<PAGE>
 
                    
                    U.S. SECURITIES AND EXCHANGE COMMISSION
                            Washington, D.C.  20549
                             --------------------
                                  FORM 10-KSB

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

For the fiscal year ended December 31, 1996

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

For the transition period from ________________ to ________________
 
                          Commission File No. 0-25750
 
                             PENFED BANCORP, INC.
---------------------------------------------------------------------
                (NAME OF SMALL BUSINESS ISSUER IN ITS CHARTER)
 
               Delaware                                    61-1275478
             ------------                               ---------------
   (STATE OR OTHER JURISDICTION                        (I.R.S. EMPLOYER
 OF INCORPORATION OR ORGANIZATION)                    IDENTIFICATION NO.)

215 W. Shelby Street, Falmouth, Kentucky                 41040-1238
-----------------------------------------                ----------
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)                 (ZIP CODE)

        ISSUER'S TELEPHONE NUMBER, INCLUDING AREA CODE:  (606) 654-6961
                                                         --------------

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

                                Not Applicable

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

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

Check whether the issuer: (1) filed all reports required to be filed by Section
13 or 15(d) of the Securities Exchange Act of 1934 during the past 12 months (or
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       No   X
    ----     -----

Check if no disclosure of delinquent filers in response to Item 405 of
Regulation S-B is not contained in this form, and no disclosure will 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-KSB
or any amendment to this Form 10-KSB.  [X]

Issuer's revenues for the fiscal year ended December 31, 1996:  $2,310,674

As of September 30, 1997, the aggregate market value of the 294,378 shares of
Common Stock of the registrant issued and outstanding held by non-affiliates on
such date was approximately $3,826,914 based on recent sale prices.  For
purposes of this calculation, it is assumed that directors, officers and
beneficial owners of more than 5% of the registrant's outstanding voting stock
are affiliates.

Number of shares of Common Stock outstanding as of December 31, 1996: 306,387

Transitional Small Business Disclosure Format   Yes            No   X
                                                    -------       ------
<PAGE>
 
                                 PART I

ITEM 1.  DESCRIPTION OF BUSINESS.
-------------------------------- 

GENERAL

     PENFED BANCORP, INC.  Penfed Bancorp, Inc. (the "Company") was incorporated
under the laws of the State of Delaware in November 1994.  On March 23, 1995,
Pendleton Federal Savings Bank ("Pendleton Federal" or the "Bank") converted
from mutual to stock form and reorganized into the holding company form of
ownership as a wholly owned subsidiary of the Company.  The Company is primarily
engaged in the business of directing, planning and coordinating the business
activities of the Bank.  The Company does not currently maintain offices
separate from those of the Bank or employ any persons other than its officers,
who are not separately compensated for such service.

     The Company's main office and telephone number are the same as Pendleton
Federal's main office (see below).  At December 31, 1996, the Company had total
assets of $30.5 million and retained earnings of $5.0 million.

     PENDLETON FEDERAL SAVINGS BANK.  Pendleton Federal opened for business in
1913.  The Bank is principally engaged in the business of accepting deposits
from the general public through a variety of deposit programs and investing
these funds by originating loans secured primarily by one- to four-family
residential properties located in its market area, construction loans and
savings account loans.  Pendleton Federal's business strategy is to operate a
well capitalized, profitable community savings association dedicated to
financing home ownership in its market area and providing quality service to its
customers.  At December 31, 1996, the Bank had deposits of $23.1 million and net
loans receivable of $27.0 million.

     Pendleton Federal's executive offices are located at 215 W. Shelby Street,
Falmouth, Kentucky 41040-1238, and its telephone number is (606) 654-6961.

IMPACT OF FLOODING

     On March 2, 1997 a severe storm created flooding on the Licking River in
Northern Kentucky.  As a result, the Company's wholly owned subsidiary, the
Savings Bank, experienced significant property damage.  The sixty-one inches of
water in the Savings Bank's office in Falmouth, Kentucky severely damaged the
internal fixtures of the Savings Bank and numerous financial documents.
Collateral properties on several loans held by the Savings Bank were also
damaged.

     The Savings Bank's office and many of the documents have been
reconstructed.  During the first quarter of fiscal year 1997 the Savings Bank
recognized an extraordinary loss of $167,329, which is net of a related income
tax benefit of $86,200, as a result of uninsured flood loss.  Management
estimates that less than 10% of the loans in the Savings Bank's portfolio were
adversely affected by the flood.  Management attributes this to the geographic
diversity of the Savings Bank's loans, in that an increasing percentage of the
Savings Bank's loans have been collateralized by properties located outside of
Pendleton County in recent years.  On the basis of management's assessment of
all information currently available to it regarding the Savings Bank's loan
portfolio, including the loans affected by the flood, the Company added $25,937
to the loan loss allowance during the quarter ended March 31, 1997.  Management
does not believe that the impact of the flood on the Company's continuing
financial condition or results of operations will be material.

MARKET AREA

     The Bank considers its primary market area to consist of Pendleton County,
Kentucky and surrounding counties within a radius of approximately 75 miles.
These counties incorporate urban, suburban and rural areas.  The economy of this
area has been relatively stable in recent years.  Pendleton County serves as a
"bedroom" community for residents commuting north to Cincinnati, Ohio and south
to the Lexington, Kentucky area.  The relative diversity of industries and other
sources of employment in these areas has had a stabilizing influence on the
economy of the Bank's market area.

                                       2
<PAGE>
 
LENDING ACTIVITIES

     General.   Pendleton Federal's primary lending activity is the origination
of conventional mortgage loans for the purpose of constructing, purchasing or
refinancing one- to four-family residential properties in its primary market
area.  The Bank also originates loans secured by savings accounts at the Bank.

     Savings institutions generally are subject to the lending limits applicable
to national banks.  With certain limited exceptions, the maximum amount that a
savings institution or a national bank may lend to any borrower (including
certain related entities of the borrower) at one time may not exceed 15% of the
unimpaired capital and surplus of the institution, plus an additional 10% of
unimpaired capital and surplus for loans fully secured by readily marketable
collateral.  Savings institutions are additionally authorized to make loans to
one borrower, for any purpose, in an amount not to exceed $500,000 or, by order
of the Director of OTS, in an amount not to exceed the lesser of $30,000,000 or
30% of unimpaired capital and surplus to develop residential housing, provided:
(i) the purchase price of each single-family dwelling in the development does
not exceed $500,000; (ii) the savings institution is in compliance with its
fully phased-in capital requirements; (iii) the loans comply with applicable
loan-to-value requirements; and (iv) the aggregate amount of loans made under
this authority does not exceed 15% of unimpaired capital and surplus.

     Loan Portfolio Composition.  The following table sets forth selected data
relating to the composition of the Bank's loan portfolio by type of loan at the
dates indicated.  At December 31, 1996, the Bank had no concentrations of loans
exceeding 10% of total loans that are not otherwise disclosed below.

<TABLE>
<CAPTION>
 
                                            At December 31,
                             ----------------------------------------------
                                      1995                      1996
                             -------------------------  -------------------
                                Amount          %          Amount       %
                             --------------  ---------  ------------  -----
<S>                          <C>             <C>        <C>           <C>
Real estate loans:
 Construction..............  $ 1,790,360          7.2%  $ 3,267,700   11.5%
 One- to four-family
  residential..............   20,667,143         82.8    21,817,915   76.9
 Agricultural (farm).......    1,435,587          5.8     1,838,743    6.5
 Multi-family residential..      604,587          2.4       574,375    2.0
 Non-residential property
  (excluding land).........      295,909          1.2       553,298    2.0
 
Consumer loans:
 Savings account loans.....      142,688          0.6       123,705    0.5
 Secured loans.............           --           --       175,160    0.6
                             -----------        ------  -----------  ------
                              24,936,274        100.0%   28,350,896  100.0%
                             ===========                ===========
 
Less:
 Loans in process..........      490,427                  1,238,610
 Loan loss reserve.........      106,064                    124,063
                             -----------                -----------
   Total...................  $24,339,783                $26,988,223
                             ===========                ===========
</TABLE>

                                       3

<PAGE>
 
     Loan Maturity Schedule.  The following table sets forth certain information
at December 31, 1996 regarding the dollar amount of loans maturing in the Bank's
portfolio based on their contractual terms to maturity, including scheduled
repayments of principal.  Demand loans, loans having no stated schedule of
repayments and no stated maturity, and overdrafts are reported as due in one
year or less.
<TABLE>
<CAPTION>
 
                                              Due After
                            Due during the  1 year through  Due after 5
                             year ending    5 years after   years after
                             December 31,    December 31,   December 31,
                                 1997            1996           1996       Total
                            --------------  --------------  ------------  -------
                                                   (In thousands)
<S>                         <C>             <C>             <C>           <C>
Real estate mortgage......          $   26           $ 591       $21,201  $21,818
Real estate construction..           3,268              --            --    3,268
Agricultural real estate..              12              50         1,777    1,839
Multifamily residential...              --              --           574      574
Non-residential property
 (excluding land).........              --              --           553      553
Savings accounts..........              68              56            --      124
Secured loans.............              35             140            --      175
                                    ------           -----       -------  -------
  Total...................          $3,409           $ 837       $24,105  $28,351
                                    ======           =====       =======  =======
--------------------
</TABLE>
(1)  Demand loans, loans having no stated schedule of repayments and no stated
     maturity and overdrafts are reported as due in one year or less.

     The next table sets forth at December 31, 1996, the dollar amount of all
loans due one year or more after December 31, 1996 which have predetermined
interest rates and have floating or adjustable interest rates.
<TABLE>
<CAPTION>
 
                                           Predetermined    Floating or
                                               Rate       Adjustable Rates
                                           -------------  ----------------
                                                  (In thousands)
<S>                                        <C>            <C>
 
          Real estate mortgage......           $283           $21,509
          Agricultural real estate..             --             1,827
          Multi-family residential..             --               574
          Non-residential property..             --               553
          Savings account...........             --                56
          Secured loans.............             --               140
                                               ----           -------
              Total.................           $283           $24,659
                                               ====           =======
</TABLE>

     Scheduled contractual principal repayments of loans do not necessarily
reflect the actual life of such assets.  The average life of long-term loans is
substantially less than their contractual terms, due to prepayments.  In
addition, "due-on-sale" clauses in mortgage loans generally give Pendleton
Federal the right to declare a loan due and payable in the event, among other
things, that a borrower sells the real property subject to the mortgage and the
loan is not repaid.

     One- to Four-Family Real Estate Loans.  The primary emphasis of the Bank's
lending activity is the origination of loans secured by first mortgages on one-
to four-family residential properties.   At December 31, 1996, $21.8 million, or
76.9%, of the Bank's gross loan portfolio consisted of loans secured by one- to
four-family residential real properties primarily located in the Bank's market
area.

     Pendleton Federal has sought to build an interest rate-sensitive loan
portfolio by originating adjustable-rate mortgage loans (i.e., ARMs).  As of
December 31, 1996, approximately 91.4% of the mortgage loan portfolio was
comprised of ARM loans.  Pendleton Federal's ARM loans have an interest rate
that adjusts periodically to the index 

                                       4
<PAGE>
 
 
value of the National Average Contract Interest Rate for Major Lenders on the
Purchase of Previously Occupied Homes. The interest rates on these mortgage
loans are adjustable once a year with a limitation on upward or downward
adjustments of two percentage points per adjustment, and a lifetime cap of five
or six percentage points.

     The retention of ARMs in the portfolio helps reduce Pendleton Federal's
exposure to increases in interest rates.  However, there are unquantifiable
credit risks resulting from potential increased costs to the borrower as a
result of repricing of ARMs.  It is possible that during periods of rising
interest rates, the risk of default on ARMs may increase due to the upward
adjustment of interest costs to the borrower.  Although ARMs allow Pendleton
Federal to increase the sensitivity of its asset base to changes in interest
rates, the extent of this interest sensitivity is limited by the periodic and
lifetime interest rate ceiling contained in ARM contracts.  Accordingly, there
can be no assurance that yields on Pendleton Federal's ARM's will adjust
sufficiently to compensate for increases in its cost of funds.

     To satisfy customer demand for long term, fixed rate mortgage loans, the
Bank originates fixed rate mortgage loans for sale in the secondary mortgage
market. The Bank retains the servicing on such loans.

     Generally, Pendleton Federal originates residential mortgage loans with
loan-to-value ratios of 80% or less.  At December 31, 1996, one- to four-family
real estate loans totaled $21.8 million, or 76.9%, of the Bank's loan portfolio.

     Construction Loans.  Pendleton Federal engages in construction lending
involving loans to qualified borrowers for construction of one- to four-family
residential properties.  Such loans converting to permanent financing upon
completion of construction.  These properties are primarily located in the
Bank's market area.  At December 31, 1996, the Bank's loan portfolio included
$3.3 million of loans secured by properties under construction.  All
construction loans are secured by a first lien on the property under
construction.  Loan proceeds are disbursed in increments as construction
progresses and as inspections warrant.  Construction/permanent loans generally
have adjustable rates and are underwritten in accordance with the same terms and
requirements as the Bank's permanent mortgages, except the loans generally
provide for disbursement in stages during a construction period of up to six
months, during which period the borrower is not required to make monthly
payments.  Interest is paid monthly.  Monthly principal and interest payments
commence when the loan is converted to permanent financing.  Borrowers must
satisfy all credit requirements which would apply to the Bank's permanent
mortgage loan financing for the subject property.

     Construction financing generally is considered to involve a higher degree
of risk of loss than long-term financing on improved, occupied real estate.
Risk of loss on a construction loan is dependent largely upon the accuracy of
the initial estimate of the property's value at completion of construction or
development and the estimated cost (including interest) of construction.  During
the construction phase, a number of factors could result in delays and cost
overruns.  If the estimate of construction costs proves to be inaccurate, the
Bank may be required to advance funds beyond the amount originally committed to
permit completion of the development.  If the estimate of value proves to be
inaccurate, the Bank may be confronted, at or prior to the maturity of the loan,
with collateral having a value which is insufficient to assure full repayment.
The Bank has sought to minimize this risk by limiting construction lending to
qualified borrowers (i.e., borrowers who satisfy all credit requirements and
whose loans satisfy all other underwriting standards which would apply to the
Bank's permanent mortgage loan financing for the subject property) in the Bank's
market area and by limiting the aggregate amount of outstanding construction
loans.  At December 31, 1996, construction loans totaled $3.3 million, or 11.5%,
of the Bank's loan portfolio.

     Savings Account Loans.  The Bank makes savings account loans for terms
corresponding with the term of the underlying certificate account for up to 90%
of the face amount of the certificate.  The interest rate charged on these loans
is normally two percentage points above the rate paid on the certificate account
and the account must be pledged as collateral to secure the loan.  These loans
are payable on demand.  At December 31, 1996, savings account loans totaled
approximately $124,000, or 0.5%, of the Bank's loan portfolio.


                                       5
<PAGE>
 
 
     Agricultural Real Estate (Farm) Loans.  The Bank has also made loans for
the purchase of agriculture-related real estate, and made 16 of these loans
during fiscal year 1996.  All of the Bank's agricultural real estate loans are
performing in accordance with their terms.

     In originating farm loans, the Bank considers, among other things, the debt
service coverage of the borrower's cash flow, the appraised value of the
underlying property and the Bank's experience with and knowledge of the
borrower.  At December 31, 1996, agricultural real estate loans totaled
approximately $1,839,000, or 6.5%, of the Bank's loan portfolio.

     Agricultural real estate loans are generally larger and involve a greater
degree of risk than single-family residential mortgage loans.  Payments on an
agricultural real estate loan depend to a large degree on the results of
operations of the related farm, and repayment is therefore subject to adverse
economic or weather conditions as well as market prices for agricultural
products, which can be highly volatile.

     Other Loans.  In the past, Pendleton Federal actively originated multi-
family residential loans, and at December 31, 1996, the Bank had approximately
$574,000 of such loans in its portfolio.  Such loans were generally made to
individuals and are secured by first mortgages on small apartment buildings.
Currently, the Bank does not actively solicit such loans, and management
believes that any such loans would be originated by the Bank only as an
accommodation to stable customers who request them.

     During 1996, the Bank originated three loans secured by nonresidential
properties located in the Bank's market area.  One of these loans was secured by
a church and the other two by retail stores.  The aggregate balance of these
loans was approximately $553,000 at December 31, 1996.  All are performing in
accordance with their terms.

     Loans secured by non-residential properties generally involve a greater
degree of risk than single-family mortgage loans due to the concentration of
principal in a limited number of loans and borrowers, the effects of general
economic conditions on income producing properties and the increased difficulty
of evaluating and monitoring these types of loans.  Further, the repayment of
loans secured by non-residential property is typically dependent upon the
successful operation or management of the related real estate project.  If the
cash flow from the project is reduced, the borrower's ability to repay the loan
may be impaired.

     Consumer Loans.  During 1996, the Bank began originating consumer loans,
primarily including small unsecured and automobile loans.  The aggregate balance
of these loans was approximately $175,000 at December 31, 1996.

     Loan Solicitation and Processing.  Loan originations are derived from a
number of sources, including walk-in customers and referrals by realtors,
depositors and borrowers.  Upon receipt of a loan application from a prospective
borrower, a credit report and verifications are ordered to verify specific
information relating to the loan applicant's employment, income and credit
standing.  An appraisal of the real estate intended to secure the proposed loan
is undertaken by an independent appraiser approved by the Bank.

     All mortgage loans in amounts exceeding $20,000 are required to be
presented to the Board of Directors for final approval.  The president has the
authority to approve loans in amounts under $20,000 if the Bank already has the
first mortgage on the collateral property; these loans are required to be
subsequently ratified by the Board.  Loan applicants are promptly notified of
the decision of the Bank.  Interest rates on approved loans are subject to
change if the loan is not funded within 30 days after approval.  It has been
management's experience that substantially all approved loans are funded.  Fire
and casualty insurance, as well as flood insurance, are required for all loans
as appropriate, and a title opinion is required for loans secured by real
estate.


                                       6
<PAGE>
 
 
     Originations, Purchases and Sales of Loans .  The following table sets
forth certain information with respect to originations of loans during the
periods indicated.  During such periods, no loans were purchased.
<TABLE>
<CAPTION>
 
                                          Year Ended December 31,
                                          -----------------------
                                             1995        1996
                                          ----------  -----------
<S>                                       <C>         <C>
 
Real estate loans:
  Construction..........................  $3,424,360  $ 5,162,000
  One- to four-family...................   4,654,043    7,579,040
  Agricultural real estate..............     510,600      523,000
  Savings account loans.................     175,001       70,560
  Multifamily residential...............     155,000           --
  Non-residential property  (excluding
      loans)............................     372,500      508,600
  Secured loans.........................          --      199,800
                                          ----------  -----------
             Total loans originated.....  $9,291,504  $14,043,000
                                          ==========  ===========
 
Loans sold:
 Whole loans............................  $3,246,350  $ 3,266,663
 Participation loans....................          --           --
                                          ----------  -----------
            Total loans sold(1).........  $3,246,350  $ 3,266,663
                                          ==========  ===========
</TABLE> 
---------
(1)  Represents fixed-rate single-family loans originated by the Bank for sale
     in the secondary mortgage market.

     Interest Rates and Loan Fees.  Interest rates charged by the Bank on
mortgage loans are primarily determined by competitive loan rates offered in its
market area.  Mortgage loan rates reflect factors such as general interest rate
levels, the supply of money available to the savings industry and the demand for
such loans.  These factors are in turn affected by general economic conditions,
the monetary policies of the Federal government, including the Board of
Governors of the Federal Reserve System (the "Federal Reserve Board"), the
general supply of money in the economy, tax policies and governmental budget
matters.

     In addition to the interest earned on loans, the Bank receives fees in
connection with loan commitments and originations, loan modifications, late
payments and fees for miscellaneous services related to its loans.  The Bank
charges an origination fee for its adjustable-rate mortgage loans and fixed rate
mortgage loans.

     Further, management plans to continue to originate fixed rate loans for
sale in the secondary mortgage market and believes that servicing fee income
will become an increasingly important source of funds as the Bank's involvement
in fixed rate loan sales grows.

     Asset Classification and Allowance for Loan Losses.  Federal regulations
require savings associations to review their assets on a regular basis and to
classify them as "substandard," "doubtful" or "loss," if warranted.  Assets
classified as substandard or doubtful require the institution to establish
general allowances for loan losses.  If an asset or portion thereof is
classified loss, the insured institution must either establish specified
allowances for loan losses in the amount of 100% of the portion of the asset
classified loss, or charge off such amount.  An asset which does not currently
warrant classification but which possesses weaknesses or deficiencies deserving
close attention is required to be designated as "special mention."  Currently,
general loss allowances established to cover possible losses related to assets
classified substandard or doubtful may be included in determining an
institution's regulatory capital, while specific valuation allowances for loan
losses do not qualify as regulatory capital.  See "Regulation -- Regulation of
the Bank -- Regulatory Capital Requirements."  OTS examiners may disagree with
the insured institution's classifications and amounts reserved.  If an
institution does not agree with an examiner's classification of an asset, it may
appeal this determination to the OTS.  Management of the Bank reviews assets on
a monthly basis, and at the end of each quarter prepares an asset classification
listing in conformity with the OTS regulations, which is reviewed by the Board
of Directors.  At December 


                                       7
<PAGE>
 
 
31, 1996 the Bank had approximately $116,000 and $550,000 in assets classified
as special mention and substandard, respectively, and no loans classified as
doubtful or loss. All loans classified as substandard at December 31, 1996 were
secured by single-family residences.

     In originating loans, the Bank recognizes that credit losses will be
experienced and that the risk of loss will vary with, among other things, the
type of loan being made, the creditworthiness of the borrower over the term of
the loan, general economic conditions and, in the case of a secured loan, the
quality of the security for the loan.  It is management's policy to maintain an
adequate allowance for loan losses based on, among other things, the Bank's and
the industry's historical loan loss experience, evaluation of economic
conditions and regular reviews of delinquencies and loan portfolio quality.  The
Bank increases its allowance for loan losses by charging provisions for loan
losses against the Bank's income.

     General allowances are made pursuant to management's assessment of risk in
the Bank's loan portfolio as a whole.  Specific allowances are provided for
individual loans when ultimate collection is considered questionable by
management after reviewing the current status of loans which are contractually
past due and considering the net realizable value of the security for the loan.
Management also reviews individual loans for which full collectibility may not
be reasonably assured and evaluates among other things the net realizable value
of the underlying collateral.  General allowances are included in calculating
the Bank's risk-based capital, while specific allowances are not so included.
Management continues to actively monitor the Bank's asset quality and to charge
off loans against the allowance for loan losses when appropriate or to provide
specific loss reserves when necessary.  Although management believes it uses the
best information available to make determinations with respect to the allowance
for loan losses, future adjustments may be necessary if economic conditions
differ substantially from the economic conditions in the assumptions used in
making the initial determinations.

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

                                         Year Ended December 31,
                                         -----------------------
                                             1995        1996
                                         ------------ -----------
<S>                                      <C>          <C>

Balance at beginning of period.........  $ 94,064        $106,064
Loans charged-off:
  Real estate -- mortgage:
    Residential........................        --              --
    Commercial.........................        --              --
                                         --------        --------
Total charge-offs......................  $     --        $     --
                                         ========        ========
Recoveries:
  Real estate -- mortgages:
    Residential........................        --              --
    Commercial.........................        --              --
                                         --------        --------
Total recoveries.......................  $     --        $     --
                                         ========        ========

Net loans charged-off..................        --              --
                                         --------        --------

Provision for possible loan losses.....    12,000          18,000
                                         --------        --------
Balance at end of period...............  $106,064        $124,064
                                         ========        ========

Ratio of net charge-offs to average
  loans outstanding during the period..       N/A              NA
                                         ========        ========
</TABLE>

                                       8
<PAGE>
 
     The following table sets forth the breakdown of the allowance for loan
losses by loan category at the dates indicated.  Management believes that the
allowance can be allocated by category only on an approximate  basis. The
allocation of the allowance to each category is not necessarily indicative of
future losses and does not restrict the use of the allowance to absorb losses in
any category.
<TABLE>
<CAPTION>
  
                                                              At  December 31,
                                        -------------------------------------------------------
                                                   1995                            1996
                                        ----------------------------     ----------------------
                                                         Percent                      Percent
                                                         of Loans                     of Loans
                                                       in Category                  in Category
                                                         to Total                     to Total
                                          Amount         Loans(1)         Amount      Loans(1)
                                        -----------     ------------     --------     ---------
<S>                                        <C>              <C>          <C>          <C>
 
Real estate - mortgage:
  Residential.........................     $ 99,700         94.0%        $116,620      94.0%
  Commercial..........................
Real estate - construction............        6,364          6.0            7,444       6.0
                                           --------                      --------
     Total allowance for loan losses..     $106,064                      $124,064
                                           ========                      ========
 
</TABLE>

     Non-Performing Loans and Other Problem Assets.  Management reviews the
Bank's loans on a regular basis.  Loans are placed on a non-accrual status when,
in the opinion of management, the collection of additional interest is doubtful.

