EXHIBIT 13
<PAGE>


                        [LOGO] Bedford Bancshares, Inc.

                               1998 Annual Report
<PAGE>

BEDFORD BANCSHARES, INC. - 1998 ANNUAL REPORT



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                               Table of Contents

Corporate Profile and Stock Market Information............................... 2

Letter to Stockholders ...................................................... 3

Selected Financial and Other Data............................................ 4

Management's Discussion and Analysis of
  Financial Condition and Results of Operations.............................. 6

Report of Independent Certified Public Accountants...........................14

Consolidated Financial Statements............................................15

Notes to Consolidated Financial Statements...................................30

Office Locations.............................................................53

Glossary of Financial Terms..................................................54


                                                                               1
<PAGE>

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Corporate Profile and Related Information
-----------------------------------------

Bedford  Bancshares,  Inc.  (the  "Company")  is the  parent  company of Bedford
Federal Savings Bank ("Bedford  Federal" or the "Savings Bank"). The Company was
organized  as a  Virginia  corporation  in March  1994 at the  direction  of the
Savings  Bank to acquire all of the capital  stock that Bedford  Federal  issued
upon  its   conversion   from  the  mutual  to  stock  form  of  ownership  (the
"Conversion")  in  connection  with a  $12.6  million  initial  public  offering
completed on August 19, 1994. The Company is a unitary  savings and loan holding
company which, under exisiting laws, generally is not restricted in the types of
business  activities  in which it may engage,  provided  that the  Savings  Bank
retains a specified amount of its assets in housing-related  investments. At the
present  time,  since the  Company  does not conduct  any active  business,  the
Company does not intend to employ any persons other than officers,  but utilizes
the support staff and facilities of the Savings Bank from time to time.

Bedford  Federal,  a  federally-chartered  stock savings bank  headquartered  in
Bedford,  Virginia,  was  originally  chartered in 1935 under the name  "Bedford
Federal  Savings  and Loan  Association."  The  Savings  Bank has  operated as a
federally-chartered stock savings bank since August 19, 1994. Deposits have been
federally  insured since 1935 and are currently insured up to the maximum amount
allowable by the Federal Deposit Insurance Corporation (the "FDIC"). The Savings
Bank is a community oriented savings institution offering a variety of financial
services to meet the needs of the  communities  that it serves.  Bedford Federal
conducts  its  business  from its main  office in  Bedford,  Virginia,  two full
service branch offices located in Bedford County,  Virginia,  and four Automated
Teller Machines ("ATMs").

--------------------------------------------------------------------------------
Stock Market Information
------------------------

The Company's common stock trades on the Nasdaq National Maket under the trading
symbol of "BFSB".  The daily stock  quotation for Bedford  Bancshares,  Inc., is
published  in The Wall Street  Journal and in other local  newspapers  under the
trading symbol of "BFSB" or "Bedford Bc". The following table reflects the stock
price  published  by the  Nasdaq  National  Market  statisical  report and other
related data.

                                                    Dividends       Dividends
Quarter                                             Per Share       Per Share
Ended                 High       Low     Volume      Declared         Paid
December 1995         $9.38     $8.75    186,752     $0.045          $0.075
March 1996            $9.13     $8.38    241,940     $0.045          $0.045
June 1996             $8.88     $7.88    378,812     $0.050          $0.045
September 1996        $8.63     $8.25    171,182     $0.055          $0.050
December 1996         $9.25     $8.32    192,478     $0.060          $0.055
March 1997           $10.00     $8.75    163,568     $0.065          $0.060
June 1997            $12.38     $9.50    319,064     $0.070          $0.065
September 1997       $12.75    $11.75    186,580     $0.070          $0.070
December 1997        $17.50    $11.50    337,000     $0.070          $0.070
March 1998           $17.38    $14.00    365,200     $0.070          $0.070
June 1998            $16.25    $13.88    198,600     $0.080          $0.070
September 1998       $15.75    $10.25    186,300     $0.080          $0.080

On September 30, 1998,  there were  approimately 580 shareholders of record with
approximately  60.6% of the  2,297,900  outstanding  shares  held in  nominee or
"street" name through various  brokerage firms.  There were eight firms making a
market in the Company's common stock during the month of September 1998.

2


<PAGE>
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Letter from the Chief Executive Officer
---------------------------------------

To Our Stockholders:

I am very pleased to report that fiscal 1998 proved to be a most successful year
for Bedford Bancshares. Your company achieved record earnings, experienced solid
asset  growth,  increased  the per share amount of dividends  paid for the third
consecutive  year and distributed a 100% stock dividend in the form of a two for
one stock split.

Net income for the year ended September 30, 1998 amounted to $1,973,000,  up 24%
from the $1,591,000 for fiscal 1997. On a per share basis,  diluted earnings for
fiscal  1998 were  $.85,  up 21.4% from the $.70  earned in 1997.  The return on
average assets was 1.33% for the year ended September 30, 1998 compared to 1.19%
for fiscal 1997.  The returns on average  equity were 9.68% and 8.40% for fiscal
1998 and 1997, respectively.

Early in fiscal 1998, the management of your company began updating its business
plan and  developed a detailed  strategic  plan designed to build on and enhance
the success Bedford  Bancshares had enjoyed in the past. The financial  services
industry had changed dramatically and our role as a traditional thrift had to be
altered to effectively  compete in the future. In addition,  interest rates were
dropping at a rapid pace,  negatively impacting both our net interest margin and
spread.  As a result, we intensified our efforts to incease  noninterest  income
and examined  strategies  that would  expand our  commercial  and consumer  loan
portfolios.  Our efforts were rewarded with a 46% increase in noninterest income
in fiscal 1998 over fiscal 1997,  and a 33% increase in the level of  commercial
and consumer loans from September 30, 1997 to September 30, 1998.

Mortgage lending has always been, and will continue to be, the foundation of our
operations.  At September 30, 1998, mortgage loans,  including  construction and
home equity  loans,  totaled  $118.3  million,  up 11.3% from the level one year
earlier.  This growth  combined with the increase in the  securities  portfolio,
resulted in a 14.1%  increase in assets to $158.7  million at September 30, 1998
from $139.1 million on September 30, 1997. Total deposits were $107.1 million at
September 30, 1998 and stockholders'  equity was $21.2 million.  A more detailed
review of our progress in 1998 is contained in this report.

Although  fiscal 1998 was highly  successful  and provides  good  momentum as we
enter 1999,  we cannot allow  ourselves to grow  complacent.  Our business  plan
calls  for us to build on the  successes  of this  past  year and to  constantly
review our operations for opportunities to enhance  profitability and to control
expenses. We intend to deliver the products and services that will allow Bedford
Federal to serve the needs of our customers better than our  competitors.  By so
doing we expect to continue to provide an attractive return to our shareholders.

While Bedford  Bancshares  must  constantly  compete with larger  banks,  we are
mindful of the role we play as a community oriented financial  institution.  Our
business plan  recognizes  this fact and our  directors,  management,  and staff
recognize this fact. The employees and directors of Bedford  Bancshares devote a
tremendous amount of personal time and talent to many community activities.  And
as a  corporation,  Bedford  Bancshares is keenly aware of the important role it
plays in the quality of life that we all enjoy in our communities.

The continued  loyalty and support of our customers  and  stockholders,  and the
commitment  of our  directors,  management  and  staff are key  reasons  for our
success. On behalf of the Corporation, I thank each one of you.

Sincerely,

/s/Harold K. Neal
-------------------------------------
Harold K. Neal
President and Chief Executive Officer
December 11, 1998



                                                                               3
<PAGE>
<TABLE>
<CAPTION>
SELECTED FINANCIAL AND OTHER DATA
--------------------------------------------------------------------------------------------------------------------
Financial Condition (Dollars in Thousands)
--------------------------------------------------------------------------------------------------------------------
     September 30,                                      1998          1997          1996          1995          1994
--------------------------------------------------------------------------------------------------------------------
<S>                                                <C>           <C>           <C>           <C>           <C>     
     Total assets                                   $158,711      $139,089      $127,201      $115,054      $105,217
     Loans receivable, net                           129,744       116,093       108,873        97,669        89,309
     Investment securities                            14,470         9,655         8,006         7,761         7,651
     Marketable equity securities                      4,396         4,185         3,879         3,660         3,360
     Mortgage-backed securities                           15            20           482            31            37
     Foreclosed real estate, net                           -           212             -             -             -
     Deposits                                        107,086       103,612        95,378        90,063        84,841
     FHLB advances                                    29,000        15,000        12,000         5,000         1,000
     Retained earnings                                10,900         9,763         8,739         8,263         7,519
     Total stockholders' equity                       21,248        19,621        18,227        18,685        18,659
</TABLE>
<TABLE>
<CAPTION>
Summary of Operations (Dollars in Thousands)
--------------------------------------------------------------------------------------------------------------------
     Years Ended September 30,                          1998          1997          1996          1995          1994
--------------------------------------------------------------------------------------------------------------------
<S>                                                <C>           <C>           <C>           <C>           <C>     
     Interest income                                 $11,299       $10,280        $9,264        $8,137        $6,964
     Interest expense                                  5,809         5,167         4,492         3,778         3,478
     Net interest income                               5,490         5,113         4,772         4,359         3,486
     Provision for credit losses                          90           100            22            20            51
     Noninterest income                                  863           593           735           543           554
     Noninterest expense                               3,130         3,041         3,429 (3)     2,620         2,238
     Net income before income taxes and
       cumulative effect of change in
       accounting principle                            3,133         2,565         2,056         2,262         1,751
     Net income                                        1,973         1,591         1,302         1,401         1,445
</TABLE>
<TABLE>
<CAPTION>
Other Selected Data
--------------------------------------------------------------------------------------------------------------------
     Years Ended September 30,                          1998          1997          1996          1995        1994(1)
--------------------------------------------------------------------------------------------------------------------
<S>                                                  <C>           <C>           <C>           <C>           <C>     
     Return on average assets                           1.33 %        1.19 %        1.10 %        1.28 %        1.12 %
     Return on average equity                           9.68          8.40          6.98          7.31         12.89
     Average equity to average assets                  13.72         14.21         15.69         17.49          8.71
     Net interest rate spread                           3.03          3.27          3.34          3.26          3.28
     Nonperforming assets to total assets               0.34          0.52          0.54          1.14          1.07
     Nonperforming loans to total loans                 0.41          0.45          0.63          1.34          1.26
     Allowance for credit losses to total loans         0.59          0.58          0.60          0.63          0.71
</TABLE>
<TABLE>
<CAPTION>
Per Share Data
--------------------------------------------------------------------------------------------------------------------
     Years Ended September 30,                          1998          1997          1996          1995        1994(2)
--------------------------------------------------------------------------------------------------------------------
<S>                                                   <C>           <C>           <C>           <C>           <C>     
     Basic earnings per share                          $0.90         $0.74         $0.59         $0.60         $0.62
     Diluted earnings per share                         0.85          0.70          0.56          0.59          0.62
     Book value per share                               9.25          8.58          7.97          7.75          7.43
     Cash dividends declared per share                  0.30          0.27          0.20          0.15           N/A

</TABLE>

-------------
(1)  Income and  related  ratios  exclude the  cumulative  effect of a change in
     accounting principle of $323,000 in fiscal year 1994.
(2)  Annualized
(3)  Includes a  one-time,  special  assessment  of  approximately  $555,000  to
     recapitalize the "SAIF."

4
<PAGE>

Total Assets [Graphics Omitted - Plotting Points Below]

         Bar graph  showing  Total  Assets in  thousands of dollars for the year
ended  September  30. The  horizontal  axis shows the years 1994 to 1998 and the
vertical  axis shows  amounts  from $0 to $160,000.  Graph values are  $105,217,
$115,054,  $127,201,  $139,039,  $158,711,  for 1994,  1995, 1996, 1997, and
1998, respectively.

Loan Portfolio Composition [Graphics Omitted - Plotting Points Below]

         Pie Chart showing Loan Portfolio  Composition  identifying  the type of
loan and in  percentages At September 30, 1998. 1-4 Family  Residential (69.5%),
Commercial  &  Multi-Family  Real  Estate  (3.8%), Consumer/Commercial  Business
(16.3%), Construction (6.4%), and Land (4.0%).

Deposit Portfolio Composition [Graphics Omitted - Plotting Points Below]

         Pie Chart showing Deposit Portfolio Composition identifying the type of
deposit  and in  percentages  At  September  30,  1998.  Certificates  (66.05%),
Checking (14.89%), Savings (14.58%), Money Market (4.48%).

Net Interest Income [Graphics Omitted - Plotting Points Below]

         Bar graph  showing Net Interest  Income in thousands of dollars for the
year ended  September 30. The  horizontal  axis shows the years 1994 to 1998 and
the  vertical  axis shows  amounts  from $0 to $6,000.  Graph values are $3,486,
$4,359,   $4,772,   $5,113,  $5,490  for  1994,  1995,  1996,  1997,  and  1998,
respectively.

Net Income [Graphics Omitted - Plotting Points Below]

         Bar graph showing Net Income in thousands of dollars for the year ended
September 30. The horizontal  axis shows the years 1994 to 1998 and the vertical
axis shows amounts from $0 to $2,100. Graph values are $1,445,  $1,401,  $1,302,
$1,591, $1,973 for 1994, 1995, 1996, 1997, and 1998, respectively.

Return on Average Assets [Graphics Omitted - Plotting Points Below]

         Bar graph showing Return on Average  Assets stated in  percentages  for
the year ended  September 30. The  horizontal  axis shows the years 1994 to 1998
and the  vertical  axis shows  amounts  from $0.00% to 1.50%.  Graph  values are
1.12%,  1.28%,  1.10%,  1.19%,  1.33%  for 1994,  1995,  1996,  1997,  and 1998,
respectively.

                                                                               5
<PAGE>

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

--------------------------------------------------------------------------------
Management Strategy
-------------------
The  Company's  management  strategy is to maintain a strong  capital
position  through  controlled  growth  and  the  production  of  high
quality,   steadily   increasing   core   earnings.   This  has  been
accomplished   by  the  continued   focus  upon  the  origination  of
traditional one- to four family,  adjustable rate mortgage loans, and
more recently,  the emphasis on expanding the commercial and consumer
loan  portfolios.   This  strategy,  along  with  sound  underwriting
standards  designed  to reduce  the risk of loss in the  Bank's  loan
portfolio,  help to lessen  the  income  impact  caused by  declining
interest rates.

