UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

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

                    For the fiscal year ended: June 30, 1997

                                       OR

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

                          Commission File No.: 0-27940

                        HARRINGTON FINANCIAL GROUP, INC.
--------------------------------------------------------------------------------
             (Exact name of registrant as specified in its charter)


                  Indiana                                 48-1050267
------------------------------------------         -------------------------
       (State or other jurisdiction                    (I.R.S. Employer
     of incorporation or organization)              Identification Number)

    722 East Main Street, P. O. Box 968
             Richmond, Indiana                               47375
------------------------------------------         --------------------------
           (Address of Principal                           (Zip Code)
            Executive Offices)

       Registrant's telephone number, including area code: (765) 962-8531

          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 $0.125 per share)
                    -----------------------------------------
                                (Title of Class)

Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the  preceding 12 months (or for such  shorter  period that the  Registrant  was
required  to file  such  reports),  and  (2) has  been  subject  to such  filing
requirements for the past 90 days. Yes [X]  No [ ]

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

As of September 19, 1997,  the aggregate  value of the 943,690  shares of Common
Stock of the  Registrant  issued and  outstanding  on such date,  which excludes
2,313,048 shares held by all directors and executive  officers of the Registrant
as a group, was  approximately  $12.7 million.  This figure is based on the last
known  trade  price of $13.50  per  share of the  Registrant's  Common  Stock on
September 19, 1997.

                  Number of shares of Common Stock outstanding
                      as of September 19, 1997: 3,256,738
<PAGE>

                       DOCUMENTS INCORPORATED BY REFERENCE

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

(1) Portions of the Annual Report to Stockholders for the fiscal year ended June
    30, 1997 are incorporated into Parts II and IV.

(2)  Portions  of the  definitive  proxy  statement  for the  Annual  Meeting of
     Stockholders are incorporated into Part III.
<PAGE>
PART I.

Item 1.         Business

General

         Harrington    Financial    Group,    Inc.   (the   "Company")   is   an
Indiana-chartered,  registered  thrift holding company for Harrington  Bank, FSB
(the  "Bank").  The Bank is a federally  chartered  savings bank which  conducts
business  through  four  full-service  offices  located in Carmel,  Fishers  and
Noblesville,  Indiana,  suburbs of  Indianapolis,  and  Richmond,  Indiana.  The
Company was organized in March 1988 in connection  with its  acquisition  of the
Bank. The Bank was originally organized in 1889 as an Indiana-chartered  savings
association  under  the name  "The  Peoples  Home  and  Savings  Association  of
Richmond,  Indiana." In 1936,  the Bank obtained  federal  insurance and in 1984
adopted a federal  charter  and changed  its name to  "Peoples  Federal  Savings
Association."  In 1985,  the Bank  converted  from  mutual to stock form and, in
March 1994,  changed its name to  "Harrington  Bank,  FSB." On May 6, 1996,  the
Company sold  1,265,000  shares of common stock at $10.00 per share to investors
in an initial public offering  resulting in gross proceeds of $12,650,000 to the
Company.  Net proceeds to the Company after offering  expenses were $11,437,000.
At June 30, 1997, the Company had total  consolidated  assets of $446.8 million,
total consolidated  borrowings of $281.6 million, total consolidated deposits of
$136.2 million, and total consolidated stockholders' equity of $25.0 million.

         The Company was organized in March 1988 by certain  principals of Smith
Breeden Associates, Inc. ("Smith Breeden") for the sole purpose of acquiring the
Bank. This investor group purchased the Bank with the intention of expanding the
Bank's mortgage originations, investment and retail operations and improving the
Bank's return on equity.  The Company has contracted  with Smith Breeden for the
provision of consulting services regarding, among other things, providing advice
on  management  of its  investments  and  borrowings,  the  pricing of loans and
deposits,  and the use of various financial  instruments to reduce interest rate
risk. Certain directors of the Company and the Bank are principals or affiliates
of Smith Breeden.

         The Company  attempts to achieve  attractive  returns  consistent  with
prudent risk management by: (i) controlling interest rate risk by using interest
rate risk  management  contracts to match the interest rate  sensitivity  of its
assets to that of its liabilities; (ii) controlling credit risk by maintaining a
substantial  portion of the  Company's  assets in  mortgage-backed  and  related
securities  and  single-family  residential  loans;  (iii)  expanding its retail
banking  locations  and  product  offerings  in order  to build a strong  retail
franchise; and (iv) the pursuit of acquisition opportunities when appropriate.

         Highlights of the principal elements of the Company's business strategy
are as follows:

       Control Interest Rate Risk. The Company attempts to manage its assets and
       liabilities  in order to maintain a  portfolio  which  produces  positive
       returns in either an increasing or decreasing  interest rate environment.
       The  Company  has sought to control  interest  rate risk both  internally
       through the management of the  composition of its assets and  liabilities
       and  externally  through  the  utilization  of interest  rate  contracts.
       Interest rate  contracts  are purchased  with the intention of protecting
       both the net interest income of the Bank and, along with  mortgage-backed
       derivative  securities,  the market  value of the Bank's  portfolio  on a
       mark-to-market basis.

       Control Credit Risk. In order to limit the Company's  credit exposure and
       as part of its  strategy to earn a positive  interest  rate  spread,  the
       Company maintains a substantial  portion of its assets in mortgage-backed
       and related securities,  which are primarily issued or guaranteed by U.S.
       Government   agencies   or   government   sponsored   enterprises,    and
       single-family   residential  loans.  At  June  30,  1997,  the  Company's
       investment in mortgage-backed  and related securities  amounted to $311.6
       million or 97.9% of the  Company's  securities  portfolio  (both held for
       trading and available for sale) and 69.8% of the Company's  total assets.
       In addition,  as of such date, the Company's  investment in single-family
       residential loans amounted to $91.1 million or 20.4% of total assets. See
       "- Lending" and "- Investment Activities."

       Increase  Emphasis on Retail  Banking.  An integral part of the Company's
       strategy  is to  increase  the Bank's  emphasis  on retail  products  and
       services.  The Company's  primary lending  emphasis is on the origination
       (both  directly  and through  correspondents)  of loans  secured by first
       liens on single-family  (one-to-four  units) residences.  Originations of
       such loans have  increased from $18.9 million during fiscal 1995 to $41.6
       million during fiscal 1996 and decreased slightly to $37.2 million during
       fiscal  1997.  See "- Lending  Activities."  In addition,  the  Company's
       retail deposits (including  transaction  accounts and retail certificates
       of deposit) have  increased from $82.3 million or 71.4% of total deposits
       at June 30, 1995 to $123.5 million or 90.7% of total deposits at June 30,
       1997.  See "- Sources  of Funds  Deposits."  The  Company  believes  that
       single-family  residential loan  originations  generally offer attractive
       risk adjusted returns and, with respect to direct originations, allow the
       Company to establish a relationship  with the  underlying  borrower which
       the Company can utilize to cross-sell  additional  products and services.
       In  addition,   the  Company   believes   that  retail   deposits  are  a
       cost-effective  source  of funds,  provide  an  additional  source of fee
       income, and also permit the further  cross-selling of additional products
       and services.  Consequently,  the Company expects to continue to focus on
       increasing  its retail  deposit base and its  portfolio of  single-family
       residential loans.

       Asset  Growth and  Acquisitions.  The  Company  has and will  continue to
       pursue a policy of utilizing its existing capital and  infrastructure  to
       grow through the purchase of  mortgage-backed  and related securities and
       the continued  growth of the Bank's  retail  operations  consistent  with
       Board mandated capital levels. The Company will also consider acquisition
       opportunities when it perceives that they are advantageous to the Company
       and  its  stockholders.  There  are  currently  no  plans,  arrangements,
       understandings    or   agreements    regarding   any   such   acquisition
       opportunities.

         The Company,  as a  registered  savings and loan  holding  company,  is
subject  to  examination  and  regulation  by the  Office of Thrift  Supervision
("OTS")  and is subject  to  various  reporting  and other  requirements  of the
Securities and Exchange Commission  ("SEC").  The Bank, as a federally chartered
savings bank, is subject to comprehensive regulation and examination by the OTS,
as its chartering  authority and primary  regulator,  and by the Federal Deposit
Insurance  Corporation  ("FDIC"),  which  administers  the  Savings  Association
Insurance Fund ("SAIF"), which insures the Bank's deposits to the maximum extent
permitted by law. The Bank is a member of the Federal Home Loan Bank ("FHLB") of
Indianapolis,  which is one of the 12  regional  banks which  comprise  the FHLB
System.  The Bank is further subject to regulations of the Board of Governors of
the Federal Reserve System ("Federal Reserve Board") governing reserves required
to be maintained against deposits and certain other matters.  See "- Supervision
and Regulation."

Investment Advisor

         Smith Breeden is a money management and consulting firm involved in (i)
money  management for separate  accounts such as corporate,  state and municipal
pensions, endowments and mutual funds, (ii) financial institution consulting and
investment advice, and (iii) equity  investments.  Smith Breeden  specializes in
mortgage-backed and related securities,  interest rate risk management,  and the
application of option pricing to loans and investments.  Smith Breeden currently
advises, or manages on a discretionary basis, assets totaling  approximately $18
billion.  The firm has acted as a consultant to banks,  thrifts and governmental
agencies  charged  with  the  regulation  of  financial   institutions  and  the
resolution of troubled thrifts.

         Smith Breeden was  co-founded in 1982 by Douglas T. Breeden and Gregory
Smith,  who retired in 1988. Dr. Breeden is Chairman of the Board of the Company
and  currently  is a Research  Professor of Finance at Duke  University's  Fuqua
School of  Business.  He  previously  served  on the  faculty  at  Massachusetts
Institute of  Technology,  the  University  of Chicago and Stanford  University,
where he obtained his Ph.D. in Finance.

         Since  1988,  Smith  Breeden and  certain of its  principals  have been
involved in making equity  investments in financial  institutions in tandem with
the  application  of  modern   investment  and  interest  rate  risk  management
techniques.  Certain of the  principals  of Smith Breeden are investors in other
banks and thrift institutions.

         Smith Breeden is based in Chapel Hill, North Carolina, and employs over
67 people in its main office and its offices in Overland Park,  Kansas,  Dallas,
Texas and Boulder, Colorado.

Lending Activities

         General.  At June 30, 1997, the Bank's net loan portfolio totaled $94.0
million,  representing  approximately  21.0% of the Company's  $446.8 million of
total  assets at that date.  In addition to  utilizing  option-adjusted  pricing
analysis in order to manage the Company's investment portfolio, the Company also
uses such analysis to price its loan  originations  and ascertain the net spread
expected to be earned  with  respect to the Bank's  loan  portfolio.  The Bank's
primary focus with respect to its lending  operations has historically  been the
direct  origination and servicing of single-family  residential  mortgage loans.
Since  fiscal  1995,  the  Bank  has  also  been  active  in  originating  whole
residential  mortgage  loans through  correspondents  which meet its pricing and
credit  quality  objectives.  To a  much  lesser  extent,  the  Bank  originates
commercial real estate loans and consumer loans. Substantially all of the Bank's
loan portfolio consists of conventional  loans, which are loans that are neither
insured by the Federal Housing  Administration  nor partially  guaranteed by the
Department of Veterans Affairs.

         The  risks  associated  with  mortgage  lending  are  well-defined  and
controllable.  Credit  risk  is  controlled  through  the  adherence,  with  few
exceptions,  to secondary market underwriting guidelines. A strong internal loan
review program monitors compliance with the Bank's underwriting standards, which
is reflected by the low level of non-performing  assets.  See - "Asset Quality -
Non-Performing  Assets." Market risk is controlled by a disciplined  approach to
pricing  and by regular  monitoring  and  hedging of the  institution's  overall
sensitivity to interest rate changes.

         As a  federally  chartered  savings  institution,  the Bank has general
authority  to  originate  and  purchase  loans  secured by real  estate  located
throughout the United States. Notwithstanding this nationwide lending authority,
the Company  estimates that at June 30, 1997,  approximately 88% of the loans in
the Bank's  portfolio  are secured by  properties  located or made to  customers
residing in its  primary  market  area,  which  consists  of Wayne and  Hamilton
counties in eastern and central Indiana and contiguous counties.