     Real estate acquired by the Bank as a result of foreclosure is classified
as real estate owned until such time as it is sold.  When such property is
acquired, it is recorded at fair value which establishes a new cost basis.  Any
required write-down of the loan to the appraised fair market value upon
foreclosure is charged against the allowance for loan losses.  Subsequent to
foreclosure, in accordance with generally accepted accounting principles, a
valuation allowance is established if the carrying value of the property exceeds
its fair value net of related selling expenses.

     The following table sets forth information with respect to the Bank's
nonperforming assets at the dates indicated.  No loans were recorded as
restructured loans within the meaning of SFAS No. 15 at the dates indicated.
<TABLE>
<CAPTION>
 
                                                                                       At December 31,
                                                                     ------------------------------------------------
                                                                         1995                              1996
                                                                         ----                              ----
<S>                                                                   <C>                               <C>
Loans accounted for on a non-accrual basis:
  Real estate:
    Residential.................................                      $707,607                          $810,484
    Commercial..................................                            --                                --
                                                                      --------                          --------
      Total.....................................                      $707,607                          $810,484(1)
                                                                      ========                          ========
 
Accruing loans which are contractually
  past due 90 days or more:
  Real Estate:
    Residential.................................                      $     --                          $    --
    Commercial..................................                            --                               --
                                                                      --------                         --------
      Total.....................................                      $     --                          $    --
                                                                      --------                         --------
 
Total of nonaccrual and 90 days past due loans..                      $707,607                         $810,484
                                                                      ========                         ========
Percentage of total loans.......................                           2.9%                             3.0%
                                                                      ========                         ========
Other non-performing assets (2).................                      $ 59,948                         $ 31,464
                                                                      ========                         ========
</TABLE>
------------------------
(1)  All nonperforming loans are collateralized by one- to four-family
     residential property.  Based on management's review of the value of the
     underlying collateral and other factors, no losses are expected.
(2)  Other non-performing assets represents property acquired by the Bank
     through foreclosure or repossession.  This property is carried at fair
     value less estimated costs of sale.

                                       9
<PAGE>
 
     There are no loans which are not currently classified as non-accrual, 90
days past due or restructured but where known information about possible credit
problems of borrowers causes management to have serious concerns as to the
ability of the borrowers to comply with present loan repayment terms and may
result in disclosure as non-accrual, 90 days past due or restructured at
December 31, 1996.

INVESTMENT ACTIVITIES

     Pendleton Federal is permitted under federal law to make certain
investments, including investments in securities issued by various federal
agencies and state and municipal governments, deposits at the FHLB of
Cincinnati, certificates of deposits in federally insured institutions, certain
bankers' acceptances and federal funds.  The Bank may also invest, subject to
certain limitations, in commercial paper having one of the two highest
investment ratings of a nationally recognized credit rating agency, and certain
other types of corporate debt securities and mutual funds.  Federal regulations
require the Bank to maintain an investment in FHLB of Cincinnati stock and a
minimum amount of liquid assets which may be invested in cash and specified
securities.  From time to time, the OTS adjusts the percentage of liquid assets
which savings institutions are required to maintain.  For additional
information, see "Regulation -- Regulation of the Bank -- Liquidity
Requirements."

     The Bank invests in investment securities in order to diversify its assets,
manage cash flow, obtain yield and maintain the minimum levels of liquid assets
required by regulatory authorities.  Such investments generally include federal
government and agency securities and qualified deposits in other financial
institutions.  Investment decisions generally are made by the Chief Executive
Officer.

     It is management's intention, and the Company has the ability, to hold all
of its investment security portfolio to maturity.  In accordance with SFAS No.
115, effective January 1, 1994, the Company classified its investments portfolio
as held to maturity.  The Company's investment securities are thus recorded at
cost, adjusted for amortization of premiums and accretion of discounts on a
method which approximates the interest method over the term of the related
security.  For further information, see Notes 1, 2 and 3 of Notes to Financial
Statements.

     The following table sets forth the carrying value of the Company's
investments and FHLB stock at the dates indicated.
<TABLE>
<CAPTION>
 
                                                                           At December 31,
                                                          ----------------------------------------
                                                              1995                         1996
                                                          -----------                   ----------
<S>                                                       <C>                           <C>
Investment securities:
  U.S. government and agency securities, including
    mortgage-backed securities......................       $  828,671                   $1,011,489
                                                           ----------                   ----------
      Total investment securities...................          828,671                    1,011,489
                                                           ----------                   ----------
Interest-earning deposits and certificates..........          347,413                    1,474,583
FHLB stock..........................................          224,500                      243,900
                                                           ----------                   ----------
      Total investments.............................       $1,400,584                   $2,729,972
                                                           ==========                   ==========
 
</TABLE>

                                       10
<PAGE>
 
     The following table sets forth the scheduled maturities, carrying values,
market values and average yields for the Bank's investment securities at
December 31, 1996.
<TABLE>
<CAPTION>
                                                 After One          After Five
                         Less than One Year Through Five Years  Through Ten Years More than Ten Years  Total Investment Portfolio
                          -----------------  -----------------  -----------------  ----------------   ----------------------------- 
                          Carrying  Average  Carrying  Average  Carrying  Average  Carrying  Average   Carrying   Market    Average
                           Value     Yield    Value     Yield     Value    Yield     Value    Yield      Value     Value     Yield
                          --------  -------  --------  --------  --------  ------   -------  -------  ----------  ------    ------ 
<S>                       <C>       <C>      <C>       <C>      <C>       <C>      <C>       <C>      <C>         <C>        <C> 
Investment securities:
  U.S. government and
    agency securities...  $219,065  9.00%    $605,782  7.28%    $101,843  9.23%    $84,799   9.73%    $1,011,489  $1,025,592 7.28%
                          --------           --------           --------           -------             ---------  ----------
</TABLE>

                                       11
<PAGE>
 
DEPOSIT ACTIVITY AND OTHER SOURCES OF FUNDS

     General.  Deposits are the primary source of the Bank's funds for lending
and other investment purposes.  In addition to deposits, Pendleton Federal
derives funds primarily from loan principal repayments, maturing investment
securities, and interest payments.  Loan repayments and interest payments are a
relatively stable source of funds, while deposit inflows and outflows are
significantly influenced by general interest rates and money market conditions.

     Deposits.  Deposits are attracted principally from within the Bank's
primary market area through the offering of a variety of deposit instruments,
including passbook and statement accounts and certificates of deposit currently
ranging in term from six months to four years.  Deposit account terms vary,
principally on the basis of the minimum balance required, the time periods the
funds must remain on deposit and the interest rate.  The Bank also offers
individual retirement accounts ("IRAs").

     The Bank's policies are designed primarily to attract deposits from local
residents rather than to solicit deposits from areas outside its primary market.
The Bank does not accept deposits from brokers due to the volatility and rate
sensitivity of such deposits.   Interest rates paid, maturity terms, service
fees and withdrawal penalties are established by the Bank on a periodic basis.
Determination of rates and terms are predicated upon funds acquisition and
liquidity requirements, rates paid by competitors, growth goals and federal
regulations.   The Bank has periodically offered premium rates on deposits in
order to fund loan growth.

     The following tables set forth, for the periods indicated, the average
balances and interest rates based on month-end balances for interest-bearing
demand deposits and time deposits.
<TABLE>
<CAPTION>
 
 
                                                Year Ended December 31,
                   ----------------------------------------------------------------------------------
                                    1995                                     1996
                   ---------------------------------------    ---------------------------------------
                    Interest-                 Noninterest-    Interest-                 Noninterest-
                     Bearing                     Bearing       Bearing                     Bearing
                     Demand         Time         Demand        Demand         Time         Demand
                    Deposits      Deposits      Deposits      Deposits      Deposits      Deposits
                   -----------  ------------  -------------  -----------  ------------  -------------
<S>                <C>          <C>           <C>            <C>          <C>           <C>
 
Average balance..  $2,912,046   $15,221,502       $359,758   $3,566,765   $16,630,998       $519,659
Average rate.....        2.69%         5.94%            --%        2.82%         5.88%            --%
 
</TABLE>

     The following table indicates the amount of the Bank's certificates of
deposit of $100,000 or more by time remaining until maturity as of December 31,
1996.
<TABLE>
<CAPTION>
 
                                                 Certificates
                Maturity Period                  of Deposits
                ---------------                  -----------
                <S>                              <C>
 
                Three months or less...........   $  324,116
                Over three through six months..      100,000
                Over six through 12 months.....      669,726
                Over 12 months.................      102,225
                                                  ----------
                    Total......................   $1,196,067
                                                  ==========
 
</TABLE>

     Borrowings.  Savings deposits historically have been the primary source of
funds for the Bank's lending and investment activities and for its general
business activities.  The Bank is authorized, however, to use advances from the
FHLB of Cincinnati to supplement its supply of lendable funds and to meet
deposit withdrawal requirements.  Advances from the FHLB are secured by the
Bank's stock in the FHLB and a portion of the Bank's mortgage loans.

                                       12
<PAGE>
 
     The FHLB of Cincinnati functions as a central reserve bank providing credit
for savings institutions and certain other member financial institutions.  As a
member, Pendleton Federal is required to own capital stock in the FHLB and is
authorized to apply for advances on the security of such stock and certain of
its home mortgages and other assets (principally, securities which are
obligations of, or guaranteed by, the United States) provided certain standards
related to creditworthiness have been met.  See "Regulation -- Regulation of the
Bank -- Federal Home Loan Bank System."

     The following table sets forth certain information regarding the Bank's
FHLB advances (the Bank's only borrowing's outstanding during the periods) at
the dates and for the periods indicated.
<TABLE>
<CAPTION>
 
                                                At or for the
                                          Year Ended December 31,
                                       -----------------------------
                                           1995          1996
                                        ----------   ----------
<S>                                     <C>          <C> 
Amounts outstanding at end of period..  $1,400,000   $2,200,000
                                        ==========   ==========
 
Weighted average rate paid............     6.0%         7.2%
 
</TABLE>
<TABLE> 
<CAPTION> 
                                              For the Year Ended December 31,
                                            ----------------------------------
                                                     1995        1996
                                                 ----------    ----------
<S>                                              <C>           <C> 
Maximum amount outstanding at any month end      $3,800,000    $3,400,000
                                                 ==========    ==========
</TABLE> 
<TABLE>
<CAPTION>
 
 
                                             For the Year Ended December 31,
                                            ---------------------------------
                                                 1995             1996
                                              ----------      -----------
<S>                                       <C>                               <C>
 
Approximate average outstanding.........      $2,100,000      $2,042,000
                                              ==========      ==========
 
Approximate weighted average rate paid..        6.9%             5.6%
 
</TABLE>
COMPETITION

     The Bank experiences competition both in attracting and retaining savings
deposits and in the making of mortgage and other loans.  Direct competition for
savings deposits and loans in Pendleton County and the other counties in the
Bank's market area comes from other savings institutions, credit unions,
commercial banks, money market mutual funds, brokerage firms and insurance
companies.  The primary factors in competing for loans are interest rates and
loan origination fees and the range of services offered by various financial
institutions.

EMPLOYEES

     As of December 31, 1996, Pendleton Federal had eight full-time employees
and no part-time employees, none of whom was represented by a collective
bargaining agreement.  Pendleton Federal believes that it enjoys good relations
with its personnel.

                                       13
<PAGE>
 
                                 REGULATION

     GENERAL.  As a federally chartered savings bank, Pendleton Federal is
subject to extensive regulation by the OTS.  The lending activities and other
investments of the Bank must comply with various federal regulatory
requirements, and the OTS periodically examines the Bank for compliance with
various regulatory requirements.  The FDIC also has the authority to conduct
special examinations.  Pendleton Federal must file reports with the OTS
describing its activities and financial condition and is also subject to certain
reserve requirements promulgated by the Federal Reserve Board.  This supervision
and regulation is intended primarily for the protection of depositors.  Certain
of these regulatory requirements are referred to below or appear elsewhere
herein.

PENDING FINANCIAL SERVICES MODERNIZATION LEGISLATION

     Legislation currently under consideration by Congress would repeal the
federal thrift charter and require federal savings associations like the Bank to
convert to national banks two years after the enactment of the bill.  The bill,
in its current form, would permit federal thrifts that converted to national
banks to exercise any authority which they were legally entitled to exercise
immediately prior to such conversion and would not be required to divest any
branches.  Further, these institutions could continue to branch in any state in
which they were located to the same extent as national banks.  Unitary savings
and loan holding companies, like the Company, could continue to exercise any
powers they had prior to their subsidiary becoming a bank by operation of law as
long as they did not acquire another bank.  Powers of those unitary savings and
loan holding companies that were grandfathered, however, could not be
transferred to another company which acquires control of the unitary holding
company after the effective date of the law.  There can be no assurance that
this legislation will be passed in its current form.  At this time, the Company
is unable to predict whether such legislation would significantly impact its
operations.

REGULATION OF THE BANK

     FEDERAL HOME LOAN BANK SYSTEM.  The Bank is a member of the FHLB System,
which consists of 12 district Federal Home Loan Banks subject to supervision and
regulation by the Federal Housing Finance Board.  The Federal Home Loan Banks
provide a central credit facility primarily for member institutions.  As a
member of the FHLB of Cincinnati, the Bank is required to acquire and hold
shares of capital stock in the FHLB of Cincinnati in an amount at least equal to
1% of the aggregate unpaid principal of its home mortgage loans, home purchase
contracts, and similar obligations at the beginning of each year, or 1/20 of its
advances (i.e., borrowings) from the FHLB of Cincinnati, whichever is greater.
Pendleton Federal was in compliance with this requirement with an investment in
FHLB of Cincinnati stock at December 31, 1996 of $243,900.

     The FHLB of Cincinnati serves as a reserve or central bank for its member
institutions within its assigned district.  It is funded primarily from proceeds
derived from the sale of consolidated obligations of the FHLB System.  It makes
advances to members in accordance with policies and procedures established by
the OTS and the Board of Directors of the FHLB of Cincinnati.  Advances may only
be made for the purpose of providing funds for residential housing finance.  As
of December 31, 1996, Pendleton Federal had $2.2 million in advances
outstanding.  See -- Deposit Activity and Other Sources of Funds -- Borrowings."

     LIQUIDITY REQUIREMENTS.  Pendleton Federal is required to maintain average
daily balances of liquid assets (cash, certain time deposits, bankers'
acceptances, highly rated corporate debt and commercial paper, securities of
certain mutual funds, and specified United States government, state or federal
agency obligations) equal to the monthly average of not less than a specified
percentage (currently 5%) of its net withdrawable savings deposits plus short-
term borrowings.  Savings institutions are also required to maintain average
daily balances of short-term liquid assets at a specified percentage (currently
1%) of the total of their net withdrawable savings accounts and borrowings
payable in one year or less.

                                      14
<PAGE>
 
     FEDERAL RESERVE SYSTEM.  Pursuant to regulations of the Federal Reserve
Board, all FDIC-insured depository institutions must maintain average daily
reserves against their transaction accounts.  No reserves are required to be
maintained on the first $4.3 million of transaction accounts, reserves equal to
3% must be maintained on the next $52.0 million of transaction accounts, and a
reserve of 10% must be maintained against all remaining transaction accounts.
These reserve requirements are subject to adjustment by the Federal Reserve
Board.  Because required reserves must be maintained in the form of vault cash
or in a noninterest bearing account at a Federal Reserve Bank, the effect of the
reserve requirement is to reduce the amount of the institution's interest-
earning assets.  At December 31, 1996, the Bank met its reserve requirements.

     QUALIFIED THRIFT LENDER TEST.  The Home Owners' Loan Act (the "HOLA")
requires savings institutions to meet a qualified thrift lender ("QTL") test.  A
savings institution that does not meet the QTL test must either convert to a
bank charter or comply with the following restrictions on its operations: (i)
the institution may not engage in any new activity or make any new investment,
directly or indirectly, unless such activity or investment is permissible for a
national bank; (ii) the branching powers of the institution shall be restricted
to those of a national bank; (iii) the institution shall not be eligible to
obtain any advances from its FHLB; and (iv) payment of dividends by the
institution shall be subject to the rules regarding payment of dividends by a
national bank.  Upon the expiration of three years from the date the institution
ceases to be a QTL, it must cease any activity and not retain any investment not
permissible for a national bank and immediately repay any outstanding FHLB
advances (subject to safety and soundness considerations).

     In order to satisfy, the QTL Test, a savings association must either
satisfy the definition of domestic building and loan association under the
Internal Revenue Code or its Qualified Thrift Investments must represent at
least 65% of portfolio assets.  Qualified Thrift Investments include investments
in residential mortgages, home equity loans, loans made for educational
purposes, small business loans, credit card loans and mortgage-backed
securities.  Portfolio assets are defined as total assets less intangibles,
property used by a savings association in its business and liquidity investments
in an amount not exceeding 20% of assets.  A savings association shall be deemed
a QTL as long as its percentage of Qualified Thrift Investments continues to
equal or exceed 65% in at least nine out of each 12 months.  A savings
association that fails to maintain QTL status will be permitted to requalify
once, and if it fails the QTL Test a second time, it will become immediately
subject to all penalties as if all time limits on such penalties had expired.
At December 31, 1996, Pendleton Federal was in compliance with the QTL Test.

     REGULATORY CAPITAL REQUIREMENTS.  Under OTS capital regulations, savings
institutions must maintain "tangible" capital equal to 1.5% of adjusted total
assets, "core" capital equal to 3% of adjusted total assets and "total" capital
(a combination of core and "supplementary" capital) equal to 8% of risk-weighted
assets.  In addition, the OTS has recently adopted regulations which impose
certain restrictions on savings associations that have a total risk-based
capital ratio that is less than 8%, a ratio of Tier 1 capital to risk-weighted
assets of less than 4% or a ratio of Tier 1 capital to adjusted total assets of
less than 4% (or 3% if the institution is rated Composite 1 under the OTS
examination rating system).  For purposes of these regulations, Tier 1 capital
has the same definition as core capital.  See "-- Prompt Corrective Regulatory
Action."  The OTS capital rule defines core capital as common stockholders'
equity (including retained earnings), noncumulative perpetual preferred stock
and related surplus, minority interests in the equity accounts of fully
consolidated subsidiaries, certain nonwithdrawable accounts and pledged deposits
and "qualifying supervisory goodwill," less intangible assets other than certain
qualifying supervisory goodwill and certain mortgage servicing rights.  Tangible
capital is given the same definition as core capital but does not include
qualifying supervisory goodwill and is reduced by the amount of all the savings
institution's intangible assets except for certain mortgage servicing rights.

     The OTS capital rule requires that core and tangible capital be reduced by
an amount equal to a savings institution's debt and equity investments in
subsidiaries engaged in activities not permissible to national banks, other than
subsidiaries engaged in activities undertaken as agent for customers or in
mortgage banking activities and subsidiary depository institutions or their
holding companies ("nonincludable subsidiaries").  As of December 31, 1996,
Pendleton Federal had no material investments in or extensions of credit to
nonincludable subsidiaries.

                                      15
<PAGE>
 
     Adjusted total assets for purposes of the core and tangible capital
requirements are a savings institution's total assets as determined under
generally accepted accounting principles, increased by certain goodwill amounts
and by a prorated portion of the assets of subsidiaries in which the savings
institution holds a minority interest and which are not engaged in activities
for which the capital rules require the savings institution to net its debt and
equity investments in such subsidiaries against capital, as well as a prorated
portion of the assets of other subsidiaries for which netting is not fully
required under phase-in rules. Adjusted total assets are reduced by the amount
of assets that have been deducted from capital, the portion of savings
institution's investments in subsidiaries that must be netted against capital
under the capital rules and, for purposes of the core capital requirement,
qualifying supervisory goodwill.

     In determining compliance with the risk-based capital requirement, a
savings institution is allowed to include both core capital and supplementary
capital in its total capital, provided the amount of supplementary capital
included does not exceed the savings institution's core capital. Supplementary
capital is defined to include certain preferred stock issues, nonwithdrawable
accounts and pledged deposits that do not qualify as core capital, certain
approved subordinated debt, certain other capital instruments and a portion of
the savings institution's general loan and lease loss allowances.

     The risk-based capital requirement is measured against risk-weighted
assets, which equal the sum of each on-balance-sheet asset and the credit-
equivalent amount of each off-balance-sheet item after being multiplied by an
assigned risk weight. Under the OTS risk-weighting system, cash and securities
backed by the full faith and credit of the U.S. government are given a 0% risk
weight. Mortgage-backed securities that qualify under the Secondary Mortgage
Enhancement Act, including those issued, or fully guaranteed as to principal and
interest, by the FNMA or FHLMC, are assigned a 20% risk weight. Single-family
first mortgages not more than 90 days past due with loan-to-value ratios under
80%, multi-family mortgages (maximum 36 dwelling units) with loan-to-value
ratios under 80% and average annual occupancy rates over 80%, and certain
qualifying loans for the construction of one- to four-family residences pre-sold
to home purchasers are assigned a risk weight of 50%. Consumer loans, non-
qualifying residential construction loans and commercial real estate loans,
repossessed assets and assets more than 90 days past due, as well as all other
assets not specifically categorized, are assigned a risk weight of 100%. The
portion of equity investments not deducted from core or supplementary capital is
assigned a 100% risk-weight. OTS capital regulations require savings
institutions to maintain minimum total capital, consisting of core capital plus
supplemental capital, equal to 8% of risk-weighted assets.

     The OTS risk-based capital rule requires savings institutions with more
than a "normal" level of interest rate risk to maintain additional total
capital. A savings institution's interest rate risk is measured for this purpose
in terms of the sensitivity of its "net portfolio value" to changes in interest
rates. Net portfolio value is defined, generally, as the present value of
expected cash inflows from existing assets and off-balance sheet contracts less
the present value of expected cash outflows from existing liabilities. A savings
institution is considered to have a "normal" level of interest rate risk
exposure if the decline in its net portfolio value after an immediate 200 basis
point increase or decrease in market interest rates (whichever results in the
greater decline) is less than two percent of the current estimated economic
value of its assets. A savings institution with a greater than normal interest
rate risk is required to deduct from total capital, for purposes of calculating
its risk-based capital requirement, an amount (the "interest rate risk
component") equal to one-half the difference between the institution's measured
interest rate risk and the normal level of interest rate risk, multiplied by the
economic value of its total assets.

     The OTS calculates the sensitivity of a savings institution's net portfolio
value based on data submitted by the institution in a schedule to its quarterly
Thrift Financial Report and using the interest rate risk measurement model
adopted by the OTS. The amount of the interest rate risk component, if any, to
be deducted from a savings institution's total capital is based on the
institution's Thrift Financial Report filed two quarters earlier. Savings
institutions with less than $300 million in assets and a risk-based capital
ratio above 12% are generally exempt from filing the interest rate risk schedule
with their Thrift Financial Reports. However, the OTS requires any exempt
savings institution that it determines may have a high level of interest rate
risk exposure to file such schedule on a quarterly basis. Management has
determined that, on the basis of current financial data, Pendleton Federal would
not be deemed to have more than

                                       16
<PAGE>
 
normal level of interest rate risk under the new rule and will not be required
to increase its total capital as a result of the rule.