Management   monitors  the  interest  rate   sensitivity  of  Bedford
Federal's  balance  sheet in order to  better  match  the  level  and
duration of interest  earning  assets with the level and  duration of
interest bearing  liabilities.  Changes in the interest rates charged
for loans and the interest  rate paid on deposits  are primary  tools
used to influence  the level and duration of earning  earning  assets
and  interest   bearing   liabilities.   In   addition,   short-  and
intermediate-term  investments, as well as borrowings, can be used to
help  reduce  interest  rate  risk.  the  tables on pages 7, 8, and 9
provide details about the Company's interest rate sensitivity and net
interest income.

In its efforts to manage the interest rates it pays on deposits,  the
Bank  focuses  on  maintaining  a  stable  core  deposit  base  while
providing competitive products and services to its customers. Bedford
Federal relies primarily on customer  deposits and mortgage  payments
as its major  sources  of funds,  but also  borrows  from the FHLB to
supplement  its  funding  needs  and to  help  manage  interest  rate
sensitivity.

--------------------------------------------------------------------------------
General
-------
Net interest income is the primary source of the Company's  earnings.
Net  interest  income is  affected  by the levels of average  earning
assets and average interest bearing  liabilities,  and the respective
interest rates earned and paid. The difference  between average rates
of interest earned on interest  earning assets and average rates paid
on interest  bearing  liabilities  is the "interest rate spread." The
"net interest  margin" relates net interest income to average earning
assets  and serves as an  indication  of the  effectiveness  of funds
allocation.

The Bank also  receives  income from  service  charges and other fees
primarily  related to credit and deposit  services.  Bedford  Federal
incurs expenses in its day-to-day  operations  including salaries and
benefits, deposit insurance,  facilities expense, marketing and other
related business expenses.

--------------------------------------------------------------------------------
Interest Rate Sensitivity Analysis
----------------------------------
The table that  follows  sets forth the amounts of  interest  earning
assets and interest bearing liabilities  outstanding at September 30,
1998,  which are  expected to reprice or mature in each of the future
time periods shown. It is important to note that certain shortcomings
are inherent in the method of analysis  presented  in the table.  For
example,  although  certain assets and  liabilities  may have similar
maturities  or  periods  of  repricing,  they may react in  different
degrees to changes in market interest rates. Also, the interest rates
on certain types of assets and  liabilities  may fluctuate in advance
of changes in market rates,  while  interest rates on other types may
lag behind  changes in market rates.  Additionally,  certain  assets,
such as  adjustable-rate  mortgage loans have features which restrict
changes in interest rates on a short-term  basis over the life of the
assets.  Further,  in  the  event  of a  change  in  interest  rates,
prepayment  levels  and  decay  rates on core  deposits  may  deviate
significantly from those assumed in calculating the table.



6

<PAGE>
The following table indicates the time periods in which interest-earning  assets
and interest bearing liabilities will mature or reprice in accordance with their
contractual  terms.  The  table  assumes  prepayments  and  scheduled  principal
amortization of fixed-rate  loans and  mortgage-backed  securities,  and assumes
that  adjustable  rate  mortgage  loans will  reprice at  contractual  repricing
intervals. There has been no adjustment for the impact of future commitments and
loans in process.

<TABLE>
<CAPTION>
                                                     At September 30, 1998
--------------------------------------------------------------------------------------------------------------------------------
                                               Three    More than    More than     More than  More than  
                                               months   3 Months to  6 Months to   1 Year to  3 Years to    More than
                                               or less   6 Months      1 Year       3 Years    5 Years       5 Years     Total
                                               -------   --------      ------       -------    -------       -------     -----
                                                                              (Dollars in Thousands)
<S>                                           <C>       <C>          <C>          <C>         <C>         <C>          <C>        
Interest-earning assets:
  Mortgage loans(1)(2)                          $5,047    $4,791       $62,159      $21,854     $8,480      $12,576      $114,907
  Other loans(1)                                 5,108       820         1,492        4,375      2,510          860        15,165
  Marketable equity securities(3)                4,346         -             -            -          -            -         4,346
  Federal funds sold and other                                                                                                 
    short-term investments                       3,649         -             -            -          -            -         3,649
  Investment securities                            300         -         5,789        1,300      3,037        4,044        14,470
  Mortgage-backed securities(2)                      -         -             -           15          -            -            15
  FHLB stock                                     1,550         -             -            -          -            -         1,550
                                                ------     -----        ------       ------     ------       ------       -------
    Total interest-earning assets               20,000     5,611        69,440       27,544     14,027       17,480       154,102
                                                ------     -----        ------       ------     ------       ------       -------
Less:                                                                                                                  
Loans in process                                 1,640     1,633         1,633            -          -            -         4,906
Unearned discount and deferred fees(2)              13        12           157           55         22           32           291
Allowance for credit losses                         60        34           373          154         64           79           764
                                                ------     -----        ------       ------     ------       ------       -------
    Net interest-earning assets                 18,287     3,932        67,277       27,335     13,941       17,369       148,141
                                                ------     -----        ------       ------     ------       ------       -------
Interest-bearing liabilities:                                                                                          
  Money market deposits                          1,545     1,046         1,187          526        250          228         4,782
  Passbook deposits                                704       671         1,251        3,987      2,599        6,230        15,442
  NOW and other demand deposits                    970       864         1,456        3,011        806        1,784         8,891
  Certificate accounts                           9,183         -        29,089       30,832      1,800            -        70,904
  Borrowed funds                                 1,000         -             -       18,000          -       10,000        29,000
                                                ------     -----        ------       ------     ------       ------       -------
    Total interest-bearing liabilities          13,402     2,581        32,983       56,356      5,455       18,242       129,019
                                                ------     -----        ------       ------      -----       ------       -------
Interest sensitivity gap(4)                     $4,885    $1,351       $34,294     ($29,021)    $8,486        ($873)      $19,122
                                                ======    ======       =======     =========    ======        ======      =======
Cumulative interest sensitivity gap             $4,885    $6,236       $40,530      $11,509    $19,995      $19,122    
                                                ======    ======       =======      =======    =======      =======    
Cumulative interest sensitivity gap                                                                                    
  as a percent of total assets                    3.08%     3.93%        25.54%        7.25%     12.60%       12.05%    
Cumulative net interest-bearing                                                                                        
  assets as a percent of                                                                                               
  interest-bearing liabilities                  136.45%   139.02%       182.77%      110.93%    118.05%      114.82%    
</TABLE>
                                                                          
------------------------
(1)  For purposes of the gap analysis,  mortgage and other loans are reduced for
     nonperforming loans but are not reduced for the allowace for credit losses.
(2)  For purposes of the gap analysis,  unearned  discount and deferred fees are
     pro rated for mortgage loans and mortgage backed securities.
(3)  Includes assets held for sale.
(4)  Interest   sensitivity   gap   represents   the   difference   between  net
     interest-earning assets and interest-bearing liabilities.

                                                                               7
<PAGE>
--------------------------------------------------------------------------------
Analysis of Net Interest Income
-------------------------------
The  following  table sets forth  certain  information  relating to the Savings
Bank's  average  balance sheet and reflects  the interest  earned on assets and
interest expense of liabilities for the periods indicated and the average yields
earned and rates paid.  Such yields and costs are derived by dividing income or
expense by the average balance of assets or liabilities,  respectively, for the
periods presented. Average balances are derived from daily balances.

<TABLE>
<CAPTION>
                                       -------------------------------------------------------------------------------
                                                       1998                                      1997
                                       -------------------------------------     -------------------------------------
                                             Average                 Yield/            Average                 Yield/
                                             Balance    Interest       Cost            Balance    Interest       Cost
                                                                  (Dollars in Thousands)  
<S>                                        <C>          <C>          <C>             <C>          <C>          <C>     
Assets:
  Interest-earning assets:
    Mortgage loans(1)                       $103,502      $8,044       7.77 %          $98,666      $7,816       7.92 %  
    Other loans(1)                            19,188       1,861       9.70             14,600       1,481      10.15    
    Interest-earning deposits(2)               4,239         242       5.72              3,966         217       5.47    
    Federal funds sold and other
      short-term investments                   3,785         280       7.41              1,231         119       9.69    
    Investment securities                     12,437         781       6.27              7,643         549       7.18    
    Mortgage-backed securities, net               17           1       6.98                431          30       6.85    
    FHLB stock                                 1,264          90       7.11                932          68       7.19    
                                               -----      ------                       -------      ------               
      Total interest-earning assets          144,432      11,299       7.82            127,469      10,280       8.07    
                                                          ------                                    ------
Noninterest-earning assets                     4,041                                     5,667                           
                                               -----                                     -----                           
      Total assets                          $148,473                                  $133,136                           
                                            ========                                  ========                           

Liabilities and equity:
  Interest-bearing liabilities:
    Money market deposits                     $4,378         149       3.40 %            4,603         143       3.11 %  
    Passbook deposits                         15,217         454       2.98             14,675         446       3.04    
    NOW and other demand deposits              8,908         182       2.04              8,203         196       2.40    
    Certificate accounts                      70,337       3,779       5.37             65,834       3,517       5.34    
                                              ------       -----                        ------       -----               
  Total deposit accounts                      98,840       4,564       4.62             93,315       4,302       4.61    
    Borrowed funds                            22,487       1,245       5.54             14,249         865       6.07    
                                              ------       -----                        ------         ---               
      Total interest-bearing liabilities     121,327       5,809       4.79            107,564       5,167       4.80    
                                                           -----                                     -----               
Noninterest-bearing liabilities                6,769                                     6,610                           
Equity                                        20,377                                    18,962                           
                                              ------                                    ------                           
      Total liabilities and equity          $148,473                                  $133,136                           
                                            ========                                  ========                           
Net interest income                                       $5,490                                    $5,113               
                                                          ======                                    ======               
Interest rate spread(3)                                                3.03 %                                    3.27 %  
Net interest margin(4)                                                 3.80 %                                    4.02 %  
Interest-earning asset to
  interest-bearing liabilities               119.04%                                   118.51%                           
</TABLE>

------------------
(1)  Amount is net of  deferred  loan fees and  discounts,  loans in process and
     allowance for credit losses and includes accrued interest.
(2)  Includes assets held for sale.
(3)  Net interest rate spread  represents  the  difference  between the yield on
     average  interest-earning  asets and the cost of  average  interest-bearing
     liabilities.
(4)  Net  interest  margin  represents  net interest  income  divided by average
     interest-earning assets.

8
<PAGE>
--------------------------------------------------------------------------------

The following table sets forth certain information regarding changes in interest
income and  expense of the  Savings  Bank for the  periods  indicated.  For each
category   of   interest-earning   assets  and   interest-bearing   liabilities,
information  is  provided  on changes  due to (1)  changes in volume  (change in
average  volume times the old rate);  (2) changes in rate (changes in rate times
the new average  volume);  and (3) net change.  The change  attributable  to the
combined  impact of volume and rate have been allocated  proportionately  to the
changes due to volume and the changes due to rate.

<TABLE>
<CAPTION>

                                                                                 Year Ended September 30,
                                                            --------------------------------------------------------------------
                                                                    1998 vs. 1997                        1997 vs. 1996
                                                            -------------------------------      -------------------------------
                                                               Volume       Rate       Net          Volume       Rate       Net
                                                                                  (Dollars in Thousands)
<S>                                                             <C>       <C>        <C>             <C>       <C>        <C> 
    Interest-earning assets:
      Mortgage loans                                             $383      ($155)     $228            $567      ($159)     $408
      Other loans                                                 466        (86)      380             545        (36)      509
      Interest-earning deposits                                    15         10        25              15        (23)       (8)
      Federal funds sold and other short-term
        investments                                               247        (86)      161              16         10        26
      Investment securities, net                                  345       (113)      232              36         34        70
      Mortgage-backed securities, net                             (29)         0       (29)             10          -        10
      FHLB stock                                                   23         (1)       22               1          -         1
                                                                -----       ----     -----            ----       ----     -----
        Total interest-earning assets                           1,450       (431)    1,019            1190       (174)    1,016
                                                                -----       -----    -----            ----       -----    -----

    Interest-bearing liabilities:
      Money market deposits                                        (7)        13         6             (12)         1       (11)
      Passbook deposits                                            17         (9)        8             (22)        10       (12)
      NOW and other demand deposits                                17        (31)      (14)             22        (29)       (7)
      Certificate accounts                                        241         21       262             316       (112)      204
      Borrowed funds                                              500       (120)      380             498          3       501
                                                                  ---       -----      ---             ---          -       ---
        Total interest-bearing liabilities                        768       (126)      642             802       (127)      675
                                                                  ---       -----      ---             ---       -----      ---
    Net change in net interest income                            $682      ($305)     $377            $388       ($47)     $341
                                                                 ====      ======     ====            ====       =====     ====
</TABLE>

--------------------------------------------------------------------------------
Comparison of Financial  Condition for Fiscal Years Ended September 30, 1998 and
1997
--------------------------------------------------------------------------------

The  Company's  total  assets were $158.7  million at  September  30,  1998,  an
increase of $19.6 million or 14.1%,  from $139.1  million at September 30, 1997.
The asset growth was primarily due to an 11.8% rise in net loans  receivable and
a 50.7% increase in investment securities from the end of fiscal 1997.

The  continuaton of new home  construction  within the markets  Bedford  Federal
serves  combined with growth of both commercial and consumer loans during fiscal
1998 were the major factors in the expansion of loans.  This increase was funded
primarily by  principal  repayments  of the loan  portfolio,  FHLB  advances and
increased  deposits.  Because lending is directly  affected by interest rates, a
rise in  interest  rates  could  cause a slow  down  in new  loan  originations.
Investment  securities increased  $4,868,000,  marketable equity securities rose
$158,000  , while  mortgage-backed  securities  declined  $5,000 in fiscal  1998
compared to fiscal 1997.

Deposits  totaled  $107.1  million at September  30,  1998,  an increase of $3.5
million from $103.6 million on September 30, 1997,  while advances from the FHLB
increased $14 million as the Savings Bank utilized additional borrowings to meet
funding needs.

                                                                               9
<PAGE>

                                                                    
Total stockholders'  equity was $21.2 million on September 30, 1998, an increase
of $1.6 million from the $19.6 million one year previous. This increase reflects
the continued profitability of the Corporation and allowed Bedford Bancshares to
increase the level of  dividends  declared to $.30 per share in fiscal 1998 from
$.265 per share in 1997.