         Although the Bank has historically  originated loans with lesser dollar
balances  than  are  permitted  by  federal  regulations,  current  loans-to-one
borrower  limitations  may  restrict  its  ability to do business  with  certain
customers.  A  savings  institution  generally  may not  make  loans  to any one
borrower and related  entities in an amount which exceeds 15% of its  unimpaired
capital and surplus,  although  loans in an amount equal to an additional 10% of
unimpaired  capital and surplus may be made to a borrower if the loans are fully
secured  by  readily  marketable  securities.  At  June  30,  1997,  the  Bank's
regulatory limit on loans-to-one  borrower was $4.0 million and its five largest
loans or groups of loans-to-one borrower, including related entities, aggregated
$578,000,  $564,000,  $395,000,  $375,000 and  $369,000.  All five of the Bank's
largest  loans or  groups  of  loans  are  secured  primarily  by  single-family
residential  real estate located in its primary market area and were  performing
in accordance with their terms at June 30, 1997.
<PAGE>
Loan Portfolio  Composition.  The following  table sets forth the composition of
the Bank's loan portfolio by type of loan at the dates indicated.
<TABLE>
<CAPTION>
                                                                          June 30,                                          
                                     ---------------------------------------------------------------------------------------
                                               1997                         1996                          1995              
                                     -------------------------- ----------------------------- ------------------------------
                                       Amount        Percent        Amount         Percent         Amount         Percent   
                                     ------------   ----------- ---------------  ------------ -----------------  -----------
                                                                   (Dollars in Thousands)                                   

<S>                                    <C>             <C>        <C>               <C>           <C>                 <C>  
Single-family residential (1)          $91,140          97.2%     $64,899            97.8%        $35,998              96.1%
Commercial real estate (2)                 258           0.3          441             0.7             711               1.9 
                                       -------         -----      -------           -----         -------             ----- 
     Total real estate loans            91,398          97.5       65,340            98.5          36,709              98.0 
Consumer loans:
     Deposit secured                       252           0.2          267             0.4             255               0.7 
     Home improvement/equity             2,136           2.3          732             1.1             498               1.3 
     Other                                   --          --             --            --               --               --  
                                       --------        -----      --------          -----         -------             ----- 
       Total consumer loans              2,388           2.5          999             1.5             753               2.0 
                                       -------         -----      -------           -----         -------             ----- 
         Total loans                    93,786         100.0%      66,339           100.0%         37,462             100.0%
                                                       =====                        =====                             ===== 
Less:
     Unamortized push-down
       accounting adjustment (3)          (136)                      (182)                           (350)                  
     Unamortized discount on loans         --                          (7)                            (13)                  
     Undisbursed funds (4)                  (9)                      (420)                            (43)                  
     Deferred loan origination
       (fees) costs                        530                        315                              75                   
     Allowance for loan losses            (213)                      (120)                           (121)                  
                                       -------                    -------                         -------                   
       Net loans                       $93,958                    $65,925                         $37,010                   
                                       =======                    =======                         =======                   
<PAGE>
<CAPTION>
                                                            June 30,
                                     ------------------------------------------------------
                                               1994                        1993
                                     --------------------------  --------------------------
                                        Amount        Percent       Amount       Percent
                                     --------------  ----------  -------------  -----------
                                                    (Dollars in Thousands)
<S>                                       <C>           <C>          <C>           <C>
Single-family residential (1)             $20,525        96.6%       $16,696        96.0%
Commercial real estate (2)                    349         1.6            456         2.6
                                          -------       -----        -------       -----
     Total real estate loans               20,874        98.2         17,152        98.6
Consumer loans:
     Deposit secured                          150         0.7             88         0.5
     Home improvement/equity                  210         1.0            160         0.9
     Other                                     17         0.1              3         --
                                          -------       -----        -------       -----
       Total consumer loans                   377         1.8            251         1.4
                                          -------       -----        -------       -----
         Total loans                       21,251       100.0%        17,403       100.0%
                                                        =====                      =====
Less:
     Unamortized push-down
       accounting adjustment (3)             (419)                      (592)
     Unamortized discount on loans            (19)                       (21)
     Undisbursed funds (4)                     (8)                        (7)
     Deferred loan origination
       (fees) costs                           (17)                        (7)
     Allowance for loan losses               (106)                      (156)
                                          -------                    -------
       Net loans                          $20,682                    $16,620
                                          =======                    =======
</TABLE>

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

(1)    Includes single-family  residential construction loans. At June 30, 1997,
       the Bank's single-family  residential loan portfolio included $151,000 of
       single-family residential construction loans.

(2)    Includes $258,000,  $291,000, $321,000, $349,000 and $456,000 of mortgage
       revenue bonds secured by commercial real estate at each of the respective
       dates.

(3)    Reflects  the  balance  of the fair  value  adjustments  made on the loan
       portfolio  as a  result  of  the  completion  in  September  1988  of the
       Company's  acquisition of the Bank,  which  acquisition was accounted for
       under the purchase method of accounting.

(4)    Includes   undisbursed   funds  relating  to  single-family   residential
       construction loans.
<PAGE>
         Contractual  Principal  Repayments  and Interest  Rates.  The following
table sets forth  certain  information  at June 30,  1997  regarding  the dollar
amount of loans  maturing  in the  Bank's  total  loan  portfolio,  based on the
contractual terms to maturity, before giving effect to net items.
<TABLE>
<CAPTION>
                                                              Due After            Due After
                                       Due in One            One to Five          Five or More
                                      Year or Less              Years                Years                Total
                                   --------------------     ----------------    ------------------    ---------------
                                                                       (In Thousands)
<S>                                      <C>                    <C>                <C>                    <C>     
Single-family residential                $ 195                  $ 560              $ 90,385               $ 91,140
Commercial real estate                      --                     --                   258                    258
Consumer                                   226                    228                 1,934                  2,388
                                         -----                  -----              --------               --------
     Total                               $ 421                  $ 788              $ 92,577               $ 93,786
                                         =====                  =====              ========               ========
</TABLE>
         The following  table sets forth the dollar amount of all loans,  before
net items,  due after one year from June 30,  1997,  which  have fixed  interest
rates or which have floating or adjustable interest rates.
<TABLE>
<CAPTION>
                                                                           Floating or
                                                  Fixed Rates           Adjustable-Rates                 Total
                                               ------------------     -----------------------      -------------------
                                                                         (In Thousands)
<S>                                               <C>                          <C>                     <C>     
Single-family residential                         $ 56,567                     $ 34,378                $ 90,945
Commercial real estate                                 258                           --                     258
Consumer                                               957                        1,205                   2,162
                                                  --------                     --------                --------
    Total                                         $ 57,782                     $ 35,583                $ 93,365
                                                  ========                     ========                ========
</TABLE>
<PAGE>
         Origination,  Purchase and Sale of Loans. The lending activities of the
Bank are subject to the written,  non-discriminatory  underwriting standards and
loan  origination  procedures  established  by the Bank's Board of Directors and
management.  Loan  originations are obtained by a variety of sources,  including
referrals  from real  estate  brokers,  builders,  existing  customers,  walk-in
customers, loan officers and advertising.  In its marketing, the Bank emphasizes
its community ties,  customized  personal  service,  competitive  rates,  and an
efficient  underwriting  and approval  process.  Loan  applications are taken by
lending personnel,  and the loan department  supervises the obtainment of credit
reports,  appraisals  and other  documentation  involved  with a loan.  Property
valuations  are  performed by  independent  outside  appraisers  approved by the
Bank's Board of Directors.  The Bank requires  title,  hazard and, to the extent
applicable, flood insurance on all security property.

         Mortgage  loan  applications  are reviewed by Bank  employees  who have
approval  authority  up  to  designated  limits.  All  loans  in  excess  of  an
individual's designated limits are referred to the Bank's Loan Committee,  which
has approval  authority  for all loans up to $1.0 million.  Any loans  exceeding
$1.0 million (of which,  at June 30, 1997,  there were none) must be approved by
the Board of Directors of the Bank.  In addition,  the Board of Directors of the
Bank ratifies all loans originated and purchased by the Bank.

         The  single-family   residential  loans  originated  by  the  Bank  are
generally made on terms,  conditions and documentation  which permit the sale to
the Federal  Home Loan  Mortgage  Corporation  ("FHLMC"),  the Federal  National
Mortgage Association ("FNMA") and other institutional investors in the secondary
market.  From fiscal 1991 to fiscal 1993, the Bank sold substantially all of its
fixed-rate single-family  residential loans to FNMA in the secondary market as a
means of  generating  fee  income  as well as  providing  additional  funds  for
lending, investing and other purposes. Sales of loans were generally under terms
which did not provide any recourse to the Company by the  purchaser in the event
of default on the loan by the  borrower.  With  respect to such loan sales,  the
Company  generally  retained  responsibility  for  collecting and remitting loan
payments,  inspecting the properties,  making certain insurance and tax payments
on behalf of borrowers and otherwise servicing the loans it sold, and received a
fee for performing  these services.  At June 30, 1997, the Company was servicing
$4.7 million of loans for others.

         During fiscal year 1994,  the Bank  initiated  programs to increase its
portfolio  of  single-family  residential  loans  and  terminated  its loan sale
program.   In  addition,   during  fiscal  1995,  the  Bank  began   originating
single-family residential loans through a correspondent mortgage banking company
headquartered  in Indianapolis,  Indiana.  During fiscal 1997, the Bank expanded
its correspondent  relationships with an additional  mortgage banking company in
Indianapolis,  Indiana and a company in Overland Park, Kansas. The Bank plans to
expand further its  single-family  residential loan portfolio through the use of
additional correspondent mortgage banking companies in the future.

         The Bank requires that all loans originated  through  correspondents be
underwritten in accordance with its underwriting  guidelines and standards.  The
Bank reviews the loans for  adherence  to its  underwriting  standards  prior to
acceptance  from the  correspondent.  Such  loans are  obtained  with  servicing
released.
<PAGE>
         The  following  table sets forth the loan  origination  activity of the
Company during the periods indicated.
<TABLE>
<CAPTION>
                                                                           Year Ended June 30,
                                                    -------------------------------------------------------------------
                                                           1997                    1996                   1995
                                                    --------------------    -------------------    --------------------
                                                                          (Dollars in Thousands)
<S>                                                        <C>                    <C>                     <C>    
Direct loan originations:
  Single-family residential                                $12,615                $18,895                 $ 9,082
  Commercial real estate                                        --                     --                   1,387
  Consumer                                                   2,931                  1,246                   1,255
                                                           -------                -------                 -------
    Total loans originated
      directly                                              15,546                 20,141                  11,724
Originations by
  correspondents (1)                                        24,545                 22,721                   9,830
                                                           -------                -------                 -------
    Total loans originated                                  40,091                 42,862                  21,554
Loan principal reductions                                  (12,233)               (13,985)                 (5,343)
                                                           -------                -------                 -------
Net increase in loan portfolio                             $27,858                $28,877                 $16,211
                                                           =======                =======                 =======
</TABLE>

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

(1) Consisted solely of single-family residential loans.


         Single-Family  Residential  Real Estate  Loans.  Historically,  savings
institutions such as the Bank have concentrated  their lending activities on the
origination  of loans  secured  primarily  by first  mortgage  liens on existing
single-family residences. At June 30, 1997, $91.1 million or 97.2% of the Bank's
total loan portfolio  consisted of single-family  residential real estate loans,
substantially all of which are conventional loans.

         The Bank offers fixed-rate  single family  residential loans with terms
of 10 to 30 years.  Such loans are amortized on a monthly  basis with  principal
and interest due each month. Generally, the value of fixed-rate loans fluctuates
inversely  with  changes in  interest  rates.  Consequently,  if left  unhedged,
long-term fixed-rate  single-family  residential loans would increase the Bank's
interest rate risk. However,  the Bank believes that its sophisticated asset and
liability  management  techniques provide the Bank with a competitive  advantage
and allow for the Bank to  continue  to offer  fixed-rate  residential  mortgage
loans over a variety of interest rate scenarios.

         Since the early 1980s, the Bank has also been offering  adjustable-rate
single-family  residential  mortgage  loans.  Such  loans  generally  have up to
30-year terms and an interest rate which adjusts after one,  three or five years
in accordance with a designated index (the weekly average yield on U.S. Treasury
securities  adjusted  to a constant  comparable  maturity  of one year,  as made
available by the Federal Reserve  Board).  Such loans currently have a 2% cap on
the amount of any increase or decrease in the interest  rate per year,  and a 6%
limit on the amount by which the interest rate can increase or decrease over the
life of the loan. In addition,  the Bank's  adjustable-rate  loans are currently
not convertible into fixed-rate loans and do not contain  prepayment  penalties.
Approximately  36.7% of the  single-family  residential loans in the Bank's loan
portfolio at June 30, 1997 had adjustable interest rates.