     In addition to generally applicable capital standards for savings
institutions, the Director of the OTS is authorized to establish the minimum
level of capital for a savings institution at such amount or at such ratio of
capital-to-assets as the Director determines to be necessary or appropriate for
such institution in light of the particular circumstances of the institution.
The Director of the OTS may treat the failure of any savings institution to
maintain capital at or above such level as an unsafe or unsound practice and may
issue a directive requiring any savings institution which fails to maintain
capital at or above the minimum level required by the Director to submit and
adhere to a plan for increasing capital. Such an order may be enforced in the
same manner as an order issued by the FDIC.

     At December 31, 1996, Pendleton Federal exceeded all regulatory minimum
capital requirements.

     DEPOSIT INSURANCE. The Bank is required to pay assessments based on a
percentage of its insured deposits to the FDIC for insurance of its deposits by
the SAIF. Under the FDIC's risk-based deposit insurance assessment system, the
assessment rate for an insured depository institution depends on the assessment
risk classification assigned to the institution by the FDIC, which is determined
by the institution's capital level and supervisory evaluations. Based on the
data reported to regulators for the date closest to the last day of the seventh
month preceding the semi-annual assessment period, institutions are assigned to
one of three capital groups -- well capitalized, adequately capitalized or
undercapitalized -- using the same percentage criteria as in the prompt
corrective action regulations. See "-- Prompt Corrective Regulatory Action."
Within each capital group, institutions are assigned to one of three subgroups
on the basis of supervisory evaluations by the institution's primary supervisory
authority and such other information as the FDIC determines to be relevant to
the institution's financial condition and the risk posed to the deposit
insurance fund. Subgroup A consists of financially sound institutions with only
a few minor weaknesses. Subgroup B consists of institutions that demonstrate
weaknesses which, if not corrected, could result in significant deterioration of
the institution and increased risk of loss to the deposit insurance fund.
Subgroup C consists of institutions that pose a substantial probability of loss
to the deposit insurance fund unless effective corrective action is taken. The
assessment rate for SAIF members had ranged from 0.23% of deposits for well
capitalized institutions in Subgroup A to 0.31% of deposits for undercapitalized
institutions in Subgroup C while assessments for over 90% of the members of the
Bank Insurance Fund ("BIF") had been the statutory minimum of $2,000. Recently
enacted legislation provided for a one-time assessment of 65.7 basis points of
insured deposits of SAIF members as of March 31, 1995 in order to fully
capitalize the SAIF. Accordingly, the Bank paid the special assessment which
resulted in a one-time charge to the Bank of approximately $114,000 pre-tax. The
payment of the special assessment by SAIF members fully recapitalized the SAIF
and had the effect of reducing the Bank's future deposit insurance premiums to
the SAIF. Under the recently enacted legislation, both BIF and SAIF members will
be assessed an amount for the Financing Corporation Bond payments. BIF members
will be assessed approximately 1.3 basis points while the SAIF rate will be
approximately 6.4 basis points until January 1, 2000. At that time, BIF and SAIF
members will begin pro rata sharing of the payment at an expected rate of 2.43
basis points.

     The FDIC has adopted a regulation which provides that any insured
depository institution with a ratio of Tier 1 capital to total assets of less
than 2% will be deemed to be operating in an unsafe or unsound condition, which
would constitute grounds for the initiation of termination of deposit insurance
proceedings. The FDIC, however, will not initiate termination of insurance
proceedings if the depository institution has entered into and is in compliance
with a written agreement with its primary regulator, and the FDIC is a party to
the agreement, to increase its Tier 1 capital to such level as the FDIC deems
appropriate. Tier 1 capital is defined as the sum of common stockholders'
equity, noncumulative perpetual preferred stock (including any related surplus)
and minority interests in consolidated subsidiaries, minus all intangible assets
other than certain servicing rights and purchased credit card receivables and
qualifying supervisory goodwill eligible for inclusion in core capital under OTS
regulations and minus identified losses and investments in certain securities
subsidiaries. Insured depository institutions with Tier 1 capital equal to or
greater than 2% of total assets may also be deemed to be operating in an unsafe
or unsound condition notwithstanding such capital level. The regulation further
provides that in considering applications that must be submitted to it by
savings

                                       17
<PAGE>
 
institutions, the FDIC will take into account whether the savings association is
meeting the Tier 1 capital requirement for state non-member banks of 4% of total
assets for all but the most highly rated state non-member banks.

     DIVIDEND RESTRICTIONS. Under OTS regulations, the Bank will not be
permitted to pay dividends on its capital stock if its regulatory capital would
thereby be reduced below the remaining balance of the liquidation account
established in connection with the Bank's conversion from mutual to stock form
for the benefit of certain depositors of the Bank. In addition, Pendleton
Federal is required by OTS regulations to give the OTS 30 days' prior notice of
any proposed declaration of dividends to the Company.

     OTS regulations impose additional limitations on the payment of dividends
and other capital distributions (including stock repurchases and cash mergers)
by the Bank. Under these regulations, a savings institution that, immediately
prior to, and on a pro forma basis after giving effect to, a proposed capital
distribution, has total capital (as defined by OTS regulation) that is equal to
or greater than the amount of its fully phased-in capital requirements (a "Tier
1 Association") is generally permitted, after notice, to make capital
distributions during a calendar year in the amount equal to the greater of: (a)
75% of its net income for the previous four quarters; or (b) up to 100% of its
net income to date during the calendar year plus an amount that would reduce by
one-half the amount by which its ratio of total capital to assets exceeded its
fully phased-in risk-based capital ratio requirement at the beginning of the
calendar year. A savings institution with total capital in excess of current
minimum capital ratio requirements but not in excess of the fully phased-in
requirements (a "Tier 2 Association") is permitted, after notice, to make
capital distributions without OTS approval of up to 75% of its net income for
the previous four quarters, less dividends already paid for such period. A
savings institution that fails to meet current minimum capital requirements (a
"Tier 3 Association") is prohibited from making any capital distributions
without the prior approval of the OTS. A Tier 1 Association that has been
notified by the OTS that its is in need of more than normal supervision will be
treated as either a Tier 2 or Tier 3 Association. Pendleton Federal is a Tier 1
Association. Despite the above authority, the OTS may prohibit any savings
institution from making a capital distribution that would otherwise be permitted
by the regulation, if the OTS were to determine that the distribution
constituted an unsafe or unsound practice. Furthermore, under the OTS prompt
corrective action regulations, Pendleton Federal would be prohibited from making
any capital distributions if, after making the distribution, it would have: (i)
a total risk-based capital ratio of less than 8.0%; (ii) a Tier 1 risk-based
capital ratio of less than 4.0%; or (iii) a leverage ratio of less than 4.0%.
See "-- Prompt Corrective Regulatory Action."

     ENFORCEMENT. Under the Federal Deposit Insurance Act (the "FDI Act"), the
OTS has primary enforcement responsibility over savings institutions and has the
authority to bring enforcement action against all "institution-related parties,"
including stockholders, and any attorneys, appraisers and accountants who
knowingly or recklessly participate in wrongful action likely to have an adverse
effect on a savings institution. Civil penalties cover a wide range of
violations and actions and range up to $25,000 per day unless a finding of
reckless disregard is made, in which case penalties may be as high as $1.0
million per day. Criminal penalties for most financial institution crimes
include fines of up to $1.0 million and imprisonment for up to 30 years. In
addition, regulators have substantial discretion to take enforcement action
against an institution that fails to comply with its regulatory requirements,
particularly with respect to the capital requirements. Possible enforcement
actions range from the imposition of a capital plan and capital directive to
receivership, conservatorship or the termination of deposit insurance. Under the
FDI Act, the FDIC has the authority to recommend to the Director of OTS
enforcement action to be taken with respect to a particular savings institution.
If action is not taken by the Director, the FDIC has authority to take such
action under certain circumstances.

     TRANSACTIONS WITH RELATED PARTIES. Transactions between savings
institutions and any affiliate are governed by Sections 23A and 23B of the
Federal Reserve Act. An affiliate of a savings institution is any company or
entity which controls, is controlled by or is under common control with the
savings institution. In a holding company context, the parent holding company of
a savings institution (such as the Company) and any companies which are
controlled by such parent holding company are affiliates of the savings
institution. Generally, Sections 23A and 23B (i) limit the extent to which the
savings institution or its subsidiaries may engage in "covered transactions"
with any one affiliate to an amount equal to 10% of such institution's capital
stock and surplus, and contain an aggregate limit on all such transactions with
all affiliates to an amount equal to 20% of such capital stock and surplus and
(ii) require that all such transactions be on terms substantially the same, or
at least as favorable, to the institution or subsidiary as those provided 

                                       18
<PAGE>
 
to a non-affiliate. The term "covered transaction" includes the making of loans,
purchase of assets, issuance of a guarantee and similar other types of
transactions. In addition to the restrictions imposed by Sections 23A and 23B,
no savings institution may (i) make a loan or otherwise extend credit to an
affiliate, except for any affiliate which engages only in activities which are
permissible for bank holding companies, or (ii) purchase or invest in any
stocks, bonds, debentures, notes or similar obligations of any affiliate, except
for affiliates which are subsidiaries of the savings institution.

     Further, savings institutions are subject to the restrictions contained in
Section 22(h) of the Federal Reserve Act and the Federal Reserve Board's
Regulation O thereunder on loans to executive officers, directors and principal
stockholders. Under Section 22(h), loans to a director, executive officer and to
a greater than 10% stockholder of a savings institution and certain affiliated
interests of such persons, may not exceed, together with all other outstanding
loans to such person and affiliated interests, the institution's loans-to-one-
borrower limit (generally equal to 15% of the institution's unimpaired capital
and surplus). Section 22(h) also prohibits the making of loans above amounts
prescribed by the appropriate federal banking agency, to directors, executive
officers and greater than 10% stockholders of a savings institution, and their
respective affiliates, unless such loan is approved in advance by a majority of
the board of directors of the institution with any "interested" director not
participating in the voting. Regulation O prescribes the loan amount (which
includes all other outstanding loans to such person) as to which such prior
board of director approval is required as being the greater of $25,000 or 5% of
capital and surplus (up to $500,000). Further, Section 22(h) requires that loans
to directors, executive officers and principal stockholders be made on terms
substantially the same as offered in comparable transactions to other persons.
Section 22(h) also generally prohibits a depository institution from paying the
overdrafts of any of its executive officers or directors.

     Savings institutions are also subject to the requirements and restrictions
of Section 22(g) of the Federal Reserve Act and Regulation O on loans to
executive officers and the restrictions of 12 U.S.C. (S)1972 on certain tying
arrangements and extensions of credit by correspondent banks. Section 22(g) of
the Federal Reserve Act requires that approval by the board of directors of a
depository institution for extension of credit to executive officers of the
institution, and imposes reporting requirements for and additional restrictions
on the type, amount and terms of credits to such officers. Section 1972 (i)
prohibits a depository institution from extending credit to or offering any
other services, or fixing or varying the consideration for such extension of
credit or service, on the condition that the customer obtain some additional
service from the institution or certain of its affiliates or not obtain services
of a competitor of the institution, subject to certain exceptions, and (ii)
prohibits extensions of credit to executive officers, directors, and greater
than 10% stockholders of a depository institution by any other institution which
has a correspondent banking relationship with the institution, unless such
extension of credit is on substantially the same terms as those prevailing at
the time for comparable transactions with other persons and does not involve
more than the normal risk of repayment or present other unfavorable features.

     PROMPT CORRECTIVE REGULATORY ACTION. Under FDICIA, the federal banking
regulators are required to take prompt corrective action if an institution fails
to satisfy certain minimum capital requirements, including a leverage limit, a
risk-based capital requirement, and any other measure deemed appropriate by the
federal banking regulators for measuring the capital adequacy of an insured
depository institution. All institutions, regardless of their capital levels,
are restricted from making any capital distribution or paying any management
fees that would cause the institution to become undercapitalized. An institution
that fails to meet the minimum level for any relevant capital measure (an
"undercapitalized institution") generally is: (i) subject to increased
monitoring by the appropriate federal banking regulator; (ii) required to submit
an acceptable capital restoration plan within 45 days; (iii) subject to asset
growth limits; and (iv) required to obtain prior regulatory approval for
acquisitions, branching and new lines of businesses. The capital restoration
plan must include a guarantee by the institution's holding company that the
institution will comply with the plan until it has been adequately capitalized
on average for four consecutive quarters, under which the holding company would
be liable up to the lesser of 5% of the institution's total assets or the amount
necessary to bring the institution into capital compliance as of the date it
failed to comply with its capital restoration plan. A significantly
undercapitalized institution, as well as any undercapitalized institution that
does not submit an acceptable capital restoration plan, may be subject to
regulatory demands for recapitalization, broader application of restrictions on
transactions with affiliates, limitations on interest rates paid on deposits,
asset growth and other activities, possible replacement of directors and

                                       19
<PAGE>
 
officers, and restrictions on capital distributions by any bank holding company
controlling the institution. Any company controlling the institution may also be
required to divest the institution. The senior executive officers of such an
institution may not receive bonuses or increases in compensation without prior
approval and the institution is prohibited from making payments of principal or
interest on its subordinated debt, with certain exceptions. If an institution's
ratio of tangible capital to total assets falls below the "critical capital
level" established by the appropriate federal banking regulator, the institution
is subject to conservatorship or receivership within 90 days unless periodic
determinations are made that forbearance from such action would better protect
the deposit insurance fund. Unless appropriate findings and certifications are
made by the appropriate federal bank regulatory agencies, a critically
undercapitalized institution must be placed in receivership if it remains
critically undercapitalized on average during the calendar quarter beginning 270
days after the date it became critically undercapitalized.

     The OTS has adopted regulations implementing the prompt corrective action
provisions of FDICIA. Under the regulations, the OTS measures a savings
institution's capital adequacy on the basis of its total risk-based capital
ratio (the ratio of its total capital to risk-weighted assets), Tier 1 risk-
based capital ratio (the ratio of its core capital to risk-weighted assets) and
leverage ratio (the ratio of its core capital to adjusted total assets). A
savings institution that is not subject to an order or written directive to meet
or maintain a specific capital level is deemed "well capitalized" if it also
has: (i) a total risk-based capital ratio of 10% or greater; (ii) a Tier 1 risk-
based capital ratio of 6.0% or greater; and (iii) a leverage ratio of 5.0% or
greater. An "adequately capitalized" savings institution is a savings
institution that does not meet the definition of well capitalized and has: (i) a
total risk-based capital ratio of 8% or greater; (ii) a Tier 1 capital risk-
based ratio of 4.0% or greater; and (iii) a leverage ratio of 4.0% or greater
(or 3.0% or greater if the savings institution has a composite 1 CAMEL rating).
An "undercapitalized institution" is a savings institution that has (i) a total
risk-based capital ratio less than 8.0%; or (ii) a Tier 1 risk-based capital
ratio of less than 4.0%; or (iii) a leverage ratio of less than 4.0% (or 3.0% if
the institution has a composite 1 CAMEL rating). A "significantly
undercapitalized" institution is defined as a savings institution that has: (i)
a total risk-based capital ratio of less than 6.0%; or (ii) a Tier 1 risk-based
capital ratio of less than 3.0%; or (iii) a leverage ratio of less than 3.0%. A
"critically undercapitalized" savings institution is defined as a savings
institution that has a ratio of core capital to total assets of less than 2.0%.
The OTS may reclassify a well capitalized savings institution as adequately
capitalized and may require an adequately capitalized or undercapitalized
institution to comply with the supervisory actions applicable to institutions in
the next lower capital category if the OTS determines, after notice and an
opportunity for a hearing, that the savings institution is in an unsafe or
unsound condition or that the institution has received and not corrected a less-
than-satisfactory rating for any CAMEL rating category. The Bank is classified
as "well capitalized" under the OTS regulations.

     SAFETY AND SOUNDNESS GUIDELINES. On July 10, 1995, the federal banking
agencies, including the OTS and the Federal Reserve Board, released Interagency
Guidelines Establishing Standards for Safety and Soundness and published a final
rule establishing deadlines for submission and review of safety and soundness
compliance plans. The final rule and the guidelines went into effect on August
9, 1995. The guidelines require depository institutions to maintain internal
controls and information systems and internal audit systems that are appropriate
for the size, nature and scope of the institution's business. The guidelines
also establish certain basic standards for loan documentation, credit
underwriting, interest rate risk exposure, and asset growth. The guidelines
further provide that depository institutions should maintain safeguards to
prevent the payment of compensation, fees and benefits that are excessive or
that could lead to material financial loss, and should take into account factors
such as comparable compensation practices at comparable institutions. If the
appropriate federal banking agency determines that a depository institution is
not in compliance with the safety and soundness guidelines, it may require the
institution to submit an acceptable plan to achieve compliance with the
guidelines. A depository institution must submit an acceptable compliance plan
to its primary federal regulator within 30 days of receipt of a request for such
a plan. Failure to submit or implement a compliance plan may subject the
institution to regulatory sanctions. Management believes that the Bank meets
substantially all the standards adopted in the interagency guidelines.

                                       20
<PAGE>
 
REGULATION OF THE COMPANY

     GENERAL. The Company is a savings and loan holding company as defined by
the HOLA. As such, the Company is registered with the OTS and is subject to OTS
regulation, examination, supervision and reporting requirements. As a subsidiary
of a savings and loan holding company, the Bank is subject to certain
restrictions in its dealings with the Company and affiliates thereof.

     ACTIVITIES RESTRICTIONS. The Board of Directors of the Company presently
intends to operate the Company as a unitary savings and loan holding company.
There are generally no restrictions on the activities of a unitary savings and
loan holding company. However, if the Director of the OTS determines that there
is reasonable cause to believe that the continuation by a savings and loan
holding company of an activity constitutes a serious risk to the financial
safety, soundness or stability of its subsidiary savings institution, the
Director of the OTS may impose such restrictions as deemed necessary to address
such risk including limiting: (i) payment of dividends by the savings
institution; (ii) transactions between the savings institution and its
affiliates; and (iii) any activities of the savings institution that might
create a serious risk that the liabilities of the holding company and its
affiliates may be imposed on the savings institution. Notwithstanding the above
rules as to permissible business activities of unitary savings and loan holding
companies, if the savings institution subsidiary of such a holding company fails
to meet the QTL test, then such unitary holding company shall also presently
become subject to the activities restrictions applicable to multiple holding
companies and, unless the savings institution requalifies as a QTL within one
year thereafter, register as, and become subject to, the restrictions applicable
to a bank holding company. See " -- Regulation of the Bank -- Qualified Thrift
Lender Test."

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

     RESTRICTIONS ON ACQUISITIONS. Savings and loan holding companies are
prohibited from acquiring, without prior approval of the Director of OTS, (i)
control of any other savings institution or savings and loan holding company or
substantially all the assets thereof or (ii) more than 5% of the voting shares
of a savings institution or holding company thereof which is not a subsidiary.
Under certain circumstances, a registered savings and loan holding company is
permitted to acquire, with the approval of the Director of the OTS, up to 15% of
the voting shares of an under-capitalized savings institution pursuant to a
"qualified stock issuance" without that savings institution being deemed
controlled by the holding company. In order for the shares acquired to
constitute a "qualified stock issuance," the shares must consist of previously
unissued stock or treasury shares, the shares must be acquired for cash, the
savings and loan holding company's other subsidiaries must have tangible capital
of at least 6 1/2% of total assets, there must not be more than one common
director or officer between the savings and loan holding company and the issuing
savings institution, and transactions between the savings institution and the
savings and loan holding company and any of its affiliates must conform to
Sections 23A and 23B of the Federal Reserve Act. Except with the prior approval
of the Director of the OTS, no director or officer of a savings and loan holding
company or person owning or controlling by proxy or

                                       21
<PAGE>
 
otherwise more than 25% of such company's stock, may also acquire control of any
savings institution, other than a subsidiary savings institution, or of any
other savings and loan holding company.

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

     Under the Bank Holding Company Act of 1956, bank holding companies are
specifically authorized to acquire control of any savings association. Pursuant
to rules promulgated by the Federal Reserve Board, owning, controlling or
operating a savings institution is a permissible activity for bank holding
companies, if the savings institution engages only in deposit-taking activities
and lending and other activities that are permissible for bank holding
companies. A bank holding company that controls a savings institution may merge
or consolidate the assets and liabilities of the savings institution with, or
transfer assets and liabilities to, any subsidiary bank which is a member of the
with the approval of the appropriate federal banking agency and the Federal
Reserve Board. The resulting bank will be required to continue to pay
assessments to the SAIF at the rates prescribed for SAIF members on the deposits
attributable to the merged savings institution plus an annual growth increment.


                                 TAXATION

FEDERAL INCOME TAXATION

     The Company files a consolidated federal income tax return based on a
fiscal year ending December 31.

     On August 21,1996, the Small Business Job Protection Act was signed into
law, which repeals the favorable tax bad debt deduction method available to
savings banks. The Bank is required to change its tax bad debt method to the
experience method under Internal Revenue Code Section 585 effective for the
fiscal year ending December 31, 1996. The change in method will result in
taxable income of approximately $126,885 representing the excess of the Bank's
tax bad debt reserve at December 31, 1996 over the reserve that arose in tax
years beginning before December 31, 1987 (base year amount). Generally, the
income will be recognized for tax purposes ratably over a six-year period.
However, the Bank is permitted to suspend this recognition for two years as it
meets the residential loan requirement. A deferred tax liability has been
established for the effect of this new legislation.

     As of December 31, 1996, the Bank's bad debt reserve for federal tax
purposes was approximately $538,516, of which $411,631 represents the base year
amount. A deferred tax liability has not been recognized for the base year
amount. If the Bank uses the base year reserve for any reason other than to
absorb loan losses, a tax liability could be incurred. It is not anticipated
that the reserve will be used for any other purpose.

     The Savings Bank's and the Company's federal corporate income tax returns
have not been audited in the past five years.

STATE INCOME TAXATION

     The Commonwealth of Kentucky imposes no income or franchise taxes on
savings institutions. Pendleton Federal is subject to an annual Kentucky ad
valorem tax. This tax is 0.1% of the Bank's savings accounts, common stock,
capital and retained income with certain deductions allowed for amounts borrowed
by depositors and for securities guaranteed by the U.S. Government or certain of
its agencies. For the fiscal year ended December 31, 1996, the amount of such
expense for the Bank was $26,135.

                                       22
<PAGE>
 
     Stockholders of the Company who are residents of the Commonwealth of
Kentucky may be subject to a Kentucky tax on intangible property, defined for
this purpose to include shares of stock in a corporation. The tax is an ad
valorem tax based upon the fair market value of the shares held by the
individual, and is assessed at a rate of $.25 per $100 in value. All Kentucky
residents are urged to consult their own tax and financial advisors as to the
applicability of this tax.

     See Note 10 of Notes to Financial Statements included in Exhibit 13 herein.

ITEM 2.  DESCRIPTION OF PROPERTY.
-------------------------------- 

     The following table sets forth the location and certain additional
information regarding the Bank's sole office at December 31, 1996.

                                          Approximate
                         Year   Owned or    Square
                        Opened   Leased     Footage    Net Book Value
                        ------  --------  -----------  --------------
215 W. Shelby Street     1958    Owned       1,400        $339,239
Falmouth, Kentucky


     During 1997 the Bank purchased one property for approximately $68,000, part
of which will be used as additional parking and part of which will be leased.
The Bank has another property on contract for approximately $203,000, part of
which will be used as a branch office and the remaining space will be leased.

ITEM 3. LEGAL PROCEEDINGS.
------------------------- 

     Although Pendleton Federal, from time to time, is involved in various legal
proceedings in the normal course of business, there are no material legal
proceedings to which Pendleton Federal is a party or to which any of its
property is subject.

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

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


                                 PART II

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

MARKET INFORMATION

     At the present time, there is no market in which shares of the Company's
common stock are actively traded, nor are there uniformly quoted prices for such
shares. Penfed Bancorp, Inc. common stock is listed over-the-counter through the
National Daily Quotation System "Pink Sheets", with prices reported under the
symbol: PFDB. There are currently 306,387 shares of the common stock outstanding
and approximately 183 holders of record of the common stock.

