<TABLE>
<CAPTION>

SELECTED FINANCIAL DATA
                                                                                    Years ended December 31,

<S>                                                  <C>                 <C>              <C>              <C>            <C>       
(Dollars in thousands, except per share data)             1997              1996             1995              1994          1993
Interest income                                      $    59,301         $  45,800        $  40,511        $  22,208      $  16,667 
Interest expense                                          46,063            34,815           31,946           17,513         11,828 
   Net interest income                                    13,238            10,985            8,565            4,695          4,839 
Provision for loan losses                                    921               919            1,722              492            211 
Non-interest income                                        4,093             2,756            3,777              175          1,157 
General and administrative expenses                        9,042             8,375            5,561            3,503          2,997 
Other non-interest operating expenses                      1,100               700              679              153            739 
   Income before income taxes and cumulative
     effect of change in accounting principle              6,268             3,747            4,380              722          2,049
Income tax expense                                         1,657             1,195            1,660              182            842 
Cumulative effect of change in                                                                                                      
    accounting principle                                      --                --               --               --            170 
   Net income                                        $     3,671         $   2,552        $   2,720        $     540      $   1,377 
Earnings per share:                                                                                                                 
  Basic                                              $      1.68        $     1.25        $    1.33        $    0.31      $    1.06 
  Diluted                                            $      1.49        $     1.16        $    1.33        $    0.31      $    1.06 
At December 31,                                                                                                                     
Total assets                                         $ 1,100,352         $ 647,965        $ 553,943         $427,292      $ 220,301 
Loans receivable, net                                    540,704           351,821          248,492          154,742        100,859 
Mortgage-backed securities (a)                           340,313           184,743          234,385          236,464         80,782 
Investment securities (a)                                 91,237            78,826           40,058           12,444         18,110 
Deposits                                                 522,221           390,486          306,500          212,411        113,132 
Advances from the FHLB                                   200,000           144,800          105,500           96,000         61,000 
Securities sold under agreements to repurchase           279,909            57,581           93,905           79,613         29,642 
Total stockholders equity                                 45,824            24,658           21,565           17,028         12,378 
Financial ratios:                                                                                                                   
Return on average                                                                                                                   
   Total assets                                             0.45%             0.61%(c)        0.53%            0.17%           0.61%
   Stockholders' equity                                     9.17%            16.50%(c)       14.10%            3.17%          11.79%
Average stockholders'                                                                                                               
   equity to average total assets                           4.92%             3.70%           3.77%            5.27%           5.20%
Total general and administrative expenses                                                                                           
    to total assets                                         0.82%             1.03%(c)        1.00%            0.82%           1.36%
Number of (b):                                                                                                                      
     Deposit accounts                                     25,507            16,506          12,919            8,564           2,932 
     Full-time equivalent employees                           58                39              30               29              18 
Total assets per employee (b)                           $ 18,972         $  16,614        $ 18,465        $  14,734       $  12,239
</TABLE>
(a) Includes  available for sale, held to maturity,  held for sale, and trading.
(b) At end of period. (c) Excludes SAIF assessment.


<PAGE>


MANAGEMENT'S  DISCUSSION  AND  ANALYSIS OF  FINANCIAL  CONDITION  AND RESULTS OF
OPERATIONS

The information contained in this section should be read in conjunction with the
Company's 1997 Consolidated Financial Statements and Notes thereto. In addition,
this  Annual  Report,  which  includes  Management's  Discussion  and  Analysis,
contains certain  forward-looking  information.  This  information  includes the
plans  and  objectives  of  management  for  future   operations  and  financial
objectives,   loan  portfolio   growth,   and   availability   of  funds.   This
forward-looking   information  is  subject  to  the  inherent  uncertainties  in
predicting  future  results and  conditions.  Certain  factors  that could cause
actual results and conditions to differ  materially  from those projected in the
forward-looking information are set forth below in the Interest Rate Sensitivity
Management  section.  Other  factors that could cause  actual  results to differ
materially  include  the  uncertainties  of  economic,  competitive  and  market
conditions,  and  future  business  decisions,  all of which  are  difficult  or
impossible to predict accurately and many of which are beyond the control of the
Company.  Although the Company  believes  that the  assumptions  underlying  the
forward-looking   information  included  herein  are  reasonable,   any  of  the
assumptions  could be inaccurate and  therefore,  there can be no assurance that
the  forward-looking  information  included  herein  will prove to be  accurate.
Therefore,  the  inclusion  of such  information  should  not be  regarded  as a
representation  by the Company or any other person that the objectives and plans
of the Company will be achieved.

INTRODUCTION

         TeleBanc  Financial  Corporation  ("TeleBanc"  or  the  "Company")  was
organized  by  its  majority   stockholder,   MET  Holdings   Corporation  ("MET
Holdings"),  to become,  in March  1994,  the parent  savings  and loan  holding
company for TeleBank  ("the  Bank"),  a federally  chartered  savings  bank.  In
February 1997,  TeleBanc  acquired  TeleBanc Capital Markets,  Inc.  ("TCM"),  a
registered investment advisor, funds manager, and broker-dealer  specializing in
mortgages and  mortgage-related  securities.  In June 1997,  the Company  formed
TeleBanc  Capital Trust I ("TCT"),  which in turn sold shares of trust preferred
securities,  Series A, for a total of $10.0 million in a private placement.  All
references  to the Company  include  the  business  of the Bank,  TCM,  and TCT.
Financial and other data as of and for all periods prior to March 1994 represent
the consolidated  data of the Bank only. Prior to March 1996, the Bank was known
as Metropolitan Bank for Savings, F.S.B.

         Since 1994, TeleBanc has raised approximately $61.8 million through the
sale of capital  stock and warrants and the issuance of  subordinated  notes and
trust preferred  securities.  In the second quarter of 1994,  TeleBanc completed
its initial  public  offering,  raising $4.6 million  through the sale of common
stock and an additional $17.3 million through the issuance of subordinated notes
with warrants.  Upon the completion of this offering,  the Company  invested $15
million of the proceeds as capital of the Bank.  In February  1997,  the Company
consummated  the sale of $29.9  million  of  units  to  investment  partnerships
managed  by  Conning  &  Company,  CIBC WG  Argosy  Merchant  Fund 2,  LLC,  the
Progressive Corporation,  and The Northwestern Mutual Life Insurance Company and
the purchase of the assets of Arbor Capital  Partners,  Inc., which was majority
owned by MET Holdings, through the issuance of 162,461 shares of TeleBanc common
stock and a $500,000 cash payment.  The units consist of  convertible  preferred
stock and senior



                                       2
<PAGE>

subordinated  notes with warrants.  For the period ending December 31, 1997, the
Company invested $15.3 million in the Bank and $3.0 million in TCM.

         Overall growth in assets and deposits reflects the Company's efforts to
invest and  leverage  the capital  proceeds.  At  December  31,  1997,  TeleBanc
reported  total assets of $1.1 billion,  total deposits of $522.2  million,  and
stockholders'  equity  of $45.8  million,  compared  to $220.3  million,  $113.1
million, and $12.4 million, respectively, at December 31, 1993.

         Since 1989,  the Bank has been  developing  an operating  strategy that
seeks to minimize  general and  administrative  expenses  through more efficient
deposit  gathering,  borrowing,  and asset generation.  From its headquarters in
Arlington,  Virginia, the Company attracts deposit accounts such as certificates
of deposit,  money market  accounts,  and interest  checking  accounts through a
targeted direct marketing program.  Unlike traditional  financial  institutions,
the Company  pursues a "branchless"  marketing  strategy and thus interacts with
its customers primarily through the telephone,  internet, mail, and fax. Company
representatives  utilize a sophisticated  computer software system to market and
process  deposits,  build a customer  database for future products,  and provide
quality service.  Other funding sources for the Company include  borrowings from
the Federal Home Loan Bank of Atlanta ("FHLB"), securities sold under agreements
to repurchase, and subordinated debt.

         The  Company's  asset  acquisition  strategy is focused on investing in
one-to-four  unit,   single-family  mortgages  and  mortgage  backed  securities
purchased in the secondary  market rather than to originate  loans.  The Company
seeks to manage  interest  rate risk  through  matching  the  maturities  of its
deposit  solicitations  and borrowings as compared with its asset  purchases and
the use of certain hedging  techniques in order to operate profitably in various
interest rate environments.

         In the first quarter of 1998,  TeleBanc  announced that it had signed a
definitive merger agreement to acquire (the "DFC Acquisition")  Direct Financial
Corporation  ("DFC").  DFC is the parent  holding  company of  Premium  Bank,  a
federal  savings bank  headquartered  in New Jersey.  At December 31, 1997,  DFC
reported  total  assets  of  $326.1  million,  loans  receivable,  net of $187.2
million,  total  deposits of $273.9  million and total  stockholders'  equity of
$12.3 million.  TeleBanc will pay $12 for each share of Direct  Financial common
stock or common stock  equivalent.  The  transaction is valued at  approximately
$26.4 million.  The DFC  Acquisition is expected to be consummated in the second
quarter of 1998, subject to DFC stockholder and regulatory approvals.

         Also  in  January  1998,  TeleBanc  signed  a  definitive   acquisition
agreement  whereby  MET  Holdings  will sell  substantially  all of its  assets,
including  approximately  1,433,081 shares of TeleBanc Common Stock owned by MET
Holdings,  and  assign  substantially  all  of  its  liabilities,  to  TeleBanc.
Immediately  following  consummation  of  the  acquisition,  MET  Holdings  will
dissolve  and   distribute   its  remaining   assets  and   liabilities  to  its
stockholders,  assuming such  dissolution is approved by the requisite number of
stockholders of MET Holdings and TeleBanc.

         Given the ever-increasing  competitive  financial services environment,
the Company has adopted a plan to establish  the Bank as a leading brand name in
direct  banking.  The  Company  intends  to focus on  higher  growth  rates  and
therefore  anticipates  increased  associated  expenses,   including  marketing,
compensation, and technology costs, for



                                       3
<PAGE>

the  next  two  years.  The  Bank's  core  competency  has  been to  incorporate
technology  to  operate  at  a  significantly  lower  cost  structure  than  its
competitors  and to use a portion of the expense  differential  to offer  higher
value  savings  products.  The Bank has also  evolved from using  national  rate
surveys as the primary means of attracting deposits to developing sophisticated,
multiple  channel  marketing  strategies.  These  strategies  are building brand
identity,  franchise  value,  and savings  patterns  that  mirror the  favorable
deposit  structure  of a  traditional  savings  bank  without the  corresponding
infrastructure  expense.   Management  believes  this  commitment  to  expansion
directly associated with brand building is necessary to establish the preeminent
direct banking franchise.

         The following  financial review presents  management's  analysis of the
consolidated  financial  condition  and results of  operations  of TeleBanc  and
should  be  read  together  with  the  consolidated   financial  statements  and
accompanying notes.

INTEREST RATE SENSITIVITY MANAGEMENT

         The  Company  actively  monitors  the  sensitivity  of its  assets  and
liabilities  to various  interest rate  environments  due to repricing in future
time periods.  Effective  interest rate  sensitivity  management seeks to ensure
that net  interest  income is  protected  from the impact of changes in interest
rates.  The  risk  management  function  is  responsible  for  the  measurement,
monitoring,  and  control of market  risk and the  communication  of risk limits
throughout  the  Company  in  connection  with  its  asset-liability  management
activities and trading.

     The Company's  strategies are intended to stabilize the Company's  exposure
to market  risk and net  interest  rate  spread  under a variety  of  changes in
interest  rates.  In  an  effort  to  manage  growth  effectively,  the  Company
undertakes  a slow and  steady  path to  leverage  its  capital  and  invest  in
interest-earning assets. This growth is funded by raising deposits and incurring
debt including FHLB advances and securities sold under  agreements to repurchase
("repos").  The Company's  deposit  gathering  strategy  tends to rely on higher
yielding interest checking accounts,  money market accounts, and certificates of
deposit  accumulated  through the Bank's  branchless  banking telephone and mail
operations,  rather than  relying on extensive  branch  networks  which  require
higher  overhead.  Similarly,  the  Company  tends to invest its funds in assets
purchased in the secondary  market rather than incurring  overhead for extensive
loan origination operations.  As a result, the Company's interest rate spread is
lower than that of traditional financial institutions.  By actively managing the
maturities of its interest-sensitive  assets and liabilities,  the Company seeks
to maintain relatively consistent interest rate spreads and mitigate much of the
interest rate risk associated with such assets and liabilities.

         Management  utilizes a risk management  process that allows risk-taking
within well defined  limits which can be used to create and enhance  shareholder
value through the effective employment of risk capital. To this end, the Company
has  established  an  Asset-Liability   Committee  ("ALCO")  and  implemented  a
measurement of risk using "market value of equity"and  "gap"  methodologies  and
other measures.

         ALCO  establishes the policies and guidelines for the management of the
Company's assets and  liabilities.  The ALCO meets a minimum of eight times each
year and its  membership  is  composed of  individuals  from the Company and two
members of the Board of Directors.  The ALCO policy is directed  toward reducing
the variability of the market value of its equity under a wide range of interest
rate environments. Fair value of equity (FVE) represents the



                                       4
<PAGE>

net fair value of the  company's  financial  assets and  liabilities,  including
off-balance sheet hedges. The Company monitors the sensitivity of changes in its
fair value of equity with  respect to various  interest  rate  environments  and
reports  regularly  to ALCO.  Effective  fair  value  management  maximizes  net
interest income while  constraining the changes in the fair value of equity with
respect to changes in interest rates to acceptable  levels. The model calculates
a benchmark FVE for current market conditions.

         The Company  utilizes  sensitivity  analysis  to evaluate  the rate and
extent of changes to its FVE under  various  market  environments.  In preparing
simulation analysis,  the Company breaks down the aggregate investment portfolio
into discrete  product types that share  similar  properties,  such as fixed- or
adjustable  rate,  similar coupon,  and similar age. In the model,  each product
type exhibits different projected cashflows (i.e. prepayment assumptions). Under
this  analysis,  the net  present  value  of  expected  cashflows  for  interest
sensitive  assets and  liabilities  are calculated  under various  interest rate
scenarios.  In conducting  this  sensitivity  analysis,  the model considers all
asset, liability,  and off-balance sheet hedges, including whole loan mortgages,
mortgage-backed securities, mortgage derivatives, corporate bonds, interest rate
swaps, caps, floors, and options. The range of interest rate scenarios evaluated
encompasses  significant changes to current market conditions.  By this process,
the Company  subjects its interest  rate  sensitive  assets and  liabilities  to
substantial  market stress and evaluates the FVE resulting  from various  market
scenarios.  ALCO  reviews  the  results of these  stress  tests and  establishes
appropriate   strategies  to  promote  continued   compliance  with  established
guidelines.

         Management  measures the efficiency of its  asset/liability  management
strategies by analyzing,  on a quarterly basis,  the Bank's  theoretical FVE and
the  expected  effect of  changes  in  interest  rates.  The Board of  Directors
establishes  limits within which such changes in FVE are to be maintained in the
event of changes in interest rates.

         The Company  calculates a theoretical FVE in response to a hypothetical
change in market  interest risk. The model addresses the exposure to the Bank of
its market sensitive (i.e.  interest rates) non-trading  financial  instruments.
The model excludes the Bank's  trading  portfolio,  which based on  management's
analysis,   has  an  immaterial   impact  on  the  Bank's  FVE.  A  hypothetical
instantaneous  move  upward of 100 basis  points  would cause FVE to decrease by
7.7%.

         Every method of market value  sensitivity  analysis  contains  inherent
limitations  and express and implied  assumptions  that can affect the resulting
calculations.   For  example,   each  interest  rate  scenario  reflects  unique
prepayment and repricing assumptions. In addition, this analysis offers a static
view of assets,  liabilities,  and hedges held as of December 31, 1997 and makes
no  assumptions  regarding  transactions  the Company  might take in response to
changing market conditions.

         The Company  employs  various  hedging  techniques  to  implement  ALCO
strategies  directed  toward  managing the variability of the FVE by controlling
the  relative  sensitivity  of  market  value  of  interest-earning  assets  and
interest-bearing  liabilities.  The  sensitivity  of changes in market  value of
assets and  liabilities  is  affected  by such  factors as the level of interest
rates,  market expectations  regarding future interest rates,  projected related
loan  prepayments,   and  the  repricing  characteristics  of  interest  bearing
liabilities.



                                       5
<PAGE>

         The Company  utilizes  hedging  techniques to reduce the variability of
FVE and its overall interest rate risk exposure over a one-to-seven year period.
A policy adopted by the Company's Board of Directors  prohibits  management from
speculative  purchases or sales of futures,  options,  stripped  mortgage-backed
securities, or other mortgage derivative products.

         Interest  rate  swaps,  caps,  swaptions,  floors,  collars,  financial
options, and other mortgage derivative products are used to manage

interest rate exposure by hedging  certain  assets and  liabilities  and are not
used for  speculative  purposes.  The Company's  interest rate spread was 1.49%,
1.84%, and 1.72% for 1997, 1996, and 1995, respectively.  The Company's yield on
interest-earning   assets  for  such  periods  was  1.73%,   1.94%,  and  1.88%,
respectively.  Since the initial  public  offering in May 1994,  the Company has
steadily grown in both assets and  liabilities,  with average  interest  earning
assets  growing  from $206.9  million  for the  quarter  ended March 31, 1994 to
$772.2  million for the year ended  December  31,  1997,  and  average  interest
bearing  liabilities growing from $206.1 million to $738.3 million over the same
period.  The  Company's  ongoing  strategy  is to maintain a  relatively  stable
interest rate margin and interest rate spread.

