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

Bedford  Bancshares,  Inc.  (the  "Company")  is the  parent  company of Bedford
Federal  Savings  Bank  ("Bedford  Federal" or the "Bank") and Central  Virginia
Financial services ("CVFS"). The Company was organized as a Virginia corporation
in March 1994 at the  direction of the 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 existing laws,  generally is not restricted in the
types of  business  activities  in which it may engage,  provided  that the 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 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  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 Bank is
a community  oriented  financial  institution  offering a variety of services to
meet the needs of the  communities  it  serves.  Bedford  Federal  conducts  its
business from its main office in Bedford,  Virginia,  three full service  branch
offices located in Bedford County, Virginia, and eight Automated Teller Machines
(ATMs").


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

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

                                                       Dividends   Dividends
                                                      Per Share    Per Share
Quarter 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
December 1998       15.00     10.50       184,500        0.080        0.080
March 1999          13.75     11.50       109,700        0.080        0.080
June 1999           13.75     11.50       166,200        0.090        0.080
September 1999      14.50     12.25       220,800        0.090        0.090
December 1999       12.25     10.25       116,400        0.090        0.090
March 2000          10.94      6.35       248,800        0.100        0.090
June 2000            9.25      7.00        88,300        0.100        0.100
September 2000      10.00      8.83       113,200        0.100        0.100
December 2000       10.50      8.00        87,400        0.100        0.100
March 2001          10.25      8.88        85,900        0.110        0.100
June 2001           10.76      9.13        78,700        0.110        0.110
September 2001      13.90     10.64       129,500        0.110        0.110
December 2001       14.00     12.25        88,600        0.110        0.110
March 2002          14.35     13.50       128,400        0.120        0.110
June 2002           18.42     13.84       167,600        0.120        0.120
September 2002      17.92     13.40       109,600        0.120        0.120


<PAGE>


SELECTED FINANCIAL AND OTHER DATA

<TABLE>
               Financial Condition (Dollars in Thousands)

              September 30,                            2002       2001        2000        1999       1998
              -------------                          --------   --------    --------    --------   --------
<S>                                               <C>        <C>         <C>         <C>        <C>
              Total assets                           $255,614   $214,305    $187,541    $165,737   $158,711
              Loans receivable, net                   219,634    184,405     169,592     147,689    129,744
              Investment securities                    16,691      9,936       9,201       8,129     14,470
              Marketable equity securities                 --         --          50       4,575      4,396
              Foreclosed real estate, net                  26         94          --          --         --
              Deposits                                177,214    149,167     129,770     114,720    107,086
              FHLB advances                            52,000     40,000      34,000      28,000     29,000
              Retained earnings                        14,570     13,275      12,503      11,223     10,900
              Total stockholders' equity               24,562     23,303      22,556      21,066     21,248
</TABLE>



<TABLE>
         Summary of Operations (Dollars in Thousands)

               Years Ended September 30,              2002       2001        2000        1999       1998
               -------------------------            --------   --------    --------    --------   --------
<S>                                            <C>         <C>         <C>          <C>         <C>

               Interest income                     $15,612     $14,996     $13,368      $11,894     $11,299
               Interest expense                      7,888       8,261       7,125        6,031       5,809
               Net interest income                   7,724       6,735       6,243        5,863       5,490
               Provision for credit losses             295         150         120           90          90
               Noninterest income                    1,843       1,137       1,040        1,069         863
               Noninterest expense                   4,570       3,976       3,484        3,328       3,130
               Net income before taxes               4,702       3,746       3,679        3,514       3,133
               Net income                            2,939      $2,325      $2,249       $2,191      $1,973
</TABLE>


<TABLE>

         Other selected Data

              Years Ended September 30,              2002         2001        2000        1999         1998
              -------------------------            --------     --------   --------     --------     --------
<S>                                              <C>          <C>         <C>          <C>          <C>
              Return on average assets               1.25%        1.17%       1.26%        1.35%        1.33%
              Return on average equity              12.40        10.37       10.13        10.05         9.68
              Average equity to average             10.09        10.87       12.11        13.72        14.21
              assets
              Net interest rate spread               2.81         2.96        2.74         2.85         3.03
              Nonperforming assets to assets          .26          .28         .51          .66          .34
              Nonperforming loans to loans            .29          .28         .57          .41          .54
              Allowance for credit losses
              to loans                                .54          .53         .50          .54          .59
</TABLE>

<TABLE>
        Per Share Data

              Years Ended September 30,               2002      2001         2000        1999        1998
              -------------------------             --------   --------    --------    --------    --------
<S>                                               <C>        <C>          <C>         <C>           <C>
              Basic earnings                         $1.49      $ 1.13       $ 1.08      $ 1.01        $.90
              Diluted earnings                        1.43        1.09         1.04         .96         .85
              Book value                             12.21       11.29        10.49        9.69        9.25
              Cash dividends declared                  .47         .43          .39         .34         .30
</TABLE>


<PAGE>

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


Management Strategy


Our  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 minimize the
risk of loss in our loan  portfolio,  help to lessen the income impact caused by
changing interest rates.

We monitor the interest rate sensitivity of our 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 interest earning assets and interest bearing
liabilities. In addition,  investments and borrowings can be used to help manage
interest  rate risk.  The tables on pages 7, 8, and 9 provide  details about our
interest rate sensitivity and our net interest income.

In our efforts to manage the interest rates that we pay on deposits, we focus on
maintaining a stable core deposit base while providing  competitive products and
services to our customers.  We rely primarily on customer  deposits and mortgage
payments  as our  major  source  of  funds,  but  also  borrow  from the FHLB to
supplement our funding needs and to help manage our interest rate sensitivity.

General

Net interest  income is the primary source of our 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 the average rate of interest  earned on interest  earning assets and the
average rate paid on interest bearing liabilities is the "interest rate spread."
Our "net interest  margin" is defined as our net interest  income divided by our
average earning assets.

We also receive income from service charges and other fees primarily  related to
credit and deposit  services  and incur  expenses in our  day-to-day  operations
including  salaries  and  benefits,   deposit  insurance,   facilities  expense,
marketing and other related business expenses.

The  Private  Securities  Litigation  Reform Act of 1995  contains  safe  harbor
provisions regarding forward-looking  statements.  When used in this discussion,
the words,  "believes",  "anticipates",  "contemplates",  "expects", and similar
expressions are intended to identify forward-looking statements. Such statements
are subject to certain risks and uncertainties, which could cause actual results
to differ materially from those projected. Those risks and uncertainties include
changes in interest rates, risk associated with the ability to control costs and
expenses,  and general  economic  conditions.  We  undertake  no  obligation  to
publicly  release  the  results  of  any  revisions  to  those   forward-looking
statements,  which may be made to reflect events or circumstances after the date
hereof or to reflect the occurrence of unanticipated events.

