<PAGE>
 
                      SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
                                        
                                  FORM 10-KSB
                                        
(Mark One)

[X]  ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
     1934
For the fiscal year ended June 30, 1997
                                 OR
     TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
     OF 1934

[_]  For the transition period from _____________________ to ________________

                          Commission File No. 0-20899
                                   __________

                        FIRST LANCASTER BANCSHARES, INC.
                        --------------------------------
                (Name of small business issuer  in its charter)

         Delaware                                     61-1297318
-------------------------------         -------------------------------------
(State or other jurisdiction of          (I.R.S. Employer Identification No.)
 incorporation or organization)

     208 Lexington Street, Lancaster, Kentucky                40444-1131
     -----------------------------------------                ----------
     (Address of principal executive offices)                 (Zip Code)

       Registrant's telephone number, including area code: (606) 792-3368

       Securities registered pursuant to Section 12(b) of the Act:  None.

 Securities registered pursuant to Section 12(g) of the Act:
                                        Common Stock, par value $0.01 per share
                                        ---------------------------------------
                                                     (Title of Class)

Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports) and (2) has been
subject to such filing requirements for the past 90 days.  Yes  X   No  __
                                                               ---        

Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B is contained herein, and will not be contained, to the best of
registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB.  [X]

Issuer's revenues for the fiscal year ended June 30, 1997:  $3,238,399

As of September 24, 1997, the aggregate market value of the 821,619 shares of
Common Stock of the registrant issued and outstanding held by non-affiliates on
such date was approximately $13.2 million based on the average bid and asked
price of $16-1/8 per share of the registrant's Common Stock on September 24,
1997.  For purposes of this calculation, it is assumed that directors, officers
and beneficial owners of more than 5% of the registrant's outstanding voting
stock are affiliates.

Number of shares of Common Stock outstanding as of September 24, 1997:   958,812

Transitional Small Business Disclosure Format   Yes ________  No   X
                                                                 -----

                                       1
<PAGE>
 
                      DOCUMENTS INCORPORATED BY REFERENCE

The following lists the documents incorporated by reference and the Part of this
Form 10-KSB into which the document is incorporated:

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

        2.  Portions of Proxy Statement for 1997 Annual Meeting of Stockholders
            (Part III)

                                       2
<PAGE>
 
                                     PART I
                                        
ITEM 1.  DESCRIPTION OF BUSINESS
--------------------------------

GENERAL

  FIRST LANCASTER BANCSHARES, INC.  First Lancaster Bancshares, Inc. (the
"Company"), a Delaware corporation, was organized at the direction of the Board
of Directors of First Lancaster Federal Savings Bank, Lancaster, Kentucky (the
"Bank"), in February 1996 to acquire all of the capital stock to be issued by
the Bank in its conversion from mutual to stock form (the "Conversion").  The
Conversion was completed June 28, 1996.  Prior to the Conversion, the Company
did not engage in any material operations.  The Company does not have any
significant assets other than the outstanding capital stock of the Bank, a
portion of the net proceeds of the Conversion and a note receivable from the
ESOP.  The Company's principal business is  the business of the Bank.

  FIRST LANCASTER FEDERAL SAVINGS BANK.  The Bank is a federal savings bank
serving Garrard, Jessamine and Fayette Counties, Kentucky and which operates a
full-service office in Lancaster, Kentucky and a loan production office in
Nicholasville, Kentucky.  The Bank was chartered by the Commonwealth of Kentucky
in 1873 under the name Lancaster Building and Loan Association.  The Bank
adopted a federal charter and received federal insurance of its deposit accounts
in 1966, at which time it adopted the name First Lancaster Federal Savings and
Loan Association.  In 1988 the Bank converted from a federally chartered mutual
savings and loan association to a federally chartered mutual savings bank and
adopted its present name.

  The principal business of the Bank consists of attracting deposits from the
general public and investing these deposits in loans secured by first mortgages
on single-family residences in the Bank's market area.  The Bank derives its
income principally from interest earned on loans and, to a lesser extent,
interest earned on mortgage-backed securities and investment securities and
noninterest income.  Funds for these activities are provided principally by
operating revenues, deposits and repayments of outstanding loans and investment
securities and mortgage-backed securities.

  As a federally chartered savings institution, the Bank is subject to extensive
regulation by the Office of Thrift Supervision (the "OTS").  The lending
activities and other investments of the Bank must comply with various federal
regulatory requirements, and the OTS periodically examines the Bank for
compliance with various regulatory requirements.  The Federal Deposit Insurance
Corporation ("FDIC") also has the authority to conduct special examinations.
The Bank must file reports with OTS describing its activities and financial
condition and is also subject to certain reserve requirements promulgated by the
Board of Governors of the Federal Reserve System ("Federal Reserve Board").  For
additional information, see " -- Regulation."

  The Company's and the Bank's executive offices are located at 208 Lexington
Street, Lancaster, Kentucky 40444-1131, and their telephone number is (606) 792-
3368.

RECENT DEVELOPMENTS

  The United States Congress currently is considering legislation that would, if
enacted, require all federal savings institutions (such as the Bank) to convert
to a national bank or a state bank or savings bank charter.  In addition, the
proposed legislation would cause the Company to be regulated not as a savings
and loan holding company, but rather as a bank holding company or a "financial
services" holding company (a new regulatory classification created by the
legislation).  If the pending legislation were to be adopted in its current
form, it would eliminate certain advantages now enjoyed by federal savings
institutions, such as unrestricted interstate branching and the absence of
restrictions on the business activities of unitary savings and loan holding
companies.  As consideration of the proposed legislation is in its early stages,
the Company cannot predict whether or in what form the legislation will be
enacted.

                                       3
<PAGE>
 
LENDING ACTIVITIES

  GENERAL.  The Bank's loan portfolio totaled $38.3 million at June 30,1997,
representing 89.4% of total assets at that date.  It is the Bank's policy to
concentrate its lending within its market area.  At June 30, 1997, $31.0
million, or 73.4% of the Bank's gross loan portfolio, consisted of single-
family, residential mortgage loans.  Other loans secured by real estate include
multi-family residential mortgage loans and residential construction loans,
which amounted to $7.6 million, or 18.0% of the Bank's gross loan portfolio at
June 30, 1997.  To a lesser extent, the Bank originates consumer loans, which
consist of non-residential loans and loans  secured by deposits.  At June 30,
1997, consumer loans totaled $3.6 million, or 8.6% of the Bank's gross loan
portfolio.

  LOAN PORTFOLIO COMPOSITION.  The following table sets forth selected data
relating to the composition of the Bank's loan portfolio by type of loan at the
dates indicated.  At June 30, 1997, the Bank had no concentrations of loans
exceeding 10% of gross loans other than as disclosed below.

<TABLE>
<CAPTION>
                                                                                 June 30,
                                                    ---------------------------------------------------------------
                                                                  1997                              1996
                                                    -----------------------------      ----------------------------
<S>                                                   <C>            <C>                 <C>           <C>
                                                                         (Dollars in thousands)
                                                         Amount           %                 Amount          %
                                                      -------------  ------------        ------------  ------------
Real estate loans:
Single-family residential...........................        $30,996          73.4%            $27,709          86.6%
Multi-family residential and commercial.............            997           2.3                 579           1.8
Construction........................................          6,632          15.7               2,135           6.7
Nonresidential (1)..................................          3,335           7.9               1,222           3.8
                                                            -------         -----             -------         -----
 
Total real estate loans.............................         41,980          99.3              31,645          98.9
 
Consumer Loans                                                  276           0.7                 344           1.1
                                                            -------         -----             -------         -----
                                                             42,256         100.0%             31,989         100.0%
                                                                            -----                             -----
Less:
Loans in process....................................          3,828                               462
Unearned loan origination fees......................             19                                42
Allowance for loan losses...........................            125                               100
                                                            -------                           -------
 
Total...............................................        $38,284                           $31,385
                                                            =======                           =======
</TABLE>

(1) Consists of loans secured by first liens on residential lots and loans
    secured by first mortgages on  commercial real property.

          LOAN MATURITY SCHEDULE.  The following table sets forth certain
information at June 30, 1997 regarding the dollar amount of loans maturing in
the Bank's portfolio based on their contractual terms to maturity, including
scheduled repayments of principal. Demand loans, loans having no stated schedule
of repayments and no stated maturity, and overdrafts are reported as due in one
year or less.  The table does not include any estimate of prepayments which
significantly shorten the average life of all mortgage loans and may cause the
Bank's repayment experience to differ from that shown below.

                                       4
<PAGE>
 
<TABLE>
<CAPTION>
                                     Due during the          Due after 1 through          Due after 5
                                     year ended June            5 years after          years after June
                                        30, 1998                June 30, 1998              30, 1998               Total
                                  -------------------     -----------------------    -------------------     --------------
                                                                        (In thousands)
<S>                                 <C>                     <C>                        <C>                     <C>
Single-family residential.........            $23,641                      $2,755                 $4,600            $30,996
Multi-family residential..........                 --                          25                    972                997
Construction......................              6,209                          --                    423              6,632
Nonresidential....................              3,005                          48                    302              3,355
Consumer..........................                168                         108                     --                276
                                              -------                      ------                 ------            -------
Total.............................            $33,023                      $2,936                 $6,297            $42,256
                                              =======                      ======                 ======            =======
</TABLE>

     The following table sets forth at June 30, 1997, the dollar amount of all
loans which have predetermined interest rates and have floating or adjustable
interest rates.

<TABLE>
<CAPTION>
                                             Predetermined               Floating or
                                                 Rate                  Adjustable Rates
                                           ----------------------------------------------
                                                            (In thousands)
<S>                                          <C>                     <C>
Singe-family residential...................             $ 6,160                   $24,786
Multi-family residential...................                 365                       632
Construction...............................               6,410                       222
Nonresidential.............................               3,113                       242
Consumer...................................                 276                        --
                                                        -------                   -------
Total......................................             $16,324                   $25,932
                                                        =======                   =======
</TABLE>

         Scheduled contractual principal repayments of loans do not reflect the
actual life of such assets.  The average life of loans is substantially less
than their contractual terms because of prepayments.  In addition, due-on-sale
clauses on loans generally give the Bank the right to declare a loan immediately
due and payable in the event, among other things, that the borrower sells the
real property subject to the mortgage and the loan is not repaid.  The average
life of mortgage loans tends to increase when current mortgage loan market rates
are substantially higher than rates on existing mortgage loans and, conversely,
decrease when current mortgage loan market rates are substantially lower than
rates on existing mortgage loans.