         The Company also monitors its assets and  liabilities  by examining the
extent to which such assets and liabilities are "interest rate sensitive" and by
monitoring  interest rate sensitivity "gap." An asset or liability is said to be
interest rate  sensitive  within a specific  period if it will mature or reprice
within  that  period.  The  interest  rate  sensitivity  gap is  defined  as the
difference between the amount of  interest-earning  assets maturing or repricing
within a specific  time  period and the amount of  interest-bearing  liabilities
maturing or repricing within the same time period. A gap is considered  positive
when the amount of interest rate sensitive assets exceeds the amount of interest
rate  sensitive  liabilities  and is  considered  negative  when the  amount  of
interest  rate  sensitive  liabilities  exceeds  the  amount  of  interest  rate
sensitive  assets.  Generally,  during a period  of  rising  interest  rates,  a
negative gap would  adversely  affect net  interest  income while a positive gap
would result in an increase in net interest income; conversely,  during a period
of falling  interest  rates,  a negative  gap would result in an increase in net
interest income and a positive gap would adversely  affect net interest  income.
The  Company's  current  asset-liability  management  strategy is to maintain an
evenly matched  one-to-five year gap giving effect to hedging,  but depending on
market conditions and related circumstances,  a positive or negative one-to-five
year gap of up to 20% may be  acceptable.  Inclusive  of the  Company's  hedging
activities,  the  Company's  one-year  gap at December  31,  1997 is 5.35%.  The
Company's hedge-effected one-to-five year gap at such date is (6.36)%.

         The following  assumptions  were used by management in order to prepare
the  Company's gap table set forth on the next page.  Non-amortizing  investment
securities  are  shown  in  the  period  in  which  they  contractually  mature.
Investment  securities  which contain embedded options such as puts or calls are
shown in the period in which that  security is  currently  expected to be put or
called or to mature.  The table  assumes  that  fully-indexed,  adjustable-rate,
residential  mortgage loans and  mortgage-backed  securities prepay at an annual
rate  between  10% and 15%,  based on  estimated  future  prepayment  rates  for
comparable market benchmark securities and the Company's prepayment history. The
table also assumes that fixed rate,  current-coupon  residential loans prepay at
an annual rate of between 10% and 15%. The above assumptions were adjusted up or
down on a pool by pool basis to model the effects of product type,  coupon rate,
rate adjustment  frequency,  lifetime cap, net coupon reset margin, and periodic
rate caps upon prevailing



                                       6
<PAGE>

annual  prepayment  rates.  Time  deposits are shown in the period in which they
contractually mature, and savings deposits are shown to reprice immediately. The
interest rate  sensitivity of the Company's  assets and  liabilities  could vary
substantially if different assumptions were used or if actual experience differs
from the assumptions  used.  Certain  shortcomings are inherent in the method of
analysis presented in the gap table. Although certain assets and liabilities may
have similar  maturities  or periods of  repricing,  they may react in different
degrees to changes in market interest rates. The interest rates on certain types
of assets and liabilities may fluctuate in advance of changes in market interest
rates,  while  interest rates on other types of assets and  liabilities  may lag
behind changes in market interest rates. Certain assets, such as adjustable-rate
mortgages,  have  features  which  restrict  changes  in  interest  rates  on  a
short-term  basis and over the life of the  assets.  In the event of a change in
interest rates,  prepayment rates would likely deviate  significantly from those
assumed in calculating the table. The ability of many borrowers to service their
debt may decease in the event of an interest rate increase.

<TABLE>
<CAPTION>
                                                                      Repricing       Repricing     Repricing
                                                                         Within          Within        Within    Repricing
                                      Balance       Percent                 0-3            4-12           1-5         Over
<S>                                <C>               <C>              <C>             <C>            <C>          <C>     
(Dollars in Thousands)      December 31, 1997      of Total              Months          Months         Years      5 Years
Interst-earning assets:
  Loans receivable, net            $  540,704        50.43%           $  62,981       $ 174,892      $204,997     $ 97,834
  Investment securities
    available for sale, interest
    bearing accounts & FHLB stock      91,237         8.51               15,158             638        61,934       13,507
  Mortgage backed securities
    available for sale and trading    340,313        31.74              127,191         104,601        61,715       46,805
  Federal funds sold & interest
    bearing deposits                   99,991         9.32               99,991              --            --           --
Total interest-earning assets      $1,072,245       100.00%           $ 305,321       $ 280,131      $328,647     $158,146
Non-interest earning assets:           28,107
Total assets                       $1,100,352
Interest-bearing liabilities:
  Savings deposits                 $  123,611        11.98%           $ 123,611       $   --         $     --     $     --
  Time deposits                       398,610        38.63               23,414         102,348       266,838        6,010
  FHLB advances                       200,000        19.39              200,000              --            --           --
  Other borrowings                    279,909        27.13              279,909              --            --           --
  Subordinated debt                    29,614         2.87                   --              --        12,937       16,677
Total interest-bearing liabilities $1,031,744       100.00%           $ 626,934       $ 102,348      $279,775     $ 22,687
Non-interest bearing liabilities       13,212
  Total liabilities                $1,044,956
  Total trust preferred                 9,572
  Stockholders' equity                 45,824
Total liabilities and
  stockholders equity              $1,100,352
Periodic repricing difference
  (periodic gap)                                                      $(321,613)      $  177,783     $  48,872    $135,459
Cumulative repricing difference
  (cumulative gap)                                                    $(321,613)      $ (143,830)    $ (94,958)   $ 40,501
Cumulative gap to total assets                                           (29.23)%         (13.07)%       (8.63)%      3.68%
Cumulative gap to total assets
  hedge affected (a)                                                     (10.81)%           5.35%        (6.36)%      3.68%
</TABLE>
 (a) The hedge effected  cumulative  gap to total assets  reflects the effect of
hedging  instruments  on the Company's gap at December 31, 1997. For purposes of
determining  the  effect  of  such  hedging  instruments,   interest  rate  swap
agreements are treated as part of the hedged  liability;  hence,  the cash flows
from the swap and the hedged  asset or  liability  are netted and the  resulting
cash flows are used in the gap  calculation.  Interest rate cap agreements  also
are



                                       7
<PAGE>

treated as part of the hedged  asset or  liability  and  weighted  the  market's
estimate of the likelihood the cap strike will be met or exceeded.  The net cash
flows are used in the gap calculations.

FINANCIAL CONDITION

         The Company's  total assets  increased by $452.0  million or 69.8% from
$648.0 million at December 31, 1996 to $1.1 billion at December 31, 1997. Growth
in assets is attributable to increases in  mortgage-backed  securities and loans
receivable. The primary sources of funds for this growth in assets were deposits
and borrowings.

         Loans  receivable,  net and loans  receivable  held for sale  increased
$188.9  million or 53.7%,  from $351.8  million at  December  31, 1996 to $540.7
million at December 31,  1997.  The increase  reflects  whole loan  purchases of
$343.2 million offset by $95.1 million of principal repayments and $60.7 million
of loans sold in 1997.  In the past year,  the  Company  focused  its efforts on
expanding  its direct loan  acquisition  program.  As a result,  the Company has
significantly  improved  its ability to source,  price,  and close whole  loans.
During 1996, the Company  recorded whole loan purchases of $103.1 million offset
by $50.2 million of principal repayments and $27.1 million of loans sold. In the
second quarter of 1996, the Company  reevaluated its loan  investment  strategy.
The  Company  determined  that  the  probable  sale of  loans,  subsequent  to a
restructuring or credit enhancement,  would add value to the portfolio. Pursuant
to this  strategy,  the Company  created a loans held for sale  category  with a
one-time   transfer   of  loans  from  the   investment   portfolio   that  have
characteristics that make them susceptible to sale after  restructuring,  credit
enhancement,  or other  improvements.  Loans held for sale are  recorded  at the
lower of cost or market.  The  Company  maintains  loans held for sale and loans
held for investment categories.

         Mortgage-backed   securities,   available-for-sale,   increased  $134.5
million, or 72.8%, from $184.7 million at December 31, 1996 to $319.2 million at
December 31, 1997.  Investment  securities,  available for sale, increased $12.4
million,  or 15.7%,  from $78.8 million at December 31, 1996 to $91.2 million at
December  31,  1997.  These  securities  are held  for  liquidity  purposes  and
increased along with the growth of assets of the Bank in 1997.

         Deposits  increased  $131.7 million,  or 33.7%,  from $390.5 million at
December 31, 1996 to $522.2 million at December 31, 1997, largely as a result of
the  Company's   continued   marketing  efforts  to  attract  money  market  and
certificate of deposit accounts.  During fiscal year 1997,  approximately  $25.9
million of  interest  was  credited  to the  accounts  while  deposits  exceeded
withdrawals  by $105.8  million,  resulting  in a net change of $131.7  million.
During  1997,  the  Company  completed  a systems  conversion  to an  integrated
platform for marketing,  deposit  operations,  and  accounting/finance.  The new
system will support  future growth and improve the  Company's  ability to launch
new products.  To prepare for the systems upgrade,  management controlled growth
of deposits in an effort to focus on the  conversion  process and  minimize  the
impact  to new  customers.  The  Company  relied  on  FHLB  advances  and  other
borrowings to support asset growth. .

         FHLB advances increased $55.2 million, or 38.1%, from $144.8 million at
December  31, 1996 to $200.0  million at December 31,  1997.  Other  borrowings,
composed of securities  sold under  agreements to repurchase,  increased  $222.3
million, or 385.9%, from $57.6 million at December 31, 1996 to $279.9 million at
December 31, 1997. For the year ended 1997,  subordinated  debt, net of original
issue discount, was $29.6 million, which includes the 9.5% senior



                                       8
<PAGE>

subordinated debt raised in February 1997 and the 11.5% subordinated debt raised
in the second  quarter of 1994. In June 1997,  the Company  formed TCT, which in
turn sold shares of trust preferred  securities,  Series A, for a total of $10.0
million in a private  placement.  The trust preferred  securities have an annual
dividend rate of 11.0% payable semi-annually,  beginning in December 1997. These
transactions  reflect  the  Company's  ability to utilize  alternate  sources of
funding in order to support asset growth.

         Stockholders'  equity  increased  $21.1  million  to $45.8  million  at
December 31, 1997 from $24.7 million at December 31, 1996. The increase reflects
the issuance of $15.3 million of 4% convertible  preferred  stock,  $1.5 million
stock issuance in exchange for Arbor's assets,  $4.6 million in net income,  and
an unrealized  gain for the year on  securities  available for sale of $642,000,
net of taxes, which increases the Company's  stockholders'  equity, but does not
impact the statement of  operations.  The  consolidated  average  balance sheets
along with income and expense and related  interest yields and rates at December
31, 1997 and for each of the preceding  three fiscal years are shown below.  The
table also presents  information  for the periods  indicated with respect to the
difference between the weighted average yield earned on interest-earning  assets
and weighted  average rate paid on  interest-bearing  liabilities,  or "interest
rate spread," which savings  institutions  traditionally  use as an indicator of
profitability.  Another indicator of an institution's  profitability is its "net
yield on  interest-earning  assets," which is its net interest income divided by
the average balance of interest-earning  assets. Net interest income is affected
by the  interest  rate spread and by the  relative  amounts of interest  earning
assets and  interest-bearing  liabilities.  As discussed  above,  the  Company's
operating  strategy  results in lower spreads and margins than other  comparable
financial  institutions,  but the Company  believes lower net interest income is
mitigated by savings in general and administrative expenses.

<TABLE>
<CAPTION>
                                                1997                            1996                      1995
                                  Balance      Average   Interest    Average Average Interest  Average   Average  Interest Average
(Dollars in thousands)     December 31, 1997   Balance  Inc./Exp. Yield/Cost Balance Inc./Exp.Yield/Cost Balance Inc./Exp.Yield/Cost
<S>                          <C>              <C>         <C>          <C>   <C>       <C>         <C>    <C>       <C>        <C>  
Interest-earning assets:
Loans receivable, net(a)     $  540,704       $441,819    $34,729      7.86% $279,038  $23,089     8.28%  $201,737  $17,726    8.80%
Mortgage-backed &
  related securities                 --             --         --        --        --       --       --    233,728   18,614    7.96
Investment securities (b)        54,241         16,203      1,064      6.48    12,841      871     6.79     13,627      990   7.274
Mortgage-backed &
  related securities, AFS       319,203        226,064     17,646      7.81   221,656   17,955     8.10     19,138    1,597    8.35
Investment securities, AFS (c)   91,237         73,649      4,776      6.49    61,169    3,959     6.47     25,516    2,071    8.12
Federal funds sold               45,750          1,844        100      5.37       842       44     5.22        810       49    6.05
Trading account                  21,110         12,581      1,124      8.81        --       --       --      1,932      166    8.59
   Total interest-earning
     assets                  $1,072,245       $772,160    $59,439      7.70% $575,546  $45,918    7.98%   $496,488  $41,213    8.31%
Non-interest earning assets      28,107         41,465                         26,929                       15,388
    Total assets             $1,100,352       $813,625                       $602,475                     $511,876
Interest-bearing liabilities:                          
Savings deposits             $  123,611       $120,901    $ 6,380      5.28% $ 99,346$   4,815     4.85%  $ 41,387$   2,111    5.10%
Time deposits                   398,610        311,740     19,578      6.28   258,870   16,542     6.39    223,745   14,922    6.67
FHLB advances                   200,000        160,681      9,885      6.07   120,678    6,689     5.54     94,718    5,985    6.32
Other borrowings                279,909        117,515      6,941      5.83    68,154    4,569     6.70    107,330    6,839    6.37
Subordinated debt, net           29,614         27,434      3,279     11.95    17,250    2,200    12.75     17,250    2,089   12.11
   Total interest-bearing                              
    liabilities              $1,031,744       $738,271    $46,063      6.21% $564,298  $34,815     6.14%  $484,430 $31,9466.59%
Non-interest-bearing                                   
   liabilities                   13,212         25,719                         15,900                        8,150
   Total liabilities         $1,044,956       $763,990                       $580,198                     $492,580
   Total Trust Preferred          9,572          9,597                             --                           --
   Stockholders' equity          45,824         40,038                         22,277                       19,296
Total liabilities and                                  
   stockholders' equity      $1,100,352       $813,625                       $602,475                     $511,876
Excess of  interest-earning                  
  assets over interest-
  bearing liabilities/
  net interest income/

</TABLE>


                                       9
<PAGE>

<TABLE>
<CAPTION>
<S>                          <C>             <C>          <C>          <C>  <C>        <C>        <C>  <C>                     <C>  
  interest rate spread       $   40,501      $ 33,889     $13,376      1.49% $ 11,248  $11,103    1.84%$    12,058$  9,267     1.72%
Net yield on interest
  earning assets                                                       1.73%                      1.94%                        1.87%
Ratio of  interest-earning
  assets to interest-bearing
  liabilities                                                        104.59%                    101.99%                      102.49%

</TABLE>

(a)   Includes   mortgages   held  for  sale  and   investment.   (b)   Includes
interest-bearing deposits, repurchase agreements,  investment securities held to
maturity,  and FHLB stock.  (c) Interest  income and average yields on municipal
bonds are presented on a tax equivalent basis.

LIQUIDITY MANAGEMENT AND FUNDING

         Liquidity is a company's  ability to maintain  sufficient cash flows to
fund  operations and meet existing and future  obligations,  including  maturing
liabilities, loan commitments, and depositors' withdrawals. The asset portion of
the  balance  sheet  provides  liquidity  through  short-term   investments  and
maturities and repayments of loans and investment  securities.  Other sources of
asset liquidity include sales of loans or securities.

         Liquidity  is  provided  through the  Company's  ability to attract and
maintain  sufficient  deposits and to access available funding markets.  Federal
regulations  require that the Bank maintain an average of 5.00%  liquidity ratio
in relation to certain  borrowings  and the deposit base.  The Bank exceeded the
requirement throughout 1997 and 1996.

         The Company  continues  to enhance the core  deposit  base  through its
branchless  marketing  strategy  that targets  individual  savers who deposit an
average of $21,000.  Management is developing new deposit  products,  such as an
interest checking account, responsive to our customers needs and cross marketing
these  services,  which should provide stable funding sources in future periods.
In an effort to decrease the costs  associated  with new  accounts,  the Company
attracted  several new affinity groups  including the National Council of Senior
Citizens.  Members of the affinity groups receive increased  benefits  including
higher rates and lower minimum balances.

         The following table shows the changes in deposits for each of the prior
periods:

<TABLE>
<CAPTION>
                                                                 Years ended December 31,
(Dollars in thousands)                               1997                   1996                  1995
<S>                                              <C>                    <C>                   <C>     
Balance at beginning of period                   $390,486               $306,500              $212,411
Deposits in excess of (less than)
   withdrawals                                    105,777                 62,629                76,866
Interest credited on deposits                      25,958                 21,357                17,223
Balance at end of period                         $522,221               $390,486              $306,500
</TABLE>

         Management  believes that liquidity of bank deposits  coupled with FDIC
insurance will continue to encourage depositors to maintain significant portions
of their funds in insured depository  accounts.  Management also believes that a
high level of service  and  convenience  coupled  with a growing  acceptance  of
electronic and branchless banking will allow the Company to compete  efficiently
and  effectively  against other FDIC insured banks and other non-bank  financial
institutions.   Savings  deposits   increased  $11.7  million,   or  10.5%,  and
certificate of deposit accounts increased $120.0 million, or 43.1% during 1997.

