability  by $238,000  (with a  corresponding  reduction in income tax expense)
during the quarter ended September 30, 1996.

     Generally,  New York State has requirements similar to Federal requirements
regarding  the  recapture  of  base-year  tax bad  debt  reserves.  One  notable
exception is that,  after the 1996  legislation,  New York  continues to require
that the Bank maintain its thrift  institution  charter and hold at least 60% of
its assets in specified  assets  (generally,  loans secured by residential  real
estate or deposits, educational loans, cash and certain government obligations).
The Bank expects to continue to meet the 60% requirement and does not anticipate
engaging  in  any  of the  transactions  that  would  require  recapture  of the
base-year  reserves.  Accordingly,  in conformity with SFAS No. 109, the related
state deferred tax liability of  approximately  $0.6 million (net of Federal tax
effect) has not been recognized.

     Delaware Taxation.  As a Delaware holding company,  the Company is exempted
from Delaware corporate income tax but is required to file an annual report with
and pay an annual fee to the State of  Delaware.  The Company is also subject to
an annual franchise tax imposed by the State of Delaware.

Item 2. Properties

     The Bank  conducts its business at its main office and two other  locations
in its market area. The following table sets forth  information  concerning each
of these offices as of June 30, 1998. At


                                       35
<PAGE>


June 30,  1998,  the total net book value of the Bank's  office  properties  and
equipment (including land, building and leasehold  improvements,  and furniture,
fixtures and equipment) was $1.0 million, distributed as follows by location:

                                       Year         Owned or   Net Book Value at
    Location                         Acquired        Leased      June 30, 1998
    --------                         --------        ------      -------------
Main Office:
1019 Park Street                        1959          Owned        $115,000
Peekskill, New York

Full Service Branches:
1961 Commerce Street                    1977         Leased          27,000
Yorktown Heights, New York

Cortlandt Town Center, Rte. 6           1997          Owned (1)     901,000
Mohegan Lake, New York

(1)  Building is owned; land is leased.

     Management believes that the Bank's current facilities are adequate to meet
its present and foreseeable future needs.

     The Bank's  depositor  and borrower  customer  files are  maintained  by an
independent data processing company.


                                       36
<PAGE>


Item 3. Legal Proceedings

     From time to time,  the Bank is  involved  as  plaintiff  or  defendant  in
various legal  proceedings  arising in the normal course of its business.  While
the ultimate outcome of these various legal proceedings cannot be predicted with
certainty,  it is the opinion of management  that the  resolution of these legal
actions should not have a material effect on the Bank's  financial  condition or
results of operations.

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

     No  matter  was  submitted  to a vote  of  security  holders,  through  the
solicitation of proxies or otherwise, during the quarter ended June 30, 1998.


                                     PART II


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

     Page 47 of the  attached  1998  Annual  Report  to  Stockholders  is herein
incorporated by reference.

Item 6. Selected Financial Data

     Page 1 of the  attached  1998  Annual  Report  to  Stockholders  is  herein
incorporated by reference.

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

     Pages 3 through 15 of the attached 1998 Annual Report to  Stockholders  are
herein incorporated by reference.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

     Pages 5 and 6 of the attached 1998 Annual Report to Stockholders are herein
incorporated by reference.

Item 8. Financial Statements and Supplementary Data

     Pages 16 through 45 of the attached 1998 Annual Report to Stockholders  are
herein incorporated by reference.


                                       37
<PAGE>


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

     There has been no Current  Report on Form 8-K filed  within 24 months prior
to the  date of the most  recent  financial  statements  reporting  a change  of
accountants and/or reporting disagreements on any matter of accounting principle
or financial statement disclosure.

                                    PART III

Item 10. Directors and Executive Officers of the Registrant

     Information concerning directors is incorporated herein by reference to the
definitive Proxy Statement for the 1998 Annual Meeting of  Stockholders,  a copy
of which  will be filed not later  than 120 days  after the close of the  fiscal
year.

Item 11. Executive Compensation

     Information  concerning  executive  compensation is incorporated  herein by
reference  to the  definitive  Proxy  Statement  for the 1998 Annual  Meeting of
Stockholders,  a copy of which  will be filed not later  than 120 days after the
close of the fiscal year.

Item 12. Security Ownership of Certain Beneficial Owners and Management

     Information  concerning security ownership of certain beneficial owners and
management is incorporated herein by reference to the definitive Proxy Statement
for the 1998 Annual Meeting of  Stockholders,  a copy of which will be filed not
later than 120 days after the close of the fiscal year.

Item 13. Certain Relationships and Related Transactions

     Information  concerning certain  relationships and related  transactions is
incorporated  herein by reference to the definitive Proxy Statement for the 1998
Annual Meeting of Stockholders, a copy of which will be filed not later than 120
days after the close of the fiscal year.


                                       38
<PAGE>

                                     PART IV

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

(a)(1) Financial Statements

     The following  information  appearing in 1998 Annual Report to Stockholders
is herein incorporated by reference:

                                                                        Pages in
                                                                         Annual
Annual Report Section                                                    Report
---------------------                                                    ------
Independent Auditors' Report............................................    16

Consolidated Balance Sheets as of June 30, 1998 and 1997................    17

Consolidated Statements of Income for the Years
  Ended June 30, 1998, 1997 and 1996....................................    18

Consolidated Statements of Changes in Stockholders' Equity for the
  Years Ended June 30, 1998, 1997 and 1996..............................    19

Consolidated Statements of Cash Flows for the Years
  Ended June 30, 1998, 1997 and 1996....................................    20

Notes to Consolidated Financial Statements.............................. 21-45

(a)(2) Financial Statement Schedules

     All  financial  statement  schedules  have  been  omitted  as the  required
information is not applicable or has been included in the consolidated financial
statements and notes thereto.

(a)(3) Exhibits


                                                                
                                                                  Reference to  
 Regulation                                                      Prior Filing or
 S-K Exhibit                                                     Exhibit Number 
   Number                   Document                             Attached Hereto
   ------                   --------                             ---------------
     2      Plan of acquisition, reorganization,
            arrangement, liquidation or succession                      None

     3(a)   Articles of Incorporation                                    *

     3(b)   By-Laws                                                      *

     4      Instruments defining the rights of security
            holders, including debentures                                *

     9      Voting Trust Agreement                                      None

    10      Material contracts
              Savings and Investment Plan                                *
              Retirement Income Plan                                     *


                                       39
<PAGE>


              Form of 1995 Stock Option and Incentive Plan               *
              Employment Agreements of Eldorus Maynard and               *
              William J. LaCalamito
              Supplemental Executive Retirement Agreements of
              Eldorus Maynard and William J. LaCalamito                  **
              Form of Recognition and Retention Plan                     **
              Employee Stock Ownership Plan                              **

    11      Statement regarding computation of per share earnings       None

    13      Annual Report to Security Holders                            13

    16      Letter regarding change in certifying accountants           None

    18      Letter regarding change in accounting principles            None

    21      Subsidiaries of Registrant                                   21

    22      Published report regarding matters submitted to 
             vote of security holders                                   None

    23      Consents of Experts and Counsel                              23

    24      Power of Attorney                                           None

    27      Financial Data Schedule (EDGAR filing only)

    28      Information from reports furnished to state 
              insurance regulatory authorities                          None

    99      Additional Exhibits                                         None


(*)  Filed as exhibits to the Company's Form S-1 registration statement filed on
     October 3, 1995 (File No. 33-97730) pursuant to Section 5 of the Securities
     Act of 1933. All of such previously filed documents are hereby incorporated
     herein by reference in accordance with Item 601 of Regulation S-K.

**   Filed as exhibits to the Company's Amendment No. 1 to Form S-1 registration
     statement filed on November 8, 1995 (File No. 33-97730) pursuant to Section
     5 of the Securities Act of 1933. All of such previously filed documents are
     hereby incorporated herein by reference in accordance with Item 601 of
     Regulation S-K.

(b)  Reports on Form 8-K

     During the quarter ended June 30, 1998, no current reports on Form 8-K were
filed by the Company.


                                       40

<PAGE>




                                   SIGNATURES

     Pursuant to the  requirements  of Section 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.

                                 PEEKSKILL FINANCIAL CORPORATION


                                 By: /s/ Eldorus Maynard 
                                     ----------------------------------
                                     Eldorus Maynard, Chief Executive Officer
                                     and Chairman of the Board
                                     (Duly Authorized Representative)

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


/s/ Dominick Bertoline                     /s/ John A. McGurty
--------------------------------           ----------------------------
Dominick Bertoline, Director               John A. McGurty, Director

Date:    September 28, 1998                Date: September 28, 1998


/s/ Edward H. Dwyer                        /s/ Eldorus Maynard
--------------------------------           ----------------------------
Edward H. Dwyer, Director                  Eldorus Maynard, Chief Executive
                                           Officer and Chairman of the Board
Date:  September 28, 1998                  (Principal Executive and 
                                           Operating Officer)

                                           Date:  September 28, 1998

/s/Robert E. Flower                        /s/ William J. LaCalamito
--------------------------------           ----------------------------
Robert E. Flower, Director                 William J. LaCalamito, President,
                                           Chief Operating Officer and Secretary
Date: September 28, 1998                   (Principal Financial and 
                                           Accounting Officer)

                                           Date: September 28, 1998



                                       41

<PAGE>

SELECTED CONSOLIDATED FINANCIAL DATA 
At or for the Fiscal Year ended June 30
(Dollars in thousands, except per share data)

<TABLE>
<CAPTION>
                                                                       1998         1997         1996          1995         1994
                                                                    ---------    ---------    ---------     ---------    ---------
<S>                                                                 <C>          <C>          <C>           <C>          <C>      
Selected Financial Condition Data:
Total assets                                                        $ 200,341    $ 182,560    $ 191,323     $ 155,716    $ 156,652
Loans, net                                                             47,631       45,507       39,557        41,060       39,961
Held-to-maturity securities (1)                                       135,446      126,450      129,200       105,421      113,966
Available-for-sale securities                                           8,498        2,983        2,459         1,976         --
Cash and cash equivalents                                               4,626        4,158       17,320         4,681          157
Depositor accounts                                                    139,858      132,418      128,304       130,933      133,891
Securities repurchase agreements                                       13,000         --           --            --           --
Equity                                                                 43,206       46,966       59,774        21,178       19,267


Selected Operating Data:
Interest and dividend income                                        $  12,643    $  12,309    $  11,794     $  10,722    $  10,858
Interest expense                                                        6,034        5,431        5,401         4,785        4,216
                                                                    ---------    ---------    ---------     ---------    ---------
   Net interest income                                                  6,609        6,878        6,393         5,937        6,642
Provision for loan losses                                                  60          143           45           160           60
                                                                    ---------    ---------    ---------     ---------    ---------
   Net interest income after provision for loan losses                  6,549        6,735        6,348         5,777        6,582
Loan fees and service charges                                             135          149          207           201          227
Other non-interest income                                                  90           87          101            76           88
Non-interest expense (excluding special assessment)                     3,474        3,318        2,807         2,490        2,315
SAIF special assessment (2)                                              --            884         --            --           --
                                                                    ---------    ---------    ---------     ---------    ---------
   Income before income tax expense and cumulative
       effect of changes in accounting principles                       3,300        2,769        3,849         3,564        4,582
Income tax expense (3)                                                  1,446          957        1,628         1,640        2,040
Cumulative effect of changes in accounting principles:
     Postretirement health care benefits, net                            --           --            (59)         --           --
     Income taxes                                                        --           --           --            --           (205)
                                                                    ---------    ---------    ---------     ---------    ---------
Net income (4)                                                      $   1,854    $   1,812    $   2,162     $   1,924    $   2,337
                                                                    =========    =========    =========     =========    =========
Earnings per share, from date of conversion (4):
   Basic                                                            $    0.68    $    0.58    $    0.36
   Diluted                                                               0.66         0.58         0.36
                                                                    =========    =========    =========

Selected Statistical Data:
Return on average assets (4)                                             0.98%        0.98%        1.23%         1.22%        1.52%
Return on average equity (4)                                             4.02         3.57         4.96          9.38        12.80
Net interest margin                                                      3.55         3.76         3.66          3.82         4.38
Average interest rate spread                                             2.52         2.57         2.57          3.32         3.98
Equity to total assets at end of period                                 21.57        25.73        31.24         13.60        12.30
Efficiency ratio (5)                                                    50.83        61.09        42.04         40.07        33.28
Non-interest expense to average assets (4)                               1.84         2.27         1.59          1.58         1.50
Non-performing loans to total loans, net                                 3.13         4.40         3.17          5.10         4.29
Allowance for loan losses to non-performing loans                       45.74        31.04        41.45         22.61        19.58
Non-performing assets to total assets                                    0.79         1.22         0.65          1.35         1.10
Book value per share                                                $   14.92    $   14.71    $  14.58
Cash dividends per share                                                 0.36         0.36        0.09
Dividend payout ratio                                                   54.69%       62.25%      26.86
</TABLE>

(1)  At June 30, 1994, all securities were  classified as  "held-for-investment"
     prior to the adoption of SFAS No. 115.

(2)  Represents  the  Bank's  share  of a  special  assessment  imposed  on  all
     financial  institutions  with deposits  insured by the Savings  Association
     Insurance Fund ("SAIF"). After taxes, this assessment reduced net income by
     approximately  $520,000.  See  "Management's  Discussion  and  Analysis  of
     Financial  Condition  and Results of  Operations - Comparison  of Operating
     Results for the Fiscal Years Ended June 30, 1997 and 1996."

(3)  Income tax  expense  for fiscal  1997 has been  reduced by a tax benefit of
     $238,000  resulting  from a change in New York state tax law. See Note 7 to
     Consolidated Financial Statements.

(4)  Excluding the after-tax SAIF charge and the state tax benefit  described in
     notes (2) and (3),  net income for fiscal 1997 would have been  $2,094,000,
     resulting  in a return on  average  assets of  1.13%,  a return on  average
     equity  of 4.13%  and  basic  earnings  per  share of  $0.68.  The ratio of
     non-interest expense to average assets would have been 1.80%.

(5)  The efficiency  ratio is computed by dividing  non-interest  expense by the
     sum of net interest  income and  non-interest  income (other than gains and
     losses on sales of securities  and real estate  owned).  Excluding the SAIF
     special  assessment,  the efficiency  ratio for fiscal 1997 would have been
     48.24%.


                                       1
<PAGE>

To Our Stockholders:

Peekskill Financial Corporation  successfully  completed its second full year of
operations  as a public  company  by growing  its core  business  and  enhancing
stockholder  value.  During fiscal 1998, our  subsidiary,  First Federal Savings
Bank, a  service-oriented  community bank,  opened a modern expanded facility in
Mohegan Lake, New York,  introduced  several new mortgage products and continued
to expand  customer  services  by  introducing  24 hour  banking  at two  branch
locations.

     Net income increased to $1.9 million,  or $0.68 per basic share, for fiscal
1998  compared  to net income of $1.8  million,  or $0.58 per basic  share,  for
fiscal  1997.  Net income for the year ended  June 30,  1997 was  affected  by a
one-time charge to earnings for a Federal deposit insurance  special  assessment
and a credit to earnings for the recognition of a tax benefit due to a change in
the New York State tax law.

     Total assets  increased  $17.7  million to $200.3  million at June 30, 1998
from $182.6  million at June 30, 1997. The increase was funded by a $7.4 million
increase in depositor  accounts and $13.0 million of borrowings under securities
repurchase   agreements,   partially  offset  by  a  $3.8  million  decrease  in
stockholders'  equity. The Company began utilizing repurchase  agreements during
fiscal 1998 as a funding source to supplement  retail deposit  growth.  Proceeds
from these  borrowings  were  invested in  fixed-rate  government  agency bonds,
adjustable-rate   mortgage-backed   securities  and  fixed-rate   collateralized
mortgage  obligations at an anticipated average spread of approximately 90 basis
points.  The  spread  was  conservatively   achieved  by  closely  matching  the
maturities of these securities and borrowings.  Any additional future leveraging
using borrowings will be carried out in the same conservative manner.

     The Bank  completed  construction  of a new  building  for its Mohegan Lake
branch.  The new  facility,  with a drive-up  teller and ATM,  is located in the
Cortlandt Town Center, a 600,000 square foot shopping  center,  which allows the
branch  greater  visibility  and foot traffic.  While this  increased the Bank's
occupancy  costs in fiscal 1998,  it also helped  achieve the $7.4  million,  or
5.6%, increase in depositor accounts during the year. The Bank's growth strategy
includes  opening new brick and mortar branches where there exists the potential
of obtaining core deposits,  or purchasing  existing branches from consolidating
competitors.

     The $3.8 million decrease in stockholders'  equity in fiscal 1998 primarily
reflects  treasury  stock  purchases of $5.2 million and dividends  paid of $1.0
million, partially offset by net income of $1.9 million. During fiscal 1998, the
Company  purchased  297,552  shares of its common  stock at an average  price of
$17.43.  The Company plans to continue its current repurchase program as long as
the Company's stock continues to be an attractive investment. Since going public
on December 29, 1995, the Company has purchased 1.2 million treasury shares,  or
29.37% of its issued stock, for $17.7 million. The stock purchases during fiscal
1998  caused the ratio of  stockholders'  equity to total  assets to decrease to
21.57% at June 30,  1998  from  25.73% at June 30,  1997.  Book  value per share
increased from $14.71 at June 30, 1997 to $14.92 at June 30, 1998.

     At this time, the Company would like to take the opportunity to regretfully
announce  the  passing  of John Fay, a Director  of the Bank  since  1981.  John
contributed substantially to the success of First Federal Savings Bank, and more
recently Peekskill Financial  Corporation.  His wisdom,  leadership and sense of
humor will be missed.  On behalf of the Board of Directors,  I wish to thank our
customers, staff and stockholders for their continued support.


Sincerely,



Eldorus Maynard
Chairman of the Board and
      Chief Executive Officer



                                       2
<PAGE>

Management's Discussion and Analysis of Financial Condition and Results of
Operations

General

     Peekskill  Financial  Corporation (the "Holding  Company" or, together with
its wholly-owned  subsidiary,  the "Company") was incorporated in September 1995
and on December 29, 1995 became the holding  company for First  Federal  Savings
Bank (the  "Bank")  upon the  completion  of the  conversion  of the Bank from a
federally  chartered mutual savings bank to a federally  chartered stock savings
bank (the  "Conversion").  Concurrent with the  Conversion,  the Holding Company
sold 4,099,750 shares of its common stock in a subscription  offering at a price
of $10 per  share,  resulting  in net  proceeds  of $40.0  million  (the  "Stock
Offering").