         ORIGINATIONS, PURCHASES AND SALES OF LOANS.  The Bank generally has
authority to originate and purchase loans secured by real estate located
throughout the United States.  Consistent with its emphasis on being a
community-oriented financial institution, the Bank concentrates its lending
activities in its market area.

                                       5
<PAGE>
 
         The following table sets forth certain information with respect to the
Bank's loan origination activity for the periods indicated.  The Bank has not
purchased or sold any loans in the periods presented.

<TABLE>
<CAPTION>
                                                                   Year Ended June 30,
                                              ------------------------------------------------------------
                                                          1997                             1996
                                                -------------------------       --------------------------
<S>                                             <C>                             <C>
                                                                      (In thousands)
Loans originated:
 Real estate loans:
 Single-family residential (1)................                    $ 7,539                          $ 6,551
 Construction (2).............................                      7,063                            3,193
 Nonresidential (3)...........................                      1,980                              241
Consumer loans................................                        117                              194
                                                                  -------                          -------
Total loans originated........................                    $16,699                          $10,179
                                                                  =======                          =======
</TABLE>
____________
(1)  Includes home equity loans.
(2)  Loans are for six months and must be converted to permanent loans.
(3)  Includes loans secured by first liens on residential lots.

  The Bank's loan originations are derived from a number of sources, including
referrals by realtors, depositors and borrowers and advertising, as well as
walk-in customers.  The Bank's solicitation programs consist of  advertisements
in local media, in addition to occasional participation in various community
organizations and events.  Real estate loans are originated by the Bank's loan
personnel.  All of the Bank's loan personnel are salaried, and the Bank does
not compensate loan personnel on a commission basis for loans originated.  Loan
applications are accepted at the Bank's office.

  LOAN UNDERWRITING POLICIES.  The Bank's lending activities are subject to the
Bank's written, non-discriminatory underwriting standards and to loan
origination procedures prescribed by the Bank's Board of Directors and its
management.  Detailed loan applications are obtained to determine the borrower's
ability to repay, and the more significant items on these applications are
verified through the use of credit reports, financial statements and
confirmations.  All loans must be reviewed by the Bank's loan committee, which
is comprised of President Stump and Directors David W. Gay and Jack C. Zanone
and two Loan personnel.  In addition, the full Board of Directors reviews and
approves all loans on a monthly basis.

  Applications for single-family real estate loans are underwritten and closed
in accordance with the standards of the Federal Home Loan Mortgage Corporation
("FHLMC") and Federal National  Mortgage Association ("FNMA") except that,
consistent with banking practice  in Kentucky, title opinions rather than title
insurance are obtained.  Generally, upon receipt of a loan application from a
prospective borrower, a credit report and verifications are ordered to confirm
specific information relating to the loan applicant's employment, income and
credit standing.  If a proposed loan is to be secured by a mortgage on real
estate, an appraisal of the real estate is usually undertaken by an appraiser
approved by the Bank's Board of Directors and licensed or certified (as
necessary) by the Commonwealth of Kentucky.  In the case of single-family
residential mortgage loans, except when the Bank becomes aware of a particular
risk of environmental contamination, the Bank generally does not obtain a formal
environmental report on the real estate at the time a loan is made.  A formal
environmental report may be required in connection with nonresidential real
estate loans.

  It is the Bank's policy to record a lien on the real estate securing a loan
and to obtain a title opinion from Kentucky counsel which provides that the
property is free of prior encumbrances and other possible title defects.
Borrowers must also obtain hazard insurance policies prior to closing and, when
the property is in a flood plain as designated by the Department of Housing and
Urban Development, pay flood insurance policy premiums.

                                       6
<PAGE>
 
  The Bank is permitted to lend up to 100% of the appraised value of the real
property securing a mortgage loan.  The Bank is required by federal regulations
to obtain private mortgage insurance on that portion of the principal amount of
any loan that is greater than 90% of the appraised value of the property.  The
Bank will make a single-family residential mortgage loan for owner-occupied
property with a loan-to-value ratio of up to 89.9% on such loans.  For
residential properties that are not owner-occupied, the Bank generally does not
lend more than 80% of the appraised value.   For construction loans, the Bank
limits the loan-to-value ratio to 85%.  The Bank generally limits the loan-to-
value ratio on multi-family residential or commercial real estate mortgage loans
to 80%.  The federal banking agencies, including the OTS, have adopted
regulations that would establish new loan-to-value ratio requirements for
specific categories of real estate loans.  See "Regulation -- Regulation of the
Bank -- Uniform Lending Standards."

  Under applicable law, with certain limited exceptions, loans and extensions of
credit by a savings institution to a person outstanding at one time shall not
exceed 10% of the institution's unimpaired capital and surplus.  Under this
general law, the Bank's loans to one borrower were limited to $1.3 million at
June 30, 1997.  Loans and extensions of credit fully secured by readily
marketable collateral may comprise an additional 10% of unimpaired capital and
surplus.  Applicable law additionally authorizes savings institutions to make
loans to one borrower, for any purpose, in an amount not to exceed $500,000 or
in an amount not to exceed the lesser of $30,000,000 or 30% of unimpaired
capital and surplus to develop residential housing, provided: (i) the purchase
price of each single-family dwelling in the development does not exceed
$500,000; (ii) the savings institution is and continues to be in compliance with
its fully phased-in regulatory capital requirements; (iii) the loans comply with
applicable loan-to-value requirements; (iv) the aggregate amount of loans made
under this authority does not exceed 150% of unimpaired capital and surplus; and
(v) the Director of OTS, by order, permits the savings institution to avail
itself of this higher limit.  Under these limits, the Bank's loans to one
borrower to develop residential housing were limited to $4.0 million at June 30,
1997.  At that date, the Bank had no lending relationships in excess of the
loans-to-one-borrower limit.  At June 30, 1997, the Bank's largest lending
relationship was a $1.5 million loan to develop property for single-family
residences.  The loan was current and performing in accordance with its terms at
June 30, 1997.

  Interest rates charged by the Bank on loans are affected principally by
competitive factors, the demand for such loans and the supply of funds available
for lending purposes.  These factors are, in turn, affected by general economic
conditions, monetary policies of the federal government, including the Federal
Reserve Board, legislative tax policies and government budgetary matters.

  SINGLE-FAMILY RESIDENTIAL REAL ESTATE LENDING.  The Bank historically has been
and continues to be an originator of single-family, residential real estate
loans in its market area.  At June 30, 1997, single-family residential mortgage
loans, totaled approximately $31.0 million, or 73.4% of the Bank's gross loan
portfolio.  Of such loans, $11.5 million were secured by nonowner-occupied
investment properties consisting of single-family and duplex residential
properties.  All loans originated by the Bank are maintained in its portfolio
rather than sold in the secondary market.

  The Bank primarily originates residential mortgage loans with adjustable rates
("ARM's").  As of June 30, 1997, 61.4% of single-family mortgage loans in the
Bank's loan portfolio carried adjustable rates.  Such loans are primarily for
terms of 30 years, although the Bank does occasionally originate ARM's for 20
year and 25 year terms, in each case amortized on a monthly basis with principal
and interest due each month.  The interest rates on these mortgages are adjusted
once a year, with a maximum adjustment of 2% per adjustment period and a maximum
aggregate adjustment of 5% over the life of the loan.   Further, the interest
rates on such loans may not be decreased by more than 1% below the interest rate
at which the loan was originated.  Rate adjustments on the Bank's adjustable-
rate loans are indexed to a rate which adjusts annually based upon changes in an
index based on the weekly average yield on U.S. Treasury securities adjusted to
a constant comparable maturity of one year, as made available by the Federal
Reserve Board, and the adjusted interest rate is equal to such Treasury rate
plus 2.75%.  The adjustable-rate mortgage loans offered by the Bank do not
provide for initial rates of interest below the rates that would prevail when
the index used for repricing is applied.

                                       7
<PAGE>
 
  The retention of adjustable-rate loans in the Bank's portfolio helps reduce
the Bank's exposure to increases in prevailing market interest  rates.  However,
there are unquantifiable credit risks resulting from potential increases in
costs to borrowers in the event of upward repricing of adjustable-rate loans.
It is possible that during periods of rising interest rates, the risk of default
on adjustable-rate loans may increase  due to increases in interest costs to
borrowers.  Further, although adjustable-rate loans allow the Bank to increase
the sensitivity of its interest-earning assets to changes in interest rates,
the extent of this interest sensitivity is limited by the initial fixed-rate
period before the first adjustment and the lifetime interest rate adjustment
limitations.  Accordingly, there can be no assurance that yields on the Bank's
adjustable-rate loans will fully adjust to compensate for increases in the
Bank's cost of funds.  Finally, adjustable-rate loans increase the Bank's
exposure to decreases in prevailing market interest rates, although decreases
in the Bank's cost of funds and the limitations on decreases in the ARM's
interest rate tend to offset this effect.

  The Bank also originates, to a limited extent, fixed-rate loans for terms of
15 years and 20 years.  In each case, such loans are secured by first mortgages
on single-family, owner-occupied residential real property located in the Bank's
market area.  Because of the Bank's policy to mitigate its exposure to interest
rate risk through the use of adjustable-rate rather than fixed-rate products,
the Bank does not emphasize fixed-rate mortgage loans.  At June 30, 1997, $16.3
million, or 38.6%, of the Bank's loan portfolio consisted of fixed-rate mortgage
loans.  To further reduce its  interest rate risk associated with such loans,
the Bank relies upon Federal Home Loan Bank ("FHLB") advances with similar
maturities to fund such loans.  See "-- Deposit  Activity and Other Sources of
Funds -- Borrowings."