         The  Company  also relies  upon  borrowed  funds to provide a source of
liquidity at  attractive  interest  rates.  Total  borrowings  increased  $277.5
million, or 137.1%, during 1997. Advances from the FHLB increased $55.2 million,
or 38.1%, during the period largely as a result of attractive interest rates and
due to the various products offered by the



                                       10
<PAGE>

FHLB to member  institutions.  Advances are  collateralized by specific liens on
mortgage loans in accordance with an "Advances,  Specific  Collateral Pledge and
Security Agreement", which requires the Company to maintain qualified collateral
equal to 120 to 160 percent of the Company's advances.  Accordingly, the Company
increased  single-family  residential  mortgage  loan  collateral to the FHLB to
$255.8  million  during  the  year.  Additional  borrowings  from  the  FHLB are
contingent  upon the Company  providing the appropriate  collateral.  Repurchase
agreements  increased  $222.3  million,  or 386.1%,  during  1997.  Principally,
mortgage-backed   securities  are  pledged  as  collateral  for  the  repurchase
agreements.  As of December 31, 1997, the Bank had approximately  $154.0 million
in additional borrowing capacity.

         As of December 31 1997, the Company had approximately  $31.0 million of
face  amount  of  subordinated  notes  with  warrants.   The  subordinated  debt
represents a very stable,  although  relatively  expensive,  source of funds. At
December 31, 1997,  subordinated debt, net was $29.6 million. In addition to the
subordinated debt, the Company also had outstanding $10.0 million face amount of
11.0%  trust  preferred  securities  and  $16.2  million  face  amount  of  4.0%
cumulative  preferred stock at December 31, 1997. The annual cost to service the
subordinated debt and trust preferred  securities is $4.4 million and the annual
dividend requirement on the cumulative  preferred stock is $648,000.  Subject to
regulatory  approval,  the Bank will  dividend  this  balance to the  Company to
service the debt.  There are  various  regulatory  limitations  on the extent to
which federally chartered savings institutions may pay dividends.  Also, savings
institution  subsidiaries of holding companies generally are required to provide
their OTS Regional  Director  with no less than 30 days'  advance  notice of any
proposed  declaration on the institution's  stock.  Under terms of the indenture
pursuant to which the subordinated  notes were issued,  the Company presently is
required to maintain,  on an  unconsolidated  basis,  liquid assets in an amount
equal to or greater than $3.3 million,  which  represents  100% of the aggregate
interest  expense for one year on the  subordinated  debt. The Company had $48.6
million in liquid assets at December 31, 1997.

CAPITAL ADEQUACY

         The  Company's  stockholders'  equity at December 31,  1997,  was $45.8
million.  This  represents a $21.2  million,  or 85.8%,  increase from the prior
year.  The increase  reflects the  issuance of $15.3  million of 4%  convertible
preferred  stock,  $1.6 million stock  issuance in exchange for Arbor's  assets,
$4.2  million in net income and an  unrealized  gain for the year on  securities
available  for sale of $642,000,  net of taxes,  which  increases  the Company's
stockholders' equity, but does not impact the statement of operations.  See Note
2 of the Consolidated Financial Statements.

         The Bank meets all current and fully phased-in capital  requirements as
adjusted for the changes  which are effective to the  computation  of risk-based
capital and core capital at December 31, 1997.

         The required and actual amounts and ratios of capital pertaining to the
Bank as of December 31, 1997 are set forth as follows (dollars in thousands):

<TABLE>
<CAPTION>
                                                                                                                   To Be Well
                                                                      For Capital                             Capitalized Under
                                                                        Adequacy                               Prompt Corrective
                                           Actual                      Purposes:                              Action Provisions:
                              Amount               Ratio        Amount             Ratio            Amount            Ratio
As of December 31, 1997:
Total Capital (to risk
<S>                          <C>                  <C>          <C>                  <C>            <C>                <C>  

</TABLE>

                                       11
<PAGE>

<TABLE>
<CAPTION>
<S>                          <C>                  <C>          <C>                  <C>            <C>                <C>  
   weighted assets)          $55,701              11.91%      _$37,409             _8.0%          _$46,761           _10.0%
Core Capital (to adjusted
   tangible assets)          $52,617               5.06%      _$41,606             _4.0%          _$52,008            _5.0%
Tangible Capital (to
   tangible assets)          $52,608               5.06%      _$15,602             _1.5%               N/A             N/A
Tier I Capital (to
   risk weighted assets)     $52,617              11.25%           N/A              N/A           _$28,057             _6.0%
As of December 31, 1996:
Total Capital (to risk
   weighted assets)          $34,104              10.41%      _$26,205             _8.0%          _$32,756           _10.0%
Core Capital (to adjusted
   tangible assets)          $31,726               5.08%      _$24,999             _4.0%          _$31,248            _5.0%
Tangible Capital (to
   tangible assets)          $31,711               5.07%       _$9,374             _1.5%               N/A             N/A
Tier I Capital (to
   risk weighted assets)     $31,726               9.69%           N/A              N/A           _$19,654            _6.0%

</TABLE>


EARNINGS PERFORMANCE
Comparison  of Operating  Results for the Years Ended  December 31, 1997 , 1996,
and 1995

NET INCOME.  Net income for fiscal year 1997 was $3.7  million  compared to $2.6
million for fiscal year 1996.  Net income for the year ended  December  31, 1997
consisted primarily of $12.3 million in net interest income, $3.3 million in net
gains  on the  sale of  loans  held for  sale,  mortgage-backed  and  investment
securities, and trading assets offset by $10.1 million in non-interest expenses,
$921,000 in provision for loan losses,  and $1.7 million in income tax expenses.
For  fiscal  year 1997,  the  Company's  return on average  assets and return on
average  equity  was 0.45% and  9.17%,  respectively.  The  Company's  return on
average assets and return on average equity has  historically  declined in years
of capital raising.  Based on 2,833,036  weighted average shares of common stock
issued and  outstanding  as well as  potentially  dilutive  securities,  diluted
earnings per share was $1.49.

         Net income decreased by $168,000,  or 6.2%, from $2.7 million in fiscal
year 1995, to $2.6 million in fiscal year 1996. Net income for 1996 includes the
effect of a one-time $1.7 million,  before tax,  assessment to recapitalize  the
Savings Association Insurance Fund ("SAIF"). Without such assessment, net income
would have been $3.6  million.  Net income for the year ended  December 31, 1996
consisted primarily of $11.0 million in net interest income, $1.8 million in net
gains on the sale of loans  held  for sale and  mortgage-backed  and  investment
securities  offset  by  $9.1  million  in  non-interest  expenses,  $919,000  in
provision for loan losses,  and $1.2 million in income tax expenses.  For fiscal
year 1996,  the Company's  return on average assets and return on average equity
was 0.42% and 11.46%,  respectively.  Based on 2,203,075 weighted average shares
of  common  stock  issued  and  outstanding  as  well  as  potentially  dilutive
securities, diluted earnings per share was $1.16.

NET INTEREST INCOME.  Net interest income is the principal source of a financial
institution's  income stream and represents the spread between  interest and fee
income  generated from earning assets and the interest  expense paid on deposits
and  borrowed  funds.  Fluctuations  in  interest  rates as well as  volume  and
composition changes in interest-earning assets and interest-bearing  liabilities
materially affect net interest income.

         Net interest  income  increased by $2.2 million,  or 20.0%,  from $11.0
million  to $13.2  million  for the  years  ended  December  31,  1996 and 1997,
respectively.  Interest rate spreads decreased from 1.84% to 1.49% for the years



                                       12
<PAGE>

ended December 31, 1996 and 1997, respectively. The decrease in spreads reflects
a 28 basis point decline in the yield of interest  earning  assets and a 7 basis
point  increase  in the costs of  interest-bearing  liabilities.  The decline in
yield  reflects  a  decrease  in loan  yield due to a larger  loan held for sale
portfolio and an increase in costs  associated with hedging  instruments used to
reduce  interest rate risk matched  against the deposit  portfolio  resulting in
higher  costs.  Average  interest-earning  assets and  liabilities  were  $772.2
million and $738.3  million,  respectively,  for 1997 compared to $575.5 million
and $564.3 million, respectively, for 1996.

         Net interest income increased $2.4 million, or 27.9%, from $8.6 million
to $11.0 million for the years ended  December 31, 1995 and 1996,  respectively.
Interest rate spreads increased to 1.84% from 1.72% for the years ended December
31, 1996 and 1995,  respectively.  For 1995, average interest-earning assets and
liabilities were $ $496.5 million and $484.4 million, respectively.

         The  following  table  allocates  the  period-to-period  changes in the
Company's various  categories of interest income and expense between changes due
to changes in volume  (calculated by multiplying the change in average volume of
the related interest-earning asset or interest-bearing liability category by the
prior year's  rate) and due to changes in rate  (changes in rate  multiplied  by
prior  year's  volume).  Changes due to changes in  rate-volume  (change in rate
multiplied  by changes in volume) have been  allocated  proportionately  between
changes in volume and changes in rate.

<TABLE>
<CAPTION>
                                                           1997 vs. 1996                                  1996 vs. 1995
                                                 Increase (Decrease) Due to             Increase (Decrease) Due to
(Dollars in thousands)                    Volume          Rate          Total          Volume         Rate        Total
<S>                                     <C>       <C>              <C>              <C>            <C>         <C>     
Interest-earning assets:
    Loans receivable, net (a)           $  12,732 $    (1,092)     $   11,640       $   6,333   $    (968)     $  5,365
    Mortgage-backed and

      related securities                       --          --              --          (9,307)     (9,307)      (18,614)
    Investment securities (b)                 220         (27)            193              16        (134)         (118)
    Mortgage-backed and related securities
      available for sale                      373        (682)           (309)         16,404         (45)       16,359
    Investment securities
      available for sale (c)                  809           8             817           2,194        (305)        1,889
    Federal funds sold                         54           2              56               2          (8)           (6))
    Trading account                           562         562           1,124              17        (185)         (168)
     Total interest-earning assets        $14,750     $(1,229)     $   13,521         $15,659   $ (10,952)     $  4,707
Interest-bearing liabilities:
    Savings deposits                     $  1,111     $   454      $    1,565         $ 2,803   $    (100)     $  2,703
    Time deposits                           3,315        (279)          3,036           2,208        (596)        1,612
    FHLB advances                           2,400         796           3,196             972        (292)          680
    Other borrowings                        2,838        (466)          2,372          (1,778)       (446)      (2,224)
    Subordinated debt                       1,207        (128)          1,079              --          112          112
Total interest-bearing liabilities         10,871         377          11,248           4,205       (1,322)       2,883
Change in net interest income              $3,879   $  (1,606)      $   2,273        $ 11,454   $   (9,630)    $  1,824

</TABLE>

(a) Includes mortgage and other loans. (b) Includes  interest-bearing  deposits,
repurchase  agreements,  investment securities held to maturity, and FHLB stock.
(c)  Interest  income  and  average  yields  on  municipal  bonds,  included  in
investment securities, are presented on a tax equivalent basis.

INTEREST INCOME.  Total interest income increased $13.5 million,  or 29.5%, from
$45.8 million for the year ended December 31, 1996 to $59.3 million for the year
ended December 31, 1997.  Interest  income on mortgage and other loans increased
$11.6 million or 50.4%. The increase is largely attributed to the $162.8 million
increase in average loan



                                       13
<PAGE>

balance.  Interest income on  mortgage-backed  securities  held-to-maturity  and
available-for-sale  decreased  by  $400,000,  or 2.2%,  from  $18.0  million  at
December 31, 1996 to $17.6 million at December 31, 1997 largely as a result of a
29 basis point decline in the yield.

         Total  interest  income  increased $5.3 million,  or 13.1%,  from $40.5
million for the year ended December 31, 1995 to $45.8 million for the year ended
December 31, 1996.  Interest  income on mortgage and other loans  increased $5.4
million or 30.5%.  The  increase  is  largely  attributed  to the $77.3  million
increase in average loan balance. Interest income on mortgage-backed  securities
held-to-maturity  and  available-for-sale  decreased by $2.2 million,  or 10.9%,
from $20.2  million at December  31, 1995 to $18.0  million at December 31, 1996
largely  as a result of a $31.2  million  decline  in  average  mortgage  backed
securities held-to-maturity and available-for-sale.

INTEREST EXPENSE.  Total interest expense increased by $11.3 million,  or 32.5%,
from $34.8 million for the year ended December 31, 1996 to $46.1 million for the
year ended December 31, 1997. The increase is  attributable  to a $174.0 million
increase in interest bearing  liabilities  coupled with a 7 basis point increase
in interest costs.  Total interest expense  increased by $2.9 million,  or 9.1%,
from $31.9 million for the year ended December 31, 1995 to $34.8 million for the
year ended  December 31, 1996. The increase is  attributable  to a $79.9 million
increase in interest bearing  liabilities  offset by a 45 basis point decline in
interest costs.

PROVISION  FOR LOAN LOSSES.  The provision for loan losses is the annual cost of
providing an allowance for estimated losses in the loan portfolio. The allowance
reflects management's judgment as to the level considered  appropriate to absorb
such losses  based upon a review of factors  including  delinquent  loan trends,
historical  loss  experience,  economic  conditions,  loan portfolio mix and the
Company's internal credit review process.

         Total  provisions  for loan losses  increased  by $2,000,  or 0.2% from
$919,000  for the year ended  December  31, 1996 to $921,000  for the year ended
December  31,  1997.  The stable  level of  provision  expenses  during  1997 is
attributed to the low level of net charge-offs. The total loan loss allowance as
of December 31, 1997 and 1996 was $3.6  million and $3.0  million  respectively,
which was 0.67% and 0.80% of total loans outstanding,  respectively.  Total loan
loss  allowance as a percentage  of total  non-performing  loans was 31.0% as of
December 31, 1997 as compared to 26.3% as of December 31, 1996.

         The Company's  strategy of purchasing loans in the secondary market has
provided management with the ability to acquire certain assets at discounts.  As
of  December  31,  1997,  the  Company  reported a total net  discount  of $10.2
million.  These discounts are only taken into income as the balance of the loans
receivable are repaid.

         Total loans  receivable  as of December  31, 1997 include four pools of
credit enhanced one-to-four family mortgage loans totaling $41.7 million or 7.5%
of total loans  outstanding.  Two of these pools  totaling  $28.3 million have a
credit reserve from the seller equal to 2.5% of the unpaid principal  balance at
the time of the purchase available to offset any losses.  Another pool, totaling
$7.3 million, has an indemnification whereby the seller must repurchase any loan
that become more than four  payments past due at any time during the life of the
loan.  The final pool,  totaling  $6.1  million,  has a credit  reserve equal to
approximately 10.0% of the unpaid balance at the time of the acquisition.



                                       14
<PAGE>

<TABLE>
<CAPTION>
                                                        Year Ended December 31,
                                          1997              1996              1995             1994              1993
<S>                                      <C>               <C>               <C>               <C>               <C> 
Balance at beginning of period           $2,957            $2,311            $   989           $ 835             $659
Loans charged off, net of recoveries:
    Real estate loans:
       One-to-four family                  (283)             (273)                --            (338)             (19)
       Land                                  --                --                 --              --               (1)
    Other:
       Other                                 --                --               (400)             --              (15)
Total charge-offs                          (283)             (273)              (400)           (338)             (35)
Provision for loan losses                   921               919              1,722             492              211
Balance at end of period                 $3,595            $2,957             $2,311           $ 989             $835
Ratio of net charge-offs to net average
  loans outstanding during the period      0.06%             0.10%              0.14%           0.24%            0.03%

</TABLE>

NON-INTEREST  INCOME.  Total non-interest  income increased by $1.3 million,  or
46.4%,  from $2.8  million for fiscal year 1996 to $4.1  million for fiscal year
1997. With the addition of trading assets, the Company  recognized  non-interest
income of $1.2 million.  Gains on loans held for sale increased $274,000.  Gains
on sales of  mortgage-backed  securities and investment  totaled $982,000.  Loan
fees, service charges and other decreased $188,000, which includes loan fees and
other income of $829,000, TCM commission income of $572,000 and a equity loss of
$642,000 for the  write-off of the Bank's  investment  in AGT Mortgage  Services
("AGT"). AGT serviced performing and non-performing loans for a fee. Given lower
than  anticipated  non-performing  loan  levels,  AGT did not  achieve  adequate
economies  of scale to  generate  sufficient  revenue.  Accordingly,  management
decided to cease operations of AGT on July 31, 1997.

         Total non-interest income declined by $1.0 million, or 26.3%, from $3.8
million for fiscal year 1995 to $2.8 million for fiscal year 1996. Loan fees and
service  charges  increased  $756,000  due to fees  collected on $2.8 million in
purchased  mortgage  servicing  rights.  Gains on loans held for sale  increased
$642,000.  Gains on sales of mortgage-backed  securities and investments totaled
$935,000.