Interest Rate Sensitivity Analysis

The table that  follows  sets forth the amounts of interest  earning  assets and
interest  bearing  liabilities  outstanding  at September  30,  2002,  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.  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 a adjustable rate mortgage loans have
features which restrict  changes in interest rates,  on a short-term  basis over
the life of the  loan.  Further,  in the event of a change  in  interest  rates,
prepayment  levels and decay rates on core  deposits  may deviate  significantly
from those presented in the table.


<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 mortgage 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>

                                                         At September 30, 2002
                                 -----------------------------------------------------------------------------
                                                        (Dollars in Thousands)

                                    Three       Three  Six Months  One year   Three
                                   Months      to Six    To One   To Three   Years to   More than
                                  Or less      Months     Year      Years   Five years  Five years    Total
                                  --------    --------  --------  --------- ---------- ----------- ----------
<S>                            <C>         <C>       <C>         <C>         <C>        <C>     <C>


Interest earning assets:
 Mortgage loans (1)(2)             17,506      12,929    102,250     24,739      5,741      2,719   $165,884
 Other loans (1)                   14,896       1,005      1,878     19,884      3,147     13,249     54,059
 Marketable equity securities(3)       53          --         --         --         --         --         53
 Federal funds sold and other
  short-term investments            8,865          --         --         --         --         --      8,865
 Investment securities                 --          --     14,036         --         --         --     14,036
 Mortgage-backed securities (2)         2          --         --         --         --         --          2
 FHLB stock                         2,600          --         --         --         --         --      2,600
                                    -----          --         --         --         --         --      -----
   Total interest earning assets   43,922      13,934    118,164     44,623      8,888     15,968    245,499

Less:
 Loans in process                   1,731       2,077      2,424        693         --         --      6,925
 Unearned discount and
  deferred fees(2)                     62         111         97         38         24         15        347
  Allowance for credit losses         205          65        463        280         52        129      1,194
                                      ---          --        ---        ---         --        ---      -----
   Net interest-earning assets     41,924      11,681    115,180     43,612      8,812     15,824    237,033
                                   ------      ------    -------     ------      -----     ------    -------

Interest bearing liabilities:
 Money market deposits              7,567       5,123      5,815      2,577      1,227      1,123     23,432
 Passbook deposits                    798         762      1,422      4,530      2,956      7,195     17,663
 NOW and other demand deposits      1,501       1,337      2,253      4,661      1,247      2,763     13,762
 Certificate accounts              17,933      22,257     22,387     26,435     12,250      4,135    105,397
 Borrowed funds                    14,000      10,000         --     22,000      6,000         --     52,000
                                   ------      ------         --     ------      -----         --     ------
  Total interest bearing           41,799      39,479     31,877     60,203     23,680     15,216    212,254
                                   ------      ------     ------     ------     ------     ------    -------
liabilities

Interest sensitivity gap(4)          $125    $(27,798)   $83,303   $(16,591)  $(14,868)     $ 608   $24,779
                                     ====    ========    =======   ========   ========      =====   =======

Cumulative interest
sensitivity gap                      $125    $(27,673)   $55,630    $39,039    $24,171    $24,779
                                     ====    ========    =======    =======    =======    =======

Cumulative interest sensitivity gap
 as a percent of total assets        .05%      10.83%     21.78%     15.28%      9.46%      9.70%

Cumulative net interest bearing
 assets as a percent of interest
 bearing liabilities              100.30%      65.95%    149.16%    122.52%    112.27%    111.67%

</TABLE>

-------------
(1)  For purposes of the gap analysis,  mortgage and other loans are reduced for
     nonperforming  loans  but are not  reduced  for the  allowance  for  credit
     losses.
(2)  For purposes of the gap analysis,  unearned  discount and deferred fees are
     prorated 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.


<PAGE>

Analysis of Net Interest Income

The  following  table sets forth  certain  information  relating  to our 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  interest income or expense
by the average balance of assets or liabilities,  respectively,  for the periods
presented. Average balances are derived from daily balances.

<TABLE>

                                                               Years Ended September 30
                                ---------------------------------------------------------------------------------------
                                            2002                          2001                          2000
                                ----------------------------   ----------------------------   -------------------------
                                  Average             Yield/     Average             Yield/    Average           Yield/
                                  Balance  Interest    Cost      Balance   Interest   Cost     Balance  Interest  Cost
                                ---------  --------  -------   ---------   --------  ------   --------- -------- ------
                                                         (Dollars in Thousands)
<S>                           <C>        <C>        <C>      <C>        <C>       <C>      <C>       <C>        <C>

Assets:
 Interest earning assets:

  Mortgage loans (1)             $163,196   $10,955    6.71%    $146,336   $ 11,024  7.53%    $133,380  $ 9,828    7.37%
  Other loans (1)                  41,063     3,261    7.94       33,823      3,084  9.12       28,519    2,680    9.40
  Interest earning deposits           ---       ---     ---          ---        ---   ---        1,399       79    5.66
  Federal Funds sold and other
   short-term investments           4,991       114    2.28        2,980        177  5.96        1,170      130   11.07
  Investment securities            15,792     1,142    7.23        7,157        559  7.81        6,958      514    7.38

  FHLB stock                        2,470       140    5.68        2,141        152  7.09        1,695      137    8.04
                                 --------   -------             --------   --------           --------  -------
  Total interest earning assets   227,512    15,612    6.86      192,437     14,996  7.79      173,121   13,368    7.72
                                            -------                          ------                     -------
 Noninterest earning assets         7,391                          6,636                         6,038
                                 --------                       --------                      --------
    Total Assets                 $234,903                       $199,073                      $179,159
                                 ========                       ========                      ========
Liabilities and equity:
 Interest bearing deposits:
  Money market deposits           $15,593       375   2.40        $7,515        233  3.09       $7,090     252    3.55
  Savings deposits                 16,532       205   1.25        14,817        302  2.04       15,315     388    2.53
  Demand and other deposits        13,225        56   0.42        11,406        102  0.90       10,424     130    1.25
  Certificates of deposit         102,510     4,822   4.70        91,091      5,358  5.88       79,415   4,304    5.42
                                ---------  --------               ------      -----             ------   -----
 Total deposit accounts           147,860     5,458   3.69       124,829      5,995  4.80      112,244   5,074    4.52
  Borrowed funds                   47,022     2,430   5.17        38,766      2,266  5.85       34,104   2,051    6.02
                                           --------               ------      -----             ------   -----

    Total interest bearing
      liabilities                 194,882     7,888   4.05       163,595      8,261  5.05      146,348   7,125    4.87
                                           --------                           -----            -------   -----
 Noninterest bearing
  liabilities                      16,324                         12,339                        11,120
 Equity                            23,697                         23,139                        21,691
                                   ------                         ------                        ------

 Total liabilities and equity    $234,903                       $199,073                      $179,159
                                 ========                       ========                      ========

Net interest income                          $7,724                          $6,735                     $6,243
                                             ======                          ======                     ======