  The Bank engages in construction lending involving loans to individuals for
construction of one- to four-family residential housing located within the
Bank's market area, with such loans converting to permanent financing upon
completion of construction.   Such loans are generally made to individuals for
construction primarily in established subdivisions within Garrard, Jessamine and
Fayette Counties, Kentucky.  At June 30, 1997, the Bank's loan portfolio
included $6.6 million of loans secured by properties under construction, all of
which were construction/permanent loans structured to become permanent loans
upon the completion of construction and none of which was an interim
construction loan structured to be repaid in full upon completion of
construction and receipt of permanent financing.  The Bank also makes a limited
amount of loans to qualified builders for the construction of one- to four-
family residential housing located in established subdivisions in Garrard,
Jessamine and Fayette Counties, Kentucky.   Because such homes are intended for
resale, such loans are generally not converted to permanent financing at the
Bank.   All construction loans are secured by a  first lien on the property
under construction.  Loan proceeds are disbursed in increments as construction
progresses and as inspections warrant.  Construction/permanent loans may have
adjustable or fixed interest rates and are underwritten in accordance with the
same terms and requirements as the Bank's permanent mortgages, except the loans
generally provide for disbursement in stages during a construction period of up
to six months, during which period the borrower is required to make interest-
only monthly payments.  The permanent loans are typically 30-year ARM's, with
the same terms and conditions otherwise offered by the Bank.  Monthly payments
of principal and interest commence one month from the date the loan is
converted to permanent financing.  Borrowers must satisfy all credit
requirements that would apply to the Bank's permanent mortgage loan financing
prior to receiving construction financing for the subject property and must
execute a Construction Loan Agreement with the Bank.

  Construction financing generally is considered to involve a higher degree of
risk of loss than long-term financing on improved, occupied real estate.  Risk
of loss on a construction loan is dependent largely upon the accuracy of the
initial estimate of the property's value at completion of construction or
development and the estimated cost (including interest) of construction.  During
the construction phase, a number of factors could result in delays and cost
overruns.  If the estimate of construction costs proves to be inaccurate, the
Bank may be required to advance funds beyond the amount originally committed to
permit completion of the development.  If the estimate of value proves to be
inaccurate, the Bank may be confronted, at or prior to the maturity of the loan,
with a project having a value which is insufficient to assure full repayment.
The ability of a developer to sell developed lots or completed dwelling units
will depend on, among other things, demand, pricing, availability of comparable
properties and economic conditions.  The Bank has sought to minimize this risk
by limiting construction lending to qualified borrowers in the Bank's market
area and by requiring the involvement of qualified builders.

                                       8
<PAGE>
 
  MULTI-FAMILY RESIDENTIAL AND COMMERCIAL REAL ESTATE LENDING.  The Bank's
multi-family residential loan portfolio generally consists of both fixed-rate
and ARM loans secured by small (i.e., fewer than sixteen units) apartment
buildings.  Such loans currently range in size from $25,000 to $160,000.  At
June 30, 1997, the Bank had $997,000 of multi-family residential loans and
commercial real estate loans, which amounted to 2.3% of the Bank's gross loan
portfolio at such date.  The Bank's commercial real estate portfolio generally
consists of fixed-rate or adjustable-rate loans secured by first mortgages on
residential lots upon which single-family homes will be constructed or upon a
business's building and real property.  In each case, such property is located
in Garrard, Jessamine and Fayette Counties, Kentucky.  At June 30, 1997, the
Bank had approximately $3.4 million of such loans, which comprised 7.9% of its
loan portfolio.  Multi-family and commercial real estate loans either are
originated on an adjustable-rate basis with terms of up to 15 years or on a
fixed rate for a ten-year term and are underwritten with loan-to-value ratios of
up to 80% of the lesser of the appraised value or the purchase price of the
property.

  Multi-family residential and commercial real estate lending entails
significant additional risks as compared with single-family residential
property lending.  Multi-family residential and commercial real estate loans
typically involve larger loan balances to single borrowers or groups of related
borrowers.  The payment experience on such loans typically is dependent on the
successful operation of the real estate project, retail establishment or
business.  These risks can be significantly impacted by supply and demand
conditions in the market for office, retail and residential space, and, as such,
may be subject to a greater extent to adverse conditions in the economy
generally.  To minimize these risks, the Bank generally limits itself to its
market area or to borrowers with which it has prior experience or who are
otherwise known to the Bank.  It has been the Bank's policy to obtain annual
financial statements of the business of the borrower or the project for which
multi-family residential real estate or commercial real estate loans are made.

  CONSUMER AND OTHER LENDING.  The majority of consumer loans currently in the
Bank's loan portfolio consist of loans secured by savings deposits.  Such
savings account loans are usually made for up to 90% of the depositor's savings
account balance.  The interest rate is normally 1.25% above the rate paid on
such deposit account serving as collateral, and the account must be pledged as
collateral to secure the loan.  Interest generally is billed on a semi-annual
basis.  At June 30, 1997, loans on deposit accounts totaled $243,000, or 0.6% of
the Bank's gross loan portfolio.  The remaining $33,000 in consumer loans
includes loans secured by automobiles.

  LOAN FEES AND SERVICING.  The Bank receives fees in connection with late
payments and for miscellaneous services related to its loans.  The Bank also
charges a fee on loan originations ranging from 0.5% to 1.0% of the principal
balance.  The Bank does not service loans for others.

  NONPERFORMING LOANS AND OTHER PROBLEM ASSETS.  It is management's policy to
continually monitor its loan portfolio to anticipate and address potential and
actual delinquencies.  When a borrower fails to make a payment on a loan, the
Bank takes immediate steps to have the delinquency cured and the loan restored
to a current status.  Loans which are delinquent 45 days incur a late fee of
5.0% of principal and interest due.  As a matter of policy, the Bank will
contact the borrower after the loan has been delinquent 30 days.  If payment is
not promptly received, the borrower is contracted again, and efforts are made to
formulate an affirmative plan to cure the delinquency.  Generally, after any
loan is delinquent 90 days or more, formal legal proceedings are commenced to
collect amounts owed.  Loans placed on nonaccrual status if the loan becomes
past due more than 90 days unless such loans are well-secured and in the process
of collection.  Loans are charged off when management concludes that they are
uncollectible.  See Note 1 of Notes to Consolidated Financial Statements.

  Real estate acquired by the Bank as a result of foreclosure is classified as
real estate acquired through foreclosure until such time as it is sold.  When
such property is acquired, it is initially recorded at estimated fair value and
subsequently at the lower of book value or fair value, less estimated costs to
sell.  Costs relating to holding such real estate are charged against income in
the current period, while costs relating to improving such real estate are
capitalized until a salable condition is reached.  Any required write-down of
the loan to its fair value less estimated selling costs upon foreclosure is
charged against the allowance for loan losses.  See Note 1 of Notes to
Consolidated Financial Statements.

                                       9
<PAGE>
  The following table sets forth information with respect to the Bank's
nonperforming assets at the dates indicated.  Further, no loans were recorded as
restructured loans within the meaning of Statement of Financial Accounting
Standards ("SFAS") No. 15 at the dates indicated.

<TABLE>
<CAPTION>
                                                                          At June 30,
                                                  --------------------------------------------------------
                                                             1997                           1996
                                                    -----------------------       -------------------------
<S>                                                 <C>                           <C>
                                                                    (Dollars in thousands)
Loans accounted for on a non-accrual basis: (1)
 Real estate:
  Residential.....................................                   $ 808                           $ 231
      Non-residential.............................                      20                              --
Accruing loans which are contractually past due
  90 days or as to which repayment is in doubt....                      --                              76
                                                                     -----                           -----
  Total nonperforming loans.......................                   $ 828                           $ 307
                                                                     =====                           =====
 
Percentage of real estate loans...................                    1.97%                           0.97%
Other non-performing assets (2)...................                   $  --                           $ 169
                                                                     =====                           =====
</TABLE>
________________
(1) Loans, including impaired loans, are generally classified as nonaccrual if
    they are past due as to maturity or payment of principal or interest for a
    period of more than 90 days, unless such loans are well-secured and in the
    process of collection.  Loans that are on a current payment status or past
    due less than 90 days may also be classified as nonaccrual if repayment in
    full of principal and/or interest is in doubt.
(2) Other nonperforming assets represent property acquired by the Bank through
    foreclosure or repossession.  This property is carried at fair market value.

          For the year ended June 30, 1997, gross interest accrued but not
recognized of $16,000, would have been recorded on loans accounted for on a
nonaccrual basis if the loans had been current.

          At June 30, 1997, nonaccrual loans consisted of sixteen single-family
residential real estate loans and one equipment loan totaling $828,000 and
represented an increase of $597,000, or 258.4% from nonaccrual loans of $231,000
at June 30, 1996.  At June 30, 1997, no other non-performing assets were held by
the bank.

          Federal regulations require savings institutions to classify their
assets on the basis of quality on a regular basis.  An asset meeting one of the
classification definitions set forth below may be classified and still be a
performing loan.  An asset is classified as substandard if it is determined to
be inadequately protected by the current retained earnings and paying capacity
of the obligor or of the collateral pledged, if any.  An asset is classified as
doubtful if full collection is highly questionable or improbable.  An asset is
classified as loss if it is considered uncollectible, even if a partial recovery
could be expected in the future.  The regulations also provide for a special
mention designation, described as assets which do not currently expose a savings
institution to a sufficient degree of risk to warrant classification but do
possess credit deficiencies or potential weaknesses deserving management's close
attention.  Such assets designated as special mention may include nonperforming
loans consistent with the above definition.  Assets classified as substandard or
doubtful require a savings institution to establish general allowances for loan
losses.  If an asset or portion thereof is classified loss, a savings
institution must either establish a specific allowance for loss in the amount of
the portion of the asset classified loss, or charge off such amount.  Federal
examiners may disagree with a savings institution's classifications.  If a
savings institution does not agree with an examiner's classification of an
asset, it may appeal this determination to the OTS Regional Director. The Bank
regularly reviews its assets to determine whether any assets require
classification or re-classification.  At June 30, 1997, the Bank had $955,000 in
assets classified as special mention, $705,000 in assets classified as
substandard, no assets classified as doubtful and no assets classified as loss.
Special mention assets consist primarily of residential real estate loans
secured by first mortgages. This

                                       10
<PAGE>
 
classification is primarily used by management as a "watch list" to monitor
loans that exhibit any potential deviation in performance from the contractual
terms of the loan. Substandard assets are also primarily residential real estate
loans, the highest balance to a single borrower, of which was $239,000 at June
30, 1997 secured by a single-family residence.