                                       23
<PAGE>
 
Dividend Information

     The Board of Directors declared dividends of $0.15 per share on February
29, 1996 which was paid on April 12, 1996 to shareholders of record on March 31,
1996 and on August 30, 1996 which was paid on October 11, 1996 to shareholders
of record on September 30, 1996.

     Under regulations of the OTS, the Bank is not permitted to pay dividends on
its capital stock if its regulatory capital would thereby be reduced below
regulatory capital requirements, or the amount then required for the liquidation
account established for the benefit of certain depositors of the Bank at the
time of the Conversion. In addition, savings institution subsidiaries of savings
and loan holding companies such as the Company are required to give the OTS 30
days' prior notice of any proposed declaration of dividends to the holding
company.

     Federal regulations impose additional limitations on the payment of
dividends and other capital distributions (including stock repurchases and cash
mergers) by the Bank. Under these regulations, a savings institution, such as
the Bank, that, immediately prior to and on a pro forma basis after giving
effect to a proposed capital distribution, has total capital (as defined by OTS
regulation) that is equal to or greater than the amount of its fully phased-in
capital requirements (a "Tier 1 Association") is generally permitted without OTS
approval to make capital distributions during a calendar year in the amount of
(i) up to 100% of its net earnings to date during the calendar year plus (ii) an
amount that would reduce by one-half the amount by which its total capital
exceeded its fully phased-in risk-based capital requirement at the beginning of
the calendar year. In addition to the foregoing, earnings of the Bank
appropriated to bad debt reserves and deducted for federal income tax purposes
are not available for payment of cash dividends or other distributions to the
Company without payment of taxes at the then current tax rate by the Bank on the
amount of earnings removed from the reserves for such distributions. The Company
intends to make full use of this favorable tax treatment afforded to the Bank
and Company and does not contemplate use of any earnings of the Bank in a manner
which would limit the Bank's bad debt deduction or create federal tax
liabilities.

     Although the Company is not subject to these restrictions, the Company's
primary source of funds for payment of dividends are dividends from the Bank.

ITEM 6.  MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF  OPERATION.
------------------------------------------------------------------- 

GENERAL

     The principal business of the Company consists of accepting deposits from
the general public and investing these funds in loans secured by one- to four-
family residential properties in the Company's primary market area. The Company
also maintains an investment portfolio, most of which is in the form of U.S.
government agency securities, FHLB stock and deposit accounts held at other
institutions.

     The Company's net income is dependent primarily on its net interest income,
which is the difference between interest income earned on its loan and
investment portfolio and interest paid on interest-bearing liabilities. To a
lesser extent, the Company's net income is also affected by the level of
noninterest income, such as service charges and other fees. In addition, net
income is affected by the level of noninterest (general and administrative)
expenses.

     The operations of the Company and the entire thrift industry are
significantly affected by prevailing economic conditions, competition, and the
monetary and fiscal policies of governmental agencies. 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 rates of interest --primarily
on competing investments, account maturities, and the levels of personal income
and savings in the Company's market area.

     The Company's strategy is to continue to aggressively pursue growth in the
Bank's portfolio of single-family residential loans.

                                       24
<PAGE>
 
RECENT DEVELOPMENTS -- PENDING FINANCIAL SERVICES MODERNIZATION LEGISLATION

     Legislation currently under consideration by Congress would repeal the
federal thrift charter and require federal savings associations like the Bank to
convert to national banks two years after the enactment of the bill. The bill,
in its current form, would permit federal thrifts that converted to national
banks to exercise any authority which they were legally entitled to exercise
immediately prior to such conversion and would not be required to divest any
branches. Further, these institutions could continue to branch in any state in
which they were located to the same extent as national banks. Unitary savings
and loan holding companies, like the Company, could continue to exercise any
powers they had prior to their subsidiary becoming a bank by operation of law as
long as they did not acquire another bank. Powers of those unitary savings and
loan holding companies that were grandfathered, however, could not be
transferred to another company which acquires control of the unitary holding
company after the effective date of the law. There can be no assurance that this
legislation will be passed in its current form. At this time, the Company is
unable to predict whether such legislation would significantly impact its
operations.

IMPACT OF FLOODING

     On March 2, 1997 a severe storm created flooding on the Licking River in
Northern Kentucky. As a result, Pendleton Federal experienced significant
property damage. The sixty-one inches of water in the Bank's office in the
Falmouth, Kentucky severely damaged the internal fixtures of the Bank and
numerous financial documents. Collateral properties on several loans held by the
Bank were also damaged.

     The Bank's office and many of the documents have been reconstructed. The
Bank recognized an extraordinary loss of $167,329 during the first quarter of
1997, which is net of a related income tax benefit of $86,200, as a result of
uninsured flood loss. Management estimates that less than 10% of the loans in
the Bank's portfolio were adversely affected by the flood. Management attributes
this to the geographic diversity of the Bank's loans, in that an increasing
percentage of the Bank's loans have been collateralized by properties located
outside of Pendleton County in recent years. On the basis of management's
assessment of all information currently available to it regarding the Bank's
loan portfolio, including the loans affected by the flood, the Company added
$25,937 to the loan loss allowance during the quarter ended March 31, 1997.
Management does not believe that the impact of the flood on the Company's
continuing financial condition or results of operations will be material.

ASSET/LIABILITY MANAGEMENT

     Key components of a successful asset/liability strategy are the monitoring
and managing of interest rate sensitivity of both the interest-earning asset and
interest-bearing liability portfolios. Pendleton Federal's lending activities
are intended to minimize the adverse effect of interest rate risk on future
operations by providing a better match between the interest rate sensitivity
match between its assets and liabilities. In particular, the Bank emphasizes the
origination of one-year adjustable-rate residential mortgage loans, which have
far greater interest rate sensitivities than long-term, fixed-rate residential
mortgage loans. Although customers typically prefer fixed-rate mortgage loans in
a decreasing interest rate environment, Pendleton Federal has been successful in
originating adjustable-rate loans in recent years. In addition, the Bank has
used excess funds to invest in various short-term investments with one to five
year maturities.

NET PORTFOLIO VALUE OF EQUITY

     Management also measures the Bank's interest rate risk ("IRR") by computing
estimated changes in the net portfolio value of equity ("NPV") in the event of a
range of assumed changes in market interest rates. NPV is the difference between
incoming and outgoing discounted cash flows from assets and liabilities and off-
balance sheet items. The IRR computations estimate the effects on the Bank's NPV
of sudden and sustained 1% to 4% increases and decreases in market interest
rates.

                                       25
<PAGE>
 
     The following table presents the prospected changes of the Bank's NPV for
the various interest rate shock levels at December 31, 1996.


<TABLE>
<CAPTION>
 
                                   Net Portfolio Value                   NPV as % of PV of Assets
      Change         ---------------------------------------------   --------------------------------
     in Rates          $ Amount         $ Change        % Change        NPV Ratio         % Change
------------------  ---------------  --------------  --------------  ----------------  ---------------
<S>                 <C>              <C>             <C>             <C>               <C>
 
     + 400 bp*               $3,767         (1,566)           (29)%            13.00%          (417) bp
 
     + 300 bp                 4,278         (1,056)           (20)%            14.46%          (271)
 
     + 200 bp                 4,712           (622)           (12)%            15.63%          (154)
 
     + 100 bp                 5,085           (278)            (5)%            16.51%           (66)
 
         0 bp                 5,334             --             -- %            17.17%            --
 
     - 100 bp                 5,607            274               5%            17.80%            63
 
     - 200 bp                 5,920            586              11%            18.51%           134
 
     - 300 bp                 6,305            971              18%            19.37%           220
 
     - 400 bp                 6,815          1,481              28%            20.51%           334
</TABLE>

--------------
*  Basis points.

             Interest Rate Risk Measures:  200 Basis Point (bp) Rate Shock
<TABLE> 
<CAPTION> 
                                                             September 30, 1996
                                                             ------------------
<S>                                                      <C> 
           Pre-shock NPV Ratio: NPV as % of PV of Assets......       17.17%
           Exposure Measure: Post-Shock NPV Ratio.............       15.63%
           Sensitivity Measure: Change in NPV Ratio...........      (154) bp
           Change in NPV as % of PV of Assets.................      (2.00)%
</TABLE> 
                                       26
<PAGE>
 
AVERAGE BALANCES, INTEREST AND AVERAGE YIELDS

     Net interest income is affected by (i) the difference ("interest rate
spread") between rates of interest earned on interest-earning assets and rates
of interest paid on interest-bearing liabilities and (ii) the relative amounts
of interest-earning assets and interest-bearing liabilities.  When interest-
earning assets approximate or exceed interest-bearing liabilities, any positive
interest rate spread will generate net interest income.  Savings institutions
have traditionally used interest rate spreads as a measure of net interest
income.  Another indication of an institution's net interest income is its "net
yield on interest-earning assets" which is net interest income divided by
average interest-earning assets.  The following table sets forth certain
information relating to the Bank's average interest-earning assets and interest-
bearing liabilities and reflects the average yield on assets and average cost of
liabilities for the periods indicated.  Such yields and costs are derived by
dividing income or expense by the average monthly balance of assets or
liabilities, respectively, for the periods presented.  During the periods
indicated, nonaccruing loans are included in the net loan category.  Average
balances are derived from month-end average balances.  Management does not
believe that the use of month-end average balances instead of average daily
balances has caused any material difference in the information presented.
<TABLE>
<CAPTION>
 
                                                                      Year Ended December 31,
                                                -------------------------------------------------------------------
                                                               1995                             1996
                                                --------------------------------  ---------------------------------
                                                                         Average                            Average
                                                  Average                 Yield/     Average                Yield/
                                                  Balance     Interest     Cost      Balance     Interest    Cost
                                                -----------  ----------  --------  -----------  ----------  -------
<S>                                             <C>          <C>         <C>       <C>          <C>         <C>
Interest-earning assets:
  Loans receivable............................  $23,038,509  $1,850,871      8.0%  $25,579,583  $2,201,648     8.6%
  Investment securities.......................      250,000      19,775      7.9       258,293      16,444     6.4
  Mortgage-backed securities..................      444,749      32,126      7.2       681,576      51,991     7.6
  Federal Home Loan Bank capital stock........      215,962      14,500      6.7       233,454      16,200     6.9
  Short-term investment and other
    interest-earning assets...................      491,004      36,475      7.4       454,126      24,391     5.4
                                                -----------  ----------            -----------  ----------
    Total interest-earning assets.............   24,440,224   1,953,747      8.0    27,207,032   2,310,674     8.5
                                                             ----------                         ----------
  Non-interest-earning assets.................      915,450                            789,061
                                                -----------                        -----------
    Total assets..............................  $25,355,674                        $27,996,093
                                                ===========                        ===========
 
Interest-bearing liabilities:
  Deposits....................................  $18,493,306  $  991,622      5.4   $20,717,422  $1,078,769     5.2
  Borrowings..................................    2,100,000     144,087      6.9     2,042,308     115,132     5.6
                                                -----------  ----------            -----------  ----------
     Total interest-bearing liabilities.......   20,593,306   1,135,709      5.5    22,759,730   1,193,901     5.2
Non-interest-bearing liabilities..............      181,437                            182,079
                                                -----------                        -----------
     Total liabilities........................   20,774,743                         22,941,809
Retained earnings.............................    4,580,931                          5,054,284
                                                -----------                        -----------
     Total liabilities and retained earnings..  $25,355,674                        $27,996,093
                                                ===========                        ===========
Net interest income...........................               $  818,038                         $1,116,773
                                                             ==========                         ==========
Interest rate spread..........................                               2.5%                             3.3%
                                                                           =====                            =====
Net yield on interest-earning assets..........                               3.3%                             4.1%
                                                                           =====                            =====
Ratio of average interest-earning assets
  to average interest-bearing liabilities.....                             118.7%                           119.5%
                                                                           =====                            =====
</TABLE>

                                       27
<PAGE>
 
RATE/VOLUME ANALYSIS

     The table below sets forth certain information regarding changes in
interest income and interest expense of Pendleton Federal for the periods
indicated. For each category of interest-earning asset and interest-bearing
liability, information is provided on changes attributable to (i) changes in
volume (changes in volume multiplied by old rate), (ii) changes in rate (changes
in rate multiplied by old volume), (iii) changes in rate/volume (change in rate
multiplied by change in volume), and (iv) total change (the sum of the previous
columns). Average balances are derived from month-end balances. Management does
not believe that the use of month-end balances instead of average daily balances
has caused any material difference in the information presented.
<TABLE>
<CAPTION>
 
 
                                               Year Ended December 31,
                                         ----------------------------------------
                                              1995       vs.       1996
                                         ----------------------------------------
<S>                                      <C>        <C>        <C>       <C>
                                                 Increase (Decrease)
                                                        Due to
                                         ----------------------------------------
                                                                Rate/
                                          Volume      Rate     Volume     Total
                                         --------   --------   -------   --------
Interest Income:
 Loan portfolio........................  $204,145   $132,065   $14,567   $350,777
 Investment securities.................       656     (3,859)     (128)    (3,331)
 Mortgage-backed securities............    17,107      1,800       958     19,865
 Federal Home Loan Bank capital stock..     1,175        486        39      1,700
 Other interest-earning assets.........    (2,740)   (10,103)      759    (12,084)
                                         --------   --------   -------   --------
Total interest-earning assets..........   220,343    120,389    16,195    356,927
 
Interest expense:
 Savings deposits......................   119,258    (28,664)   (3,447)    87,147
 Borrowings and FHLB
  advances.............................    (3,958)   (25,703)      706    (28,955)
                                         --------   --------   -------   --------
Total interest expense.................   115,300    (54,367)   (2,741)    58,192
                                         --------   --------   -------   --------
Charge in net interest income..........  $105,043   $174,756   $18,936   $298,735
                                         ========   ========   =======   ========
</TABLE>

                                       28
<PAGE>
 
COMPARISON OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FOR THE YEARS ENDED
DECEMBER 31, 1995 AND 1996

FINANCIAL CONDITION

     Total assets increased by 14.90% during the year ended December 31, 1996.
Loans receivable and investments and mortgage-backed securities increased 10.88%
and 22.06%, respectively.  Deposits increased 16.06% and Federal Home Loan Bank
(FHLB) advances increased 57.14%.  The increases in assets were funded by an
increase in deposit accounts and FHLB advances.

     The Bank's loans receivable balance increased during 1996 due to
management's continued marketing efforts aimed at taking advantage of
opportunities for lending growth in the Bank's market areas. During 1996, the
Bank was able to increase its loans receivable balance by originating adjustable
rate mortgage loans that are retained in its portfolio. Future increases in the
Bank's loans receivable balances will be funded through increased deposits or
FHLB advances, if required.

     The Bank experienced an increase in deposits largely due to a promotional
certificate of deposit offered during the last quarter of the year.  Management
will continue to monitor deposit levels in light of  prevailing interest rates
and other factors and may choose to increase deposit rates in the future to
preserve market share or obtain   required levels of cash flows.  To the extent
the Bank elects to increase deposit rates in order to attract and/or maintain
deposits to fund future loan growth and other operating needs, interest income
may be adversely affected.  Currently, however, management does not anticipate
the necessity of offering above-market interest rates on deposits.

     Stockholders' equity decreased from 19.22% of assets at December 31, 1995
to 16.50% of assets at December 31, 1996. This is attributable to the Company's
repurchase of 19,402 shares of its stock at an aggregate price of $235,105.

     Although the level of nonperforming loans increased during 1996 as compared
to 1995 (see table below), the Bank experienced no loan losses during 1996. The
following table sets forth information with respect to the Bank's nonperforming
assets for the periods indicated.
<TABLE>
<CAPTION>
 
                                                                     At December 31,
                                                                    ----------------
                                                                    1995        1996
                                                                    ----        ----
<S>                                                              <C>           <C>
                                                                   (In thousands)
 
Loans accounted for on non-accrual basis...................       $ 708        $ 810
Accruing loans contractually past due 90 days or more......         --           --
                                                                  -----        -----
Total of non-accrual and 90 days past due loans............       $ 708        $ 810
                                                                  -----        -----
 
Other real estate owned....................................          60           31
                                                                  -----        -----
Total nonperforming assets.................................       $ 768        $ 841
                                                                  -----        -----
Ratio of nonperforming loans to total loans................         2.9%         3.1%
Ratio of nonperforming loans to total assets...............         2.7%         2.8%
Ratio of allowance for loan losses to total loans..........          .4%          .5%
Ratio of allowance for loan losses to nonperforming loans..        15.0%        15.3%
</TABLE>

     The Bank's total nonperforming loans at December 31, 1996 increased 9.51%,
as compared to December 31, 1995. Nonperforming loans at December 31, 1996
increased due to the Bank fully funding the purchase of some of its other real
estate owned. The interest on these loans cannot be accrued until a minimum
amount of the principal has been paid. All nonperforming loans are
collateralized by single-family residential property. On the basis of its
analysis of the value of collateral property and other relevant facts,
management does not expect significant losses associated with these properties.

                                       29
<PAGE>
 
     The Bank's allowance for loan losses increased 16.97% from December 31,
1995 to December 31, 1996 and the provision for loan losses increased from
$12,000 for the year 1995 as compared to $18,000 for the year ended 1996. The
increase was due to management wanting to increase the ratio of allowance for
loan losses to nonperforming loans in light of greater loan volume.

RESULTS OF OPERATIONS

     Net Income. Net income increased 33.48% for the year ended December 31,
1996 as compared to the year ended December 31, 1995. The increase was primarily
due to a 36.52% increase in net interest income and a 27.15% increase in
noninterest income offset by and 35.91% increase in other expenses.

     Interest Income. Total interest income increased 18.27% for the year ended
December 31, 1996 as compared to the year ended December 31, 1995. The increase
was primarily due to higher interest rates and an increase in the volume of
loans. The average yield on loans increased from 8.0% in 1995 to 8.6% in 1996.
Loan volume increases accounted for $204,145 of the total increase in interest
income. Interest on mortgage-backed securities and investment securities
increased 31.86% during fiscal 1996 as compared to fiscal 1995, primarily due to
a $245,120 increase in average investment balances for the period.

     Interest Expense. Total interest expense increased 5.12% from December 31,
1995 to December 31, 1996. In order to meet competitive rates being paid on
deposits in Pendleton County during 1996, the Bank offered a promotional
certificate of deposit during the year. The average rate on deposits was 5.4%
for 1995 and 5.2% for 1996.

     Non-Interest Income. Non-interest income increased 27.15% for the year
ended December 31, 1996, as compared to the year ended December 31, 1995. The
increase was primarily due to the implementation of SFAS No. 122, "Accounting
for Mortgage Servicing Rights." The Statement amended FASB Statement No. 65
"Accounting for Certain Mortgage Banking Activities" to require that a mortgage
banking enterprise recognize as separate assets rights to service mortgage loans
for others, regardless of how those servicing rights are acquired. The total
cost of the mortgage loans to be sold are required to be allocated between the
mortgage servicing rights and the loans based on their relative fair value if it
is practicable to estimate those fair values. If not, the entire cost is
required to be allocated to the mortgage loans.

     Non-Interest Expense. Non-interest expense increased 35.91% for the year
ended December 31, 1996, as compared to the year ended December 31, 1995.
Salaries and benefits increased 22.07% due to salary raises. Federal insurance
premium increased 288.80% due to a one time assessment of $114,000.

     Provision for Loan Losses. The provision for loan losses was $12,000 for
the year ended December 31, 1995 and $18,000 for the year ended 1996. Among the
many factors considered by management in determining the appropriate level of
the provision for loan losses are an analysis of specific loans in portfolio,
known and inherent risk in the portfolio, estimated value of the underlying
collateral assessment of general trends in relevant real estate markets, and
current and prospective economic conditions, including property values,
employment and occupancy rates, interest rates and other conditions that may
affect a borrower's ability to comply with the repayment terms.

     Income Taxes. Income tax expense increased 37.90% for the year ended
December 31, 1996, as compared to the year ended December 31, 1995. The increase
was the result of higher profits.

                                       30
<PAGE>
 
LIQUIDITY AND CAPITAL RESOURCES

     Since the completion of the Conversion the Company has had no business
other than that of the Bank and investing the Conversion proceeds retained by
it. Management believes that the net proceeds retained by the Company, earnings
on such proceeds and principal and interest payments on the ESOP loan, together
with dividends that may be paid from the Bank to the Company, will provide
sufficient funds for its initial operations and liquidity needs; however, no
assurance can be given that the Company will not have a need for additional
funds in the future.

     Pendleton Federal's capital ratios are substantially in excess of current
regulatory capital requirements. At December 31, 1996, the Bank's tangible and
core capital amounted to 15% of adjusted total assets, or 13.5% and 12%,
respectively, in excess of the Bank's current 1.5% tangible and 3.0% core
capital requirements. Additionally, the Bank's risk-weighted assets ratio was
28% at December 31, 1996, or 20% in excess of the Bank's 8.0% risk-based capital
requirement.

     Pendleton Federal's principal sources of funds for operations are deposits
from its primary market area, principal and interest payments on loans and
proceeds from maturing investment securities. In addition, as a member of the
FHLB of Cincinnati, the Bank is eligible to borrow funds from the FHLB of
Cincinnati in the form of advances.

     Pendleton Federal is required by OTS regulations to maintain minimum levels
of specified liquid assets (currently 5% of deposits and borrowings). Pendleton
Federal's liquidity ratio at December 31, 1996, was approximately 10.69%.
Management seeks to maintain a liquidity ratio at or near the regulatory minimum
as a means of improving the return on the investment of the Bank's assets. The
Bank's liquidity was affected by expenditures associated with the reconstruction
of its office following the flooding in March 1997, but not to a material
extent.

     The Bank's most liquid assets are cash and cash equivalents, which are
short term, highly liquid investments with original maturities of less than
three months. The level of this asset is dependent on the Bank's operating,
financing and investing activities during any given period. At December 31, 1996
and 1995, cash and cash equivalents totaled approximately $1,745,377 and
$595,960, respectively.

     An important component of liquidity is provided by operating activities.
Net cash provided by operating activities was $331,978 and $338,372 for the
years ended December 31, 1996 and 1995, respectively.

     The Company uses cash in its investing activities. The majority of net cash
used in investing activities is for the purchase of investment securities and
the funding of loans to customers. Net cash used in investing activities was
$2,850,811 and $4,119,283 for the years ended December 31, 1996 and 1995,
respectively.

     The Company funds investment and loan growth through growth in deposits,
borrowings from the Federal Home Loan Bank and in 1995 through its common stock
offering. Funds provided by financing activities totaled $3,668,250 and
$3,475,371 for years ended December 31, 1996 and 1995, respectively.

     In accordance with the Bank's interest rate risk policy, management
emphasizes the origination of one-year adjustable-rate mortgage loans with rate
adjustments indexed to the National Average Contract Interest Rate for Major
Lenders on the Purchase of Previously Occupied Homes. In response to customer
demand for long term, fixed rate mortgage loans in the low interest rate
environment then prevailing, in April 1994, the Bank began originating fixed
rate mortgage loans for sale in the secondary mortgage market. The Bank retains
the servicing on such loans.

IMPACT OF INFLATION AND CHANGING PRICES

     The Consolidated Financial Statements and Notes thereto presented herein
have been prepared in accordance with generally accepted accounting principles,
which require the measurement of financial position and operating results in
terms of historical dollars without considering the change in the relative
purchasing power of money over time and

                                       31
<PAGE>
 
due to inflation. The impact of inflation is reflected in the increased cost of
the Company's operations. Unlike most industrial companies, nearly all the
assets and liabilities of the Company are monetary in nature. As a result,
interest rates have a greater impact on the Company'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 price of goods and services.

IMPACT OF NEW ACCOUNTING STANDARDS

     In June 1996, the FASB issued SFAS No. 125 "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities". Under this
standard, accounting for transfers and servicing of financial assets and
extinguishments of liabilities is based on control. After a transfer of
financial assets, an entity recognizes the financial and servicing assets it
controls and the liabilities it has incurred, derecognizes financial assets when
control has been surrendered and derecognizes liabilities when extinguished.
This statement applies prospectively in fiscal years beginning after December
31, 1996. The Corporation does not expect the implementation of this statement
to have a material affect on the financial statements.