Interest rate spread (2)                              2.81%                          2.74%                        2.85%

Net interest margin (3)                               3.39%                          3.50%                        3.61%

Interest earning assets to
 Interest bearing liabilities      116.74%                        117.63%                       118.29%

</TABLE>

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


<PAGE>

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

<TABLE>
                                                               Year Ended September 30,
                                        --------------------------------------------------------------------
                                                 2002 versus 2001                      2001 versus 2000
                                        -------------------------------        -----------------------------
                                        Volume        Rate         Net         Volume       Rate        Net
                                        ------        ----         ---         ------       ----        ---
                                                              (Dollars in Thousands)
<S>                                  <C>       <C>            <C>             <C>        <C>      <C>

Interest earning assets:
  Mortgage loans                        $1,269    ($1,338)       ($69)           $955       $241     $1,196
  Other loans                              661       (484)         177            498       (94)        404
  Interest earning deposits                  0           0           0           (79)          0       (79)
  Federal funds sold and other
   short-term investments                  120       (183)        (63)            201      (154)         47
  Investment securities, net               674        (91)         583             15         30         45
  FHLB stock                                23        (35)        (12)             36       (21)         15
                                            --        ----        ----             --       ----         --
    Total interest earning assets        2,747     (2,131)         616          1,626          2      1,628
                                         -----     -------         ---          -----          -      -----
Interest bearing liabilities:
  Money market deposits                    250       (108)         142             15       (34)       (19)
  Savings deposits                          34       (131)        (97)           (13)       (73)       (86)
  NOW and other demand deposits             17        (63)        (46)             12       (40)       (28)
  Certificate accounts                     673     (1,209)       (536)            633        421      1,054
  Borrowed funds                           483       (319)         164            280       (65)        215
                                           ---       -----         ---            ---       ----        ---
    Total interest bearing
       liabilities                       1,457     (1,830)       (373)            928        208      1,136
                                         -----     -------       -----            ---        ---      -----
Net change in net interest income       $1,290      $(301)        $989           $698     $(206)       $492
                                        ======      ======        ====           ====     ======       ====

</TABLE>

Comparison of Financial  Condition for Fiscal Years Ended September 30, 2002 and
2001


The  Company's  total  assets were $255.6  million at  September  30,  2002,  an
increase of  $41.3million,  or 19.3%,  from the $214.3  million at September 30,
2001.  The asset  expansion  was  primarily  due to growth of available for sale
securities and net loans receivable.

At September 30, 2002,  available for sale  securities  were $13.6  million,  an
increase of $6.5 million, or 90.5%, from the $7.1 million at September 30, 2001.
The Company had entered into  commitments  to purchase $9.0 million in available
for sale securities in September,  2001 and the transaction  settled in October,
2001.  This  purchase,  offset by the proceeds from  maturities  of  securities,
accounted  for most of the  increase.  At September  30,  2002,  the Company had
committed to purchase  $3.5 million of available  for sale  securities  and such
purchase settled in October, 2002.


<PAGE>

Net loans  receivable  increased  $35.2 million,  or 19.1%, to $219.6 million at
September 30, 2002 from $184.4  million at September 30, 2001. A 17.2%  increase
in first mortgage  loans combined with an 86.8% increase in the commercial  loan
portfolio during fiscal 2002 accounted for the majority of the loan growth. This
increase  was funded  primarily  by  principal  repayments  of  existing  loans,
increased deposits, and advances from the FHLB.

Deposits  increased  $28.0 million to $177.2  million at September 30, 2002 from
$149.2  million at September 30, 2001. The increase was reflected in all deposit
categories with  certificates  of deposit up $7.5 million,  NOW accounts up $5.4
million and money market  accounts up $12.8 million.  Continued  merger activity
and branch  closings and sales  combined with  effective  marketing were primary
factors in the growth.

FHLB advances  totaled $52.0 million at September 30, 2002, an increase of $12.0
million,  or 30%, from the $40.0  million at September  30, 2001.  The advances,
which were used to  supplement  funding for the loan and  investment  securities
expansion,  were secured at attractive  rates. The lower rates on these advances
helped  lower the cost of total FHLB  advances  by 68 basis  points to 5.17% for
fiscal 2002, compared to 5.85% for fiscal 2001.

Total  stockholders'  equity was $24.6  million at September  30, 2002,  up $1.3
million or 5.4% from the $23.3 million at September 30, 2001. Net income of $2.9
million,  offset  by the  repurchase  of 86,556  shares  of  common  stock at an
aggregate price of $1.2 million and dividends of $.9 million, accounted for most
of the equity increase.

Comparison of  Operating Results for Years Ended September 30, 2002 and 2001

Net Income. Net income increased 26.4%, or $614,000,  to $2.9 million for fiscal
2002 from fiscal 2001. A 14.7% rise in net interest  income and a 62.1% increase
in  noninterest  income,  partially  offset by a 14.9%  increase in  noninterest
expense accounted for the improvement in profitability.

Interest Income. Interest income totaled $15.6 million for the fiscal year ended
September 30, 2002, a 4.1%  increase from the $15.0 million  recorded for fiscal
2001.  The  $616,000  increase is  primarily  due to the 18.2% growth of average
earning assets. See "Analysis of Net Interest Income" on page 8.

Interest Expense. Interest expense decreased $373,000 to $7.9 million for fiscal
2002 from $8.3 million for the year ended September 30, 2001. Although the level
of average  interest  bearing  liabilities  rose 19.1% to $194.9 million for the
year ended  September 30, 2002, from $163.6 million for fiscal 2001, the cost of
average  interest bearing  liabilities  declined 100 basis points in fiscal 2002
compared to fiscal 2001.  The decrease in the cost of funds was primarily due to
the lower general rate  environment  experienced in fiscal 2002,  reflecting the
aggressive  moves of the Federal  Reserve to stimulate  economic  activity.  See
"Analysis of Net Interest Income" on page 8.

Net Interest Income. Net interest income totaled $7.7 million for the year ended
September 30, 2002, up 14.7% from the $6.7 million  realized in fiscal 2001. The
increase is due to the higher volume of average  interest earning assets and the
lower cost of interest bearing  liabilities,  offset somewhat by the increase in
volume of interest  bearing  liabilities  and lower  yield on  interest  earning
assets.

Provision  for Loan  Losses.  The  provision  for loan losses for the year ended
September  30, 2002,  was $295,000,  up $145,000 from the provision  recorded in
fiscal 2001 due primarily to the $35.2 million  increase in loans.  At September
30,  2002,  the  allowance  for loan losses was $1.2  million,  or .54% of loans
receivable, net, and 182% of nonperforming assets. Based upon the


<PAGE>

quality of the Bank's loan  portfolio,  the relatively  stable local economy and
the level of nonperforming assets,  management believes the Bank's allowance for
loan  losses is  adequate  to absorb any  anticipated  credit  losses.  However,
assessment of the adequacy of the allowance for loan losses involves  subjective
judgments and thus there can be no assurance that additional provisions for loan
losses will not be required.