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

          Management will continue to actively monitor the Bank's asset quality
and allowance for loan losses.  Management will charge off loans and properties
acquired in settlement of loans against the allowances for losses on such
loans and such properties when appropriate and will provide specific loss
allowances when necessary.  Although management believes it uses the best
information available to make determinations with respect to the allowances for
loan losses and believes such allowances are adequate, future adjustments may be
necessary if economic conditions differ substantially from the economic
conditions in the assumptions used in making the initial determinations.

          The Bank's methodology for establishing the allowance for loan losses
takes into consideration probable losses that have been identified in connection
with specific assets as well as losses that have not been  identified but can be
expected to occur.  Management conducts regular reviews of the Bank's assets and
evaluates the need to establish allowances on the basis of this review.
Allowances are established by the Board of Directors on a quarterly basis based
on an assessment of risk in the Bank's assets taking into consideration the
composition and quality of the portfolio, delinquency trends, current charge-off
and loss experience, loan concentrations, the state of the real estate market,
regulatory reviews conducted in the regulatory examination process and economic
conditions generally.  Specific reserves will be provided for individual assets,
or portions of assets, when ultimate collection is considered improbable by
management based on the current payment status of the assets and the fair value
of the security.  At the date of foreclosure or other repossession, the bank
would transfer the property to real estate acquired in settlement of loans
initially at estimated fair value and subsequently at the lower of book value or
fair value less estimated selling costs.  Any portion of the outstanding loan
balance in excess of fair value less estimated selling costs would be charged
off against the allowance for loan losses.  If, upon ultimate disposition of the
property, net sales proceeds exceed the net carrying value of the property, a
gain on sale of real estate would be recorded.

          Banking regulatory agencies, including the OTS, have adopted a policy
statement regarding maintenance of an adequate allowance for loan and lease
losses and an effective loan review system.  This policy includes an arithmetic
formula for determining the reasonableness of an institution's allowance for
loan loss estimate compared to the average loss experience of the industry as a
whole.  Examiners will review an institution's allowance for loan losses and
compare it against the sum of:  (i) 50% of the portfolio that is classified
doubtful; (ii) 15% of the portfolio that is classified as substandard; and (iii)
for the portions of the portfolio that have not been classified (including those
loans designated as special mention), estimated credit losses over the upcoming
12 months given the facts and circumstances as the evaluation date.  This amount
is considered neither a "floor" nor a

                                       11
<PAGE>
 
"safe harbor" of the level of allowance for loan losses an institution should
maintain, but examiners will view a shortfall relative to the amount as an
indication that they should review management's policy on allocating these
allowances to determine whether it is reasonable based on all relevant factors.

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

<TABLE>
<CAPTION>
                                                                    Year Ended June 30,
                                                      --------------------------------------------
                                                               1997                     1996
                                                        -------------------       -----------------
<S>                                                     <C>                       <C>
                                                                  (Dollars in thousands)
 
Balance at beginning of period........................               $ 100                   $  70
Loans charged off:
 Real estate mortgage:
   Residential........................................                  14                      11
                                                                     -----                   -----
Total charge-offs.....................................                  14                      11
Recoveries............................................                  --                      --
Net loans charged off.................................                 (14)                    (11)
Provision for loan losses.............................                  39                      41
                                                                     -----                   -----
Balance at end of period..............................               $ 125                   $ 100
                                                                     =====                   =====
Ratio of net charge-offs to average
 loans outstanding during the period..................                0.04%                   0.04%
                                                                     =====                   =====
</TABLE>

        The following table allocates the allowance for loan losses by loan
category at the dates indicated.  The allocation of the allowance to each
category is not necessarily indicative of future losses and does not restrict
the use of the allowance to absorb losses in any category.

<TABLE>
<CAPTION>
                                                                                 At June 30,
                                             ---------------------------------------------------------------------------------
                                                               1997                                       1996
                                             -------------------------------------      --------------------------------------
                                                       Percent of Loans in                         Percent of Loans in
                                                         Each Category to                           Each Category to
                                                  Amount             Total Loans              Amount             Total Loans
                                             ---------------     -----------------      ----------------     -----------------
<S>                                            <C>                 <C>                    <C>                  <C>
                                                                           (Dollars in thousands)
 
Real estate - mortgage:
 Residential.................................           $125                  74.4%                 $100                  88.4%
                                                        ----                                        ----
      Total allowance for loan losses........           $125                                        $100
                                                        ====                                        ====
</TABLE>

INVESTMENT ACTIVITIES

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

     The Bank makes investments in order to maintain the levels of liquid assets
required by regulatory authorities and manage cash flow, diversify its assets,
obtain yield and to satisfy certain requirements for favorable tax treatment.
The investment activities of the Bank consist primarily of investments in
mortgage-backed securities and other investment securities, consisting primarily
of securities issued or guaranteed by the U.S.

                                       12
<PAGE>
 
government or agencies thereof. Typical investments include federally sponsored
agency mortgage pass-through and federally sponsored agency and mortgage-related
securities. Investment and aggregate investment limitations and credit quality
parameters of each class of investment are prescribed in the Bank's investment
policy. The Bank performs analyses of mortgage-related securities prior to
purchase and on an ongoing basis to determine the impact on earnings and market
value under various interest rate and prepayment conditions. Under the Bank's
current investment policy, securities purchases must be approved by the Bank's
President and Executive Vice President, both of whom also serve as directors of
the Bank. The Board of Directors review all securities transactions on a monthly
basis.

     The Bank adopted SFAS No. 115 as of July 1, 1994.  Pursuant to SFAS No.
115, the Bank has classified securities with an aggregate cost of $24,158 and an
approximate market value of $864,000 at June 30, 1997 as available for sale.
Management of the Bank presently does not intend to sell such securities and,
based on the Bank's current liquidity level and the Bank's access to borrowings
through the FHLB of Cincinnati, management currently does not anticipate that
the Bank will be placed in a position of having to sell securities with material
unrealized losses.

     Securities designated as "held to maturity" are those assets which the Bank
has the ability and intent to hold to maturity.  Upon acquisition, securities
are classified as to the Bank's intent, and a sale would only be effected due to
deteriorating investment quality.  The held to maturity investment portfolio is
not used for speculative purposes and  is carried at amortized cost.  In the
event the Bank sells securities from this portfolio for other than credit
quality reasons, all securities within the investment portfolio with matching
characteristics will be reclassified as assets available for sale.  Securities
designated as "available for sale" are those assets which the Bank may not hold
to maturity and thus are carried at market value with unrealized gains or
losses, net of tax effect, recognized in retained earnings.

     MORTGAGE-BACKED AND RELATED SECURITIES.  Mortgage-backed securities
represent a participation interest in a pool of single-family or multi-family
mortgages, the principal and interest payments on which are passed from the
mortgage originators through intermediaries that pool and repackage the
participation interest in the form of securities to investors such as the Bank.
Such intermediaries may include quasi-governmental agencies such as FHLMC, FNMA
and the Government National Mortgage Association ("GNMA"), which guarantee or
insure the payment of principal and interest to investors.  Mortgage-backed
securities generally increase the quality of the Bank's assets by virtue of the
guarantees that back them, are more liquid than individual mortgage loans and
may be used to collateralize borrowings or other obligations of the Bank.

     Mortgage-backed securities typically are issued with stated principal
amounts and the securities are backed by pools of mortgages that  have loans
with interest rates that are within a range and have similar maturities.
The underlying pool of mortgages can be composed of either fixed-rate or
adjustable-rate mortgage loans.  Mortgage-backed securities generally are
referred to as mortgage participation certificates or pass-through
certificates.  As a result, the interest rate risk characteristics of the
underlying pool of mortgages, i.e., fixed-rate or adjustable-rate, as well as
prepayment risk, are passed on to the certificate holder.  The life of a
mortgage-backed pass-through security is equal to the life of the underlying
mortgages.

     The actual maturity of a mortgage-backed security varies, depending on when
the mortgagors prepay or repay the underlying mortgages.  Prepayments of the
underlying mortgages may shorten the life of the investment, thereby
adversely affecting its yield to maturity and the related market value of the
mortgage-backed security.  The yield is based upon the interest income and the
amortization of the premium or accretion of the discount related to the
mortgage-backed security.  Premiums and discounts on mortgage-backed securities
are amortized or accredited over the estimated term of the securities using a
level yield method.  The prepayment assumptions used to determine the
amortization period for premiums and discounts can significantly affect the
yield of the mortgage-backed security, and these assumptions are reviewed
periodically to reflect the actual prepayment.  The actual prepayments of the
underlying mortgages depend on many factors, including the type of mortgage, the
coupon rate, the age of the mortgages, the geographical location of the
underlying real estate collateralizing the mortgages and general levels of
market interest rates.  The difference between the interest rates

                                       13
<PAGE>
 
on the underlying mortgages and the prevailing mortgage interest rates is an
important determinant in the rate of prepayments. During periods of falling
mortgage interest rates, prepayments generally increase, and, conversely, during
periods of rising mortgage interest rates, prepayments generally decrease. If
the coupon rate of the underlying mortgage significantly exceeds the prevailing
market interest rates offered for mortgage loans, refinancing generally
increases and accelerates the prepayment of the underlying mortgages. Prepayment
experience is more difficult to estimate for adjustable-rate mortgage-backed
securities.

     The Bank's mortgage-backed and related securities portfolio consists
primarily of seasoned fixed-rate and adjustable-rate, mortgage-backed and
related securities.  The Bank makes such investments in order to manage cash
flow, diversify assets, obtain yield, to satisfy certain requirements for
favorable tax treatment and to satisfy the qualified thrift lender test.
See "-- Regulation -- Regulation of the Bank -- Qualified Thrift Lender Test."

     The following table sets forth the carrying value of the Bank's investment
securities at the dates indicated.


<TABLE>
<CAPTION>
                                                                       At June 30,
                                                     ---------------------------------------------
                                                             1997                     1996
                                                       -----------------       -------------------
<S>                                                    <C>                     <C>
                                                                 (Dollars in thousands)
Securities available for sale:
  U.S. government and agency securities............               $  864                     $ 527
Securities held to maturity:
  Mortgage-backed securities.......................                  540                       115
                                                                  ------                     -----
Total investment securities........................               $1,404                     $ 642
                                                                  ======                     =====
</TABLE>

The following table sets forth information in the scheduled maturities,
amortized cost, market values and average yields for the Bank's investment
portfolio at June 30, 1997.