         Adjustable-rate  mortgage loans decrease but do not eliminate the risks
associated  with changes in interest rates.  Because  periodic and lifetime caps
limit the interest rate adjustments, the value of adjustable-rate mortgage loans
also  fluctuates  inversely  with  changes in  interest  rates.  In  addition as
interest rates increase,  the required payments by the borrower  increase,  thus
increasing the potential for default.

         The demand for adjustable-rate  loans in the Bank's primary market area
has been a function of several  factors,  including the level of interest rates,
the  expectations  of changes in the level of interest  rates and the difference
between  the  interest  rates and loan fees  offered  for  fixed-rate  loans and
adjustable-rate  loans.  The relative  amount of fixed-rate and  adjustable-rate
residential  loans that can be originated  at any time is largely  determined by
the demand for each in a competitive environment.

         Pursuant to underwriting  guidelines adopted by the Board of Directors,
the Bank will  generally  lend up to 95% of the appraised  value of the property
securing a single-family  residential loan. However,  the Bank generally obtains
private mortgage insurance on the principal amount that exceeds 80% of appraised
value of the security property.

         Although the Bank does not emphasize  the  origination  of  residential
construction  loans, in recent years the Bank has occasionally  originated loans
in its primary market area to construct  single-family  residences.  At June 30,
1997,  the Bank had one  construction  loan amounting to $151,000 or 0.2% of the
Bank's total loan portfolio.

         Commercial Real Estate Loans. At June 30, 1997, $258,000 or 0.3% of the
Bank's  total loan  portfolio  consisted  of loans  secured by  commercial  real
estate.  At June 30,  1997,  the Bank's  commercial  real estate loan  portfolio
included two mortgage  revenue  bonds secured by  commercial  buildings  located
within the Company's primary market area.

         Commercial real estate lending entails  different and significant risks
when compared to single-family  residential lending because such loans typically
involve  large  loan  balances  to single  borrowers  and  because  the  payment
experience on such loans is typically  dependent on the successful  operation of
the project or the borrower's  business.  The Bank is considering  expanding its
commercial lending business by recruiting or acquiring  additional  expertise to
expand the commercial lending  operations.  In the interim,  the Bank intends to
continue to originate small commercial real estate loans on a case-by-case basis
that  comply  with  its  strict  underwriting  standards,   including  stringent
loan-to-value requirements and conservative debt coverage ratios.

         Consumer Loans. The Bank is authorized to make loans for a wide variety
of personal or consumer purposes.  The Bank has been originating  consumer loans
in recent years in order to provide a wider range of  financial  services to its
customers and because such loans  generally  have higher  interest  spreads than
mortgage loans. The consumer loans offered by the Bank include home equity loans
and lines of credit,  home improvement  loans and deposit account secured loans.
At June 30,  1997,  $2.4  million  or 2.5% of the Bank's  total  loan  portfolio
consisted of consumer loans.

         Home equity loans and lines of credit are originated by the Bank for up
to 90% of the appraised  value,  less the amount of any existing  prior liens on
the property.  The Bank also offers home improvement  loans in amounts up to 95%
of the  appraised  value,  less the amount of any  existing  prior  liens on the
property,  provided the loan is guaranteed by an approved  insurer.  Home equity
loans and home  improvement  loans have a maximum term of twenty years and carry
fixed interest rates.  Home equity lines of credit have a maximum repayment term
of 10 years,  a five-year  term with respect to draws,  and carry interest rates
which adjust monthly in accordance  with a designated  prime rate. The Bank will
secure each of these types of loans with a mortgage on the property (generally a
second mortgage) and will originate the loan even if another  institution  holds
the first mortgage.  At June 30, 1997, home equity loans and lines of credit and
home  improvement  loans  totaled  $2.1  million  or 89.4% of the  Bank's  total
consumer loan portfolio.

         The Bank  currently  offers loans  secured by deposit  accounts,  which
amounted to $252,000 or 10.6% of the Bank's  total  consumer  loan  portfolio at
June 30, 1997.  Such loans are originated  for up to 95% of the deposit  account
balance,  with a hold placed on the account  restricting  the  withdrawal of the
account balance.

         Consumer loans  generally have shorter terms and higher  interest rates
than mortgage  loans but generally  involve more credit risk than mortgage loans
because of the type and nature of the collateral. In addition,  consumer lending
collections are dependent on the borrower's continuing financial stability,  and
thus are more likely to be adversely affected by job loss, divorce,  illness and
personal  bankruptcy.  The Bank believes that the generally higher yields earned
on consumer loans  compensate for the increased credit risk associated with such
loans,  and the Company  intends to continue to offer consumer loans in order to
provide a full range of services to its customers.


Asset Quality

         Loan Delinquencies. When a borrower fails to make a required payment on
a loan,  the Bank attempts to cure the deficiency by contacting the borrower and
seeking payment. Contacts are generally made following the fifteenth day after a
payment  is due,  at which  time a late  payment  is  assessed.  In most  cases,
deficiencies  are cured promptly.  If a delinquency  extends beyond 15 days, the
loan and payment  history is reviewed  and efforts are made to collect the loan.
While  the Bank  generally  prefers  to work  with  borrowers  to  resolve  such
problems,  when the account becomes 90 days delinquent,  the Bank does institute
foreclosure or other proceedings, as necessary, to minimize any potential loss.

         Non-Performing  Assets.  All loans are reviewed on a regular  basis and
are  placed on  non-accrual  status  when,  in the  opinion of  management,  the
probability  of  collection  of additional  interest is deemed  insufficient  to
warrant  further  accrual.  As a matter  of  policy,  the Bank  does not  accrue
interest on loans past due 90 days or more except  when the  estimated  value of
the  collateral  and  collection  efforts are deemed  sufficient  to ensure full
recovery. The Bank provides an allowance for the loss of uncollected interest on
all  non-accrual  loans.  Impaired  loans covered  under  Statement of Financial
Accounting  Standards ("SFAS") No. 114 and No. 118 are defined by the Company to
consist  of  non-accrual  commercial  loans  which  have not  been  collectively
evaluated for  impairment.  The allowance is established by a charge to interest
income  equal to all interest  previously  accrued,  and income is  subsequently
recognized  only to the  extent  that  cash  payments  are  received  until,  in
management's  judgment,  the  borrower's  ability to make periodic  interest and
principal  payments  returns to normal,  in which case the loan is  returned  to
accrual status.

         Real estate acquired through foreclosure is carried at the lower of the
loan's unpaid  principal  balance  (cost) or fair value less  estimated  selling
expenses  at the  date  of  transfer.  A loan  charge-off  is  recorded  for any
writedown  in the loan's  carrying  value to fair value at the date of transfer.
Real  estate  loss  provisions  are  recorded  if  the  properties'  fair  value
subsequently  declines  below the value  determined  at the  recording  date. In
determining  the lower of cost or fair value at  acquisition,  costs relating to
development  and  improvement  of property  are  considered.  Costs  relating to
holding real estate  acquired  through  foreclosure,  net of rental income,  are
charged against earnings as incurred.
<PAGE>
         The following table sets forth the amounts and categories of the Bank's
non-performing assets at the dates indicated. The Bank did not have any troubled
debt restructuring at any of the periods presented.
<TABLE>
<CAPTION>
                                                                         June 30,
                                      -------------------------------------------------------------------------------
                                          1997            1996             1995             1994            1993
                                      -------------   -------------    -------------    -------------   -------------
                                                                  (Dollars in Thousands)
<S>                                      <C>             <C>              <C>               <C>              <C> 
Non-accruing loans:
    Single-family residential            $  336          $  261           $  350            $  559           $449
    Commercial real estate                   --              --               --                --             50
                                         ------          ------           ------            ------           ----
    Total non-accruing loans                336             261              350               559            499
Accruing loans greater than
    90 days delinquent                       --              --               --                --             --
                                         ------          ------           ------            ------           ----
      Total non-performing loans            336             261              350               559            499
Real estate owned                            --              --               --                --             26
Other non-performing assets (1)             789           1,088            1,415             2,282             --
                                         ------          ------           ------            ------           ----
      Total non-performing assets        $1,125          $1,349           $1,765            $2,841           $525
                                         ======          ======           ======            ======           ====
      Total non-performing loans as a
        percentage  of  total loans        0.36%           0.40%            0.95%             2.70%         3.00%
                                           ====            ====             ====              ====          ====
      Total non-performing assets as a 
        percentage of total assets         0.25%           0.32%            0.59%             1.34%         0.24%
                                           ====            ====             ====              ====          ====
</TABLE>

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

(1)    Consists of a non-agency  participation  certificate.  See "-  Classified
       Assets."

         The  interest  income  that would have been  recorded  during the years
ended June 30, 1997, 1996, 1995, 1994 and 1993 if the Bank's  non-accrual  loans
at the end of such  periods  had been  current in  accordance  with their  terms
during  such  periods  was  $6,000,  $6,000,   $13,000,   $26,000  and  $46,000,
respectively.

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

         The Bank's classified assets at June 30, 1997 consisted of $1.0 million
of assets classified as substandard (including $217,000 of loans and $789,000 of
securities) and no loans classified as doubtful.  In addition, at June 30, 1997,
$513,000 of the Bank's loans were designated special mention.

         The $789,000 of securities  classified as  substandard at June 30, 1997
relates to a single non-agency participation  certificate which was purchased by
the Bank during  fiscal 1991.  The security was issued by a savings  institution
located in Huntington Beach,  California and the underlying mortgages consist of
six-month  adjustable-rate  notes  (priced  off of LIBOR)  which are  secured by
single-family  properties located in southern  California.  As of June 30, 1997,
approximately  33.0% of the underlying  mortgages were at least 30 days past due
and/or in foreclosure or already  foreclosed upon by the servicer.  The security
was structured into both senior and  subordinate  classes and the Bank owns only
senior classes.  As of June 30, 1997, the pool had cumulative realized losses of
$21.4  million  which were  initially  absorbed by certain  credit  supports and
subsequently  absorbed by subordinate  certificate  holders.  Currently,  senior
certificate  holders  (such as the Bank) are  having to absorb the  losses.  The
credit supports,  which totaled $11.0 million at the date of issuance,  had been
depleted  as of June 30,  1997.  The  security is  currently  held in the Bank's
available for sale  portfolio and its $789,000  carrying  value at June 30, 1997
reflects  $76,000 of net  unrealized  losses as of such date as well as $414,000
and $253,000 of write-downs  with respect to such security which were recognized
by the Bank during fiscal 1995 and 1994, respectively.

         Allowance  for Loan Losses.  It is  management's  policy to maintain an
allowance for estimated  losses on loans based upon the estimated net realizable
value of the underlying collateral, general economic conditions, particularly as
they relate to the Bank's market area,  historical  loss  experience,  and other
factors related to the collectibility of the loan portfolio. Although management
believes   that  it  uses  the  best   information   available   to  make   such
determinations,  future  adjustments to the allowance may be necessary,  and net
income could be significantly  affected,  if circumstances  differ substantially
from the assumptions used in making the initial determinations.

         Effective December 21, 1993, the OTS, in conjunction with the Office of
the Comptroller of the Currency,  the FDIC and the Federal Reserve Board, issued
an  Interagency  Policy  Statement  on the  Allowance  for Loan and Lease Losses
("Policy  Statement").  The  Policy  Statement  includes  guidance  (i)  on  the
responsibilities  of  management  for the  assessment  and  establishment  of an
adequate allowance and (ii) for the agencies' examiners to use in evaluating the
adequacy  of  such  allowance  and  the  policies  utilized  to  determine  such
allowance.  The Policy Statement also sets forth  quantitative  measures for the
allowance with respect to assets  classified  substandard  and doubtful and with
respect  to  the  remaining   portion  of  an   institution's   loan  portfolio.
Specifically,  the  Policy  Statement  sets  forth  the  following  quantitative
measures  which  examiners  may  use  to  determine  the  reasonableness  of  an
allowance: (i) 50% of the portfolio that is classified doubtful; (ii) 15% of the
portfolio  that is  classified  substandard  and (iii) for the  portions  of the
portfolio that have not been  classified  (including  loans  designated  special
mention),  estimating  credit  losses over the upcoming  twelve  months based on
facts and  circumstances  available  on the  evaluation  date.  While the Policy
Statement sets forth this quantitative measure, such guidance is not intended as
a "floor" or "ceiling."
<PAGE>
         The following table sets forth an analysis of the Bank's  allowance for
loan losses during the periods indicated.
<TABLE>
<CAPTION>
                                                                 Year Ended June 30,
                                   ----------------------------------------------------------------------------------
                                       1997            1996            1995             1994              1993
                                   -------------    ------------    ------------    --------------    --------------
                                                                (Dollars in Thousands)
<S>                                  <C>              <C>             <C>              <C>               <C>    
Total loans outstanding, net         $93,958          $65,925         $37,010          $20,682           $16,620
                                     =======          =======         =======          =======           =======
Average loans outstanding, net       $78,545          $52,399         $25,467          $19,369           $19,437
                                     =======          =======         =======          =======           =======
Balance at beginning of period       $   120          $   121         $   106          $   156           $    99
Charge-offs:
  Single-family residential               --               --              --                2                --
  Commercial real estate (1)              --               --              --               45                --
  Consumer                                --               --              --               --                10
                                     -------          -------         -------          -------           -------
    Total charge-offs                     --               --              --               47                10
Recoveries:
 Single-family residential                 1               --              --               --                --
  Consumer                                --               --              --               --                 1
                                     -------          -------         -------          -------           -------
    Total recoveries                       1               --              --               --                 1
                                     -------          -------         -------          -------           -------
Net charge-offs                           (1)              --              --               47                 9
Provision (recovery) for loan             92               (1)             15               (3)               66
                                     -------          -------         -------          -------           -------
losses
Balance at end of period             $   213          $   120         $   121          $   106           $   156
                                     =======          =======         =======          =======           =======
Allowance for loan losses as a
  percent of total loans
  outstanding                            0.2%             0.2%            0.3%             0.5%              0.9%
                                     =======          =======         =======          =======           =======
Ratio of net charge-offs to
  average loans outstanding               --%              --%             --%             0.2%               --%
                                     =======          =======         =======          =======           =======
</TABLE>

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

(1)    The $45,000  charge-off  during fiscal 1994 related to a mortgage revenue
       bond secured by commercial real estate.