Noninterest  Income.  For the year ended September 30, 2002,  noninterest income
amounted  to $1.8  million,  an  increase  of  $706,000,  or 62.1% from the $1.1
million  earned in fiscal  2001.  Service  charges  and fees on loans  were $1.2
million for fiscal 2002,  compared to $549,000 for fiscal 2001. The increase was
due to a 68.8%  increase  in the number of loans  closed in fiscal  2002.  Other
customer  service  fees and  commissions  rose 21.4% to $511,000 for fiscal 2002
from  $421,000  for  fiscal  2001 due  primarily  to fees  related to check card
activity and an increase in the number of transaction accounts.

Noninterest Expense.  Noninterest expense increased $594,000,  or 14.9%, to $4.6
million for the year ended  September  30, 2002, as compared to $4.0 million for
fiscal 2001.  The increase was  primarily  due to a $479,000 rise in the cost of
compensation  and  employee  benefits.  The  higher  compensation  and  employee
benefits was  primarily  due to merit  increases,  staff  additions and expenses
related to an employee incentive plan.

Income taxes.  The  provision for income taxes for the year ended  September 30,
2002 was $1.8  million,  up $342,000  from the $1.4 million  recorded for fiscal
2001. The higher tax expense is primarily due to the increased  level of taxable
income in fiscal 2002.

Liquidity and Capital Resources

Our  liquidity  is an  indication  of our  ability to fund  loans,  pay  deposit
withdrawals, and other cash outflows in an efficient, cost effective manner. Our
primary sources of funds are deposits and scheduled  amortization and prepayment
of loans.  We have used  these  funds to pay  maturing  time  deposits,  savings
withdrawals,  fund lending commitments,  purchase new investments,  and increase
liquidity.  We also borrow funds from the Federal Home Bank ("FHLB") of Atlanta.
As of September 30, 2002,  such  borrowed  funds  totaled  $52.0  million.  Loan
payments and maturing  investments  are greatly  influenced by general  interest
rates, economic condition and competition.

The amount of certificate accounts which are scheduled to mature within one year
is approximately  $62.6 million. We believe that we can replace these funds with
other deposits,  excess liquidity, FHLB borrowings , or other borrowings if this
deposits do not remain with us. It has been our  experience  that a  substantial
portion of such maturing  deposits remain with us. At September 30, 2002, we had
commitments  to fund  loans  of $35.7  million,  and  $6.9  million  of loans in
process. In addition, we had committed to purchase $3.5 million of available for
sale securities.

Net cash provided by operating activities for fiscal 2002, totaled $2.7 million,
which was primarily due to net income of $2.9 million.

Net cash absorbed by investing activities for fiscal 2002 totaled $42.3 million,
an increase of $26.8  million  from fiscal  2001.  The  increase  was  primarily
attributable to a $20.6 million increase in net loans to customers.

Net cash provided by financing activities for the year ended September 30, 2002,
totaled $38.5  million.  This is a result of a net increase in deposits of $28.0
million,  and a net increase in FHLB advances of $12.0 million.  These increases
were used primarily to fund the increase in loan originations.


<PAGE>

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

Impact of Inflation and Changing Prices

Unlike most industrial  companies,  substantially all of our assets are monetary
in nature. As a result,  interest rates have a greater impact on our 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.


<PAGE>

                         [BDO Seidman, LLP Letterhead]

               Report of Independent Certified Public Accountants



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


We have audited the  consolidated  statements of financial  condition of Bedford
Bancshares,  Inc. and subsidiaries  (the "Company") as of September 30, 2002 and
2001, and the related consolidated  statements of income,  stockholders' equity,
and cash flows for each of the three  years in the period  ended  September  30,
2002.  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 auditing standards generally accepted
in the  United  States of  America.  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, 2002 and 2001,  and the
results of their  operations and their cash flows for each of the three years in
the period ended  September 30, 2002 in conformity  with  accounting  principles
generally accepted in the United States of America.


                                                            /s/ BDO Seidman, LLP


Richmond, Virginia
October 23, 2002



<PAGE>


                            Bedford Bancshares, Inc.
                                and Subsidiaries

                 Consolidated Statements of Financial Condition
                                 (in thousands)


September 30,                                           2002           2001
--------------------------------------------------------------------------------

     Assets

Cash (including interest bearing deposits of
   approximately $8,865 - 2002, $11,933 - 2001)    $  15,668      $  16,761
Securities (Note 1)
   Held-to-maturity                                      502            504
   Available for sale                                 13,589          7,132
Investment in Federal Home Loan Bank stock,
   at cost (Note 6)                                    2,600          2,300
Loans receivable, net (Notes 2, 6 and 14)            219,634        184,405
Property and equipment, net (Note 4)                   1,239          1,273
Accrued interest receivable                            1,328          1,093
Deferred income taxes (Note 8)                           355            159
Other assets                                             699            678
--------------------------------------------------------------------------------

Total assets                                        $255,614       $214,305
================================================================================


                                                                               4

<PAGE>

                            Bedford Bancshares, Inc.
                                and Subsidiaries

                 Consolidated Statements of Financial Condition
                                 (in thousands)


<TABLE>

September 30,                                                   2002        2001
--------------------------------------------------------------------------------------
<S>                                                        <C>         <C>

      Liabilities and Stockholders' Equity

Liabilities
   Deposits (Note 5)                                          $177,214    $149,167
   Advances from Federal Home Loan Bank (Note 6)                52,000      40,000
   Advances from borrowers for taxes and insurance                 815         717
   Dividends payable                                               241         227
   Other liabilities                                               782         891
--------------------------------------------------------------------------------------

Total liabilities                                              231,052     191,002
--------------------------------------------------------------------------------------

Commitments and contingencies (Notes 12 and 13)
--------------------------------------------------------------------------------------

Stockholders' equity
   Preferred stock, par value $.10, authorized 250,000
     shares, none outstanding                                        -           -
   Common stock, par value $.10, authorized 2,750,000
     shares, 2,011,952 and 2,063,453 shares,
     issued and outstanding                                        201         206
   Additional paid-in capital                                   10,089      10,171
   Retained earnings, substantially restricted (Note 10)        14,570      13,275
   Accumulated other comprehensive income                           22          60
   Stock acquired by ESOP and RRP (Note 11)                       (320)       (409)
--------------------------------------------------------------------------------------

Total stockholders' equity                                      24,562      23,303
--------------------------------------------------------------------------------------

Total liabilities and stockholders' equity                    $255,614    $214,305
======================================================================================

</TABLE>


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


                                                                               5
<PAGE>

                            Bedford Bancshares, Inc.
                                and Subsidiaries

                        Consolidated Statements of Income
                                 (in thousands)