     The primary market area of the Company,  with three full-service  branches,
consists of northern  Westchester,  Putnam and Dutchess counties.  The Bank is a
community-oriented  savings  institution  engaged principally in the business of
attracting  deposits from customers  within its market area and investing  those
funds in residential  mortgage loans and  mortgage-backed  and other securities.
The  financial  condition  and  operating  results of the Company are  primarily
dependent  upon the financial  condition and operating  results of the Bank. The
operating results of the Company depend primarily on its net interest income, or
the difference  between  interest income on earning assets  (primarily loans and
securities) and interest expense on deposits and borrowings.  Net income is also
affected  by  non-interest  income,  such  as loan  fees  and  service  charges;
non-interest  expense,  which includes  salaries and employee benefits and other
operating  expenses;  and Federal and state income taxes. The Holding  Company's
primary business activity has been limited to its ownership of the Bank.

     The Company's results of operations are  significantly  affected by general
economic and  competitive  conditions  (particularly  changes in market interest
rates),  government  policies,  changes in  accounting  standards and actions of
regulatory  agencies.   Future  changes  in  applicable  laws,   regulations  or
government  policies  may  have  a  material  impact  on  the  Company.  Lending
activities are  influenced by the demand for and supply of housing,  competition
among  lenders,  the  level of  interest  rates and the  availability  of funds.
Deposit flows and costs of funds are  influenced by prevailing  market  interest
rates  (including  rates  on  non-deposit  investment   alternatives),   account
maturities,  and the  levels of  personal  income and  savings in the  Company's
market area.

Liquidity

     Liquidity  is defined as the  ability to generate  sufficient  cash flow to
meet all present  and future  funding  commitments,  depositor  withdrawals  and
operating  expenses.  Management  monitors the Company's liquidity position on a
daily basis and evaluates its ability to meet depositor  withdrawals and to make
new loans and  investments  as  opportunities  arise.  The Bank is  required  to
maintain  an average  daily  balance  of liquid  assets as a  percentage  of net
withdrawable  deposit  accounts plus short-term  borrowings of at least 5.0%, as
defined by the regulations of the Office of Thrift  Supervision (the "OTS").  At
June 30, 1998, the Bank's  liquidity  ratio of 34.4% was in compliance  with the
OTS regulations.

     The  Company's  cash  flows  are  classified  according  to  their  source:
operating activities,  investing activities and financing activities. Cash flows
from operating  activities  consist  primarily of interest received on loans and
securities,  and payments for interest on deposits and operating expenses.  Cash
flows  from  


                                       3
<PAGE>

investing activities include  disbursements for purchases of securities and loan
originations,  as well as proceeds from principal payments, maturities and calls
of securities and principal collections on loans. Changes in depositor accounts,
proceeds and repayments of borrowings such as securities  repurchase  agreements
and Federal  Home Loan Bank  ("FHLB")  advances,  dividend  payments and capital
stock  transactions  comprise the Company's  principal cash flows from financing
activities.  While  maturities  and scheduled  payments on loans and  securities
provide an indication of the timing of the receipt of funds, changes in interest
rates,   economic  conditions,   and  competition  strongly  influence  mortgage
prepayment rates and deposit flows, reducing the predictability of the timing of
these cash flows.

     For the three-year  period ended June 30, 1998, the average annual net cash
provided by operating activities was in excess of $2.4 million. Net cash used in
investing  activities  during  fiscal  1998  was  approximately  $17.9  million,
primarily reflecting net purchases of $14.9 million from securities transactions
and net disbursements of $2.4 million to fund loan growth.

     An important source of funds is the Company's core deposit base. Management
believes that a substantial  portion of the Company's  total  deposits of $139.9
million at June 30, 1998 are core  deposits.  The deposit base increased by $7.4
million in fiscal 1998,  reflecting the Company's increased advertising and more
competitive rates for deposit products.  Core deposits are generally  considered
to be a highly stable  source of liquidity  due to the  long-term  relationships
with deposit  customers.  The Company also has the ability to borrow advances of
up to $49.9  million  from the  FHLB of New York at June 30,  1998.  Significant
financing  activities  in fiscal  1998 also  included  borrowing  $13.0  million
through securities  repurchase agreements with the FHLB; disbursing $3.8 million
for treasury stock  purchases;  and paying $1.0 million in cash  dividends.  The
Holding  Company's  future  ability  to  pay  dividends  to  stockholders  or to
repurchase  stock will be dependent on dividends  received from the Bank,  which
are subject to certain  regulatory  restrictions and income tax  considerations.
See Notes 7 and 9 to Consolidated Financial Statements.

     At June 30, 1998,  the Company had  outstanding  loan  commitments  of $6.6
million and loans in process of $112,000.  Since certain origination commitments
may not be funded  and  loans in  process  may not be fully  drawn  upon,  these
amounts  do  not  necessarily  represent  future  cash  outlays.  The  Company's
liquidity  sources  described  above are  anticipated  to be  sufficient to fund
outstanding loan commitments and other obligations.

Capital

     The OTS has established  regulations  which require  savings  associations,
such as the Bank,  to meet  minimum  capital  requirements.  These  requirements
include tangible capital of 1.5% of total adjusted assets;  core capital of 3.0%
of total  adjusted  assets;  and  risk-based  capital  of 8.0% of  risk-weighted
assets. The Bank satisfied these minimum capital standards at June 30, 1998 with
tangible and core capital ratios of 21.8% and a total  risk-based  capital ratio
of  88.6%.  In  determining  the  amount  of   risk-weighted   assets,   savings
associations must classify all assets, and certain off-balance sheet items, into
one of four  risk-weighted  categories.  The amount of  risk-weighted  assets is
determined  by  applying a  specific  percentage  (ranging  from 0% for cash and
obligations  issued by the United States  Government or its agencies to 100% for
consumer and commercial  loans) to the amounts in each  category.  These capital
requirements,  which are applicable to the Bank only, do not consider additional
capital held at the Holding Company level,  and require  certain  adjustments to
the Bank's total equity to arrive at the various regulatory capital amounts.


                                       4
<PAGE>

See Note 9 to Consolidated  Financial  Statements for a further  analysis of the
Bank's actual and required regulatory capital.

     At the time of the  Conversion,  the  Bank  was  required  to  establish  a
liquidation  account equal to its capital as of June 30, 1995. This  liquidation
account is reduced to the extent that  eligible  account  holders  have  reduced
their qualifying  deposits.  In the unlikely event of a complete  liquidation of
the  Bank,  each  eligible   account  holder  will  be  entitled  to  receive  a
distribution from the liquidation  account. The Bank is not permitted to declare
or pay  dividends on its capital  stock,  or repurchase  any of its  outstanding
stock, if the effect thereof would cause its stockholder's  equity to be reduced
below the amount required for the liquidation  account or applicable  regulatory
capital requirements.

Interest Rate Risk Management

     The  Company's  net income is  dependent on its net  interest  income.  Net
interest  income  is  susceptible  to  interest  rate  risk to the  degree  that
interest-bearing  liabilities  mature  or  reprice  on a  different  basis  than
interest-earning  assets.  When  interest-bearing  liabilities mature or reprice
more quickly  than  interest-earning  assets in a given  period,  a  significant
increase in market rates of interest could adversely affect net interest income.
Similarly,  when  interest-earning  assets  mature or reprice  more quickly than
interest-bearing liabilities,  falling interest rates could result in a decrease
in net income.

     In an  attempt  to manage  its  exposure  to  changes  in  interest  rates,
management  monitors the Company's interest rate risk. Since 1991,  management's
asset/liability  committee has met monthly to review the Company's interest rate
risk position and profitability,  and to recommend adjustments for consideration
by the  Board of  Directors.  Management  also  reviews  the  Bank's  securities
portfolio,  formulates  investment  strategies,  and  oversees  the  timing  and
implementation of transactions to assure attainment of the Board's objectives in
the most  effective  manner.  Notwithstanding  the Company's  interest rate risk
management  activities,   the  potential  for  changing  interest  rates  is  an
uncertainty that can have an adverse effect on net income.

     In  adjusting  the  Company's   asset/liability  position,  the  Board  and
management  attempt to manage the Company's  interest rate risk while  enhancing
net  interest  margins.  At times,  depending  on the general  level of interest
rates,  the  relationship  between long and short-term  interest  rates,  market
conditions and  competitive  factors,  the Board and management may determine to
increase the Company's interest rate risk position somewhat in order to increase
its net interest margin.  The Company's  results of operations and net portfolio
values remain  vulnerable to increases in interest rates and to  fluctuations in
the difference between long- and short-term interest rates.

     Consistent with the asset/liability  management philosophy described above,
the Company has taken several steps to manage its interest rate risk. First, the
Company  has  structured  the  security  portfolio  to shorten  the lives of its
interest-earning  assets.  The  Company's  recent  purchases of  mortgage-backed
securities  have had either  short or medium  terms to  maturity  or  adjustable
interest  rates.  At June 30, 1998,  the Company had securities of $40.2 million
with contractual maturities of five years or less and adjustable-rate securities
of $45.1 million. Mortgage-backed securities amortize and experience prepayments
of  principal;  the  Company  has  received  average  cash flows from  principal
paydowns,  maturities and calls of securities of $31.1 million annually over the
past three  fiscal  years.  The  Company  also  controls  interest  rate risk by
emphasizing non-certificate depositor accounts. The Board and


                                       5
<PAGE>

management  believe  that such  accounts  carry a lower  cost  than  certificate
accounts,  and that a material portion of such accounts may be more resistant to
changes in interest rates than are certificate  accounts.  At June 30, 1998, the
Company  had $51.6  million  of regular  savings  and club  accounts,  and $13.2
million of money market and NOW accounts,  representing 46.4% of total depositor
accounts.

     One approach used to quantify interest rate risk is the net portfolio value
("NPV") analysis.  In essence,  this analysis  calculates the difference between
the present  value of  liabilities  and the present value of expected cash flows
from assets and off-balance sheet contracts.  The following table sets forth, at
June 30, 1998,  an analysis of the Bank's  interest rate risk as measured by the
estimated  changes in NPV resulting from  instantaneous  and sustained  parallel
shifts in the yield curve (+ or - 400 basis points,  measured in 100 basis point
increments).

                                                     Estimated Increase
                                                      (Decrease) in NPV
      Change in            Estimated       -------------------------------------
   Interest Rates          NPV Amount            Amount             Percent
----------------------  ------------------ ------------------- -----------------
    (Basis Points)                         (Dollars in thousands)

         +400               $37,493          $ (10,468)               (22)%
         +300                40,936             (7,025)               (15)
         +200                44,098             (3,863)                (8)
         +100                46,573             (1,388)                (3)
          ---                47,961                 ---                ---
         -100                48,960                 999                  2
         -200                49,512               1,551                  3
         -300                50,431               2,470                  5
         -400                51,727               3,766                  8
 
     Certain assumptions utilized by the OTS in assessing the interest rate risk
of thrift  institutions were employed in preparing data for the Bank included in
the preceding table. These assumptions relate to interest rates, loan prepayment
rates,  deposit decay rates,  and the market values of certain  assets under the
various interest rate scenarios. It was also assumed that delinquency rates will
not change as a result of changes in  interest  rates  although  there can be no
assurance  that this  will be the case.  Even if  interest  rates  change in the
designated  amounts,  there  can be no  assurance  that the  Bank's  assets  and
liabilities  would  perform as set forth above.  In  addition,  a change in U.S.
Treasury rates in the designated amounts accompanied by a change in the shape of
the Treasury yield curve would cause significantly  different changes to the NPV
than indicated above.

     The  Company  does  not  currently  engage  in  trading  activities  or use
derivative   instruments  to  control  interest  rate  risk.  Even  though  such
activities  may be permitted  with the approval of the Board of  Directors,  the
Company does not intend to engage in such activities in the foreseeable future.

     Interest  rate  risk is the most  significant  market  risk  affecting  the
Company. Other types of market risk, such as foreign currency exchange rate risk
and  commodity  price risk,  do not arise in the normal  course of the Company's
business activities.


                                       6
<PAGE>

Analysis of Net Interest Income

     The following table sets forth the Company's average  consolidated  balance
sheets, interest income and expense, average yields and costs, and certain other
information for the fiscal years ended June 30:

<TABLE>
<CAPTION>
                                                      1998                          1997                            1996
                                        ----------------------------- -------------------------------   ----------------------------
                                                              Average                         Average                        Average
                                          Average              Yield/   Average                Yield/    Average              Yield/
                                        Balance(1)  Interest   Rate   Balance(1)   Interest     Rate    Balance(1)  Interest   Rate
                                        ----------  --------   -----  ----------   --------    ------   ----------  --------   ----
                                                                         (Dollars in thousands)
<S>                                       <C>        <C>        <C>     <C>        <C>          <C>     <C>        <C>        <C>  
Interest-earning assets:
   Loans (2)                              $ 46,559   $ 3,720    7.99%   $ 42,956   $ 3,402      7.92%   $ 39,171   $ 3,363    8.59%
   Mortgage-backed securities (3)          120,993     7,709    6.37     116,546     7,440      6.38     109,740     6,959    6.34
   Other debt securities (3)                12,904       852    6.60      13,005       858      6.60       9,887       589    5.96
   Other interest-earning assets             5,474       362    6.61      10,346       609      5.89      16,290       883    5.42
                                          --------   -------            --------   -------              --------   -------  
      Total interest-earning assets        185,930   $12,643    6.80%    182,853   $12,309      6.73%    175,088   $11,794    6.73%
                                                     =======                       =======                         =======    

Non interest-earning assets                  2,382                         1,863                           1,384
                                          --------                      --------                        --------
      Total assets                        $188,312                      $184,716                        $176,472
                                          ========                      ========                        ========

Interest-bearing liabilities:
   Regular savings and club accounts      $ 52,922   $ 1,541    2.91%   $ 56,300   $ 1,696      3.01%   $ 62,029   $ 1,903    3.07%
   Money market and NOW accounts            11,909       329    2.76      11,252       285      2.53      12,069       303    2.51
   Savings certificates                     71,717     3,919    5.46      62,973     3,450      5.48      55,506     3,184    5.74
   Borrowings                                4,567       245    5.36        --        --        --           150        11    7.33
                                          --------   -------            --------   -------              --------   -------  
      Total interest-bearing liabilities   141,115   $ 6,034    4.28%    130,525   $ 5,431      4.16%    129,754   $ 5,401    4.16%
                                                     =======                       =======                         =======    
Non interest-bearing liabilities             1,100                         3,495                           3,094
                                          --------                      --------                        --------
      Total liabilities                    142,215                       134,020                         132,848
Stockholders' equity                        46,097                        50,696                          43,624
                                          --------                      --------                        --------
      Total liabilities and stockholders'
        equity                            $188,312                      $184,716                        $176,472
                                          ========                      ========                        ========

Net interest income                                  $ 6,609                       $ 6,878                         $ 6,393
                                                     =======                       =======                         =======
Interest rate spread                                            2.52%                           2.57%                         2.57%
Net yield on interest-earning assets (4)                        3.55                            3.76                          3.66
Average interest-earning assets to
    average interest-bearing liabilities      1.32                          1.40                           1.35
</TABLE>

(1)  Average  balances are calculated  using  end-of-month  balances,  producing
     results which are not materially different from average daily balances.

(2)  Balances  are net of deferred  loan fees and loans in process.  Non-accrual
     loans are included in the balances.

(3)  Balances   represent   amortized   cost.   Yields   are  not  stated  on  a
     tax-equivalent  basis,  as  the  Company  does  not  invest  in  tax-exempt
     securities.

(4)  Represents net interest  income  divided by average total  interest-earning
     assets.

     The following  table sets forth,  for the years  indicated,  an analysis of
changes in interest  and  dividend  income,  interest  expense and net  interest
income  resulting  from changes in average  balances  ("volume")  and changes in
average  rates  ("rate").  The changes  attributable  to the combined  impact of
volume and rate have been allocated proportionately to the changes due to volume
and rate.

<TABLE>
<CAPTION>
                                                                  Fiscal 1998 vs. 1997                  Fiscal 1997 vs. 1996
                                                            --------------------------------       ---------------------------------
                                                            Increase (Decrease)                    Increase (Decrease)
                                                                  Due to                                  Due to                   
                                                            ------------------         Net         -------------------         Net
                                                            Volume        Rate        Change       Volume         Rate        Change
                                                            ------        ----        ------       ------         ----        ------
                                                                                         (In thousands)
<S>                                                          <C>          <C>          <C>          <C>          <C>          <C>  
Interest-earning assets:
       Loans                                                 $ 287        $  31        $ 318        $ 311        $(272)       $  39
       Mortgage-backed securities                              284          (15)         269          434           47          481
       Other debt securities                                    (7)           1           (6)         201           68          269
       Other interest-earning assets                          (311)          64         (247)        (345)          71         (274)
                                                             -----        -----        -----        -----        -----        -----
            Total                                              253           81          334          601          (86)         515
                                                             -----        -----        -----        -----        -----        -----
Interest-bearing liabilities:
       Regular savings and club accounts                       (99)         (56)        (155)        (174)         (33)        (207)
       Money market and NOW accounts                            18           26           44          (21)           3          (18)
       Savings certificates                                    478           (9)         469          416         (150)         266
       Borrowings                                              245         --            245          (11)        --            (11)
                                                             -----        -----        -----        -----        -----        -----
            Total                                              642          (39)         603          210         (180)          30
                                                             =====        =====        =====        =====        =====        =====
Net change in net interest income                            $(389)       $ 120        $(269)       $ 391        $  94        $ 485
                                                             =====        =====        =====        =====        =====        =====
</TABLE>


                                       7
<PAGE>

Comparison of Financial Condition at June 30, 1998 and 1997

     Total assets were $200.3  million at June 30,  1998,  as compared to $182.6
million at June 30, 1997. The $17.7 million  overall  increase  reflects a $14.5
million  increase in  securities,  a $2.1  million  increase in net loans and an
$803,000  increase in office  properties  and  equipment.  Funding the Company's
asset growth was a $7.4 million increase in depositor accounts and $13.0 million
of securities repurchase agreements, partially offset by a $3.8 million decrease
in stockholders' equity.