--------------------------------------------------------------------------------
Comparison of Operating Results for Years Ended September 30, 1998 and 1997
--------------------------------------------------------------------------------

Net Income.  Net income increased  $382,000,  to $1,973,000 for fiscal 1998 from
fiscal  1997.  A 7.4%  increase in net interest  income,  combined  with a 45.5%
increase in  noninterest  income and a 10%  reduction in the  provision for loan
losses accounted for the improvement in profitability.

Interest Income. Interest income totaled $11.3 million for the fiscal year ended
September 30, 1998, a 9.9%  increase from the $10.3 million  recorded for fiscal
1997.  The  interest  income  growth is due to the 13.3%  expansion  of  average
earning assets, offset by a 25 basis point decline in the rate earned on average
earning assets.  The decline in the rate earned was primarily  reflective of the
decline in general market rates of interest.  A detailed analysis of the changes
in interest  income due to changes in volume and rate is  presented in the table
on page 8.

Interest Expense.  Interest expense increased $642,000 from $5.2 million for the
year  ended  September  30,  1997 to $5.8  million  for the  fiscal  year  ended
September 30, 1998. The level of average interest-bearing liabilities rose 12.9%
to $121.3  million  for  fiscal  1998 from  $107.6 for  fiscal  1997.  There was
virtually  no change in the overall  cost of  interest  bearing  liabilities  in
fiscal 1998 over fiscal 1997.  The table on page 8 provides a detailed  analysis
of the changes in interest expense due to the changes in volume and rate.

Net Interest Income. Net interest income totaled $5.5 million for the year ended
September 30, 1998, up 7.4% from the $5.1 million  realized in fiscal 1997.  The
increase is primarily due to the higher volume of earning  assets which equalled
119.0% of average  interest  bearing  liabilities  in fiscal  1998,  compared to
118.5% in fiscal 1997.  A detailed  analysis of the  components  of net interest
income is presented on pages 8 and 9 of this report.

Provision  for Loan  Losses.  The  provision  for loan losses for the year ended
September  30,  1998  decreased  $10,000 to $90,000  compared  to the  provision
recorded in fiscal  1997.  The decrease in fiscal 1998 was  attributable  to the
lower  level  of  nonperforming   loans  and  the  lower  level  of  charge-offs
experienced  during the year.  At September  30, 1998,  the allowance for credit
losses  was  $764,000,   or  .59%  of  net  loans   receivable  and  143.55%  of
nonperforming  assets.  Based  upon  the  quality  of the  Savings  Bank's  loan
portfolio,  the level of  nonperforming  assets,  the  relatively  stable  local
economy, and current interest rate environment,  management believes the Savings
Bank's allowance for credit losses is adequate to absorb any anticipated  credit
losses.  Management  currently  expects future  provisions for loan losses to be
based  primarily upon growth in the loan portfolio,  the level of  nonperforming
assets, the interest rate environment and other factors. However,  assessment of
the adequacy of the  allowance  for credit loss  involves  subjective  judgments
regarding  future  events and thus  there can be no  assurance  that  additional
provisions for credit losses will not be required in future periods.

Noninterest  Income.  For the year ended September 30, 1998,  noninterest income
amounted to $863,000,  up $270,000 from the $593,000  earned in fiscal 1997. The
increase  reflects  management's  focus and  commitment  on improving  fee based
income.  Service  charges and fees on loans increased 55.1% primarily due to the
introduction of loan processing fees during fiscal 1998.  Other customer service
fees and commissions  rose 32.2% due primarily to a change in the way overdrafts
are  processed.  Other  noninterest  income rose 89.7% due to a higher  level of
income  from the sale of  mortgage  insurance  and higher ATM usage  charges for
noncustomers.

10
<PAGE>

Noninterest Expense. Noninterest expense totaled $3.1 million for the year ended
September  30, 1998  compared to $3.0 million for fiscal 1997.  The increase was
primarily due to $201,000 in professional fees incurred during 1998, compared to
$120,000 in fiscal 1997. The increase in professional  fess was primarily due to
charges  incurred  during the development of the Bank's three year stategic plan
and increased expenses related to the Company's 1998 proxy solicitation process.


Income Taxes. The provision for income taxes increased $186,000 to $1,160,000 in
fiscal 1998 from $974,000 in fiscal 1997 due to the  increased  level of taxable
income.

--------------------------------------------------------------------------------
Liquidity and Capital Resources
--------------------------------------------------------------------------------

The Bank's  liquidity is a measure of its  abilility to fund loans,  pay deposit
withdrawals, and other cash outflows in an efficient, cost effective manner. The
Bank's  primary  sources of funds are scheduled  amortization  and prepayment of
loans,  deposits and FHLB advances.  The Bank uses these sources to fund lending
commitments and maturing time deposits,  pay deposit  withdrawals,  purchase new
investments, increase liquidity and for capital expenditures. Generally the Bank
funds its  operations  internally,  but also  borrows from the Federal Home Loan
Bank ("FHLB") of Atlanta.  As of September 30, 1998,  FHLB advances  totaled $29
million.  Loan  payments  and maturing  investments  are greatly  influenced  by
general interest rates, economic conditions and competition.

The OTS adopted a new liquidity rule  effective  November 24, 1997. The new rule
lowered liquidity  requirements for savings  associations from 5 to 4 percent of
the association's liquidity base. In addition, the liquidity base was reduced by
modifying the definition of net  withdrawable  accounts to exclude accounts with
maturities  exceeding one year.  Another  change  removed the  requirement  that
certain  obligations  must mature in five years of less in order to qualify as a
liquid  asset.  The new rule also  eliminated  a separate  limit  that  required
savings  associations to hold assets equal to 1 percent of a thrift's  liquidity
base in cash or short-term  liquid  assets.  At September  30, 1998,  the Bank's
regulatory liquidity as measured by the new requirement was 19%.

The amount of  certificate  of deposit  scheduled  to mature  within one year is
approximately  $5.1 million.  To the extent that these deposits do not remain at
the Bank upon  maturity,  management  of the Bank  believes  that it can replace
these funds with other  deposits,  excess  liquidity,  FHLB  advances,  or other
borrowings. It has been the Bank's experience that a substantial portion of such
maturing  deposits  remain at the Bank. In addition,  at September 30, 1998, the
Bank had commitments to fund loans of $8.2 million, and $4.9 million of loans in
process.

Net cash provided by operating activities for fiscal 1998 totaled $2.3 million.

Net cash absorbed by investing activities for fiscal 1998 totaled $19.2 million,
an  increase  from fiscal  1997 of $9.2  million.  The  increase  was  primarily
attributable  to a rise in cash used for net loan  originations  of $6.2 million
and cash used for net purchases of investments of $8.0 million.

Net cash provided by financing  activities for the year ended September 30, 1998
totaled  $17.1  million.  This is a result of a net increase in deposits of $3.5
million, an increase in net FHLB advances of $14.0 million and dividends paid of
$665,000.  The increase in deposits and net  borrowings  were used  primarily to
fund the increase in loan originations and investment securities.

Liquidity may be adversely  affected by unexpected  deposit outflows,  excessive
interest rates paid by competitors,  adverse  publicity  relating to the savings
and loan industry, and similar matters.  Management monitors projected liquidity
needs and  determines the level  desirable,  based in part on the Savings Bank's
commitment  to make loans and  management's  assessment  of the  Savings  Bank's
ability  to  generate  funds.  The  Savings  Bank is  also  subject  to  federal
regulations that impose certain minimum capital requirements.

                                                                              11
<PAGE>
--------------------------------------------------------------------------------

Impact of Inflation and Changing Prices
---------------------------------------
Unlike most industrial  companies,  substantially  all assets of the Corporation
are monetary in nature. As a result, interest rates have a greater impact on the
Corporation's  performance  than do the effects of general  levels of inflation.
Interest  rates do not  necessarily  move in the same  direction  or to the same
extent as the price of goods and services.

The Year 2000  Issue
--------------------------------------------------------------------------------
The Year 2000 ("Y2K")  Issue relates to whether  computer  systems will properly
recognize and process date  sensitive  information on and after January 1, 2000.
Systems that do not properly interpret such information could generate erroneous
data or fail. The Bank is heavily  dependent on computer  systems in the conduct
of substantially all of its business activities.

During fiscal 1998, the Company  established a Y2K Committee  (the  "Committee")
and adopted a Y2K Compliance Plan (the "Plan"). The purpose of the Committee and
Plan are to identify  the systems that could be affected by the Y2K issue and to
determine  the  actions  required  to  prepare  for the proper  recognition  and
processing  of date  sensitive  information  on and after  January 1, 2000.  The
Federal Financial Institutions Examination Council has recommended that the Plan
include  five  phases:  Awareness,   Assessment,   Renovation,   Validation  and
Implementation.  The phases are  intended  to help the Company  identify  risks,
develop an action plan, perform adequate testing and complete certification that
its processing systems will be Y2K compliant.

The Bank has conducted a comprehensive review of its computer systems, including
its core  processing  systems  maintained  by a third party service  bureau,  to
identify  the systems  that could be affected by the Y2K issue.  The Company has
maintained  ongoing  contact with this vendor  throughout the Renovation  phase,
which  included  program  changes  and  other  modifications  necessary  for Y2K
readiness.  The Company is  currently  in Phase 4,  Validation,  which  involves
testing of changes to hardware and  software,  including  all vendor  maintained
software and hardware.  The Validation phase is scheduled for completion by June
30, 1999. The  Implementation  phase is targeted for completion by September 30,
1999.  In  addition,  the Bank is  required  by  Federal  regulators  to develop
contingency plans in the event that any of its mission critical computer systems
fail to meet the Y2K requirements. These detailed contingency plans will also be
tested and reviewed by both the Bank's management and regulators to ensure their
readiness and reliability.

Based on preliminary estimates, the Bank expects to spend approximately $125,000
to $150,000 to modify its computer information systems, both internal and vendor
maintained, enabling proper processing of transactions relative to the year 2000
and beyond.  The Bank  continues to evaluate  appropriate  courses of corrective
action, including replacement of certain systems whose associated costs would be
recorded  as assets  and  amortized.  Accordingly,  the Bank does not expect the
amounts to be expensed to have a material  impact on its  financial  position or
results of its  operations.  For the twelve months ended September 30, 1998, the
Bank had  recorded  $21,000  of  expense  related  to the Y2K  issue and had not
replaced any assets.

Successful  and timely  completion  of the Y2K project is based on  management's
best estimates  derived from various  assumptions  of future  events,  which are
inherently  uncertain,  including  the  testing  results of the core  processing
system maintained by a third party service bureau, and readiness of all vendors,
suppliers  and  customers.  No  assurance  can be given  that  the Plan  will be
successfully  completed by the Year 2000,  in which case the Company could incur
data processing delays, mistakes or failures. These delays, mistakes or failures
could have a  significant  adverse  impact on the  financial  statements  of the
Company.


12
<PAGE>
                            Bedford Bancshares, Inc.
                                and Subsidiaries






                                               Consolidated Financial Statements
                                                    (with supplemental material)

                                           As of September 30, 1998 and 1997 and
                           For the Years Ended September 30, 1998, 1997 and 1996









                                                                              13
<PAGE>
                                                  300 ARBORETUM PLACE, SUITE 520
                                                        RICHMOND, VIRGINIA 23236
                                                        Telephone (804) 330-3092
                                                             FAX: (804) 330-7753

[LOGO]    BDO SEIDMAN LLP
          ACCOUNTANTS AND CONSULTANTS








Report of Independent Certified Public Accountants



The Board of Directors and Stockholders
Bedford Bancshares, Inc.
Bedford, Virginia

We have audited the consolidated balance sheets of Bedford Bancshares,  Inc. and
subsidiaries  (the "Company") as of September 30, 1998 and 1997, and the related
consolidated statements of operations,  stockholders' equity, and cash flows for
each of the three years ended September 30, 1998. These financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audit.

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

In our opinion, the consolidated  financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Bedford
Bancshares,  Inc. and  subsidiaries  as of September 30, 1998 and 1997,  and the
results of their  operations  and their  cash flows for each of the three  years
ended  September  30, 1998 in  conformity  with  generally  accepted  accounting
principles.


                                                             /s/BDO Seidman, LLP


 Richmond, Virginia
 October 23, 1998

                                                                               
14
<PAGE>




                                       Bedford Bancshares, Inc. and Subsidiaries

                                                     Consolidated Balance Sheets
                                                                  (in thousands)

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

September 30,                                             1998          1997
--------------------------------------------------------------------------------


   Assets

Cash (including interest bearing deposits of
  approximately $3,650 and $2,791)                     $  5,666     $   5,446
Securities (Notes 1 and 6)
  Held-to-maturity                                        2,114         4,616
  Available for sale                                     16,820         9,244
Investment in Federal Home Loan Bank stock,
  at cost (Note 6)                                        1,550           932
Loans receivable, net (Notes 2, 6 and 14)               129,744       116,093
Foreclosed real estate, net                                 -             212
Property and equipment, net (Note 4)                      1,160         1,214
Accrued interest receivable                                 996           847
Deferred income taxes (Note 9)                               95            58
Other assets                                                566           427
--------------------------------------------------------------------------------













Total assets                                           $158,711      $139,089
--------------------------------------------------------------------------------




                                                                              15

<PAGE>




                                       Bedford Bancshares, Inc. and Subsidiaries

                                                     Consolidated Balance Sheets
                                                                  (in thousands)

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

September 30,                                                   1998       1997
--------------------------------------------------------------------------------


   Liabilities and Stockholders' Equity

Liabilities
  Deposits (Note 5)                                         $107,086   $103,612
  Advances from Federal Home Loan Bank (Note 6)               29,000     15,000
  Advances from borrowers for taxes and insurance                528        502
  Dividends payable                                              184        160
  Other liabilities (Note 8)                                     665        194
--------------------------------------------------------------------------------


Total liabilities                                            137,463    119,468
--------------------------------------------------------------------------------


Commitments and contingencies (Notes 11 and 12)
--------------------------------------------------------------------------------


Stockholders' equity
  Preferred stock, par value $.10, authorized 250,000
    shares, none outstanding                                       -        -
  Common stock, par value $.10, authorized 2,750,000
    shares, 2,297,900 and 1,142,425 shares, issued and
    outstanding                                                  230        114
  Additional paid-in capital                                  10,939     10,836
  Retained earnings, substantially restricted (Note 10)       10,900      9,763
  Unrealized gain on securities available for sale (Note 1)       60         22
  Stock acquired by ESOP and RRP (Note 11)                      (881)    (1,114)
--------------------------------------------------------------------------------


Total stockholders' equity                                    21,248     19,621
--------------------------------------------------------------------------------


Total liabilities and stockholders' equity                  $158,711   $139,089
--------------------------------------------------------------------------------



See  accompanying  summary  of  accounting  policies  and notes to  consolidated
financial statements.