<TABLE>


Year Ended September 30,                                             2002               2001                2000
--------------------------------------------------------------------------------------------------------------------
<S>                                                            <C>                <C>                 <C>

Interest income
   Loans                                                          $14,216            $14,108             $12,508
   U.S. government obligations, including agencies                  1,325                826                 687
   Other investments                                                   71                 62                 173
--------------------------------------------------------------------------------------------------------------------

Total interest income                                              15,612             14,996              13,368
--------------------------------------------------------------------------------------------------------------------

Interest expense
   Deposits (Note 5)                                                5,458              5,995               5,074
   Borrowed money                                                   2,430              2,266               2,051
--------------------------------------------------------------------------------------------------------------------

Total interest expense                                              7,888              8,261               7,125
--------------------------------------------------------------------------------------------------------------------

Net interest income                                                 7,724              6,735               6,243

Provision for loan losses (Note 2)                                    295                150                 120
--------------------------------------------------------------------------------------------------------------------

Net interest income after provision for
   loan losses                                                      7,429              6,585               6,123
--------------------------------------------------------------------------------------------------------------------

Noninterest income
   Service charges and fees on loans                                1,194                549                 562
   Other customer service fees and commissions                        511                421                 403
   Gain on sale of loans, investments and
     foreclosed real estate                                            78                101                   8
   Other                                                               60                 66                  67
--------------------------------------------------------------------------------------------------------------------

Total noninterest income                                            1,843              1,137               1,040
--------------------------------------------------------------------------------------------------------------------

</TABLE>


continued...

6


<PAGE>



                            Bedford Bancshares, Inc.
                                and Subsidiaries

                        Consolidated Statements of Income
                                 (in thousands)
                                   (continued)

<TABLE>

Year Ended September 30,                                             2002               2001                2000
--------------------------------------------------------------------------------------------------------------------
<S>                                                            <C>                <C>                 <C>

Noninterest expense
   Compensation and employee benefits                             $ 2,619            $ 2,140             $ 1,966
   Occupancy and equipment                                            509                471                 340
   Data processing                                                    488                485                 426
   Federal insurance of accounts                                       27                 25                  38
   Advertising                                                        127                129                 129
   Professional fees                                                  250                298                 167
   Other                                                              550                428                 418
--------------------------------------------------------------------------------------------------------------------

Total noninterest expense                                           4,570              3,976               3,484
--------------------------------------------------------------------------------------------------------------------

Income before income taxes                                          4,702              3,746               3,679

Provision for income taxes (Note 8)                                 1,763              1,421               1,430
--------------------------------------------------------------------------------------------------------------------

Net income                                                        $ 2,939            $ 2,325             $ 2,249
====================================================================================================================

Basic earnings per share (Note 16)                              $   1.49           $   1.13            $   1.08

Diluted earnings per share (Note 16)                            $   1.43           $   1.09            $   1.04
====================================================================================================================

</TABLE>

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



7

<PAGE>



                            Bedford Bancshares, Inc.
                                and Subsidiaries

                 Consolidated Statements of Stockholders' Equity
                                 (in thousands)

<TABLE>

                                                                               Accumulated
                                                   Additional                    Other          Acquired
                                        Common      Paid-in     Retained      Comprehensive      By ESOP
                                         Stock      Capital     Earnings         Income          and RRP     Total
----------------------------------------------------------------------------------------------------------------------

<S>                                    <C>       <C>          <C>          <C>               <C>         <C>

Balance, September 30, 1999                $217      $10,497      $11,223      $  (151)          $(720)      $21,066

Comprehensive income
   Net income                                 -            -        2,249            -               -         2,249
   Change in unrealized loss
     on securities available for
     sale (Note 9)                            -            -            -           29               -            29
                                                                                                          ------------

Total comprehensive income                    -            -            -            -               -         2,278
                                                                                                          ------------

   Allocated/earned ESOP
     shares (Note 11)                         -          124           14            -             214           352
   Repurchase of stock (23,809
     shares)                                 (2)        (117)        (145)           -               -          (264)
   Dividends declared ($.39
     per share)                               -            -         (838)           -               -          (838)
   RRP vesting (Note 11)                      -          (38)           -            -               -           (38)
----------------------------------------------------------------------------------------------------------------------

Balance, September 30, 2000                 215       10,466       12,503         (122)           (506)       22,556

Comprehensive income
   Net income                                 -            -        2,325            -               -         2,325
   Change in unrealized loss
     on securities available for
     sale (Note 9)                            -            -            -          182               -           182
                                                                                                          ------------

Total comprehensive income                    -            -            -            -               -         2,507
                                                                                                          ------------

   Allocated/earned ESOP
     shares (Note 11)                         -          125           62            -              80           267
   Repurchase of stock (117,334
     shares)                                (12)        (575)        (724)           -               -        (1,311)
   Dividends declared ($.43
     per share)                               -            -         (907)           -               -          (907)
   Exercise of options (Note 11)              3          154           16            -               -           173
   RRP vesting (Note 11)                      -            1            -            -              17            18
----------------------------------------------------------------------------------------------------------------------

</TABLE>


continued...


8

<PAGE>

                            Bedford Bancshares, Inc.
                                and Subsidiaries

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

<TABLE>

                                                                               Accumulated
                                                   Additional                    Other          Acquired
                                        Common      Paid-in     Retained      Comprehensive      By ESOP
                                         Stock      Capital     Earnings         Income          and RRP     Total
----------------------------------------------------------------------------------------------------------------------

<S>                                    <C>       <C>          <C>          <C>               <C>         <C>

Balance, September 30, 2001                $206      $10,171      $13,275          $60           $(409)      $23,303

Comprehensive income
   Net income                                 -            -        2,939            -               -         2,939
   Change in unrealized loss
     on securities available for
     sale (Note 9)                            -            -            -          (38)              -           (38)
                                                                                                          ------------

Total comprehensive income                    -            -            -            -               -         2,901
                                                                                                          ------------

   Allocated/earned ESOP
     shares (Note 11)                         -          169           80            -              81           330
   Repurchase of stock (86,556
     shares)                                 (9)        (430)        (800)           -               -        (1,239)
   Dividends declared ($.47
     per share)                               -            -         (949)           -               -          (949)
   Exercise of options (Note 11)              4          178           25            -               -           207
   RRP vesting (Note 11)                      -            1            -            -               8             9
----------------------------------------------------------------------------------------------------------------------

Balance, September 30, 2002                $201      $10,089      $14,570          $22           $(320)      $24,562
======================================================================================================================

</TABLE>



9

<PAGE>



                            Bedford Bancshares, Inc.
                                and Subsidiaries

                      Consolidated Statements of Cash Flows
                                 (in thousands)


<TABLE>


Year Ended September 30,                                                  2002               2001             2000
--------------------------------------------------------------------------------------------------------------------
<S>                                                               <C>                <C>              <C>