     The increase in securities  consisted of increases of $9.0 million and $5.5
million  in  held-to-maturity  securities  and  available-for-sale   securities,
respectively.  The  increase  in net loans  reflects  growth in the  one-to-four
family  residential  mortgage  portfolio.  The  increase in  depositor  accounts
reflects an $8.3  million  increase in savings  certificates  and a $2.2 million
increase in money market  demand and NOW  accounts,  partially  offset by a $3.1
million  decrease  in regular  savings  accounts.  The Company  began  utilizing
repurchase  agreements as a funding  source in fiscal 1998 to supplement  retail
deposit  growth.  Proceeds  from the  borrowings  were  invested  in  fixed-rate
government  agency  bonds,   adjustable-rate   mortgage-backed   securities  and
fixed-rate  collateralized mortgage obligations at an anticipated average spread
of  approximately  90 basis points.  The spread was  conservatively  achieved by
closely matching the maturities of the securities and borrowings.

     Stockholders'  equity decreased $3.8 million from $47.0 million at June 30,
1997 to $43.2 million at June 30, 1998. The decrease  primarily  reflects common
stock  purchases of $5.2 million for the  treasury  and  dividends  paid of $1.0
million,  partially  offset by net income of $1.9 million.  The Company plans to
continue its current repurchase program as long as the Company's stock continues
to be an  attractive  investment.  The  ratio of  stockholders'  equity to total
assets  decreased  from 25.73% at June 30, 1997 to 21.57% at June 30, 1998.  The
Company's  tangible book value per share was $14.92 at June 30, 1998 compared to
$14.71 at June 30, 1997.

Comparison  of  Operating  Results for the Fiscal  Years Ended June 30, 1998 and
1997

     General.  Net  income for the  fiscal  year  ended  June 30,  1998 was $1.9
million,  or basic earning per share ("EPS") of $0.68, as compared to net income
of $1.8 million,  or basic EPS of $0.58 for the fiscal year ended June 30, 1997.
Diluted EPS was $0.66 and $0.58,  respectively,  for fiscal years 1998 and 1997.
Net income for the year ended June 30, 1998 was affected by a charge to earnings
of $64,000  ($37,000 net of taxes) for the full vesting of certain  shares under
the Company's Recognition and Retention Plan ("RRP"), due to the death of one of
the  Company's  Directors.  Net  income  for the year  ended  June 30,  1997 was
affected  by a  one-time  charge to  earnings  for a Federal  deposit  insurance
special  assessment of $884,000 ($520,000 net of taxes) and a credit to earnings
for the recognition of a $238,000 reduction to New York State tax expense due to
a change in tax law.  Excluding  these  events,  net income would have been $1.9
million  and  $2.1  million  for  the  years  ended  June  30,  1998  and  1997,
respectively, and basic EPS would have been $0.70 and $0.68, respectively.

     Net Interest Income. Net interest income decreased $269,000,  or 3.9%, from
$6.9  million for the year ended June 30,  1997 to $6.6  million for the current
year.  The components of net interest  income are interest and dividend  income,
which increased $334,000,  and interest expense,  which increased $603,000.  The
Company's interest rate spread decreased to 2.52% for fiscal 1998 from 2.57% for
fiscal 1997. The 


                                       8
<PAGE>

net yield on interest-earning  assets decreased 21 basis points to 3.55% for the
year ended June 30,  1998,  reflecting  a $7.5  million  decrease in average net
earning assets.

     Total interest and dividend income  increased  $334,000,  or 2.7%, to $12.6
million  for  fiscal  1998 from $12.3  million  for fiscal  1997.  The  increase
primarily  reflects a $3.1 million increase in average  interest-earning  assets
and a 7 basis point  increase in the average yield on  interest-earning  assets.
The  overall  increase  in  average  interest-earning  assets  is  comprised  of
increases of $3.6 million in the average loan  portfolio and $4.3 million in the
average securities portfolio,  partially offset by a decrease of $4.9 million in
other  interest-earning  assets.  The change in mix of  interest-earning  assets
reflects the use of generally  lower yielding other  interest-earning  assets to
purchase  shares of the  Company's  common  stock for the  treasury.  Management
intends to  continue  its  current  strategy of  increasing  the loan  portfolio
(primarily   residential  mortgage  loans),  as  market  conditions  permit,  by
introducing new products and stimulating loan demand through advertising.

     The $603,000  increase in total interest  expense was caused primarily by a
12 basis point increase in the average rate paid on interest-bearing liabilities
and a $10.6 million increase in average interest-bearing liabilities. The higher
average  rate  in  fiscal  1998  reflects  a  continuing  shift  in  the  mix of
interest-bearing  deposits from  generally  lower rate savings and club accounts
(the average of which  decreased  $3.4 million  during fiscal 1998) to generally
higher rate savings  certificates  (the average of which  increased $8.7 million
during  fiscal  1998).  This  shift was  partially  offset  by a 10 basis  point
decrease in the average rate paid on regular  savings and club accounts.  During
fiscal 1998,  the Company  entered  into two  securities  repurchase  agreements
totaling  $13.0  million  at an  average  rate of 5.36%,  for which the  Company
recorded $245,000 of interest expense.

     Provision  for Loan  Losses.  The  provision  for loan  losses  is a charge
against  income which  increases the allowance for loan losses.  The adequacy of
the allowance for loan losses is evaluated  periodically and is determined based
on  management's  judgment  concerning  the  amount of risk and  potential  loss
inherent  in the  portfolio.  Management's  judgment  is based  upon a number of
factors  including a review of  non-performing  and other classified  loans, the
value of collateral for such loans,  historical loss experience,  changes in the
nature and volume of the loan portfolio,  and current economic conditions.  When
doubt exists in the view of management as to the collectibility of the remaining
balance  of a loan,  the  Company  will  charge-off  that  portion  deemed to be
uncollectible.  While  management  believes  that it uses the  best  information
available  to  determine  the  allowance  for  loan  losses,  unforeseen  market
conditions could result in adjustments to the allowance for loan losses, and net
earnings could be significantly  affected, if circumstances differ substantially
from the assumptions used in making the final determination.

     The  provision  for loan losses was $60,000 in fiscal 1998 and  $143,000 in
fiscal 1997. The higher provision in fiscal 1997 was due to the establishment of
an $83,000 allowance for loan losses on certain participation loans. The overall
allowance for loan losses was  $682,000,  or 45.74% of  non-performing  loans at
June 30, 1998,  as compared to $622,000,  or 31.04% of  non-performing  loans at
June 30,  1997.  The  Company  did not have any  charge-offs  in fiscal  1998 as
compared to $40,000 in fiscal 1997.  Non-performing  loans at June 30, 1998 were
$1.5  million  compared  to  $2.0  million  at  June  30,  1997.  The  ratio  of
non-performing  loans to net loans was 3.13% at June 30, 1998  compared to 4.40%
at June 30, 1997.  See  "Comparison  of  Operating  Results for the Fiscal Years
ended June 30, 1997 and 1996" and "Asset Quality" for further information.



                                       9
<PAGE>

     Non-Interest Income.  Non-interest income decreased $11,000 to $225,000 for
fiscal 1998 from  $236,000  for fiscal  1997.  Non-interest  income is primarily
comprised  of loan fees,  service  charges  and rental  income on the  Company's
office  properties.  The decrease  reflects a $14,000  decrease in loan fees and
service  charges,  partially  offset by a $3,000 increase in other  non-interest
income.

     Non-Interest  Expense.  Non-interest  expense  decreased  $728,000  to $3.5
million for the year ended June 30,  1998 from $4.2  million for the prior year.
The decrease is primarily the result of a $985,000  decrease in Federal  deposit
insurance  costs,  partially  offset by a $155,000  increase in compensation and
benefits  expense and an $88,000  increase in occupancy  costs.  The decrease in
deposit  insurance  costs  reflects  the  absence in fiscal  1998 of the special
assessment  of $884,000  included in the fiscal  1997  amount,  as well as lower
ongoing  costs  subsequent  to  recapitalization  of the SAIF.  The  increase in
compensation  and benefits expense  primarily  reflects (i) a $64,000 charge for
the full vesting of certain  shares under the Company's RRP, due to the death of
one of the Company's  Directors,  and (ii) a $53,000 increase in expense related
to the Employee Stock  Ownership Plan ("ESOP") due to increases in the Company's
stock price. The increase in occupancy costs primarily reflects costs associated
with the new  building  completed  in fiscal  1998 for the Bank's  Mohegan  Lake
branch.

     Income Tax  Expense.  Income tax  expense was $1.4  million  and  $957,000,
respectively,  for  fiscal  years 1998 and 1997.  The  increase  in tax  expense
reflects  a  $531,000  increase  in  pre-tax  income,  as well as the  Company's
recognition  of a tax benefit of $238,000 in fiscal 1997 due to the reduction of
a deferred tax  liability  caused by an amendment to the New York State tax law.
The  effective  tax rates for the years  ended June 30, 1998 and 1997 were 43.8%
and  34.6%,  respectively.  Excluding  the  one-time  benefit of  $238,000,  the
effective tax rate for fiscal 1997 would have been 43.2%.

Comparison  of  Operating  Results for the Fiscal  Years Ended June 30, 1997 and
1996

     General.  Net  income for the  fiscal  year  ended  June 30,  1997 was $1.8
million,  or basic EPS of $0.58 per  share,  as  compared  to net income of $2.2
million for the year ended June 30, 1996.  Basic EPS was $0.36 for the six-month
period from the Stock  Offering to June 30, 1996.  The $350,000  decrease in net
income was primarily the result of a one-time charge to earnings of $884,000 for
a  special  Federal  deposit  insurance  assessment,   a  $346,000  increase  in
compensation and benefits expense and a $269,000 increase in other  non-interest
expense,  partially  offset by a $485,000  increase in net interest income and a
$671,000  decrease in income tax  expense.  The lower tax expense was  partially
attributable to a $238,000 tax benefit resulting from a change in New York state
tax law.  Excluding  this tax benefit and the  after-tax  charge for the special
deposit insurance assessment,  net income for the year ended June 30, 1997 would
have been $2.1 million, or $0.68 per share.

     Net Interest Income.  Net interest income increased  $485,000,  or 7.6%, to
$6.9 million for the year ended June 30, 1997 from $6.4 million for fiscal 1996.
The components of net interest  income are interest and dividend  income,  which
increased $515,000, and interest expense, which increased $30,000. The Company's
interest  rate spread was  unchanged  at 2.57% in fiscal  1997,  with no overall
change in the average yield on  interest-earning  assets or average rate paid on
interest-bearing liabilities. The net yield on interest-earning assets increased
10 basis points to 3.76% for fiscal 1997,  reflecting a $7.0 million increase in
average net earning assets.



                                       10
<PAGE>

     Total interest and dividend income increased  $515,000 to $12.3 million for
fiscal  1997,  as  compared  to $11.8  million for fiscal  1996.  This  increase
primarily  reflects a $7.8 million increase in average  interest-earning  assets
principally  due to the  investment  of funds  from the Stock  Offering  (net of
subsequent  stock  purchases)  for a full year in fiscal  1997  compared  to six
months in fiscal 1996. The overall increase in average  interest-earning  assets
reflects  increases  of $3.8  million in the  average  loan  portfolio  and $9.9
million in the average securities portfolio,  partially offset by a $5.9 million
decrease in other interest-earning assets. The change in mix of interest-earning
assets  reflects the  deployment  of capital  raised in the Stock  Offering from
short-term  investments  to  higher-yielding  loans and  securities.  Management
intends to  continue  its  current  strategy of  increasing  the loan  portfolio
(primarily   residential  mortgage  loans),  as  market  conditions  permit,  by
introducing new products and stimulating loan demand through advertising.

     The overall yield on average interest-earning assets was unchanged at 6.73%
in fiscal 1997, as higher  average yields on securities and other earning assets
were offset by a 67 basis point decline in the average yield on loans. The lower
yield in fiscal  1997  reflects  the  overall  decline in  interest  rates,  the
origination  of certain  loans at lower  introductory  rates,  and the effect of
non-accrual loans.  Interest income for the year ended June 30, 1997 was reduced
by the  reversal of $67,000 in  interest  previously  received on the  Company's
participation  interest in certain  residential  mortgage  loans  purchased from
Thrift Association Service  Corporation ("TASCO Loans").  Since these loans were
placed on non-accrual  status during the first quarter of fiscal 1997,  interest
income was  further  reduced by foregone  interest of $74,000 for the year.  The
Company took these  actions  since the FDIC,  as a servicer of these  loans,  is
disputing its obligation to pass-through certain principal and interest payments
on the loans  whether or not such  amounts  are  collected  from the  borrowers.
Although  the FDIC  resumed  making  certain  payments in the fourth  quarter of
fiscal  1997,  the  matter  has not been  resolved  and the TASCO  Loans of $1.1
million  remained on  non-accrual  status at June 30, 1997.  There were no other
loans on non-accrual  status at June 30, 1997 and 1996. See "Asset  Quality" for
further information.

     Interest  expense  of $5.4  million  in  fiscal  1997  reflected  a $30,000
increase  over fiscal  1996,  primarily  due to an increase of $771,000 in total
average  interest-bearing  liabilities.  Although  the overall  average  cost of
interest-bearing  liabilities  was unchanged at 4.16% in fiscal 1997,  this rate
reflects  a  continuing  shift  in the  mix of  interest-bearing  deposits  from
generally  lower rate savings and club accounts (the average of which  decreased
$5.7 million during fiscal 1997) to generally  higher rate savings  certificates
(the average of which increased $7.5 million during fiscal 1997). This shift was
offset  by a 26  basis  point  decrease  in the  average  rate  paid on  savings
certificates to 5.48%.

     Provision  for Loan Losses.  The  provision for loan losses was $143,000 in
fiscal 1997 and $45,000 in fiscal 1996. The $98,000 increase is primarily due to
the  establishment  of an $83,000  allowance for loan losses on the TASCO Loans.
The overall allowance for loan losses was $622,000,  or 31.04% of non-performing
loans at June 30,  1997,  as compared to $519,000,  or 41.45% of  non-performing
loans at June 30, 1996.  Charge-offs amounted to $40,000 in fiscal 1997 (none in
fiscal 1996),  partially due to the foreclosure of a residential  mortgage loan.
Non-performing loans at June 30, 1997 were $2.0 million compared to $1.3 million
at June 30, 1996.  The ratio of  non-performing  loans to net loans was 4.40% at
June 30,  1997  compared  to 3.17% at June 30,  1996.  See "Asset  Quality"  for
further information.

     Non-Interest Income.  Non-interest income decreased $72,000 to $236,000 for
fiscal  1997,  as compared to $308,000  for the 1996 fiscal  year.  Non-interest
income is primarily comprised of loan fees, service charges and rental income on
the Company's  office  properties.  The decrease  reflects a $58,000 decrease in

                                       11
<PAGE>

loan fees and  service  charges,  as well as the  inclusion  in fiscal 1996 of a
$24,000 gain on the sale of real estate owned.

     Non-Interest  Expense.  Non-interest expense increased $1.4 million to $4.2
million  for the year ended June 30,  1997 from $2.8  million for the year ended
June 30, 1996. The increase is primarily the result of the $884,000 SAIF special
assessment,  a $346,000  increase in  compensation  and  benefits  expense and a
$269,000 increase in other non-interest expense,  partially offset by a $122,000
decrease  in  ongoing  Federal  deposit   insurance   costs.   The  increase  in
compensation and benefits expense primarily  reflects (i) a $129,000 increase in
expense  recognized for the Company's ESOP which was in effect for all of fiscal
1997 compared to six months in fiscal 1996, and (ii)  recognition of $212,000 in
RRP  expense  for the year ended  June 30,  1997  (none in fiscal  1996).  Other
non-interest  expense increased primarily from increased  advertising  expenses,
printing and other costs  associated  with  operations as a public company for a
full year in fiscal 1997 compared to six months in fiscal 1996.

     On September 30, 1996, the Deposit  Insurance Funds Act of 1996 (the "Funds
Act") was enacted  into law to address  the  disparity  in the  minimum  deposit
insurance  assessment rates applicable to deposits insured by the Bank Insurance
Fund ("BIF") and the higher  assessment  rates applicable to deposits insured by
the Savings  Association  Insurance Fund ("SAIF").  The Funds Act authorized the
Federal Deposit Insurance Corporation ("FDIC") to impose a special assessment on
all financial institutions with SAIF-assessable deposits in the amount necessary
to recapitalize the SAIF. Pursuant to such authority, the FDIC imposed a special
assessment  of 65.7 basis  points per $100 of an  institution's  SAIF-assessable
deposits  held on March 31,  1995.  The  Company's  special SAIF  assessment  of
$884,000  before  taxes  ($520,000  net of taxes)  was  charged  to  expense  in
September 1996 and paid in November 1996. In view of the recapitalization of the
SAIF, the FDIC reduced the assessment rates for  SAIF-assessable  deposits.  For
the calendar years 1998 and 1997, the SAIF  assessment  rates range from 0 to 27
basis points,  which is the same range of rates  applicable to the BIF. Prior to
the SAIF  recapitalization,  all  SAIF-insured  institutions  were  subject to a
minimum  assessment  of 23  basis  points.  The  Funds  Act  also  expanded  the
assessment base to include BIF-insured, as well as SAIF-insured, institutions to
fund payments on the bonds issued by the Financing  Corporation to  recapitalize
the now defunct Federal Savings and Loan Insurance Corporation. In order to fund
such interest payments,  a separate  assessment has been in effect since January
1, 1997.

     Income Tax  Expense.  Income tax  expense for the years ended June 30, 1997
and 1996 was  $957,000  and $1.6  million,  respectively.  The  reduction in tax
expense  reflects the lower pre-tax  income in fiscal 1997, as well as a benefit
of  $238,000  due to the  reduction  of a deferred  tax  liability  caused by an
amendment  to the New York State tax law  enacted  during  the first  quarter of
fiscal 1997. As discussed in Note 7 to Consolidated  Financial  Statements,  the
amendment  changed the base-year for tax bad debt  reserves and  eliminated  the
need for a deferred tax liability  previously  recognized for reserves in excess
of the base-year  amount.  The effective tax rates for fiscal 1997 and 1996 were
34.6% and 42.3%,  respectively.  Excluding the $238,000  one-time  benefit,  the
effective tax rate would have been 43.2% in fiscal 1997.