NON-INTEREST  EXPENSES.  Total non-interest  expenses increased $1.0 million, or
11.0%,  from $9.1 million for fiscal year 1996 to $10.1  million for fiscal year
1997.  Non-interest expenses are composed of general and administrative expenses
and other non-interest expenses.  General and administrative  expenses increased
$600,000,  or 7.1%,  from $8.4  million for the year ended  December 31, 1996 to
$9.0  million  for the year ended  December  31,  1997.  The slight  increase is
primarily  attributed  to the $1.2 million  increase in  compensation  which was
offset by the effect of a one-time $1.7 million  assessment to recapitalize  the
SAIF which was recognized in fiscal year 1996.  Compensation expenses reflect an
increase of 19 employees from the prior year including the compensation expenses
for  TCM  employees.  Other  administrative  costs  increased  $1.1  million  to
accommodate the growing deposit base and increased marketing expenses associated
with building a brand  identity and enhancing  franchise  value.  As in previous
years,  it is the Company's  compensation  policy to pay a combination of salary
and  incentive  based  compensation  consisting  of bonuses  tied to the overall
Company's performance and individual  performances  consistent with the improved
performance of the Company. Bonuses increased from $1.1 million for 1996 to $1.5
million for 1997.  General and  administrative  expenses  net of bonuses and the
SAIF  assessment  as a  percentage  of total  assets was 0.69% and 0.86% for the
years ended



                                       15
<PAGE>

December 31, 1997 and 1996,  respectively.  General and administrative  expenses
net of the SAIF  assessment as a percentage of total assets were 0.69% and 1.03%
for the years ended December 31, 1997 and 1996, respectively. Other non-interest
expense increased $1.1 million, or 36.7%, from $3.0 million at December 31, 1996
to $4.1  million at  December  31,  1997.  This  increase is  attributable  to a
$375,000 increase in advertising expense in conjunction with the marketing plan,
$150,000  increase in  amortization  of  purchased  mortgage  servicing  rights,
$228,000 increase in office occupancy,  and $350,000 increase in other operating
expenses.

         Total non-interest expenses increased $2.9 million, or 46.8%, from $6.2
million for fiscal year 1995 to $9.1 million for fiscal year 1996.  Non-interest
expenses  are  composed  of  general  and  administrative   expenses  and  other
non-interest  expenses.  General  and  administrative  expenses  increased  $2.8
million,  or 50.0%,  from $5.6  million for the year ended  December 31, 1995 to
$8.4 million for the year ended  December  31,  1996.  The increase is primarily
attributed to the effect of a one-time $1.7 million  assessment to  recapitalize
the SAIF, a $660,000 increase in compensation,  employee benefits,  and $483,000
in federal  insurance  premium  and  overall  administrative  costs for a higher
deposit base. As in previous years, it is the Company's  compensation  policy to
pay a  combination  of salary and  incentive  based  compensation  consisting of
bonuses tied to the overall Company's  performance and individual  performances.
Consistent with the improved  performance of the Company net of SAIF assessment,
bonuses increased to $1.1 million for 1996 from $775,000 for 1995.  Bonuses were
$1.1  million  and  $745,000  for the year  ended  December  31,  1996 and 1995,
respectively.  General and  administrative  expenses net of bonuses and the SAIF
assessment  as a  percentage  of total  assets was 0.86% and 0.87% for the years
ended  December  31, 1996 and 1995,  respectively.  General  and  administrative
expenses net of the SAIF  assessment  as a percentage  of total assets was 1.03%
and 1.00% for the years ended  December 31, 1996 and 1995,  respectively.  Other
non-interest  expense increased $21,000,  or 3.1%, from $679,000 at December 31,
1995 to $700,000 at December 31, 1996. The slight  increase is attributable to a
$213,000 increase in amortization of purchased  mortgage servicing rights offset
by a $192,000 decline in real estate owned expenses.

INCOME TAX EXPENSE.  Income tax expense is computed upon,  and generally  varies
proportionally with, earnings before income tax expense adjusted for non-taxable
income and non-deductible expenses.

         The effective  tax rate for the year ended  December 31, 1997 was 26.4%
compared to 31.9% for 1996.  The income tax expense for the year ended  December
31,  1997 was $1.7  million as  compared  with $1.2  million  for the year ended
December 31, 1996.  The effective tax rate  decreased  largely as a result of an
increase in municipal bond interest.

         The effective  tax rate for the year ended  December 31, 1996 was 31.9%
compared to 37.9% for 1995.  The income tax expense for the year ended  December
31,  1996 was $1.2  million as  compared  with $1.7  million  for the year ended
December 31, 1995.  The  effective tax rate  decreased  largely as a result of a
decrease in municipal bond interest.

IMPACT OF INFLATION AND CHANGING PRICES

         Since interest rates and inflation rates do not always move in concert,
the effect of inflation on financial  institutions  may not  necessarily  be the
same as on other  businesses.  A bank's asset and  liability  structure  differs



                                       16
<PAGE>

significantly from that of industrial companies in that virtually all assets and
liabilities  are of a monetary  nature.  Management  believes that the impact of
inflation on financial  results  depends  upon the  Company's  ability to manage
interest  rate  sensitivity  and, by such  management,  reduce the  inflationary
impact upon  performance.  Interest  rates do not  necessarily  move in the same
direction,  or in the same magnitude, as the prices of other goods and services.
As discussed above, management seeks to manage the relationship between interest
sensitive  assets and liabilities in order to protect against wide interest rate
fluctuations, including those resulting from inflation.

YEAR 2000

         The Company utilizes and is dependent upon data processing  systems and
software to conduct its business.  The data  processing  systems include various
software packages licensed to the Company by outside vendors and a client server
core processing system which are run on in-house computer networks. In 1997, the
Company  initiated  a review and  assessment  of all  hardware  and  software to
confirm that it will  function  properly in the year 2000.  The  Company's  core
processing  software  vendor and the  majority  of the  vendors  which have been
contacted  have  indicated  that their  hardware  and/or  software are Year 2000
compliant.  Testing will be performed  for  compliance.  While there may be some
additional  expenses incurred during the next two years, Year 2000 compliance is
not expected to have a material effect on the Company's  consolidated  financial
statements.

NEW GENERALLY ACCEPTED ACCOUNTING PRINCIPLES

         Statement  of  Financial   Accounting   Standards  Nos.  130  and  131,
"Reporting   Comprehensive   Income"  and  "Disclosures  about  Segments  of  an
Enterprise  and Related  Information,"  respectively,  were issued in June 1997.
SFAS 130  requires  that  certain  financial  activity  typically  disclosed  in
shareholders' equity be reported in the financial statements as an adjustment to
net income in determining  comprehensive income. SFAS 131 requires the reporting
of selected segmented  information in quarterly and annual reports.  The Company
does not anticipate any material  financial  impact from the  implementation  of
SFAS Nos. 130 and 131.




                                       17
<PAGE>

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
December 31, 1997 and 1996

<TABLE>
<CAPTION>
(Dollars  in thousands)                                           1997                               1996

Assets
<S>                                                         <C>                                 <C>       
Cash and cash equivalents                                   $    92,156                         $    3,259
Trading securities                                               21,110                                 --
Investment securities available-for-sale                         91,237                             78,826
Mortgage-backed securities available-for-sale                   319,203                            184,743
Loans receivable held for sale                                  149,086                            166,064
Loans receivable, net                                           391,618                            185,757
Other assets                                                     35,942                             29,316
    Total assets                                              1,100,352                            647,965

Liabilities and Stockholders' Equity

Deposits                                                        522,221                            390,486
Advances from the Federal Home
  Loan Bank of Atlanta                                          200,000                            144,800
Securities sold under agreements to repurchase                  279,909                             57,581
Subordinated debt, net                                           29,614                             16,586
Other liabilities                                                13,212                             13,854
    Total liabilities                                         1,044,956                            623,307

Corporation--Obligated Mandatorily Redeemable
    Capital Securities of Subsidiary Trust
    Holding Solely Junior Subordinated
    Debentures of the Corporation                                 9,572                                 --

Commitments and contingencies                                        --                                 --

Stockholders' equity:

4% Cumulative Preferred Stock, $0.01 par value,
    500,000 shares authorized
    Series A,   18,850  issued and outstanding                    9,634                                --
    Series B,   4,050  issued and outstanding                     2,070                                --
    Series C,   7,000  issued and outstanding                     3,577                                --
Common stock, $0.01 par value, 8,500,000 shares authorized;
    2,229,161 and 2,049,500 issued and outstanding at
    December 31,1997 and 1996                                        22                                20
Additional paid-in capital                                       16,207                            14,637
Retained earnings                                                11,576                             7,905
Unrealized gain on securities
    available for sale,  net of tax                               2,738                             2,096
    Total stockholders' equity                                   45,824                            24,658
    Total liabilities and stockholders' equity               $1,100,352                          $647,965

</TABLE>

See accompanying notes to consolidated financial statements.




                                       18
<PAGE>


CONSOLIDATED STATEMENTS OF OPERATIONS
For the years ended December 31, 1997, 1996, and 1995

<TABLE>
<CAPTION>

<S>                                                            <C>                    <C>                  <C>     
(Dollars in thousands, except per share data)                    1997                   1996                  1995
Interest income:
    Loans                                                      $34,729                $23,089              $ 17,726
    Mortgage-backed and related securities                      17,646                 17,955                20,205
    Investment securities                                        5,702                  4,690                 2,347
    Trading securities                                           1,124                    --                     --
    Other                                                          100                     66                   233
        Total interest income                                   59,301                 45,800                40,511
Interest expense:
    Deposits                                                    25,958                 21,357                17,033
    Advances from the Federal Home
      Loan Bank of Atlanta                                       9,885                  6,689                 5,985
    Repurchase agreements                                        6,941                  4,569                 6,839
    Subordinated debt                                            3,279                  2,200                 2,089
        Total interest expense                                  46,063                 34,815                31,946
           Net interest income                                  13,238                 10,985                 8,565
    Provision for loan losses                                      921                    919                 1,722
           Net interest income after
            provision for loan losses                           12,317                 10,066                 6,843
Non-interest income:
    Gain on sale of available for sale securities                  982                    935                 3,412
    Gain on sale of loans                                        1,148                    874                   232
    Gain on trading securities                                   1,204                     --                    --
    Fees, service charges, and other                               759                    947                   133
        Total non-interest income                                4,093                  2,756                 3,777
Non-interest expenses:
    General and administrative expenses:
        Compensation and employee benefits                       4,909                  3,690                 3,030
        SAIF assessment                                             --                  1,671                    --
        Other                                                    4,133                  3,014                 2,531
        Total general and administrative expenses                9,042                  8,375                 5,561
Other non-interest expenses:
    Net operating cost of real estate
      acquired through foreclosure                                 278                    238                   430
    Amortization of goodwill and other intangibles                 822                    462                   249
    Total other non-interest expenses                            1,100                    700                   679
    Total non-interest expenses                                 10,142                  9,075                 6,240
        Income before income tax expense and
                minority interest                                6,268                  3,747                 4,380
        Income tax expense                                       1,657                  1,195                 1,660
        Minority interest in subsidiary                            394                     --                    --
        Net income                                            $  4,217               $  2,552              $  2,720
        Preferred stock dividends                                  546                     --                    --
        Net income available to common stockholders           $  3,671               $  2,552              $  2,720
Earnings per share:
    Basic                                                    $    1.68              $    1.25              $   1.33
    Diluted                                                  $    1.49              $    1.16              $   1.33

</TABLE>

See accompanying notes to consolidated financial statements.




                                       19
<PAGE>


CONSOLIDATED  STATEMENTS OF CHANGES IN STOCKHOLDERS'  EQUITY For the years ended
December 31, 1997, 1996, and 1995

<TABLE>
<CAPTION>
                                                                                           Unrealized
                                                                                       Gains (Losses)
                                                           Additional                   on Available-
                                 Preferred       Common       Paid-in        Retained        for-Sale
(Dollars in thousands)               Stock        Stock       Capital        Earnings      Securities          Total

<S>                                    <C>          <C>       <C>              <C>            <C>            <C>    
Balances at December 31, 1994          $--          $20       $14,637          $2,633         $ (262)        $17,028
Net income                              --           --            --           2,720             --           2,720
Unrealized gain on available-for-
    sale securities,
     net of tax effect                  --           --            --              --           1,817          1,817
Balances at December 31, 1995          $--          $20       $14,637          $5,353          $1,555        $21,565
Net income                              --           --            --           2,552              --          2,552
Unrealized gain on available-for-
    sale securities,
     net of tax effect                  --           --            --              --             541            541
Balances at December 31, 1996          $--          $20       $14,637          $7,905          $2,096        $24,658
Net income                              --           --            --           4,217              --          4,217
Common stock issued                     --            2         1,570              --              --          1,572
Issuance of 4% cumulative
  preferred stock, Series A          9,634           --            --              --              --          9,634
Issuance of 4% cumulative
  preferred stock, Series B          2,070           --            --              --              --          2,070
Issuance of 4% cumulative
  preferred stock, Series C          3,577           --            --              --              --          3,577
Dividends on 4% cumulative
  preferred stock                       --           --            --            (546)             --           (546)
Unrealized gain on available
  for sale securities, net of
  tax effect                            --           --            --              --             642            642
                                   -------          ---       -------         -------          ------        -------
Balances at December 31, 1997      $15,281          $22       $16,207         $11,576          $2,738        $45,824
                                   -------          ---       -------         -------          ------        -------
</TABLE>

See accompanying notes to consolidated financial statements.




                                       20
<PAGE>


CONSOLIDATED  STATEMENTS  OF CASH FLOWS For the years ended  December  31, 1997,
1996, and 1995

<TABLE>
<CAPTION>
(Dollars in thousands)                                            1997                  1996               1995

Cash flows from operating activities:
<S>                                                        <C>                  <C>                    <C>         
Net income                                                 $     4,611          $       2,552          $      2,720
Adjustments to reconcile net income to net cash provided
  by (used in) operating activities:
    Equity in losses of subsidiaries                             1,129                    274                    --
    Depreciation, amortization, and discount accretion          (1,038)                (1,516)               (2,153)
    Provision for loan losses                                      921                    919                 1,722
    Provision for losses on foreclosed real estate                  19                     78                   213
    Other gains and losses, net                                 (1,624)                (1,011)                 (153)
    Deferred income tax provision                                 (445)                  (224)                 (559)
    Proceeds from sales of loans held for sale                  60,145                 27,865                    --
    Purchases of loans held for sale                           (72,804)               (91,943)                   --
    Net realized gains on available-for sale securities,
       loans held for sale and trading                          (2,613)                  (935)               (3,412)
    Purchases of trading assets                               (100,630)                    --                    --
    Proceeds from sale of trading assets                        80,990                     --                    --
    Increase in accrued interest receivable                     (1,492)                (2,220)               (4,954)
    Increase in accrued expenses and other liabilities             345                  3,730                 2,693
    Increase in other assets                                    (3,373)                (2,433)                  (80)
    Interest credited to deposits                               25,958                 21,361                17,033

Net cash (used in) provided
  by operating activities                                       (9,901)               (43,503)               13,070

Cash flows from investing activities:
    Net increase in loans                                     (269,036)               (90,717)              (98,439)
    Equity investments in subsidiaries                          (1,736)                (2,359)                   --
    Purchases of available-for-sale securities                (395,675)              (356,882)             (122,785)
    Proceeds from sale of available-for-sale securities        144,718                220,293                71,084
    Proceeds from maturities of and principal
       payments on available-for-sale securities               197,036                201,547                39,646
    Net sales (purchases) of premises and equipment                110                   (842)                 (537)
    Proceeds from sale of foreclosed real estate                 1,563                  1,156                    --

Net cash used in investing activities                         (323,020)               (27,804)             (111,031)

Cash flows from financing activities:
    Net increase in time deposits                              105,777                 62,625                77,056
    Increase in advances from FHLB                             322,000                273,500                59,000
    Payments on advances from FHLB                            (266,800)              (234,200)              (49,500)
    Net  increase (decrease) in securities sold
      under agreements to repurchase                           222,328                (36,324)               14,292
    Net increase in other borrowed funds                        13,028                     --                    --
    Issuance of  trust preferred stock, net                      9,572                     --                    --

</TABLE>



                                       21
<PAGE>

<TABLE>
<CAPTION>
    Issuance of preferred and common stock and
<S>                                                             <C>                                                
      additional paid in capital                                16,853                     --                    --
    Interest paid to minority interest in subsidiary              (394)                    --                    --
    Dividends paid on common and preferred stock                  (546)                    --                    --

Net cash provided by financing activities                      421,818                 65,601               100,848

Net increase (decrease) in cash and cash equivalents            88,897                 (5,706)                2,887

Cash and cash equivalents at beginning of period                 3,259                  8,965                 6,078

Cash and cash equivalents at end of period                 $    92,156           $      3,259           $     8,965



 (Dollars in thousands)                                           1997                   1996                  1995

Supplemental information:
Interest paid on deposits and borrowed funds                   $45,440                $32,660               $29,852
Income taxes paid                                                2,473                    972                   950
Gross unrealized gain (loss) on
  marketable securities available-for-sale                         873                    795                 2,926
Tax effect of gain (loss) on
  available-for-sale securities                                    231                    254                 1,109

</TABLE>

See accompanying notes to consolidated financial statements.