Operating activities
   Net income                                                        $   2,939          $   2,325        $   2,249
   Adjustments to reconcile net income to
     net cash provided by operating activities
       Provision for loan losses                                           295                150              120
       Provision for depreciation and amortization                         202                213              149
       (Increase) decrease in deferred income taxes                        (23)               111              (45)
       Gain on sale of loans, investments, and
         foreclosed real estate                                            (78)              (101)              (8)
       Loans originated for sale                                        (1,969)                 -                -
       Proceeds from sale of loans originated for sale                   1,827                  -                -
       (Increase) decrease in interest receivable                         (235)                39             (209)
       Increase in other assets                                           (194)              (228)             (75)
       Increase (decrease) in other liabilities                           (109)               587             (845)
--------------------------------------------------------------------------------------------------------------------

Net cash provided by operating activities                                2,655              3,096            1,336
--------------------------------------------------------------------------------------------------------------------

Investing activities
   Proceeds from maturities of securities                                6,500              8,500            1,300
   Proceeds from sales of available for sale securities                    529                 50            4,664
   Purchase of available for sale securities                           (13,500)            (8,500)          (2,021)
   Principal collected on mortgage-backed securities                         2                  3                3
   Net increase in loans to customers                                  (35,524)           (14,944)         (22,337)
   Net proceeds from sales of foreclosed real estate                       197                  -              293
   Purchases of premises, equipment and leasehold
     improvements                                                         (168)              (209)            (439)
   Purchase of FHLB stock                                                 (300)              (400)            (400)
--------------------------------------------------------------------------------------------------------------------

Net cash absorbed by investing activities                              (42,264)           (15,500)         (18,937)
--------------------------------------------------------------------------------------------------------------------

</TABLE>


                                                                   continued...

10


<PAGE>

                            Bedford Bancshares, Inc.
                                and Subsidiaries

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



<TABLE>

Year Ended September 30,                                                  2002               2001             2000
--------------------------------------------------------------------------------------------------------------------
<S>                                                                 <C>                <C>              <C>

Financing activities
   Net increase in deposits                                            $28,046            $19,397          $15,050
   Net increase in advance payments from borrowers                          98                 23               89
   Proceeds from FHLB advances                                          24,000             19,000           80,000
   Principal payments of FHLB advances                                 (12,000)           (13,000)         (74,000)
   Allocation of ESOP and RRP shares                                       339                267              314
   Repurchase of stock                                                  (1,239)            (1,311)            (264)
   Dividends paid                                                         (935)              (896)            (820)
   Issuance of common stock                                                207                173                -
--------------------------------------------------------------------------------------------------------------------

Net cash provided by financing activities                               38,516             23,653           20,369
--------------------------------------------------------------------------------------------------------------------

Increase (decrease) in cash and cash equivalents                        (1,093)            11,249            2,768

Cash and cash equivalents - beginning of year                           16,761              5,512            2,744
--------------------------------------------------------------------------------------------------------------------

Cash and cash equivalents - end of year                                $15,668            $16,761          $ 5,512
====================================================================================================================

Cash payments of interest expense                                      $ 7,404            $ 8,295          $ 7,508
====================================================================================================================

Cash payments of income taxes                                          $ 1,554            $ 1,457          $ 1,246
====================================================================================================================

Transfer of loans to foreclosed real estate                            $    90            $    94          $   316
====================================================================================================================

</TABLE>


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


11

<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.,  Bedford  Federal  Savings  Bank and CVFS,  its  wholly-owned
subsidiaries.  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

Investment in debt securities classified as held-to-maturity are stated at cost,
adjusted for amortization of premiums and accretion of discounts using the level
yield  method.  Management  has a  positive  intent  and  ability  to hold these
securities to maturity and, accordingly,  adjustments are not made for temporary
declines in their market value below amortized cost.  Investment in Federal Home
Loan Bank stock is stated at cost.



12

<PAGE>

                            Bedford Bancshares, Inc.
                                and Subsidiaries

                         Summary of Accounting Policies
                                   (continued)



Investment Securities (continued)

Investments in debt and equity securities classified as  available-for-sale  are
stated at market value with  unrealized  holding gains and losses  excluded from
earnings and reported as a separate  component of stockholders'  equity,  net of
tax effect, until realized.

Investments  in debt and equity  securities  classified as trading are stated at
market value.  Unrealized  holding gains and losses for trading  securities  are
included in the statement of income.

Gains and losses on the sale of  securities  are  determined  using 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.



13


<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,  2002,  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.

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.


14


<PAGE>

                            Bedford Bancshares, Inc.
                                and Subsidiaries

                         Summary of Accounting Policies
                                   (continued)



Sale of Loans, Participations in Loans (continued)

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 bank 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.  At September 30, 2002
there were no rights that were considered impaired.

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.

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.


15

<PAGE>

                            Bedford Bancshares, Inc.
                                and Subsidiaries

                         Summary of Accounting Policies
                                   (continued)




Income Taxes (continued)

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  $424,821  ratably over six years,  beginning  with the year ended
September 30, 1999.

Accounting Pronouncements

In July 2001, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards No. 141 ("SFAS 141"), "Business Combinations",
which was  effective  July 1, 2001.  SFAS 141 requires  the  purchase  method of
accounting  for  business  combinations   initiated  after  June  30,  2001  and
eliminates the  pooling-of-interests  methods.  The adoption of SFAS 141 did not
have an effect on the Company's financial statements.

In July 2001, the FASB issued  Statement of Financial  Accounting  Standards No.
142 ("SFAS 142"),  "Goodwill and Other Intangible  Assets",  which was effective
January 1, 2002. SFAS 142 requires,  among other things,  the  discontinuance of
goodwill  amortization.  In addition,  the standard includes  provisions for the
reclassification  of  certain  existing  recognized   intangibles  as  goodwill,
reassessment   of  the  useful   lives  of  existing   recognized   intangibles,
reclassification  of certain intangibles out of previously reported goodwill and
the identification of reporting units for purposes of assessing potential future
impairments  of  goodwill.  SFAS  142  also  requires  a  transitional  goodwill
impairment  test six months  from the date of adoption  and further  requires an
evaluation of the carrying value of goodwill for impairment annually thereafter.
The  adoption  of SFAS 142 did not have an  effect  on the  Company's  financial
statements.