                                       12
<PAGE>

Asset Quality

     The following table sets forth information  regarding  non-performing loans
and real estate owned at the dates indicated. The Company's prospective adoption
of SFAS No. 114,  "Accounting by Creditors for Impairment of a Loan,"  effective
July 1, 1995, had no impact on the comparability of the information set forth in
the table.  See Notes 1 and 3 to Consolidated  Financial  Statements for further
information  concerning SFAS No. 114. There were no troubled debt restructurings
at the dates set forth below.

<TABLE>
<CAPTION>
                                                                                         At June 30,
                                                          ------------------------------------------------------------------------
                                                             1998            1997           1996            1995             1994
                                                          ---------       ---------       ---------       ---------       ---------
                                                                                   (Dollars in thousands)
<S>                                                       <C>             <C>             <C>             <C>             <C>      
Non-accrual (impaired) loans:
       Participation interest in TASCO Loans              $     876       $   1,074       $      --       $      --       $      --
       One-to-four family mortgage loans                        245              --              --              --              --
                                                          ---------       ---------       ---------       ---------       ---------
           Total non-accrual loans                            1,121           1,074              --              --              --
Accruing loans past due more than 90 days:                                    
       One-to-four family mortgage loans                        370             930           1,252           2,096           1,698
       Other loans                                               --              --              --              --              18
                                                          ---------       ---------       ---------       ---------       ---------
           Total non-performing loans                         1,491           2,004           1,252           2,096           1,716
 Real estate owned                                               94             220              --              --              --
                                                          ---------       ---------       ---------       ---------       ---------
          Total non-performing assets                     $   1,585       $   2,224       $   1,252       $   2,096       $   1,716
                                                          =========       =========       =========       =========       =========
                                                                              
Ratios:                                                                       
      Allowance for loan losses to:                                           
         Non-performing loans                                 45.74%          31.04%          41.45%          22.61%          19.58%
         Total loans, net                                      1.43            1.37            1.31            1.15            0.84
      Non-performing loans to total loans, net                 3.13            4.40            3.17            5.10            4.29
      Non-performing assets to total assets                    0.79            1.22            0.65            1.35            1.10
</TABLE>

     Non-performing loans are those loans past due for more than 90 days, or for
a shorter  period if management  determines  the ability of the borrower to make
contractual payments is in doubt. When a borrower is more than 90 days past due,
management  evaluates the loan,  the  underlying  collateral  and the borrower's
credit  history to determine  whether to place the loan on  non-accrual  status.
Management  and  the  Board  of  Directors  perform  a  monthly  review  of  all
non-performing  loans.  The  actions  taken  by  the  Company  with  respect  to
delinquencies (workout,  settlement or foreclosure) vary depending on the nature
of the loan,  length of delinquency and the borrower's past credit history.  The
classification  of a loan as non-performing  does not necessarily  indicate that
the  principal  and  interest  ultimately  will  be  uncollectible.   Historical
experience indicates that a portion of non-performing  assets will eventually be
recovered.

     At June 30, 1998,  non-performing  assets totaled $1.6 million, or 0.79% of
total assets,  compared to $2.2 million,  or 1.22% of total assets,  at June 30,
1997.  The $513,000  decrease in  non-performing  loans  primarily  reflects the
foreclosure of two properties during the year, with balances totaling  $247,000,
and a  $198,000  decrease  in the  TASCO  Loans  reflecting  principal  payments
received  during the year.  At June 30,  1998,  the Company had $1.1  million of
non-accrual  loans  consisting  of $876,000  in TASCO Loans and two  one-to-four
family mortgages with principal balances totaling $245,000. Real estate owned at
June 30, 1998  represents a single-family  residence  acquired by foreclosure in
fiscal 1998.  The allowance  for loan losses as a percentage  of  non-performing
loans was 45.74% at June 30, 1998 compared to 31.04% at June 30, 1997 and 41.45%
at June 30, 1996. As a percentage of total loans,  the allowance for loan losses
increased to 1.43% at June 30, 1998 compared to 1.37% at June 30, 1997 and 1.31%
at June 30, 1996.



                                       13
<PAGE>

     The following table sets forth activity in the Company's allowance for loan
losses for the periods indicated.

<TABLE>
<CAPTION>
                                                                                         Year ended June 30,
                                                                     -------------------------------------------------------------
                                                                      1998        1997           1996          1995           1994
                                                                     -----        -----          -----        -----          -----
                                                                                        (Dollars in thousands)
<S>                                                                  <C>          <C>            <C>          <C>            <C>  
Balance at beginning of year                                         $ 622        $ 519          $ 474        $ 336          $ 276
Provision for loan losses                                               60          143             45          160             60
Charge-offs                                                             --          (40)            --          (22)            --
                                                                     -----        -----          -----        -----          -----
Balance at end of year                                               $ 682        $ 622          $ 519        $ 474          $ 336
                                                                     =====        =====          =====        =====          =====

Ratio of charge-offs to average loans outstanding                       --%        0.09%            --%        0.10%            --%
Ratio of charge-offs to average non-performing loans                    --         2.00             --         1.20             --
</TABLE>

Recent Accounting Pronouncements

     See  Note 12 to  Consolidated  Financial  Statements  for a  discussion  of
recently issued accounting standards concerning  comprehensive  income,  segment
reporting, benefit plan disclosures, and derivatives and hedging activities.

Impact of Inflation

     The  consolidated  financial  statements  and other  financial  information
presented in this annual report have been prepared in conformity  with generally
accepted  accounting  principles,  which  require the  measurement  of financial
position  and  operating   results  in  terms  of  historical   dollars  without
considering  changes in the relative  purchasing power of money over time due to
inflation.  Unlike  industrial  companies,  virtually  all  of  the  assets  and
liabilities  of a financial  institution  are  monetary in nature.  As a result,
interest  rates  have a more  significant  impact on a  financial  institution's
performance  than do the effects of general levels of inflation.  Interest rates
do not  necessarily  move in the same  direction  or to the same  extent  as the
prices of goods and services.


Impact of Year 2000 Issue

     Like other financial institutions,  the Company relies on computers for the
daily conduct of its business,  all its  transaction  processing and for general
data  processing.  The "Year 2000 Issue" arose  because many  existing  computer
programs  use  only the last two  digits  to refer to a year.  Therefore,  these
computer  programs  may not  properly  recognize  a year that  begins  with "20"
instead of the familiar "19",  causing the programs to fail or create  erroneous
results.

     The Company has initiated  formal  communications  with all its significant
suppliers to determine  the extent to which the Company is  vulnerable  to those
third  parties'  failure to remediate  their own Year 2000 Issue.  The Company's
data processing is performed  almost  entirely by a third party vendor.  At this
time, the vendor has asserted that it is Year 2000 compliant and the Company, in
conjunction with other customers of this vendor,  will begin testing the updated
system  during the quarter  ending  September  30, 1998.  The Company  currently
believes that, with  modifications  to existing  software and conversions to


                                       14
<PAGE>

new software,  the Year 2000 Issue will be mitigated  without causing a material
adverse impact on its operations. However, if such modifications and conversions
are not made,  or are not  completed  timely,  the Year 2000 Issue  could have a
material adverse impact on the operations of the Company.

     The Company will utilize both internal and external resources to reprogram,
or replace, and test all software for Year 2000 modifications. Related costs are
expensed as incurred,  except for costs incurred in the purchase of new software
or hardware, which are capitalized.  To date, costs incurred and expensed relate
to the  dedication  of  internal  resources  employed in the  assessment  of and
development of the Company's Year 2000 compliance  remediation  plan, as well as
the testing of the  hardware  and  software  owned or licensed  for its personal
computers.  Costs  incurred to date are not material,  and  management  does not
expect that  additional  costs to be incurred in  connection  with the Year 2000
Issue  will have a  material  impact on the  Company's  financial  condition  or
results  of  operations.  Since  substantially  all of the  Company's  loans are
residential  mortgages,  the ability of the  Company's  borrowers to become Year
2000 compliant is not a significant concern.

     The estimated costs and timetable for the Year 2000 modifications are based
on  management's  best  estimates,   which  were  derived   utilizing   numerous
assumptions  of future events  including the continued  availability  of certain
resources,  third party modification plans and other factors. However, there can
be no guarantee  that these  estimates will be achieved and actual results could
differ  materially  from those  plans.  Specific  factors in respect of both the
Company and its suppliers  that might cause such material  differences  include,
but are not limited to, the availability  and cost of personnel  trained in this
field,  the ability to locate and correct all relevant  computer codes,  testing
complications and similar uncertainties.  In addition, there can be no guarantee
that the systems of other companies on which the Company's  systems rely will be
timely  converted,  or that a  failure  to  convert  by  another  company,  or a
conversion that is  incompatible  with the Company's  systems,  would not have a
material adverse effect on the Company.

     The Company plans to complete the Year 2000 project not later than December
31,  1998.  Given the  near-term  timing of the test plan,  the  Company has not
developed  a  contingency  plan,  but  will  do so if  testing  results  are not
satisfactory.   Such  a  contingency  plan  could  entail  converting  all  data
processing  applications  to a third  party  vendor  who is  already  Year  2000
compliant.


                                       15
<PAGE>

Management's Report

     Management  is  responsible  for  the  preparation  and  integrity  of  the
consolidated  financial  statements and the other information  presented in this
annual  report.  The  consolidated  financial  statements  have been prepared in
conformity   with   generally   accepted   accounting   principles  and  reflect
management's  judgments  and  estimates  with  respect  to  certain  events  and
transactions.

     Management is responsible for maintaining a system of internal control. The
purpose of this system is to provide reasonable  assurance that transactions are
recorded in accordance with management's  authorization,  assets are safeguarded
against loss or unauthorized  use, and underlying  financial records support the
preparation of financial  statements.  The system includes the  communication of
written  policies  and  procedures,   selection  of  qualified  personnel,   and
appropriate segregation of responsibilities.

     The Board of Directors meets  periodically with Company  management and the
independent  auditors,  KPMG Peat Marwick LLP, to review matters  related to the
quality of financial  reporting,  internal control,  and the nature,  extent and
result of the audit efforts.

     The  independent   auditors  conduct  an  annual  audit  of  the  Company's
consolidated financial statements to enable them to express an opinion as to the
fair  presentation  of  the  statements.  In  connection  with  the  audit,  the
independent  auditors consider the Company's internal control to the extent they
consider necessary to determine the nature,  timing and extent of their auditing
procedures.




Eldorus Maynard                                  William J. LaCalamito
Chairman and Chief Executive Officer             President



Independent Auditors' Report

The Board of Directors and Stockholders
Peekskill Financial Corporation:

     We have audited the accompanying  consolidated  balance sheets of Peekskill
Financial  Corporation  and  subsidiary  as of June 30,  1998 and 1997,  and the
related consolidated  statements of income, changes in stockholders' equity, and
cash flows for each of the years in the  three-year  period ended June 30, 1998.
These consolidated  financial statements are the responsibility of the Company's
management.  Our  responsibility is to express an opinion on these  consolidated
financial statements based on our audits.

     We conducted  our audits in accordance  with  generally  accepted  auditing
standards.  Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements.  An audit also includes
assessing the  accounting  principles  used and  significant  estimates  made by
management,  as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

     In our opinion,  the consolidated  financial  statements  referred to above
present fairly,  in all material  aspects,  the financial  position of Peekskill
Financial  Corporation  and  subsidiary  as of June 30,  1998 and 1997,  and the
results  of their  operations  and their cash flows for each of the years in the
three-year  period ended June 30, 1998 in  conformity  with  generally  accepted
accounting principles.


KPMG Peat Marwick, LLP

Stamford, Connecticut
July 30, 1998


                                       16
<PAGE>


CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)

<TABLE>
<CAPTION>
                                                                                                                    June 30,
                                                                                                           ------------------------
                                                                                                              1998           1997
                                                                                                           ---------      ---------
<S>                                                                                                        <C>            <C>      
Assets
Cash and due from banks                                                                                    $   2,616      $     478
Interest-bearing deposits                                                                                      2,010          3,680
Securities (note 2):
       Held-to-maturity, at amortized cost (fair value of $136,883 in 1998 and $127,348 in 1997)             135,446        126,450
       Available-for-sale, at fair value (amortized cost of $8,500 in 1998 and $2,999 in 1997)                 8,498          2,983
                                                                                                           ---------      ---------
          Total securities                                                                                   143,944        129,433
Loans, net of allowance for loan losses of $682 in 1998 and $622 in 1997 (note 3)                             47,631         45,507
Federal Home Loan Bank stock, at cost                                                                          1,463          1,463
Accrued interest receivable                                                                                    1,050          1,064
Office properties and equipment, net (note 4)                                                                  1,043            240
Real estate owned                                                                                                 94            220
Deferred income taxes, net (note 7)                                                                              362            304
Other assets                                                                                                     128            171
                                                                                                           ---------      ---------
             Total assets                                                                                  $ 200,341      $ 182,560
                                                                                                           =========      =========


Liabilities and Stockholders' Equity

Liabilities:
       Depositor accounts (note 5)                                                                         $ 139,858      $ 132,418
       Securities repurchase agreements (note 6)                                                              13,000             --
       Mortgage escrow deposits                                                                                1,759          1,943
       Other liabilities                                                                                       2,518          1,233
                                                                                                           ---------      ---------
          Total liabilities                                                                                  157,135        135,594
                                                                                                           ---------      ---------

Stockholders' equity (notes 8 and 9):
       Preferred stock (par value $0.01 per share; 100,000 shares authorized; none
          issued or outstanding)                                                                                  --             --
       Common stock (par value $0.01 per share; 4,900,000 shares authorized;
          4,099,750 shares issued)                                                                                41             41
       Additional paid-in capital                                                                             40,181         40,032
       Unallocated common stock held by employee stock ownership plan ("ESOP")                                (2,870)        (3,034)
       Unamortized awards of common stock under recognition and retention plan ("RRP")                          (922)        (1,188)
       Treasury stock, at cost (1,204,181 shares in 1998 and 906,629 shares in 1997)                         (17,730)       (12,543)
       Retained earnings                                                                                      24,508         23,668
       Net unrealized loss on available-for-sale securities, net of taxes (note 2)                                (2)           (10)
                                                                                                           ---------      ---------
          Total stockholders' equity                                                                          43,206         46,966
                                                                                                           ---------      ---------
             Total liabilities and stockholders' equity                                                    $ 200,341      $ 182,560
                                                                                                           =========      =========
</TABLE>


See accompanying notes to consolidated financial statements.


                                       17
<PAGE>


CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)

<TABLE>
<CAPTION>
                                                                                                       Year ended June 30,
                                                                                               ------------------------------------
                                                                                                 1998          1997          1996
                                                                                               --------      --------      --------
<S>                                                                                            <C>           <C>           <C>     
Interest and dividend income:
       Loans                                                                                   $  3,720      $  3,402      $  3,363
       Securities                                                                                 8,561         8,298         7,548
       Interest-bearing deposits and other                                                          362           609           883
                                                                                               --------      --------      --------
          Total interest and dividend income                                                     12,643        12,309        11,794
                                                                                               --------      --------      --------
Interest expense:
       Depositor accounts (note 5)                                                                5,789         5,431         5,390
       Securities repurchase agreements                                                             245            --            --
       Federal Home Loan Bank advances                                                               --            --            11
                                                                                               --------      --------      --------
          Total interest expense                                                                  6,034         5,431         5,401
                                                                                               --------      --------      --------

          Net interest income                                                                     6,609         6,878         6,393
Provision for loan losses (note 3)                                                                   60           143            45
                                                                                               --------      --------      --------
          Net interest income after provision for loan losses                                     6,549         6,735         6,348
                                                                                               --------      --------      --------

Non-interest income:
       Loan fees and service charges                                                                135           149           207
       Other                                                                                         90            87           101
                                                                                               --------      --------      --------
          Total non-interest income                                                                 225           236           308
                                                                                               --------      --------      --------

Non-interest expense:
       Compensation and benefits (note 8)                                                         1,884         1,729         1,383
       Federal deposit insurance costs, including a special assessment of
          $884 in 1997 (note 5)                                                                      84         1,069           307
       Occupancy costs (note 10)                                                                    429           341           328
       Computer service fees                                                                        182           180           179
       Professional fees                                                                            163           140           137
       Safekeeping and custodial services                                                            98            94            93
       Other                                                                                        634           649           380
                                                                                               --------      --------      --------
          Total non-interest expense                                                              3,474         4,202         2,807
                                                                                               --------      --------      --------
          Income before income tax expense and cumulative effect of
              change in accounting principle                                                      3,300         2,769         3,849
Income tax expense (note 7)                                                                       1,446           957         1,628
                                                                                               --------      --------      --------
          Income before cumulative effect of change in accounting principle                       1,854         1,812         2,221
Cumulative effect of change in accounting for postretirement health care benefits,
       net of taxes (note 8)                                                                         --            --           (59)
                                                                                               --------      --------      --------
          Net income                                                                           $  1,854      $  1,812      $  2,162
                                                                                               ========      ========      ========
Earnings per share, from date of conversion in fiscal 1996 (note 9):
       Basic                                                                                   $   0.68      $   0.58      $   0.36
       Diluted                                                                                     0.66          0.58          0.36
                                                                                               ========      ========      ========
</TABLE>



See accompanying notes to consolidated financial statements.