     In February 1997, the FASB issued SFAS No. 128, "Earnings Per Share" (EPS).
This statement specifies the computation, presentation, and disclosure
requirements for EPS. SFAS No. 128 is designed to improve the EPS information
provided in financial statements by simplifying the existing computational
guidelines, revising the disclosure requirements, and increasing the
comparability of EPS data on an international basis. Some of the changes made to
simplify the EPS computations include: (a) eliminating the presentation of
primary EPS and replacing it with basic EPS, with the principal difference being
that common stock equivalents (CSEs) are not considered in computing basic EPS,
(b) eliminating the modified treasury stock method and three percent provision
and (c) revising the contingent share provisions and the supplemental EPS data
requirements. SFAS No. 128 requires presentation of basic EPS amounts from
income for continuing operations and net income on the face of the income
statement for entities with simple capital structures and dual presentation of
basic and diluted EPS on the face of the income statement for all entities with
complex capital structures regardless of whether basic and diluted EPS are the
same. The statement also requires a reconciliation of the numerator and
denominator used on computing basic and diluted EPS and is applicable to all
entities with publicly held common stock or potential common stock. SFAS No. 128
is effective for periods ending, including interim periods after December 15,
1997. Earlier application is not permitted. EPS calculated under SFAS No. 128
are not expected to be materially different from EPS calculated under the
current method.

     In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income." This statement establishes standards for reporting and displaying
comprehensive income and its components in a full set of general-purpose
financial statements. The purpose of reporting comprehensive income is to
present a measure of all changes in equity that result from recognized
transactions and other economic events of the period other than transactions
with owners in their capacity as owners. If used with related disclosures and
other information in the financial statements, the FASB believes that the
information provided by reporting comprehensive income should help investors,
creditors, and others in assessing an enterprise's activities and the timing and
magnitude of its future cash flows. The statement requires that an enterprise
classify items of other comprehensive income by their nature in a financial
statement and display the accumulated balance of other comprehensive income
separately from retained earnings and additional paid-in capital in the equity
section of the balance sheet. This statement is effective for fiscal years
beginning after December 31, 1997 and reclassification of financial statements
for earlier periods provided for comparative purposes is required. Currently the
Company does not have any transactions that meet the definition of comprehensive
income. Therefore, there should not be any impact on the financial statements.

                                       32
<PAGE>
 
ITEM 7.  FINANCIAL STATEMENTS.
----------------------------- 

                SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA


SELECTED FINANCIAL CONDITION DATA
<TABLE>
<CAPTION>
 
                                                      At December 31,
                                        -------------------------------------------
                                         1992     1993     1994     1995     1996
                                        -------  -------  -------  -------  -------
                                                 (Dollars in thousands)

<S>                                     <C>      <C>      <C>      <C>      <C>
Total amount of:
 Assets...............................  $18,742  $21,138  $23,172  $26,550  $30,506
 Loans receivable, net................   17,189   19,238   20,999   24,340   26,988
 Cash and investment securities.......    1,183    1,578    1,362    1,070    2,255
 Mortgage-backed securities...........      279      166      108      579      746
 Deposits.............................   16,000   16,760   18,419   19,920   23,120
 FHLB advances........................    1,000    2,400    2,300    1,400    2,200
 Retained earnings - substantially
  restricted..........................    1,593    1,894    2,134    2,236    2,337
Number of:
 Real estate loans outstanding........      540      570      593      720      765
 Savings accounts.....................    1,829    1,840    2,250    2,100    2,264
 Offices..............................        1        1        1        1        1
</TABLE> 


<TABLE> 
<CAPTION>   
SELECTED OPERATIONS DATA
 
                                                 Year Ended December 31,
                                        -------------------------------------------
                                         1992     1993     1994     1995     1996
                                        -------  -------  -------  -------  -------
                                                      (In thousands)
 
<S>                                     <C>      <C>      <C>      <C>      <C>
Interest income.......................  $ 1,586  $ 1,547  $ 1,623  $ 1,954  $ 2,311
Interest expense......................      855      786      894    1,136    1,194
                                        -------  -------  -------  -------  -------
Net interest income before provision
 for loan losses......................      731      761      729      818    1,117
Provision for loan losses.............       18       11       12       12       18
Non-interest income...................       14       15       29       61       77
Non-interest expense..................      305      358      384      641      871
                                        -------  -------  -------  -------  -------
 
Income before income tax expense and
 cumulative effect of change in
 accounting principle.................      422      407      363      226      305
Income tax expense....................      138      138      123       77      107
Cumulative effect of charge in
 accounting principle (1).............       --       32       --       --       --
                                        -------  -------  -------  -------  -------
Net income............................  $   284  $   301  $   240  $   149  $   199
                                        =======  =======  =======  =======  =======
 
--------------------
</TABLE>
(1)  Reflects adoption of Statement of Financial Accounting Standards No. 109,
     "Accounting for Income Taxes."

                                       33
<PAGE>
 
KEY OPERATING RATIOS:
<TABLE>
<CAPTION>
 
 
                                                          At or for the
                                                     Year Ended December 31,
                                                   ---------------------------

<S>                                                  <C>      <C>      <C>
                                                       1994     1995     1996
                                                       ----     ----     ---- 
PERFORMANCE RATIOS:
 Return on assets (net income divided by
  average total assets).............................    1.09%     .59%     .71%
 Return on equity (net income divided by
  average equity)...................................   11.89     3.25     3.93
 Equity-to-assets ratio (average equity divided by
  average total assets).............................    9.14    18.07    18.05
 Interest rate spread (combined weighted average
  interest rate earned less combined weighted
  average interest rate cost).......................    3.00     2.50     3.30
 Net interest margin................................    3.37     3.35     4.10
 Ratio of noninterest expense to average
  total assets......................................    1.74     2.53     3.11
 
ASSET QUALITY RATIOS:
 Nonperforming assets to total assets
  at end of period..................................    1.23     2.89     2.66
 Allowance for loan losses to total
  assets at end of period...........................     .41      .40      .41
 Allowance for loan losses to nonperforming
   loans at end of period...........................   32.94    14.99    15.31
 Allowance for loan losses to total loans
   receivable, net..................................     .45      .44      .46
 
CAPITAL RATIOS:
 Equity to total assets at end of period............    9.21    19.22    16.50
 Average equity to average assets...................    9.14    18.07    18.05
 Ratio of average interest-earning assets to
  average interest-bearing liabilities..............  108.37   118.68   119.54
 Dividend payout ratio..............................     N/A      .32      .48
</TABLE>

                                       34
<PAGE>
 
                      PENFED BANCORP, INC. AND SUBSIDIARY
             REPORT ON AUDITS OF CONSOLIDATED FINANCIAL STATEMENTS
                FOR THE YEARS ENDED DECEMBER 31, 1995 AND 1996

                                      35
<PAGE>
 
REPORT OF INDEPENDENT ACCOUNTANTS

Board of Directors
Penfed Bancorp, Inc.
Falmouth, Kentucky

We have audited the accompanying consolidated statements of financial condition
of Penfed Bancorp, Inc. and Subsidiary as of December 31, 1995 and 1996, and the
related consolidated statements of income, changes in stockholders' equity, and
cash flows for the years then ended. These financial statements are the
responsibility of the Corporation's management. Our responsibility is to express
an opinion on these 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 respects, the consolidated financial position of Penfed
Bancorp, Inc. and Subsidiary as of December 31, 1995 and 1996, and the
consolidated results of its operations and its cash flows for the years then
ended in conformity with generally accepted accounting principles.


/s/ Coopers & Lybrand L.L.P.


Lexington, Kentucky
July 25, 1997

                                       1
<PAGE>
 
PENFED BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
<TABLE> 
<CAPTION> 
                                                                                          December 31,
                                   ASSETS                                            1995               1996
                                                                                 -------------     -------------
 <S>                                                                             <C>               <C> 
 Cash and balances with banks                                                    $     248,547     $     270,794
 Interest-bearing deposits in other depository institutions                            347,413         1,474,583
 Federal Home Loan Bank capital stock                                                  224,500           243,900
 Investments, held-to-maturity (estimated fair value of $251,105 and
      $262,667 at December 31, 1995 and 1996, respectively)                            250,000           265,396
 Mortgage-backed securities, held-to-maturity (estimated fair value of
      $592,929 and $762,925 at December 31, 1995 and 1996, respectively)               578,671           746,093
 Loans receivable, net                                                              24,339,783        26,988,223
 Accrued interest receivable on loans and investments                                   64,909           102,732
 Office property and equipment, at cost, less accumulated depreciation                 379,033           339,239
 Other assets                                                                          117,494            75,070
                                                                                 -------------     -------------
             Total assets                                                        $  26,550,350     $  30,506,030
                                                                                 =============     =============

                    LIABILITIES AND STOCKHOLDERS' EQUITY

 Savings deposits                                                                $   3,630,984     $   4,220,863
 Certificates of deposit                                                            16,289,193        18,898,762
 Advances from Federal Home Loan Bank                                                1,400,000         2,200,000
 Accrued interest on savings accounts and certificates                                  11,689             9,333
 Other liabilities                                                                      93,651           130,067
 Deferred income tax                                                                    21,855            14,224
                                                                                 -------------     -------------
             Total liabilities                                                      21,447,372        25,473,249

 Commitments (Note 5)

 Preferred stock, 500,000 shares authorized and unissued 
 Common stock, $.01 par value; 2,000,000 shares authorized; 345,000 shares 
      issued; 320,474  and 306,387 shares outstanding at December 31, 1995 
      and 1996, respectively                                                             3,450             3,450
 Additional paid-in capital                                                          3,109,755         3,117,084
 Employee stock ownership plan                                                        (244,260)         (208,490)
 Treasury stock                                                                         (1,200)         (215,859)
 Retained earnings, substantially restricted                                         2,235,233         2,336,596
                                                                                 -------------     -------------
             Total stockholders' equity                                              5,102,978         5,032,781
                                                                                 -------------     -------------
             Total liabilities and stockholders' equity                          $  26,550,350     $  30,506,030
                                                                                 =============     =============
</TABLE> 
The accompanying notes are an integral part of the consolidated financial
statements.

                                       2
<PAGE>
 
PENFED BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
<TABLE> 
<CAPTION> 
                                                                                            for the years ended
                                                                                                December 31,
                                                                                            1995           1996
                                                                                        ------------   ------------
<S>                                                                                     <C>            <C> 
 Interest on loans                                                                      $  1,850,871   $  2,201,648
 Interest on mortgage-backed securities                                                       32,126         51,991
 Interest on investment securities                                                            19,775         16,444
 Dividends on Federal Home Loan Bank Capital Stock                                            14,500         16,200
 Other interest income                                                                        36,475         24,391
                                                                                        ------------   ------------
         Total interest income                                                             1,953,747      2,310,674
                                                                                        ------------   ------------
 Interest on savings deposits and advances:
    NOW accounts                                                                               8,369         16,743
    Savings accounts                                                                          79,683         83,867
    Certificates                                                                             903,570        978,159
    Federal Home Loan Bank advances                                                          144,087        115,132
                                                                                        ------------   ------------
         Total interest expense                                                            1,135,709      1,193,901
                                                                                        ------------   ------------
         Net interest income                                                                 818,038      1,116,773
                                                                                        ------------   ------------
 Provision for loan losses                                                                    12,000         18,000
                                                                                        ------------   ------------
         Net interest income after provision for loan losses                                 806,038      1,098,773
                                                                                        ------------   ------------
 Noninterest income:
    Net gain on sale of real estate owned                                                        394          1,494
    Gain on sale of loans                                                                                    19,289
    Other income                                                                              60,728         56,931
                                                                                        ------------   ------------
         Total noninterest income                                                             61,122         77,714
                                                                                        ------------   ------------
 Noninterest expenses:
    Salaries and benefits                                                                    282,078        344,336
    Occupancy expense                                                                         74,084         68,556
    Equipment and data processing                                                             42,531         52,372
    Federal insurance premium                                                                 41,096        159,783
    State ad valorem taxes                                                                    20,755         26,135
    Professional services                                                                     90,459         84,123
    Other                                                                                     89,980        135,861
                                                                                        ------------   ------------
         Total other expenses                                                                640,983        871,166
                                                                                        ------------   ------------
         Income before income taxes                                                          226,177        305,321

 Income tax expense                                                                           77,256        106,537
                                                                                        ------------   ------------
             Net income                                                                 $    148,921   $    198,784
                                                                                        ============   ============
 Primary earnings per share                                                             $       0.39   $       0.62
 Weighted average shares outstanding for primary earnings per share                          319,163        319,184
 Fully diluted earnings per share                                                       $       0.39   $       0.62
 Weighted average shares outstanding for fully diluted earnings per share                    320,730        319,535
</TABLE> 

The accompanying notes are an integral part of the consolidated financial
statements.

                                       3
<PAGE>
 
PENFED BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDER'S EQUITY

<TABLE> 
<CAPTION> 
                                                                  Employee                  Retained
                                                     Additional     Stock                   Earnings,         Total
                                          Common      Paid-In     Ownership   Treasury    Substantially    Stockholders'
                                Shares     Stock      Capital       Plan       Stock       Restricted         Equity
                              ------------------------------------------------------------------------------------------
<S>                           <C>         <C>       <C>           <C>         <C>        <C>             <C> 
 Balance, December 31, 1994                                                              $   2,133,922   $    2,133,922
 Proceeds from issuance of
    common stock, net of
    conversion expense
    of $338,868                 345,000  $   3,450  $ 3,107,682                                               3,111,132
 Less Employee Stock
    Ownership Plan (ESOP)       (27,600)                         $ (276,000)                                   (276,000)
 Purchase of treasury stock        (100)                                     $  (1,200)                          (1,200)
 ESOP shares earned in 1995       3,174                   2,073      31,740                                      33,813
 Dividends declared,
    $0.15 per share                                                                            (47,610)         (47,610)
 Net income                                                                                    148,921          148,921
                              ------------------------------------------------------------------------------------------
 Balance, December 31, 1995     320,474      3,450    3,109,755    (244,260)    (1,200)      2,235,233        5,102,978
 Purchase of treasury stock     (19,402)                                      (235,105)                        (235,105)
 Issuance of treasury stock
    for MRP                       1,738                                         20,446          (1,328)          19,118
 ESOP shares earned in 1996       3,577                   7,329      35,770                                      43,099
 Dividends declared, $0.30
    per share                                                                                  (96,093)         (96,093)
 Net Income                                                                                    198,784          198,784
                              ------------------------------------------------------------------------------------------
 Balance, December 31, 1996     306,387  $   3,450  $ 3,117,084  $(208,490)  $(215,859)  $   2,336,596   $    5,032,781
                              ==========================================================================================
</TABLE> 
The accompanying notes are an integral part of the consolidated financial
statements.

                                       4
<PAGE>
 
PENFED BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE> 
<CAPTION> 

                                                                                 for the years ended
                                                                                     December 31,
                                                                                 1995           1996
                                                                             ------------    -----------
<S>                                                                         <C>             <C> 
Cash flows from operating activities:
  Net income                                                                $    148,921    $   198,784
  Adjustments to reconcile net income to net cash provided by operating 
    activities: 
    Depreciation                                                                  39,162         45,122
    ESOP expense                                                                  33,813         43,099
    Shares issued for MRP                                                                        19,118
    Stock dividend, FHLB stock                                                   (14,500)       (16,200)
    Deferred income taxes                                                         (3,935)        (7,631)
    Premium amortization and discount accretion on mortgage-backed      
         securities and investment securities, net                                (7,012)         3,359
    Gain on sale of other real estate                                             (3,754)           (60)
    Provision for loan losses                                                     12,000         18,000
    Loans originated for sale                                                  3,246,350      3,266,663
    Sale of loans                                                             (3,206,350)    (3,210,025)
    Gain on sale of loans                                                                       (19,289)
  Change in assets and liabilities:                                     
    Accrued interest receivable on loans and investments                         (13,176)        (5,199)
    Other assets                                                                                 (5,199)
    Federal income tax receivable                                                 40,884
    Accrued interest on savings accounts and certificates                         (7,742)        (2,356)
    Other liabilities                                                             73,711         36,416
                                                                            -------------   ------------

            Net cash provided by operating activities                            338,372        331,978
                                                                            -------------   ------------

Cash flows from investing activities:
  Proceeds from maturities of investment securities                              250,000
  Proceeds from maturities of mortgage-backed securities                                         96,355
  Purchase of investments securities                                            (250,000)       (15,403)
  Purchase of mortgage-backed securities                                        (666,054)      (308,498)
  Purchase of FHLB stock                                                                         (3,200)
  Mortgage-backed securities principal repayments                                203,029         41,369
  Net increase in loans receivable                                            (3,448,468)    (2,694,534)
  Purchase of office property and equipment                                     (154,362)        (5,328)
  Purchase of other investments                                                                 (15,000)
  Increase (decrease) in other assets                                            (53,428)        53,428
                                                                            -------------   ------------

            Net cash used in investing activities                             (4,119,283)    (2,850,811)
                                                                            -------------   ------------
</TABLE> 
           Continued

The accompanying notes are an integral part of the consolidated financial
statements.

                                       5
<PAGE>
 
PENFED BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS, Continued
<TABLE> 
<CAPTION> 
                                                                                for the years ended
                                                                                   December 31,
                                                                                1995           1996
                                                                            -------------   ------------
<S>                                                                         <C>             <C> 
Cash flows from financing activities:
  Net increase in savings accounts and certificates of deposits                2,270,850      3,199,448
  Net increase (decrease) in advances from Federal Home Loan Bank              (900,000)        800,000
  Dividends paid                                                                (47,610)       (96,093)
  Stock conversion costs                                                       (251,231)
  Purchase of treasury stock                                                     (1,200)      (235,105)
  Proceeds from stock conversion                                               2,404,562
                                                                            -------------   ------------

            Net cash provided by financing activities                          3,475,371      3,668,250
                                                                            -------------   ------------

            Net increase (decrease) in cash and cash equivalents               (305,540)      1,149,417

Cash and cash equivalents at beginning of year                                   901,500        595,960
                                                                            -------------   ------------

Cash and cash equivalents at end of year                                    $    595,960    $ 1,745,377
                                                                            =============   ============

Supplemental disclosure of cash flow information:

  Cash paid during the year for:  
                                  
    Interest                                                                $  1,143,451    $ 1,196,301
    Income taxes                                                            $     45,424    $    96,988

  Supplemental disclosure of noncash investing and financing activities:

    Real estate acquired                                                    $     78,456    $   146,935
    Real estate sold and financed by the Bank                               $     26,375    $   176,500
    Conversion proceeds transferred from savings deposits                   $    769,438
</TABLE> 




The accompanying notes are an integral part of the consolidated financial
statements.

                                       6
<PAGE>
 
PENFED BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


1.   Summary of Significant Accounting Policies
     ------------------------------------------

     The following is a description of the more significant accounting policies
     which Penfed Bancorp, Inc. (the Corporation) and its wholly owned
     subsidiary, Pendleton Federal Savings Bank (the Bank), follow in preparing
     and presenting its consolidated financial statements.

     A. Basis of Presentation
        ---------------------

        The consolidated financial statements include the accounts of the
        Corporation and the Bank. All significant intercompany accounts and
        transactions have been eliminated in consolidation.

        In preparing the financial statements, management is required to make
        estimates and assumptions that affect the reported amounts of assets and
        liabilities as of the date of the statements of financial condition and
        income and expenses for the period. Actual results could differ
        significantly from those estimates. Estimates used in the preparation of
        the financial statements are based on various factors including the
        current interest rate environment and the general strength of the local
        economy. Changes in the overall interest rate environment can
        significantly affect the Bank's net interest income and the value of its
        recorded assets and liabilities. Material estimates that are
        particularly susceptible to significant change in the near-term relate
        to the determination of the allowance for loan losses. In connection
        with this determination, management obtains independent appraisals for
        significant properties and prepares fair value analyses as appropriate.

        Management believes that the allowance for loan losses is adequate.
        While management uses available information to recognize such losses,
        future additions to the allowance may be necessary based on changes in
        economic conditions, particularly in Pendleton County and the State of
        Kentucky. 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 about information
        available to them at the time of their examination.

     B. Organization
        ------------

        The Bank is a federally chartered mutual savings bank and a member of
        the Federal Home Loan Bank System. As a member of this system, the Bank
        is required to maintain an investment in capital stock of the Federal
        Home Loan Bank of Cincinnati.

        The Corporation's purpose is to act as a holding company with the Bank
        as its sole subsidiary. The Corporation's principle business is the
        business of the Bank, and the Bank is predominately engaged in the
        business of receiving deposits from and making first

                                       7
<PAGE>
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued

1.   Summary of Significant Accounting Policies, continued
     ------------------------------------------

        mortgage loans to borrows on one to four family residential properties
        domiciled in Pendleton and surrounding counties. All activity is from
        the main office.

        Savings deposits of the Bank are insured by the FDIC up to certain
        limitations. The Bank pays a premium to the FDIC for the insurance of
        such savings deposits.

     C. Investment Securities
        ---------------------

        All investments in debt securities and all investments in equity
        securities that have readily determinable fair values are classified
        into three categories. Debt securities that management has the positive
        intent and ability to hold until maturity are classified as held to
        maturity. Securities that are bought and held specifically for the
        purpose of selling them in the near future are classified as trading
        securities. All other securities are classified as available for sale.
        Securities classified as trading and available for sale are carried at
        market value. Unrealized holding gains and losses for trading securities
        are included in current income. Unrealized holding gains and losses for
        available for sale securities are reported as a net amount in a separate
        component of stockholders' equity until realized. Investments classified
        as held to maturity will be carried at amortized cost.

        The Bank has analyzed its debt securities portfolio, and based on this
        analysis, the Bank has determined to classify all debt securities as
        held to maturity due to management's intent and ability to hold all debt
        securities so classified until maturity. Premiums and discounts on
        mortgage-backed securities are amortized over the term of the security
        using the interest method.

        No active market exists for Federal Home Loan Bank capital stock. The
        carrying value is estimated to be fair value, since if the Bank
        withdraws membership in the Federal Home Loan Bank, the stock must be
        redeemed for face value.

        Regulations require the Bank to maintain an amount of cash and U.S.
        government and other approved securities equal to a prescribed
        percentage (5% at December 31, 1995 and 1996) of deposit accounts (net
        of loans on deposits) plus short-term borrowings. At December 31, 1995
        and 1996, the Bank met these requirements.

     D. Depreciation
        ------------

        Depreciation of office property and equipment is calculated by the
        straight-line method over the estimated useful lives of such property.
        The gain or loss on the sale of office property and equipment is
        recorded in the year of disposition.

     E. Loans
        -----

        Loans are stated at the principal amount outstanding. Interest income on
        loans not made on a discount basis is recognized based on loan principal
        amounts outstanding during the period. Interest earned on loans
        receivable is recorded in the period earned.

                                       8
<PAGE>
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued

1.   Summary of Significant Accounting Policies, continued
     ------------------------------------------

     F. Loan Fees
        ---------

        Loan fees are accounted for in accordance with SFAS No. 91. SFAS No 91
        requires that loan origination fees and certain related direct loan
        origination costs be offset and the resulting net amount be deferred and
        amortized over the contractual life of the related loans as an
        adjustment to the yield of such loans.

     G. Provision for Loan Losses
        -------------------------

        The Bank has established an allowance for loan losses for the purpose of
        absorbing losses associated with the Bank's loan portfolio. All actual
        loan losses are charged to the related allowance and all recoveries are
        credited to it. Additions to the allowance for loan losses are provided
        by charges to operations based on various factors, including the market
        value of the underlying collateral, growth and composition of the loan
        portfolios, the relationship of the allowance for loan losses to
        outstanding loans, historical loss experience, delinquency trends and
        prevailing and projected economic conditions. Management evaluates the
        carrying value of loans periodically in order to evaluate the adequacy
        of the allowance. While management uses the best information available
        to make these evaluations, future adjustments to the allowance may be
        necessary if the assumptions used in making the evaluations require
        material revision.