                                       22
<PAGE>


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. ORGANIZATION

TeleBanc  Financial  Corporation  ("TeleBanc" or the "Company") is a savings and
loan holding  company  organized under the laws of Delaware in 1994. The primary
business of the Company is the  activities  conducted by TeleBank  (the "Bank"),
formerly  known as  Metropolitan  Bank for  Savings,  F.S.B.,  TeleBanc  Capital
Markets, Inc. ("TCM"), formerly known as Arbor Capital Partners, Inc. ("Arbor"),
and TeleBanc Capital Trust I ("TCT").  The Bank is a federally chartered savings
bank, which provides  deposit accounts insured by the Federal Deposit  Insurance
Corporation  ("FDIC") to customers  nationwide.  TCM is a registered  investment
advisor,  funds manager,  and broker-dealer.  TCT is a business trust formed for
the purpose of issuing  capital  securities and investing the proceeds in junior
subordinated   debentures  issued  by  the  Company.   The  Bank,   through  its
wholly-owned  subsidiary TeleBanc Servicing  Corporation ("TSC"),  funded 50% of
the capital commitment for two new entities,  AGT Mortgage Services, LLC ("AGT")
and AGT PRA, LLC ("AGT  PRA").  AGT services  performing  loans and  administers
workouts for troubled or defaulted loans for a  fee.Management  ceased operation
of AGT on July 31, 1997.  The primary  business of AGT PRA is its  investment in
Portfolio Recovery Associates, LLC ("PRA"). PRA acquires and collects delinquent
consumer debt  obligations for its own portfolio.  The net equity  investment in
AGT PRA at December 31, 1997 is $2.1 million.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION

The  accompanying  consolidated  financial  statements  include the  accounts of
TeleBank,  TCM,  TCT,  and TSC,  a wholly  owned  subsidiary  of the  bank.  All
significant   intercompany   transactions   and  balances  are   eliminated   in
consolidation.  The  investment  in AGT PRA is  accounted  for under the  equity
method.

BASIS OF FINANCIAL STATEMENT PRESENTATION

The  accompanying  financial  statements  have been prepared in conformity  with
generally accepted accounting principles. In preparing the financial statements,
management  is  required  to make  estimates  and  assumptions  that  affect the
reported amounts of assets and liabilities, disclosures of contingent assets and
liabilities,  and revenues and expenses  for the period.  Actual  results  could
differ significantly from those estimates. Material estimates for which a change
is  reasonably  possible in the  near-term  relate to the  determination  of the
allowance for loan losses,  the fair value of  investments  and  mortgage-backed
securities   available-for-sale,   loan  receivables  held  for  sale,   trading
securities,  and the  valuation  of real  estate  acquired  in  connection  with
foreclosures and mortgage servicing rights. In addition, the regulatory agencies
which supervise the financial services industry  periodically  review the Bank's
allowance for losses on loans.  This review,  which is an integral part of their
examination  process,  may result in additions to the  allowance for loan losses
based on judgments with regard to available  information provided at the time of
their examinations.




                                       23
<PAGE>


CASH AND CASH EQUIVALENTS

Cash  and  cash   equivalents   are  composed  of   interest-bearing   deposits,
certificates  of  deposit,  funds due from banks,  and  federal  funds sold with
original  maturities  of  three  months  or  less.

INVESTMENT SECURITIES AND MORTGAGE-BACKED SECURITIES

The Company  generally  classifies its debt and marketable  equity securities in
one of three categories:  held-to-maturity,  trading, or available-for-sale.  In
December 1995, the Company reclassified the existing held-to-maturity investment
and mortgage-backed securities portfolios as available-for-sale.

Trading  securities are bought and held  principally  for the purpose of selling
them in the near term.  Securities  purchased  for trading are carried at market
value with the  corresponding  unrealized  gains and losses being  recognized by
credits or charges  to income.  The  Company  had $21.1  million  classified  as
trading  securities  at December 31, 1997.  No  securities  were  classified  as
trading  securities  at December 31, 1996.  For the period  ending  December 31,
1997, the Company recognized $564,000 in realized gains from the sale of trading
assets and $640,000 in  unrealized  appreciation  of trading  assets.  All other
securities  not  included  in  held-to-maturity  or trading  are  classified  as
available-for-sale.  Available-for-sale  securities  are recorded at fair value.
Unrealized gains and losses on available-for-sale securities, net of the related
tax effects,  are reported as a separate component of stockholders' equity until
realized.  A decline in market value of any  available-for-sale  asset below its
cost, that is deemed other than temporary, is charged to earnings,  resulting in
the  establishment  of a new cost basis for the asset.  Transfers of  securities
into the  available-for-sale  category are recorded at fair value at the date of
the transfer.  Any unrealized gain or loss at the date of transfer is recognized
as a separate component of stockholders' equity, net of tax effect. Dividend and
interest  income  are  recognized  when  earned.  Realized  gains and losses for
securities classified as available-for-sale and trading are included in earnings
and are derived using the specific  identification  method for  determining  the
cost of the security sold.

LOANS HELD FOR SALE

Mortgages  acquired by the Company and intended for sale in the secondary market
are carried at lower of cost or  estimated  market value in the  aggregate.  The
market value of these  mortgage  loans is determined by obtaining  market quotes
for loans with similar characteristics.

LOANS RECEIVABLE

Loans  receivable  consists  of  mortgages  that  management  has the intent and
ability to hold for the foreseeable  future or until maturity or pay-off and are
carried at amortized  cost  adjusted for  charge-offs,  the  allowance  for loan
losses,  any  deferred  fees or costs on  purchased  or  originated  loans,  and
unamortized  premiums or  discounts on purchased  loans.  The loan  portfolio is
reviewed by the Company's  management to set provisions for estimated  losses on
loans  which are charged to earnings  in the  current  period.  In this  review,
particular  attention  is paid to  delinquent  loans and loans in the process of
foreclosure.  The  allowance  and provision for loan losses are based on several
factors,  including continuing examinations and appraisals of the loan portfolio
by management,  examinations by supervisory  authorities,  continuing reviews of
problem loans and overall  portfolio  quality,  analytical  reviews of loan loss
experience in relation to  outstanding  loans,  and  management's  judgment with
respect to economic conditions and its impact on the loan portfolio.



                                       24
<PAGE>

NONPERFORMING ASSETS

Nonperforming  assets  consist of loans for which  interest  is no longer  being
accrued, loans which have been restructured in order to increase the opportunity
to collect amounts due on the loan, real estate acquired through foreclosure and
real estate upon which deeds in lieu of foreclosure have been accepted. Interest
previously  accrued but not  collected on nonaccrual  loans is reversed  against
current income when a loan is placed on nonaccrual status. Accretion of deferred
fees is discontinued  for nonaccrual  loans.  All loans past due ninety days, as
well as other loans considered uncollectible,  are placed on non-accrual status.
Interest  received on  nonaccrual  loans is  recognized  as  interest  income or
applied to principal when it is doubtful that full payment will be collected.

LOAN  AND  COMMITMENT  FEES, DISCOUNTS AND PREMIUMS

Loan fees and certain direct loan origination costs are deferred and the net fee
or cost is recognized  into interest  income using the interest  method over the
contractual  life of the loans.  Premiums and discounts on loans  receivable are
amortized or accreted,  respectively, into income using the interest method over
the  remaining  period to  contractual  maturity and  adjusted  for  anticipated
prepayments.  Premiums and  discounts on loans held for sale are  recognized  as
part of the loss or gain upon sale and not amortized or accreted, respectively.

REAL ESTATE ACQUIRED THROUGH FORECLOSURE AND HELD FOR SALE

Real  estate  properties  acquired  through  foreclosure  and  held for sale are
recorded at fair value less estimated  selling costs at acquisition.  Fair value
is determined  by appraisal or other  appropriate  method of  valuation.  Losses
estimated  at the time of  acquisition  are  charged to the  allowance  for loan
losses. Valuations are periodically performed by management and an allowance for
losses is  established  through a charge  to income if the  carrying  value of a
property exceeds its estimated fair value less selling costs.

DEFERRED FINANCING COSTS

Deferred  financing costs related to the issuance of the subordinated notes have
been capitalized and are being amortized using the interest method over the life
of the subordinated notes.

INCOME TAXES

Effective  January 1, 1993,  the Bank  adopted the  provisions  of  Statement of
Financial  Accounting  Standards No. 109, Accounting for Income Taxes ("SFAS No.
109"). Under the asset and liability method of SFAS No. 109, deferred tax assets
and liabilities are recognized for the future tax  consequences  attributable to
temporary  differences  between  the  financial  statement  carrying  amounts of
existing  assets  and their  respective  tax  basis.  Deferred  tax  assets  and
liabilities  are measured  using enacted tax rates  expected to apply to taxable
income in the years in which  those  temporary  differences  are  expected to be
recovered or settled.

FINANCIAL INSTRUMENTS

Interest  rate swaps and caps are used by the Company in the  management  of its
interest-rate  risk. The Company is generally  exposed to rising  interest rates
because of the nature of the repricing of rate-sensitive assets as compared with
rate-sensitive  liabilities.  The objective of these financial instruments is to
match estimated  repricing periods of  rate-sensitive  assets and liabilities to
reduce interest rate exposure. These instruments are used only to hedge specific
assets and liabilities and are not used for speculative purposes. In order to be
eligible for hedge accounting treatment, high



                                       25
<PAGE>

correlation  must  be  probable  at the  inception  of the  hedge  and  must  be
maintained  throughout the hedge period.  Once high correlation ceases, any gain
or  loss on the  hedge,  up to the  time  high  correlation  ceased,  should  be
recognized to the extent the results of the hedging  instrument  were not offset
by the effects of interest  rate  changes on the hedged  item.  Upon the sale or
disposition   of  the   hedged   item,   the   hedging   instrument   should  be
marked-to-market with changes recorded in the income statement. The net interest
received or paid on these  contracts is treated as an adjustment to the interest
expense  related to the hedged  obligations  in the period in which such amounts
are due.  Premiums and fees  associated with interest rate caps are amortized to
interest expense on a straight-line basis over the lives of the contracts.

OTHER ASSETS

Other assets include purchased loan servicing rights,  premiums paid on interest
rate caps,  and prepaid  assets.  The Bank services the loans  underlying  these
servicing  rights.  The  cost of the  loan  servicing  rights  is  amortized  in
proportion to, and over the period of, the estimated net servicing  income.  For
the period  ending  December 31, 1997,  amortization  expense of loan  servicing
rights was $547,000.  Impairment of mortgage  servicing rights is assessed based
on the fair value of those rights.  Fair values are estimated  using  discounted
cash flows based on a current  market  interest  rate. For purposes of measuring
impairment,  the rights are  stratified  based on mortgage  product  types.  The
amount of impairment  recognized is the amount by which the capitalized mortgage
servicing rights exceed their fair value in aggregate.  As of December 31, 1997,
the amortized cost and fair value of the loan servicing rights were $3.3 million
and $3.4  million,  respectively.  No  valuation  allowance  was  recognized  at
December 31, 1997.  Effective  January 1, 1997, the Company adopted Statement of
Financial  Accounting  Standards No. 125, Accounting for Transfers and Servicing
of Financial Assets and  Extinguishments of Liabilities ("SFAS 125"), as amended
by  Statement  of  Financial  Accounting  Standards  No.  127,  Deferral  of the
Effective Date of Certain  Provisions of FASB Statement No. 125--An Amendment of
FASB Statement No. 125 ("SFAS 127"). The implementation of SFAS 125 did not have
a material impact on the company's final position.

COMMITMENTS AND CONTINGENT LIABILITIES

In managing the Company's  interest-rate  risk, the Company  utilizes  financial
derivatives in the normal course of business.  These products consist  primarily
of interest rate cap and swap agreements.  Financial derivatives are employed to
assist in the management  and/or reduction of interest rate risk for the Company
and can  effectively  alter the interest  sensitivity of segments of the balance
sheet for specified periods of time. The Company accounts for interest rate swap
agreements and cap agreements as hedges of debt issuances, deposit balances, and
investment in loan  portfolio to which such  agreements  have been  specifically
designated.  Cash  remittances due or received  pursuant to these agreements are
reported as  adjustments to interest  expense on an accrual basis.  Any premiums
paid in  conjunction  with  these  interest  rate  swap  and  interest  rate cap
agreements are amortized as additional interest expense on a straight-line basis
over the term of these  agreements.  Any gain or loss upon early  termination of
these  instruments  would be deferred and amortized as an adjustment to interest
expense over the term of the applicable interest rate agreement.



                                       26
<PAGE>

RECLASSIFICATIONS

Certain  reclassifications  of the 1996 and 1995 financial  statements have been
made to conform to the 1997 presentation.

3. CAPITAL REQUIREMENTS

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

Quantitative  measures  established  by  regulation to ensure  capital  adequacy
require  the Bank to  maintain  minimum  amounts  and ratios of total and Tier I
capital  to  risk-weighted  assets  and of Tier I  capital  to  average  assets.
Management  believes,  as of December 31, 1997,  that the Bank meets all capital
adequacy  requirements to which it is subject. As of December 31, 1997 and 1996,
the OTS categorized the Bank as well capitalized under the regulatory  framework
for prompt  corrective  action.  To be categorized as well  capitalized the Bank
must maintain minimum total risk-based,  Tier I risk-based,  and Tier I leverage
ratios as set forth in the table.  There are no  conditions or events since that
notification that management  believes have changed the institution's  category.
The Bank's actual capital amounts and ratios  are  presented  in the table below
($ in thousands):

<TABLE>
<CAPTION>
                                                                                                        To Be Well
                                                                         For Capital                Capitalized Under
                                                                          Adequacy                  Prompt Corrective
                                              Actual                      Purposes:                Action Provisions:
                                      Amount            Ratio       Amount          Ratio        Amount           Ratio
<S>                                   <C>             <C>           <C>             <C>           <C>             <C>  
As of December 31, 1997:
Total Capital (to risk                                             greater than   greater than  greater than    greater than
   weighted assets)                   $55,701         11.91%       $37,409        8.0%          $46,761         10.0%

Core Capital (to adjusted                                          greater than   greater than  greater than    greater than
   tangible assets)                   $52,617          5.06%       $41,606        4.0%          $52,008         5.0%

Tangible Capital (to                                               greater than   greater than  
   tangible assets)                   $52,608          5.06%       $15,602        1.5%             N/A           N/A

Tier I Capital (to                                                                              greater than    greater than
   risk weighted assets)              $52,617         11.25%            N/A         N/A         $28,057         6.0%
As of December 31, 1996:
Total Capital (to risk                                             greater than   greater than  greater than    greater than
   weighted assets)                   $34,104         10.41%       $26,205        8.0%          $32,756         10.0%

Core Capital (to adjusted                                          greater than   greater than  greater than    greater than
   tangible assets)                   $31,726          5.08%       $24,999        4.0%          $31,248         5.0%

Tangible Capital (to                                               greater than   greater than 
   tangible assets)                   $31,711          5.07%       $9,374         1.5%              N/A          N/A

</TABLE>


                                       27
<PAGE>
<TABLE>
<CAPTION>

<S>                                   <C>              <C>                                        <C>              <C> 
Tier I Capital (to
   risk weighted asset)               $31,726          9.69%            N/A         N/A          _$19,654         _6.0%

</TABLE>

 On August 8, 1996, the OTS terminated the May 1993  Supervisory  Agreement with
TeleBank  subsequent  to the  completion  of a full scope  safety and  soundness
examination of the Bank.

4. INVESTMENT SECURITIES

The  cost   basis  and   estimated   fair   values  of   investment   securities
available-for-sale at December 31, 1997 and 1996, by contractual  maturity,  are
shown below (in thousands):

<TABLE>
<CAPTION>
                                                                      Gross               Gross
                                            Amortized            unrealized          unrealized            Estimated
                                                 cost                 gains              losses          fair values
<S>                                            <C>                   <C>                   <C>                <C>   
1997:
Due within one year:
    Agency notes                               $  539                $   --                $ --               $  539
    Other investments                             323                     1                  --                  324
Due within one to five years:
    Municipal bonds                               565                    12                  --                  577
    Other investments                          25,038                    16                  --               25,054
    Certificate of deposit                        499                    --                  --                  499
Due within five to ten years:
    Corporate debt                              7,433                   242                  --                7,675
    Municipal bonds                             3,562                   130                  --                3,692
    Other investments                             175                    --                  --                  175
Due after ten years:
    Agency notes                               21,608                   398                 (40)              21,966
    Equities                                   15,038                   436                 (50)              15,424
    Corporate debt                             11,103                   797                  --               11,900
    Municipal bonds                             3,200                   212                  --                3,412
                                              $89,083                $2,244                $(90)             $91,237
1996:
Due within one year:
    Repurchase agreement                     $  1,730                $   --                $ --             $  1,730
    Margin account                                 18                    --                  --                   18
Due within one to five years:
    Corporate debt                              2,000                    --                 (10)               1,990
    Agency notes                                  988                     1                  --                  989
    Municipal bonds                               565                     3                  --                  568
    Certificate of deposit                        499                    --                  --                  499
Due within five to ten years:
    Corporate debt                              7,436                    61                  --                7,497
    Municipal bonds                             3,560                    27                  --                3,587
Due after ten years:
    Agency notes                               30,151                   132                  --               30,283
    Equities                                   14,011                   220                  --               14,231
    Corporate debt                             13,089                   994                  --               14,083
    Municipal bonds                             3,200                   151                  --                3,351
                                              $77,247                $1,589                $(10)             $78,826

</TABLE>

                                       28
<PAGE>

The  proceeds  from  sale and gross  realized  gains  and  losses on  investment
securities  available  for sale  that  were  sold in 1997  were  $25.9  million,
$423,000, and $34,000,  respectively.  The proceeds from sale and gross realized
gains and losses on investment  securities  available for sale that were sold in
1996 were $25.1 million, $311,000, and $153,000, respectively. The proceeds from
sale and gross realized gains and losses on investment  securities available for
sale that were sold in 1995 were  $24.1  million,  $1.1  million,  and  $52,000,
respectively.