                                       18
<PAGE>


CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (Dollars in
thousands, except share data)

<TABLE>
<CAPTION>
                                                                           Unamortized
                                                              Unallocated    Awards
                                                                Common         of                              Net
                                                    Additional   Stock       Common                         Unrealized     Total
                                          Common     Paid-in     Held         Stock     Treasury  Retained   Loss on   Stockholders'
                                           Stock     Capital    By ESOP     Under RRP    Stock    Earnings  Securities    Equity
                                           -----     -------    -------     ---------    -----    --------  ----------    ------
<S>                                       <C>        <C>        <C>         <C>         <C>       <C>        <C>         <C>     
Balance at June 30, 1995                  $     --   $     --   $     --    $     --    $     --  $ 21,191   $    (13)   $ 21,178
   Net income                                   --         --         --          --          --     2,162         --       2,162
   Dividends paid ($0.09 per share)             --         --         --          --          --      (369)        --        (369)
   Issuance of 4,099,750 common
          shares                                41     39,959         --          --          --        --         --      40,000
  Shares purchased by ESOP
        (327,980 shares)                        --         --     (3,280)         --          --        --         --      (3,280)
   ESOP shares allocated (8,200
          shares)                               --         13         82          --          --        --         --          95
  Increase in net unrealized loss on
       available-for-sale securities,
        net of taxes                            --         --         --          --          --        --        (12)        (12)
                                          --------   --------   --------    --------    --------  --------   --------    --------

Balance at June 30, 1996                        41     39,972     (3,198)         --          --    22,984        (25)     59,774
  Net income                                    --         --         --          --          --     1,812         --       1,812
  Dividends paid ($0.36 per share)              --         --         --          --          --    (1,128)        --      (1,128)
  Purchase of 859,929 treasury
         shares                                 --         --         --          --     (11,985)       --         --     (11,985)
  Purchase of 163,990 
     shares to fund the RRP:
          Awarded to participants
             (117,290 shares)                   --         --         --      (1,400)         --        --         --      (1,400)
          Treasury stock available for
             future awards (46,700
            shares)                             --         --         --          --        (558)       --         --        (558)
  Amortization of RRP awards                    --         --         --         212          --        --         --         212
  ESOP shares allocated (16,399
         shares)                                --         60        164          --          --        --         --         224
  Decrease in net unrealized loss on
       available-for-sale securities,
       net of taxes                             --         --         --          --          --        --         15          15
                                          --------   --------   --------    --------    --------  --------   --------    --------

Balance at June 30, 1997                        41     40,032     (3,034)     (1,188)    (12,543)   23,668        (10)     46,966
  Net income                                    --         --         --          --          --     1,854         --       1,854
  Dividends paid ($0.36 per share)              --         --         --          --          --    (1,014         --      (1,014)
  Purchase of 297,552 treasury
         shares                                 --         --         --          --      (5,187)       --         --      (5,187)
  Amortization of RRP awards                    --         --         --         266          --        --         --         266
  Tax benefit from vesting of
         RRP awards                             --         36         --          --          --        --         --          36
  ESOP shares allocated (16,399
         shares)                                --        113        164          --          --        --         --         277
  Decrease in net unrealized loss on
       available-for-sale securities,
       net of taxes                             --         --         --          --          --        --          8           8
                                          --------   --------   --------    --------    --------  --------   --------    --------
Balance at June 30, 1998                  $     41   $ 40,181   $ (2,870)   $   (922)   $(17,730) $ 24,508   $     (2)   $ 43,206
                                          ========   ========   ========    ========    ========  ========   ========    ========
</TABLE>

See accompanying notes to consolidated financial statements.


                                       19
<PAGE>


CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)

<TABLE>
<CAPTION>
                                                                                                         Year ended June 30,
                                                                                                   --------------------------------
                                                                                                     1998        1997        1996
                                                                                                   --------    --------    --------
<S>                                                                                                <C>         <C>         <C>
Cash flows from operating activities:
          Net income                                                                               $  1,854    $  1,812    $  2,162
          Adjustments to reconcile net income to net cash provided
              by operating activities:
                  Provision for loan losses                                                              60         143          45
                  Depreciation and amortization expense                                                  96          66          66
                  ESOP and RRP expense                                                                  543         436          95
                  Net amortization and accretion of deferred fees, discounts and premiums               (61)       (122)       (186)
                  Net decrease (increase) in accrued interest receivable                                 14          47        (263)
                  Net decrease in other assets                                                           43           2          11
                  Deferred tax benefit                                                                  (58)       (384)       (117)
                  Net increase in other liabilities                                                     434          90         423
                  Other adjustments, net                                                                 (1)         10          35
                                                                                                   --------    --------    --------
                       Net cash provided by operating activities                                      2,924       2,100       2,271
                                                                                                   --------    --------    --------

Cash flows from investing activities:
          Purchases of securities:
                  Held-to-maturity                                                                  (52,950)    (18,422)    (44,722)
                  Available-for-sale                                                                (11,100)     (1,000)     (1,500)
          Proceeds from principal payments, maturities and calls of securities:
                  Held-to-maturity                                                                   44,046      21,232      21,068
                  Available-for-sale                                                                  5,100       1,000       1,000
          Net (disbursements) receipts for loan originations and principal collections               (2,431)     (6,261)      1,319
          Purchase of Federal Home Loan Bank stock                                                       --        (144)         --
          Proceeds from sales of real estate owned                                                      373          --         163
          Purchases of office properties and equipment                                                 (899)       (122)        (23)
                                                                                                   --------    --------    --------
                       Net cash used in investing activities                                        (17,861)     (3,717)    (22,695)
                                                                                                   --------    --------    --------

Cash flows from financing activities:
          Net increase (decrease) in depositor accounts                                               7,440       4,114      (2,629)
          Proceeds from securities repurchase agreements                                             13,000          --          --
          Proceeds from Federal Home Loan Bank advances                                                  --          --       7,630
          Repayments of Federal Home Loan Bank advances                                                  --        (500)     (7,130)
          Net decrease in mortgage escrow deposits                                                     (184)        (88)     (1,159)
          Treasury stock purchases                                                                   (3,837)    (12,543)         --
          Purchase of shares to fund current-year RRP awards                                             --      (1,400)         --
          Net proceeds from issuance of common stock, exclusive of ESOP shares                           --          --      36,720
          Dividends paid                                                                             (1,014)     (1,128)       (369)
                                                                                                   --------    --------    --------
                       Net cash provided by (used in) financing activities                           15,405     (11,545)     33,063
                                                                                                   --------    --------    --------
Net increase (decrease) in cash and cash equivalents                                                    468     (13,162)     12,639
Cash and cash equivalents at beginning of year                                                        4,158      17,320       4,681
                                                                                                   --------    --------    --------
Cash and cash equivalents at end of year                                                           $  4,626    $  4,158    $ 17,320
                                                                                                   ========    ========    ========

Supplemental information:
          Interest paid                                                                            $  5,918    $  5,468    $  5,366
          Income taxes paid                                                                           1,390       1,105       1,722
          (Decrease) increase in liability for securities purchased, not yet settled                   (499)        499          --
          Increase in liability for treasury stock purchased, not yet settled                         1,350          --          --
          Mortgage loans transferred to real estate owned                                               247         220         139
                                                                                                   ========    ========    ========
</TABLE>



See accompanying notes to consolidated financial statements.


                                       20
<PAGE>

Notes to Consolidated Financial Statements

1.   Summary of Significant Accounting Policies

On December 29, 1995, Peekskill Financial Corporation (the "Holding Company" or,
together with its  wholly-owned  subsidiary,  the "Company")  became the holding
company for First  Federal  Savings Bank (the  "Bank"),  formerly  First Federal
Savings and Loan Association of Peekskill, upon the completion of the conversion
of  the  Bank  from  a  mutual  savings  bank  to  a  stock  savings  bank  (the
"Conversion").

The  Company  operates  three   full-service   branches,   and  serves  northern
Westchester,  Putnam and Dutchess  counties as its primary market area. The Bank
is engaged  principally in the business of attracting deposits from customers in
its market area and  investing  those funds in  residential  mortgage  loans and
mortgage-backed  and other  securities.  Deposits  are insured up to  applicable
limits by the Savings Association Insurance Fund ("SAIF") of the Federal Deposit
Insurance  Corporation.  The Company's primary regulator is the Office of Thrift
Supervision ("OTS").

The following is a summary of the significant  accounting  policies  followed by
the Company in the preparation of the consolidated financial statements.

Basis of Presentation

The  consolidated  financial  statements  include  the  accounts  of the Holding
Company and the Bank. All  significant  intercompany  accounts and  transactions
have been  eliminated in  consolidation.  Prior to the  Conversion,  the Holding
Company  had  no  operations  other  than  those  of an  organizational  nature.
Subsequent thereto,  the Holding Company's only significant business activity is
the ownership of the Bank. All financial information included herein for periods
prior to the Conversion refers to the Bank.

The  consolidated  financial  statements  have been prepared in conformity  with
generally  accepted  accounting   principles.   In  preparing  the  consolidated
financial  statements,  management is required to make estimates and assumptions
that affect the reported amounts of assets, liabilities,  revenues and expenses.
Material estimates that are particularly susceptible to near-term change include
the  allowance  for loan losses and the  valuation  allowance  for  deferred tax
assets.  The Company's  accounting  policies with respect to these estimates are
discussed below.

Certain reclassifications have been made to prior year amounts to conform to the
current year  presentation.  For purposes of reporting cash flows, cash and cash
equivalents represent cash and due from banks and interest-bearing deposits.

Securities

Statement of Financial  Accounting  Standards ("SFAS") No. 115,  "Accounting for
Certain Investments in Debt and Equity Securities",  requires the classification
of individual  securities as held-to-maturity,  trading, or  available-for-sale.
SFAS No. 115 limits the  held-to-maturity  category to debt securities for which
the entity has the  positive  intent and  ability to hold to  maturity.  Trading
securities are debt and equity  securities  that are bought  principally for the
purpose of selling them in the near term.  All other debt and equity  securities
are classified as  available-for-sale.  Management  determines  the  appropriate
classification of the Company's securities at the time of purchase.


                                       21
<PAGE>

Notes to Consolidated Financial Statements (continued)

Held-to-maturity  securities are carried at amortized  cost.  Available-for-sale
securities are carried at fair value,  with unrealized gains and losses excluded
from  earnings  and reported on a  net-of-tax  basis as a separate  component of
stockholders'  equity. The Company has no trading securities.  Federal Home Loan
Bank  stock  is a  non-marketable  security  held  in  accordance  with  certain
regulatory requirements and, accordingly, is carried at cost.

Premiums and discounts on debt  securities are amortized to interest income on a
level-yield basis over the expected term of the security. Purchases and sales of
securities are recorded on the trade date. Realized gains and losses on sales of
securities are determined based on the amortized cost of the specific securities
sold.  Unrealized  losses are charged to earnings when the decline in fair value
of a security is judged to be other than temporary.

Allowance for Loan Losses

The allowance for loan losses is increased by provisions  for losses  charged to
income.  Losses on loans (including impaired loans) are charged to the allowance
for loan losses  when all or a portion of a loan is deemed to be  uncollectible.
Recoveries of loans  previously  charged-off  are credited to the allowance when
realized.  Management  estimates  the  allowance  for  loan  losses  based on an
evaluation of the Company's past loan loss experience,  known and inherent risks
in the portfolio, estimated value of underlying collateral, and current economic
conditions.  In management's judgment, the allowance for loan losses is adequate
to absorb probable losses in the existing portfolio.

Establishing  the  allowance  for loan losses  involves  significant  management
judgments utilizing the best information  available at the time. Those judgments
are  subject  to further  review by various  sources,  including  the  Company's
regulators. Adjustments to the allowance for loan losses may be necessary in the
future based on changes in economic and real estate market  conditions,  further
information  obtained  regarding  known problem  loans,  the  identification  of
additional problem loans, and other factors.

Under SFAS No. 114,  "Accounting  by  Creditors  for  Impairment  of a Loan," as
amended by SFAS No.  118, a loan is  considered  to be impaired  when,  based on
current  information and events, it is probable that the creditor will be unable
to collect all principal and interest contractually due. Creditors are permitted
to measure impaired loans based on (i) the present value of expected future cash
flows  discounted  at the  loan's  effective  interest  rate,  (ii)  the  loan's
observable market price or (iii) the fair value of the collateral if the loan is
collateral dependent. If the approach used results in a measurement that is less
than an impaired loan's recorded investment, an impairment loss is recognized as
part of the allowance for loan losses. SFAS No. 118 allows creditors to continue
to use existing  methods for recognizing  interest income on impaired loans. The
Company applies SFAS No. 114 to loans (including  participation  interests) that
are individually  evaluated for collectibility.  The standard generally does not
apply to  smaller-balance  homogeneous  loans  (such as  individual  one-to-four
family mortgage loans) that are collectively evaluated for impairment.

Interest and Fees on Loans

Interest income is accrued monthly on outstanding loan principal balances unless
management  considers  collection  to  be  uncertain.  Interest  collections  on
non-accrual loans are either deferred or reported as 


                                       22
<PAGE>

Notes to Consolidated Financial Statements (continued)

interest  income,  depending on  management's  judgment as to the  likelihood of
further collections. Loans are returned to accrual status when collectibility is
no longer considered uncertain.

Loan origination  fees and certain direct loan  origination  costs are deferred,
and the net fee or cost is recognized as an adjustment to interest  income using
the  level-yield  method  over the  contractual  term of the related  loan.  Net
deferred fees and costs  applicable to prepaid loans are  recognized in interest
income at the time of prepayment.

Office Properties and Equipment

Office   properties   and  equipment  are  carried  at  cost  less   accumulated
depreciation and amortization.  Depreciation is computed using the straight-line
method  over  the  estimated  useful  lives  of the  related  assets.  Leasehold
improvements  are amortized using the  straight-line  method over the shorter of
the lease term or the  estimated  useful  life of the  improvement.  Repairs and
maintenance,  as well as renewals  and  replacements  of a routine  nature,  are
charged  to  expense  as  incurred.   Costs  of  significant   improvements  are
capitalized.

Real Estate Owned

Property acquired through  foreclosure is initially  recorded at fair value less
estimated sales costs, with any resulting writedown charged to the allowance for
loan  losses.  Thereafter,  an  allowance  for  losses on real  estate  owned is
established  for any further  declines in fair value less estimated sales costs.
Fair  value  estimates  are  based on  recent  appraisals  and  other  available
information.

Securities Repurchase Agreements

In  securities  repurchase  agreements,  the Company  transfers  securities to a
counterparty  under an agreement to  repurchase  the  identical  securities at a
fixed  price in the  future.  These  agreements  are  accounted  for as  secured
financing transactions provided the Company maintains effective control over the
transferred  securities  and meets the other  criteria  for such  accounting  as
specified in SFAS No. 125,  "Accounting for Transfers and Servicing of Financial
Assets and Extinguishments of Liabilities." When agreements are accounted for as
secured  financings,  the  transaction  proceeds  are recorded by the Company as
borrowed  funds and the  underlying  securities  continue  to be  carried in the
Company's securities portfolio.

Income Taxes

In  accordance  with the asset and  liability  method  required by SFAS No. 109,
"Accounting  for Income Taxes,"  deferred taxes are recognized for the estimated
future  tax  effects   attributable  to  temporary   differences  and  tax  loss
carryforwards.  Temporary  differences  are  differences  between the  financial
statement carrying amounts and the tax bases of existing assets and liabilities.

A deferred tax liability is recognized for all temporary  differences  that will
result in future  taxable  income.  A deferred tax asset is  recognized  for all
temporary  differences  that will  result in future tax  deductions  and for all
unused tax loss carryforwards,  subject to reduction of the asset by a valuation
allowance in certain  circumstances.  This valuation allowance is recognized if,
based on an analysis of available  evidence, 


                                       23
<PAGE>

Notes to Consolidated Financial Statements (continued)

management  determines  that it is more likely than not that a portion or all of
the deferred tax asset will not be realized.  The valuation allowance is subject
to ongoing adjustment based on changes in circumstances that affect management's
judgment  about the  realizability  of the  deferred tax asset.  Adjustments  to
increase  or  decrease  the   valuation   allowance  are  charged  or  credited,
respectively, to income tax expense.

Deferred  tax  assets and  liabilities  are  measured  using  enacted  tax rates
expected to apply to future  taxable  income.  The effect on deferred tax assets
and  liabilities  of a change in tax laws or rates is  recognized  in income tax
expense in the period that includes the enactment date of the change.

Treasury Stock

Treasury  stock  is  carried  at  cost  and is  presented  as a  deduction  from
stockholders'  equity.  Purchases  of treasury  shares are recorded on the trade
date.

Postretirement Benefit Plans

The Company  maintains a  non-contributory  defined  benefit  pension plan which
covers substantially all employees. Pension costs are funded on a current basis.
Costs  for  this  plan,  as  well as  supplemental  retirement  agreements,  are
accounted  for in  accordance  with  SFAS No.  87,  "Employers'  Accounting  for
Pensions."

Effective  July 1,  1995,  the  Company  changed  its method of  accounting  for
postretirement  health care benefits upon adoption of SFAS No. 106,  "Employers'
Accounting for Postretirement  Benefits Other Than Pensions." The full amount of
the  Company's  accumulated  benefit  obligation at July 1, 1995 (net of related
income taxes) was recognized as the cumulative  effect of a change in accounting
principle in the 1996 consolidated  statement of income. Under SFAS No. 106, the
cost of postretirement health care benefits is recognized on an accrual basis as
such benefits are earned by active employees.  Prior to fiscal 1996, the Company
recognized the cost of these benefits on a pay-as-you-go (cash) basis.

Stock-Based Compensation Plans

Compensation  expense is recognized for the Company's  employee stock  ownership
plan  ("ESOP")  equal to the fair value of shares  committed  to be released for
allocation to participant  accounts.  Any  difference  between the fair value at
that time and the ESOP's  original  acquisition  cost is charged or  credited to
stockholders' equity (additional paid-in capital).  The cost of unallocated ESOP
shares  (shares not yet committed to be released) is reflected as a reduction of
stockholders' equity.

The Company  accounts for its stock option plan in  accordance  with  Accounting
Principles  Board  ("APB")  Opinion  No.  25,  "Accounting  for Stock  Issued to
Employees." Accordingly, compensation expense is recognized only if the exercise
price of the option is less than the fair value of the  underlying  stock at the
grant date. SFAS No. 123, "Accounting for Stock-Based  Compensation," encourages
entities to recognize the fair value of all stock-based  awards (measured on the
grant date) as compensation expense over the vesting period. Alternatively, SFAS
No.  123 allows  entities  to apply the  provisions  of APB  Opinion  No. 25 and
provide pro forma  disclosures  of net income and  earnings  per share as if the
fair-value-based  method  defined  in SFAS No.  123 had been  applied  to awards
granted in fiscal years  beginning  after


                                       24
<PAGE>

Notes to Consolidated Financial Statements (continued)

December  15,  1994.  The  Company has  elected to apply the  provisions  of APB
Opinion No. 25 and provide these pro forma disclosures.

The Company's  recognition  and retention  plan ("RRP") is also accounted for in
accordance  with APB  Opinion  No. 25.  The fair  value of the  shares  awarded,
measured at the grant date, is recognized as unearned  compensation (a deduction
from stockholders'  equity) and amortized to compensation  expense as the shares
become vested.