16

<PAGE>




                                       Bedford Bancshares, Inc. and Subsidiaries

                                           Consolidated Statements of Operations
                                                                  (in thousands)
<TABLE>
<CAPTION>

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

Year Ended September 30,                                               1998                1997              1996
-------------------------------------------------------------------------------------------------------------------
<S>                                                                <C>                 <C>                <C>   
Interest income
  Loans                                                             $ 9,905             $ 9,297            $8,380
  U.S. government obligations, including agencies                     1,055                 796               748
  Other investments                                                     339                 187               136
-------------------------------------------------------------------------------------------------------------------

Total interest income                                                11,299              10,280             9,264
-------------------------------------------------------------------------------------------------------------------

Interest expense
  Deposits (Note 5)                                                   4,564               4,302             4,128
  Borrowed money                                                      1,245                 865               364
-------------------------------------------------------------------------------------------------------------------

Total interest expense                                                5,809               5,167             4,492
-------------------------------------------------------------------------------------------------------------------

Net interest income                                                   5,490               5,113             4,772

Provision for loan losses (Note 2)                                       90                 100                22
-------------------------------------------------------------------------------------------------------------------

Net interest income after provision for
  loan losses                                                         5,400               5,013             4,750
-------------------------------------------------------------------------------------------------------------------

Noninterest income
  Service charges and fees on loans                                     459                 296               403
  Other customer service fees and commissions                           320                 242               257
  Gain on sale of loans, investments
    and foreclosed real estate                                           10                  16                30
  Other                                                                  74                  39                45
-------------------------------------------------------------------------------------------------------------------

Total noninterest income                                                863                 593               735
-------------------------------------------------------------------------------------------------------------------

Noninterest expense
  Compensation and employee benefits                                  1,712               1,684             1,467
  Occupancy and equipment                                               321                 318               336
  Data processing                                                       354                 341               311
  Federal insurance of accounts                                          64                  88               207
  Advertising                                                           111                 140                87
  Professional fees                                                     201                 120               115
  BIF/SAIF premium disparity assessment (Note 8)                          -                 -                 555
  Other                                                                 367                 350               351
-------------------------------------------------------------------------------------------------------------------

Total noninterest expense                                             3,130               3,041             3,429
-------------------------------------------------------------------------------------------------------------------

</TABLE>

                                                                    continued...

                                                                              17

<PAGE>




                                       Bedford Bancshares, Inc. and Subsidiaries

                                           Consolidated Statements of Operations
                                                      (in thousands) (continued)
<TABLE>
<CAPTION>

-------------------------------------------------------------------------------------------------------------------
Year Ended September 30,                                               1998                1997              1996
-------------------------------------------------------------------------------------------------------------------

<S>                                                                  <C>                 <C>               <C>   
Income before income taxes                                           $3,133              $2,565            $2,056

Provision for income taxes (Note 9)                                   1,160                 974               754
-------------------------------------------------------------------------------------------------------------------

Net income                                                           $1,973              $1,591            $1,302
-------------------------------------------------------------------------------------------------------------------

Basic earnings per share (Note 16)                                    $ .90             $   .74           $   .59

Diluted earnings per share (Note 16)                                  $ .85             $   .70           $   .56
-------------------------------------------------------------------------------------------------------------------

</TABLE>


See  accompanying  summary  of  accounting  policies  and notes to  consolidated
financial statements.


18                                                                       

<PAGE>




                                       Bedford Bancshares, Inc. and Subsidiaries

                                 Consolidated Statements of Stockholders' Equity
                                                                  (in thousands)
<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------------------------------
                                                  Additional                 Unrealized       Acquired
                                       Common       Paid-in    Retained      Gain/(Loss)       By ESOP
                                        Stock       Capital    Earnings     on Securities      and RRP      Total
-------------------------------------------------------------------------------------------------------------------


<S>                                     <C>         <C>         <C>           <C>           <C>           <C>    
Balance, September 30, 1995              $121        $11,366     $8,263        $ (9)         $(1,056)      $18,685

Net income                                -              -        1,302         -                -           1,302
Change in unrealized loss
  on securities available
  for sale (Note 1)                       -              -          -           (24)             -             (24)
Allocated/earned ESOP
  shares (Note 11)                        -               55         88         -                 26           169
Purchase of RRP shares
  (Note 11)                               -              -          -           -               (483)         (483)
Repurchase of stock
  (130,180 shares)                         (7)          (647)      (461)        -                -          (1,115)
Dividends declared ($.20
  per share)                              -              -         (457)        -                -            (457)
Exercise of options (Note 11)             -               41          4         -                -              45
RRP vesting (Note 11)                     -              (42)       -           -                147           105
-------------------------------------------------------------------------------------------------------------------


Balance, September 30, 1996               114         10,773      8,739         (33)          (1,366)       18,227

Net income                                -              -        1,591         -                -           1,591
Change in unrealized loss
  on securities available
  for sale (Note 1)                       -              -          -            55              -              55
Allocated/earned ESOP
  shares (Note 11)                        -              147         49         -                 80           276
Purchase of RRP shares
  (Note 11)                               -              (12)       (11)        -                -             (23)
Dividends declared ($.27
  per share)                              -              -         (605)        -                -            (605)
RRP vesting (Note 11)                     -              (72)       -           -                172           100
-------------------------------------------------------------------------------------------------------------------

</TABLE>



                                                                    continued...

                                                                              19

<PAGE>




                                       Bedford Bancshares, Inc. and Subsidiaries

                                 Consolidated Statements of Stockholders' Equity
                                                      (in thousands) (continued)

<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------------------------------
                                                  Additional                 Unrealized       Acquired
                                       Common       Paid-in    Retained      Gain/(Loss)       By ESOP
                                        Stock       Capital    Earnings     on Securities      and RRP      Total
-------------------------------------------------------------------------------------------------------------------


<S>                                     <C>         <C>         <C>               <C>       <C>           <C>    
Balance, September 30, 1997              $114        $10,836     $9,763            $22       $(1,114)      $19,621

Net income                                -              -        1,973             -            -           1,973
Change in unrealized loss
  on securities available
  for sale (Note 1)                       -              -          -               38           -              38
Allocated/earned ESOP
  shares (Note 11)                        -               96         16             -             69           181
Purchase of RRP shares
  (Note 11)                               -              (29)       (57)            -            -             (86)
Effect of 2 for 1 stock split             115            -         (115)            -            -             -
Dividends declared ($.30
  per share)                              -              -         (689)            -            -            (689)
Exercise of options (Note 11)               1             93          9             -            -             103
RRP vesting (Note 11)                     -              (57)       -               -            164           107
-------------------------------------------------------------------------------------------------------------------


Balance, September 30, 1998              $230        $10,939    $10,900            $60         $(881)      $21,248
-------------------------------------------------------------------------------------------------------------------

</TABLE>


See  accompanying  summary  of  accounting  policies  and notes to  consolidated
financial statements.


20
<PAGE>




                                       Bedford Bancshares, Inc. and Subsidiaries

                                           Consolidated Statements of Cash Flows
                                                                  (in thousands)

<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------------------------------

Year Ended September 30,                                               1998                1997              1996
-------------------------------------------------------------------------------------------------------------------

<S>                                                               <C>                  <C>               <C>    
Operating activities
  Net income                                                       $  1,973             $ 1,591           $ 1,302
  Adjustments to reconcile net income to
    net cash provided by operating activities
      Provision for loan losses                                          90                 100                22
      Provision for depreciation and amortization                       150                 159               163
      (Increase) decrease in deferred income taxes                      (37)                380              (121)
      (Gain) loss on sale of loans and securities                        (4)                (11)               (2)
      (Gain) loss on sale of foreclosed real estate                      (7)                 (4)              (28)
      Loans originated for sale                                        (304)               (185)             (152)
      Proceeds from sale of loans originated for sale                   304                 185               153
      (Increase) decrease in interest receivable                       (149)               (185)               51
      (Increase) decrease in other assets                              (139)                121              (295)
      Increase (decrease) in other liabilities                          471                (745)              356
-------------------------------------------------------------------------------------------------------------------

Net cash provided by operating activities                             2,348               1,406             1,449
-------------------------------------------------------------------------------------------------------------------

Investing activities
  Proceeds from maturities of investments                             7,500               2,090             2,200
  Proceeds from sales of available for sale securities                1,004               1,000               872
  Purchase of available for sale securities                         (13,542)             (5,500)           (4,035)
  Principal collected on mortgage-backed securities                       5                  55                26
  Net increase in loans to customers                                (13,741)             (7,575)          (11,311)
  Net proceeds from sales of foreclosed real estate                     220                  47               113
  Purchases of premises, equipment and leasehold
    improvements                                                        (96)               (131)              (88)
  Purchase of FHLB stock                                               (618)                -                 -
-------------------------------------------------------------------------------------------------------------------

Net cash absorbed by investing activities                           (19,268)            (10,014)          (12,223)
-------------------------------------------------------------------------------------------------------------------

</TABLE>








                                                                    continued...

                                                                              21

<PAGE>




                                       Bedford Bancshares, Inc. and Subsidiaries

                                           Consolidated Statements of Cash Flows
                                                      (in thousands) (continued)


<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------------------------------
Year Ended September 30,                                               1998                1997              1996
-------------------------------------------------------------------------------------------------------------------

<S>                                                                <C>                <C>               <C>     
Financing activities
  Net increase in deposits                                          $ 3,474            $  8,234          $  5,315
  Net increase (decrease) in advance payments
    from borrowers                                                       26                 (37)               (6)
  Proceeds from FHLB advances                                        22,000              23,500            11,000
  Principal payments of FHLB advances                                (8,000)            (20,500)           (4,000)
  Purchase of stock by ESOP and RRP                                     (86)                (23)             (483)
  Allocation of ESOP and RRP shares                                     288                 376               274
  Repurchase of stock                                                   -                   -              (1,115)
  Dividends paid                                                       (665)               (571)             (518)
  Issuance of common stock                                              103                 -                  45
-------------------------------------------------------------------------------------------------------------------

Net cash provided by financing activities                            17,140              10,979            10,512
-------------------------------------------------------------------------------------------------------------------

Increase (decrease) in cash and cash equivalents                        220               2,371              (262)

Cash and cash equivalents - beginning of year                       $ 5,446               3,075             3,337
-------------------------------------------------------------------------------------------------------------------

Cash and cash equivalents - end of year                               5,666            $  5,446          $  3,075
-------------------------------------------------------------------------------------------------------------------


Supplemental Disclosures of Cash Flow Information
-------------------------------------------------------------------------------------------------------------------

Cash payments of interest expense                                   $ 5,880            $  5,387          $  4,503
-------------------------------------------------------------------------------------------------------------------

Cash payments of income taxes                                       $   570            $    823          $    817
-------------------------------------------------------------------------------------------------------------------

Transfer of loans to foreclosed real estate                         $   110            $    255         $     -
-------------------------------------------------------------------------------------------------------------------

</TABLE>


See  accompanying  summary  of  accounting  policies  and notes to  consolidated
financial statements.


22

<PAGE>




                                       Bedford Bancshares, Inc. and Subsidiaries

                                                  Summary of Accounting Policies

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


Nature of Business and Regulatory Environment

Bedford  Bancshares,  Inc. (the "Parent  Company") is a unitary  thrift  holding
company whose principal asset is its  wholly-owned  subsidiary,  Bedford Federal
Savings Bank (the  "Savings  Bank").  The Savings Bank is a federally  chartered
stock savings bank that provides a full range of banking  services to individual
and corporate customers. In these financial statements the consolidated group is
referred to collectively as "the Company".

The Office of Thrift Supervision  ("OTS") is the primary regulator for federally
chartered savings associations, as well as savings and loan holding companies.

The Federal  Deposit  Insurance  Corporation  ("FDIC")  is the  federal  deposit
insurance  administrator for both banks and savings  associations.  The FDIC has
specified  authority to prescribe  and enforce such  regulations  and issue such
orders  as it deems  necessary  to  prevent  actions  or  practices  by  savings
associations  that pose a serious  threat to the Savings  Association  Insurance
Fund ("SAIF").

Principles of Consolidation

The  consolidated   financial   statements   include  the  accounts  of  Bedford
Bancshares,  Inc. and Bedford Federal Savings Bank, its wholly-owned subsidiary,
and First  Financial  Enterprises,  Inc.,  the  wholly-owned  subsidiary  of the
Savings  Bank.  During the first  quarter of fiscal year 1997,  First  Financial
Enterprises,  Inc. was dissolved.  The assets and liabilities of First Financial
were   transferred  to  the  Bank.  All  material   intercompany   accounts  and
transactions have been eliminated in the consolidation.  Prior year accounts are
reclassified when necessary to conform to current year classifications.

Estimates

The preparation of financial  statements in conformity  with generally  accepted
accounting principles requires management to make estimates and assumptions that
affect  the  reported  amounts  of  assets  and  liabilities  at the date of the
financial  statements and the reported  amounts of revenues and expenses  during
the reporting period.
Actual results could differ from those estimates.

Investment Securities

The Company adopted  Statement of Financial  Accounting  Standards No. 115 (SFAS
115),  "Accounting for Certain Investments in Debt and Equity Securities," as of
October 1, 1994. This statement  requires certain securities to be classified as
"held to maturity," "trading" or "available for sale," according to management's
intent and ability.

Debt  securities for which the Bank has the positive  intent and ability to hold
to maturity are reported at cost,  adjusted for premiums and discounts  that are
recognized  in  interest  income  using the  interest  method over the period to
maturity.

                                                                              23

<PAGE>




                                       Bedford Bancshares, Inc. and Subsidiaries

                                                  Summary of Accounting Policies
                                                                     (continued)

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


Investment Securities (continued)

Trading securities, if any, are carried at fair value. Realized gains and losses
on sales and  unrealized  changes in fair  values are  included  in  noninterest
income.