5. MORTGAGE-BACKED AND RELATED SECURITIES

Mortgage-backed  and related  securities  represent  participating  interests in
pools of long-term  first mortgage loans  originated and serviced by the issuers
of the  securities.  The Company has also  invested in  collateralized  mortgage
obligations  ("CMOs") which are securities  issued by special  purpose  entities
generally collateralized by pools of mortgage-backed  securities.  The Company's
CMOs are senior tranches  collateralized  by federal agency  securities or whole
loans.  The fair  value of  mortgage-backed  and  related  securities  fluctuate
according to current  interest rate  conditions and  prepayments.  Fair value is
estimated using quoted market prices. For illiquid securities, market prices are
estimated by obtaining  market price  quotes on similar  liquid  securities  and
adjusting the price to reflect differences  between the two securities,  such as
credit  risk,  liquidity,  term,  coupon,  payment  characteristics,  and  other
information.   The   amortized   cost  basis  and   estimated   fair  values  of
mortgage-backed securities  available-for-sale at December 31, 1997 and 1996, by
contractual maturity, are shown as follows (in thousands):

<TABLE>
<CAPTION>
                                                                      Gross               Gross
                                            Amortized            unrealized          unrealized            Estimated
                                                 cost                 gains              losses          fair values
<S>                                            <C>                   <C>               <C>                    <C>   
1997: Due within one year:
    Agencies                                   $  939                $   --            $     --               $  939
Due within one to five years:
    Agencies                                      627                     2                  (6)                 623
    Private issuer                              2,643                    --                 (22)               2,621
Due within five to ten years:
    Private issuer                              5,982                    39                  --                6,021
Due after ten years:
    Agencies                                   23,907                   124                 (27)              24,004
    Private Issuer                            143,889                 2,971              (1,443)             145,417
    Collateralized mortgage
           obligations                        139,663                   536                (621)             139,578
                                             $317,650                $3,672            $ (2,119)            $319,203
1996:
Due within one to five years:
    Private issuer                           $  4,172                $   --            $    (56)            $  4,116
Due within five to ten years:
    Private issuer                              8,262                    75                  --                8,337
Collateralized mortgage
         obligations                              371                    --                  (3)                 368
Due after ten years:
    Private issuer                            132,791                 1,367                  --              134,158
    Collateralized mortgage
         obligations                           24,896                   461                  --               25,357
    Agency certificates                        12,310                    97                  --               12,407

</TABLE>


                                       29
<PAGE>
<TABLE>
<CAPTION>
<S>                                          <C>                     <C>                  <C>               <C>     
                                             $182,802                $2,000               $ (59)            $184,743

</TABLE>

The  Company  pledged  $104.1  million  and  $61.4  million  of  private  issuer
mortgage-backed  securities as collateral for repurchase  agreements at December
31, 1997 and 1996, respectively. The proceeds from sale and gross realized gains
and losses on  mortgage-backed  securities  available for sale that were sold in
1997 were $112.4 million,  $845,000,  and $253,000,  respectively.  The proceeds
from sale and realized gains and losses on mortgage-backed  securities available
for sale that were sold in 1996 were $185.2 million,  $1.4 million, and $707,000
respectively.   The  proceeds  from  sale  and  realized  gains  and  losses  on
mortgage-backed  securities available for sale that were sold in 1995 were $39.7
million, $1.6 million, and $3,000, respectively.

6. LOANS RECEIVABLE

Loans  receivable  at December 31, 1997 and 1996 are  summarized  as follows (in
thousands):

<TABLE>
<CAPTION>
                                                                   1997                               1996
<S>                                                            <C>                                <C>     
First mortgage loans (principally conventional):
    Secured by one-to-four family residences                   $547,734                           $359,563
    Secured by commercial real estate                             3,009                              4,017
    Secured by mixed-use property                                   856                              1,180
    Secured by five or more dwelling units                        1,447                              1,516
    Secured by land                                                 378                                781
                                                                553,424                            367,057
Less:
    Net deferred loan origination fees                              (34)                               (42)
    Unamortized discounts, net                                   (9,938)                           (13,750)
Total first mortgage loans                                      543,452                            353,265
Other loans:
    Home equity and second  mortgage loans                          541                              1,208
    Other                                                           305                                305
                                                                544,298                            354,778
Less: allowance for loan losses                                  (3,594)                            (2,957)
Net loans receivable                                           $540,704                           $351,821

</TABLE>

The mortgage loans are located  primarily in California,  New York, and Virginia
according to the following percentages 15.1%, 13.3%, and 7.4%, respectively.  As
of December 31, 1997,  the mortgage  loan  portfolio  consisted of variable rate
loans of $335.2 million or 62% and fixed rate loans of $205.5  million,  or 38%.
The weighted  average  maturity of mortgage  loans secured by one to four family
residences is 266 months as of December 31, 1997. The unpaid  principal  balance
of  mortgage  loans owned by the Company  but  serviced by other  companies  was
$301.5 million and $203.9  million at December 31, 1997 and 1996,  respectively.
Loans past due ninety  days or more,  and  therefore  on  non-accrual  status at
December 31, 1997 and 1996, are summarized as follows (in thousands):

<TABLE>
<CAPTION>
                                                                   1997                               1996
<S>                                                           <C>                                 <C>     
First mortgage loans:
    Secured by one-to-four family residences                  $  10,802                           $  8,979
    Secured by commercial real estate                               635                              1,217
Home equity and second mortgage loans                                 0                                 54

</TABLE>

                                       30
<PAGE>

<TABLE>
<CAPTION>
<S>                                                             <C>                                <C>    
Total                                                           $11,437                           $10,250

</TABLE>

The interest  accrual balance for each loan that enters  non-accrual is reversed
from income. If all  nonperforming  loans had been performing during 1997, 1996,
and 1995,  the Bank  would  have  recorded  $739,000,  $789,000,  and  $365,000,
respectively,  in additional interest income.  There were no commitments to lend
additional funds to these borrowers as of December 31, 1997 and 1996.

Activity in the allowance for loan losses for the years ended December 31, 1997,
1996, and 1995 is summarized as follows (in thousands):

<TABLE>
<CAPTION>
                                                                  1997                   1996                  1995

<S>                                                             <C>                    <C>                  <C>    
Balance, beginning of the year                                  $2,957                 $2,311               $   989
Provision for loan losses                                          921                    919                 1,722
Charge-offs, net                                                  (284)                  (273)                 (400)
Balance, end of year                                            $3,594                 $2,957                $2,311

</TABLE>

According to Statement of Financial  Accounting Standards No. 114, Accounting by
Creditors  for  Impairment  of a Loan,  ("SFAS No.  114"),  a loan is considered
impaired when, based upon current  information and events, it is probable that a
creditor will be unable to collect all amounts due according to the  contractual
terms of the loan  agreement.  The term  "all  amounts  due"  includes  both the
contractual  interest and principal  payments of a loan as scheduled in the loan
agreement.  The Company has determined  that once a loan becomes 90 or more days
past due,  collection of all amounts due is no longer  probable and is therefore
considered  impaired.  The amount of impairment is measured  based upon the fair
value of the underlying  collateral  and is reflected  through the creation of a
valuation allowance.  The table below presents impaired loans as of December 31,
1997 and 1996 (in thousands):

<TABLE>
<CAPTION>
                                                                                                             Amount
                                                                 Total              Amount of           of recorded
                                                   recorded investment               specific     investment net of
Description of Loans                                 in impaired loans               reserves     specific reserves
<S>                                                             <C>                   <C>                   <C>    
1997: Impaired loans:
Commercial real estate                                        $    635                $   248               $   387
One-to-four family                                              10,802                  1,760                 9,042
Total                                                         $ 11,437                $ 2,008               $ 9,429

Restructured loans:

Commercial real estate                                        $    248                $     -               $   248
One-to-four family                                                 177                      -                   177
Total                                                         $    425                $     -               $   425

1996:
Impaired loans:

Commercial real estate                                        $  1,217                $   318               $   899
One-to-four family                                               9,033                  1,492                 7,541
Total                                                         $ 10,250                $ 1,810               $ 8,440

Restructured loans:

</TABLE>


                                       31
<PAGE>

<TABLE>
<CAPTION>

<S>                                                           <C>                     <C>                   <C>    
Commercial real estate                                        $    251                $     8               $   243
One-to-four family                                                 184                      0                   184
Total                                                         $    435                $     8               $   427

</TABLE>

The average recorded investment in impaired loans, with identified losses, as of
December 31, 1997,  1996,  and 1995 was $2.3  million,  $2.2  million,  and $2.0
million,  respectively.  The related amount of interest income the Company would
recognize as additional  interest  income for the years ended December 31, 1997,
1996, and 1995 was $739,000, $789,000, and $365,000, respectively. The Company's
charge-off  policy for impaired loans is consistent  with its charge-off  policy
for other  loans;  impaired  loans  are  charged-off  when,  in the  opinion  of
management,  all  principal  and interest  due on the impaired  loan will not be
fully  collected.  Consistent with the Company's  method for non-accrual  loans,
interest  received on impaired loans is recognized as interest income or applied
to principal when it is doubtful that full payment will be collected.

7. REAL ESTATE ACQUIRED THROUGH FORECLOSURE

Real estate acquired  through  foreclosure at December 31, 1997 and December 31,
1996 was $681,000 and $1.2 million, respectively.  Activity in the allowance for
real estate  losses for the years ended  December  31, 1997,  1996,  and 1995 is
summarized as follows (in thousands):

<TABLE>
<CAPTION>
                                                                  1997                   1996                  1995
<S>                                                                <C>                   <C>                  <C>  
Balance, beginning of year                                        $ 65                  $ 213                 $  92
Provision for real estate losses                                    19                     77                   256
Charge-offs                                                        (84)                  (225)                 (135)
Balance, end of year                                              $  -                  $  65                 $ 213

</TABLE>

8. LOANS SERVICED FOR OTHERS

Mortgage  loans  serviced  by the  Bank  for  others  are  not  included  in the
accompanying  consolidated statements of financial condition because the related
loans  are not  owned by the  Company  or any of its  subsidiaries.  The  unpaid
principal  balances of these loans at December 31, 1997 and 1996 are  summarized
as follows (in thousands):

<TABLE>
<CAPTION>
                                                                   1997                               1996
<S>                                                            <C>                                <C>     
Mortgage loans underlying pass-through securities:
    Federal Home Loan Mortgage Corporation                     $  2,140                           $  2,843
    Federal National Mortgage Association                        28,417                             11,548
    Subtotal                                                   $ 30,557                           $ 14,391
Mortgage loan portfolio serviced for:

    Other investors                                              27,125                             31,465
Total                                                          $ 57,682                           $ 45,856

</TABLE>



                                       32
<PAGE>

Custodial  escrow  balances held in connection with the foregoing loans serviced
were  approximately  $120,000  and  $84,000  at  December  31,  1997  and  1996,
respectively. Included in other assets is purchased mortgage servicing rights of
$3.3 million and $2.8 million as of December 31, 1997 and 1996, respectively.

9. DEPOSITS

The Bank  initiates  deposits  directly with  customers  through  contact on the
phone,  the mail,  and  walk-in at its  headquarters.  On May 2, 1996,  TeleBanc
entered into an  agreement  to assume  certain  deposit  liabilities  with First
Commonwealth  Savings  Bank  FSB  ("First  Commonwealth"),   First  Commonwealth
Financial Corp., and John York, Jr. Pursuant to this agreement, TeleBanc assumed
certain brokered and telephone solicited deposits accounts of First Commonwealth
which had a current balance of approximately $53.1 million as of April 30, 1996.
In the deposit  assumption,  First  Commonwealth paid TeleBanc the amount of the
deposit  liabilities  assumed,  plus the amount of the deposit liabilities (less
certain renewals) multiplied by 0.25 percent.  Deposits at December 31, 1997 and
1996 are summarized as follows (in thousands):

<TABLE>
<CAPTION>
                                     Weighted
                                  average rate at
                                    December 31                      Amount                       Percent
                               1997           1996            1997        1996              1997         1996
<S>                            <C>            <C>       <C>         <C>                     <C>              
Demand accounts,
    non interest-
    bearing                      --%            --%      $     761   $     309               0.2%          --%
Money market                   5.26           5.10         122,185     109,835              23.4         28.1
Passbook savings               3.00           3.00             665       1,758               0.1          0.5
Certificates of
    deposit                    6.24           6.28         398,610     278,584              76.3         71.4
    Total                                                $ 522,221   $ 390,486             100.0%       100.0%

</TABLE>

Certificates  of deposit and money market  accounts,  classified  by rates as of
December 31, 1997 and 1996 are as follows (in thousands):

<TABLE>
<CAPTION>
Amount                                                             1997                               1996
<S>                                                           <C>                                <C>      
0 -   1.99%                                                   $       5                          $   5,235
2 -   3.99%                                                          --                                148
4 -   5.99%                                                     231,048                            210,481
6 -   7.99%                                                     289,046                            170,056
8 -   9.99%                                                         696                              1,709
10 - 11.99%                                                          --                                790
Total                                                         $ 520,795                          $ 388,419

</TABLE>

At December 31, 1997,  scheduled maturities of certificates of deposit and money
market accounts are as follows (in thousands):

<TABLE>
<CAPTION>
                       Less than            1-2            2-3           3-4           4-5            5+
                        one year          years          years         years         years         years        Total
<S>                       <C>          <C>            <C>           <C>           <C>           <C>         <C>      
0 -  1.99%             $      5        $     --       $     --      $     --      $     --      $     --    $       5
2 -  3.99%                    --             --             --            --            --            --           --
4 - 5.99%                209,547         17,708          2,217         1,126           362            88      231,048

</TABLE>


                                       33
<PAGE>

<TABLE>
<CAPTION>

<S>                       <C>           <C>             <C>           <C>            <C>           <C>        <C>    
6 -  7.99%                37,687        124,905         97,079        13,550         9,849         5,976      289,046
8 - 9.99%                    578             --             82            --            36            --          696
10 - 11.99%                   --             --             --            --            --            --           --
                       $ 247,817       $142,613       $ 99,378      $ 14,676      $ 10,247      $  6,064    $ 520,795

</TABLE>

The aggregate amount of certificates of deposit with denominations  greater than
or equal to $100,000  was $47.5  million and $45.1  million at December 31, 1997
and 1996,  respectively.  Interest  expense  on  deposits  for the  years  ended
December 31, 1997, 1996, and 1995 is summarized as follows (in thousands):

<TABLE>
<CAPTION>
                                                                  1997                   1996                  1995
<S>                                                           <C>                    <C>                   <C>     
Money market                                                  $  6,353               $  4,740              $  2,036
Passbook savings                                                    27                     59                    78
Certificates of deposit                                         19,578                 16,558                14,919
Total                                                          $25,958                $21,357               $17,033

</TABLE>

Accrued  interest payable on deposits at December 31, 1997 and 1996 was $728,000
and $667,000, respectively.

10. ADVANCES FROM THE FHLB OF ATLANTA

Advances to the Bank from the FHLB of Atlanta at December 31, 1997 and 1996 were
as follows (dollars in thousands):

<TABLE>
<CAPTION>
                                                                   Weighted                                 Weighted
                                                                    average                                  average
                                                 1997         interest rate                1996        interest rate
<S>                                         <C>                                      <C>                     <C>   
1996                                        $      --                  -- %            $     --              5.52 %
1997                                               --                  --                64,800              5.56
1998                                           71,000                5.61                41,000              5.53
1999                                          129,000                5.69                39,000              5.60
Total                                        $200,000                5.66%             $144,800              5.56%

</TABLE>

All advances,  except for $2.0 million  which  matured in November of 1996,  are
floating  rate  advances  and adjust  quarterly or  semi-annually  to the London
InterBank  Offering Rate  ("LIBOR")  rate.  In 1997 and 1996,  the advances were
collateralized  by a  specific  lien on  mortgage  loans in  accordance  with an
"Advances,  Specific  Collateral Pledge and Security Agreement" with the FHLB of
Atlanta, executed September 10, 1980. Under this agreement, the Bank is required
to maintain qualified  collateral equal to 120 to 160 percent of the Bank's FHLB
advances,  depending on the  collateral  type. As of December 31, 1997 and 1996,
the Company secured these advances with an assignment of specific  mortgage loan
collateral  from  its  loan  and  mortgage-backed   security  portfolio.   These
one-to-four  family  whole  first  mortgage  loans  and  securities  pledged  as
collateral totaled approximately $ 259.9 million and $ 186.1 million at December
31, 1997 and 1996,  respectively.  The Company is required to be a member of the
FHLB System and to maintain an investment in the stock of the FHLB of Atlanta at
least equal to the greater of 1 percent of the unpaid  principal  balance of its
residential  mortgage  loans or 1 percent of 30  percent of its total  assets or
1/20th of its outstanding advances from the FHLB.

11. SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE



                                       34
<PAGE>

Information   concerning   borrowings  under  fixed  and  variable  rate  coupon
repurchase agreements is summarized as follows (dollars in thousands):

<TABLE>
<CAPTION>
                                                                     1997              1996
                                                                 --------          -------
<S>                                                              <C>              <C>    
Weighted average balance during the year                         $117,431         $68,920
Weighted average interest rate during the year                       5.76%           5.77%
Maximum month-end balance during the year                        $279,909          $97,416
Balance at year-end                                              $279,909          $57,581
Private issuer mortgage-backed securities underlying
   the agreements as of the end of the year:

      Carrying value, including accrued interest                 $295,556          $61,418
      Estimated market value                                     $295,500          $61,426

</TABLE>

The securities sold under the repurchase agreements at December 31, 1997 are due
in less than one  year.  The  Company  enters  into  sales of  securities  under
agreements  to  repurchase  the  same  securities.   Repurchase  agreements  are
collateralized  by  fixed  and  variable  rate  mortgage-backed   securities  or
investment grade  securities.  Repurchase  agreements are treated as financings,
and the  obligations to repurchase  securities sold are reflected as a liability
in the balance sheet.  The dollar amount of securities  underlying the agreement
remains in the asset  accounts.  The  securities  underlying  the agreements are
physical and book entry  securities  and the brokers  retain  possession  of the
securities  collateralizing the repurchase agreements.  If the counterparty in a
repurchase  agreement was to fail, the Company may incur an accounting  loss for
the excess  collateral  posted with the  counterparty.  As of December 31, 1997,
Lehman Brothers Inc.  represents the only  counterparty with which the Company's
amount at risk exceeded 10% of the Company's stockholders' equity. The amount of
risk at December  31, 1997 with Lehman  Brothers  Inc.  was $5.1  million with a
weighted average maturity of 47 days.