16

<PAGE>



                            Bedford Bancshares, Inc.
                                and Subsidiaries

                         Summary of Accounting Policies
                                   (continued)



Accounting Pronouncements (continued)

In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets".  This statement  addresses financial  accounting
and  reporting  for the  impairment  or  disposal  of  long-lived  assets.  This
statement  supersedes FASB Statement No. 121,  "Accounting for the Impairment of
Long-Lived  Assets  and  for  Long-Lived  Assets  to Be  Disposed  Of",  and the
accounting  and  reporting  provisions  of APB  Opinion No. 30,  "Reporting  the
Results of  Operations  --  Reporting  the Effects of Disposal of a Segment of a
Business,  and  Extraordinary,  Unusual and  Infrequently  Occurring  Events and
Transactions".  This statement also amends ARB No. 51,  "Consolidated  Financial
Statements",  to eliminate the exception to  consolidation  for a subsidiary for
which  control  is likely to be  temporary.  This  statement  requires  that one
accounting  model be used  for  long-lived  assets  to be  disposed  of by sale,
whether previously held and used or newly acquired. This statement also broadens
the   presentation   of   discontinued   operations  to  include  more  disposal
transactions.  SFAS 144 is effective for fiscal years  beginning  after December
15, 2001 and interim periods within those fiscal years. The Company believes the
adoption of SFAS 144 will not have a material effect on the Company's  financial
statements.

In October 2002, the FASB issued SFAS 147,  "Acquisitions  of Certain  Financial
Institutions  - an  amendment  of  FASB  Statements  No.  72 and  144  and  FASB
Interpretation   No.  9.  This  statement  removes   acquisitions  of  financial
institutions  from  the  scope of both  Statement  72 and  Interpretation  9 and
requires  that those  transactions  be  accounted  for in  accordance  with FASB
Statements No. 141,  "Business  Combinations",  and No. 142, "Goodwill and Other
Intangible  Assets".  Thus,  the  requirement  in paragraph 5 of Statement 72 to
recognize  (and  subsequently   amortize)  any  excess  of  the  fair  value  of
liabilities assumed over the fair value of tangible and identifiable  intangible
assets  required  as an  unidentifiable  intangible  asset no longer  applies to
acquisitions  within the scope of this  Statement.  In addition,  this Statement
amends FASB  Statement No. 144,  "Accounting  for the  Impairment or Disposal of
Long-Lived  Assets",  to  include in its scope  long-term  customer-relationship
intangible   assets  of   financial   institutions   such  as  depositor  -  and
borrower-relationship intangible assets and credit cardholder intangible assets.
Consequently,  those intangible assets are subject to the same undiscounted cash
flow  recoverability  test  and  impairment  loss  recognition  and  measurement
provisions that Statement 144 requires for other long-lived assets that are held
and used.  The  adoption  of SFAS 147 did not have an  effect  on the  Company's
financial statements.

Earnings Per Share

Basic earnings per share include 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 stock  options that could share in the earnings of the Company.  The
computation of basic and diluted earnings per share is presented in Note 16.


17


<PAGE>



Comprehensive Income

SFAS No.  130,  "Reporting  Comprehensive  Income",  established  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 No. 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.

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.



18

<PAGE>



                            Bedford Bancshares, Inc.
                                and Subsidiaries

                   Notes to Consolidated Financial Statements





1.   Securities

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

September 30, 2002

<TABLE>

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

                                                                        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                       $    500                $  4                   $  -              $    504

   Mortgage-backed securities                            2                   -                      -                     2
-------------------------------------------------------------------------------------------------------------------------------

                                                       502                   4                      -                   506
-------------------------------------------------------------------------------------------------------------------------------

Available for Sale

   United States government
     and agency obligations                         13,500                  40                      4                13,536

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

                                                    13,553                  40                      4                13,589
-------------------------------------------------------------------------------------------------------------------------------

                                                   $14,055                 $44                   $  4               $14,095
==============================================================================================================================

</TABLE>


Gross  gains  of  approximately  $29,000,  $8,000  and $0 and  gross  losses  of
approximately  $0, $5,000 and $0 were realized on sales of securities  available
for sale during the years ended September 30, 2002, 2001 and 2000, respectively.



19

<PAGE>



                            Bedford Bancshares, Inc.
                                and Subsidiaries

                   Notes to Consolidated Financial Statements
                                   (continued)




1.      Securities (continued)

September 30, 2001
<TABLE>

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

                                                                        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                         $  500                $ 24                    $ -                $  524

   Mortgage-backed securities                            4                   -                      -                     4
-------------------------------------------------------------------------------------------------------------------------------

                                                       504                  24                      -                   528
-------------------------------------------------------------------------------------------------------------------------------

Available for Sale

   United States government
     and agency obligations                          6,982                 108                     11                 7,079

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

                                                     7,035                 108                     11                 7,132
-------------------------------------------------------------------------------------------------------------------------------

                                                    $7,539                $132                    $11                $7,660
===============================================================================================================================

</TABLE>


Held to maturity securities consisted of a FHLMC term note of $500,000 which was
pledged to secure public deposits at September 30, 2002 and 2001, respectively.


20


<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, 2002, by contractual maturity, were as follows:


                                                                 Estimated
                                               Amortized           Market
                                                 Cost              Value
--------------------------------------------------------------------------------

Held to Maturity

   Due in one year or less                       $   500            $   504
   Due in one through five years                       -                  -
   Due after five years                                -                  -
--------------------------------------------------------------------------------

                                                     500                504
   Mortgage-backed securities                          2                  2
--------------------------------------------------------------------------------

                                                     502                506
--------------------------------------------------------------------------------

Available for Sale
   Due in one year or less                        11,500             11,506
   Due in one through five years                   2,000              2,030
   Due after five years                                -                  -
--------------------------------------------------------------------------------

                                                  13,500             13,536

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

                                                  13,553             13,589
--------------------------------------------------------------------------------

                                                 $14,055            $14,095
================================================================================

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.


21


<PAGE>


                            Bedford Bancshares, Inc.
                                and Subsidiaries

                   Notes to Consolidated Financial Statements
                                   (continued)


2.   Loans Receivable

Loans receivable, in thousands, are summarized as follows

September 30,                                       2002                  2001
--------------------------------------------------------------------------------

First mortgage loans                            $162,720               $138,792
Construction loans                                18,448                 17,701
Home equity loans                                  9,952                  6,904
Loans to depositors, secured by savings              185                    219
Installment loans                                 12,847                 15,819
Term notes                                        23,948                 12,820
--------------------------------------------------------------------------------

                                                 228,100                192,255
Less
   Undistributed loans in process                  6,925                  6,607
   Deferred loan fees and costs, net                 347                    262
   Allowance for credit losses                     1,194                    981
--------------------------------------------------------------------------------

                                                $219,634               $184,405
================================================================================


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

Year ended September 30,                         2002        2001        2000
--------------------------------------------------------------------------------

Balance at beginning of year                   $  981        $850        $804
Provision charged to operations                   295         150         120
Charge offs net of recoveries                     (82)        (19)        (74)
--------------------------------------------------------------------------------

Balance at end of year                         $1,194        $981        $850
================================================================================


22

<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:

September 30,                                     2002        2001        2000
--------------------------------------------------------------------------------

Federal Home Loan Mortgage Corporation (FHLMC)  $3,626      $3,226      $1,538
================================================================================


4.      Property and Equipment

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

September 30,                                          2002            2001
--------------------------------------------------------------------------------