         The  Bank  established  provisions  (recoveries)  for  loan  losses  of
$92,000, $(1,000), $15,000, $(3,000) and $66,000 during the years ended June 30,
1997,  1996,  1995,  1994 and  1993  respectively.  During  such  periods,  loan
charge-offs  (net of  recoveries)  amounted  to  $(1,000),  $0, $0,  $47,000 and
$9,000, respectively.  The increases in the provision for loan losses during the
periods presented were due to substantial  growth in the Company's mortgage loan
portfolio.
<PAGE>
         The following table sets forth information concerning the allocation of
the Bank's allowance for loan losses by loan categories at the dates indicated.
<TABLE>
<CAPTION>
                                                                    June 30,                                         
                           ------------------------------------------------------------------------------------------
                                      1997                           1996                          1995              
                           ----------------------------  -----------------------------  ---------------------------- 
                                          Percent of                     Percent of                     Percent of   
                                           Loans in                    Loans in Each                     Loans in    
                                             Each                       Category to                        Each      
                              Amount      Category to      Amount       Total Loans        Amount      Category to   
                                          Total Loans                                                  Total Loans   
                           ------------- --------------  ------------  ---------------  -------------  ------------- 
                                                             (Dollars in Thousands)                                  
<S>                               <C>          <C>             <C>           <C>             <C>             <C>     
Single-family residential         $ 188         97.2%           $ 95          97.8%           $ 96            96.1%  
  loans
Commercial real estate               10          0.3              10           0.7              10             1.9   
  loans(1)
Consumer loans                       15          2.5              15           1.5              15             2.0   
                                  -----        -----           -----         -----           -----           -----   
     Total                        $ 213        100.0%          $ 120         100.0%          $ 121           100.0%  
                                  =====        =====           =====         =====           =====           =====   

<CAPTION>
                                                     June 30,
                           --------------------------------------------------------------
                                       1994                            1993
                           ------------------------------  ------------------------------
                                            Percent of                      Percent of
                                             Loans in                        Loans in
                                               Each                            Each
                              Amount        Category to       Amount        Category to
                                            Total Loans                     Total Loans
                           -------------   --------------  -------------   --------------
                                               (Dollars in Thousands)
<S>                             <C>              <C>            <C>               <C>   
Single-family residential        $ 91             96.6%          $ 96              96.0%
  loans
Commercial real estate           --                1.6             45               2.6
  loans(1)
Consumer loans                     15              1.8             15               1.4
                                -----            -----          -----             ----- 
     Total                      $ 106            100.0%         $ 156             100.0%
                                =====            =====          =====             ===== 
</TABLE>

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

(1) Includes mortgage revenue bonds.
<PAGE>
Investment Activities

         General.  The Company's  securities  portfolio is managed by investment
officers in accordance  with a  comprehensive  written  investment  policy which
addresses  strategies,  types and levels of allowable  investments  and which is
reviewed and approved by the Bank's Board of Directors on an annual  basis.  The
management of the securities  portfolio is set in accordance  with the direction
of the Bank's Investment  Committee.  In addition,  the Bank has entered into an
agreement  with Smith  Breeden  whereby  Smith  Breeden  has been  appointed  as
investment  advisor  with  respect to the  management  of the Bank's  securities
portfolio.  With the  assistance of Smith  Breeden,  the Bank's Chief  Executive
Officer and Chief Investment  Officer execute various  transactions with respect
to the portfolio and are responsible  for informing the Investment  Committee of
the types of investments available,  the status and performance of the portfolio
and current  market  conditions.  The  investment  officers are  authorized  to:
purchase  or sell  any  securities  as well as  commitments  to  hedge  eligible
investments;  purchase or sell eligible  investments under repurchase or reverse
repurchase  agreements;  execute hedging  strategies  approved by the Investment
Committee;  pledge  securities owned as collateral for public agency deposits or
repurchase  accounts or agreements;  and lend securities to approved  dealers in
government  securities or approved  commercial banks. Any one investment officer
has the  authority to purchase or sell  securities up to $5.0 million in any one
transaction and acting  together,  two members of the Investment  Committee have
authority  to  purchase  or  sell  securities  up to  $10.0  million  in any one
transaction.  For  purchases  or sales  greater  than $10.0  million,  the prior
approval of a majority  of the  Investment  Committee  is  required.  Investment
officers are also  authorized  to invest  excess  liquidity  in approved  liquid
investment vehicles. In addition, both the Investment Committee and the Board of
Directors of the Bank ratify all securities purchased and sold by the Bank.

         The  Company  invests in a  portfolio  of  mortgage-backed  securities,
mortgage-backed derivative securities,  interest rate risk management contracts,
equity  securities  and  municipal  bonds.  In  selecting   securities  for  its
portfolio,  the  Company  employs  option-adjusted  pricing  analysis  with  the
assistance of Smith Breeden in order to ascertain the net  risk-adjusted  spread
expected to be earned with respect to the various investment  alternatives.  The
nature of this  analysis  is to quantify  the costs  embedded in the yield of an
investment,  such as the duration matched funding cost, the costs of the options
embedded in the investment's cash flows (such as a borrower's  ability to prepay
a mortgage),  credit costs,  if any, and servicing  costs.  The objective of the
Company's  investment  management  process  is to  select  investments  with the
greatest  net  spreads  and  actively  manage  the  underlying  risks  of  these
investments.

         The Company  actively  manages  its  securities  portfolio  in order to
enhance net interest and other income on a risk-adjusted basis. As a result, the
Company continuously  monitors the net risk-adjusted  spreads of its investments
and compares them with the spreads available with respect to other securities in
the market.  Accordingly, as market conditions fluctuate (e.g., as risk-adjusted
spreads  narrow),  the Company will sell  individual  securities  prior to their
maturity and reinvest the proceeds into new  investments  which  generally carry
wider risk-adjusted  spreads.  The Company's  securities portfolio also contains
various  interest rate risk  management  contracts (such as interest rate swaps,
collars,  caps,  floors,  options and futures)  which are primarily  utilized to
hedge the Company's  interest  rate exposure in the trading  portfolio and which
require active management in order to respond to changing market conditions.

         In recognition of the Company's  business strategy of actively managing
its  securities   portfolio,   during  fiscal  1994,  the  Company  reclassified
substantially  all of its  securities as held for trading.  Pursuant to SFAS No.
115, securities classified as trading securities are reported at fair value with
unrealized gains and losses included in earnings,  and securities  classified as
available for sale are  similarly  reported at fair value,  but with  unrealized
gains and losses  excluded  from  earnings  and  instead  reported as a separate
component of stockholders' equity.

         Mortgage-Backed and Related Securities. At June 30, 1997, the Company's
mortgage-backed  and related  securities  portfolio  (including $28.5 million of
mortgage-backed  derivative  securities)  amounted to $311.6 million or 97.9% of
the  Company's  securities  portfolio  (both held for trading and  available for
sale) and 69.8% of the Company's total assets.  By investing in  mortgage-backed
and related securities,  management seeks to achieve a targeted  option-adjusted
spread over applicable funding costs.

         The  Company  invests  in  mortgage-backed   and  related   securities,
including mortgage participation  certificates,  which are insured or guaranteed
by U.S. Government agencies and government sponsored  enterprises,  and CMOs and
real estate mortgage investment conduits ("REMICs").  Mortgage-backed securities
(which also are known as mortgage  participation  certificates  or  pass-through
certificates)  represent a participation  interest in a pool of single-family or
multi-family mortgages,  the principal and interest payments on which are passed
from the mortgage originators, through intermediaries (generally U.S. Government
agencies and  government  sponsored  enterprises)  that pool and  repackage  the
participation  interests in the form of  securities,  to  investors  such as the
Company.  Such U.S.  Government agencies and government  sponsored  enterprises,
which  guarantee the payment of principal  and interest to investors,  primarily
include the FHLMC,  the FNMA and the Government  National  Mortgage  Association
("GNMA").

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

         The Company's mortgage-backed derivative securities include CMOs, which
include  securities  issued by entities which have qualified  under the Internal
Revenue Code as REMICs. CMOs and REMICs  (collectively CMOs) have been developed
in  response  to  investor  concerns  regarding  the  uncertainty  of cash flows
associated  with the  prepayment  option  of the  underlying  mortgagor  and are
typically issued by governmental agencies,  government sponsored enterprises and
special  purpose  entities,  such  as  trusts,   corporations  or  partnerships,
established by financial  institutions or other similar institutions.  A CMO can
be  collateralized  by loans or  securities  which are insured or  guaranteed by
FNMA, FHLMC or GNMA. In contrast to pass-through  mortgage-backed securities, in
which cash flow is received pro rata by all security holders, the cash flow from
the  mortgages  underlying  a CMO is  segmented  and paid in  accordance  with a
predetermined  priority to investors holding various CMO classes.  By allocating
the principal and interest cash flows from the underlying  collateral  among the
separate CMO classes,  different classes of bonds are created, each with its own
stated   maturity,   estimated   average  life,   coupon  rate  and   prepayment
characteristics.

         The  Company's  mortgage-backed   derivative  securities  also  include
mortgage-backed   residuals  and   interest-only  and   principal-only   strips.
Mortgage-backed  residuals  consist of certificates of particular  tranches of a
CMO  whereby  the  principal  repayments  and  prepayments  with  respect to the
underlying  pool of loans are generally not allocated to the residual  until all
other  certificates or tranches have been fully paid and retired.  Interest-only
strips are a  particular  class of  mortgage-backed  derivative  security  which
receives and pays only  interest with respect to the  underlying  pool of loans,
while  principal-only  strips  receive  and pay only  principal  repayments  and
prepayments. As a result of the foregoing, mortgage-backed derivative securities
often  exhibit   elasticity  and  convexity   characteristics   (i.e.,   respond
differently  to changes in  interest  rates)  which the  Company  can utilize to
internally hedge other  components of the Company's  portfolio of assets against
interest rate risk.

         The OTS has issued a  statement  of policy  which  states,  among other
things,  that mortgage derivative products (including CMOs and CMO residuals and
stripped  mortgage-backed  securities such as interest-only  and  principal-only
strips) which possess average life or price  volatility in excess of a benchmark
fixed-rate 30-year mortgage-backed security are "high risk mortgage securities,"
and must be carried in the  institution's  trading account or as assets held for
sale, and therefore marked to market on a regular basis. At June 30, 1997, $25.0
million or 8.0% of the securities held in the Company's  portfolio  consisted of
such "high risk  mortgage  securities,"  as  defined in such  policy  statement.
However,  the Bank is in compliance with this OTS policy  statement since all of
such  securities are held in the Company's  trading account and marked to market
on a regular basis in accordance with generally accepted accounting principles.

         Like  most  fixed-income   securities,   mortgage-backed   and  related
securities are subject to interest rate risk. However,  unlike most fixed-income
securities,  the mortgage loans underlying a mortgage-backed or related security
generally  may be prepaid at any time without  penalty.  The ability to prepay a
mortgage  loan  generally  results in  significantly  increased  price and yield
volatility (with respect to mortgage-backed  and related securities) than is the
case with non-callable  fixed-income  securities.  Furthermore,  mortgage-backed
derivative  securities often are more sensitive to changes in interest rates and
prepayments than traditional mortgage-backed securities and are, therefore, even
more volatile. Nevertheless, the Company attempts to hedge against both interest
rate and prepayment risk.