12. SUBORDINATED DEBT

In May and June 1994, the Company issued 15,000 units of subordinated  debt at a
price of $15.0 million and 2,250 units at a price of $2.3 million, respectively.
The units each consist of $1,000 of 11.5%  subordinated notes due in 2004 and 20
detachable  warrants to purchase one share each of TeleBanc  common  stock.  The
notes may not be redeemed  prior to May 1, 1999. The notes are redeemable at the
option of the  Company  after May 1,  1999,  at an initial  redemption  price of
105.75% of the principal  amount plus accrued interest with the redemption price
declining  to  104.60%,   103.45%,  102.30%,  and  101.15%  annually  each  year
thereafter.  Interest  is  payable  semi-annually  on  May  1  and  November  1,
commencing  November 1, 1994. The indenture,  among other things,  restricts the
ability  of  the  Company  under  certain   circumstances  to  incur  additional
indebtedness,  limits cash  dividends  and other  capital  distributions  by the
Company,  requires the  maintenance  of a reserve equal to 100% of the Company's
annual interest expense on all indebtedness,  restricts  disposition of the Bank
or its assets,  and limits  transactions  with  affiliates.  The annual interest
expense to service the subordinated debt is $2.0 million.

The total  value of the  345,000  warrants  was  $948,750  which  resulted in an
original issue discount on the subordinated debt in the amount of $899,289.  The
original issue discount is amortized on a level yield basis over the life of the
debt.



                                       35
<PAGE>

The warrants became  transferable on November 27, 1994 and are exercisable on or
after May, 27, 1995. The exercise price of each warrant is $7.65625.

On February 28, 1997,  the Company sold $29.9 million of units in the form of 4%
convertible  preferred stock and 9.5% senior  subordinated notes and warrants to
investment  partnerships  managed  by  Conning  & Co.,  CIBC Wood  Gundy  Argosy
Merchant Fund 2, LLC, The Progressive  Corporation,  and The Northwestern Mutual
Life Insurance  Company.  Upon the sale of the units,  representatives  from the
Conning  partnerships and the CIBC Merchant Fund were appointed to the Company's
Board. The units consist of $13.7 million in 9.5% senior subordinated notes with
198,088 detachable warrants,  $16.2 million in 4.0% convertible preferred stock,
and rights to 205,563 contingent warrants. The senior subordinated notes are due
on March 31, 2004 and stipulate increases over time in interest rates subsequent
to March 31, 2002 from 9.5% up to 15.25%.  The warrants are exercisable at $9.50
with an expiration  date of February 28, 2005.  The preferred  stock consists of
Series A Voting  Convertible  Preferred  Stock,  Series B Nonvoting  Convertible
Preferred  Stock,  and Series C  Nonvoting  Convertible  Preferred  Stock and is
convertible  to 1,199,743  shares of common stock.  Series A and Series B shares
may be converted at any time into fully-paid and non-assessable shares of Voting
Common Stock. Series C shares may be converted at any time to Series A or Series
B shares or at any time into  fully-paid  and  non-assessable  nonvoting  common
stock. The aforementioned  preferred stock has no liquidation  preferences.  The
contingent  warrants  may be  exercised  upon a change of control or at any time
after February 19, 2002  ("Exercise  Event").  If the Company's  annual internal
rate of return is less than 25% at the time of an Exercise  Event,  unit holders
may exercise the contingent  warrants for $0.01 until an internal rate of return
of  25%  is  reached.   The  annual  interest  expense  to  service  the  senior
subordinated  notes is $1.3 million and the annual  dividend  requirement on the
preferred stock is $648,000.

In June 1997, the Company formed  TeleBanc  Capital Trust I, which in turn sold,
at par,  10,000  shares of trust  preferred  securities,  Series A,  liquidation
amount of $1,000,  for a total of $10,000,000 in a private  placement.  TeleBanc
Capital  Trust I is a business  trust formed for the purpose of issuing  capital
securities and investing the proceeds in junior  subordinated  debentures issued
by the company. The trust preferred securities mature in 2027 and have an annual
dividend rate of 11.0%,  or $1.1 million,  payable  semi-annually,  beginning in
December 1997. The net proceeds will be used,  for general  corporate  purposes,
including  to  fund  Bank  operations  and the  creation  and  expansion  of its
financial service and product operations.

13. EARNINGS PER SHARE

In February 1997, the Financial  Accounting  Standards Board issued Statement of
Financial  Accounting  Standards  No. 128  "Earnings  per Share"  ("SFAS  128"),
effective   December  15,  1997.  This  statement   specifies  the  computation,
presentation,  and  disclosure  requirements  for earnings per share ("EPS") for
entities  with  publicly  held common stock or  potential  common  stock.

Basic  earnings  per common  share,  as  required  by SFAS 128,  is  computed by
dividing  adjusted  net income by the total of the  weighted  average  number of
common shares  outstanding during the respective  periods.  Diluted earnings per
common  share  for the  years  ended  December  31,  1997,  1996,  and 1995 were
determined on the assumptions that the



                                       36
<PAGE>

dilutive  options and warrants were  exercised  upon  issuance.  The options and
warrants  are  deemed to be  dilutive  if (a) the  average  market  price of the
related common stock for a period exceeds the exercise price or (b) the security
to be  tendered  is  selling at a price  below that at which it may be  tendered
under the option or warrant  agreement and the resulting  discount is sufficient
to establish an  effective  exercise  price below the market price of the common
stock  obtainable  upon exercise.  The Company's  year to date weighted  average
number of common  shares  outstanding  was  2,191,455  at December  31, 1997 and
2,049,500  at  December  31,  1996 and  1995.  For  diluted  earnings  per share
computation,  weighted  average  shares  outstanding  also  include  potentially
dilutive securities.

<TABLE>
<CAPTION>
                                                       EPS Calculation

                                                      Income                 Shares             Per Share Amount
                                              -----------------------------------------------------------------------
                                                               For the Year Ended December 31, 1997
                                              -----------------------------------------------------------------------
<S>                                           <C>                            <C>                      <C>   
Net income                                    $       4,216,826
less: preferred stock dividends                        (546,182)
                                              -----------------------
Basic earnings per share
Income available to common shareholders       $       3,670,644              2,191,455                $ 1.68
                                                                                              =======================
Options issued to management                                 --                224,145
Warrants                                                     --                250,410
Convertible preferred stock                             546,182                167,026
                                              ----------------------- -----------------------
Diluted earnings per share                    $       4,216,826              2,833,036                $ 1.49
                                              ======================= ======================= =======================
                                                               For the Year Ended December 31, 1996
                                              -----------------------------------------------------------------------
Basic earnings per share
Net income                                    $       2,552,044              2,049,500                $ 1.25
                                                                                              =======================
Options issued to management                                 --                 91,031
Warrants                                                     --                 62,544
Diluted earnings per share                    $       2,552,044              2,203,075                $ 1.16
                                              ======================= ======================= =======================
                                                               For the Year Ended December 31, 1995
                                              -----------------------------------------------------------------------
Basic earnings per share
Net income                                    $       2,719,875              2,049,500                $ 1.33
                                                                                              =======================
Options issued to management                                 --                  2,694
Diluted earnings per share                    $       2,719,875              2,052,194                $ 1.33
                                              ======================= ======================= =======================

</TABLE>


14. INCOME TAXES

Income tax expense for the years ended  December  31,  1997,  1996,  and 1995 is
summarized as follows (in thousands):

<TABLE>
<CAPTION>
                                                             1997          1996         1995
                                                             ----          ----         ----
<S>                                                      <C>            <C>            <C>    
Current:   Federal                                       $  1,881       $  1,194       $ 2,038
           State                                              221            225           181
                                                         -------------------------------------
                                                            2,102          1,419         2,219
Deferred:  Federal                                           (398)           (78)         (474)
           State                                              (47)          (146)          (85)
                                                         -------------------------------------
                                                             (445)          (224)         (559)
Total:     Federal                                          1,483          1,116         1,564
           State                                              174             79            96
                                                         -------------------------------------
                                                         $  1,657       $  1,195        $1,660
</TABLE>


                                       37
<PAGE>


A  reconciliation  of the  statutory  Federal  income tax rate to the  Company's
effective  income tax rate for the years ended December 31, 1997, 1996, and 1995
is as follows:

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------------------
                                                             1997          1996         1995
-----------------------------------------------------------------------------------------------------------------------------
<S>                                                         <C>            <C>           <C>  
Federal income tax at statutory rate                        34.0%          34.0%         34.0%
State taxes, net of federal benefit                          4.2            4.2           4.2
Municipal bond interest, net of
     disallowed interest expense                            (5.8)          (3.6)         (7.0)
Other                                                       (6.0)          (2.7)          6.7
                                                           -----------------------------------
                                                            26.4%          31.9%         37.9%

</TABLE>

Deferred  income taxes result from temporary  differences in the  recognition of
income and expense for tax versus financial reporting  purposes.  The sources of
these  temporary  differences  and the  related  tax effects for the years ended
December 31, 1997 and 1996 are as follows (in thousands):

<TABLE>
<CAPTION>
                                                                     1997          1996
                                                                   ------       ------- 
<S>                                                                <C>         <C>     
Deferred Tax Liabilities:
     Acquired Loan Servicing Rights                                $   -       $   (12)
     Purchase Accounting  Premium                                    (75)          (40)
     Depreciation                                                    (44)          (17)
     Tax Reserve in Excess of Base Year                             (134)          (93)
     Tax Effect of Securities Available-for-sale
        Adjustment to Fair Value (notes 4 and 5)                    (722)       (1,030)
     FHLB Stock Dividends                                           (129)         (168)
     Other                                                           (89)          (52)
                                                                  ---------------------
        Total                                                     (1,193)      $(1,412)
Deferred Tax Assets:
     General Reserves & Real Estate Owned Losses                   1,293            819
     Other                                                            80             20
                                                                   --------------------
        Total                                                      1,373            839
     Net Deferred Tax Asset (Liability)                            $ 180       $   (573)

</TABLE>

The Company has a tax bad debt base year  reserve of $264,000  for which  income
taxes have not been provided.  Certain  distributions  or transactions may cause
the Bank to recapture its tax bad debt base year reserve,  resulting in taxes of
$100,000.  In addition,  the Bank has entered into a tax sharing  agreement with
TeleBanc  under which it is allocated its share of income tax expense or benefit
based on its portion of consolidated income or loss.

15. FINANCIAL INSTRUMENTS

The  Company  is party to a variety  of  interest  rate caps and swaps to manage
interest rate exposure. In general, the Company enters into agreements to assume
fixed-rate  interest payments in exchange for variable  market-indexed  interest
payments.  The effect of these  agreements  is to lengthen  short-term  variable
liabilities  into longer term  fixed-rate  liabilities  or to shorten  long-term
fixed rate assets into short-term  variable rate assets.  The net costs of these



                                       38
<PAGE>

agreements  are charged to interest  expense or interest  income,  depending  on
whether the agreement is designated to hedge a liability or an asset.

Interest rate exchange agreements for the years ended December 31, 1997 and 1996
are summarized as follows (dollars in thousands):

<TABLE>
<CAPTION>
                                                                 1997            1996
                                                              ---------      ---------
<S>                                                                <C>            <C>  
Weighted average fixed rate payments                               6.15%          5.97%
Weighted average original term                                     4.6 yrs        5.0 yrs
Weighted average variable rate obligation                          5.81%          5.62%
Notional Amount                                               $ 205,000      $ 130,000

</TABLE>

The Company enters into interest rate cap agreements to hedge  outstanding  FHLB
advances and  repurchase  agreements.  Under the terms of the interest  rate cap
agreements,  the  Company  generally  would  receive  an  amount  equal  to  the
difference  between 3 month  LIBOR or 6 month LIBOR and the cap's  strike  rate,
multiplied  by the  notional  amount.  The  interest  rate  cap  agreements  are
summarized as follows (dollars in thousands):

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------------------
                                           Effective       Notional       Maturity

Cap Strike Rate                              Date           Balance         Date
-----------------------------------------------------------------------------------------------------------------------------
<S>        <C>                                <C>           <C>               <C> 
           4%                            July 1992          $10,000      July 1999
           6%                            October 1996       $20,000      October 1999
           7%                            January 1997       $10,000      January 2002
           7%                            January 1995       $10,000      July 1998
           7.5%                          July 1997          $25,000      July 1999
           8%                            July 1997          $25,000      July 2000
           8%                            June 1997          $25,000      June 2000
           9%                            December 1994      $14,000      December 1998
           10%                           April 1995         $10,000      January 2002

</TABLE>

The counterparties to the interest rate cap agreements are Goldman Sachs, Lehman
Brothers,  Merrill Lynch, NationsBank,  Nomura, Salomon Brothers, and UBS. As of
December  31,  1997,  the  associated   credit  risk  with  the   aforementioned
counterparties are $332,000, $104,000, $117,000, $66,000, $30,000, $132,000, and
$605,000,  respectively.  The credit risk is attributable to the unamortized cap
premium and any amounts due from the  counterparty as of December  31,1997.  The
total  amortization  expense for  premiums on interest  rate caps was  $777,000,
$638,000,  and $213,000 for the years ended  December 31, 1997,  1996, and 1995,
respectively.

16. FAIR VALUE DISCLOSURE OF FINANCIAL INSTRUMENTS

The fair value information for financial  instruments,  which is provided below,
is based on the requirements of Statement of Financial  Accounting Standards No.
107,  Disclosure About Fair Value of Financial  Instruments ("SFAS No. 107") and
does not  represent  the  aggregate  net fair  value  of the  Bank.  Much of the
information used to determine fair value is subjective and judgmental in nature,
therefore, fair value estimates,  especially for less marketable securities, may
vary.  In addition,  the amounts  actually  realized or paid upon  settlement or
maturity could be significantly different.



                                       39
<PAGE>

The following  methods and  assumptions  were used to estimate the fair value of
each class of financial  instrument  for which it is reasonable to estimate that
value:

CASH AND  INTEREST-BEARING  DEPOSITS - Fair value is  estimated  to be  carrying
value.

FEDERAL FUNDS SOLD - Fair value is estimated to be carrying value.

SECURITIES  PURCHASED  UNDER AGREEMENT TO RESELL - Fair value is estimated to be
carrying value.

INVESTMENT  SECURITIES - Fair value is estimated by using quoted  market  prices
for most  securities.  For illiquid  securities,  market prices are estimated by
obtaining  market price quotes on similar  liquid  securities  and adjusting the
price to reflect  differences  between the two securities,  such as credit risk,
liquidity, term coupon, payment characteristics, and other information.

MORTGAGE-BACKED  AND RELATED  SECURITIES - Fair value is estimated  using quoted
market prices. For illiquid securities, market prices are estimated by obtaining
market price quotes on similar  liquid  securities  and  adjusting  the price to
reflect differences between the two securities,  such as credit risk, liquidity,
term coupon, payment characteristics, and other information.

LOANS  RECEIVABLE  - For  certain  residential  mortgage  loans,  fair  value is
estimated  using quoted market  prices for similar  types of products.  The fair
value of other  certain  types of loans is estimated  using quoted market prices
for securities backed by similar loans.

The fair value for loans which  could not be  reasonably  established  using the
previous  two  methods  was  estimated  by  discounting  future cash flows using
current rates for similar loans.

Management  adjusts the discount rate to reflect the individual  characteristics
of the loan, such as credit risk, coupon, term, payment characteristics, and the
liquidity of the secondary market for these types of loans.

DEPOSITS - For passbook savings,  checking and money market accounts, fair value
is estimated at carrying value. For fixed maturity certificates of deposit, fair
value is estimated by  discounting  future cash flows at the  currently  offered
rates for deposits of similar remaining maturities.

ADVANCES FROM THE FHLB OF ATLANTA - For adjustable rate advances,  fair value is
estimated at carrying value. For fixed rate advances, fair value is estimated by
discounting  future cash flows at the  currently  offered  rates for  fixed-rate
advances of similar remaining maturities.



                                       40
<PAGE>

SECURITIES  SOLD UNDER  AGREEMENTS TO REPURCHASE - Fair value is estimated using
carrying value. The securities are repriced on a semiannual basis.

SUBORDINATED DEBT - For subordinated  debt, fair value is estimated using quoted
market prices.