<TABLE>
<CAPTION>
                                                                                                      
                                     One Year or Less        One to Five Years       Five to Ten Years    
                               ---------------------------------------------------------------------------
                                  Carrying     Average      Carrying    Average     Carrying    Average  
                                  Value        Yield        Value       Yield       Value       Yield    
                                 ---------  -------------  ----------  ----------  ----------  ---------- 
<S>                              <C>        <C>            <C>         <C>         <C>         <C>       
                                                          (Dollars in thousands)
Securities available
for sale:
  U.S. government and
   agency securities.......       $864      45.8%(1)        $  --       -- %        $ --           %
Securities held to                                                       
 maturity:                                                                
Mortgage-backed securities.       $ --        --                6       9.5%          24        8.3%
                                  ----                      -----                   ----            
Total......................       $864      45.8%           $   6       9.5%        $ 24        8.3%
                                  ====                      =====                   ====                   
</TABLE>


<TABLE>
<CAPTION>
                                         More than                                    Total
                                         Ten Years                             Investment Portfolio                           
                                --------------------------------------------------------------------------
                                  Carrying          Average             Carrying     Market      Average   
                                    Value            Yield                Value      Value        Yield    
                                ------------     --------------        ----------  ----------  ----------- 
<S>                             <C>              <C>                    <C>         <C>         <C>          
                                                     (Dollars in thousands)
Securities available
for sale:
  U.S. government and
   agency securities.......      $ --                %                $  864      $  864        45.8%
Securities held to          
 maturity:                                                                                        
Mortgage-backed securities.       510             7.6%                   540         546         7.7% 
                                 ----                                 ------      ------              
Total......................      $510             7.6%                $1,404      $1,410         7.7%
                                 ====                                 ======      ======
</TABLE>
___________
(1)  Based on historical cost of $24,000.

   The Bank is required to maintain average daily balances of liquid assets
(cash, deposits maintained pursuant to Federal Reserve Board requirements, time
and savings deposits in certain institutions, obligations of state and political
subdivisions thereof, shares in mutual funds with certain restricted investment
policies, highly rated corporate debt, and mortgage loans and mortgage-backed
securities with less than one year to maturity or subject to repurchase within
one year) equal to a monthly average of not less than a specified percentage
(currently 5%) of its net withdrawable savings deposits plus short-term
borrowings.  Monetary penalties may be imposed for failure to meet liquidity
requirements.  The average liquidity ratio of the Bank for the month of June 30,
1997, was 9.27%. See "Item 6. Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Liquidity and Capital Resources."

                                       14
<PAGE>
 
DEPOSIT ACTIVITY AND OTHER SOURCES OF FUNDS

   GENERAL.  Deposits are the primary source of the Bank's funds for lending,
investment activities and general operational purposes.  In addition to
deposits, the Bank derives funds from loan principal and interest repayments,
maturities of investment securities and mortgage-backed securities and interest
payments thereon.  Although loan repayments are a relatively stable source of
funds, deposit inflows and outflows are significantly influenced by general
interest rates and money market conditions.  Borrowings may be used on a short-
term basis to compensate for reductions in the availability of funds, or on a
longer term basis for general operational purposes.  The Bank has access to
borrow from the FHLB of Cincinnati.  See " -- Borrowings".

   DEPOSITS.  The Bank attracts deposits principally from within its market area
by offering competitive rates on its deposit instruments, including money market
accounts, passbook savings accounts, Individual Retirement Accounts, and
certificates of deposit which range in maturity from 91 days to five years.
Deposit terms vary according to the minimum balance required, the length of time
the funds must remain on deposit and the interest rate.  Maturities, terms,
service fees and withdrawal penalties for its deposit accounts are established
by the Bank on a  periodic basis.  The Bank reviews its deposit mix and pricing
on a weekly basis. In determining the characteristics of its deposit accounts,
the Bank considers the rates offered by competing institutions, lending and
liquidity requirements, growth goals and federal regulations.  The Bank does not
accept brokered deposits.

   The Bank attempts to compete for deposits with other institutions in its
market area by offering competitively priced deposit instruments  that are
tailored to the needs of its customers. Additionally, the Bank seeks to meet
customers' needs by providing convenient customer service to the community,
efficient staff and convenient hours of service. Substantially all of the Bank's
depositors are Kentucky residents who reside in the Bank's market area.

  The following table sets forth the average balances and average interest rates
based on daily balances for deposits for the periods indicated.

<TABLE>
<CAPTION>
                                                                    Year Ended June 30,
                                      ----------------------------------------------------------------------------
                                                         1997                                  1996
                                        --------------------------------------  ----------------------------------
                                         Average                                 Average
                                         Deposits         Average Rate           Deposits      Average Rate
                                       ------------      ---------------       ------------   ---------------  
<S>                                     <C>                <C>                 <C>               <C>
                                                                  (Dollars in thousands)
Non-interest bearing demand
 deposits............................. $     3               --  %              $   --               --  %
Savings deposits......................   3,180               3.13                 3,952             3.64
Time deposits.........................  19,023               5.64                21,550             5.95
                                       -------                                  -------
 Total deposits....................... $22,203                                  $25,502
                                       =======                                  =======
</TABLE>


  The following table indicates the amount of the Bank's certificates of deposit
of $100,000 or more by time remaining until maturity as of June 30, 1997.

<TABLE>
<CAPTION>
                                         Certificates of Deposits
                                       -----------------------------
                                              (In thousands)
 
Maturity Period
-------------------------------------
<S>                                    <C>
Three months or less                                  $  721
Over three through six months                            100
Over six through 12 months                               909
Over 12 months                                           932
                                                      ------
Total                                                 $2,662
                                                      ======
</TABLE>

                                       15
<PAGE>
 
      BORROWINGS.  Savings deposits historically have been the source of funds
for the Bank's lending, investments and general activities.  The Bank is
authorized, however, to use advances from the of Cincinnati to supplement its
supply of lendable funds and to deposit withdrawal requirements.  The FHLB of
Cincinnati functions as a central reserve bank providing credit for savings
institutions and certain other member financial institutions.  As a member of
the FHLB System, Bank is required to own stock in the FHLB of Cincinnati and is
authorized to apply for advances.  Advances are pursuant to several different
programs, each of which has its own interest rate and range of maturities.  The
Bank has a Blanket Agreement for advances with the FHLB under which the Bank may
borrow up to 25% of assets (approximately $10.7 million), subject to normal
collateral and underwriting requirements.  Advances from the FHLB of Cincinnati
are secured by the Bank's stock in the FHLB of Cincinnati and first mortgage
loans.

      As of June 30, 1997, the Bank had $5.9 million in advances outstanding.
For further information, see Note 9 of Notes to Consolidated Financial
Statements.  Further asset growth may be funded through additional advances.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources."

SUBSIDIARY ACTIVITIES

      As a federally chartered savings bank, the Bank is permitted to invest an
amount equal to 2% of its assets in subsidiaries, with an additional investment
of 1% of assets where such investment serves primarily community, inner-city and
community development purposes.  Under such limitations, as of June 30, 1997,
the Bank was authorized to invest up to approximately $1.3 million in the stock
of or loans to subsidiaries, including the additional 1% investment for
community inner-city and community development purposes.  Institutions meeting
their applicable minimum regulatory capital requirements may invest up to 50% of
their regulatory capital in conforming first mortgage loans to subsidiaries in
which they own 10% or more of the capital stock.

      The Bank has one subsidiary service corporation, First Lancaster
Corporation, which it formed in 1978 to hold stock in Intrieve, Inc., a data
processing service.

MARKET AREA

      The Bank's market area for gathering deposits and making loans consists of
Garrard, Fayette and Jessamine Counties, Kentucky, which are located around
Lexington, Kentucky.  The economy in the Bank's market area is based upon a
variety of manufacturing and service industries within a one-hour drive from its
office in Lancaster Kentucky rather than a single large employer or a single
industry.  Such industries include an automobile and truck manufacturer, a
computer printer manufacturer, an electrical equipment manufacturer, a printing
company and a heating and air conditioning equipment manufacturer.  Other
significant employers include the Garrard County school system and the Christian
Appalachian Project, a nonprofit organization with over 300 employees.

COMPETITION

      The Bank faces strong competition both in originating real estate and
consumer loans and in attracting deposits.  The Bank competes for real estate
and other loans principally on the basis of interest rates, the types of loans
it originates, the deposit products it offers and the quality of services it
provides to borrowers.  The Bank also competes by offering products which are
tailored to the local community.  Its competition in originating real estate
loans comes primarily from other savings institutions, commercial banks and
mortgage bankers making loans secured by real estate located in the Bank's
market area.  Commercial banks, credit unions and finance companies provide
vigorous competition in  consumer lending.  Competition may increase as a result
of the continuing reduction of restrictions on the interstate operations of
financial  institutions.

      The Bank attracts its deposits through its sole office primarily from the
local community. Consequently, competition for deposits is principally from
other savings institutions, commercial banks and brokers in the local

                                       16
<PAGE>
 
community as well as from the corporate credit unions sponsored by the large
private employers in the Bank's market area. The Bank competes for deposits and
loans by offering what it believes to be a variety of deposit accounts at
competitive rates, convenient business hours, a commitment to outstanding
customer service and a well-trained staff. The Bank believes it has developed
strong relationships with local realtors and the community in general.

      Management considers its market area for gathering deposits to be Garrard
and Jessamine Counties in Kentucky.  The Bank estimates that it competes with
two banks for deposits and loans.  Based on data provided by the FHLB, the
Bank estimates that at June 30, 1997, the latest date for which information was
available, it had 18.6% of deposits held by all banks and thrifts in its market
area.

EMPLOYEES

      As of June 30, 1997, the Bank had 9 full-time and 2 part-time employees.