Earnings Per Share

The Company  has adopted  SFAS No. 128,  "Earnings  per Share,"  which  requires
entities  with complex  capital  structures  to present both basic  earnings per
share  ("EPS") and diluted EPS.  Basic EPS excludes  dilution and is computed by
dividing  income  available to common  stockholders  by the  weighted  number of
common shares  outstanding for the period.  Shares  outstanding for this purpose
exclude  unallocated  ESOP shares that have not been committed to be released to
participants.  Diluted EPS reflects the  potential  dilution that could occur if
securities or other contracts to issue common stock (such as stock options) were
exercised or  converted  into common stock or resulted in the issuance of common
stock that  would  then share in the  earnings  of the  entity.  Diluted  EPS is
computed by dividing net income by the weighted  average number of common shares
outstanding  for the period,  plus  common-equivalent  shares computed using the
treasury stock method. In accordance with SFAS No. 128, the Company has restated
all prior period EPS data  (reported for periods  following the  Conversion)  to
conform to the new requirements.


                                       25
<PAGE>


Notes to Consolidated Financial Statements (continued)

2.  Securities

A summary of the Company's securities follows:

<TABLE>
<CAPTION>
                                                                                               Gross Unrealized                  
                                                                         Amortized       --------------------------          Fair
                                                                           Cost            Gains            Losses           Value
                                                                         ---------       ---------        ---------        ---------
June 30, 1998                                                                                 (In thousands)
<S>                                                                      <C>             <C>              <C>              <C>      
Held-to-Maturity Securities
Mortgage-backed securities:
      Pass-through securities:
         Freddie Mac                                                     $  43,258       $     684        $    (136)       $  43,806
         Ginnie Mae                                                         40,767             625               --           41,392
         Fannie Mae                                                          7,370              62               (3)           7,429
      Collateralized mortgage obligations                                   36,065             213              (11)          36,267
                                                                         ---------       ---------        ---------        ---------
                                                                           127,460           1,584             (150)         128,894
U.S. Government Agency and other debt securities                             7,986              21              (18)           7,989
                                                                         ---------       ---------        ---------        ---------
               Total                                                     $ 135,446       $   1,605        $    (168)       $ 136,883
                                                                         =========       =========        =========        =========
Available-for-Sale Securities
U.S. Government Agency and other debt securities                         $   8,500       $       5        $      (7)       $   8,498
                                                                         =========       =========        =========        =========

June 30, 1997
Held-to-Maturity Securities
Mortgage-backed securities:
      Pass-through securities:
         Freddie Mac                                                     $  57,834       $     185        $    (109)       $  57,910
         Ginnie Mae                                                         32,526             834               --           33,360
         Fannie Mae                                                          8,056              36              (62)           8,030
      Collateralized mortgage obligations                                   18,049             159              (64)          18,144
                                                                         ---------       ---------        ---------        ---------
                                                                           116,465           1,214             (235)         117,444
U.S. Government Agency and other debt securities                             9,985               3              (84)           9,904
                                                                         ---------       ---------        ---------        ---------
               Total                                                     $ 126,450       $   1,217        $    (319)       $ 127,348
                                                                         =========       =========        =========        =========
Available-for-Sale Securities
U.S. Government Agency and other debt securities                         $   2,999       $       1        $     (17)       $   2,983
                                                                         =========       =========        =========        =========
</TABLE>

The amortized  cost of securities  at June 30, 1998  consisted of  approximately
$98.8 million of  fixed-rate  securities  and $45.1  million of  adjustable-rate
securities  ($91.2 million and $38.2 million,  respectively,  at June 30, 1997).
Substantially all collateralized  mortgage obligations at June 30, 1998 and 1997
were Freddie Mac and Fannie Mae securities.

Changes   in  the   after-tax   unrealized   holding   gains   and   losses   on
available-for-sale   securities   resulted   in  an   increase   (decrease)   in
stockholders'  equity  of  $8,000 in fiscal  1998,  $15,000  in fiscal  1997 and
($12,000)  in fiscal  1996.  These gains and losses will  continue to  fluctuate
based on changes in the portfolio and market conditions.

The Company did not sell any securities during fiscal 1998, 1997 and 1996.

The  following  is a  summary  of the  amortized  cost  and  fair  value of debt
securities,   other  than  mortgage-backed  securities,  by  remaining  term  to
contractual  maturity as of June 30,  1998.  Actual  maturities  may differ from
these  amounts  because  certain  issuers have the right to call or prepay their
obligations.



                                       26
<PAGE>


Notes to Consolidated Financial Statements (continued)

<TABLE>
<CAPTION>
                                                    Held-to-Maturity                   Available-for-Sale
                                               -------------------------           -------------------------
                                               Amortized           Fair            Amortized           Fair
                                                 Cost             Value              Cost              Value
                                                ------            ------            ------            ------
                                                                       (In thousands)
<S>                                             <C>               <C>               <C>               <C>   
Less than one year                              $1,500            $1,499            $   --            $   --
More than one year to five years                 2,000             1,997             2,000             2,000
More than five years to ten years                4,486             4,493             5,000             5,001
More than ten years                                 --                --             1,500             1,497
                                                ------            ------            ------            ------
          Total                                 $7,986            $7,989            $8,500            $8,498
                                                ======            ======            ======            ======
</TABLE>

3.   Loans

Loans at June 30 consist of the following:

                                                             1998         1997
                                                           --------    --------
                                                              (In thousands)
Mortgage loans:
       One-to-four family                                  $ 46,271    $ 44,163
       Multi-family                                             674         724
       Commercial                                               507         531
       Construction                                             676         670
       Construction loans in process                           (112)       (195)
                                                           --------    --------
                                                             48,016      45,893
                                                           --------    --------
Other loans:
       Passbook loans and other                                 460         341
       Student loans                                             63         102
                                                           --------    --------
                                                                523         443
                                                           --------    --------

            Total loans                                      48,539      46,336
Allowance for loan losses                                      (682)       (622)
Net deferred loan origination fees                             (226)       (207)
                                                           --------    --------
            Total loans, net                               $ 47,631    $ 45,507
                                                           ========    ========

Total loans (net of construction  loans in process)  consisted of  approximately
$47.7 million of fixed-rate loans and $876,000 of adjustable-rate  loans at June
30,  1998 ($45.2  million and $1.1  million,  respectively,  at June 30,  1997).
One-to-four  family mortgage loans include home equity loans of $1.9 million and
$2.4 million at June 30, 1998 and 1997, respectively.

The  Company   primarily   originates   mortgage   loans   secured  by  existing
single-family  residential properties.  The Company also originates multi-family
and commercial real estate loans, and construction  loans. A substantial portion
of  the  loan  portfolio  is  secured  by  real  estate  properties  located  in
Westchester  County,  New York,  and, to a lesser  extent in Putnam and Dutchess
Counties, New York. The ability of the Company's borrowers to make principal and
interest  payments is dependent upon,  among other things,  the level of overall
economic  activity and the real estate market  conditions  prevailing within the
Company's concentrated lending area.

The  Company's  impaired  loans at June 30, 1998, as defined under SFAS No. 114,
consisted of the  participation  interest  described below (which had a recorded
investment of $876,000 at June 30, 1998 and $1.1 million at June 30, 1997).  The
allowance  for loan losses at both dates  includes an  impairment 


                                       27
<PAGE>


Notes to Consolidated Financial Statements (continued)

allowance  of  $83,000   established   in  fiscal  1997  with  respect  to  this
participation  interest.  The Company's average recorded  investment in impaired
loans was  $965,000  in fiscal  1998 and $1.1  million  in fiscal  1997 (none in
fiscal 1996).

The Company holds a participation interest in certain residential mortgage loans
purchased from Thrift Association Service  Corporation (the "TASCO Loans").  The
Company  placed this  participation  interest on  non-accrual  status during the
first  quarter  of  fiscal  1997,  resulting  in  foregone  interest  income  of
approximately $76,000 in fiscal 1998 and $74,000 in fiscal 1997. Interest income
for  fiscal  1997 was also  reduced  by the  reversal  of  $67,000  in  interest
previously received on the TASCO Loans. The Company took these actions since the
FDIC, as a servicer of these loans,  is disputing its obligation to pass-through
certain principal and interest payments on the loans whether or not such amounts
are  collected  from the  borrowers.  Although the FDIC resumed  making  certain
payments in the fourth quarter of fiscal 1997, the matter has not been resolved.
Accordingly,  the TASCO Loans have remained on non-accrual  status, and interest
payments of $55,000 and $21,000 received in fiscal 1998 and 1997,  respectively,
have been deferred.

The Company had two additional loans on non-accrual status at June 30, 1998 with
principal balances totaling $245,000 (none at June 30, 1997). One-to-four family
mortgage  loans past due more than 90 days but still accruing  interest  totaled
$370,000 and $930,000 at June 30, 1998 and 1997, respectively.

Activity in the allowance for loan losses is summarized as follows for the years
ended June 30:


                                                   1998        1997         1996
                                                  -----       -----        -----
                                                         (In thousands)

Balance at beginning of year                      $ 622       $ 519        $ 474
Provision for losses                                 60         143           45
Charge-offs                                          --         (40)          --
                                                  -----       -----        -----
Balance at end of year                            $ 682       $ 622        $ 519
                                                  =====       =====        =====

4.   Office Properties and Equipment

A summary of office properties and equipment at June 30 follows:

                                                             1998        1997
                                                           -------      -------
                                                              (In thousands)

Land                                                       $   55       $    55
                                                                             
Buildings                                                    1,452          738
Furniture, fixtures and equipment                              456          335
Leasehold improvements                                         157          216
                                                           -------      -------
                                                             2,120        1,344
Less accumulated depreciation and amortization              (1,077)      (1,104)
                                                           -------      -------
         Office properties and equipment, net              $ 1,043      $   240
                                                           =======      =======



                                       28
<PAGE>

Notes to Consolidated Financial Statements (continued)


5.  Depositor Accounts

Depositor accounts at June 30 are summarized below:

                                            1998                  1997
                                     -------------------    -------------------
                                                 Average                Average
                                      Amount      Rate      Amount       Rate
                                      ------     -------    ------      -------

                                               (Dollars in thousands)

Money market demand and NOW          $ 13,196     2.85%    $ 10,989      2.85%
                                                           
Regular savings                        50,928     2.75       54,000      3.00
Club                                      710     2.75          717      3.00
                                     --------              --------
                                       64,834     2.77       65,706      2.97
                                     --------              --------
Savings certificates by remaining                          
  period to maturity:                                      
     Under one year                    58,118     5.53       53,825      5.53
     One year to under three years     11,889     6.43        9,707      6.26
     Three years and over               5,017     6.25        3,180      6.17
                                     --------              --------
                                       75,024     5.72       66,712      5.66
                                     --------              --------
           Total                     $139,858     4.35%    $132,418      4.33%
                                     ========              ========
                                                         
Savings certificates issued in denominations greater than $100,000 totaled $10.1
million and $8.2 million at June 30, 1998 and 1997, respectively.

The  following is a summary of interest  expense on  depositor  accounts for the
years ended June 30:

                                                 1998         1997         1996
                                                ------       ------       ------
                                                         (In thousands)

Money market demand and NOW                     $  329       $  285       $  303
Regular savings and club                         1,541        1,696        1,903
Savings certificates                             3,919        3,450        3,184
                                                ------       ------       ------
         Total                                  $5,789       $5,431       $5,390
                                                ======       ======       ======


The Deposit  Insurance  Funds Act of 1996 (the "Funds Act") was enacted into law
on September  30, 1996.  Among other things,  the Funds Act required  depository
institutions to pay a one-time special  assessment of 65.7 basis points on their
SAIF-assessable  deposits held on March 31, 1995, in order to  recapitalize  the
SAIF to the level required by law. The Bank's special assessment of $884,000 was
accrued as a charge to non-interest  expense for the quarter ended September 30,
1996. The assessment was paid in November 1996. 


                                       29
<PAGE>


Notes to Consolidated Financial Statements (continued)

Securities Repurchase Agreements

The following borrowings under securities repurchase agreements were outstanding
at June 30, 1998 (dollars in thousands):

<TABLE>
<S>                                                                                                   <C>
Agreement with a final maturity in January 2008, callable quarterly at the
   counterparty's option beginning in January 2003, and bearing interest at 5.42%                     $ 10,000

Agreement with a final maturity in June 2005, callable quarterly at the counterparty's
   option beginning in June 1999, and bearing interest at 5.20%                                          3,000
                                                                                                      --------
                                                                                                      $ 13,000
                                                                                                      ========
</TABLE>

The Federal  Home Loan Bank  ("FHLB") of New York is the  counterparty  in these
transactions which were  collateralized by securities  included in the Company's
portfolio  with an  amortized  cost of $13.1  million  and a fair value of $13.2
million at June 30, 1998.  During the year ended June 30, 1998,  the average and
maximum borrowings under securities  repurchase agreements were $4.6 million and
$13.0 million, respectively.  Accrued interest payable of $110,000 on securities
repurchase  agreements is included in other  liabilities  at June 30, 1998.  The
Company did not borrow under securities  repurchase  agreements during the years
ended June 30, 1997 and 1996.

7.   Income Taxes

Income tax  expense  for the years  ended  June 30  consisted  of the  following
components:

                                        1998             1997             1996
                                      -------          -------          -------
                                                   (In thousands)
Federal:
       Current                        $ 1,086          $   972          $ 1,235
       Deferred                           (39)              31              (88)
                                      -------          -------          -------
                                        1,047            1,003            1,147
                                      -------          -------          -------
State:
       Current                            418              369              510
       Deferred                           (19)            (415)             (29)
                                      -------          -------          -------
                                          399              (46)             481
                                      -------          -------          -------
Total:
       Current                          1,504            1,341            1,745
       Deferred                           (58)            (384)            (117)
                                      -------          -------          -------
                                      $ 1,446          $   957          $ 1,628
                                      =======          =======          =======

Total  income tax  expense  differs  from the amounts  computed by applying  the
applicable  statutory  Federal  income tax rate of 34% to income  before  income
taxes.  A  reconciliation  of tax expense at the statutory rate to the Company's
actual tax expense follows for the years ended June 30:

                                                    1998       1997        1996
                                                   ------     ------      ------
                                                          (In thousands)

Tax at Federal statutory rate                      $1,122     $  941      $1,309
State taxes, net of Federal tax benefit               263        (30)        317
Other, net                                             61         46           2
                                                   ------     ------      ------
Actual income tax expense                          $1,446     $  957      $1,628
                                                   ======     ======      ======


                                       30
<PAGE>

Notes to Consolidated Financial Statements (continued)

The tax  effects  of  temporary  differences  that  give  rise to the  Company's
deferred tax assets and liabilities at June 30 are as follows:

<TABLE>
<CAPTION>
                                                                     1998        1997
                                                                    -------    -------
                                                                      (In thousands)
<S>                                                                 <C>        <C>
Deferred tax assets:
       Allowance for loan losses                                    $   279    $   256
       Capital loss carryforward                                         19        428
       Loan origination fees                                             93         85
       Other deductible temporary differences                           259        237
                                                                    -------    -------
            Total gross deferred tax assets                             650      1,006
       Less valuation allowance                                         (19)      (428)
                                                                    -------    -------
            Deferred tax assets, net                                    631        578
                                                                    -------    -------
Deferred tax liabilities:
       Federal tax bad debt reserve in excess of base-year amount      (268)      (268)
       Other taxable temporary differences                               (1)        (6)
                                                                    -------    -------
            Total gross deferred tax liabilities                       (269)      (274)
                                                                    -------    -------

Net deferred tax asset                                              $   362    $   304
                                                                    =======    =======
</TABLE>

A capital loss  carryforward of  approximately  $46,000 is available at June 30,
1998 to reduce future  capital  gains,  if any,  through  December 31, 1998. The
valuation allowances for deferred tax assets at June 30, 1998 and 1997 relate to
unused capital loss  carryforwards.  The decrease in the valuation  allowance in
fiscal 1998 reflects the expiration of capital loss  carryforwards  which had no
effect on income tax expense for the year. Based on the Company's historical and
anticipated future pre-tax earnings,  management believes that it is more likely
than not that the Company's net deferred tax assets will be realized.

As a thrift  institution,  the Bank is  subject  to  special  provisions  in the
Federal  and New  York  state  tax laws  regarding  its  allowable  tax bad debt
deductions and related tax bad debt reserves. These deductions historically were
determined  using  methods  based on loss  experience or a percentage of taxable
income. Tax bad debt reserves represent the excess of allowable  deductions over
actual bad debt losses and other reserve reductions. These reserves consist of a
defined  base-year   amount,   plus  additional   amounts  ("excess   reserves")
accumulated  after the base year. SFAS No. 109 requires  recognition of deferred
tax liabilities with respect to such excess reserves,  as well as any portion of
the base-year  amount which is expected to become taxable (or  "recaptured")  in
the foreseeable future.

Certain amendments to the Federal and New York state tax laws regarding bad debt
deductions  were enacted in the quarter ended  September  30, 1996.  The Federal
amendments  eliminated  the  percentage-of-taxable-income  method  for tax years
beginning  after  December 31, 1995 and imposed a requirement  to recapture into
taxable  income (over a six-year  period) the bad debt reserves in excess of the
base-year  amounts.  The Company  previously  established,  and has continued to
maintain, a deferred tax liability with respect to such excess Federal reserves.
The New York State  amendments  redesignated  the  then-existing  state bad debt
reserve  as the  base-year  amount and  provide  for  future  base-year  reserve
additions   using  the   percentage-of-taxable-income   method.   These  changes
effectively  eliminated  the excess New York state reserve for which the Company
had recognized a deferred tax liability.  Accordingly,  the Company  reduced its
deferred tax  liability in the quarter  ended  September  30, 1996, by $238,000,
representing  a state  deferred tax benefit of $361,000  less  related  deferred
Federal taxes of $123,000.



                                       31
<PAGE>

Notes to Consolidated Financial Statements (continued)

At June 30, 1998, the Bank's  base-year  Federal and state tax bad debt reserves
were $4.5 million and $8.6 million,  respectively.  In accordance  with SFAS No.
109,  deferred tax  liabilities  have not been  recognized with respect to these
reserves,  since the Bank does not expect that these amounts will become taxable
in the  foreseeable  future.  Under the tax laws as  amended,  events that would
result in taxation of these reserves include (i) redemptions of the Bank's stock
or certain excess  distributions to the Holding Company, and (ii) failure of the
Bank to  maintain a  specified  qualifying  assets  ratio or meet  other  thrift
definition  tests for New York state tax purposes.  At June 30, 1998, the Bank's
unrecognized  deferred  tax  liabilities  with  respect to the Federal and state
base-year reserves were $1.5 million and $0.6 million, respectively.