OFF-BALANCE  SHEET  INSTRUMENTS  - The fair  value  of  interest  rate  exchange
agreements  is the  net  cost to the  Company  to  terminate  the  agreement  as
determined  from market  quotes.  The fair value of financial  instruments as of
December 31, 1997 and 1996 is as follows (in thousands):

<TABLE>
<CAPTION>
                                                 1997          1997          1996            1996
                                             Carrying          Fair      Carrying            Fair
                                                Value         Value         Value           Value
                                            ---------   ----------       --------       ----------
<S>                                            <C>           <C>            <C>              <C>  
Assets:
     Cash and cash equivalents                 92,156        92,156         3,259            3,259
     Investment securities
        available-for-sale                     91,237        91,237        78,826           78,826
     Mortgage-backed securities
        available-for-sale                    319,203       319,203       184,743          184,743
     Loans receivable                         540,704       562,270       351,821          365,401
     Trading                                   21,110        21,110            --               --
Liabilities:
     Deposits                               $ 522,221   $  524,022       $390,486       $  393,820
     Advances from the FHLB Atlanta           200,000       200,000       144,800          144,800
     Securities sold under agreements
        to repurchase                         279,909       279,909        57,581           57,581
     Subordinated debt, net                    29,614        30,953        16,586           16,625
     Trust preferred                            9,572        10,000            --               --
     Off-balance sheet instruments                 -- $     (1 ,342)           --        $   1,684
     Commitments to purchase loans                 --                          --               --

</TABLE>

17. DISTRIBUTIONS

The Bank is subject to certain  restrictions  on the amount of  dividends it may
declare without prior regulatory approval.  At December 31, 1997,  approximately
$10.6 million of retained earnings were available for dividend declaration.

18. EMPLOYEE STOCK OWNERSHIP PLAN

The Company  sponsors an Employee Stock  Ownership Plan ("ESOP").  All full-time
employees  of the Company who meet  limited  qualifications  participate  in the
ESOP.  Under the ESOP,  the Company  contributes  cash to a separate  trust fund
maintained  exclusively  for the  benefit  of those  employees  who have  become
participants.  Participants will have shares of TeleBanc common stock, valued at
market  value,  allocated to their  personal  plan  accounts  based on a uniform
percentage  of wages.  At  December  31, 1997 and 1996,  the  Company  carried a
$305,000 note receivable from the ESOP which was collateralized by the Company's
common  stock.  The  ESOP  owned  67,600  shares  of the  Company's  stock  with
approximately  39,000 and 32,000  shares  vested at December  31, 1997 and 1996,
respectively.  The  Company's



                                       41
<PAGE>

contribution  to the ESOP,  which is  reflected  in  compensation  expense,  was
$247,000, $224,000 and $210,000 for the years ended December 31, 1997, 1996, and
1995, respectively.

19. STOCK BASED COMPENSATION

In 1997,  the  Company  authorized  and issued  349,201  options  to  directors,
officers and employees to purchase  349,201  shares of TeleBanc  common stock at
prices ranging from $2.66 to $13.50. In 1996, officers and employees were issued
80,500  options to purchase  80,500  shares of TeleBanc  common  stock at prices
ranging  from $7.75 to $8.875.  As of December  31,  1997 and 1996,  299,124 and
180,438 of the shares,respectively,  were vested at exercise prices ranging from
$2.66 to $12.50. The maximum term for the outstanding options is 10 years. As of
December  31,  1997,  the total  number of  authorized  options is 901,431.  The
options'  exercise  price  was the  market  value  of the  stock  at the date of
issuance.

<TABLE>
<CAPTION>
                                                     1997                         1996                          1995
Options                                   Shares      Weighted Avg.    Shares      Weighted Avg.    Shares       Weighted Avg.
                                           (000's)    Exercise Price    (000's)    Exercise Price    (000's)    Exercise Price
                                           -------    --------------    -------    --------------    -------    --------------
<S>                                          <C>          <C>             <C>          <C>             <C>           <C>  
Outstanding at beginning of year             352           $6.89          271          $6.51           242           $6.64
Granted                                      349          $12.51           81          $8.17            32           $5.50
Exercised                                     17           $6.52            -              -             -               -
Forfeited                                     19          $11.40            -              -             3           $6.13
Outstanding at end of year                   665           $9.72          352          $6.89           271           $6.51
Options exercisable at year-end              299           $8.06          180          $6.69           110           $6.55
Weighted avg. fair value of options                        $3.49                       $2.61                         $1.81
granted

</TABLE>

The following table summarizes  information  about fixed options  outstanding at
December 31, 1997:

<TABLE>
<CAPTION>
                                          Options Outstanding (000's)                         Options Exercisable (000's)
Range of Exercise Prices       Number          Weighted Avg.         Weighted Avg.       Number Exercisable     Weighted Avg.
                             Outstanding         Remaining          Exercise Price                             Exercise Price
                                              Contractual Life
                                                  (Years)
<S>                              <C>                <C>                  <C>                     <C>                <C>  
Less than $5.00                  24                 9.2                  $2.66                   5                  $2.66
$5.00 - $7.49                    255                6.5                  $6.55                  202                 $6.57
$7.50 - $9.99                    74                 8.3                  $8.21                   30                 $8.21
$10.00 - $12.49                   -                   -                      -                    -                     -
$12.50 - $14.99                  312                9.2                 $13.23                   62                $13.23
                                 ---                                                            ---

Less than $5.00 - $14.99         665                8.0                  $9.72                  299                 $8.06
                                 ===                                                            ===

</TABLE>

Because the method of  accounting  required by SFAS No. 123 has not been applied
to options  granted prior to January 1995, the resulting pro forma  compensation
cost may not be  representative of that to be expected in future years. The fair
value of each  option  grant is  estimated  on the date of grant  using the Roll
Geske option pricing model with the


                                       42
<PAGE>

following weighted average  assumptions for grants;  risk-free interest rates of
5.08  percent,  5.25  percent  and  6.00  percent  for  1997,  1996,  and  1995,
respectively;  expected life of 10 years for all options granted in 1997,  1996,
and 1995;  expected  volatility  of 25 percent,  23 percent,  and 16 percent for
1997, 1996, and 1995 respectively.  The Company accounts for this plan under APB
No. 25, under which no compensation  cost has been recognized.  Had compensation
cost for the plan been  determined  consistent  with SFAS No. 123, the Company's
net income and net income per share would have been reduced to the following pro
forma amounts:

<TABLE>
<CAPTION>
                                                            Year Ended          Year Ended         Year Ended
                                                              12/31/97          12/31/96            12/31/95
                                                              --------          --------            --------
<S>                                                            <C>                  <C>               <C>    
Net income:
    As reported                                              $ 3,671            $ 2,552             $ 2,720
    Pro forma                                                $ 2,629            $ 2,409             $ 2,684
Basic earnings per share:
    As reported                                              $  1.68            $  1.25             $  1.33
    Pro forma                                                $  1.20            $  1.18             $  1.31
Diluted earnings per share:
    As reported                                              $  1.49            $  1.16             $  1.33
    Pro forma                                                $  1.12            $  1.09             $  1.31

</TABLE>

20. COMMITMENTS AND CONTINGENCIES

In the  ordinary  course  of  business,  the  Company  has  various  outstanding
commitments   and  contingent   liabilities   that  are  not  reflected  in  the
accompanying consolidated financial statements. The principal commitments of the
Company are as follows:

At December 31, 1997,  the Company was  obligated  under an operating  lease for
office  space  with an  original  term of ten  years.  Net  rent  expense  under
operating  leases was  approximately  $238,000,  $142,000,  and $127,000 for the
years ended December 31, 1997, 1996, and 1995, respectively.

The  projected  minimum  rental  payments  under  the  terms of the lease are as
follows:

<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------
Years ending
December 31,                                                                         Amount
---------------------------------------------------------------------------------------------------
<S>                                                                             <C>        
1998                                                                            $   190,000
1999                                                                                165,000
2000                                                                                166,000
2001                                                                                167,000
2002                                                                                168,000
---------------------------------------------------------------------------------------------------
2003 and thereafter                                                                 267,000
                                                                                $ 1,123,000
---------------------------------------------------------------------------------------------------

</TABLE>

As of December 31, 1997,  the Company had  commitments to purchase $24.0 million
of mortgage loans.



                                       43
<PAGE>

The Company  self-insures for a portion of health insurance expenses paid by the
Company as a benefit to its employees.  At December 31, 1997 and 1996, there was
no reserve  needed for  incurred but not  reported  claims under this  insurance
arrangement.

21. SUBSEQUENT EVENTS

In the first quarter of 1998, TeleBanc signed a definitive merger agreement (the
"DFC Acquisition") to acquire Direct Financial  Corporation  ("DFC"). DFC is the
parent holding company of Premium Bank, a federal savings bank  headquartered in
New Jersey.  At December 31, 1997, DFC reported total assets of $326.1  million,
loans  receivable,  net of $187.2 million,  total deposits of $273.9 million and
total  stockholders'  equity of $12.3  million.  TeleBanc  will pay $12 for each
share  of  Direct  Financial  common  stock  or  common  stock  equivalent.  The
transaction is valued at  approximately  $26.4 million.  The DFC  Acquisition is
expected  to be  consummated  in the  second  quarter  of 1998,  subject  to DFC
stockholder and regulatory approvals.

Also in  January  1998,  TeleBanc  announced  that it had  signed  a  definitive
acquisition  agreement  whereby MET Holdings will sell  substantially all of its
assets,  including approximately 1,433,081 shares of TeleBanc Common Stock owned
by MET Holdings,  and assign substantially all of its liabilities,  to TeleBanc.
Immediately  following  consummation  of  the  acquisition,  MET  Holdings  will
dissolve  and   distribute   its  remaining   assets  and   liabilities  to  its
stockholders,  assuming such  dissolution is approved by the requisite number of
stockholders of MET Holdings and TeleBanc.

22. CONDENSED FINANCIAL INFORMATION (PARENT COMPANY ONLY)

Statements of Financial Condition
($ in thousands)

<TABLE>
<CAPTION>
                                                                      December 31,
                                                  ---------------------------------------------------
                                                       1997                                      1996
                                                  ---------                                  --------
<S>                                              <C>                                       <C>       
Assets:
Cash                                             $    5,401                                  $    159
Investment securities available-for-sale              4,186                                     4,132
Mortgage-backed securities
   available-for-sale                                26,219                                    14,086
Loans receivable, net                                   566                                       305
Loan receivable held for sale                         6,367                                        --
Trading                                              14,011                                        --
Equity in net assets of subsidiary                   58,976                                    34,130
Deferred charges                                      1,460                                       940
Other assets                                          4,806                                     1,099
                                                  ---------                                  --------
Total assets                                      $ 121,992                                  $ 54,851

Liabilities and Stockholders' Equity
Liabilities:

</TABLE>


                                       44
<PAGE>

<TABLE>
<CAPTION>
                                                                      December 31,
                                                  ---------------------------------------------------
                                                       1997                                      1996
                                                  ---------                                  --------
<S>                                                <C>                                       <C>     
Subordinated debt                                  $ 39,614                                  $ 16,586
Securities sold under agreements
   to repurchase                                     33,555                                    12,831
Accrued interest payable                              1,037                                       357
Taxes payable and other liabilities                   1,962                                       419
                                                  ---------                                  --------
     Total liabilities                             $ 76,168                                  $ 30,193
                                                  ---------                                  --------
Stockholders' Equity
Preferred Stock                                    $ 15,281                                  $     --
Common Stock                                             22                                        20
Additional Paid in Capital                           16,207                                    14,637
Retained earnings                                    11,576                                     7,905
Unrealized gain/loss on
   securities available-for-sale                      2,738                                     2,096
                                                  ---------                                  --------
Total stockholders' equity                           45,824                                    24,658
                                                  ---------                                  --------
Total liabilities and stockholders' equity         $121,992                                  $ 54,851

<CAPTION>

STATEMENTS OF OPERATIONS
($ in thousands)
                                                                               December 31,
                                                    ----------------------------------------------------------------
                                                        1997                       1996                        1995
                                                    ---------                   --------                     -------
<S>                                                 <C>                         <C>                           <C>   
Interest income                                     $ 2,683                     $   531                       $  429
Interest expense                                      4,352                       2,163                        2,111

Net interest loss                                    (1,669)                     (1,632)                      (1,682)
Non interest income                                      13                         133                           92
Total general and
   administrative expenses                            1,288                       1,393                        1,046
Non interest expenses                                   195                         127                          126

Net loss before equity in
   net income of subsidiary
   and income taxes                                  (3,139)                     (3,019)                      (2,762)
Equity in net income
   of subsidiary                                      5,668                       6,716                        4,434
Income taxes                                         (1,688)                      1,145                       (1,048)
Preferred stock dividend                                546                          --                           --

Net income                                          $ 3,671                     $ 2,552                      $ 2,720


<CAPTION>

STATEMENTS OF CASH FLOWS
                                                                               Year ended December 31,
                                                              -----------------------------------------------------
(Dollars in thousands)                                            1997                   1996                  1995
                                                              --------               --------              --------
<S>                                                           <C>                    <C>                   <C>     
Cash flows from operating activities:
Net income                                                    $  4,217               $  2,552              $  2,720
Adjustments to reconcile net income to
  net cash provided by operating activities:
    Equity in undistributed earnings of subsidiaries            (5,668)               (4,426)               (4,434)
    Purchases of loans held for sale                            (6,367)                    --                    --

</TABLE>


                                       45
<PAGE>

<TABLE>
<CAPTION>
                                                                               Year ended December 31,
                                                              -----------------------------------------------------
(Dollars in thousands)                                            1997                   1996                  1995
                                                              --------               --------              --------
<S>                                                            <C>                    <C>                    <C>     
    Net (increase) in trading securities                       (14,011)                    --                    --

    (Increase) decrease in other assets                         (4,227)                  (686)                   38
    Increase in accrued expenses and other liabilities           2,223                    267                   122

Net cash provided by operating activities                      (23,833)                (2,293)               (1,554)

Cash flows from investing activities:
    Net (increase) decrease in loan to Employee Stock
      Ownership Plan                                                --                    (65)                    60
    Net increase in loans                                         (261)                    --                    --
    Net (increase) decrease in equity investments              (19,178)                 2,074                 2,089
    Purchases of available-for-sale securities                 (92,862)              (100,574)              (20,771)
    Proceeds from sale of available-for-sale securities         80,159                 11,103                 5,170
    Proceeds from maturities of and principal payment
      on available-for-sale securities                           1,158                 76,910                14,619
    Net sales (purchases) of premises and equipment                  -                    (37)                  (21)

Net cash (used in) provided by investing activities            (30,984)               (10,589)                1,146

Cash flows from financing activities:
    Net  increase in securities sold under agreements
      to repurchase                                             20,724                 12,831                    --
    Increase in subordinated debt                               23,028                     --                    --
    Increase in common stock and additional paid in capital     16,853                     --                    --
    Dividends paid on common and preferred stock                  (546)                    --                    --

Net cash provided by financing activities                       60,059                 12,831                    --

Net increase (decrease) in cash and cash equivalents             5,242                    (51)                 (408)

Cash and cash equivalents at beginning of period                   159                    210                   618

Cash and cash equivalents at end of period                    $  5,401              $     159              $    210

</TABLE>

TeleBanc  Financial  Corporation  commenced  activities on January 27, 1994, the
effective date of its formation as a holding  company of the Bank. The Bank paid
dividends of $992,000 and $2.2  million to TeleBanc  for  subordinated  interest
expense payments for the years ended December 31, 1997 and 1996, respectively.

22. SELECTED QUARTERLY FINANCIAL DATA (unaudited)

Condensed  quarterly  financial  data for the years ended  December 31, 1997 and
1996 is shown as follows:

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------------------
                                                                      Three months ended
                                                   Mar. 31,        June 30,      Sept. 30,        Dec. 31,
(Dollars in thousands except per share data)           1997           1997          1997              1997
-----------------------------------------------------------------------------------------------------------------------------
<S>                                                 <C>             <C>           <C>               <C>    
Interest income                                     $12,837         $15,275       $14,821           $16,368
Interest expense                                      9,878          11,865        11,548            12,772

</TABLE>


                                       46
<PAGE>

<TABLE>
<CAPTION>

<S>                                                   <C>             <C>           <C>               <C>  
     Net interest income                              2,959           3,410         3,273             3,596
Provision for loan and lease losses                     243             308           120               250
Non-interest income                                     607           1,244         1,084             1,158
General and administrative expenses                   1,897           2,251         2,078             2,816
Other non-interest operating expenses                   208             202           260               430
     Income before income taxes
           and minority interest                      1,218           1,893         1,899             1,258
Income tax expense                                      355             618           709              (25)
Minority interest in subsidiary                           -              67           285                42
Net income                                              863           1,208           905             1,241
Preferred stock dividends                                60             162           162               162
     Net income after preferred stock dividends     $   803         $ 1,046       $   743           $ 1,079
Basic earnings per share                            $ 0.38          $  0.48       $  0.33           $  0.48
Diluted earnings per share                          $  0.35         $  0.44       $  0.30           $  0.40

-----------------------------------------------------------------------------------------------------------------------------
                                                                   Three months ended
                                                  Mar. 31,            June 30,     Sept. 30,         Dec. 31,
(Dollars in thousands except per share data)           1996               1996             1996       1996
-----------------------------------------------------------------------------------------------------------------------------
<S>                                                 <C>             <C>           <C>               <C>    
Interest income                                     $11,131         $11,364       $11,871           $11,433
Interest expense                                      8,357           8,449         9,034             8,975
     Net interest income                              2,774           2,915         2,837             2,458
Provision for loan and lease losses                     419             200           125               175
Non-interest income                                     605             291           540             1,320
General and administrative expenses                   1,679           1,749         3,287             1,660
Other non-interest operating expenses                   300              81           247                71
     Income before income taxes                         981           1,176          (282)             1,872
Income tax expense                                      332             417          (220)               667
     Net income                                     $   649         $   759       $   (62)          $  1,205
Basic earnings per share                            $  0.32         $  0.37       $ (0.03)          $   0.59
Diluted earnings per share                          $  0.31         $  0.36       $ (0.03)          $   0.52

</TABLE>