        When a loan or portion of a loan is determined to be uncollectible, the
        portion deemed uncollectible is charged against the allowance and
        subsequent recoveries, if any, are credited to the allowance.

     H. Loan Sales
        ----------

        The Bank regularly sells whole interests in real estate loans. Mortgage
        loans originated and intended for sale are carried at lower of aggregate
        cost or market value. Gains and losses on such sales are recognized at
        the time of sale.

     I. Other Real Estate Owned
        -----------------------

        Real estate properties acquired through, or in lieu of, loan foreclosure
        are initially recorded at fair value at the date of foreclosure
        establishing a new cost basis. After foreclosure, valuations are
        periodically performed by management and the real estate is carried at
        the lower of (1) cost or (2) fair value minus estimated costs to sell.
        Any reduction to fair value from the new cost basis recorded at the time
        of acquisition is accounted for as a valuation reserve. Revenue and
        expenses from operations and additions to the valuation allowance are
        included in noninterest income.

     J. Income Taxes
        ------------

        Deferred income taxes are recognized for certain income and expenses
        that are recognized in different periods for tax and financial statement
        purposes.

                                       9
<PAGE>
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued


1.   Summary of Significant Accounting Policies, continued
     ------------------------------------------

     K. Cash and Cash Equivalents
        -------------------------

        For purposes of reporting cash flows, the Bank considers cash and
        balances with banks and interest-bearing cash deposits in other
        depository institutions with maturities of three months or less to be
        cash equivalents.

     L. Income Recognition on Impaired and Nonaccrual Loans
        ---------------------------------------------------

        Loans, including impaired loans, are generally classified as nonaccrual
        if they are past due as to maturity or payment of principal or interest
        for a period of more than 90 days, unless such loans are well-secured
        and in the process of collection. Loans that are on a current payment
        status or past due less than 90 days may also be classified as
        nonaccrual if repayment in full of principal and/or interest is in
        doubt.

        Loans may be returned to accrual status when all principal and interest
        amounts contractually due (including arrearages) are reasonably assured
        of repayment within an acceptable period of time, and there is a
        sustained period of repayment performance by the borrower, in accordance
        with the contractual terms of interest and principal.

        While a loan is classified as nonaccrual, interest income is generally
        recognized on a cash basis.

     M. Effect of Implementing New Accounting Standards
        -----------------------------------------------

        In June 1996, the Financial Accounting Standard Board (FASB) issued SFAS
        No. 125 "Accounting for Transfers and Servicing of Financial Assets and
        Extinguishments of Liabilities". Under this standard, accounting for
        transfers and servicing of financial assets and extinguishments of
        liabilities is based on control. After a transfer of financial assets,
        an entity recognizes the financial and servicing assets it controls and
        the liabilities it has incurred, derecognizes financial assets when
        control has been surrendered and derecognizes liabilities when
        extinguished. This statement applies prospectively in fiscal years
        beginning after December 31, 1996. The Corporation does not expect the
        implementation of this statement to have a material affect on the
        financial statements.

        In February 1997, the FASB issued SFAS No. 128, "Earnings Per Share"
        (EPS). This statement specifies the computation, presentation, and
        disclosure requirements for EPS. SFAS No. 128 is designed to improve the
        EPS information provided in financial statements by simplifying the
        existing computational guidelines, revising the disclosure requirements,
        and increasing the comparability of EPS data on an international basis.
        Some of the

                                       10
<PAGE>
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued

1.   Summary of Significant Accounting Policies, continued
     ------------------------------------------

        changes made to simplify the EPS computations include: (a) eliminating
        the presentation of primary EPS and replacing it with basic EPS, with
        the principal difference being that common stock equivalents are not
        considered in computing basic EPS, (b) eliminating the modified treasury
        stock method and three percent provision and (c) revising the contingent
        share provisions and the supplemental EPS data requirements. SFAS No.
        128 requires presentation of basic EPS amounts from income for
        continuing operations and net income on the face of the income statement
        for entities with simple capital structures and dual presentation of
        basic and diluted EPS on the face of the income statement for all
        entities with complex capital structures regardless of whether basic and
        diluted EPS are the same. The statement also requires a reconciliation
        of the numerator and denominator used on computing basic and diluted EPS
        and is applicable to all entities with publicly held common stock or
        potential common stock.

        SFAS No. 128 is effective for periods ending, including interim periods
        after December 15, 1997. Earlier application is not permitted. EPS
        calculated under SFAS No. 128 are not expected to be materially
        different from EPS calculated under the current method.

        In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
        Income". This statement establishes standards for reporting and
        displaying comprehensive income and its components in a full set of
        general-purpose financial statements. The purpose of reporting
        comprehensive income is to present a measure of all changes in equity
        that result from recognized transactions and other economic events of
        the period other than transactions with owners in their capacity as
        owners. If used with related disclosures and other information in the
        financial statements, the FASB believes that the information provided by
        reporting comprehensive income should help investors, creditors, and
        others in assessing an enterprise's activities and the timing and
        magnitude of its future cash flows. The statement requires that an
        enterprise classify items of other comprehensive income by their nature
        in a financial statement and display the accumulated balance of other
        comprehensive income separately from retained earnings and additional
        paid-in capital in the equity section of the balance sheet. This
        statement is effective for fiscal years beginning after December 31,
        1997 and reclassification of financial statements for earlier periods
        provided for comparative purposes is required. Currently the Corporation
        does not have any transactions that meet the definition of comprehensive
        income. Therefore, there should not be any impact on the financial
        statements.

     N. Reclassifications
        -----------------

        Certain presentations of accounts previously reported have been
        reclassified in these financial statements. Such reclassification had no
        effect on net income or retained income as previously reported.

                                       11
<PAGE>
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued

2.Investments
  -----------
<TABLE> 
<CAPTION> 
                                                                      Gross           Gross
                                                    Amortized       Unrealized     Unrealized        Estimated
                                                       Cost           Gains          Losses          Fair Value
                                                   -------------   -------------  --------------   ---------------
       <S>                                        <C>            <C>             <C>              <C> 
       December 31, 1995
         Federal Home Loan Bank
         at 6.39% due 12/6/2000                   $     250,000  $        1,015                   $       251,015
                                                  ============== ===============                  ================
       
       December 31, 1996
         Federal Home Loan Bank at 6.39%
         due 12/6/2000                            $     250,000                  $        2,345   $       247,655
         Pendleton County at 6.25% due
         2/1/2014                                        15,396                             384            15,012
                                                  --------------                 ---------------  ----------------
       
                                                  $     265,396                  $        2,729   $       262,667
                                                  ==============                 ===============  ================
</TABLE> 

       The amortized cost of investment securities includes unamortized premiums
       of $396 at December 31, 1996. Accrued interest receivable includes $1,331
       and $1,878 at December 31, 1995 and 1996, respectively, related to
       investment securities. There were no sales of investment securities
       during 1995 or 1996.


 3.    Mortgage-Backed Securities
       --------------------------

       Mortgage-backed securities are summarized as follows:
<TABLE> 
<CAPTION> 

                                                                    Gross            Gross
                                                 Amortized        Unrealized      Unrealized        Estimated
                                                    Cost            Gains           Losses          Fair Value
                                                -------------    -------------   --------------    -------------
       <S>                                     <C>              <C>             <C>              <C> 
       December 31, 1995:
       Federal Home Loan Mortgage
             Corporation                       $     578,671    $      14,258                    $      592,929
                                               ==============   ==============                   ===============
       December 31, 1996:
       Federal Home Loan Mortgage
             Corporation                       $     644,250    $      13,675                    $      657,925
       Small Business Administration                 101,843            3,157                           105,000
                                               --------------   --------------                   ---------------
                                               $     746,093    $      16,832                    $      762,925
                                               ==============   ==============                   ===============
</TABLE> 

       There were no sales of mortgage-backed securities during 1995 or 1996.

       The amortized cost of mortgage-backed securities includes unamortized
       premiums of $5,260 and $10,658 at December 31, 1995 and 1996,
       respectively.

       Accrued interest receivable includes $4,302 and $5,335 at December 31,
       1995 and 1996, respectively, related to mortgage-backed securities.

                                      12
<PAGE>
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued

 4.    Loans Receivable, Net
       ---------------------

       The Bank's loan portfolio consists principally of long-term conventional
       loans collateralized by first mortgages on single-family residences.
       Loans receivable, net at December 31, 1995 and 1996, consist of the
       following:
<TABLE> 
<CAPTION> 
                                                                                           December 31,
                                                                                      1995              1996
                                                                                  --------------    --------------
       <S>                                                                       <C>               <C> 
       Real estate loans:
          Construction                                                           $    1,790,360    $    3,267,700
          One- to four-family residential                                            20,667,142        21,817,915
          Agricultural (farm)                                                         1,435,587         1,838,743
          Multi-family residential                                                      604,587           574,375
          Non-residential property (excluding land)                                     295,909           553,298

       Consumer loans:
          Savings account loans                                                         142,688           123,705
          Secured loans                                                                                   175,160
                                                                                 ---------------   ---------------
                                                                                     24,936,273        28,350,896
       Less:
          Loans in process                                                              490,427         1,238,610
          Allowance for loan loss                                                       106,063           124,063
                                                                                 ---------------   ---------------

                                                                                 $   24,339,783    $   26,988,223
                                                                                 ===============   ===============
</TABLE> 

       Accrued interest receivable includes $59,276 and $95,535 at December
       31, 1995 and 1996, respectively, related to loans receivable.


       In 1995 and 1996 the Bank originated long-term fixed rate loans for sale
       in the secondary market to the Federal Home Loan Mortgage Corporation
       ("FHLMC"). The unpaid principal balances of loans serviced for FHLMC at
       December 31, 1995 and 1996 totaled $3,748,761 and $5,867,681,
       respectively.

       The following is a reconciliation of the allowance for loan losses:

<TABLE> 
<CAPTION> 
                                                                      December 31,
                                                                   1995           1996
                                                                -----------    -----------
      <S>                                                      <C>             <C> 
      Balance at beginning of year                             $    94,063     $  106,063

      Provision charged to operations                               12,000         18,000

      Loans charged off
                                                               ------------   ------------

       Balance and end of year                                 $   106,063    $   124,063
                                                               ============   ============
</TABLE> 

                                      13
<PAGE>
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued


 4.    Loans Receivable, Net, continued
       --------------------------------

       The following is a summary of non-performing loans:
<TABLE> 
<CAPTION> 
                                                                  December 31,
                                                               1995           1996
                                                            ------------   -----------
       <S>                                                  <C>            <C> 
       Nonaccrual loans                                     $   707,607    $  810,484
                                                            ------------   -----------
       
       Total non-performing loans at year end               $   707,607    $  810,484
                                                            ============   ===========
       
       Non-performing loans as a percentage of total
            loans                                                 2.90%         3.00%
</TABLE> 

       At December 31, 1995 and 1996, the amount of interest income that would
       have been recorded on loans in nonaccrual status, had such loans
       performed in accordance with their terms, would have been $66,403 and
       $71,971, respectively. The amount of interest income recognized on such
       loans for 1995 and 1996 totaled $26,901 and $22,047, respectively.

       Loans to executive officers and directors, including loans to affiliated
       companies of which executive officers and directors are principal owners,
       and loans to members of the immediate family of such persons at December
       31, 1995 and 1996 were as follows:
<TABLE> 
<CAPTION> 
                                                      December 31,
                                                   1995           1996
                                               -------------  -------------
       <S>                                     <C>            <C> 
       Balance at beginning of year            $    155,451   $    129,093
       
       New loans                                                   284,730
       
       Repayments                                    26,358        129,093
                                               -------------  -------------
       
       Balance at end of year                  $    129,093   $    284,730
                                               =============  =============
</TABLE> 

                                      14
<PAGE>
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued

 5.    Financial Instruments with Off-Balance Sheet Risk and Concentrations of
       -----------------------------------------------------------------------
       Credit Risk
       -----------

       The Bank is a party to financial instruments with off-balance sheet risk
       in the normal course of business to meet the financing needs of its
       customers. These financial instruments include mortgage commitments
       outstanding which amounted to approximately $1,861,000 and $2,065,000 at
       December 31, 1995 and 1996, respectively. At December 31, 1995 and 1996
       $431,000 and $298,000, respectively, of these commitments were for fixed
       rate loans and $1,430,000 and $1,767,000, respectively, were for variable
       rate loans. The weighted average rate on the fixed rate commitments at
       December 31, 1995 and 1996 was 7.22% and 8.00%, respectively. Variable
       rate loans at December 31, 1995 and 1996 were tied to the National
       Average Rate for all major types of lenders published by the Federal Home
       Loan Bank Board. These instruments involve, to varying degrees, elements
       of credit and interest rate risk in excess of the amount recognized in
       the balance sheets.

       The Bank's exposure to credit loss in the event of nonperformance by the
       other party to the financial instrument for loan commitments is
       represented by the contractual amount of those instruments. The Bank uses
       the same credit policies in making commitments and conditional
       obligations as it does for on-balance sheet instruments. Since many of
       the loan commitments may expire without being drawn upon, the total
       commitment amount does not necessarily represent future requirements. The
       Bank evaluates each customer's credit worthiness on a case-by-case basis.
       The amount of collateral obtained upon extension of credit is based on
       management's credit evaluation of the counterparty. Collateral held
       varies, but primarily includes residential real estate.

       The Bank has no significant concentrations of credit risk with any
       individual counterparty to originate loans. The Bank's lending is
       concentrated in residential real estate mortgages in the local Pendleton
       County, Kentucky market. The mortgage-backed securities held by the Bank
       consist of FHLMC pass-through securities, which are backed by the full
       faith and credit of this United States Government agency.

       The Bank has $347,413 and $1,474,583 of cash on deposit with one
       financial institution at December 31, 1995 and 1996.

 6.    Office Property and Equipment
       -----------------------------

       Office property and equipment consists of the following
<TABLE> 
<CAPTION> 

                                                                                  December 31,
                                                                               1995            1996
                                                                        ----------------  ----------------
       <S>                                                              <C>               <C> 
       Land                                                             $         4,400   $         4,400
       Office buildings and improvements                                        308,804           308,804
       Furniture and equipment                                                  207,525           212,853
                                                                        ----------------  ----------------
       
                                                                                520,729           526,057
                                                                            
       Less accumulated depreciation                                            141,696           186,818
                                                                        ----------------  ----------------
                                                                            
                                                                        $       379,033   $       339,239
                                                                        ================  ================
</TABLE> 

                                      15
<PAGE>
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued

 7. Deposits
    --------

       Deposit accounts are summarized as follows:

<TABLE>

                                                                                           December 31,
                                                                                      1995              1996
                                                                                 ---------------   ---------------
        <S>                                                                      <C>               <C>   
        Demand deposit accounts                                                  $      359,757    $      519,659
        NOW and MMDA deposits with a weighted average rate of
              4.72% and 4.38% at December 31, 1995 and 1996,
              respectively                                                            3,271,227         3,701,204
                                                                                 ---------------   ---------------

                     Savings deposits                                            $    3,630,984    $    4,220,863
                                                                                 ===============   ===============

        Certificates of deposit with a weighted average rate of 6.03%
              and 5.54% at December 31, 1995 and 1996, respectively              $   16,289,193    $   18,898,762
                                                                                 ===============   ===============
</TABLE> 

       Certificates of deposit by maturity at December 31, 1995 and 1996 are as
follows:

<TABLE> 
                                                                                             December 31,
                                                                                        1995              1996
                                                                                  ---------------   ---------------
             <S>                                                                 <C>               <C> 
             1 year                                                              $   10,946,256    $   11,941,654
             2 - 3 years                                                              4,343,412         6,853,973
             Maturing in years thereafter                                               999,525           103,135
                                                                                 ---------------   ---------------

                                                                                 $   16,289,193    $   18,898,762
                                                                                 ===============   ===============
</TABLE> 

       Certificates of deposit by maturity and interest rate category at
December 31, 1995 and 1996 are as follows:

<TABLE> 
<CAPTION> 
                                                        Amount due December 31, 1995
                           ---------------------------------------------------------------------------------------
                             Less than                                               After
                              One year         1-2 Years         2-3 Years          3 Years            Total
                           ---------------   ---------------   ---------------   ---------------   ---------------
           <S>             <C>               <C>               <C>               <C>               <C> 
           2.00-3.99%      $       10,000                                                          $       10,000
           4.00-5.99%           6,584,640    $      704,797    $      263,304                           7,552,741
           6.00-7.99%           4,321,616           989,257         2,386,054    $      999,525         8,696,452
           8.00-9.99%              30,000                                                                  30,000
                           ---------------   ---------------   ---------------   ---------------   ---------------

                           $   10,946,256    $    1,694,054    $    2,649,358    $      999,525    $   16,289,193
                           ===============   ===============   ===============   ===============   ===============
</TABLE> 

<TABLE> 
<CAPTION> 
                                                         Amount due December 31, 1996
                           -----------------------------------------------------------------------------------------
                             Less than                                               After
                              One year         1-2 Years         2-3 Years          3 Years             Total
                           ---------------   ---------------   ---------------   ---------------   -----------------
           <S>             <C>               <C>               <C>               <C>               <C>    
           2.00-3.99%      $       10,000                                                          $         10,000
           4.00-5.99%           5,650,093    $    2,434,713    $      700,356                             8,785,162
           6.00-7.99%           6,281,561         2,405,660         1,313,244    $      103,135          10,103,600
                           ---------------   ---------------   ---------------   ---------------   -----------------

                           $   11,941,654    $    4,840,373    $    2,013,600    $      103,135    $     18,898,762
                           ===============   ===============   ===============   ===============   =================
</TABLE> 

                                       16
<PAGE>
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued


 8.    Federal Home Loan Bank Advance
       ------------------------------

       The Federal Home Loan Bank advance at December 31, 1995 and 1996 consists
       of multiple notes with 90 day maturities. The weighted average interest
       rates on these borrowings is 5.95% and 7.15%, respectively. The Bank is
       required to pledge as collateral on the advance first mortgage single
       family 1-4 unit residential mortgage loans with an outstanding principal
       balance of one and a half times the amount advanced to the Bank.

 9.    Regulatory Matters
       ------------------

       The Bank is subject to various regulatory capital requirements
       administered by the OTS. Failure to meet minimum capital requirements can
       initiate certain mandatory, and possibly additional discretionary,
       actions by the OTS that, if undertaken, could have a direct material
       effect on the Bank's financial statements. Under capital adequacy
       guidelines and the regulatory framework for prompt corrective action, the
       Bank must meet specific capital guidelines that involve quantitative
       measures of the Bank's assets, liabilities, and certain off-balance-sheet
       items as calculated under regulatory accounting practices. The Bank's
       capital amounts and classification are also subject to qualitative
       judgments by the OTS about components, risk weightings, and other
       factors.

       Quantative measures established by regulation to ensure capital adequacy
       require the Bank to maintain minimum amounts and ratios (set forth in the
       table on the following page) of total and Tier I capital (as defined in
       the regulations) to risk-weighted assets (as defined), Tier I capital (as
       defined) to adjusted total assets and tangible capital to adjusted total
       assets. Management believes, as of December 31, 1996, that the Bank meets
       all capital adequacy requirements to which it is subject.

       As of December 31, 1996, the most recent notification from the OTS
       categorized the Bank as well capitalized under the regulatory framework
       for prompt corrective action. To be categorized as well capitalized the
       Bank must maintain minimum total risk-based, Tier I risk-based, and Tier
       I leverage ratios as set forth in the table on the following page. There
       are no conditions or events since that notification that management
       believes have changed the institution's category.

                                       17
<PAGE>
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued

9.    Regulatory Matters, continued
      ------------------ 

<TABLE> 
<CAPTION> 
                                                                                            To Be Well Capitalized
                                                                      For Capital          Under Prompt Corrective
                                             Actual                Adequacy Purposes          Action Provisions
                                     ------------------------   ------------------------   -------------------------
                                       Amount       Ratio         Amount       Ratio         Amount        Ratio
                                     -----------  -----------   -----------  -----------   -----------   -----------
 <S>                                 <C>          <C>           <C>          <C>           <C>           <C> 
 As of December 31, 1996:
    Total Capital (to Risk
         Weighted Assets)            $ 4,829,669          28%   $1,391,520            8%   $ 1,739,400            10%
                                                                                                                   
    Tier 1 Capital (to Risk                                                                                        
         Weighted Assets)            $44,705,606          27%   $  695,760            4%   $ 1,043,640             6%

    Tier 1 Leverage Capital
         (to Adjusted Total Assets)  $ 4,705,606          15%   $1,220,240            4%   $ 1,525,302             5%
                                                                                                                     
    Tangible Capital                                                                                                 
         (to Adjusted Total Assets)  $ 4,705,606          15%   $  457,590          1.5%   $   457,590           1.5%
                     
 As of December 31, 1995:
    Total Capital (to Risk
         Weighted Assets)            $ 4,893,165          32%   $1,219,760            8%   $ 1,524,700            10%

    Tier 1 Capital (to Risk
         Weighted Assets)            $ 4,787,102          31%   $  609,880            4%   $   914,820             6%

    Tier 1 Leverage Capital
         (to Adjusted Total Assets)  $ 4,787,102          19%   $1,062,015            4%   $ 1,327,518             5%

    Tangible Capital (to Adjusted
         Total Assets)               $ 4,787,102          19%   $  398,255          1.5%   $   398,255           1.5%
</TABLE> 

                                       18
<PAGE>
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued

10.    Income Taxes
       ------------

       Under the asset and liability method, deferred income taxes are
       recognized for the tax consequences of temporary differences by applying
       future statutory tax rates to differences between the financial
       statements carrying amounts and the tax basis of existing assets and
       liabilities.

         The provision for income taxes consists of:
<TABLE> 
<CAPTION> 
                                                                       December 31,
                                                                    1995              1996
                                                               ---------------   ---------------
           <S>                                                 <C>              <C> 
           Current                                             $      81,191    $      114,168
           Deferred                                                   (3,935)           (7,631)
                                                               ---------------   ---------------

                                                               $       77,256    $      106,537
                                                               ===============   ===============
</TABLE> 

       Deferred income taxes result from temporary differences in the
       recognition of income and expenses for tax and financial statement
       purposes. The source of these temporary differences and the tax effect of
       each are as follows:

<TABLE>
<CAPTION> 
                                                                       December 31,
                                                                    1995              1996
                                                               ---------------   ---------------
           <S>                                                 <C>               <C> 
           Reserve for loan losses                             $        3,768    $      (6,011)
           Accrual vs. cash method for income tax
                purposes                                              (28,941)          (4,283)
           Other                                                       (2,762)
           FHLB stock dividends                                         4,930            5,508
           Depreciation on office property and
                equipment                                              20,126            1,511
           Compensation expense                                        (1,056)          (4,356)
                                                               ---------------   ---------------

                                                               $       (3,935)   $      (7,631)
                                                               ===============   ===============

</TABLE> 

                                       19
<PAGE>
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued


10.    Income Taxes, continued
       ------------
 
       The following tabulation reconciles the federal statutory tax rate to the
       effective rate of taxes provided for income before taxes:


<TABLE> 
<CAPTION> 
                                                                         December 31,
                                                                     1995             1996
                                                                ---------------  ----------------
          <S>                                                   <C>              <C> 
          Tax at statutory rate                                          34.0%             34.0%
          Increases (decreases) in taxes resulting from:
                  Employee Stock Option Plan                              1.0%              0.8%
                  Other                                                  (0.8%)             0.1%
                                                                  -------------    --------------

          Effective rate                                                 34.2%             34.9%
                                                                  =============    ==============
</TABLE> 

       The tax effect of temporary differences giving rise to the Bank's
       deferred income tax asset (liability) at December 31, 1995 and 1996 are
       as follows:

<TABLE> 
<CAPTION> 
                                                                                            December 31,
                                                                                       1995              1996
                                                                                  ----------------  ----------------

             <S>                                                                  <C>               <C> 
             Deferred tax asset:
               Accrual vs. cash method for income tax purposes                    $        18,847   $        23,130
               Compensation expense                                                         1,056             5,412

             Deferred tax liability:
               Depreciation on office property and equipment                              (20,126)          (21,637)
               Reserve for loan losses                                                     (6,971)             (960)
               FHLB stock dividends                                                       (14,661)          (20,169)
                                                                                  ----------------  ----------------

             Deferred income tax liability, net                                   $       (21,855)  $       (14,224)
                                                                                  ================  ================
</TABLE> 

       On August 21, 1996, The Small Business Job Protection Act was signed into
       law which repeals the favorable tax bad debt deduction method available
       to savings banks. The Bank is required to change its tax bad debt method
       to the experience method under Internal Revenue Code Section 585
       effective for fiscal year ending December 31, 1996. The change in method
       will result in taxable income of approximately $126,885 representing the
       excess of the Bank's tax bad debt reserve at December 31, 1996 over the
       reserve that arose in tax years beginning before December 31, 1987 (base
       year amount). Generally, the income will be recognized for tax purposes
       ratably over a six-year period. However, the Bank is permitted to suspend
       this recognition for two years as it meets the residential loan
       requirement. A deferred tax liability has been established for the effect
       of this new legislation.