8.   Employee Benefit and Stock Compensation Plans

Pension Benefits

All eligible  employees  are  included in a  non-contributory,  defined  benefit
pension  plan.  Benefits are based on credited  service and final  earnings,  as
defined.  The  Company's  policy  is to fund the  consulting  actuary's  maximum
recommended   contribution,   which  includes  the   amortization   of  unfunded
liabilities over 30 years from their date of establishment.

The  following  is a  reconciliation  of the  funded  status of the plan and the
amount of accrued pension cost included in other liabilities at June 30:

<TABLE>
<CAPTION>
                                                                         1998      1997
                                                                       -------    -------
                                                                         (In thousands)
<S>                                                                    <C>        <C>
Accumulated benefit obligation:
       Vested                                                          $(2,346)   $(1,947)
       Non-vested                                                          (31)       (13)
                                                                       -------    -------
            Total accumulated benefit obligation                        (2,377)    (1,960)
Effect of future salary increases                                         (252)      (265)
                                                                       -------    -------
Projected benefit obligation for service rendered to date               (2,629)    (2,225)
Plan assets at fair value, primarily cash and short-term investments     2,149      1,987
                                                                       -------    -------
Projected benefit obligation in excess of plan assets                     (480)      (238)
Unrecognized net loss (gain)                                               204        (84)
Unrecognized prior service cost                                             24         32
Unrecognized net transition obligation                                      55         69
                                                                       -------    -------
       Accrued pension cost                                            $  (197)   $  (221)
                                                                       =======    =======
</TABLE>

The unrecognized  net transition  obligation is being amortized over a period of
approximately 15 years.


                                       32
<PAGE>

Notes to Consolidated Financial Statements (continued)

The components of net pension expense are as follows for the years ended June
30:

                                                         1998     1997     1996
                                                        -----    -----    -----
                                                            (In thousands)

Service cost (benefits earned during the year)          $  66    $  58    $  60
Interest cost on projected benefit obligation             175      155      149
Actual return on plan assets                             (129)    (235)     (68)
Net amortization and deferral                             (26)     110      (59)
                                                        -----    -----    -----
       Net pension expense                              $  86    $  88    $  82
                                                        =====    =====    =====

The  discount  rate and rate of increase in future  compensation  levels used in
determining the actuarial present value of the projected benefit obligation were
7.0% and 5.0%, respectively,  at June 30, 1998; 8.0% and 6.0%, respectively,  at
June 30, 1997; and 7.0% and 5.0%,  respectively,  at June 30, 1996. The expected
long-term rate of return on plan assets was 9.0% for each year.

The  Company  entered  into  non-qualified   Supplemental  Executive  Retirement
Agreements  with  certain  executives  during  fiscal 1996 to provide  them with
supplemental  retirement  benefits in addition to the  benefits  provided by the
pension plan.  The expense  related to these  agreements  amounted to $36,000 in
both fiscal 1998 and 1997, and $29,000 in fiscal 1996. The  accumulated  benefit
obligation  was  approximately  $115,000  at June  30,  1998,  all of  which  is
unfunded.  This  amount  was  determined  using a  discount  rate of 7.0%  and a
projected salary increase rate of 5.0%.

Postretirement Health Care Benefits

Substantially  all  employees who retired prior to October 19, 1995 are eligible
for postretirement health care (medical and dental) benefits if they met certain
age and length of service  requirements.  As discussed in note 1, effective July
1, 1995,  the Company  changed its method of  accounting  for these  benefits to
adopt SFAS No. 106 and  recognize the costs on an accrual basis as such benefits
are earned by active employees.

The Company recognized the full amount of its accumulated postretirement benefit
obligation  as of July 1,  1995,  in the  amount  of  $97,000,  as a  charge  to
earnings.  The after-tax  charge of $59,000 has been reported in the fiscal 1996
consolidated  statement  of  income  as the  cumulative  effect  of a change  in
accounting principle.  The periodic expense for these benefits was insignificant
in fiscal 1998, 1997 and 1996.

The accumulated  postretirement benefit obligation was approximately $100,000 at
June 30, 1998, all of which is unfunded. This amounts was determined using (i) a
discount rate of 8.0% and (ii) an assumed rate of increase in future health care
costs of 7.5%, gradually decreasing to 5.0% in fiscal 2003 and remaining at that
level thereafter.

Savings and Investment Plan

The Company also maintains a Savings and Investment  Plan for the benefit of its
employees.  This  401(k)  plan was  frozen in  December  1995.  Since that time,
employees have not been permitted to make salary reduction  contributions to the
plan. The Company may allow salary reduction  contributions  in the future,


                                       33
<PAGE>


Notes to Consolidated Financial Statements (continued)

but  without an  employer  matching  contribution.  Plan  expense was $30,000 in
fiscal 1996 prior to freezing the plan.

Employee Stock Ownership Plan

In connection with the Conversion,  the Company established an ESOP for eligible
employees. The ESOP borrowed approximately $3.3 million from the Holding Company
and used the funds to purchase  327,980 shares of the Holding  Company's  common
stock sold in the offering. The Bank makes semi-annual contributions to the ESOP
equal to the debt service  requirements less all dividends  received by the ESOP
on unallocated  shares. The ESOP uses these contributions and dividends to repay
principal and interest over the 20-year term of the loan.

Shares  purchased by the ESOP are held in a suspense account by the plan trustee
for allocation to participants on June 30 of each year. Shares released from the
suspense  account are allocated to  participants  on the basis of their relative
compensation.  Participants  become  vested  in the  shares  allocated  to their
respective accounts over a period not to exceed five years. Any forfeited shares
are allocated to other  participants in the same proportion as contributions.  A
cumulative  total of 40,998 shares have been allocated to  participants  through
June 30, 1998.  Expense recognized in fiscal 1998, 1997 and 1996 with respect to
allocated shares amounted to $277,000, $224,000 and $95,000, respectively, based
on the average fair value of the Holding Company's common stock for each period.
The cost of the 286,982  shares which have not yet been allocated to participant
accounts  ($2.9  million  at June  30,  1998) is  reflected  as a  reduction  to
stockholders'  equity.  The fair value of these  shares was  approximately  $5.1
million at that date.

Stock Option Plan

On July 3, 1996,  stockholders approved The Peekskill Financial Corporation 1996
Stock Option Plan ("Stock  Option Plan").  Under the Stock Option Plan,  409,975
shares of  authorized  but  unissued  Holding  Company  stock are  reserved  for
issuance  upon  option  exercises.  Options  may be either  non-qualified  stock
options or incentive stock options.  Each option entitles the holder to purchase
one share of common stock at an exercise price equal to the fair market value of
the stock on the grant date.  Options have a ten-year term and vest ratably over
five years.

Effective  July 3, 1996,  initial option grants were made under the Stock Option
Plan for 296,984 shares at an exercise price of $11.875 per share.  All of these
options were outstanding at June 30, 1998, with a remaining life of 8.0 years. A
total of 75,797  options  were  exercisable  at June 30,  1998,  and there  were
112,991 reserved shares available for future option grants.

Options were granted at an exercise  price equal to the fair value of the common
stock at the grant date.  Therefore,  in accordance  with the  provisions of APB
Opinion  No. 25 related  to fixed  stock  options,  no  compensation  expense is
recognized with respect to options  granted or exercised.  Under the alternative
fair-value-based  method  defined in SFAS No.  123,  the fair value of all fixed
stock  options on the grant date would be recognized as expense over the vesting
period.  The estimated  per-share fair value of options granted in July 1996 was
$3.18,  estimated using the Black-Scholes  option-pricing model with assumptions
approximately as follows:  dividend yield of 2.75%;  expected volatility rate of
20.2%;  risk-free  interest rate of 6.26%;  and expected option life of 8 years.
Had the Company applied the  fair-value-based 


                                       34
<PAGE>


Notes to Consolidated Financial Statements (continued)

method to the options granted, it would have reported net income, basic earnings
per share and  diluted  earnings  per share of $1.7  million,  $0.64 and  $0.61,
respectively,  in fiscal 1998 ($1.7 million, $0.55 and $0.54,  respectively,  in
fiscal 1997).

Recognition and Retention Plan

On July 3, 1996,  stockholders also approved The Peekskill Financial Corporation
1996  Recognition  and Retention  Plan  ("RRP").  The purpose of this plan is to
provide  officers and  non-employee  directors of the Company with a proprietary
interest  in the  Company in a manner  designed to  encourage  their  retention.
Awards granted under this plan vest ratably over the respective  vesting periods
from the date of grant.  On July 16, 1996, the Company  completed the funding of
the RRP by purchasing 163,990 shares of common stock in the open market for $2.0
million.  RRP awards for 117,290 of these shares were made in fiscal 1997,  with
the remaining  46,700  purchased shares included in treasury stock and available
for future  awards.  Unearned  compensation  of $1.4 million was  recorded  with
respect to the shares awarded.  Subsequent amortization of that amount, which is
included in compensation and benefits  expense,  was $266,000 in fiscal 1998 and
$212,000 in fiscal 1997.

9.   Stockholders' Equity

Conversion and Stock Offering

Concurrent  with the Conversion on December 29, 1995,  the Holding  Company sold
4,099,750  shares of its common stock in a  subscription  offering at a price of
$10 per share,  for net proceeds of $40.0 million,  after  deducting  conversion
costs of approximately  $1.0 million.  The Holding Company used $20.0 million of
the net  proceeds to acquire all of the common  stock  issued by the Bank in the
Conversion.

In accordance with regulatory  requirements,  the Bank established a liquidation
account at the time of Conversion in the amount of $21.2  million,  equal to its
equity at June 30, 1995. The  liquidation  account is maintained for the benefit
of eligible  account holders who continue to maintain their accounts at the Bank
after the Conversion.  The liquidation account is reduced annually to the extent
that eligible account holders have reduced their qualifying  deposits as of each
anniversary  date.  Subsequent  increases  will not restore an eligible  account
holder's  interest  in the  liquidation  account.  In the  unlikely  event  of a
complete  liquidation of the Bank, each eligible account holder will be entitled
to  receive  a  distribution   from  the   liquidation   account  in  an  amount
proportionate  to the current  adjusted  qualifying  balances for accounts  then
held.

Earnings per Share

As  discussed  in note 1, the Company has adopted  SFAS No. 128 and restated its
EPS data for all periods to present basic EPS and diluted EPS in accordance with
the new requirements.


                                       35
<PAGE>

Notes to Consolidated Financial Statements (continued)

The following is a summary of the number of shares utilized in the Company's EPS
calculations for the years ended June 30, 1998, 1997 and 1996. For purposes of
computing basic EPS, net income applicable to common stock equaled net income
for each of the years presented.

                                                        1998     1997   1996(1)
                                                       -----    -----    -----
                                                            (In thousands)
Weighted average common shares outstanding
    for computation of basic EPS (2)                   2,714    3,101    3,776
Common-equivalent shares due to the dilutive
    effect of stock options and RRP awards (3)           111       48       --
                                                       -----    -----    -----

Weighted average common shares for
    computation of diluted EPS                         2,825    3,149    3,776
                                                       =====    =====    =====

     (1)  From the date of Conversion, December 29, 1995.

     (2)  Excludes unvested RRP awards and unallocated ESOP shares that have not
          been committed to be released.

     (3)  Computed using the treasury stock method.

Capital Distributions

The Bank may not  declare  or pay cash  dividends  on or  repurchase  any of its
shares of common  stock if the effect  thereof  would cause equity to be reduced
below applicable  regulatory  capital  requirements or the amount required to be
maintained for the liquidation account. The OTS capital distribution regulations
applicable  to  savings   institutions   that  meet  their  regulatory   capital
requirements  (such as the Bank),  generally limit dividend  payments in any one
year to the greater of (i) 100% of  year-to-date  net income plus an amount that
would reduce surplus  capital by one-half or (ii) 75% of net income for the most
recent four  quarters.  Surplus  capital is the excess of actual  capital at the
beginning  of  the  year  over  the  institution's  minimum  regulatory  capital
requirement.  The Bank paid $3.0  million of  dividends  to the Holding  Company
during fiscal 1998 and an  additional  dividend of $1.0 million in July 1998. No
dividends were paid by the Bank during fiscal 1997 and 1996.

Unlike  the  Bank,  the  Holding  Company  is  not  subject  to  OTS  regulatory
restrictions  on the  payment of  dividends  to its  stockholders.  The  Holding
Company is subject, however, to Delaware law which generally limits dividends to
an amount  equal to the excess of the net  assets of the  Holding  Company  (the
amount by which  total  assets  exceed  total  liabilities)  over its  statutory
capital,  or if there is no such  excess,  to its net  profits  for the  current
and/or immediately preceding fiscal year.

During fiscal 1997, the Company received approvals from the OTS to repurchase an
aggregate  of 926,135  common  shares for its  treasury,  in  addition to shares
purchased to fund the RRP. The  repurchases  were  authorized  in four  separate
programs,  three  involving  5% of  outstanding  shares and one  involving  10%.
Through June 30, 1997, the Holding Company repurchased 859,929 common shares, in
open market transactions,  at a total cost of $12.0 million or $13.94 per share.
The remaining  66,206 shares were  repurchased in fiscal 1998 at a total cost of
$1.2 million.

During fiscal 1998, the Company received approvals from the OTS to repurchase an
aggregate  of 304,874  common  shares for its  treasury,  or 10% of  outstanding
shares.  Through June 30, 1998, the Holding Company  repurchased  231,346 common
shares under these  programs,  in open market  transactions,  at a total cost of
$4.0 million,  or $17.39 per share.  This total cost includes  $1.35 million for
purchases  made 


                                       36
<PAGE>

Notes to Consolidated Financial Statements (continued)

but not settled at June 30, 1998, which is reflected in other liabilities in the
consolidated  balance sheet. At June 30, 1998, an additional  73,528 shares were
authorized for repurchase prior to December 1998.


Regulatory Capital Requirements

OTS  regulations  require  savings  institutions  to maintain a minimum ratio of
tangible  capital to total  adjusted  assets of 1.5%; a minimum  ratio of Tier I
(core)  capital to total  adjusted  assets of 3.0%; and a minimum ratio of total
(core and supplementary) capital to risk-weighted assets of 8.0%.

Under its prompt  corrective  action  regulations,  the OTS is  required to take
certain supervisory actions (and may take additional discretionary actions) with
respect to an  undercapitalized  institution.  Such actions  could have a direct
material  effect on the  institution's  financial  statements.  The  regulations
establish a framework for the  classification of savings  institutions into five
categories:   well  capitalized,   adequately   capitalized,   undercapitalized,
significantly undercapitalized,  and critically undercapitalized.  Generally, an
institution  is considered  well  capitalized  if it has a Tier I (core) capital
ratio of at least 5.0%; a Tier I risk-based  capital ratio of at least 6.0%; and
a total risk-based capital ratio of at least 10.0%.

The foregoing capital ratios are based in part on specific quantitative measures
of assets,  liabilities and certain  off-balance sheet items as calculated under
regulatory  accounting  practices.  Capital amounts and classifications are also
subject to  qualitative  judgments  by the OTS about  capital  components,  risk
weightings and other factors.  These capital requirements,  which are applicable
to the Bank only,  do not  consider  additional  capital at the Holding  Company
level.

Management believes that, as of June 30, 1998 and 1997, the Bank met all capital
adequacy  requirements  to which it is  subject.  Further,  the most  recent OTS
notification  categorized the Bank as a  well-capitalized  institution under the
prompt  corrective action  regulations.  There have been no conditions or events
since that notification that management believes have changed the Bank's capital
classification.


                                       37
<PAGE>


Notes to Consolidated Financial Statements (continued)

The following is a summary of the Bank's actual capital amounts and ratios as of
June 30, 1998 and 1997, compared to the OTS requirements for classification as a
well-capitalized institution and for minimum capital adequacy:

                                            For Classification
                                                    as           Minimum Capital
                               Bank Actual   Well Capitalized       Adequacy
                            ---------------  ----------------    ---------------
                            Amount    Ratio   Amount    Ratio    Amount    Ratio
                            ------    -----   ------    -----    ------    -----
                                             (Dollars in thousands)
June 30, 1998
Tangible capital            $43,493   21.8%       N/A    N/A    $ 2,992    1.5%
Tier I (core) capital        43,493   21.8    $ 9,975    5.0%     5,985    3.0
Risk-based capital:
       Tier I                43,493   87.4      2,986    6.0        N/A    N/A
       Total                 44,116   88.6      4,977   10.0      3,982    8.0


June 30, 1997
Tangible capital            $44,697   24.9%       N/A    N/A    $ 2,696    1.5%
Tier I (core) capital        44,697   24.9    $ 8,986    5.0%     5,392    3.0
Risk-based capital:
       Tier I                44,697   95.6      2,806    6.0        N/A    N/A
       Total                 45,278   96.8      4,677   10.0      3,742    8.0

10.  Commitments and Contingencies

Off-Balance Sheet Financial Instruments

The Company's financial  instruments with off-balance sheet risk were limited to
fixed-rate mortgage loan origination  commitments with total contractual amounts
of $6.6 million and $3.6 million at June 30, 1998 and 1997, respectively.  These
instruments  involve  elements of credit risk and interest rate risk in addition
to the amounts  recognized in the consolidated  balance sheets.  The contractual
amounts represent the Company's  maximum potential  exposure to credit loss, but
do not necessarily  represent future cash requirements since certain commitments
may  expire  without  being  funded.  Loan  commitments   generally  have  fixed
expiration dates or other  termination  clauses and may require payment of a fee
by the  customer.  Commitments  are  subject to the  Company's  credit  approval
process, including a case-by-case evaluation of the customer's  creditworthiness
and related collateral requirements.

FHLB of New York Advances

The Bank may  borrow  funds  from the  FHLB of New York  subject  to an  overall
limitation of 25% of total assets or $49.9  million at June 30, 1998.  Funds may
be borrowed  through a combination  of FHLB  advances and  overnight  borrowings
under a $15.5 million line of credit.  FHLB borrowings are secured by the Bank's
investment in FHLB stock and by a blanket  security  agreement.  This  agreement
requires  maintenance  of specified  levels of  qualifying  assets  (principally
securities and residential mortgage loans) not otherwise pledged.


                                       38
<PAGE>

Notes to Consolidated Financial Statements (continued)

Lease Commitments

At June 30, 1998, the Company was obligated under two non-cancellable  operating
leases for office space.  These leases contain  escalation clauses providing for
increased  rentals and renewal options.  Rent expense under operating leases was
approximately  $97,000,  $60,000 and $63,000 for the years ended June 30,  1998,
1997 and 1996,  respectively.  The future minimum lease payments under operating
leases at June 30, 1998 were  $99,000  annually  for fiscal  years 1999  through
2002; $90,000 for fiscal 2003; and an aggregate of $1.2 million for later years.