Investments  classified as  "available  for sale" are carried at fair value with
unrealized  gains and losses  excluded  from earnings and reported as a separate
component of stockholders' equity.  Realized gains and losses on these sales are
included  in   noninterest   income  and  are   computed   under  the   specific
identification method.

Loans Held for Sale

Mortgage  loans  originated  and intended for sale in the  secondary  market are
carried at the lower of cost or  estimated  market value in the  aggregate.  Net
unrealized  losses are  recognized  through a valuation  allowance by charges to
income.

Loans Receivable

Loans  receivable  that  management  has the intent and  ability to hold for the
foreseeable   future  or  until  maturity  or  pay-off  are  reported  at  their
outstanding  principal  balance adjusted for any charge-offs,  the allowance for
loan losses,  and any deferred fees or costs on originated loans and unamortized
premiums or discounts on purchased loans.

Loans  receivable  consists  primarily of long-term real estate loans secured by
first deeds of trust on single family  residences,  other residential  property,
commercial  property  and land  located  primarily  in the  state  of  Virginia.
Interest  income on  mortgage  loans is recorded  when earned and is  recognized
based on the level yield method.  The Company  provides an allowance for accrued
interest deemed to be  uncollectible,  which is netted against accrued  interest
receivable in the consolidated balance sheets.

The Company defers loan  origination and commitment  fees, net of certain direct
loan  origination  costs,  and the net deferred fees are amortized into interest
income over the lives of the related loans as yield adjustments. Any unamortized
net fees on loans fully repaid or sold are  recognized  as income in the year of
repayment or sale.

The Company places loans on non-accrual  status after being  delinquent  greater
than 90 days or earlier if the  Company  becomes  aware  that the  borrower  has
entered  bankruptcy  proceedings,  or in  situations  in which  the  loans  have
developed  inherent  problems  prior to being 90 days  delinquent  that indicate
payments of principal or interest will not be made in full. Whenever the accrual
of interest is stopped,  previously  accrued but uncollected  interest income is
reversed. Thereafter,  interest is recognized only as cash is received until the
loan is reinstated.

24

<PAGE>




                                       Bedford Bancshares, Inc. and Subsidiaries

                                                  Summary of Accounting Policies
                                                                     (continued)

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


Loans Receivable (continued)

The allowance for loan losses is maintained at a level  considered by management
to be adequate  to absorb  future  loan  losses  currently  inherent in the loan
portfolio.  Management's  assessment  of the adequacy of the  allowance is based
upon type and volume of the loan portfolio, past loan loss experience,  existing
and  anticipated  economic  conditions,  and other factors which deserve current
recognition  in  estimating  future loan losses.  Additions to the allowance are
charged to  operations.  Loans are  charged-off  partially or wholly at the time
management determines collectability is not probable. Management's assessment of
the adequacy of the  allowance is subject to  evaluation  and  adjustment by the
Company's regulators.

During its  assessment of the allowance  for loan losses,  management  evaluates
loans for  impairment.  A loan is  considered to be impaired when it is probable
that the Company will be unable to collect all  principal  and interest  amounts
according to the contractual terms of the loan agreement. The allowance for loan
losses related to loans  identified as impaired is primarily based on the excess
of the loan's  current  outstanding  principal  balance over the estimated  fair
market   value   of  the   related   collateral.   For  a  loan   that   is  not
collateral-dependent,  the  allowance  is  recorded  at the  amount by which the
outstanding  principal  balance  exceeds the current best estimate of the future
cash flows on the loan  discounted  at the loan's  original  effective  interest
rate.

For impaired loans that are on non-accrual  status,  cash payments  received are
generally applied to reduce the outstanding principal balance. However, all or a
portion of a cash payment  received on a  non-accrual  loan may be recognized as
interest income to the extent allowed by the loan contract,  assuming management
expects to fully collect the remaining principal balance on the loan.

As of  September  30,  1998,  the Company had no loans that were  considered  as
impaired.

Real Estate Owned

Real estate acquired through  foreclosure is initially  recorded at the lower of
fair value,  less  estimated  selling  costs,  or the balance of the loan on the
property  at  date  of  foreclosure.  Costs  relating  to  the  development  and
improvement of property are  capitalized,  whereas those relating to holding the
property are charged to expense.


                                                                              25
<PAGE>




                                       Bedford Bancshares, Inc. and Subsidiaries

                                                  Summary of Accounting Policies
                                                                     (continued)

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


Real Estate Owned (continued)

Valuations are periodically performed by management, and an allowance for losses
is  established  by a charge to operations  if the carrying  value of a property
exceeds its estimated fair value.

Sale of Loans, Participations in Loans

The Company is able to generate  funds by selling  loans and  participations  in
loans  to the  Federal  Home  Loan  Mortgage  Corporation  ("FHLMC")  and  other
investors.  Under  participation  service  agreements,  the Company continues to
service  the  loans  and the  participant  is paid its  share of  principal  and
interest collections.

The Company  allocates  the cost of  acquiring  or  originating  mortgage  loans
between the mortgage  servicing  rights and the loans,  based on their  relative
fair  values,  if the banks  sells or  securitizes  the loans  and  retains  the
mortgage  servicing  rights.  The  Company  assesses  its  capitalized  mortgage
servicing rights for impairment based on the fair value of those rights.

The cost of mortgage  servicing  rights is amortized in proportion  to, and over
the  period  of,  estimated  net  servicing  revenues.  Impairment  of  mortgage
servicing  rights is  assessed  based on the fair  value of those  rights.  Fair
values are  estimated  using  discounted  cash flows  based on a current  market
interest rate. For purposes of measuring  impairment,  the rights are stratified
based on the  predominant  risk  characteristics  of the underlying  loans.  The
amount of impairment  recognized is the amount by which the capitalized mortgage
servicing rights for a stratum exceed their fair value.

Property, Equipment and Depreciation

The  various  classes  of  property  are stated at cost and are  depreciated  by
accelerated and straight-line methods over their estimated useful lives of 30 to
40 years for office buildings,  15 to 20 years for land  improvements,  15 years
for ATM  facilities,  5 to 10 years for  furniture and equipment and 5 years for
automobiles.  Additions  and  improvements  are  capitalized,  while repairs are
expensed as  incurred.  The cost and  accumulated  depreciation  on property are
eliminated  from the accounts upon  disposal,  and any resulting gain or loss is
included in the determination of net income.

Income Taxes

Deferred  income taxes are  recognized  for the tax  consequences  of "temporary
differences" by applying enacted  statutory tax rates applicable to future years
to  differences  between the financial  statement  carrying  amounts and the tax
bases of existing assets and liabilities.


26

<PAGE>




                                       Bedford Bancshares, Inc. and Subsidiaries

                                                  Summary of Accounting Policies

                                                                     (continued)

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


Income Taxes (continued)

For tax years beginning prior to January 1, 1996, savings banks that met certain
definitional tests and other conditions  prescribed by the Internal Revenue Code
were allowed, within limitations, to deduct from taxable income an allowance for
bad debts using the "percentage of taxable  income"  method.  The cumulative bad
debt reserve,  upon which no taxes have been paid, was approximately  $1,206,207
at September 30, 1998.

Section  1616 of the Small  Business  Job  Protection  Act of 1996  (the  "Act")
repealed the  percentage of taxable income method of computing bad debt reserves
and  required  the  recapture  into taxable  income of "excess  reserves,"  on a
ratable basis over the next six years.  Excess  reserves are defined in general,
as the excess of the balance of the tax bad debt reserve  (using the  percentage
of taxable income method) as of the close of the last tax year beginning  before
January 1, 1996 over the  balance of the reserve as of the close of the last tax
year beginning before January 1, 1988. The recapture of the reserves is deferred
if the Company meets the "residential loan requirement" exception, during either
or  both  of the  first  two  years  beginning  after  December  31,  1995.  The
residential  loan  requirement  is met, in general,  if the principal  amount of
residential  loans  made by the  Company  during  the year is not less  than the
Company's  base  "amount."  The base  amount is  defined  as the  average of the
principal amounts of residential loans made during the six most recent tax years
beginning before January 1, 1996.

As a  result  of the  Act,  the  Company  must  recapture  into  taxable  income
approximately  $421,440  ratably over six years,  beginning with the year ending
September 30, 1999. If the  residential  loan  requirement  exception is met, as
discussed  above,  the income will be includable  over the third through  eighth
years following the year ended September 30, 1998.





                                                                              27

<PAGE>




                                       Bedford Bancshares, Inc. and Subsidiaries

                                                  Summary of Accounting Policies
                                                                     (continued)

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


Accounting Pronouncements

In June 1997,  the  Financial  Accounting  Standards  Board issued  Statement of
Financial  Accounting  Standards No. 130, Reporting  Comprehensive  Income (SFAS
130),  which  establishes  standards for reporting and display of  comprehensive
income, its components and accumulated balances. Comprehensive income is defined
to include all changes in equity  except those  resulting  from  investments  by
owners and distributions to owners.  Among other disclosures,  SFAS 130 requires
that all items that are  required  to be  recognized  under  current  accounting
standards  as  components  of  comprehensive  income be  reported in a financial
statement  that is  displayed  with  the  same  prominence  as  other  financial
statements. SFAS 130 is effective for financial statements for periods beginning
after December 15, 1997 and requires  comparative  information for earlier years
to be restated. Management does not expect the application of this pronouncement
to have a material effect on the financial statements of the company.

Earnings Per Share

The  Corporation  adopted  Statement of Financial  Accounting  Standards No. 128
"Earnings Per Share" (SFAS 128), as of December 31, 1997.  SFAS 128 is effective
for financial  statement,  including interim reports,  issued for periods ending
after December 15, 1997.  SFAS 128 provides a different  method for  calculating
earnings  per  share  than was used in  accordance  with APB 15,  "Earnings  Per
Share." SFAS 128 provides for the calculation of basic and diluted  earnings per
share. Basic earnings per share includes no dilution and is computed by dividing
income available to common shareholders by the weighted average number of common
shares  outstanding  for the period.  Diluted  earnings  per share  reflects the
potential  dilution  of  securities  that could  share in earnings of an entity,
similar to fully  diluted  earnings  per  share.  The  computation  of basic and
diluted earnings per share is presented in Note 16.

Statement of Cash Flows

For purposes of the  statements  of cash flows the Company  considers all highly
liquid debt  instruments  with  maturities,  when purchased,  of three months or
less, to be cash  equivalents.  Cash and cash equivalents  include cash on hand,
funds due from banks, and federal funds sold.


28

<PAGE>




                                       Bedford Bancshares, Inc. and Subsidiaries

                                      Notes to Consolidated Financial Statements
                                                                     (continued)

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


1.  Securities

A summary  of the  amortized  cost and  estimated  market  values of  investment
securities, in thousands, is as follows:

<TABLE>
<CAPTION>
September 30, 1998
---------------------------------------------------------------------------------------------------------------------------
                                                                               Gross              Gross          Estimated
                                                          Amortized         Unrealized         Unrealized         Market
                                                            Cost               Gains             Losses            Value
---------------------------------------------------------------------------------------------------------------------------

<S>                                                       <C>                <C>                 <C>              <C>    
Held to Maturity

  United States government
    and agency obligations                                 $ 2,099            $ 33                $ -              $ 2,132

  Mortgage-backed securities                                    15              -                   -                   15
---------------------------------------------------------------------------------------------------------------------------

                                                             2,114              33                  -                2,147
---------------------------------------------------------------------------------------------------------------------------

Available for Sale

  United States government
    and agency obligations                                  12,262             109                  -               12,371

  Marketable Equity securities                               4,411              -                  15                4,396

  Other                                                         53              -                  -                    53
---------------------------------------------------------------------------------------------------------------------------

                                                            16,726             109                 15               16,820
---------------------------------------------------------------------------------------------------------------------------

                                                           $18,840            $142                $15              $18,967
---------------------------------------------------------------------------------------------------------------------------
</TABLE>


Gross  gains of  approximately  $3,000,  $4,000 and  $2,000 and gross  losses of
approximately  $1,000, $0 and $0 were realized on sales of securities  available
for sale during the years ended September 30, 1998, 1997 and 1996, respectively.



                                                                              29

<PAGE>




                                       Bedford Bancshares, Inc. and Subsidiaries

                                      Notes to Consolidated Financial Statements
                                                                     (continued)

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



<TABLE>
<CAPTION>
1.  Securities (continued)

September 30, 1997
---------------------------------------------------------------------------------------------------------------------------
                                                                               Gross              Gross          Estimated
                                                          Amortized         Unrealized         Unrealized         Market
                                                            Cost               Gains             Losses            Value
---------------------------------------------------------------------------------------------------------------------------

<S>                                                       <C>                 <C>                <C>              <C>    
Held to Maturity

  United States government
    and agency obligations                                 $ 4,596             $10                $25              $ 4,581

  Mortgage-backed securities                                    20              -                  -                    20
---------------------------------------------------------------------------------------------------------------------------

                                                             4,616              10                 25                4,601
---------------------------------------------------------------------------------------------------------------------------

Available for Sale

  United States government
    and agency obligations                                   4,991              25                 10                5,006

  Marketable Equity securities                               4,169              16                -                  4,185

  Other                                                         53              -                  -                    53
---------------------------------------------------------------------------------------------------------------------------

                                                             9,213              41                 10                9,244
---------------------------------------------------------------------------------------------------------------------------

                                                           $13,829             $51                $35              $13,845
---------------------------------------------------------------------------------------------------------------------------

</TABLE>



30

<PAGE>




                                       Bedford Bancshares, Inc. and Subsidiaries

                                      Notes to Consolidated Financial Statements
                                                                     (continued)

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


1. Securities (continued)

The amortized cost and estimated market value of debt securities,  in thousands,
at September 30, 1998, by contractual maturity, were as follows:

<TABLE>
<CAPTION>
                                                                                                                 Estimated
                                                                                           Amortized               Market
                                                                                             Cost                   Value
---------------------------------------------------------------------------------------------------------------------------

<S>                                                                                          <C>                   <C>    
Held to Maturity

  Due in one year or less                                                                     $   300               $   300
  Due in one through five years                                                                 1,299                 1,317
  Due after five years                                                                            500                   515
---------------------------------------------------------------------------------------------------------------------------
                                                                                                2,099                 2,132
  Mortgage-backed securities                                                                       15                    15
---------------------------------------------------------------------------------------------------------------------------

                                                                                                2,114                 2,147
---------------------------------------------------------------------------------------------------------------------------

Available for Sale
  Due in one year or less                                                                       5,757                 5,790
  Due in one through five years                                                                 3,004                 3,037
  Due after five years                                                                          3,501                 3,544
---------------------------------------------------------------------------------------------------------------------------
                                                                                               12,262                12,371

Marketable equity securities                                                                    4,411                 4,396

Other                                                                                              53                    53
---------------------------------------------------------------------------------------------------------------------------

                                                                                               16,726                16,820
---------------------------------------------------------------------------------------------------------------------------

                                                                                              $18,840               $18,967
---------------------------------------------------------------------------------------------------------------------------

</TABLE>

Expected maturities can differ from contractual maturities because borrowers may
have the right to call or prepay  obligations with or without call or prepayment
penalties.