         Although  mortgage-backed  and  related  securities  often  carry lower
yields than traditional  mortgage loans, such securities  generally increase the
quality  of  the  Company's  assets  by  virtue  of the  securities'  underlying
insurance or guarantees,  are more liquid than individual  mortgage loans (which
enhances the Company's ability to actively manage its portfolio) and may be used
to  collateralize  borrowings or other  obligations of the Company.  At June 30,
1997,  $257.8  million or 81.0% of the  Company's  mortgage-backed  and  related
securities  were pledged to secure  various  obligations of the Company (such as
reverse repurchase agreements and interest rate swaps). In addition, as a result
of  the   Company   maintaining   a   substantial   portion  of  its  assets  in
mortgage-backed and related securities,  the Company has been able to maintain a
relatively  low  level  of  operating  expenses.  Furthermore,   mortgage-backed
derivative  securities are often utilized by the Company to internally hedge its
interest  rate  exposure  and can be  attractive  alternatives  to  other  hedge
vehicles when their option-adjusted spreads are abnormally wide.
<PAGE>
         The following  table sets forth  information  relating to the amortized
cost  and  market  value  of the  Company's  securities  held  for  trading  and
securities available for sale portfolios.
<TABLE>
<CAPTION>
                                                                                        June 30,
                                                  ----------------------------------------------------------------------------------
                                                             1997                         1996                         1995
                                                  -----------------------      -----------------------      ------------------------
                                                  Amortized       Market        Amortized      Market        Amortized      Market
                                                     Cost         Value          Cost          Value           Cost         Value
                                                  ---------     ---------      ---------     ---------      ---------     ---------
                                                                                   (In Thousands)
<S>                                               <C>           <C>            <C>           <C>            <C>           <C>      
Securities held for trading:
  FHLMC participation .......................     $  41,194     $  41,516      $  83,329     $  83,384      $  54,685     $  55,247
    certificates
  FNMA participation ........................        68,800        69,355         66,182        65,997         68,286        69,201
    certificates
  GNMA participation ........................       165,894       168,102        153,048       154,240         90,408        91,751
    certificates
  Non-agency participation
    certificates ............................         2,545         2,502          3,209         3,154          3,893         3,918
                                                  ---------     ---------      ---------     ---------      ---------     ---------
    Total mortgage-backed ...................       278,433       281,475        305,768       306,775        217,272       220,117
      securities
  Collateralized mortgage ...................        25,789        26,032          6,131         6,379         12,910        13,022
    obligations
  Residuals .................................           508         1,036            707           778          4,470         4,364
  Interest-only strips ......................         2,028         1,449          3,442         2,792          4,570         2,998
  Principal only strips .....................           821           860          1,028         1,010            781           803
                                                  ---------     ---------      ---------     ---------      ---------     ---------
    Total mortgage-backed
      derivative securities .................        29,146        29,377         11,308        10,959         22,731        21,187
  Interest rate swaps .......................          --             581           --             620           --            (219)
  Interest rate collar ......................            50            (8)            83            (8)           155           (71)
  Interest rate caps ........................         3,025         1,545          3,692         3,074          2,297         1,995
  Interest rate floors ......................         3,916         3,541          2,535         2,970          1,544         3,409
  Options ...................................            78            24             54            65            266           200
  Futures ...................................          --             356           --            (784)          --            (134)
                                                  ---------     ---------      ---------     ---------      ---------     ---------

    Total interest rate .....................         7,069         6,039          6,364         5,937          4,262         5,180
      contracts
  Equity securities .........................           305           464            496           550            223           249
                                                  ---------     ---------      ---------     ---------      ---------     ---------
    Total securities held for
      trading ...............................     $ 314,953     $ 317,355      $ 323,936     $ 324,221      $ 244,488     $ 246,733
                                                  =========     =========      =========     =========      =========     =========
Securities available for sale:
  Non-agency participation
    certificates ............................     $     866     $     790      $   1,141     $   1,088      $   1,426     $   1,415
                                                  ---------     ---------      ---------     ---------      ---------     ---------
    Total mortgage-backed
      securities ............................           866           790          1,141         1,088          1,426         1,415
  Municipal bonds ...........................           317           335            921           962          1,017         1,126
                                                  ---------     ---------      ---------     ---------      ---------     ---------
    Total securities available
      for sale ..............................     $   1,183     $   1,125      $   2,062     $   2,050      $   2,443     $   2,541
                                                  =========     =========      =========     =========      =========     =========
</TABLE>
<PAGE>
The  following  table sets forth the market  value of the  Company's  securities
activities  (both  held for  trading  and  available  for sale) for the  periods
indicated:
<TABLE>
<CAPTION>
                                                     At or For the Years
                                                        Ended June 30,
                                            -----------------------------------
                                               1997         1996         1995
                                            ---------    ---------    ---------
                                                       (In Thousands)
<S>                                         <C>          <C>          <C>      
Beginning balance .......................   $ 321,897    $ 249,274    $ 174,347
  Mortgage-backed securities
    purchased - held for trading ........     890,623      385,542      497,660
  Collateralized mortgage obligations
    purchased - held for trading ........     19,823          --          7,093       
  Mortgage-backed derivative
    securities purchased - 
    held for trading.....................        --            495        2,741
  Interest rate contracts purchased -
    held for trading ....................       3,320        4,161        1,935
  Equity securities purchased -
    held for trading ....................        --            545          880
                                            ---------    ---------    ---------
    Total securities purchased ..........     913,766      390,743      510,309

Less:
  Sale of mortgage-backed securities -
    held for trading ....................     887,468      276,482      394,924
  Sale of collateralized mortgage
    obligations - held for trading ......        --          7,798       17,321
  Sale of mortgage-backed derivative
    securities - held for trading .......         625        3,642        6,933
  Sale of interest rate contracts -
    held for trading ....................         132        1,973       (1,450)
  Sale of equity securities -
    held for trading ....................         204          314        1,081
                                            ---------    ---------    ---------

    Total securities sold ...............     888,429      290,209      418,809

Less proceeds from maturities of
  securities ............................      27,277       25,829       16,372      
Realized gain (loss) on sale of
  securities held for trading ...........      (1,623)       1,834           66      
Unrealized gain (loss) on securities
  held for trading ......................       2,117       (1,960)       1,535
Change in net unrealized gain (loss)
  on securities available for sale.......         (46)         (69)          97
Amortization of premium .................      (1,925)      (1,887)      (1,485)
Permanent impairment of securities
  available for sale ....................        --           --           (414)
                                            ---------    ---------    ---------
Ending balance ..........................   $ 318,480    $ 321,897    $ 249,274
                                            =========    =========    =========
</TABLE>
<PAGE>
         At June 30, 1997, the contractual  maturity of substantially all of the
Company's  mortgage-backed or related securities was in excess of ten years. The
actual maturity of a  mortgage-backed  or related  security is usually less than
its stated maturity due to prepayments of the underlying mortgages.  Prepayments
that are faster than anticipated may shorten the life of the security and affect
its yield to maturity.  The yield to maturity is based upon the interest  income
and the  amortization  of any premium or discount  related to the  security.  In
accordance with generally accepted accounting principles, premiums and discounts
are amortized over the estimated lives of the loans, which decrease and increase
interest income, respectively.  The prepayment assumptions used to determine the
amortization  period for premiums and  discounts  can  significantly  affect the
yield of the  mortgage-backed  or related  security,  and these  assumptions are
reviewed  periodically to reflect actual  prepayments.  Although  prepayments of
underlying  mortgages  depend on many factors,  including the type of mortgages,
the  coupon  rate,  the  age of  mortgages,  the  geographical  location  of the
underlying  real estate  collateralizing  the  mortgages  and general  levels of
market  interest  rates,  the  difference  between  the  interest  rates  on the
underlying mortgages and the prevailing mortgage interest rates generally is the
most  significant  determinant  of the rate of  prepayments.  During  periods of
falling mortgage interest rates, if the coupon rate of the underlying  mortgages
exceeds  the  prevailing  market  interest  rates  offered for  mortgage  loans,
refinancing generally increases and accelerates the prepayment of the underlying
mortgages and the related  security.  At June 30, 1997, of the $311.6 million of
mortgage-backed  and related  securities  held by the  Company,  an aggregate of
$97.6  million were  secured by  fixed-rate  mortgage  loans and an aggregate of
$214.0 million were secured by adjustable-rate mortgage loans.

         Other  Securities.  Other  securities  owned by the Company at June 30,
1997 include various interest rate risk management contracts, including interest
rate swaps, collars,  caps, floors,  options and futures,  equity securities and
municipal bonds. At June 30, 1997, the carrying value of the Company's  interest
rate contracts,  equity securities and municipal bonds amounted to $6.0 million,
$464,000 and $335,000,  respectively. The municipal bonds held by the Company at
June 30, 1997 were scheduled to mature between three and four years.  See Note 2
to the Notes to Consolidated Financial Statements.

Sources of Funds

         General. The Company will consider various sources of funds to fund its
investing and lending activities and evaluates the available sources of funds in
order  to  reduce  the  Company's  overall  funding  costs.  Deposits,   reverse
repurchase  agreements,  advances from the FHLB of Indianapolis,  notes payable,
and sales, maturities and principal repayments on loans and securities have been
the  major  sources  of funds for use in the  Company's  lending  and  investing
activities,  and for other general business purposes.  Management of the Company
closely monitors rates and terms of competing  sources of funds on a daily basis
and utilizes the source which it believes to be cost effective.

         Deposits.  The Bank  attempts to price its deposits in order to promote
deposit  growth and offers a wide array of deposit  products in order to satisfy
its customers'  needs.  The Bank's current deposit  products  include  statement
savings accounts,  negotiable order of withdrawal ("NOW") and checking accounts,
money market deposit accounts, fixed-rate, fixed-maturity retail certificates of
deposit  ranging in terms from  seven  days to 10 years,  individual  retirement
accounts, and non-retail  certificates of deposit consisting of jumbo (generally
greater than  $95,000)  certificates,  inverse  variable-rate  certificates  and
brokered certificates of deposit.

         The Bank's retail deposits are generally obtained from residents in its
primary market area. The principal methods currently used by the Bank to attract
deposit  accounts  include  offering a wide variety of value-added  products and
services and competitive interest rates. The Bank utilizes traditional marketing
methods to attract new customers and savings  deposits,  including various forms
of  advertising.  Management  estimates  that as of June  30,  1997,  non-retail
deposit  accounts  totaled $12.7  million or 9.3% of the Bank's total  deposits.
These  non-retail  deposits  consist  largely of jumbo  certificates of deposit,
inverse  variable-rate  certificates  (which are obtained  through  brokers) and
brokered  deposits.  The Bank's jumbo certificates of deposit and other deposits
are also obtained through the posting of deposit rates on national  computerized
bulletin  boards  at no cost  to the  Bank.  The  Bank's  inverse  variable-rate
certificates carry rates which fluctuate  inversely with respect to market rates
of interest. For example, if market rates of interest increase, the rates on the
inverse  variable-rate  certificates  would  decrease,  while if market rates of
interest  decrease,  the rates on the inverse  variable-rate  certificates would
increase.  As a result, the Bank would generally be paying a higher rate on such
certificates  during a  declining  interest  rate  environment.  The Bank offers
inverse  variable-rate  certificates  when they represent a lower cost source of
funds.
<PAGE>
         The  following  table  shows  the  distribution  of and  certain  other
information relating to the Bank's deposits by type as of the dates indicated.
<TABLE>
<CAPTION>
                                                                            June 30,
                                         ---------------------------------------------------------------------------------
                                                   1997                       1996                        1995
                                         --------------------------  -------------------------  --------------------------
                                                         Percent                    Percent                   Percent of
                                            Amount     of Deposits       Amount   of Deposits     Amount       Deposits
                                         ------------  ------------  ------------ ------------  ------------ -------------
                                                                      (Dollars in Thousands)
<S>                                       <C>              <C>        <C>             <C>         <C>            <C>
Transaction accounts:
  NOW and checking                        $   4,778          3.5%     $   4,529         3.4%      $  3,266         2.8%
  Savings accounts                           20,523         15.1         17,342        12.8         15,183        13.2
  Money market deposit accounts               1,930          1.4         1,576          1.2          1,976         1.7
                                           --------        -----       --------       -----       --------       ----- 
    Total transaction                        27,231         20.0         23,447        17.4         20,425        17.7
                                           --------        -----       --------       -----       --------       ----- 
       accounts