REGULATION OF THE COMPANY

      General.  The Company is a savings and loan holding company as defined by
the Home Owners' Loan Act (the "HOLA") and, as such, is subject to OTS
regulation, supervision and examination.  In addition, the OTS has enforcement
authority over the Company and its non-savings institution subsidiaries and may
restrict or prohibit activities that are determined to represent a serious risk
to the safety, soundness or stability of the Bank or any other subsidiary
savings institution.  As a subsidiary of a savings and loan holding company, the
Bank is subject to certain restrictions in its dealings with the Company and
affiliates thereof.

      ACTIVITIES RESTRICTIONS.  The Board of Directors of the Company presently
operates the Company as a unitary savings and loan holding company.  There are
generally no restrictions on the activities of a unitary savings and loan
holding company, provided that its savings association subsidiary remains in
compliance with the qualified thrift lender test.  See "Regulation of the Bank 
-- Qualified Thrift Lender Test." Legislation currently pending in the United
States Congress would, if enacted, restrict the business activities of unitary
savings and loan holding companies; however, the legislation in its present form
would grandfather the current absence of restriction on business activities for
unitary savings and loan holding companies in existence on the bill's date of
enactment.  Since the Company currently is a unitary savings and loan holding
company, it would qualify for such grandfathered treatment under the current
form of the legislation.

      Upon any non-supervisory acquisition by the Company of another savings
institution that is held as a separate subsidiary, the Company would become a
multiple savings and loan holding company and would be subject to limitations on
the types of business activities in which it could engage.  The HOLA limits the
activities of a multiple savings and loan holding company and its non-insured
institution subsidiaries primarily to activities permissible for bank holding
companies under the Bank Holding Company Act, subject to the prior approval of
the OTS, and to other activities authorized by OTS regulation.

      RESTRICTIONS ON ACQUISITIONS.  Under the HOLA, a savings and loan holding
company is required to obtain the prior approval of the OTS before acquiring
another savings institution or savings and loan holding company.  A savings and
loan holding company may not (i) acquire, with certain exceptions, more than 5%
of a non-subsidiary savings institution or a non-subsidiary savings and loan
holding company; or (ii) acquire or retain control of a depository institution
that is not insured by the FDIC. In addition, while the Bank generally may
acquire a savings institution by merger in any state without restriction by
state law, the Company could acquire control of an additional savings
institution in a state other than Kentucky only if such acquisition is permitted
under the laws of the target institution's home state.

                                       17
<PAGE>
 
REGULATION OF THE BANK

      General.  The Bank is a federally chartered savings institution, is a
member of the FHLB of Cincinnati and its deposits are insured by the FDIC
through the Savings Association Insurance Fund (the "SAIF").  As a federal
savings institution, the Bank is subject to regulation and supervision by the
OTS and the FDIC and to OTS regulations governing such matters as capital
standards, mergers, establishment of branch offices, subsidiary investments and
activities and general investment authority.  The OTS periodically examines the
Bank for compliance with various regulatory requirements and for safe and sound
operations.  The FDIC also has the authority to conduct special examinations of
the Bank because its deposits are insured by the SAIF.  The Bank must file
reports with the OTS describing its activities and financial condition and must
obtain the approval of the OTS prior to entering into certain transactions, such
as mergers with or acquisitions of other depository institutions.

      As a federally insured depository institution, the Bank is subject to
various regulations promulgated by the Federal Reserve Board, including
Regulation B (Equal Credit Opportunity), Regulation D (Reserve Requirements),
Regulations E (Electronic Fund Transfers), Regulation Z (Truth in Lending),
Regulation CC (Availability of Funds and Collection of Checks) and Regulation DD
(Truth in Savings).

      The system of regulation and supervision applicable to the Bank
establishes a comprehensive framework for the operations of the Bank and is
intended primarily for the protection of the depositors of the Bank.  Changes in
the regulatory framework could have a material effect on the Bank and its
operations that in turn, could have a material adverse effect on the Company.

      PROPOSED LEGISLATION.   Legislation currently pending before the United
States Congress would, if enacted, require all federal savings institutions
(such as the Bank) to convert to a national bank or a state bank or savings bank
charter.  In addition, the proposed legislation would cause the Company to be
regulated not as a savings and loan holding company, but rather as a bank
holding company or a "financial services" holding company (a new regulatory
classification created by the legislation).  If the pending legislation were to
be adopted in its current form, it would eliminate certain advantages now
enjoyed by federal savings institutions, such as the authority to establish
branches without geographical restriction.

      As consideration of the proposed legislation is in its early stages, the
Company cannot predict whether or in what form the legislation will be enacted.
However, based upon the provisions of the currently pending legislation, the
management of the Company does not believe that the enactment of such
legislation would have a material adverse effect on its financial condition or
results of operations

      CAPITAL REQUIREMENTS. The OTS has adopted capital adequacy regulations
that require savings institutions such as the Bank to meet three minimum capital
standards: a "core" capital requirement of 3% of adjusted total assets, a
"tangible" capital requirement of 1.5% of adjusted total assets, and a "risk-
based" capital requirement of 8% of  total risk-based capital to total risk-
weighted assets.  In addition, the OTS has adopted regulations imposing certain
restrictions on savings institutions that have a total risk-based capital ratio
of less than 8%, a ratio of Tier 1 capital to risk-weighted assets of less than
4% or a ratio of Tier 1 capital to total assets of less than 4% (or 3% if the
institution is rated Composite 1 under the CAMEL examination rating system).
See "-- Prompt Corrective Regulatory Action."

      The core capital, or "leverage ratio," requirement mandates that a savings
institution maintain core capital equal to at least 3% of its adjusted total
assets.  "Core capital" includes common stockholders' equity (including retained
earnings), noncumulative perpetual preferred stock and related surplus, minority
interests in the equity accounts of fully consolidated subsidiaries and certain
nonwithdrawable accounts and pledged deposits and is generally reduced by the
amount of the savings institution's intangible assets, with limited exceptions
for permissible mortgage servicing rights, purchased credit card relationships
and certain intangible assets arising from prior regulatory accounting
practices.  Core capital is further reduced by the amount of a savings
institution's

                                       18
<PAGE>
 
investments in and loans to subsidiaries engaged in activities not permissible
for national banks. At June 30, 1997, the Bank had no such investments.

      The risk-based capital standards of the OTS require maintenance of core
capital equal to at least 4% of risk-weighted assets and total capital equal to
at least 8% of risk-weighted assets.  For purposes of the risk-based capital
requirement, "total capital" includes core capital plus supplementary capital,
provided that the amount of supplementary capital does not exceed the amount of
core capital.  Supplementary capital includes preferred stock that does not
qualify as core capital, nonwithdrawable accounts and pledged deposits to the
extent not included in core capital, perpetual and mandatory convertible
subordinated debt and maturing capital instruments meeting specified
requirements and a portion of the institution's loan and lease loss allowance.

      The risk-based capital requirement is measured against risk-weighted
assets, which equal the sum of each asset and the credit-equivalent amount of
each off-balance sheet item after being multiplied by an assigned risk weight,
which range from 0% to 100% as assigned by the OTS capital regulations based on
the risks the OTS believes are inherent in the type of asset.  Comparable risk
weights are assigned to off-balance sheet assets.

      The OTS risk-based capital regulation also includes an interest rate risk
("IRR") component that requires savings institutions with greater than normal
IRR, when determining compliance with the risk-based capital requirements, to
maintain additional total capital.  The OTS has, however, indefinitely deferred
enforcement of its IRR requirements.

      The table below provides information with respect to the Bank's compliance
with its regulatory capital requirements at June 30, 1997.

<TABLE>
<CAPTION>
                                                                                    Percent of
                                                            Amount                  Assets (1)
                                                     -------------------     ---------------------
<S>                                                    <C>                     <C>
                                                                 (Dollars in thousands)
Tangible capital                                                 $12,591                      30.0%
Tangible capital requirement                                         635                       1.5
                                                                 -------                      ----
Excess (deficit).....................................            $11,956                      28.5%
                                                                 =======                      ====
 
Core capital (2).....................................            $12,591                      30.0%
Core capital requirement                                           1,269                       3.0
                                                                 -------                     -----
Excess (deficit).....................................            $11,322                      27.0%
                                                                 =======                      ====
 
Risk-based capital...................................            $12,716                      52.0%
Risk-based capital requirement                                     1,977                       8.0
                                                                 -------                      ----
Excess (deficit).....................................            $10,739                      44.0%
                                                                 =======                      ====
</TABLE>
____________
(1)  Based on adjusted total assets for purposes of the tangible capital and
     core capital requirements and risk-weighted assets for purpose of the risk-
     based capital requirement.

(2) Reflects the capital requirement which the Bank must satisfy to avoid
    regulatory restrictions that may be imposed pursuant to prompt corrective
    action regulations.  The core requirement applicable to the Bank may
    increase to 4.0% or 5.0% if the OTS amends its capital regulations, as it
    has proposed, in response to the more stringent leverage ratio adopted by
    the Office of the Comptroller of the Currency for national banks.

     PROMPT CORRECTIVE REGULATORY ACTION.  Under the Federal Deposit Insurance
Corporation Improvement Act of 1991 ("FDICIA"), the federal banking regulators
are required to take prompt corrective action in respect of depository
institutions that do not meet certain minimum capital requirements, including a
leverage limit and a risk-based capital requirement.  All institutions,
regardless of their capital levels, are restricted from making any capital
distribution or paying any management fees that would cause the institution to
become undercapitalized.  As required by FDICIA, banking regulators, including
the OTS, have issued regulations that classify insured

                                       19
<PAGE>
 
depository institutions by capital levels and provide that the applicable agency
will take various prompt corrective actions to resolve the problems of any
institution that fails to satisfy the capital standards.

     Under the joint prompt corrective action regulations, a "well-capitalized"
institution is one that is not subject to any regulatory order or directive to
meet any specific capital level and that has or exceeds the following capital
levels: a total risk-based capital ratio of 10%, a Tier 1 risk-based capital
ratio of 6%, and a ratio of Tier 1 capital to total assets ('leverage ratio") of
5%.  An "adequately capitalized" institution is one that does not qualify as
"well capitalized" but meets or exceeds the following capital requirements: a
total risk-based capital of 8%, a Tier 1 risk-based capital ratio of 4%, and a
leverage ratio of either (i) 4% or (ii) 3% if the institution has the highest
composite examination rating.  An institution not meeting these criteria is
treated as "undercapitalized," "significantly undercapitalized," or "critically
undercapitalized" depending on the extent to which its capital levels are below
these standards.  An institution that fails within any of the three
"undercapitalized" categories will be subject to certain severe regulatory
sanctions required by FDICIA and the implementing regulations.  As of June 30,
1997, the Bank was "well-capitalized" as defined by the regulations.