                                                                              31
<PAGE>




Bedford Bancshares, Inc. and Subsidiaries

                                      Notes to Consolidated Financial Statements
                                                                     (continued)

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


2.    Loans Receivable

Loans receivable, in thousands, are summarized as follows:

<TABLE>
<CAPTION>
September 30,                                                                                   1998                  1997
---------------------------------------------------------------------------------------------------------------------------

<S>                                                                                          <C>                 <C>     
First mortgage loans                                                                          $100,863            $ 93,791
Construction loans                                                                            13,530                 8,597
Home equity loans                                                                              3,944                 3,972
Loans to depositors, secured by savings                                                          451                   581
Installment loans                                                                             10,129                 9,041
Term notes                                                                                     6,788                 3,705
---------------------------------------------------------------------------------------------------------------------------

                                                                                              135,705              119,687
Less
  Undisbursed loans in process                                                                 4,906                 2,629
  Unearned discount resulting from add-on interest                                               -                       4
  Deferred loan fees and costs, net                                                              291                   283
  Allowance for credit losses                                                                    764                   678
---------------------------------------------------------------------------------------------------------------------------

                                                                                              $129,744            $116,093
---------------------------------------------------------------------------------------------------------------------------
</TABLE>


Activity in the allowance  for credit  losses,  in  thousands,  is summarized as
follows:

<TABLE>
<CAPTION>
Year Ended September 30,                                                       1998               1997                1996
---------------------------------------------------------------------------------------------------------------------------

<S>                                                                           <C>                <C>                 <C> 
Balance at beginning of year                                                   $678               $650                $640
Provision charged to operations                                                  90                100                  22
Charge offs net of recoveries                                                    (4)               (72)                (12)
---------------------------------------------------------------------------------------------------------------------------

Balance at end of year                                                         $764               $678                $650
---------------------------------------------------------------------------------------------------------------------------

</TABLE>



32

<PAGE>




                                       Bedford Bancshares, Inc. and Subsidiaries

                                      Notes to Consolidated Financial Statements
                                                                     (continued)

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


3.    Loan Servicing

Mortgage  loans  serviced  for  others  are  not  included  in the  accompanying
statements of financial condition. The unpaid principal balances of those loans,
in thousands, are summarized as follows:


<TABLE>
<CAPTION>

September 30,                                                                  1998               1997                1996
---------------------------------------------------------------------------------------------------------------------------

<S>                                                                         <C>                <C>                 <C>   
Federal Home Loan Mortgage Corporation (FHLMC)                               $1,361             $1,719              $1,472
Virginia Housing Development Authority (VHDA)                                 1,097              1,184               1,245
---------------------------------------------------------------------------------------------------------------------------

                                                                             $2,458             $2,903              $2,717
---------------------------------------------------------------------------------------------------------------------------
</TABLE>


4.    Property and Equipment

Property and equipment, in thousands, are summarized as follows:

<TABLE>
<CAPTION>

September 30,                                                                                       1998              1997
---------------------------------------------------------------------------------------------------------------------------

<S>                                                                                              <C>               <C>   
Land                                                                                              $  251            $  251
Office buildings                                                                                   1,203             1,195
Rental buildings                                                                                      48                48
Furniture, fixtures and equipment                                                                    953               886
Automobile                                                                                            25                16
Leasehold improvements                                                                                20                22
---------------------------------------------------------------------------------------------------------------------------

                                                                                                   2,500             2,418
Less accumulated depreciation                                                                      1,340             1,204
---------------------------------------------------------------------------------------------------------------------------

                                                                                                  $1,160            $1,214
---------------------------------------------------------------------------------------------------------------------------

</TABLE>



                                                                              33

<PAGE>




                                       Bedford Bancshares, Inc. and Subsidiaries

                                      Notes to Consolidated Financial Statements
                                                                     (continued)

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


5.  Deposits

Deposits, in thousands, are summarized as follows:

<TABLE>
<CAPTION>

September 30,                                                    1998                         1997
-------------------------------------------------------------------------------------------------------------------

                                                        Amount       Percent          Amount      Percent
-------------------------------------------------------------------------------------------------------------------

<S>                                                   <C>             <C>            <C>           <C>   
NOW accounts                                           $ 15,941        14.89%         $  11,910     11.49%
Money market accounts                                     4,799         4.48            5,862        5.66
Savings accounts                                         15,611        14.58           14,980       14.46
Time deposits                                            70,735        66.05           70,860       68.39
-------------------------------------------------------------------------------------------------------------------

                                                       $107,086       100.00%         $103,612     100.00%
-------------------------------------------------------------------------------------------------------------------

</TABLE>


The  aggregate  amount  of  certificates  of  deposit  of  $100,000  or more was
approximately  $10,416,000  and  $8,677,000  at  September  30,  1998 and  1997,
respectively.

At September 30, 1998, the scheduled maturities of time deposits,  in thousands,
are as follows:

                  Year ending September 30,
                  --------------------------------------------------------------

                            1999                                     $38,107
                            2000                                      16,291
                            2001                                      14,539
                            2002                                         518
                         Thereafter                                    1,280
                  --------------------------------------------------------------

                                                                     $70,735
                  --------------------------------------------------------------


Interest expense on deposits, in thousands, is summarized as follows:

<TABLE>
<CAPTION>

Year ended September 30,                                                             1998        1997        1996
-------------------------------------------------------------------------------------------------------------------

<S>                                                                               <C>          <C>        <C>   
NOW accounts                                                                       $  182       $  194     $  197
Money market account                                                                  149          145        160
Savings account                                                                       454          445        458
Time deposits                                                                       3,779        3,518      3,313
-------------------------------------------------------------------------------------------------------------------

                                                                                   $4,564       $4,302     $4,128
-------------------------------------------------------------------------------------------------------------------

</TABLE>



34

<PAGE>




                                       Bedford Bancshares, Inc. and Subsidiaries

                                      Notes to Consolidated Financial Statements
                                                                     (continued)

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


6.    Advances from Federal Home Loan Bank

Borrowings  ("advances") from the Federal Home Loan Bank ("FHLB"), in thousands,
are scheduled to mature as follows:

<TABLE>
<CAPTION>

September 30,                                                                                      1998              1997
---------------------------------------------------------------------------------------------------------------------------

<S>                                                                                             <C>               <C>    
Within one year                                                                                  $ 1,000           $ 6,000
One to two years                                                                                   4,000             1,000
Two years or more                                                                                 24,000             8,000
---------------------------------------------------------------------------------------------------------------------------


                                                                                                 $29,000           $15,000
---------------------------------------------------------------------------------------------------------------------------

</TABLE>


The weighted  average  interest  rate on advances at September 30, 1998 and 1997
was 5.55% and 6.01%,  respectively.  These  advances are  collateralized  by the
Company's  investment  in FHLB stock and  qualifying  real estate  loans under a
blanket collateral  agreement.  Certain advances are subject to call dates which
result in earlier maturities.

Information  related to  borrowing  activity  from the Federal Home Loan Bank in
thousands is as follows:

<TABLE>
<CAPTION>

Year Ended September 30,                                                       1998                1997              1996
---------------------------------------------------------------------------------------------------------------------------

<S>                                                                          <C>                 <C>               <C>    
Maximum amount outstanding during the year                                   $31,000             $16,000           $12,000
---------------------------------------------------------------------------------------------------------------------------

Average amount outstanding during the year                                    22,487              12,249             6,333
---------------------------------------------------------------------------------------------------------------------------

Average interest rate during the year                                           5.54%               6.07%             5.85%
---------------------------------------------------------------------------------------------------------------------------

</TABLE>




                                                                              35

<PAGE>




                                       Bedford Bancshares, Inc. and Subsidiaries

                                      Notes to Consolidated Financial Statements
                                                                     (continued)

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


7.    Fair Value of Financial Instruments

The estimated fair values of the Company's financial instruments,  in thousands,
are as follows:

<TABLE>
<CAPTION>

September 30,                                                             1998                             1997
---------------------------------------------------------------------------------------------------------------------------


                                                              Carrying            Fair         Carrying             Fair
                                                               Amount             Value         Amount              Value
---------------------------------------------------------------------------------------------------------------------------

<S>                                                          <C>              <C>              <C>               <C>     
Financial assets
  Cash and short-term investments                             $ 5,666          $ 5,666          $  5,446          $  5,446
  Securities                                                   18,934           18,967            13,860            13,845
  Loans, net of allowance for loan losses                     129,744          130,667           116,093           117,402

Financial liabilities
  Deposits                                                    107,086          107,530           103,612           103,937
  Advances from Federal Home Loan Bank                         29,000           29,000            15,000            15,000

                                                              Notional            Fair          Notional              Fair
                                                                Amount           Value            Amount             Value
---------------------------------------------------------------------------------------------------------------------------

Unrecognized financial instruments
  Commitments to extend credit                                  $8,173          $8,173            $7,020            $7,020

</TABLE>

The following  methods and  assumptions  were used to estimate the fair value of
each class of financial instruments for which it is practicable to estimate that
value.

Cash and short-term investments
-------------------------------

For these short-term  investments,  the carrying amount is a reasonable estimate
of fair value.

Securities
----------

Fair  values are based on quoted  market  prices or dealer  quotes.  If a quoted
market  price is not  available,  fair value is estimated  using  quoted  market
prices for similar securities.



36

<PAGE>




                                       Bedford Bancshares, Inc. and Subsidiaries

                                      Notes to Consolidated Financial Statements
                                                                     (continued)

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


7.    Fair Value of Financial Instruments (continued)

Loan receivables
----------------

The fair value of loans is estimated by discounting  the future cash flows using
the current rates at which similar loans would be made to borrowers with similar
remaining  maturities.  This  calculation  ignores loan fees and certain factors
affecting the interest  rates  charged on various  loans such as the  borrower's
creditworthiness  and compensating  balances and dissimilar types of real estate
held as collateral.

Deposit liabilities
-------------------

The fair value of demand deposits,  savings  accounts,  and certain money market
deposits  is the amount  payable on demand at the balance  sheet date.  The fair
value of  fixed-maturity  certificates  of deposit is estimated  using the rates
currently offered for deposits of similar remaining maturities.

Advances from Federal Home Loan Bank
------------------------------------

For advances  that mature  within one year of the balance  sheet date,  carrying
value is considered a reasonable estimate of fair value.

The fair values of all other advances are estimated  using  discounted cash flow
analysis based on the Company's current  incremental  borrowing rate for similar
types of advances.

Commitments to extend credit
----------------------------

The fair value of commitments is estimated  using the fees currently  charged to
enter into similar  agreements,  taking into account the remaining  terms of the
agreements and the present  creditworthiness  of the  borrowers.  For fixed-rate
loan  commitments,  fair value also  considers the  difference  between  current
levels of interest  rates and the committed  rates.  Because of the  competitive
nature of the  marketplace  loan fees vary  greatly with no fees charged in many
cases.


                                                                              37

<PAGE>




                                       Bedford Bancshares, Inc. and Subsidiaries

                                      Notes to Consolidated Financial Statements
                                                                     (continued)

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


8. BIF/SAIF Premium Disparity Assessment

Pursuant to the Economic Growth and Paperwork Reduction Act of 1996 (the "Act"),
the FDIC imposed a special  assessment on SAIF members to capitalize the SAIF at
the  designated  reserve level of 1.25% as of September  30, 1996.  Based on the
Company's  deposits as of March 31, 1995,  the date for  measuring the amount of
the  special  assessment  pursuant  to the  Act,  the  Company  paid  a  special
assessment of $555,000 on November 27, 1996 to capitalize the SAIF.

9.    Income Taxes

The provision for income taxes, in thousands, is summarized as follows:

<TABLE>
<CAPTION>
Year Ended September 30,                                                           1998             1997             1996
---------------------------------------------------------------------------------------------------------------------------

<S>                                                                              <C>              <C>               <C>     
Current
  Federal                                                                         $1,066             $517             $816
  State                                                                              186              152               97
---------------------------------------------------------------------------------------------------------------------------

                                                                                   1,252              669              913

Deferred tax expense (benefit)                                                       (92)             305             (159)
---------------------------------------------------------------------------------------------------------------------------

Total provision for income taxes                                                  $1,160             $974             $754
---------------------------------------------------------------------------------------------------------------------------

</TABLE>

Differences  between the statutory  and  effective  tax rates are  summarized as
follows:


<TABLE>
<CAPTION>
                                                                                                   Percent of Pre-tax Income    
Year Ended September 30,                                                            1998             1997             1996
---------------------------------------------------------------------------------------------------------------------------

<S>                                                                                <C>              <C>              <C>  
Tax at statutory rate                                                               34.0%            34.0%            34.0%
Increases (decreases) in taxes resulting from:
  State income taxes, net of federal benefit                                         5.6              4.5              3.6
  Other                                                                             (2.6)             (.5)             (.9)
---------------------------------------------------------------------------------------------------------------------------

Tax at effective rate                                                               37.0%            38.0%           36.7%
---------------------------------------------------------------------------------------------------------------------------

</TABLE>

   
38
<PAGE>


                                       Bedford Bancshares, Inc. and Subsidiaries

                                      Notes to Consolidated Financial Statements
                                                                     (continued)

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

9.    Income Taxes (continued)

The components of the net deferred tax asset, in thousands, were as follows:

September 30,                                           1998              1997
--------------------------------------------------------------------------------

Deferred tax asset
  Bad debts                                             $130              $ 91
  Loan fees                                               46                 5
--------------------------------------------------------------------------------

Total deferred tax asset                                 176                96
--------------------------------------------------------------------------------

Deferred tax liability
  Accelerated depreciation                               (13)               (8)
  Unrealized gain on securities, available for sale      (35)               (6)
  Distributive share of income from partnership          (18)               -
  Other                                                  (15)              (24)
--------------------------------------------------------------------------------

Total deferred tax liability                             (81)              (38)
--------------------------------------------------------------------------------

Net deferred tax asset                                  $ 95              $ 58
--------------------------------------------------------------------------------

10.   Restricted Retained Earnings

In accordance with the current regulations  concerning  conversion from a mutual
to  a  stock  organization,  the  Savings  Bank  was  required  to  establish  a
liquidation  account  equal to its net  worth  as of the  latest  balance  sheet
contained in the final  offering  circular.  Such  liquidation  account is to be
maintained  for the benefit of  depositors,  as of the  eligibility  record date
(September 30, 1993) who continue to maintain their deposits in the Savings Bank
after the  conversion,  in the event of a complete  liquidation  of the  Savings
Bank. If, however,  on any annual closing date of the Savings Bank subsequent to
September 30, 1993, the amount in any deposit account is less than the amount in
such deposit account on September 30, 1993, then the interest in the liquidation
account  relating to such deposit account would be reduced by the amount of such
reduction,  and such  interest  will cease to exist if such  deposit  account is
closed.  The Savings Bank may not declare or pay a cash  dividend or  repurchase
any of its capital stock if the effect  thereof would cause the net worth of the
Savings Bank to be reduced below either the amount  required for the liquidation
account or the minimum regulatory capital  requirements.  At September 30, 1998,
the  liquidation   account,   unadjusted  for  customer   withdrawals,   totaled
$6,144,000.