Certificates of deposit:
  Within 1 year                              74,586         54.8         75,343        55.7         57,304        49.8
  1-2 years                                  19,437         14.3         19,890        14.7         17,890        15.5
  2-3 years                                   7,486          5.5          8,093         6.0          6,844         5.9
  3-4 years                                   1,845          1.3          2,636         2.0          5,352         4.6
  Over 4 years                                5,590          4.1          5,734         4.2          7,497         6.5
                                           --------        -----       --------       -----       --------       ----- 
    Total certificate accounts              108,944         80.0        111,696        82.6         94,887        82.3
                                           --------        -----       --------       -----       --------       ----- 
    Total deposits                         $136,175        100.0%      $135,143       100.0%      $115,312       100.0%
                                           ========        =====       ========       =====       ========       ===== 
</TABLE>

         The  following  table  shows  the  distribution  of and  certain  other
information  relating  to the  Bank's  certificates  of  deposit as of the dates
indicated.
<TABLE>
<CAPTION>
                                                                            June 30,
                                         ---------------------------------------------------------------------------------
                                                   1997                       1996                        1995
                                         --------------------------  -------------------------  --------------------------
                                                         Percent                    Percent                   Percent of
                                            Amount     of Deposits       Amount   of Deposits     Amount       Deposits
                                         ------------  ------------  ------------ ------------  ------------ -------------
                                                                      (Dollars in Thousands)
<S>                                       <C>              <C>        <C>             <C>         <C>            <C>


Total retail certificates          $ 96,946           71.2%         $ 89,462            66.2%       $ 62,465            54.1%
                                  --------            ----         --------             ----        --------            ---- 
   Non-retail certificates:
   Jumbo certificates                2,420             1.8            6,041              4.4           9,963             8.6
   Inverse variable-rate
     certificates                    6,218             4.6            8,423              6.2           9,993             8.7
   Non-brokered out-of-state
     deposits                        3,064             2.2            7,276              5.4          11,476            10.0
   Brokered deposits                   296             0.2              494              0.4             990             0.9
                                  --------            ----         --------             ----        --------            ---- 
     Total non-retail
      certificates (1)              11,998             8.8           22,234             16.4          32,422            28.2
                                  --------            ----         --------             ----        --------            ---- 
Total certificates of
deposit                           $108,944            80.0%        $111,696             82.6%       $ 94,887            82.3%
                                  ========            ====         ========             ====        ========            ==== 
</TABLE>
-------------------------------

(1)      Of the Company's  $12.0 million of non-retail  certificates  as of June
         30, 1997,  $1.9 million was  scheduled to mature in six months or less,
         $2.2 million was  scheduled to mature in 7-12 months,  $3.7 million was
         scheduled to mature in 13-36  months and $4.2 million was  scheduled to
         mature in over 36 months.
<PAGE>
         The following  table presents the average  balance of each deposit type
and the average rate paid on each deposit type for the periods indicated.
<TABLE>
<CAPTION>
                                                                 Year Ended June 30,
                                  -----------------------------------------------------------------------------------
                                            1997                        1996                        1995
                                  -------------------------  ---------------------------  ---------------------------
                                   Average       Average        Average       Average      Average        Average
                                   Balance      Rate Paid       Balance      Rate Paid     Balance       Rate Paid
                                  ------------ ------------  -------------- ------------  ------------  -------------
                                                               (Dollars in Thousands)
<S>                                 <C>               <C>        <C>               <C>       <C>              <C> 
NOW and checking accounts           $  4,697          2.6%       $  3,813          2.9%      $  3,352         2.8%
Savings accounts                      20,463           4.1         15,922           3.9        16,068         3.5
Money market deposit
   accounts                            1,886           4.4          1,777           4.3         2,147         4.1
Certificates of deposit              109,756           5.9        103,981           6.1        99,443         5.9
                                    --------          ---        --------          ---       --------         --- 
   Total deposits                   $136,802          5.5%       $125,493          5.7%      $121,010         5.5%
                                    ========          ===        ========          ===       ========         === 
</TABLE>

         The following  table sets forth the deposit  account  activities of the
Bank during the periods indicated.
<TABLE>
<CAPTION>
                                                    Year Ended June 30,
                                             1997          1996          1995
                                          ---------     ---------     ---------
                                                     (In Thousands)
<S>                                       <C>           <C>           <C>      
Deposits ............................     $ 208,032     $ 213,601     $ 184,399
Withdrawals .........................       212,517       197,550       182,443
                                          ---------     ---------     ---------
Net increase (decrease) before
     interest credited ..............        (4,485)       16,051         1,956
Interest credited ...................         5,517         3,780         5,056
                                          ---------     ---------     ---------

Net increase in deposits ............     $   1,032     $  19,831     $   7,012
                                          =========     =========     =========
</TABLE>

         The following  table shows the interest  rate and maturity  information
for the Bank's certificates of deposit at June 30, 1997.
<TABLE>
<CAPTION>
                                                                     Maturity Date
                         ------------------------------------------------------------------------------------------------------
   Interest Rate         One Year or Less      Over 1-2 Years       Over 2-3 Years       Over 3 Years             Total
---------------------    ------------------    -----------------    -----------------   -----------------   -------------------
                                                                (Dollars in Thousands)
<S>                       <C>                  <C>                   <C>                 <C>                 <C>      
3.00% or less            $                     $                    $                   $                   $
                                --                   --                   --                  10                    10
3.01 - 5.00%                 4,894                  464                   65               1,025                 6,448
5.01 - 7.00%                68,462               16,298                6,359               5,134                96,253
7.01 - 9.00%                 1,135                2,446                1,055                 517                 5,153
9.01% or greater                95                  229                    7                 749                 1,080
                          --------             --------              -------             -------             ---------
Total                     $ 74,586             $ 19,437              $ 7,486             $ 7,435             $ 108,944
                          ========             ========              =======             =======             =========
</TABLE>
<PAGE>
         The   following   table  sets  forth  the   maturities  of  the  Bank's
certificates of deposit having principal amounts of $100,000 or more at June 30,
1997.
<TABLE>
<CAPTION>
              Certificates of deposit maturing
                     in quarter ending:                                           Amount
---------------------------------------------------------------      -----------------------------------
                                                                               (In Thousands)
<S>                                                                              <C>
September 30, 1997                                                               $ 7,780
December 31, 1997                                                                  3,808
March 31, 1998                                                                     1,334
After March 31, 1998                                                               4,963
                                                                                   -----
  Total certificates of deposit with
   balances of $100,000 or more                                                  $17,885
                                                                                  ======
</TABLE>

         Borrowings.   The  following  table  sets  forth  certain   information
regarding the borrowings of the Company at or for the dates indicated.
<TABLE>
<CAPTION>
                                                                At or For the Year Ended June 30,
                                                    -------------------------------------------------------------------
                                                           1997                     1996                   1995
                                                    ---------------------     ------------------     ------------------
                                                                          (Dollars in Thousands)
<S>                                                       <C>                       <C>                  <C>     
FHLB advances:
  Average balance outstanding                             $ 26,089                  $ 27,586             $ 31,051
  Maximum amount outstanding at
    any month-end during the period                         29,300                    31,000               31,000
  Balance outstanding at end of period                      26,000                    26,000               31,000
  Average interest rate during the
    period                                                    6.3%                      5.8%                  5.6%
  Average interest rate at end of period                      5.8%                      5.4%                  6.1%

Securities sold under agreements to repurchase:
  Average balance outstanding                             $306,034                  $148,523             $ 68,277
  Maximum amount outstanding at
    any month-end during the period                        343,427                   219,067              130,217
  Balance outstanding at end of period                     245,571                   219,067              130,217
  Average interest rate during the
    period                                                     5.4%                      5.6%                 5.4%
  Average interest rate at end of period                       5.5%                      5.2%                 6.0%
</TABLE>
<PAGE>
         The Company  obtains both  fixed-rate and  variable-rate  long-term and
short-term  advances from the FHLB of Indianapolis  upon the security of certain
of its  residential  first  mortgage  loans and other assets,  provided  certain
standards  related  to  creditworthiness  of the Bank  have  been  met.  FHLB of
Indianapolis  advances are  available  for general  business  purposes to expand
lending and investing  activities.  Borrowings  have generally been used to fund
the purchase of mortgage-backed and related securities or lending activities and
have been collateralized with a blanket pledge agreement of the Bank's assets.

         Advances  from the FHLB of  Indianapolis  are made  pursuant to several
different credit programs,  each of which has its own interest rate and range of
maturities.  The Company currently has two variable-rate  advances from the FHLB
of  Indianapolis  which mature in 1997. At June 30, 1997,  the Company had total
FHLB of Indianapolis  advances of $26.0 million at a weighted  average  interest
rate of 5.8%.

         The  Company  also  obtains  funds  from  the  sales of  securities  to
investment   dealers  under  agreements  to  repurchase   ("reverse   repurchase
agreements").  In a reverse repurchase agreement  transaction,  the Company will
generally sell a mortgage-backed security agreeing to repurchase either the same
or a  substantially  identical  security  (i.e.,  "dollar rolls") on a specified
later date  (generally  not more than 90 days) at a price less than the original
sales price.  The difference in the sale price and purchase price is the cost of
the  use  of  the  proceeds.  The  mortgage-backed   securities  underlying  the
agreements  are  delivered  to the dealers who  arrange  the  transactions.  For
agreements in which the Company has agreed to repurchase substantially identical
securities,  the dealers may sell,  loan or otherwise  dispose of the  Company's
securities in the normal course of their  operations;  however,  such dealers or
third party  custodians  safe-keep the securities  which are to be  specifically
repurchased  by  the  Company.   Reverse  repurchase   agreements   represent  a
competitive  cost funding source for the Company.  Nevertheless,  the Company is
subject to the risk that the lender may default at  maturity  and not return the
collateral.  The amount at risk is the value of the collateral which exceeds the
balance of the borrowing.  In order to minimize this potential risk, the Company
only deals with large, established investment brokerage firms when entering into
these  transactions.  Reverse  repurchase  transactions  are  accounted  for  as
financing  arrangements  rather  than  as  sales  of  such  securities,  and the
obligation  to  repurchase  such  securities  is reflected as a liability in the
Consolidated Financial Statements.

         In April 1993,  the Company  entered into a $10.0 million loan facility
with an unrelated  financial  institution.  This  facility,  as amended in 1997,
includes a $10.0 million term loan (the "Refinancing  Loan") and a non-revolving
line of credit of $5.0 million. Proceeds from the Refinancing Loan were utilized
to repay the unpaid balance of a $10.0 million loan that the Company obtained in
1988 in connection with its acquisition of the Bank, reduce the average interest
rate paid on such indebtedness and increase the  capitalization of the Bank. The
loan  facility  matures in June 2000 and carries an  interest  rate equal to the
prime rate  published in the Wall Street  Journal.  The loan  facility  requires
quarterly interest-only repayments with the unpaid principal balance outstanding
payable  in full at  maturity.  The loan  facility  is  secured by (i) a general
pledge  agreement  between the parties pursuant to which the Company has pledged
100% of the outstanding stock of the Bank; (ii) a security agreement between the
parties pursuant to which the Company has provided a blanket  security  interest
in all of its assets;  and (iii) the  assignment of life  insurance  policies on
Messrs.  Breeden  and  Cerny by the  Company  in the  aggregate  amount of $1.25
million.  At June 30,  1997,  the total  balance of the loan  facility was $10.0
million.


Trust and Fiduciary Services

         The  Company  also  provides  a full  range  of  trust  and  investment
services,  and acts as executor or  administrator  of estates and as trustee for
various  types of trusts.  Trust and  investment  services  are offered  through
Harrington Investment Management and Trust Services ("Trust Department"),  which
was  created in  December  1994 as a  separate  division  of the Bank.  Services
offered  include  financial  services  related  to  trusts  and  estates,  money
management,  custodial services and pension and employee benefits consulting and
plan  administration.  As of June 30, 1997,  the Trust  Department  administered
approximately  43  trust/fiduciary  accounts,  with  aggregate  assets  of $27.6
million at such date.  Gross fee income  from the Trust  Department  amounted to
$40,000 and $31,000 during fiscal 1997 and 1996,  respectively,  while the Trust
Department  recognized  net losses with respect to its operations of $60,000 and
$59,000 during the respective periods.