                                       20
<PAGE>
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued


10.    Income Taxes, continued
       ------------

       As of December 31, 1996, the Bank's bad debt reserve for federal tax
       purposes was approximately $538,516, of which $411,631 represents the
       base year amount. A deferred tax liability has not been recognized for
       the base year amount. If the Bank uses the base year reserve for any
       reason other than to absorb loan losses, a tax liability could be
       incurred. It is not anticipated that the reserve will be used for any
       other purpose.

11.    Employee Benefit Plans
       ----------------------

       A. Profit Sharing Plan
          -------------------
 
          The Bank has a contributory profit sharing plan and contributes
          annually, based upon profits, a percentage of employee compensation,
          to a trust. The Bank's contributions to the plan for the year ended
          December 31, 1995 was $4,059. There were no contributions for the year
          ended December 31, 1996.

       B. Employee Stock Ownership Plan
          -----------------------------

          As a part of the conversion to a stock entity, the Bank formed the
          Penfed Bancorp, Inc. Employee Stock Ownership Plan (ESOP). Generally,
          all employees of the Company are eligible to participate in the ESOP
          upon attainment of age 21 and completion of two years of service.
          Participants are 100% vested in their right to ESOP benefits at all
          times. In the case of a distribution of ESOP shares which are not
          readily tradable on an established securities market, the Plan
          provides the Participant with a put option that complies with the
          requirements of Section 409(h) of the Internal Revenue Code.

          On March 23, 1995, the plan borrowed $276,000 from the Corporation to
          purchase 27,600 shares of the Corporation's common stock. The
          obligation of the ESOP to repay the debt is guaranteed by the Bank.

          In November 1993, the AICPA issued Statement of Position 93-6
          "Employers' Accounting for Employee Stock Ownership Plans." The
          statement was adopted by the Bank on March 23, 1995, the effective
          date of the Bank's conversion to stock. The Statement requires, among
          other things, that: (1) for ESOP shares committed to be released in a
          period to compensate employees directly, employers should recognize
          compensation cost equal to the average fair value (as determined on a
          monthly basis) of the shares committed to be released, (2) dividends
          on unallocated shares ($4,140 and $7,328 for 1995 and 1996,
          respectively) used to repay ESOP loans are not considered dividends
          for financial reporting purposes, (3) for an internally leveraged
          ESOP, the Corporation loan receivable and the ESOP note payable as
          well as the interest income/expense is not reflected in the
          consolidated financial statement and (4) for earnings per share
          computations, ESOP shares

                                       21
<PAGE>
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued

11.    Employee Benefit Plans, continued
       ----------------------

       B.  Employee Stock Ownership Plan, continued
           -----------------------------

           that have been committed to be released should be considered
           outstanding. ESOP shares that have not been committed to be released
           should not be considered outstanding.

           Compensation cost charged to operations for the year ended December
           31, 1995 and 1996 totaled $33,813 and $43,099, respectively. The fair
           value of the 24,426 and 20,849 unearned ESOP shares at December 31,
           1995 and 1996 was $293,112 and $260,613, respectively. The ESOP held
           3,174 and 6,010 allocated shares at December 31, 1995 and 1996,
           respectively. Shares are released based on the amount of principal
           payments made on the loan.

       C.  Stock Award Plans
           -----------------

            MRP Plan
            --------

            In connection with the conversion, the Corporation adopted the
            Penfed Bancorp, Inc. Management Recognition Plan, the objective of
            which is to enable the Corporation to retain personnel of experience
            and ability in key positions of responsibility. Those eligible to
            receive benefits under the MRPs include certain directors and
            executive officers of the Corporation and Pendleton Federal as
            determined by members of a committee appointed by the Board of
            Directors. On October 25, 1995 8,694 shares were awarded. The fair
            market value of the common stock on that date was $11 and there is
            no exercise price for the stock. Awards to directors and eligible
            employees will vest 20% on each anniversary date of the award.
            Shares are held by the trustee and are voted by the MRP trustee in
            the same proportion as the trustee of the Corporation's ESOP plan
            vote shares held therein. Assets of the trust are subject to the
            general creditors of the Corporation. All shares vest immediately if
            there is a change in control or in the case of a participant's
            retirement after age 65, death or disability. The Corporation
            applied APB Opinion 25 and related Interpretations in accounting for
            the MRP plan. Compensation cost charged to operations for the MRP
            plan totaled $3,107 and $19,118 for the year ended December 31, 1995
            and 1996, respectively.

            Stock Option Plan
            -----------------

            The Corporation also granted stock options under the 1995 Stock
            Option and Incentive Plan (the Plan). The Corporation applies APB
            Opinion 25 and related Interpretations in accounting for the Plan.
            In 1995, the FASB issued FASB Statement No. 123 "Accounting for
            Stock-Based Compensation" (SFAS 123) which, if fully adopted by the
            Corporation, would change the methods the Corporation applies in
            recognizing the cost of the Plan. Adoption of the cost recognition
            provisions of SFAS 123 is optional and the Corporation has decided
            not to elect the provisions of SFAS 123 for the MRP and stock option
            plans. However, pro forma disclosures as if the Corporation adopted
            the cost recognition provisions of SFAS 123 in 1995 are required by
            SFAS 123 and are presented below.

                                       22
<PAGE>
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued


11.  Employee Benefit Plans, continued
     ----------------------

          Under the Plan the Corporation is authorized to issue shares of Common
          Stock pursuant to "Awards" granted in various forms, including
          incentive stock options (intended to qualify under Section 422 of the
          Internal Revenue Code of 1986, as amended), non-qualified stock
          options, and other similar stock-based Awards.

          The Corporation granted stock options in 1995 to employees and
          directors. The stock options granted in 1995 have contractual terms of
          10 years. All options granted to the employees and directors have an
          exercise price no less than the fair market value of the stock at
          grant date. The options granted in 1995 vest, 20% per year, beginning
          on the first anniversary of the date of grant. The Corporation granted
          21,735 options in 1995.

          In accordance with APB 25, the Corporation has not recognized any
          compensation cost for the plan in 1995 and 1996.

          A summary of the status of the Corporation's stock options as of
          December 31, 1995 and 1996 and the charges during the year ended on
          those dates is presented below:
<TABLE> 
<CAPTION> 
                                                                                 Stock Options
                                                               ------------------------------------------------
                                                                        1995                    1996
                                                               ------------------------------------------------
                                                               # Shares    Weighted   # Shares of   Weighted
                                                               of           Average    Underlying    Average
                                                               Underlying  Exercise     Options     Exercise
                                                                Options     Prices                   Prices
                                                               ------------------------------------------------
         <S>                                                   <C>         <C>        <C>           <C> 
         Outstanding, January 1                                         0                   21,735   $11.00
         Granted during year                                       21,735   $11.00               0
         Exercised during the year                                      0                        0
                                                               ------------------------------------------------

         Outstanding, December 31                                  21,735   $11.00          21,735   $11.00
                                                               ================================================
         Eligible for exercise at year end                                                   4,347
                                                               ================================================
         Weighted-average FV of options granted at-a-
         discount                                                       $2.67
                                                               ================================================
</TABLE> 

          For purposes of presenting proforma net income and net income per
          share in accordance with SFAS 123, the fair value of each stock option
          granted is estimated on the date of grant using the Black-Scholes
          option-pricing model with the following weighted-average assumptions
          for grants in 1995: dividend yield of 0.00% for both years; risk-free
          interest rate is 5.84%; the expected life of options is estimated to
          be 6 years; and a volatility of 21.69% for all grants.

          As of December 31, 1996, 21,735 options are outstanding with a
          weighted-average remaining contractual life of all stock options being
          8.81 years.

                                      23
<PAGE>
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued


11.  Employee Benefit Plans, continued
     ----------------------

          Had the compensation cost for the Corporations stock-based
          compensation plan been determined consistent with SFAS 123, the
          Corporation's net income and net income per common share for 1995 and
          1996 would approximate the pro forma amounts below:
<TABLE> 
<CAPTION> 

                                                        As Reported      Pro Forma      As Reported     Pro Forma
                                                          12/31/96        12/31/96        12/31/95       12/31/95
                                                       ---------------  -------------   -------------  -------------
                 <S>                                   <C>              <C>             <C>            <C> 
                 Net Income                              $    198,784   $    188,799    $    148,921   $    147,055

                 Earnings per share                      $       0.62   $       0.59    $       0.39   $       0.38
</TABLE> 

          The effects of applying SFAS 123 in this pro forma disclosure are not
          indicative of future amounts.


       D. Retirement Plan for Non-Employee Directors
          ------------------------------------------

          Effective January 1, 1995, the Board of Directors of the Bank adopted
          the Pendleton Federal Savings Bank Directors Retirement Plan for
          Non-Employee Directors (the "Plan"). A participant in the Plan will
          receive a one-time payment following his retirement in an amount equal
          to the product of his "Benefit Percentage," "Vested Percentage," (as
          defined) and two times the total fees he received for service on the
          Board during the calendar year preceding his retirement. Amounts
          charged to operations under the plan totaled $27,200 and $1,511 for
          the year ended December 31, 1995 and 1996, respectively.

       E. Supplemental Executive Retirement Agreement (SERA)
          --------------------------------------------------

          Effective March 23, 1995 the Bank entered into a supplemental
          retirement agreement with the president of the Bank. Upon the
          executive's termination of employment with the Bank, the executive
          will be entitled to receive annual payments equal to the product of
          the executive's "Vested Percentage" and "Average Annual Compensation",
          less the "Annual Offset Amount", as defined in the plan. Vesting
          occurs at 5% per full year of service with the Bank following March
          23, 1995. Compensation costs charged to operations totaled $10,000 for
          the year ended December 31,1996.

12.  Disclosures About Fair Value of Financial Instruments
     -----------------------------------------------------

     In December 1991, the FASB issued SFAS No. 107, "Disclosures About Fair
     Value of Financial Instruments." This statement extends the existing fair
     value disclosure practices for some instruments by requiring all entities
     to disclose the fair value of financial instruments (as defined), both
     assets and liabilities recognized and not recognized in the statements of
     financial condition, for which it is practicable to estimate fair value.

                                      24
<PAGE>
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued

12.  Disclosures About Fair Value of Financial Instruments, continued
     ------------------------------------------------------

     There are inherent limitations in determining fair value estimates as
     they relate only to specific data based on relevant information at that
     time. As a significant percentage of the Bank's financial instruments do
     not have an active trading market, fair value estimates are necessarily
     based on future expected cash flows, credit losses and other related
     factors. Such estimates are accordingly, subjective in nature, judgmental
     and involve imprecision. Future events will occur at levels different
     from that in the assumptions, and such differences may significantly
     affect the estimates.
     
     The statement excludes certain financial instruments and all nonfinancial
     instruments from its disclosure requirements. Accordingly, the aggregate
     fair value amounts presented do not represent the underlying value of the
     Corporation.
     
     Additionally, the tax impact of the unrealized gains or losses has not
     been presented or included in the estimates of fair value.
     
     The following methods and assumptions were used by the Corporation in
     estimating its fair value disclosures for financial instruments:
     
     Cash and Cash Equivalents: The carrying amounts reported in the
     statements of financial condition for cash and short-term instruments
     approximate those assets' fair values.
     
     Investment Securities and Mortgage-Backed Securities: Fair values for
     investment securities are based on quoted market prices, where available.
     If quoted market prices are not available, fair values are based on
     quoted market prices of comparable instruments. No active market exists
     for the Federal Home Loan Bank capital stock. The carrying value is
     estimated to be fair value, since if the Bank withdraws membership in the
     Federal Home Loan Bank, the stock must be redeemed for face value.
     
     Loans Receivable: For certain homogeneous categories of loans, such as
     residential mortgages and other consumer loans, fair value is estimated
     using the quoted market prices for securities backed by similar loans,
     adjusted for differences in loan characteristics. The fair value of other
     types of loans is estimated by discounting the future cash flows using
     the current rates at which similar loans would be made to borrowers with
     similar credit ratings and for the same remaining maturities.
     
     Deposits: The fair value of savings deposits and certain money market
     deposits is the amount payable on demand at the reporting date. The fair
     value of fixed-maturity certificates of deposit is estimated using the
     rates currently offered for deposits of similar remaining maturities.
     
     Advances from the Federal Home Loan Bank: Advances from the Federal Home
     Loan Bank are short term obligations that bear interest at current market
     rates, therefore their carrying value approximate their fair value.

                                      25
<PAGE>
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued

12.  Disclosures About Fair Value of Financial Instruments, continued
     -----------------------------------------------------

     Loan Commitments: The fair value of loan commitments is estimated to
     approximate the contract values, as the related loan will have a current
     market rate, the credit worthiness of the counterparties is presently
     considered in the commitments, and the original fees charged do not vary
     significantly from the fee structure at the end of the fiscal year.

     The estimated fair values of the Corporation's financial instruments are
     as follows:
<TABLE> 
<CAPTION> 

                                                                      1995                           1996
                                                        --------------------------------------------------------------
                                                            Carrying            Fair         Carrying         Fair
                                                             Amount             Value         Amount         Value
                                                        --------------------------------------------------------------
                                                                  (in thousands)                 (in thousands)
             <S>                                        <C>                <C>           <C>           <C> 
             Financial Assets:                                          
              Cash                                      $       249        $      249     $      271    $      271
               Interest-bearing deposits in other                                                       
                depository institutions                         347               347          1,475         1,475
               Federal Home Loan Bank capital stock             225               225            244           244
               Investments                                      250               251            265           263
               Mortgage-backed securities                       579               593            746           763
               Loans receivable, net of allowance for                                                     
               loan losses of $106 and $124 for 1995         24,340            24,385         26,988        27,010
               1995 and 1996, respectively                                                                
                                                                                                          
              Financial Liabilities:                                                                      
               Savings deposits                               3,631             3,688          4,221         4,269
               Certificates of deposit                       16,289            16,388         18,899        19,016
               Advances from Federal                                                                     
                Home Loan Bank                                1,400             1,400          2,200         2,200
</TABLE>  

13.  Conversion to Stock Savings Bank, Formation of Holding Company and Sale of
     --------------------------------------------------------------------------
     Common Stock
     ------------

     On March 23, 1995, the Bank converted from a mutual savings bank to a
     capital stock savings bank. The Bank issued all of its outstanding
     capital stock to Penfed Bancorp, Inc., a holding company for Pendleton
     Federal Savings Bank. Penfed Bancorp, Inc. consummated a public offering
     of 345,000 shares of common stock which generated net proceeds of
     $2,835,132 net of conversion costs totaling $338,868.

     At the time of conversion, the Bank established a liquidation account in
     an amount of the Bank's net worth as of the latest practicable date prior
     to conversion. The liquidation account is maintained for the benefit of
     eligible deposit account holders who maintain their deposit accounts in
     the Bank after conversion.

                                      26
<PAGE>
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued


13.  Conversion to Stock Savings Bank, Formation of Holding Company and Sale of
     --------------------------------------------------------------------------
     Common Stock, continued
     ------------

     In the event of a complete liquidation (and only in such an event), each
     eligible deposit account holder will be entitled to receive a liquidation
     distribution from the liquidation account, in the proportionate amount of
     the then current adjusted balance for deposit accounts held, before any
     liquidation may be made with respect to capital stock. The Bank may not
     declare or pay a cash dividend on or repurchase any of its common stock
     if the effect thereof would cause its regulatory capital to be reduced
     below the amount required for the liquidation account.
     
     The Bank may not declare or pay a cash dividend on or repurchase any of
     its stock if the effect would be to reduce retained earnings of the Bank
     below the capital requirements of the OTS. Federal regulations adopted by
     the OTS impose certain limitations on the payment of dividends and other
     capital distributions, including stock repurchases by the Bank. OTS
     regulations utilize a tiered approach which permits various levels of
     distributions based primarily upon an institution's capital level and net
     income. Based upon current OTS regulations and its capital structure at
     December 31, 1995 and 1996, the Bank may make capital distributions
     during a year up to the greater of (i) 100% of its net earnings to date
     during the calendar year plus an amount equal to one-half of the amount
     by which its total capital-to-assets ratio exceeded its fully phased-in
     capital-to-assets ratio at the beginning of the calendar year or (ii) 75%
     of its net income during the most recent four-quarter period. The amount
     computed under these OTS regulations cannot reduce the Bank's capital
     below the liquidation account as discussed above. At December 31, 1995
     and 1996, approximately $725,000 and $1,865,000 was available for payment
     of dividends from the Bank to the Corporation under the above mentioned
     OTS restrictions.
     
     The Corporation's Certificate of Incorporation authorizes 500,000 shares
     of preferred stock of the Corporation, of $.01 par value. The
     consideration for the issuance of the shares shall be paid in full before
     their issuance and shall not be less than the par value. Neither
     promissory notes nor future services shall constitute payment or part
     payment for the issuance of shares of the Corporation. The consideration
     for the shares shall be cash, tangible or intangible property (to the
     extent direct investment in such property would be permitted), labor or
     services actually performed for the Corporation, or any combination of
     the foregoing. The preferred stock, and any series of preferred stock, as
     established by the Board of Directors, the Corporation shall file
     articles of amendment to the Corporate Certificate of Incorporation with
     the Delaware Secretary of State establishing and designating the series
     and fixing and determining the relative rights and preferences thereof.
     The Corporation's Certificate of Incorporation expressly vests in the
     Board of Directors of the Corporation the authority to issue the
     preferred stock in one or more series and to determine, to the extent
     permitted by law prior to the issuance of the preferred stock (or any
     series of the preferred stock), the relative rights, limitations and
     preferences of the preferred stock or any such series.

                                      27
<PAGE>
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued


14.  Earnings Per Share
     ------------------

     The conversion from a mutual savings bank to a stock institution was
     completed March 23, 1995 (see Note 13). The computation of earnings per
     share for the year ended December 31, 1995 was based on the net income
     earned from the date of conversion divided by the weighted-average number
     of shares issued from the date of the conversion until the end of the
     fiscal year. The computation of earnings per share for the year ended
     December 31, 1996 was based on the net income earned for the year divided
     by the weighted-average number of shares outstanding during the year.

     Employee Stock Ownership Plan (see Note 11) shares not committed to be
     released to participants are not considered outstanding for the purposes of
     computing earnings per share. Stock options (see Note 11) are regarded as
     common stock equivalents. Common stock equivalents are computed using the
     treasury stock method.

15.  Condensed Financial Information (Parent Company Only)
     -----------------------------------------------------

     The following condensed statements summarize the financial position,
     operating results and cash flows of Penfed Bancorp, Inc. (Parent Company
     only).

<TABLE> 
<CAPTION> 
     Condensed Statement of Financial Condition                      December 31,
                                                                 1995            1996
                                                           ------------------------------
     <S>                                                   <C>             <C> 
          Assets

          Cash and balances with bank                      $      57,493   $      24,204
          Investment in subsidiary                             5,031,362       4,914,096
          Other assets                                            21,399          97,685
                                                           --------------  --------------
                                                                               
                                                           $   5,110,254   $   5,035,985
                                                           ==============  ==============
                                                                               
          Liabilities and Stockholders' Equity                                 
                                                                               
          Other liabilities                                $       7,276   $       3,204
          Stockholders' equity                                 5,102,978       5,032,781
                                                           --------------  --------------
                                                                               
                                                           $   5,110,254   $   5,035,985
                                                           ==============  ==============
</TABLE> 

                                       28
<PAGE>
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued

15.  Condensed Financial Information (Parent Company Only), continued
     -----------------------------------------------------

<TABLE> 
<CAPTION> 
       Condensed Statement of Income                                         For the Year
                                                                                Ended
                                                                             December 31,
                                                                         1995             1996
                                                                   --------------------------------
       <S>                                                         <C>              <C> 
          Dividend from subsidiary                                 $      47,610    $      331,279
          Interest income                                                 21,399            21,399
          Other income                                                                       1,303
          Other expense                                                                    (34,672)
                                                                   --------------   ---------------
                                                                                      
          Net income before income taxes                                  69,009           319,309
          Income tax expense (benefit)                                     7,276            (4,070)
                                                                   --------------   ---------------
                                                                                      
          Net income before equity in undistributed                                   
            net income of subsidiary                                      61,733           323,379
                                                                                      
          Equity (deficit) in undistributed net income of                             
          subsidiary                                                      87,188          (124,595)
                                                                   --------------   ---------------
                                                                                      
          Net income                                                                  
                                                                   $     148,921    $      198,784
                                                                   ==============   ===============
</TABLE> 

                                       29
<PAGE>
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued

15.  Condensed Financial Information (Parent Company Only), continued
     -----------------------------------------------------

<TABLE> 
<CAPTION> 
       Condensed Statement of Cash Flows                                          For the Year
                                                                                     Ended
                                                                                  December 31,
                                                                             1995              1996
                                                                      -----------------------------------
       <S>                                                            <C>                <C> 
       Operating activities:
         Net income                                                   $       148,921    $       198,784
         Adjustments to reconcile net income to cash
            provided by operating activities:
              Shares issued for MRP                                                               19,118
              Equity (deficit) in undistributed net income of
                subsidiary                                                    (87,188)           124,595
              Change in other liabilities                                       7,276             (4,072)
              Change in other assets                                          (21,399)           (76,286)
                                                                      ----------------   ----------------
       
         Net cash provided by operating activities                             47,610            262,139
                                                                      ----------------   ----------------
       
       Investing activities:
         Investment in subsidiary                                          (2,532,179)
         ESOP Loan                                                           (276,000)
         Payment on ESOP Loan                                                  31,740             35,770
                                                                      ----------------   ----------------
       
       Net cash (used in) provided by investment activities                (2,776,439)            35,770
                                                                      ----------------   ----------------
       
       Financing activities:
         Proceeds from stock conversion net of expenses                     2,835,132
         Dividends paid                                                       (47,610)           (96,093)
         Purchase of treasury stock                                            (1,200)          (235,105)
                                                                      ----------------   ----------------
       
       Net cash provided by (used in) financing activities                  2,786,322           (331,198)
                                                                      ----------------   ----------------
       
       Net increase (decrease) in cash                                         57,493            (33,289)
       
       Cash, beginning of period                                                                  57,493
                                                                      ----------------   ----------------
       
       Cash, end of year                                              $        57,493    $        24,204
                                                                      ================   ================
</TABLE> 

                                       30
<PAGE>
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued

16.  Subsequent Event
     ----------------

     On March 2, 1997 a severe storm created flooding on the Licking River in
     Northern Kentucky. As a result, the Corporation's wholly owned subsidiary,
     the Savings Bank, experienced significant property damage. The sixty-one
     inches of water in the Savings Bank's office in Falmouth, Kentucky severely
     damaged the internal fixtures of the Savings Bank and numerous financial
     documents. Collateral properties on several loans held by the Savings Bank
     were also damaged.