                                                                              39

<PAGE>

                                       Bedford Bancshares, Inc. and Subsidiaries

                                      Notes to Consolidated Financial Statements
                                                                     (continued)
--------------------------------------------------------------------------------

11.   Retirement Plans and Employee Benefit Programs

The Savings  Bank has a  retirement  plan under  Internal  Revenue  Code Section
401(k) covering all full-time  employees who have completed one or more years of
continuous  service  and have  reached age 21.  Each  employee  has an option to
voluntarily  contribute  to this plan up to 10% of their  salary and the Savings
Bank will match $.50 for every $1 up to 4% of salary.  During  fiscal 1993,  the
plan also  provided for the Savings Bank to pay into the plan an amount equal to
10% of each  employee's  salary,  subject to  Department of Labor and Income Tax
Limitationa. Effective October 1, 1993, this 10% contribution was eliminated and
a new money  purchase  plan was adopted  which  provides for a fixed  percentage
contribution  for each employee's  salary.  This percentage was 5% for the years
ended September 30, 1998, 1997 and 1996, respectively. The total expense for the
plan was $61,000,  $60,000,  and $54,000 for the years ended September 30, 1998,
1997 and 1996, respectively.

Employee Stock Ownership Plan

At the time of the stock  conversion,  the Savings Bank  established an Employee
Stock  Ownership Plan (ESOP) covering all full-time  employees,  over the age of
21, with at least one year of service.  The ESOP borrowed  funds from the Parent
Company to  purchase a total of 160,000  shares of the Parent  Company's  Common
Stock, the loan being  collateralized by the Common Stock.  Contributions by the
Savings Bank, along with dividends  received on unallocated  shares, are used to
repay the loan  with  shares  being  released  from the  Parent  Company's  lien
proportional  to the loan  repayments.  Annually on  September  30, the released
shares are allocated to the participants in the same proportion that their wages
bear to the total  compensation  of all of the  participants.  The  Company  has
released and allocated  66,666 and 50,666 shares of Common Stock as of September
30, 1998 and 1997, respectively. The Company recognized $138,000 and $196,000 of
compensation cost for the years ended September 30, 1998 and 1997, respectively.
The fair value of unearned ESOP shares totaled $1,027,000 at September 30, 1998.
There were no commitments to repurchase ESOP shares.

Shares pledged as collateral are reported as a reduction of stockholders' equity
in the consolidated balance sheets. As shares are released from collateral,  the
Company  reports  compensation  expense equal to the current market price of the
shares, and the shares become  outstanding for earnings per share  computations.
Dividends  on  allocated  ESOP shares are  recorded  as a reduction  of retained
earnings,  and dividends on unallocated  ESOP shares are recorded as a reduction
of debt.

40

<PAGE>

                                       Bedford Bancshares, Inc. and Subsidiaries

                                      Notes to Consolidated Financial Statements
                                                                     (continued)

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

11.   Retirement Plans and Employee Benefit Programs (continued)

Recognition and Retention Plan

The Board of Directors approved the establishment of a Recognition and Retention
Plan  ("RRP") on January 25, 1995.  The plan states that the Trust,  established
under  the plan,  shall not  purchase  more than 4% of the  aggregate  shares of
Common Stock issued by the Parent Company in the  mutual-to-stock  conversion of
the Savings Bank (100,510  shares).  The costs of the shares awarded under these
plans are recorded as unearned  compensation,  a contra equity account,  and are
recognized as an expense in accordance with the vesting  requirements  under the
various  plans.  For the years ended  September  30,  1998 and 1997,  the amount
included in  compensation  expense was $104,000 and $87,000,  respectively.  The
status of the shares in this plan is summarized as follows:

                                      Weighted
                                       Average
                                       Share        Unawarded          Awarded
                                       Price          Shares            Shares
--------------------------------------------------------------------------------

Balance at September 30, 1996           $8.38          13,394            64,552

Granted                                  9.38          (5,000)            5,000
Vested                                   5.65             -             (17,908)
--------------------------------------------------------------------------------

Balance at September 30, 1997            6.10           8,394            51,644

Granted                                   -               -                 -
Vested                                   5.92             -             (16,224)
--------------------------------------------------------------------------------

Balance at September 30, 1998           $6.18           8,394            35,420
--------------------------------------------------------------------------------


                                                                              41

<PAGE>

                                       Bedford Bancshares, Inc. and Subsidiaries

                                      Notes to Consolidated Financial Statements
                                                                     (continued)

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

11.   Retirement Plans and Employee Benefit Programs (continued)

Stock Option Plans

The Company  established  two stock option plans  during  1995,  for  directors,
officers and  employees.  The exercise price under both plans is the fair market
price on the date of the grant. One is a non-incentive stock option plan and the
other is an incentive stock option plan. Rights to exercise options granted vest
at the rate of 20% per year,  beginning on the first anniversary of the grant. A
summary of the stock option activity is as follows:



                                 Weighted
                                  Average
                                 Exercise  Available     Options      Vested and
                                  Price    for Grant    Outstanding  Exercisable
--------------------------------------------------------------------------------

Balance at September 30, 1996     $5.72     33,494        161,408      47,998

Granted                            9.38    (12,500)        12,500         -
Vested                             5.65        -          (44,754)     44,754
--------------------------------------------------------------------------------

Balance at September 30, 1997      5.87     20,994        129,154      92,752

Granted                             -          -              -           -
Vested                              -          -          (40,555)     40,555
Exercised                          5.50        -              -       (18,792)
--------------------------------------------------------------------------------

Balance at September 30, 1998     $6.18     20,994         88,599     114,515
--------------------------------------------------------------------------------

The remaining  contractual  lives of the options  granted in 1998, 1997 and 1996
are 6.3 years, 7.3 years and 8.3 years,  respectively at September 30, 1998. The
weighted  average  remaining  contractual  life of total options is 6.5 years at
September 30, 1998.


42

<PAGE>

                                       Bedford Bancshares, Inc. and Subsidiaries

                                      Notes to Consolidated Financial Statements
                                                                     (continued)

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

11.   Retirement Plans and Employee Benefit Programs (continued)

The Company applies APB Opinion 25 and related interpretations in accounting for
its  plan.   Accordingly,   no  compensation  cost  has  been  recognized.   Had
compensation  cost for the Company's stock option plan been determined  based on
the fair value at the grant date  consistent  with the methods of SFAS 123,  the
Company's net income and net income per share would have been reduced to the pro
forma amounts  indicated  below. In accordance with the transition  provision of
SFAS 123, the pro forma amounts reflect  options with grant dates  subsequent to
April 1, 1996.

Year Ended September 30,                       1998          1997        1996
--------------------------------------------------------------------------------

Net income 
  As reported                                 $1,973        $1,591      $1,302
  Pro forma                                    1,973         1,310       1,020


Year Ended September 30,            1998               1997              1996
--------------------------------------------------------------------------------

Net income per share      Basic    Diluted    Basic   Diluted   Basic   Diluted
--------------------------------------------------------------------------------
  As reported              .90       .85       .70     .70      .59      .56
  Pro forma                .90       .85       .61     .57      .46      .43

For purposes of computing the pro forma amounts  indicated above, the fair value
of each option on the date of grant is estimated using the Black-Scholes options
pricing model with the  following  assumptions  for the grant in 1997:  dividend
yield of 2%, expected  volatility of 15%,  risk-free  interest rate of 8% and an
expected option life of 5 years.

12.   Commitments and Contingencies

The Savings Bank is lessee under a five-year operating lease expiring August 18,
2001 for the land at its  Moneta  branch at an annual  rental of $4,800 for five
years. The Savings Bank also leases ATM space in Moneta, under a five year lease
expiring in August 18, 2001 at an annual rental of $2,400.



                                                                              43

<PAGE>

                                       Bedford Bancshares, Inc. and Subsidiaries

                                      Notes to Consolidated Financial Statements
                                                                     (continued)

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

12.   Commitments and Contingencies (continued)

The current minimum annual rental  commitments  under  non-cancelable  operating
leases in effect at September 30, 1998 are as follows:

               Year Ending September 30,                           Amount
               --------------------------------------------------------------

                         1999                                     $ 7,200
                         2000                                       7,200
                         2001                                       6,600
                -------------------------------------------------------------

                                                                  $21,000
                -------------------------------------------------------------

Rent  expense was  approximately  $7,000,  $7,400 and $6,100 for the years ended
September 30, 1998, 1997, and 1996 respectively.

The Savings Bank is a party to financial instruments with off-balance-sheet risk
in the normal course of business to meet the financing  needs of its  customers.
These  financial  instruments  consist of commitments  to extend  credit.  These
instruments  involve,  to varying degrees,  elements of credit risk in excess of
the amount recognized in the statements of financial  position.  The contract or
notional  amounts of those  instruments  reflect the extent of  involvement  the
Savings Bank has in a particular class of financial instruments.

The Savings Bank's  exposure to credit loss in the event of  non-performance  by
the other party to the financial  instrument for commitments to extend credit is
represented  by  the  contractual   notional  amount  (in  thousands)  of  those
instruments  at  September  30, 1998 and 1997.  The  Savings  Bank uses the same
credit policies in making commitments and conditional obligations as it does for
on-balance-sheet instruments.

September 30,                                          1998              1997
--------------------------------------------------------------------------------

Financial instruments, in thousands,
whose contract amounts represent credit risk
   Unfunded commercial credit line                   $1,403           $    66
   Unfunded home equity lines of credit               4,978             4,071
   Commitments to finance real estate
   acquisitions and construction                      1,792             2,883
--------------------------------------------------------------------------------

                                                     $8,173            $7,020
--------------------------------------------------------------------------------

Commitments  to extend  credit are  agreements  to lend to a customer as long as
there is no violation of any condition established in the contract.  Commitments
generally  have fixed  expiration  dates or other  termination  clauses  and may
require payment of a fee. Since many of the commitments are expected to be drawn
upon, the total commitment amounts generally represent future cash requirements.
The Savings Bank evaluates each customer's  credit-worthiness  on a case-by-case
basis.  The amount of collateral,  if deemed  necessary by the Savings Bank upon
extension of credit,  is based on management's  credit  evaluation of the credit
applicant.  Collateral normally consists of real property.

44

<PAGE>

                                       Bedford Bancshares, Inc. and Subsidiaries

                                      Notes to Consolidated Financial Statements
                                                                     (continued)

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

13.   Concentrations of Credit Risk

The Savings  Bank  grants  residential,  commercial,  and  installment  loans to
customers  in the Central  Southwest  region of  Virginia,  principally  Bedford
County.  The  Savings  Bank  has a  loan  portfolio  consisting  principally  of
residential  mortgage loans,  and is not dependent upon any particular  economic
sector,  although the  portfolio as a whole may be affected by general  economic
factors in its lending area.

14.   Related Party Transactions

The  Company  has made  loans in the  ordinary  course of  business  to  various
officers and directors  generally  collateralized  by the individual's  personal
residences or by savings  accounts in the Savings Bank.  These loans are made on
substantially  the same  terms as those  prevailing  at the time for  comparable
transactions  with other borrowers.  The aggregate  balances of such loans which
exceed  $60,000 in  aggregate  outstanding  amount to any  executive  officer or
director,  at September  30,  1998,  1997 and 1996 are  approximately  $826,000,
$819,000 and $641,000, respectively.


                                                                              45

<PAGE>

                                       Bedford Bancshares, Inc. and Subsidiaries

                                      Notes to Consolidated Financial Statements
                                                                     (continued)

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

15.   Regulatory Capital of the Savings Bank

The  Office  of  Thrift   Supervision's   capital   regulations  require  thrift
institutions to maintain capital at least sufficient to meet three requirements:
tangible  capital,   core  capital,  and  risk-based  capital.   Management  has
determined  that the Savings  Bank's capital meets and exceeds all three capital
requirements  as follows as of  September  30, 1998 and 1997.  Tangible and core
capital  levels  are  shown  as a  percentage  of  adjusted  total  assets,  and
risk-based capital levels are shown as a percentage of risk-weighted assets.

<TABLE>
<CAPTION>

                                Amount              Percent            Actual              Actual               Excess
September 30, 1998             Required            Required            Amount              Percent              Amount
---------------------------------------------------------------------------------------------------------------------------
<S>                          <C>                    <C>               <C>                  <C>                 <C>        
Tangible Capital             $2,383,000             1.50%             $19,192,000          12.1%               $16,809,000
Core Capital                  6,355,000             4.00               19,192,000          12.1                 12,837,000
Risk-based Capital            7,353,000             8.00               19,857,000          21.6                 12,504,000
                                  
</TABLE>

<TABLE>
<CAPTION>
       
                                Amount              Percent            Actual              Actual               Excess
September 30, 1997             Required            Required            Amount              Percent              Amount
---------------------------------------------------------------------------------------------------------------------------
<S>                          <C>                    <C>               <C>                  <C>                 <C>        
Tangible Capital             $2,094,000             1.50%             $17,301,000          12.4%               $15,207,000
Core Capital                  4,187,000             3.00               17,301,000          12.4                 13,114,000
Risk-based Capital            6,296,000             8.00               17,887,000          22.7                 11,591,000

</TABLE>
                                          
The Bank may not declare or pay a cash dividend or repurchase any of its capital
stock, if the effect thereof would cause the net worth of the Bank to be reduced
below certain requirements imposed by Federal regulations.