Subsidiaries

         The Bank is  permitted  to invest up to 2% of its assets in the capital
stock of, or secured or unsecured  loans to,  subsidiary  corporations,  with an
additional  investment  of 1% of assets  when  such  additional  investments  is
utilized  primarily  for  community  development   purposes.   The  Bank's  only
subsidiary,  Pine Tree Mortgage Corp., is an inactive corporation formed in 1987
to originate  mortgage  loans in North  Carolina,  and has conducted no business
since 1988.  The Bank's  investment  in the  subsidiary  is not  material to its
operations or financial condition.

Supervision and Regulation

         Set forth below is a brief  description  of those laws and  regulations
which,  together  with  the  descriptions  of  laws  and  regulations  contained
elsewhere  herein,  are deemed  material to an investor's  understanding  of the
extent to which the Company and the Bank are regulated.  The  description of the
laws and regulations hereunder,  as well as descriptions of laws and regulations
contained  elsewhere herein, does not purport to be complete and is qualified in
its entirety by reference to applicable laws and regulations.

The Company

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

         Activities  Restrictions.  Although there are generally no restrictions
on the  activities  of a savings and loan holding  company  which holds only one
subsidiary savings institution under applicable OTS regulations, the Company may
be  considered  to be a  multiple  savings  and  loan  holding  company  because
principals and affiliates of Smith Breeden are deemed for regulatory purposes to
control both the Company and Harrington West Financial Group, a savings and loan
holding  company  which owns all of the  outstanding  common stock of Los Padres
Savings Bank, F.S.B., Los Padres, California.

         Multiple savings and loan holding companies are subject to restrictions
which do not apply to unitary  savings and loan holding  companies.  Among other
things, no multiple savings and loan holding company or subsidiary thereof which
is not a savings  institution shall commence or continue for a limited period of
time after  becoming a multiple  savings and loan holding  company or subsidiary
thereof any  business  activity,  upon prior  notice to, and no objection by the
OTS,  other  than:  (i)  furnishing  or  performing  management  services  for a
subsidiary  savings  institution;  (ii) conducting an insurance agency or escrow
business;  (iii) holding,  managing,  or liquidating assets owned by or acquired
from a subsidiary savings institution;  (iv) holding or managing properties used
or occupied by a subsidiary  savings  institution;  (v) acting as trustee  under
deeds of trust;  (vi) those  activities  authorized by regulation as of March 5,
1987 to be engaged in by multiple savings and loan holding  companies;  or (vii)
unless the Director of the OTS by regulation prohibits or limits such activities
for savings and loan  holding  companies,  those  activities  authorized  by the
Federal  Reserve  Board  as  permissible  for  bank  holding  companies.   Those
activities described in (vii) above also must be approved by the Director of the
OTS prior to being  engaged in by a multiple  savings and loan holding  company.
The Company does not believe that if the OTS designates it as a multiple  thrift
holding company, such a designation will limit its ability to conduct its normal
business operations.

         In  addition,  if the  Director  of the OTS  determines  that  there is
reasonable  cause to believe that the continuation by a savings and loan holding
company of an  activity  constitutes  a serious  risk to the  financial  safety,
soundness or stability of its subsidiary savings  institution,  the Director may
impose such  restrictions  as deemed  necessary to address such risk,  including
limiting (i) payment of dividends by the savings institution;  (ii) transactions
between the savings institution and its affiliates;  and (iii) any activities of
the savings institution that might create a serious risk that the liabilities of
the  holding   company  and  its  affiliates  may  be  imposed  on  the  savings
institution.

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

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

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

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

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

The Bank

         General.  The  OTS has  extensive  authority  over  the  operations  of
federally  chartered savings  institutions.  As part of this authority,  savings
institutions  are required to file periodic reports with the OTS and are subject
to periodic examinations by the OTS. The last regulatory examination of the Bank
by the OTS was conducted beginning on May 27, 1997. The Bank was not required to
make any material changes to its operations as a result of such examination. The
investment  and lending  authority of savings  institutions  are  prescribed  by
federal laws and regulations, and such institutions are prohibited from engaging
in any  activities  not permitted by such laws and  regulations.  Those laws and
regulations   generally  are  applicable  to  all  federally  chartered  savings
institutions and may also apply to state-chartered  savings  institutions.  Such
regulation  and  supervision  is  primarily   intended  for  the  protection  of
depositors.

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

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

         Both the SAIF and Bank Insurance Fund ("BIF") are statutorily  required
to be capitalized to a ratio of 1.25% of insured reserve  deposits.  The BIF met
its required  capitalization  levels in 1995 and, as a result,  most BIF insured
banks have been paying significantly lower premiums than SAIF institutions.  The
legislation  enacted by the U.S. Congress,  which was signed by the President on
September 30, 1996, has  recapitalized  the SAIF by a one-time  charge of $0.657
for each $100 of  assessable  deposits  held at March 31,  1995.  Although  this
resulted in pre-tax expense of $830,000  recognized in the Company's earnings in
fiscal  year 1997,  future  earnings  will be  enhanced  due to lower  insurance
premiums.  The Bank's insurance premiums,  which had amounted to $0.23 for every
$100 of assessable deposits, were reduced to $0.065 for every $100 of assessable
deposits beginning on January 1, 1997.

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

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

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

         In determining  compliance with the risk-based capital  requirement,  a
savings  institution  is allowed to include both core capital and  supplementary
capital in its total capital,  provided that the amount of supplementary capital
included does not exceed the savings  institution's core capital.  Supplementary
capital generally consists of hybrid capital  instruments;  perpetual  preferred
stock which is not eligible to be included as core  capital;  subordinated  debt
and intermediate-term preferred stock; and general allowances for loan losses up
to a maximum of 1.25% of  risk-weighted  assets.  In  determining  the  required
amount of risk-based capital, total assets,  including certain off-balance sheet
items,  are  multiplied by a risk weight based on the risks inherent in the type
of assets.  The risk weights  assigned by the OTS for  principal  categories  of
assets  are (i) 0% for cash and  securities  issued  by the U.S.  Government  or
unconditionally backed by the full faith and credit of the U.S. Government; (ii)
20%  for   securities   (other   than   equity   securities)   issued   by  U.S.
Government-sponsored agencies and mortgage-backed securities issued by, or fully
guaranteed  as to principal  and  interest  by, FNMA or FHLMC,  except for those
classes with residual characteristics or stripped  mortgage-related  securities;
(iii) 50% for prudently  underwritten  permanent one- to four-family  first lien
mortgage loans not more than 90 days delinquent and having a loan-to-value ratio
of not more than 80% at  origination  unless insured to such ratio by an insurer
approved by FNMA or FHLMC, qualifying residential bridge loans made directly for
the construction of one- to four-family  residences and qualifying  multi-family
residential loans; and (iv) 100% for all other loans and investments,  including
consumer  loans,  commercial  loans,  and one- to four-family  residential  real
estate loans more than 90 days delinquent, and for repossessed assets.

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

         Liquidity  Requirements.  All  savings  institutions  are  required  to
maintain an average daily balance of liquid assets equal to a certain percentage
of the sum of its average daily balance of net withdrawable deposit accounts and
borrowings payable in one year or less. The liquidity  requirement may vary from
time to time (between 4.0% and 10.0%)  depending  upon economic  conditions  and
savings flows of all savings  institutions.  At the present  time,  the required
minimum liquid asset ratio is 5.0%. At June 30, 1997, the Bank's liquidity ratio
was 5.3%.

         Capital Distributions.  OTS regulations govern capital distributions by
savings  institutions,  which  include  cash  dividends,  stock  redemptions  or
repurchases, cash-out mergers, interest payments on certain convertible debt and
other  transactions  charged to the capital account of a savings  institution to
make capital distributions.  Generally, the regulation creates a safe harbor for
specified levels of capital  distributions  from  institutions  meeting at least
their minimum capital requirements,  so long as such institutions notify the OTS
and receive no objection to the distribution from the OTS. Savings  institutions
and distributions that do not qualify for the safe harbor are required to obtain
prior OTS approval before making any capital distributions.

         Generally,  a savings  institution  that before and after the  proposed
distribution  meets or exceeds its fully phased-in capital  requirements (Tier 1
institutions) may make capital  distributions  during any calendar year equal to
the higher of (i) 100% of net income for the calendar  year-to-date  plus 50% of
its "surplus capital ratio" at the beginning of the calendar year or (ii) 75% of
net income over the most recent four-quarter period. The "surplus capital ratio"
is  defined to mean the  percentage  by which the  institution's  ratio of total
capital to assets exceeds the ratio of its fully phased-in  capital  requirement
to  assets.  "Fully  phased-in  capital  requirement"  is  defined  to  mean  an
institution's  capital requirement under the statutory and regulatory  standards
applicable  on  December  31,  1994,  as  modified  to  reflect  any  applicable
individual minimum capital requirement imposed upon the institution.  Failure to
meet fully  phased-in  or minimum  capital  requirements  will result in further
restrictions on capital  distributions,  including possible  prohibition without
explicit OTS approval.  In order to make distributions under these safe harbors,
Tier 1  institutions  such as the Bank must submit 30 days written notice to the
OTS prior to making the  distribution.  The OTS may  object to the  distribution
during that 30-day period based on safety and soundness concerns.

         In December 1994, the OTS published a notice of proposed  rulemaking to
amend its capital  distribution  regulation.  Under the  proposal,  institutions
would be permitted to only make capital  distributions  that would not result in
their  capital  being  reduced  below the level  required to remain  "adequately
capitalized."  Because  the  Bank is a  subsidiary  of a  holding  company,  the
proposal  would  require the Bank to provide  notice to the OTS of its intent to
make a capital  distribution.  The Bank does not believe that the proposal  will
adversely  affect its  ability to make  capital  distributions  if it is adopted
substantially as proposed.

         Loans to One Borrower.  The permissible amount of loans-to-one borrower
now  generally  follows the national bank standard for all loans made by savings
institutions, as compared to the pre-FIRREA rule that applied that standard only
to  commercial  loans made by  federally  chartered  savings  institutions.  The
national bank standard generally does not permit loans-to-one borrower to exceed
the greater of $500,000 or 15% of  unimpaired  capital and surplus.  Loans in an
amount equal to an additional 10% of unimpaired  capital and surplus also may be
made to a  borrower  if the  loans  are  fully  secured  by  readily  marketable
securities.  For information  about the largest  borrowers from the Bank, see "-
Lending Activities."

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

         Qualified Thrift Lender Test. All savings  institutions are required to
meet a QTL test to avoid certain restrictions on their operations. Under Section
2303 of the Economic  Growth and Regulatory  Paperwork  Reduction Act of 1996, a
savings  association can comply with the QTL test by either meeting the QTL test
set forth in the HOLA and  implementing  regulations or qualifying as a domestic
building and loan association as defined in Section  7701(a)(19) of the Internal
Revenue Code of 1986,  as amended  ("Code").  The QTL test set forth in the HOLA
requires a thrift  institution to maintain 65% of portfolio  assets in Qualified
Thrift Investments  ("QTIs").  Portfolio assets are defined as total assets less
intangibles,  property  used  by a  savings  institution  in  its  business  and
liquidity investments in an amount not exceeding 20% of assets.  Generally, QTIs
are residential  housing related assets.  At June 30, 1997, the qualified thrift
investments of the Bank were approximately 97.6% of its portfolio assets.

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

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

         Federal  Home  Loan  Bank  System.  The Bank is a member of the FHLB of
Indianapolis,  which  is one of 12  regional  FHLBs  that  administers  the home
financing credit function of savings institutions. Each FHLB serves as a reserve
or  central  bank for its  members  within  its  assigned  region.  It is funded
primarily from proceeds derived from the sale of consolidated obligations of the
FHLB  System.  It makes loans to members  (i.e.,  advances) in  accordance  with
policies and  procedures  established  by the Board of Directors of the FHLB. At
June 30, 1997, the Company had $26.0 million of FHLB advances. See "- Sources of
Funds - Borrowings."

         As a member, the Bank is required to purchase and maintain stock in the
FHLB of Indianapolis  in an amount equal to at least 1% of its aggregate  unpaid
residential  mortgage loans, home purchase  contracts or similar  obligations at
the beginning of each year. At June 30, 1997,  the Bank had $4.9 million in FHLB
stock, which was in compliance with this requirement.

         The FHLBs are required to provide funds for the  resolution of troubled
savings  institutions  and to contribute to affordable  housing programs through
direct loans or interest subsidies on advances targeted for community investment
and  low-  and  moderate-income  housing  projects.   These  contributions  have
adversely  affected  the  level of FHLB  dividends  paid in the  past and  could
continue to do so in the future.  These contributions also could have an adverse
effect on the value of FHLB stock in the future.