Legal Proceedings

In the normal course of business, the Company is involved in various outstanding
legal proceedings. Management has discussed the nature of these proceedings with
legal  counsel.  In the opinion of  management,  the  financial  position of the
Company will not be affected materially as a result of the outcome of such legal
proceedings.

11.  Fair Value of Financial Instruments

SFAS No. 107 requires disclosures about the fair value of financial  instruments
for  which  it is  practicable  to  estimate  fair  value,  whether  or not such
financial instruments are recognized on the balance sheet. Fair value is defined
by SFAS No. 107 as the amount at which a financial instrument could be exchanged
in a current transaction between willing parties, other than in a forced sale or
liquidation.

Quoted  market  prices are used to  estimate  fair  value when those  prices are
available.  However,  active  markets do not exist for many  types of  financial
instruments.  Consequently,  fair values for these instruments must be estimated
by  management  using  techniques  such as  discounted  cash flow  analysis  and
comparison to similar  instruments.  Estimates developed using these methods are
highly subjective and require judgments regarding  significant matters,  such as
the amount and timing of future cash flows and the  selection of discount  rates
that appropriately  reflect market and credit risks.  Changes in these judgments
often have a material effect on the fair value estimates.  Since these estimates
are made at a certain point in time, they are susceptible to material  near-term
changes.  Fair values  disclosed in accordance  with SFAS No. 107 do not reflect
any premium or discount  that could  result from the sale of a large volume of a
particular financial instrument,  nor do they reflect possible tax ramifications
or transaction costs.


                                       39
<PAGE>

Notes to Consolidated Financial Statements (continued)

The  following  is a summary  of the  carrying  amounts  and fair  values of the
Company's  financial assets and liabilities  (none of which are held for trading
purposes) at June 30:

<TABLE>
<CAPTION>
                                                         1998                 1997
                                                 --------------------  ---------------------
                                                 Carrying  Estimated   Carrying   Estimated
                                                  Amount   Fair Value   Amount    Fair Value
                                                  ------   ----------   ------    ----------
                                                               (In thousands)
<S>                                              <C>        <C>        <C>        <C>
Financial assets:
              Cash and due from banks            $  2,616   $  2,616   $    478   $    478
              Interest-bearing deposits             2,010      2,010      3,680      3,680
              Securities                          143,944    145,381    129,433    130,331
              Loans                                47,631     49,532     45,507     45,717
              FHLB stock                            1,463      1,463      1,463      1,463
              Accrued interest receivable           1,050      1,050      1,064      1,064

     Financial liabilities:
              Savings certificates                 75,024     75,386     66,712     66,640
              Other deposit accounts               64,834     64,834     65,706     65,706
              Securities repurchase agreements     13,000     12,315         --         --
              Accrued interest payable                110        110         --         --
</TABLE>

The following  paragraphs  describe the valuation methods used by the Company to
estimate the fair values of its financial instruments:

Securities

The fair values of securities were based on market prices or securities dealers'
estimated prices.

Loans

Fair  values were  estimated  by  portfolio,  for loans with  similar  financial
characteristics.  Loans were  segregated  by type,  such as  one-to-four  family
residential,  multi-family  residential,  commercial and other loans.  Each loan
category was further segmented into fixed and adjustable-rate categories, and by
performing and non-performing categories. The pricing methodology for performing
one-to-four  family  residential  mortgage  loans  was  determined  based on the
zero-coupon   yield  curve  plus  the  option  adjusted  spread  for  fixed-rate
mortgages.  The fair values for performing  loans in other portfolio  categories
were estimated by discounting the expected cash flows using current market rates
for loans with similar terms to borrowers of similar  credit  quality.  The fair
values of non-performing loans were based on management's  analysis of estimated
cash flows discounted at rates commensurate with the credit risk involved.

Deposit Liabilities

The  fair  value of  savings  certificates  represents  contractual  cash  flows
discounted  using  interest  rates  currently  offered on accounts  with similar
characteristics and remaining  maturities.  In accordance with SFAS No. 107, the
fair values of other deposit  accounts (those with no stated  maturity,  such as
savings  accounts)  are equal to the  carrying  amounts  payable on  demand.  In
accordance with SFAS No. 107, these fair values do not include the value of core
deposit  relationships  which  comprise a  significant  portion of the Company's
deposit base.  Management believes that the Company's core deposit relationships
provide a relatively  stable,  low-cost  funding  source which has a substantial
unrecognized value separate from the deposit balances.



                                       40
<PAGE>

Notes to Consolidated Financial Statements (continued)

Securities Repurchase Agreements

Fair value  represents  contractual cash flows discounted using current interest
rates  available for  repurchase  agreements  with similar  characteristics  and
remaining terms.

Other Financial Instruments

The other  financial  assets and  liabilities  shown in the preceding table have
fair values  which  approximate  the  respective  carrying  amounts  because the
instruments  are  payable on demand or have  short-term  maturities  and present
relatively  low credit  risk and  interest  rate risk.  Fair  values of the loan
origination commitments described in note 10 were estimated based on an analysis
of the  interest  rates  and  fees  currently  charged  to  enter  into  similar
transactions,  considering  the  remaining  terms  of the  instruments  and  the
creditworthiness of the potential borrowers. At June 30, 1998 and 1997, the fair
values of these financial instruments  approximated the related carrying amounts
which were not significant.

12.  Recent Accounting Pronouncements

In June 1997, the Financial  Accounting Standards Board ("FASB") issued SFAS No.
130,  "Reporting  Comprehensive  Income,"  which  establishes  standards for the
reporting and display of comprehensive  income (and its components) in financial
statements.  The standard does not, however, specify when to recognize or how to
measure items that make up comprehensive income. Comprehensive income represents
net income and certain  amounts  reported  directly  in equity,  such as the net
unrealized  gain or loss on  available-for-sale  securities.  While SFAS No. 130
does not require a specific reporting format, it does require that an enterprise
display in the financial  statements an amount  representing total comprehensive
income for the period.  SFAS No. 130 is  effective  for fiscal  years  beginning
after  December  15,  1997 and,  accordingly,  will be adopted by the Company in
fiscal 1999.  Had SFAS No. 130 applied to the Company in fiscal  1998,  1997 and
1996, the Company would have reported  comprehensive  income substantially equal
to its reported net income for each of those years.

In June 1997, the FASB also issued SFAS No. 131,  "Disclosures about Segments of
an  Enterprise  and  Related  Information."  Among  other  things,  SFAS No. 131
requires  public  companies  to report (i)  certain  financial  and  descriptive
information  about its  reportable  operating  segments (as  defined),  and (ii)
certain  enterprise-wide  financial  information  about  products and  services,
geographic areas and major customers. The required segment financial disclosures
include a measure of profit or loss, certain specific revenue and expense items,
and total assets. SFAS No. 131 is effective for periods beginning after December
15,  1997 and,  accordingly,  will be  adopted by the  Company  in fiscal  1999.
Management  does not expect that SFAS No. 131 will have a significant  impact on
the Company's financial reporting.

In February 1998, the FASB issued SFAS No. 132,  "Employers'  Disclosures  about
Pensions and Other  Postretirement  Benefits," which standardizes the disclosure
requirements for these benefits;  requires additional  information on changes in
the benefit  obligations and fair values of plan assets;  and eliminates certain
present  disclosure  requirements.  SFAS No. 132 is  effective  for fiscal years
beginning  after  December  15,  1997 and,  accordingly,  will be adopted by the
Company in fiscal  1999.  Management  does not expect  that this  standard  will
significantly affect the Company's financial reporting.



                                       41
<PAGE>

Notes to Consolidated Financial Statements (continued)

In June  1998,  the  FASB  issued  SFAS  No.  133,  "Accounting  for  Derivative
Instruments and Hedging Activities," which requires that an entity recognize all
derivatives  as either assets or liabilities in the balance sheet at fair value.
If certain conditions are met, a derivative may be specifically  designated as a
fair value hedge,  a cash flow hedge,  or a foreign  currency  hedge. A specific
accounting  treatment  applies to each type of hedge.  Entities  may  reclassify
securities from the held-to-maturity category to the available-for-sale category
at the time of adopting  SFAS No. 133.  SFAS No. 133 is effective for all fiscal
quarters of fiscal years  beginning after June 15, 1999 and,  accordingly,  will
apply to the Company  beginning on July 1, 1999.  The Company plans to adopt the
standard at that time and does not  presently  intend to  reclassify  securities
between  categories.  The Company does not presently  engage in derivatives  and
hedging activities covered by the new standard and, accordingly, SFAS No. 133 is
not expected to have a material impact on the Company's financial statements.



                                       42
<PAGE>


Notes to Consolidated Financial Statements (continued)

13.  Parent Company Condensed Financial Information

Set  forth  below  are the  condensed  balance  sheets  of  Peekskill  Financial
Corporation as of June 30,1998 and 1997, and its condensed  statements of income
and cash flows for the periods ended June 30, 1998, 1997 and 1996:

                                                                 June 30,
                                                           ---------------------
                                                            1998           1997
                                                           -------       -------
Condensed Balance Sheets                                       (In thousands)
Assets:
     Cash                                                  $    39       $   172
     Interest-bearing deposits                                 810         2,180
     Investment in subsidiary                               43,491        44,687
     Other assets                                              345            17
                                                           -------       -------
          Total                                            $44,685       $47,056
                                                           =======       =======

Liabilities and Stockholders' Equity:
     Liabilities                                           $ 1,479       $    90
     Stockholders' equity                                   43,206        46,966
                                                           -------       -------
          Total                                            $44,685       $47,056
                                                           =======       =======

<TABLE>
<CAPTION>
                                                                                     Period ended June 30,
                                                                                 -----------------------------
                                                                                  1998       1997       1996*
                                                                                 -------    -------    -------
                                                                                         (In thousands)
<S>                                                                              <C>        <C>        <C>    
Condensed Statements of Income
Dividends received from subsidiary                                               $ 3,000    $    --    $    --
Interest income                                                                      271        611        534
Non-interest expense                                                                (127)      (187)       (85)
                                                                                 -------    -------    -------
       Income before income tax expense and effect of subsidiary earnings          3,144        424        449
Income tax expense                                                                   (87)      (195)      (215)
                                                                                 -------    -------    -------
       Income before effect of subsidiary earnings                                 3,057        229        234
Effect of subsidiary earnings:
       Excess of dividends over current earnings of subsidiary                    (1,203)        --         --
       Equity in undistributed earnings of subsidiary                                 --      1,583      1,140
                                                                                 -------    -------    -------
            Net income                                                           $ 1,854    $ 1,812    $ 1,374
                                                                                 =======    =======    =======
</TABLE>

*  From the date of Conversion, December 29, 1995.




                                       43
<PAGE>


Notes to Consolidated Financial Statements (continued)

<TABLE>
<CAPTION>
                                                                                    Period ended June 30,
                                                                              --------------------------------
                                                                                1998        1997        1996*
                                                                              --------    --------    --------
                                                                                       (In thousands)
Condensed Statements of Cash Flows                              
<S>                                                                           <C>         <C>         <C>     
Cash flows from operating activities:
       Net income                                                             $  1,854    $  1,812    $  1,374
       Adjustments to reconcile net income to net cash provided by
          operating activities:
             Excess of dividends over current earnings of subsidiary             1,203          --          --
             Equity in undistributed earnings of subsidiary                         --      (1,583)     (1,140)
             Other adjustments, net                                                291         461         148
                                                                              --------    --------    --------
                 Net cash provided by operating activities                       3,348         690         382
                                                                              --------    --------    --------

Cash flows from investing activities:
       Purchase of subsidiary's common stock                                        --          --     (20,000)
                                                                              --------    --------    --------

Cash flows from financing activities:
       Treasury stock purchases                                                 (3,837)    (12,543)         --
       Purchase of shares to fund current-year RRP awards                           --      (1,400)         --
       Net proceeds from issuance of common stock, exclusive of ESOP shares         --          --      36,720
       Dividends paid                                                           (1,014)     (1,128)       (369)
                                                                              --------    --------    --------
                 Net cash (used in) provided by financing activities            (4,851)    (15,071)     36,351
                                                                              --------    --------    --------

Net (decrease) increase in cash and cash equivalents                            (1,503)    (14,381)     16,733
Cash and cash equivalents at beginning of period                                 2,352      16,733          --
                                                                              --------    --------    --------
Cash and cash equivalents at end of period                                    $    849    $  2,352    $ 16,733
                                                                              ========    ========    ========

Supplemental information:
       Increase in liability for treasury stock purchased, not yet settled    $  1,350    $     --    $     --
                                                                              ========    ========    ========
</TABLE>


*  From the date of Conversion, December 29, 1995.


                                       44
<PAGE>


Notes to Consolidated Financial Statements (continued)

14.  Selected Quarterly Financial Data (Unaudited)

     Summarized  quarterly  financial  data  for  fiscal  1998 and 1997 is shown
below:

<TABLE>
<CAPTION>
                                                                                     Three Months Ended
                                                               -------------------------------------------------------------
                                                               September 30       December 31        March 31        June 30
                                                               ------------       -----------        --------        -------
                                                                            (In thousands, except per share data)
<S>                                                               <C>               <C>              <C>              <C>    
Fiscal 1998
Interest and dividend income                                      $ 3,095           $ 3,059          $ 3,220          $ 3,269
Interest expense                                                    1,446             1,430            1,540            1,618
                                                                  -------           -------          -------          -------
       Net interest income                                          1,649             1,629            1,680            1,651
Provision for loan losses                                              15                15               15               15
Non-interest income                                                    57                55               54               59
Non-interest expense                                                  826               852              936              860
                                                                  -------           -------          -------          -------
       Income before income tax expense                               865               817              783              835
Income tax expense                                                    370               356              346              374
                                                                  -------           -------          -------          -------
       Net income                                                 $   495           $   461          $   437          $   461
                                                                  =======           =======          =======          =======
       Earnings per share:
            Basic                                                 $  0.18           $  0.17          $  0.16          $  0.18
            Diluted                                                  0.17              0.16             0.16             0.17
                                                                  =======           =======          =======          =======

Fiscal 1997
Interest and dividend income                                      $ 3,056           $ 3,121          $ 3,045          $ 3,087
Interest expense                                                    1,322             1,339            1,361            1,409
                                                                  -------           -------          -------          -------
       Net interest income                                          1,734             1,782            1,684            1,678
Provision for loan losses                                              98                15               15               15
Non-interest income                                                    60                64               52               60
Non-interest expense (1)                                            1,720               846              812              824
                                                                  -------           -------          -------          -------
       (Loss) income before income tax (benefit) expense              (24)              985              909              899
Income tax (benefit) expense (1)                                     (233)              419              385              386
                                                                  -------           -------          -------          -------
       Net income                                                 $   209           $   566          $   524          $   513
                                                                  =======           =======          =======          =======
       Earnings per share:
            Basic                                                 $  0.06           $  0.17          $  0.18          $  0.18
            Diluted                                                  0.06              0.17             0.18             0.18
                                                                  =======           =======          =======          =======
</TABLE>

(1)  For the quarter ended September 30, non-interest  expense includes the SAIF
     special  assessment  of $884,000 and income tax benefit  includes  $238,000
     attributable to a change in state tax law. See notes 5 and 7.


                                       45
<PAGE>

Corporate Information

Directors
Eldorus Maynard, Chairman of the Board
Dominick Bertoline
Edward H. Dwyer
Robert E. Flower
William J. LaCalamito
John A. McGurty, Jr.

Officers
Eldorus Maynard
Chairman of the Board and Chief Executive Officer

William J. LaCalamito
President and Chief Operating Officer

Scott D. Nogles
Vice President of Finance

Corporate Offices
Peekskill Financial Corporation
1019 Park Street
Peekskill, NY  10566
(914) 737-2777

Annual Meeting

The annual meeting of stockholders will be held on October 21, 1998 at 3:30 p.m.
at the Company's offices at 1019 Park Street, Peekskill, New York.

Form 10-K

For the 1998 fiscal year,  Peekskill  Financial  Corporation will file an Annual
Report on Form 10-K with the  Securities and Exchange  Commission.  Stockholders
wishing a copy may obtain one by writing to:

      William J. LaCalamito
      Secretary
      Peekskill Financial Corporation
      1019 Park Street
      Peekskill, NY  10566

Transfer Agent and Registrar
Registrar and Transfer Company
10 Commerce Drive
Cranford, NJ  07016

Independent Auditors
KPMG Peat Marwick LLP
3001 Summer Street
Stamford, CT  06905


                                       46
<PAGE>

Corporate Information

General Counsel
Carl Olson
1019 Park Street
Peekskill, NY  10566

Special Counsel
Silver, Freedman & Taff, LLP
1100 New York Avenue, NW
Washington, DC  20005

Common Stock

The common  stock of  Peekskill  Financial  Corporation  is traded on the NASDAQ
Stock Market under the symbol "PEEK." The approximate number of stockholders was
714 at June 30, 1998.

The cash dividends declared by the Company,  and the high and low sales price of
the Company's common stock in the Over-the-Counter market of the NASDAQ National
Market System were as follows for the quarters indicated:

<TABLE>
<CAPTION>
                                                                            Closing Sales Prices
                                 Cash                     -----------------------------------------------------------
                               Dividends                                                                       End of
  Quarter ended                 Declared                  High                      Low                        Period
  -------------                 --------                  ----                      ---                        ------
<S>                            <C>                      <C>                       <C>                         <C>
  June 30, 1998                $  0.09                  $18.063                   $16.625                     $17.875
  March 31, 1998                  0.09                   17.750                    16.000                      17.375
December 31, 1997                 0.09                   18.250                    16.500                      16.750
September 30, 1997                0.09                   18.250                    15.125                      16.750

  June 30, 1997                   0.09                   15.250                    13.375                      15.000
  March 31, 1997                  0.09                   15.500                    13.500                      13.875
December 31, 1996                 0.09                   14.875                    13.250                      14.250
September 30, 1996                0.09                   14.000                    11.250                      13.750
</TABLE>

These  quotations  represent  prices  between  dealers and do not include retail
markup,  markdown  or  commission.  They  do not  necessarily  represent  actual
transactions.


                                       47
<PAGE>