46

<PAGE>

                                       Bedford Bancshares, Inc. and Subsidiaries

                                      Notes to Consolidated Financial Statements
                                                                     (continued)

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

Note 16. Earnings Per Share

On May 20, 1998,  the Board of Directors  declared a 100% stock  dividend in the
form of a  two-for-one  stock  split  to be  distributed  June  15,  1998 to all
shareholders  of record as of June 1, 1998. All  applicable  share and per share
data have been adjusted for the stock dividend.

Earnings per share is calculated as follows:

<TABLE>
<CAPTION>

Year Ended September 30,                                1998             1997             1996
----------------------------------------------------------------------------------------------------
<S>                                                 <C>               <C>               <C>       
Basic earnings

Income available to common shareholders             $1,973,000        $1,591,000        $1,302,000
----------------------------------------------------------------------------------------------------

Weighted average share outstandings                  2,182,617         2,164,432         2,225,394
----------------------------------------------------------------------------------------------------

Basic earnings per share                            $      .90        $      .74        $      .59
----------------------------------------------------------------------------------------------------


Diluted earnings per share

Income available to common shareholders             $1,973,000        $1,591,000        $1,302,000
----------------------------------------------------------------------------------------------------

Weighted average shares outstanding                  2,182,617         2,164,432         2,225,394

  Diluted effect of RRP plan shares                     43,238            41,082            35,317

  Diluted effect on stock options                       93,887            93,601            92,624
----------------------------------------------------------------------------------------------------

Total weighted average shares outstanding            2,319,742         2,299,115         2,353,335
----------------------------------------------------------------------------------------------------

Diluted earnings per share                          $      .85        $      .70        $      .56
----------------------------------------------------------------------------------------------------
</TABLE>


                                                                              47

<PAGE>

                                       Bedford Bancshares, Inc. and Subsidiaries

                                      Notes to Consolidated Financial Statements
                                                                     (continued)

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

17.   Condensed Parent Company Information

Condensed financial information is shown for the Parent Company as follows:

                                 Balance Sheets
                                 (in thousands)

September 30,                                          1998             1997
--------------------------------------------------------------------------------

Assets
  Cash and cash equivalents                           $   379         $    715
  Securities                                              103              114
  Investment in Savings Bank subsidiary                19,251           17,300
  Loan to Savings Bank subsidiary                       2,000            2,000
  Other assets                                            123              162
--------------------------------------------------------------------------------

Total assets                                          $21,856          $20,291
--------------------------------------------------------------------------------


Liabilities and stockholders' equity
  Other liabilities                                   $   424         $    524
  Dividends payable                                       184              160
  Stockholders' equity                                 21,248           19,607
--------------------------------------------------------------------------------

Total liabilities and stockholders' equity            $21,856          $20,291
--------------------------------------------------------------------------------

48

<PAGE>

                                       Bedford Bancshares, Inc. and Subsidiaries

                                      Notes to Consolidated Financial Statements
                                                                     (continued)

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

17.   Condensed Parent Company Information (continued)

                       Condensed Statements of Operations
                                 (in thousands)

Year Ended September 30,                            1998       1997       1996
-------------------------------------------------------------------------------

Income
  Interest
    Savings Bank's ESOP loan                      $   34     $   40     $   44
    Loan to Savings Bank subsidiary                  170        218        292
    Other                                             57         41         23
-------------------------------------------------------------------------------

Total income                                         261        299        359
-------------------------------------------------------------------------------

Expenses
  Professional fees                                  108         42         44
  Other operating expenses                            25         36         40
-------------------------------------------------------------------------------

Total expenses                                       133         78         84
-------------------------------------------------------------------------------

Net income before income taxes and equity in
  undistributed net income of Savings Bank
  subsidiary                                         128        221        275

Provision for income taxes                            48         84        104
Equity in undistributed net income of Savings
Bank subsidiary                                    1,893      1,454      1,131
-------------------------------------------------------------------------------

Net income                                        $1,973     $1,591     $1,302
-------------------------------------------------------------------------------

                                                                              49

<PAGE>


                                       Bedford Bancshares, Inc. and Subsidiaries
 
                                      Notes to Consolidated Financial Statements
                                                                     (continued)

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

17.   Condensed Parent Company Information (continued)

                       Condensed Statements of Cash Flows
                                 (in thousands)

Year Ended September 30,                              1998       1997      1996
--------------------------------------------------------------------------------

Operating activities
  Net income                                        $1,973     $1,591    $1,302
  Adjustments
    Equity in undistributed net income of Savings
      Bank subsidiary                               (1,893)    (1,454)   (1,131)
    (Increase) decrease in other assets                 50        (79)       (3)
    Increase (decrease) in other liabilities           (76)       189      (130)
--------------------------------------------------------------------------------

Net cash provided by operating activities               54        247        38
--------------------------------------------------------------------------------

Investing activities
  Loans originated, net of principal repayments         80      1,080     1,080
  Purchase of Savings Bank subsidiary stock            -          -         -
  Purchase of investment securities                    -          (72)      -
--------------------------------------------------------------------------------

Net cash provided by investing activities               80      1,008     1,080
--------------------------------------------------------------------------------

Financing activities
  Proceeds from sale of stock                          -          -         -
  Purchase of stock, by RRP                            (86)       (23)      -
  Dividends paid                                      (665)      (571)     (518)
  Repurchase of stock                                  -          -      (1,115)
  RRP vesting                                          (57)       (95)      (42)
  ESOP note payment                                    235        -         135
  Exercise of option                                   103        -          45
--------------------------------------------------------------------------------

Net cash absorbed by financing activities             (470)      (689)   (1,495)
--------------------------------------------------------------------------------

Increase (decrease) in cash and cash equivalents      (336)       566      (377)

Cash and cash equivalents, beginning of year           715        149       526
--------------------------------------------------------------------------------

Cash and cash equivalents, end of year              $  379     $  715    $  149
--------------------------------------------------------------------------------

50

<PAGE>


                                       Bedford Bancshares, Inc. and Subsidiaries
 
                                      Notes to Consolidated Financial Statements
                                                                     (continued)

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

18.   Selected Quarterly Financial Data (Unaudited)

Condensed quarterly  consolidated financial data, in thousands (except per share
data), is shown as follows:

                                        First       Second      Third     Fourth
Year Ended September 30, 1998          Quarter      Quarter     Quarter  Quarter
--------------------------------------------------------------------------------

Total interest income                   $2,668      $2,725      $2,935    $2,971
Total interest expense                   1,371       1,379       1,504     1,555
--------------------------------------------------------------------------------

Net interest income                      1,297       1,346       1,431     1,416
Provision for credit losses                 30          30          30       -
--------------------------------------------------------------------------------

Net interest income after provision
  for credit losses                      1,267       1,316       1,401     1,416

Noninterest income                         187         224         202       250
Noninterest expense                        835         790         766       739
--------------------------------------------------------------------------------

Income before income taxes                 619         750         837       927
Provision for income taxes                 235         290         325       310
--------------------------------------------------------------------------------

Net income                              $  384      $  460      $  512    $  617
--------------------------------------------------------------------------------

Cash dividends declared per share       $  .07      $  .07      $  .08    $  .08
--------------------------------------------------------------------------------

Basic earnings per share                $  .18      $  .21     $   .23    $  .28
Diluted earnings per share              $  .16      $  .20     $   .23    $  .26
--------------------------------------------------------------------------------

                                                                              51

<PAGE>

                                       Bedford Bancshares, Inc. and Subsidiaries

                                      Notes to Consolidated Financial Statements
                                                                     (continued)

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

18.   Selected Quarterly Financial Data (Unaudited) (continued)

                                          First     Second      Third     Fourth
Year Ended September 30, 1997            Quarter    Quarter    Quarter   Quarter
--------------------------------------------------------------------------------

Total interest income                   $2,462      $2,539     $2,586     $2,693
Total interest expense                   1,268       1,252      1,292      1,355
--------------------------------------------------------------------------------

Net interest income                      1,194       1,287      1,294      1,338
Provision for credit losses                 25          25         25         25
--------------------------------------------------------------------------------

Net interest income after provision
  for credit losses                      1,169       1,262      1,269      1,313

Noninterest income                         155         145        154        139
Noninterest expense                        749         740        766        786
--------------------------------------------------------------------------------

Income before income taxes                 575         667        657        666
Provision for income taxes                 218         253        250        253
--------------------------------------------------------------------------------

Net income                               $ 357      $  414     $  407     $  413
--------------------------------------------------------------------------------

Cash dividends declared per share        $ .06      $  .07     $  .07     $  .07
--------------------------------------------------------------------------------

Basic earnings per share                 $ .17      $  .19     $  .19     $  .19
Diluted earnings per share               $ .16      $  .18     $  .18     $  .18
--------------------------------------------------------------------------------







52


<PAGE>
                                OFFICE LOCATIONS

                                CORPORATE OFFICE

           Bedford Bancshares, Inc. and Bedford Federal Savings Bank
                               125 W. Main Street
                               Bedford, VA 24523
                                 (540) 586-2590

                 BRANCH OFFICES - BEDFORD FEDERAL SAVINGS BANK

     Moneta Office                                                 Forest Office
     1152 Hendricks Store Rd.                                   14915 Forest Rd.
     Moneta, VA 24121                                           Forest, VA 24551
     (540) 297-1233                                               (804) 525-2000

Board of Directors of Bedford Bancshares, Inc. and Bedford Federal Savings Bank
                                  Hugh H. Bond
                              Chairman of the Board

     George N. Cooper                                          William T. Powell

     Harry W. Garrett, Jr.                                     Macon C. Putney

     Harold K. Neal                                         W. Henry Walton, Jr.

     William P. Pickett            

Executive Officers of Bedford Bancshares, Inc. and Bedford Federal Savings Bank

     Harold K. Neal                                               James W. Smith
     President                                     Vice President, Treasurer and
     and Chief Executive Officer                         Chief Financial Officer

     Russell E. Millner                                          Nancy T. Snyder
     Vice President                                                    Secretary

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

     Corporate Counsel                                      Independent Auditors
     Garrett and Garrett                                      B.D.O. Seidman LLP
     116 East Main Street                         300 Arboretum Place, Suite 520
     Bedford, VA 24523                                        Richmond, VA 23236

     Special Counsel                                Transfer Agent and Registrar
     Malizia, Spidi, Sloane & Fisch, P.C.                      10 Commerce Drive
     1301 K Street, N.W., Suite 700 East                      Cranford, NJ 07016
     Washington, D.C. 20005                                       (908) 272-8511

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

Bedford  Bancshares,  Inc., Annual Report for the year ended September 30, 1998,
filed  with the  Securities  and  Exchange  Commission  on Form  10-KSB  without
exhibits is available  without  charge upon written  request.  For a copy of the
Form 10-KSB or any other  investor  information,  please write or call Harold K.
Neal,  Chief  Executive  Officer at the Company's  Corporate  Office in Bedford,
Virginia. The Annual Meeting of Stockholders will be held on January 27, 1999 at
2:00 p.m. at the Olde Liberty Station, 515 Bedford Avenue, Virginia.

                                                                              53
<PAGE>

<TABLE>
<CAPTION>

                           GLOSSARY OF FINANCIAL TERMS
                           ---------------------------
<S>                                                        <C>
Basic Earnings Per Share                                    Net Interest Margin
------------------------                                    -------------------
Basic earnings per share is computed by dividing income     Net interest income divided by average earning assets.
available to common shareholders by the weighted average
number of common shares outstanding.


Basis Point ("BP")                                          Nonperforming Assets
------------------                                          --------------------
The equivalent of one hundredth of one percent (0.01%).     Loans on which interest income is not being accrued,
This unit is generally used to measure movements in         including loans past due 90 days or more and real
interest rates.                                             properties acquired through foreclosure.


Book Value Per Share                                        Provision For Credit Losses
--------------------                                        ---------------------------
The book value of a share of common stock is determined     The amount charged against current earnings in order to
by dividing shareholders' equity by the number of common    maintain an adequate allowance for credit losses, which is
shares outstanding.                                         used to absorb credit charge-offs.


Diluted Earnings Per Share                                  Return On Average Assets
--------------------------                                  ------------------------
Diluted earnings per share is calculated by dividing net    A measure that indicates how efficiently an entity uses its
income by the weighted average number of common and         total resources.  It is calculated by dividing annualized net
common equivalent shares outstanding.                       income by average assets.


Efficiency Ratio                                            Return On Average Equity
----------------                                            ------------------------
The ratio of noninterest expense to the sum of noninterest  A measure of how effectively an entity's equity has been
income plus net interest income.  It is a measure of        employed.  It is calculated by dividing annualized net
productivity based on how well non interest expense is      income by average stockholders' equity.
managed.


GAAP                                                        Risk-Based Capital Ratios
----                                                        -------------------------
Generally Accepted Accounting Principles.                   Regulatory ratios of capital to assets, including off-balance
                                                            sheet items, which have been weighted according to the
                                                            risk profile of the asset.  Tier 1 capital consists of
Interest-Bearing Liabilities                                stockholders' equity, while total capital is Tier 1 plus the
----------------------------                                allowable portion of the allowance for credit losses.
Deposits and borrowed funds on which interest is paid.


Interest Earning Assets
-----------------------
Interest-bearing financial instruments consisting primarily
of loans, investment securities and short-term investments
that generate interest and yield related fee income.


Interest Rate Spread
--------------------
The difference between the average yield on interest-
earning assets and the average rate paid on interest-bearing
liabilities.


Liquidity
---------
The ability of an entity to meet its cash flow requirements.
For a bank it is measured by the ability to quickly convert
assets into cash with minimal exposure to interest rate risk,
by the size and stability of the core funding base and by
additional borrowing capacity within the money markets.


Net Charge-Offs
---------------
The amount of loans written off as losses net of recoveries
on loans previously written off.

54
</TABLE>