     SAFETY AND SOUNDNESS STANDARDS.  FDICIA, as amended by the Riegle Community
Development and Regulatory Improvement Act of 1994, requires the OTS, together
with the other federal bank regulatory agencies, to prescribe standards, by
regulation or guideline, relating to internal controls, information systems and
internal audit systems, loan documentation, credit underwriting, interest rate
risk exposure, asset growth, asset quality, earnings, stock valuation, and
compensation, fees and benefits and such other operational and managerial
standards as the agencies deem appropriate.  The OTS and the federal bank
regulatory agencies have adopted a set of guidelines prescribing safety and
soundness standards pursuant to the statute.  The safety and soundness
guidelines establish general standards relating to internal controls and
information systems, internal audit systems, loan documentation, credit
underwriting, interest rate exposure, asset growth, and compensation, fees and
benefits.  In general, the guidelines require, among other things, appropriate
systems and practices to identify and manage the risks and exposures specified
in the guidelines.  The guidelines prohibit excessive compensation as an unsafe
and unsound practice and describe compensation as excessive when the amounts
paid are unreasonable or disproportionate to the services performed by an
executive officer, employee, director or principal stockholder.

     In addition, on July 10, 1995, the OTS and the federal bank regulatory
agencies proposed guidelines for asset quality and earnings standards.  Under
the proposed standards, a savings institution would be required to maintain
systems, commensurate with its size and the nature and scope of its operations,
to identify problem assets and prevent deterioration in those assets as well as
to evaluate and monitor earnings and ensure that earnings are sufficient to
maintain adequate capital and reserves.  Management believes that the asset
quality and earnings standards, in the form proposed by banking agencies, would
not have a material effect on the operations of  the Bank.

     FEDERAL HOME LOAN BANK SYSTEM.  The FHLB System consists of 12 district
FHLBs subject to supervision and regulation by the Federal Housing Finance Board
("FHFB").  The FHLBs provide a central credit facility primarily for member
institutions.  As a member of the FHLB of Cincinnati, the Bank is required to
acquire and hold shares of capital stock in the FHLB of Cincinnati in an amount
at least equal to 1% of the aggregate unpaid principal of its home mortgage
loans, home purchase contracts, and similar obligations at the beginning of each
year, or 1/20 of its advances (borrowings) from the FHLB of Cincinnati,
whichever is greater.  The Bank was in compliance with this requirement with
investment in FHLB of Cincinnati stock at June 30, 1997 of $327,700 The FHLB of
Cincinnati serves as a reserve or central bank for its member institutions
within its assigned district.  It is funded primarily from proceeds derived from
the sale of consolidated obligations of the FHLB System.  It offers advances to
members in accordance with policies and procedures established by the FHFB and
the Board of Directors of the FHLB of Cincinnati.  Long-term advances may only
be made for the purpose of providing funds for residential housing finance.  At
June 30, 1997, the Bank had $900,000 in long-term advances and $5.0 million in
short-term advances outstanding from the FHLB of Cincinnati.

     FEDERAL RESERVE SYSTEM.  Pursuant to regulations of the Federal Reserve
Board, all FDIC-insured depository institutions must maintain average daily
reserves against their transaction accounts.  No reserves are

                                       20
<PAGE>
 
required to be maintained on the first $4.4 million of transaction accounts, and
reserves equal to 3% must be maintained on the next $49.3 million of transaction
accounts, plus 10% on the remainder. These percentages are subject to adjustment
by the Federal Reserve Board. Because required reserves must be maintained in
the form of vault cash or in a noninterest bearing account at a Federal Reserve
Bank, the effect of the reserve requirement is to reduce the amount of the
institution's interest-earning assets. At June 30, 1997, the Bank met its
reserve requirements.

     FEDERAL DEPOSIT INSURANCE.  The Bank is required to pay assessments, based
on a percentage of its insured deposits, to the FDIC for insurance of its
deposits by the SAIF.

     Under the FDIC's risk-based deposit insurance assessment system, the
insurance assessment rate for an insured depository institution depends on the
assessment risk classification assigned to the institution.  Institutions are
assigned by the FDIC to one of three capital groups -- well-capitalized,
adequately capitalized, or undercapitalized -- and, within each capital
category, to one of three supervisory subgroups.

     In order to recapitalize the SAIF and to equalize the deposit insurance
premiums paid by SAIF-insured institutions and institutions with deposits
insured by the Bank Insurance Fund, Congress enacted the Deposit Insurance Funds
Act of 1996 (the "1996 Act"), which authorized the FDIC to impose a one-time
special assessment on all institutions with SAIF-assessable deposits in the
amount necessary to recapitalize the SAIF to the statutorily designated reserve
ratio of 1.25% of insured deposits.  Institutions were assessed at the rate of
65.7 basis points per $100 of each institution's SAIF-assessable deposits as of
March 31, 1995.  The 1996 Act provides the amount of the special assessment will
be deductible for federal income tax purposes for the taxable year in which the
special assessment is paid.  Based on the foregoing, the Bank recorded an
accrual for the special assessment of $153,000 at September 30, 1996.  Net of
related tax effects, this reduced reported earnings by $101,000 for the year
ended June 30, 1997.

     As a result of the recapitalization of the SAIF by the 1996 Act, the FDIC
reduced the insurance assessment rate for SAIF-assessable deposits for periods
beginning on October 1, 1996.  For the first half of 1997, the FDIC set the
effective insurance assessment rates for SAIF-insured institutions, such as the
Bank, at zero to 27 basis points.  In addition, SAIF-insured institutions will
be required, until December 31, 1999, to pay assessments to the FDIC at an
annual rate of between 6.0 and 6.5 basis points to help fund interest payments
on certain bonds issued by the Financing Corporation ("FICO"), an agency of the
federal government established to recapitalize the predecessor to the SAIF.
During this period, BIF member banks will be assessed for payment of the FICO
obligations at one-fifth the annual rate applicable to SAIF member institutions.
After December 31, 1999, BIF and SAIF members will be assessed at the same rate
(currently estimated at approximately 2.4 basis points) to service the FICO
obligations.

     The 1996 Act also provides that the FDIC may not assess regular insurance
assessments for the SAIF unless required to maintain or to achieve the
designated reserve ratio of 1.25%, except for such assessments on those
institutions that are not classified as "well-capitalized" or that have been
found to have "moderately severe" or "unsatisfactory" financial, operational or
compliance weaknesses.  The Bank is classified as "well-capitalized" and has not
been found by the OTS to have such supervisory weaknesses.

     LIQUIDITY REQUIREMENTS.  The Bank is required by OTS regulation to maintain
an average daily balance of liquid assets (cash, certain time deposits, bankers'
acceptances, highly rated corporate debt and commercial paper, securities of
certain mutual funds, and specified United Sates government, state or federal
agency obligations) equal to the monthly average of not less than a specified
percentage (currently 5%) of its net withdrawable savings deposits plus short-
term borrowings.  The average daily liquidity ratio of the Bank for the month
ended June 30, 1997 was 9.27%.  The Bank is also required to maintain average
daily balances of short-term liquid assets at a specified percentage (currently
1%) of the total of its net withdrawable savings accounts  and borrowings
payable in one year or less.  The Bank was in compliance with the 1% requirement
at June 30, 1997.  The OTS has proposed to revise its liquidity regulations to
decrease the burden of compliance with such rules.  Specifically, the OTS
proposal would (1) reduce the liquidity base by excluding withdrawable accounts
payable in

                                       21
<PAGE>
 
more than one year from the definition of "net withdrawable accounts," (2)
reduce the liquidity requirement from 5% of net withdrawable accounts and short-
term borrowings to 4%, (3) remove the 1% short-term liquidity requirement, and
(4) expand the categories of liquid assets that may count toward satisfaction of
the liquidity requirement.

     QUALIFIED THRIFT LENDER TEST.  The HOLA and OTS regulations require all
savings institutions to satisfy one of two Qualified Thrift Lender ("QTL") tests
or suffer a number of sanctions, including restrictions on activities.  To
qualify as a QTL, a savings institution must either (i) be deemed a "domestic
building and loan association" under the Internal Revenue Code (the "Code") by
maintaining at least 60% of its total assets in specified types of assets,
including cash, certain government securities, loans secured by and other assets
related to residential real property, educational loans, and investments in
premises of the institution or (ii) satisfy the HOLA's QTL test by maintaining
at least 65% of "portfolio assets" in certain "Qualified Thrift Investments."
For purposes of the HOLA's QTL test, portfolio assets are defined as total
assets less intangibles, property used by a savings institution in its business
and liquidity investments in an amount not exceeding 20% of assets.  Qualified
Thrift Investments consist of  (a) loans, equity positions or securities related
to domestic, residential real estate or manufactured housing, (b) 50% of the
dollar amount of residential mortgage loans subject to sale under certain
conditions, and (c) loans to small businesses, student loans and credit card
loans.  In addition, subject to a 20% of portfolio assets limit, savings
institutions are able to treat as Qualified Thrift Investments 200% of their
investments in loans to finance "starter homes" and loans for construction,
development or improvement of housing and community service facilities or for
financing small business in "credit needy" areas.

     A savings institution must maintain its status as a QTL on a monthly basis
in at least nine out of every 12 months.  An initial failure to qualify as a QTL
results in a number of sanctions, including the imposition of certain operating
restrictions and a restriction on obtaining additional advances from its Federal
Home Loan Bank.  If a savings institution does not requalify under the QTL test
within the three-year period after it fails the QTL test, it would be required
to terminate any activity not permissible for a national bank and repay as
promptly as possible any outstanding advances from its Federal Home Loan Bank.
In addition, the holding company of such an institution, such as the Company,
would similarly be required to register as a bank holding company with the
Federal Reserve Board.  At June 30, 1997, the Bank qualified as a QTL.