         Federal  Reserve  System.   The  Federal  Reserve  Board  requires  all
depository  institutions to maintain reserves against their transaction accounts
(primarily NOW and Super NOW checking  accounts) and non-personal time deposits.
As of June 30, 1997, the Bank was in compliance with this  requirement.  Because
required   reserves  must  be  maintained  in  the  form  of  vault  cash  or  a
noninterest-bearing  account  at a  Federal  Reserve  Bank,  the  effect of this
reserve requirement is to reduce an institution's earning assets.

Federal Taxation

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

         Year. The Company files a consolidated federal income tax return on the
basis of a fiscal  year  ending on June 30.  The  Company's  federal  income tax
returns for the tax years ended June 30, 1994 forward are open under the statute
of limitations and are subject to review by the IRS.

         Bad Debt Reserves.  Prior to the enactment,  on August 20, 1996, of the
Small  Business  Job  Protection  Act of 1996 (the "Small  Business  Act"),  for
federal income tax purposes,  thrift  institutions  such as the Bank,  which met
certain  definitional tests primarily relating to their assets and the nature of
their  business,  were  permitted to establish tax reserves for bad debts and to
make  annual  additions  thereto,   which  additions  could,   within  specified
limitations,  be  deducted  in  arriving  at their  taxable  income.  The Bank's
deduction with respect to "qualifying  loans," which are generally loans secured
by certain interest in real property, could be computed using an amount based on
a six-year moving average of the Bank's actual loss experience (the  "Experience
Method"),  or a percentage  equal to 8.0% of the Bank's taxable income (the "PTI
Method"),  computed  without  regard  to  this  deduction  and  with  additional
modifications  and  reduced  by the  amount  of any  permitted  addition  to the
non-qualifying reserve.

         Under the Small  Business Act, the PTI Method was repealed and the Bank
will be required to use the Experience Method of computing  additions to its bad
debt reserve for taxable years  beginning with the Bank's taxable year beginning
July 1, 1996. In addition,  the Bank will be required to recapture  (i.e.,  take
into taxable income) over a six-year  period,  beginning with the Bank's taxable
year  beginning July 1, 1996, the excess of the balance of its bad debt reserves
(other than the  supplemental  reserve) as of June 30, 1996 over (a) the greater
of the balance of such  reserves as of June 30, 1988 or (b) an amount that would
have been the  balance of such  reserves as of June 30, 1996 had the Bank always
computed the additions to its reserves  using the  Experience  Method.  However,
under the Small Business Act such recapture  requirements  will be suspended for
each of the two  successive  taxable years  beginning  July 1, 1996 in which the
Bank originates a minimum amount of certain  residential loans during such years
that is not less than the average of the principal amounts of such loans made by
the Bank during its six taxable years preceding July 1, 1996.

State Taxation

         The State of Indiana  imposes a franchise  tax on the  "adjusted  gross
income"  of  financial  institutions  at a fixed  rate of 8.5% per  annum.  This
franchise tax is imposed in lieu of the gross income tax,  adjusted gross income
tax, and  supplemental  net income tax  otherwise  imposed on certain  corporate
entities. "Adjusted gross income" is computed by making certain modifications to
an institution's  federal taxable income.  Tax-exempt interest,  for example, is
included in the savings  association's  adjusted  gross  income and the bad debt
deduction  is  limited  to actual  charge-offs  for  purposes  of the  financial
institutions tax.
<PAGE>
Item 2.           Properties

         The Company's  principal  executive  office is located at 722 East Main
Street,  Richmond,  Indiana,  47374.  The  following  table sets  forth  certain
information with respect to the offices and other properties of the Bank at June
30, 1997.
<TABLE>
<CAPTION>
                                                                              Net Book Value
           Description/Address                     Leased/Owned               of Property(1)             Deposits
------------------------------------------     ---------------------      -----------------------    ------------------
                                                               (In Thousands)
<S>                                            <C>                        <C>                        <C>
Main Office                                            Owned                         $1,631                 $69,019
722 East Main Street
Richmond, Indiana

Carmel Branch (2)                                    Leased(3)                          103                  49,262
11592 Westfield Boulevard
Carmel, Indiana

Fishers Branch (4)                                     Owned                            930                  16,495
7150 East 116th Street
Fishers, Indiana

Noblesville Branch (5)                                 Owned                            920                   1,399
107 West Logan Street
Noblesville, Indiana

Geist Branch (6)                                       Owned                            391                      --
9775 Fall Creek Road
Indianapolis, Indiana
</TABLE>

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

(1)      Includes leasehold improvements.

(2)      Branch opened in May 1994.

(3)      The lease  expires in June 2008 and may be extended  for an  additional
         ten years provided that proper notice is timely given.

(4)      Branch opened in December 1995.

(5)      Branch opened in June 1997.

(6)      Construction in progress. Branch is expected to open in December 1997.
<PAGE>
Item 3.           Legal Proceedings.

         There are no material legal proceedings to which the Company is a party
 or to which any of their property is subject.

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

         Not applicable.

PART II

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

         Shares of the Company's  common stock are traded  nationally  under the
symbol "HFGI" on the Nasdaq National Market.  The following table sets forth the
high,  low and  closing  sales  prices for the common  stock as  reported by the
Nasdaq Stock Market,  as well as the dividends  paid,  for fiscal years 1997 and
1996:
<TABLE>
<CAPTION>
                                                 Stock Price per Share
                                       ------------------------------------------
                                        High              Low              Close           Dividends
                                        ----              ---              -----           ---------
<S>                                    <C>               <C>              <C>                <C>
1997
     First quarter                     $11.00            $ 9.50           $10.125               --
     Second quarter                     10.75             10.00             10.75               --
     Third quarter                      11.00              9.75             11.00               --
     Fourth quarter                    12.375             10.50            12.125            $0.03

1996
     Fourth quarter (1)                $11.00           $10.125            $10.50               --
</TABLE>


(1) The Company's common stock commenced trading on May 10, 1996.

         There  have been no stock  dividends,  stock  splits or  reverse  stock
splits. Payment of future dividends is subject to a declaration by the Company's
Board of Directors.  Factors considered in determining the size of dividends are
the amount and  stability of profits,  adequacy of  capitalization  and expected
asset and liability growth of the Bank.

         At September 19, 1997 the Company had  approximately 64 stockholders of
record.

Item 6. Selected Financial Data.

         The information  required herein is incorporated by reference from page
13 of the Registrant's 1997 Annual Report.

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

         The information required herein is incorporated by reference from pages
14 to 25 of the Registrant's 1997 Annual Report.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

         The information required herein is incorporated by reference from pages
15 to 19 of the Registrant's 1997 Annual Report.

Item 8. Financial Statements and Supplementary Data.

         The information required herein is incorporated by reference from pages
26 to 55 of the Registrant's 1997 Annual Report.

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

        Not applicable.

PART III

Item 10. Directors and Executive Officers of the Registrant.

         The information required herein is incorporated by reference from pages
2 to 9, and 11 of the  Registrant's  Proxy  Statement  dated  September 24, 1997
("Proxy Statement").

Item 11. Executive Compensation.

         The information required herein is incorporated by reference from pages
12 to 20 of the Registrant's Proxy Statement.

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

         The information required herein is incorporated by reference from pages
9 to 11 of the Registrant's Proxy Statement.

Item 13. Certain Relationships and Related Transactions.

         The information required herein is incorporated by reference from pages
16 and 17 of the Registrant's Proxy Statement.


PART IV

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

        (a)    Document filed as part of this Report.

               (1)    The  following  documents are filed as part of this report
                      and  are   incorporated   herein  by  reference  from  the
                      Registrant's 1997 Annual Report.

        Independent Auditors' Report.

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

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

        Consolidated Statements of Changes in Stockholders' Equity for the Years
        Ended June 30, 1997, 1996 and 1995.

        Consolidated Statements of Cash Flows for the Years Ended June 30, 1997,
        1996 and 1995.

        Notes to Consolidated Financial Statements.

               (2)    All  schedules   for  which   provision  is  made  in  the
                      applicable  accounting  regulation of the  Securities  and
                      Exchange  Commission  are  omitted  because  they  are not
                      applicable or the required  information is included in the
                      Consolidated Financial Statements or notes thereto.
<PAGE>
         (3)(a) The following  exhibits are filed as part of this Form 10-K, and
this list includes the Exhibit Index.
<TABLE>
<CAPTION>
No.                                                         Description
----------------    --------------------------------------------------------------------------------------------------
<S>                 <C>
3.1                 Amended and Restated Articles of Incorporation of Harrington Financial Group, Inc.1/

3.2                 Amended and Restated Bylaws of Harrington Financial Group, Inc.1/

10.1                Stock Option Plan of Harrington Financial Group, Inc.1/*/

10.2                Loan Agreement between Financial Research Corporation (now Harrington Financial Group,
                    Inc.) and Mark Twain Kansas Bank (now Mercantile Bancorporation, Inc.), dated April 14,
                    1994, First Amendment and Loan Agreement between such parties and Smith Breeden
                    Associates, Inc. and Douglas T. Breeden, dated July 21, 1995.1/

10.2.1              Second Amendment and Loan Modification Agreement between Harrington Financial Group, Inc.
                    and Mark Twain Kansas City Bank (now Mercantile Bancorporation, Inc.), dated July 26, 1996
                    (modifies version set forth in Exhibit 10.2) 2/

10.2.2              Third Amendment and Loan Modification Agreement between Harrington Financial Group, Inc.
                    and Mark Twain Kansas City Bank (now Mercantile Bancorporation, Inc.), dated January 13,
                    1997 (modifies version set forth in Exhibits 10.2 and 10.2.1)

10.3                Investment Advisory Agreement between Peoples Federal Savings Association (now Harrington
                    Bank, FSB) and Smith Breeden Associates, Inc. dated April 1, 1992, as amended on March 1,
                    1995.1/

10.4                Lease Agreement on Carmel Branch Office Facility, set forth in Assignment of Lease,
                    between NBD Bank, N.A. and Peoples Federal Savings Association, dated November 8, 1993.1/

10.5                Trust Services Agreement dated September 30, 1994 by and between Harrington Bank, FSB and
                    The Midwest Trust Company.1/

11                  Statement of Computation of Per Share Earnings

13                  1997 Annual Report to Stockholders specified portion (p. 1 and pp. 12-55) of the
                    Registrant's Annual Report to Stockholders for the year ended June 30, 1997.

21                  Subsidiaries of the Registrant - Reference is made to Item 1.  "Business" for the Required
                    information

23                  Consent of Deloitte & Touche LLP

27                  Financial Data Schedule
</TABLE>

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

1/       Incorporated by reference from the  Registration  Statement on Form S-1
         (Registration No. 333-1556) filed by the Registrant with the Securities
         and Exchange Commission ("SEC") on February 20, 1996, as amended.

2/       Incorporated  by reference from the Form 10-K for the fiscal year ended
         June 30, 1996 filed by the  Registrant  with the SEC on  September  30,
         1996.

*/       Management contract or compensatory plan or arrangement.

               (3)(b)  Reports filed on Form 8-K.

                       None.
<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.


                                                HARRINGTON FINANCIAL GROUP, INC.



                                                By: /s/Craig J. Cerny
                                                    ----------------------------
                                                       Craig J. Cerny
                                                       President


        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.


/s/ Craig J. Cerny                                            September 23, 1997
---------------------------------------
Craig J. Cerny
President (Principal Executive Officer)


/s/ Catherine A. Habschmidt                                   September 23, 1997
---------------------------------------
Catherine A. Habschmidt
Chief Financial Officer and Treasurer
 (Principal Accounting Officer)


/s/ Douglas T. Breeden                                        September 23, 1997
---------------------------------------
Douglas T. Breeden
Chairman of the Board


/s/ William F. Quinn                                          September 23, 1997
---------------------------------------
William F. Quinn
Director



/s/ Daniel C. Dektar                                          September 23, 1997
---------------------------------------
Daniel C. Dektar
Director


/s/ Gerald J. Madigan                                         September 23, 1997
---------------------------------------
Gerald J. Madigan
Director


/s/ Michael J. Giarla                                         September 23, 1997
---------------------------------------
Michael J. Giarla
Director


/s/ Stephen A. Eason                                          September 23, 1997
---------------------------------------
Stephen A. Eason
Director


/s/ Lawrence E. Golaszewski                                   September 23, 1997
---------------------------------------
Lawrence E. Golaszewski
Director


/s/ David F. Harper                                           September 23, 1997
---------------------------------------
David F. Harper
Director


/s/ Stanley J. Kon                                            September 23, 1997
---------------------------------------
Stanley J. Kon
Director


/s/ John J. McConnell                                         September 23, 1997
---------------------------------------
John J. McConnell
Director