     The Savings Bank's office and many of the documents have been
     reconstructed. The Savings Bank recognized an extraordinary loss of
     approximately $167,000, which is the net of a related income tax benefit of
     approximately $86,200, as a result of uninsured flood loss. Management
     estimates that less than 10% of the loans in the Savings Bank's portfolio
     were adversely affected by the flood. Management attributes this to the
     geographic diversity of the Savings Bank's loans, in that an increasing
     percentage of the loans have been collateralized by properties located
     outside of Pendleton County in recent years. On the basis of management's
     assessment of all information currently available to it regarding the
     Savings Bank's loan portfolio, including the loans affected by the flood,
     the Corporation added approximately $26,000 to the loan loss allowance
     during the quarter ended March 31, 1997.

                                       31
<PAGE>
 
        Financial Statement Schedules. All schedules for which provision is made
in the applicable accounting regulations of the SEC are omitted because of the
absence of conditions under which they are required or because the required
information is included in the Consolidated Financial Statements and related
Notes thereto.

ITEM 8.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
------------------------------------------------------------------------
FINANCIAL DISCLOSURE.
-------------------- 

 None.

                              PART III

ITEM 9.  DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
----------------------------------------------------------------------
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT.
------------------------------------------------- 

        (a)  Directors, Nominees and Executive Officers.  The Company's Board of
Directors consists of six members.  The Company's Certificate of Incorporation
requires that directors be divided into three classes, as nearly equal in number
as possible, with approximately one-third of the directors elected each year.
The Board of Directors has nominated Delbert Cox and Larry A. Ritter  to serve
as directors for a three-year period.  All nominees are currently members of the
Board.

        The following table sets forth, for each nominee for director and
continuing director of the Company, his age, the year he first became a director
of the Bank, which is the Company's principal operating subsidiary, and the
expiration of his term as a director. All such persons were appointed as
directors in 1994 in connection with the incorporation and organization of the
Company. Each director of the Company also is a member of the Board of Directors
of the Bank.
<TABLE>
<CAPTION>
 
 
                                                             YEAR FIRST
                                                  AGE AT     ELECTED AS    CURRENT
                                               DECEMBER 31,  DIRECTOR OF    TERM
NAME                                               1996       THE BANK    TO EXPIRE
----                                           ------------  -----------  ---------
<S>                                            <C>           <C>          <C>
 
                                            BOARD NOMINEES FOR TERMS TO EXPIRE IN 2000
 
Delbert Cox                                         59          1994         1997
Larry A. Ritter                                     49          1983         1997
 
                                                  DIRECTORS CONTINUING IN OFFICE
 
John H. Browning                                    85          1966         1998
John D. Woodhead                                    56          1994         1998
Charles Lemmon, Jr.                                 77          1983         1999
David C. Wills                                      41          1993         1999
 
</TABLE>

                                      36
<PAGE>
 
     Set forth below is information concerning the Company's directors.  Unless
otherwise stated, all directors have held the positions indicated for at least
the past five years.

     DELBERT COX is the owner of Peach Grove Builders, a residential builder
located in Butler, Kentucky.  For the past 14 years Mr. Cox has served as a
Board member of the Three Rivers Health District.  He also serves as Treasurer
of the Peach Grove Cemetery and is a Deacon of the Second Twelve Mile Baptist
Church and a member of the Masonic Lodge.

     LARRY A. RITTER is the owner of Falmouth Lumber and Supply, a retail lumber
company located in Falmouth, Kentucky and Ritter Enterprises, Inc., a petroleum
distribution company.  Mr. Ritter is also a member of the Pendleton County
Chamber of Commerce.

     JOHN H. BROWNING has been retired since 1973.  He is a member of the
Veterans of Foreign Wars, the Kentucky Farm Bureau and the American Association
of Retired Persons.  Mr. Browning also serves as a Director of the Kincaid Park
Development Association.

     JOHN D. WOODHEAD is a funeral director and memorialist and serves as
President of Woodhead, Inc. a company which operates the Woodhead Funeral Homes
and Woodhead Memorials.  Mr. Woodhead is a member of the Rotary Club and served
as Chairman of the Pendleton County Bicentennial Celebration.

     CHARLES LEMMON, JR. is self-employed as a watchmaker and jeweler in
Falmouth, Kentucky.  Mr. Lemmon is also an elder in the Morgan Christian Church
and is past Board Chairman.

     DAVID C. WILLS serves as President and Chief Executive officer and a
Director of the Bank.  Mr. Wills joined the Bank in August 1993 as Senior Vice
President and Director and was promoted to his current position in April 1994.
Prior to joining the Bank, Mr. Wills served as Vice President of Pioneer Federal
Savings Bank, a savings bank headquartered in Winchester, Kentucky from April
1985 until August, 1993.  Mr. Wills is a Director of the Clark County Farm
Bureau.  He is also a member of the Rotary Club of Falmouth, and the Clark
County Agriculture 2000 Committee and serves as a Deacon of the Morgan Christian
Church.

EXECUTIVE OFFICERS WHO ARE NOT DIRECTORS

     The following sets forth information with respect to the executive officer
of the Company who does not serve on the Board of Directors.

                               AGE AT
                             DECEMBER 31,
      NAME                       1996           TITLE
      ----                   -----------        -----

  Leann Banta                    32        Secretary/Controller


     LEANN BANTA joined the Bank in September 1994 as Controller and currently
serves as Secretary and Controller of the Company.  From July 1989 to September
1994, Ms. Banta served as accounting clerk at Pioneer Federal Savings Bank, a
savings bank located in Winchester, Kentucky.  She is also the Treasurer of the
Pioneer Amateur Radio Club.

     (b) Section 16(a) Compliance.  Pursuant to regulations promulgated under
the Exchange Act, the Company's officers, directors and persons who own more
than ten percent of the outstanding Common Stock are required to file reports
detailing their ownership and changes of ownership in such Common Stock, and to
furnish the Company with copies of all such reports.  Based solely on its review
of the copies of such reports received during the past fiscal year or with
respect to the last fiscal year, the Company believes that during the fiscal
year ended December 31, 1996, all 

                                      37
<PAGE>
 
of its officers, directors and stockholders owning in excess of ten percent of
the Company's outstanding Common Stock have complied with the reporting
requirements.

ITEM 10.  EXECUTIVE COMPENSATION.
-------------------------------- 

DIRECTOR COMPENSATION

     The Company's directors each receive quarterly fees of $500.  The Company's
directors also serve on the Board of Directors of the Bank and each non-employee
director receives fees of $200 per meeting of the Bank's Board of Directors.

     Retirement Plan For Non-Employee Directors.  Effective January 1, 1995, the
Board of Directors of the Bank adopted the Pendleton Federal Savings Bank
Retirement Plan for Non-Employee Directors (the "Director Retirement Plan"). A
participant in the Director Retirement Plan will receive a one-time payment
following his or her retirement in an amount equal to the product of his or her
"Benefit Percentage," his or her "Vested Percentage," and two times the total
fees he or she received for service on the Board during the calendar year
preceding his or her retirement.  A participant's "Benefit Percentage" is based
on his or her overall years of service on the Board of Directors of the Bank,
and increases in increments of 33-1/3% from 0% for less than six years of
service, to 33-1/3% for six to 14 years of service, to 66-2/3% for 15 to 24
years of service, to 100% for 25 or more years of service.  Participants Benefit
Percentage accelerates to 100% upon retirement at or after age 70.  A
participant's "Vested Percentage" increases by 33-1/3% (to a maximum of 100%)
for each year of his or her service on the Board of Directors after March 23,
1995.  However, in the event a participant terminates service on the Board due
to "disability" or retirement at or after age 70, or in the event of a "change
in control" which results in the termination of the participant's service on the
Board (as such terms are defined in the Director Retirement Plan), the
participant's Vested Percentage becomes 100% regardless of his or her years of
service.  This provision may have the effect of deferring a hostile change in
control by increasing the costs of acquiring control.  If a participant dies,
his or her surviving spouse will receive an amount equal to 50% of the benefits
that would have been paid to the participant under the Director Retirement Plan
if the participant (i) had survived to collect the full benefits payable for
retirement or disability (provided that these payments had commenced prior to
the participant's death), and (ii) had a Vested Percentage equal to 100%.

EXECUTIVE COMPENSATION

     Summary Compensation Table.  The following table sets forth cash and
noncash compensation awarded to or earned by the Chief Executive Officer for the
fiscal years ended December 31, 1996, 1995 and 1994.  No executive officer
received salary and bonus in excess of $100,000 during 1996.
<TABLE>
<CAPTION>
 
                                                                 LONG-TERM COMPENSATION
                                ANNUAL COMPENSATION                      AWARDS
                         -----------------------------------    ------------------------
                                                                RESTRICTED    SECURITIES
NAME AND                                        OTHER ANNUAL      STOCK       UNDERLYING     ALL OTHER
PRINCIPAL POSITION       YEAR  SALARY   BONUS   COMPENSATION   AWARD(S)(1)    OPTIONS (1)   COMPENSATION
-----------------------  ----  -------  ------  ------------  --------------  -----------  --------------
<S>                      <C>   <C>      <C>     <C>           <C>             <C>          <C>     
 
Mr. David C. Wills       1996  $57,125  $3,800  $    --        $       --              --       $18,361(2)
  President and Chief    1995   52,500      --       --            37,950           8,625         9,287
  Executive Officer      1994   50,000   5,000       --                --              --        13,349
---------------------
</TABLE>
(1)  Awards of restricted stock granted under the Company's Management
     Recognition Plan (the "MRP") and options granted under the Company's 1995
     Stock Option and Incentive Plan (the "Option Plan") vest over a five year
     period at a rate of 20% per year.  Awards under these plans were granted on
     October 25, 1995.
(2)  Consists of insurance premiums paid by the Bank on Mr. Wills' behalf in the
     amount of $3,261, a special award of additional compensation in the amount
     of $500, and 1,168 allocated shares under the Company's Employee Stock
     Ownership Plan ("ESOP") with a market value as of December 31, 1996 of
     $12.50 per share.

                                      38
<PAGE>
 
     Year-End Option Values.  The following table sets forth information
concerning the value of options held by Mr. Wills at December 31, 1996.  Mr.
Wills did not exercise any options in 1996.  No SARs have been granted under the
Option Plan.
<TABLE>
<CAPTION>
 
                                                       NUMBER OF SECURITIES         VALUE OF UNEXERCISED
                                                      UNDERLYING UNEXERCISED        IN-THE-MONEY OPTIONS
                                                       OPTIONS AT YEAR-END             AT YEAR-END (1)
                         SHARES ACQUIRED   VALUE    --------------------------  ---------------------------
Name                       ON EXERCISE    REALIZED  EXERCISABLE  UNEXERCISABLE  EXERCISABLE   UNEXERCISABLE
----                     ---------------  --------  -----------  -------------  -----------  ---------------
<S>                      <C>              <C>       <C>          <C>            <C>          <C>
 
Mr. David C. Wills              --         $  --          1,725          6,900       $2,588         $10,350
  President and Chief
</TABLE>

Executive Officer
--------------------
(1)  Represents market price per share at end of fiscal year 1996 ($12.50 on
     December 31, 1996) less option exercise price per share ($11.00).

     Supplemental Executive Retirement Agreement. In order to secure the
continuing services of Mr. Wills, the President and Chief Executive Officer of
the Bank and the Company, the Bank has entered into a supplemental executive
retirement agreement (the "SERA") with Mr. Wills effective January 1, 1995.
Pursuant to the terms of the SERA, upon Mr. Wills' termination of employment
with the Company or the Bank, for reasons other than death or removal for "just
cause," he will be entitled to receive annual payments from the Bank in an
amount equal to (i) the product of (i) his "Vested Percentage" and 70% of his
"Average Annual Compensation," less (ii) his "Annual Offset Amount." Under the
SERA, "Vested Percentage" means 5% per full year of Mr. Wills' employment with
the Bank after March 23, 1995 (up to a maximum Vested Percentage of 100%).
Termination for "just cause" (as determined under Mr. Wills' severance
agreement) would result in his forfeiture of all benefits under the SERA. In the
event that Mr. Wills' employment is terminated due to his death or disability,
then his Vested Percentage shall be deemed to be 100%. "Average Annual
Compensation" means the average of Mr. Wills' highest annual compensation for
three of the five calendar years preceding his termination of employment, and
"Annual Offset Amount" means the sum of Mr. Wills primary social security
benefits, one-tenth of his account balance under the Bank's profit sharing plan
as of the valuation date immediately following his termination of employment,
one-tenth of the "annual additions" credited to Mr. Wills' account under the
ESOP (assuming that such amounts appreciate at seven percent from the date of
their allocation to Mr. Wills' account until the date of his termination of
employment). Annual payments under the SERA shall be made to Mr. Wills for 10
years. In the event of Mr. Wills' death before retirement benefits begin, the
Bank will pay his surviving spouse (or his estate, if no surviving spouse) a
lump sum payment equal to the present value of 50% of the retirement benefits
Mr. Wills would have received if he had terminated employment on the date of his
death and then had a Vested Percentage equal to 100%. In the event of Mr. Wills'
death after retirement benefits have commenced, the Bank will pay the surviving
spouse (or his estate, if no surviving spouse) a lump sum payment equal to the
present value of 50% of the remaining benefits that Mr. Wills would have
received had he survived to collect all the retirement benefits payable to him
under the SERA. The Bank intends to establish an irrevocable grantor trust to
hold assets in order to provide itself with a source of funds to assist the Bank
in the meeting of its liabilities under the SERA.

     Change in Control Severance Agreements. The Company and the Bank together
have entered into severance agreements (the "Severance Agreements") with Mr.
Wills. The Severance Agreements became effective on the date of completion of
the Bank's conversion from mutual to stock form, which occurred on March 23,
1995, and have a term ending on the earlier of (a) three years after March 23,
1995, and (b) the date on which Mr. Wills terminates employment with the Company
and the Bank, provided that Mr. Wills' rights under the Severance Agreement will
continue following his termination of employment after the date of the change in
control. On each annual anniversary date from the date of commencement of the
Severance Agreements, their term may be extended for additional one year periods
beyond the then effective expiration date, upon a determination by the Board of
Directors that Mr. Wills' performance has met the required performance standards
and that such Severance Agreements should be extended.

     Under the Severance Agreements, in the event of Mr. Wills' involuntary
termination of employment in connection with, or within 36 months after, any
change in control of the Bank or the Company, other than for "just cause," Mr.
Wills will be paid within 10 days of such termination an amount equal to the
difference between (i) 2.99

                                      39
<PAGE>
 
times his "base amount," as defined in Section 280G(b)(3) of the Code and (ii)
the sum of any other parachute payments, as defined under Section 280G(b)(2) of
the Code, that he receives on account of the change in control. "Control"
generally refers to the acquisition, by any person or entity, of the ownership
or power to vote more than 25% of the Bank's or Company's voting stock, the
control of the election of a majority of the Bank's or the Company's directors,
or the exercise of a controlling influence over the management or policies of
the Bank. In addition, under the Severance Agreements, a change in control
occurs when, during any consecutive two-year period, directors of the Company or
the Bank at the beginning of such period cease to constitute two-thirds of the
Board of Directors of the Company or the Bank, unless the election of
replacement directors was approved by a two-thirds vote of the initial directors
then in office. Each Severance Agreement also provides for a similar lump sum
payment to be made upon the occurrence, or within 90 days thereafter, of certain
specified events following the change in control, which have not been consented
to in writing by Mr. Wills, including (i) requiring him to perform his principal
executive functions more than 30 miles from the Bank's current primary office,
(ii) reducing Mr. Wills' base compensation as then in effect, (iii) failing to
maintain existing employee benefit plans, including material vacation, fringe
benefits, stock option and retirement plans, (iv) assigning material duties and
responsibilities to Mr. Wills which are other than those normally associated
with his position with the Bank, (v) a failure to elect or re-elect Mr. Wills to
the Board of Directors of the Company or the Bank, if he is serving on the Board
on the date of the change in control; (vi) a material reduction in Mr. Wills'
secretarial or other administrative support; and (vii) materially diminishing
Mr. Wills' authority and responsibility.

        The Severance Agreement between the Bank and Mr. Wills provides that
within five business days of a change in control, the Bank shall fund, or cause
to be funded, a trust in the amount of 2.99 times the base amount, that will be
used to pay amounts owed to him upon termination other than for just cause
within one year of the change in control. The amount to be paid to Mr. Wills
from this trust upon his termination is determined according to the procedures
outlined in the Severance Agreement with the Bank, and any money not paid to the
employee is returned to the Bank. The Severance Agreement between the Bank and
Mr. Wills also includes a provision under which Mr. Wills' severance benefits
will be adjusted upward or downward in the event benefits previously paid to him
are later determined to have been incorrectly calculated. The aggregate payments
that would be made to Mr. Wills assuming termination of his employment under the
foregoing circumstances on the Record Date would have been approximately
$173,420. These provisions may have an anti-takeover effect by making it more
expensive for a potential acquiror to obtain control of the Company. In the
event that the Mr. Wills prevails over the Company and the Bank in a legal
dispute as to the Severance Agreement, he will be reimbursed for his legal and
other expenses.

ITEM 11.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
------------------------------------------------------------------------

        (a)  Security Ownership of Certain Beneficial Owners
             -----------------------------------------------

        The following table sets forth information regarding the shares of
Common Stock beneficially owned at September 30, 1997 by persons who
beneficially own more than 5% of the Common Stock.
<TABLE>
<CAPTION>
 
                                    SHARES OF COMMON STOCK
NAME AND ADDRESS OF                   BENEFICIALLY OWNED            PERCENT
 BENEFICIAL OWNER                    AT SEPTEMBER 30, 1997         OF CLASS
-------------------                 ----------------------         --------
<S>                                 <C>                            <C>
 
Penfed Bancorp, Inc.                      26,859  (1)                8.6%
 Employee Stock Ownership Plan
 215 W. Shelby
 Falmouth, Kentucky  41040-1238
 
David C. Wills, President                 22,088 (2)                 7.0%
Penfed Bancorp, Inc.
</TABLE>

215 W. Shelby
Falmouth, Kentucky 41040-1238
--------------------
(1)  These shares are currently held in a suspense account for future allocation
     and distribution among participants as the loan used to purchase the shares
     is repaid.  The ESOP trustees vote all allocated shares in accordance with
     the instructions of the participating employees.  Unallocated shares and
     shares for which no instructions have been received are voted by the
     trustees in the same proportion as allocated shares are voted.
(2)  Includes 3,450 shares underlying options granted under the Company's Option
     Plan, 1,725 of which are immediately exercisable and 1,725 of which become
     exercisable on October 25, 1997.  Also includes 1,380 shares awarded under
     the Company's MRP, 690 of which vested on October 25, 1996 and 690 of which
     will vest on October 25, 1997.

                                      40

<PAGE>

       (b)  Security Ownership of Management 
            --------------------------------   
 
          The following table sets forth information regarding the shares of
Common Stock beneficially owned by the listed persons.  All persons listed in
this table have the same address as the Company.
<TABLE>
<CAPTION>
 
                                 SHARES OF COMMON STOCK
                                   BENEFICIALLY OWNED        PERCENT
NAME                           AT SEPTEMBER  30, 1997 (1)   OF CLASS
----                           --------------------------   --------
<S>                            <C>                          <C>
 
Delbert Cox                             8,466                    2.7%
Larry A. Ritter                        15,966 (2)                5.1
John H. Browning                        5,966                    1.9
John D. Woodhead                       15,966 (2)                5.1
Charles Lemmon, Jr.                    15,966 (2)                5.1
David C. Wills                         22,088                    7.0
 
All directors and executive
 officers of the Company
 as a group (7 persons)                88,134 (2)               27.5%
--------------------
</TABLE>
(1)  Includes stock held in joint tenancy; stock owned as tenants in common;
     stock owned or held by a spouse or other member of the individual's
     household; stock in which the individual either has or shares voting and/or
     investment power.  Except as otherwise noted, each person or relative of
     such person whose shares are included herein exercises sole (or shared with
     a spouse or other relative) voting and dispositive power as to the shares
     reported.  Also excludes 5,217 unvested shares held by the MRP.  Such
     shares are voted by the MRP trustees (Directors Ritter, Woodhead and
     Lemmon) in the same proportion as the ESOP trustees vote the shares held in
     the ESOP.  Also includes for all non-employee directors, 3,450 shares, and
     for Mr. Wills, 3,450 shares underlying options granted under the Option
     Plan.  Half of such options are exercisable immediately and half become
     exercisable  on October 25, 1997.
(2)  Does not include shares with respect to which Directors Ritter, Woodhead
     and Lemmon may have "voting power" by virtue of their positions as trustees
     of the trust holding 26,859 shares under the ESOP.


     (c)  Changes in Control
          ------------------

          Management of the Company knows of no arrangements, including any
          pledge by any person of securities of the Company, the operation of
          which may at a subsequent date result in a change in control of the
          Registrant.

ITEM 12.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
-------------------------------------------------------- 

     The Bank offers loans to its directors and employees.  All currently
outstanding loans to directors and executive officers were made in the ordinary
course of business of the Bank and on substantially the same terms, including
interest rates and collateral, as those prevailing at the time for comparable
transactions with other persons and did not involve more than the normal risk of
collectibility or present other unfavorable features.

                                      41
<PAGE>
 
                                 SIGNATURES

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

                                     PENFED BANCORP, INC.


October 3, 1997
                                     By: /s/ David C. Wills
                                     --------------------------
                                     David C. Wills
                                     President and Chief Executive Officer

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

<TABLE>
<CAPTION>
<S>                                             <C> 
/s/ David C. Wills                              October 3, 1997
------------------------------------
David C. Wills
President, Chief Executive Officer
  and Director
(Principal Executive Officer)
 
/s/ Leann Banta                                 October 3, 1997
------------------------------------
Leann Banta
Controller
(Principal Accounting Officer)
 
/s/ Larry A. Ritter                             October 3, 1997
------------------------------------
Larry A. Ritter
Chairman of the Board
 
/s/ John H. Browning                            October 3, 1997
------------------------------------
John H. Browning
Director
 
/s/ Delbert Cox                                 October 3, 1997
------------------------------------
Delbert Cox
Director
 
/s/ Charles Lemmon, Jr.                         October 3, 1997
------------------------------------
Charles Lemmon, Jr.
Director
 
/s/ John D. Woodhead                            October 3, 1997
------------------------------------
John D. Woodhead
</TABLE>
Director
<PAGE>
 
                                 PART IV

ITEM 13.  EXHIBIT LIST AND REPORTS ON FORM 8-K.
---------------------------------------------- 

     (a)  Exhibits.  The following is a list of exhibits filed as part of this
Annual Report on Form 10-KSB and is also the Exhibit Index.
<TABLE>
<CAPTION>
 
       No.                                               Description
       ---                                               -----------      
<S>                          <C>                            
 
   3.1                       Certificate of Incorporation of  Penfed Bancorp, Inc.*
   3.2                       Bylaws of Penfed Bancorp, Inc.*
   4                         Form of Common Stock Certificate  of Penfed Bancorp, Inc.*
  10.1                       Penfed Bancorp, Inc. 1995 Stock Option and Incentive Plan *+
  10.2                       Penfed Bancorp, Inc. Management Recognition Plan *+
  10.3(a)                    Severance Agreement by and between Penfed Bancorp, Inc. and David C. Wills *+
  10.3(b)                    Severance Agreement by and  between Pendleton Federal
                                Savings Bank and David C. Wills *+
  10.4                       Pendleton Federal Savings Bank Deferred Compensation Plan *+
  10.5                       Pendleton Federal Savings Bank Retirement Plan for Non-Employee Directors *+
  10.6                       Supplemental Executive Retirement  Agreement between
                                Pendleton Federal Savings Bank and David C. Wills*+
  10.7                       Pendleton Federal Savings Bank Grantor Trust Agreement *+
  11                         Computation of Earnings Per Share
  21                         Subsidiaries of the Registrant
  23                         Consent of Coopers & Lybrand, L.L.P.
  27                         Financial Data Schedule

</TABLE> 
--------------------
* Incorporated herein by reference from Registration Statement on Form S-1 filed
  November 23, 1994 (File No. 33-86686).
+ Management contract or compensatory plan or arrangement.

     (b) Reports on Form 8-K. During the quarter ended December 31, 1996, the
Registrant did not file any Current Reports on Form 8-K.

                                         

                                      43