     RESTRICTIONS ON CAPITAL DISTRIBUTIONS.  OTS regulations impose limitations
upon capital distributions by savings institutions, such as cash dividends,
payments to repurchase or otherwise acquire its shares, payments to stockholders
of another institution in a cash-out merger and other distributions charged
against capital.  A savings institution must give notice to the OTS at least 30
days before declaration of a proposed capital distribution to its holding
company, and capital distributions in excess of specified earnings or by certain
institutions are subject to approval by the OTS.  A savings institution that has
capital in excess of all regulatory capital requirements before and after a
proposed capital distribution (a "Tier 1 Association") and that is not otherwise
restricted in making capital distributions, may, after prior notice but without
the approval of the OTS, make capital distributions during a calendar year equal
to the greater of (a) 100% of its net income to date during the calendar year
plus the amount that would reduce by one-half its "surplus capital ratio" (the
excess capital over its fully phased-in capital requirements) at the beginning
of the calendar year, or (b) 75% of its net income for the previous four
quarters.  Any additional capital distributions would require prior OTS
approval.  The Bank is a Tier 1 Association.

     The OTS has issued a proposed rule that would relax the current capital
distributions by savings institutions.  Under the proposed regulations, the
approval of the OTS would be required only for capital distributions by an
institution that is deemed to be in troubled condition or that is
undercapitalized or would be undercapitalized after the capital distribution. An
institution's capital rating would be determined under the prompt corrective
action regulations.  See "-- Prompt Corrective Regulatory Action."

     Under OTS regulations, the Bank may not pay dividends on its capital stock
if its regulatory capital would thereby be reduced below the amount then
required for the liquidation account established for the benefit of certain
depositors of the Bank at the time of the Conversion.  In addition, under the
OTC's prompt corrective action

                                       22
<PAGE>
 
regulations, the Bank would be prohibited from paying dividends if the Bank were
classified as "undercapitalized" under such rules.

     TRANSACTIONS WITH AFFILIATES.  The Bank is subject to restrictions imposed
by Sections 23A and 23B of the Federal Reserve Act on extensions of credit to,
and certain other transactions with, the Company and other affiliates, and on
investments in the stock or other securities thereof.  Such restrictions prevent
the Company and such other affiliates from borrowing from the Bank unless the
loans are secured by specified collateral, and require such transactions to have
terms comparable to terms of arms-length transactions with third persons.
Further, such secured loans and other transactions and investments by the Bank
are generally limited in amount as to the Company and as to any other affiliate
to 10% of the Bank's capital and surplus and as to the Company and all other
affiliates to an aggregate of 20% of the Bank's capital and surplus.  These
restrictions may limit the Company's ability to obtain funds from the Bank for
its cash needs, including funds for acquisitions and for payment of dividends,
interest and operating expenses.

     LOANS TO DIRECTORS, EXECUTIVE OFFICERS AND PRINCIPAL STOCKHOLDERS.  The
Bank's ability to extend credit to its directors, executive officers, and 10%
stockholders, as well as to entities controlled by such persons, is governed by
the requirements of Sections 22(g) and 22(h) of the Federal Reserve Act and
Regulation O of the Federal Reserve Board thereunder. Among other things, these
provisions require that an institution's extensions of credit to insiders (a) be
made on terms that are substantially the same as, and follow credit underwriting
procedures that are not less stringent than, those prevailing for comparable
transactions with unaffiliated persons and that do not involve more than the
normal risk of repayment or present other unfavorable features and (b) not
exceed certain limitations on the amount of credit extended to such persons,
individually and in the aggregate, which limits are based, in part, on the
amount of the institution's capital.  In addition, extensions of credit in
excess of certain limits must be approved by the Bank's Board of Directors.

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

     The Company's principal executive offices are located at 208 Lexington
Street, Lancaster, Kentucky in facilities owned by the Bank.  At June 30, 1997,
the Company maintained a main office in Lancaster, Kentucky (located in Garrard
County) and a loan production office in Nicholasville, Kentucky (located in
Jessamine County).  The Company owns its premises in Lancaster and leases the
premises in Nicholasville.

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

     From time to time, the Company and its subsidiary are parties to various
legal proceedings incident to its business.  At June 30, 1997, there were no
legal proceedings that management anticipates would have a material adverse
effect on the Company

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

     No matters were submitted to a vote of security holders of the Company
through a solicitation of proxies or otherwise during the fourth quarter of the
fiscal year covered by this report.

                                    PART II
                                        
Item 5.  MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
------   --------------------------------------------------------

     The information contained under the section captioned "Market and Dividend
Information" in the Company' 1997 Annual Report to Stockholders (the "Annual
Report") filed as Exhibit 13 hereto is incorporated herein by reference.

                                       23
<PAGE>
 
ITEM 6.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
------   -----------------------------------------------------------------------
         OF OPERATIONS
         -------------

  The information contained in the section captioned "Management's Discussion
and Analysis of Financial Condition and Results of Operations" in the Annual
Report is incorporated herein by reference.

ITEM 7.   FINANCIAL STATEMENTS
------    --------------------

The consolidated financial statements  of the Company in the Annual Report are
incorporated herein by reference.

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

          None.

                                    PART III

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

  For information concerning the Board of Directors of the Company, the
information contained under the section captioned "Proposal I -- Election of
Directors" in the Company's definitive proxy statement for the Company's 1997
Annual Meeting of Stockholders (the "Proxy Statement") is incorporated herein by
reference.

     Information regarding Virginia R.S. Stump and Tony A Merida, the only
executive officers of the Company, is set forth under "Proposal I -- Election of
Directors" in the Proxy Statement.

  Information regarding delinquent Form 3, 4 or 5 filers is incorporated herein
by reference to the section entitled "Section 16(a) Beneficial Ownership
Reporting Compliance" in the Proxy Statement.

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

  The information contained under the section captioned "Proposal I -- Election
of Directors -- Executive Compensation and Other Benefits" in the Proxy
Statement is incorporated herein by reference.

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

     (a)  Security Ownership of Certain Beneficial Owners
 
     Information regarding this item in incorporated by reference to the section
captioned "Security Ownership of Certain Beneficial Owners and Management" in
the Proxy Statement.

     (b)  Security Ownership of Management

  Information required by this item is incorporated herein by reference to the
sections captioned "Security Ownership of Certain Beneficial Owners and
Management" and "Proposal I -- "Election of Directors" in the Proxy Statement.

     (c)  Changes in Control

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

                                       24
<PAGE>
 
Item 12.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
-------   ----------------------------------------------

    The information required by this item is incorporated herein by reference to
the section captioned "Proposal I -- Election of Directors -- Transactions with
Management" in the Proxy Statement.

ITEM 13.  EXHIBITS, LISTS AND REPORTS ON FORM 8-K.
-------   --------------------------------------- 

          (a)(1) The following consolidated financial statements of the Company
included in the Annual Report are incorporated herein by reference from Item 7
of this Report. The remaining information appearing in the Annual Report to
Stockholders is not deemed to be filed as part of this Report, except as
expressly provided herein.

               1.   Report of Independent Auditors.

               2.   Consolidated Statements of Financial Condition as of June
                    30, 1997 and 1996.

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

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

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

               6.   Notes to Consolidated Financial Statements.

 
(a)(2)    Exhibits
          --------
  The following is a list of exhibits filed as part of this Annual Report on
Form 10-KSB and is also the Exhibit Index.

<TABLE>
<CAPTION>
 
    No.       Description
    ---       -----------
 
<C>           <S>
     3.1      Certificate of Incorporation of First Lancaster Bancshares, Inc.*
     3.2      Bylaws of First Lancaster Bancshares, Inc.*
     4        Form of Common Stock Certificate of First Lancaster Bancshares, Inc.*
     10.1     First Lancaster Bancshares, Inc. 1997 Stock Option and Incentive Plan*
     10.2     First Lancaster Federal Savings Bank Management Recognition Plan*
     10.3(a)  Employment Agreement by and between First Lancaster Federal Savings
              Bank and Virginia R. S. Stump**
     10.3(b)  Employment Agreement by and between First Lancaster Bancshares, Inc.
              and Virginia R. S. Stump**
     10.4     First Lancaster Federal Savings Bank Directors' Retirement Plan*
     10.5     First Lancaster Federal Savings Bank Incentive Compensation Plan*
     10.6     Supplemental Executive Retirement Agreements between First Lancaster
              Federal Savings Bank and Virginia R. S. Stump*
     13       1997 Annual Report to Stockholders     
     21       Subsidiaries of the Registrant
     23       Consent of Coopers & Lybrand LLP
     27       Financial Data Schedule (For SEC use only)
</TABLE>

                                       25
<PAGE>
 
____________
*   Incorporated herein by reference to the Company's Registration Statement
    on Form SB-2 (Registration No.  333-2468).
**  Filed herewith and supersedes version previously filed.

  (b)  Reports on Form 8-K.  No Reports on Form 8-K were filed by the Company
       -------------------                                                   
during the last quarter of the fiscal year covered by this report.

                                       26
<PAGE>
 
                                   SIGNATURES

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


                                     FIRST LANCASTER BANCSHARES, INC.


                                     By:   /s/  Virginia R. S. Stump
                                           --------------------------  
September 29, 1997                         Virginia R. S. Stump
                                           Chairman of the Board, President and
                                           Chief Executive Officer
                                           (Duty Authorized Representative)

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


<TABLE>
<CAPTION>
<S>                                      <C>                                                 <C> 

/s/  Virginia R. S. Stump                Chairman of the Board, President and Chief          September 29, 1997
--------------------------------          Executive Officer (Principal Executive,
Virginia R. S. Stump                      Financial and Accounting Officer)
 
 
/s/  Tony A. Merida                       Vice Chairman of the Board and Executive          September 29, 1997 
--------------------------------            Vice President                                              
Tony A. Merida                         
                                       
 
/s/  David W. Gay                         Director                                          September 29, 1997
--------------------------------
David W. Gay
 
 
/s/  Jane G. Simpson                      Director                                            September 29, 1997
-------------------------------
Jane G. Simpson
 
 
/s/  Ronald L. Sutton                     Director                                            September 29, 1997
------------------------------
Ronald L. Sutton
 
 
/s/  Jack C. Zanone                       Director                                            September 29, 1997
------------------------------
Jack C. Zanone

</TABLE> 

                                       27