Land                                                 $  210          $  210
Office buildings                                      1,281           1,261
Furniture, fixtures and equipment                     1,497           1,350
Automobile                                               25              25
Leasehold improvements                                  254             254
--------------------------------------------------------------------------------

                                                      3,267           3,100
Less accumulated depreciation                         2,028           1,827
--------------------------------------------------------------------------------

                                                     $1,239          $1,273
================================================================================


23

<PAGE>



                            Bedford Bancshares, Inc.
                                and Subsidiaries

                   Notes to Consolidated Financial Statements
                                   (continued)


5.      Deposits

Deposits, in thousands, are summarized as follows:

September 30,                         2002                      2001
--------------------------------------------------------------------------------

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

NOW accounts                 $  30,721    17.34%      $  25,309      16.97%
Money market accounts           23,432    13.22          10,628       7.12
Savings accounts                17,664     9.97          15,313      10.27
Time deposits                  105,397    59.47          97,917      65.64
--------------------------------------------------------------------------------

                              $177,214   100.00%       $149,167     100.00%
================================================================================

The  aggregate  amount  of  certificates  of  deposit  of  $100,000  or more was
approximately  $22,535,000  and  $20,300,000  at  September  30,  2002 and 2001,
respectively.

At September 30, 2002, the scheduled maturities of time deposits,  in thousands,
are as follows:

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

                 2003                                 $ 62,577
                 2004                                   19,917
                 2005                                    6,519
                 2006                                    1,388
              Thereafter                                14,996
        ---------------------------------------------------------

                                                      $105,397
        =========================================================

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

Year ended September 30,         2002                2001              2000
-----------------------------------------------------------------------------

NOW accounts                   $   56              $  102            $  130
Money market account              375                 233               252
Savings account                   205                 302               388
Time deposits                   4,822               5,358             4,304
-----------------------------------------------------------------------------

                               $5,458              $5,995            $5,074
=============================================================================


24

<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:

September 30,                            2002                   2001
-----------------------------------------------------------------------

Within one year                       $24,000                $16,000
One to two years                       22,000                  9,000
Two years or more                       6,000                 15,000
-----------------------------------------------------------------------

                                      $52,000                $40,000
=======================================================================

The weighted  average  interest  rate on advances at September 30, 2002 and 2001
was 4.85% and 5.61%,  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:

Year ended September 30,                         2002        2001        2000
-------------------------------------------------------------------------------

Maximum amount outstanding during the year    $52,000     $42,000     $38,000
===============================================================================

Average amount outstanding during the year    $47,022     $38,766     $34,104
===============================================================================

Average interest rate during the year            5.17%       5.85%       6.02%
===============================================================================


25


<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>

September 30,                                         2002                     2001
-----------------------------------------------------------------------------------------------

                                              Carrying      Fair      Carrying      Fair
                                               Amount       Value      Amount       Value
-----------------------------------------------------------------------------------------------
<S>                                        <C>         <C>         <C>          <C>

Financial assets
   Cash and short-term investments            $  15,668   $  15,668   $ 16,761     $  16,761
   Securities                                    14,091      14,095      7,636         7,660
   Loans, net of allowance for loan losses      219,634     228,217    184,405       186,276

Financial liabilities
   Deposits                                     177,214     178,661    149,167       150,778
   Advances from Federal Home Loan Bank          52,000      52,000     40,000        40,000

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

Unrecognized financial instruments
   Commitments to extend credit                 $40,394     $40,394    $19,113       $19,113
   Forward commitment to purchase
     Government Securities                        3,500       3,500      9,000         9,000

</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.


26


<PAGE>

                            Bedford Bancshares, Inc.
                                and Subsidiaries

                   Notes to Consolidated Financial Statements
                                   (continued)


7.      Fair Value of Financial Instruments (continued)

Loan receivable
---------------

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.

Forward commitment to purchase Government Securities
----------------------------------------------------

Fair value based on quoted market prices or dealer quotes.



27


<PAGE>



                            Bedford Bancshares, Inc.
                                and Subsidiaries

                   Notes to Consolidated Financial Statements
                                   (continued)


8.   Income Taxes

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

Year ended September 30,                    2002       2001              2000
-------------------------------------------------------------------------------

Current
   Federal                                $1,599     $1,273            $1,251
   State                                     174        139               221
-------------------------------------------------------------------------------

                                           1,773      1,412             1,472

Deferred tax expense (benefit)               (10)         9               (42)
-------------------------------------------------------------------------------

Total provision for income taxes          $1,763     $1,421            $1,430
===============================================================================


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

                                                    Percent of Pre-tax Income
                                                    -------------------------
Year ended September 30,                            2002       2001      2000
-------------------------------------------------------------------------------

Tax at statutory rate                              34.0%      34.0%       34.0%
Increases (decreases) in taxes resulting from
   State income taxes, net of federal benefit       3.7        3.7        6.0
   Other                                            (.2)        .3       (1.0)
-------------------------------------------------------------------------------

                                                   37.5%      38.0%       39.0%
===============================================================================


28


<PAGE>



                            Bedford Bancshares, Inc.
                                and Subsidiaries

                   Notes to Consolidated Financial Statements
                                   (continued)


8.   Income Taxes (continued)

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

September 30,                                             2002        2001
-----------------------------------------------------------------------------

Deferred tax asset
   Bad debts                                              $400        $292
   Loan fees                                                11          16
-----------------------------------------------------------------------------

Total deferred tax asset                                   411         308
-----------------------------------------------------------------------------

Deferred tax liability
   Unrealized gain on securities available for sale        (13)        (36)
   Accelerated depreciation                                (17)        (44)
   Distributive share of income from partnership           (26)        (23)
   Other                                                     -         (46)
-----------------------------------------------------------------------------

Total deferred tax liability                               (56)       (149)
-----------------------------------------------------------------------------

Net deferred tax asset                                    $355        $159
=============================================================================


29

<PAGE>



                            Bedford Bancshares, Inc.
                                and Subsidiaries

                   Notes to Consolidated Financial Statements
                                   (continued)


9.      Comprehensive Income

The components of other comprehensive income (loss) are summarized as follows:

<TABLE>

Year ended September 30,                                     2002      2001    2000
-------------------------------------------------------------------------------------
<S>                                                       <C>       <C>      <C>

Unrealized gains (losses) on securities:                     $(61)     $293     $43
   Less:  reclassification adjustment for gains (losses)
     included in net income                                     -         -      (4)
-------------------------------------------------------------------------------------

Other comprehensive income (loss) before tax                  (61)      293      47

Income tax (expense) benefit related to items of other
   comprehensive income                                        23      (111)    (18)
-------------------------------------------------------------------------------------

Other comprehensive income (loss), net of tax                $(38)     $182     $29
=====================================================================================

</TABLE>


10.  Restricted Retained Earnings

In accordance with  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, 2002, the liquidation account,
adjusted for customer withdrawals, totaled $1,440,000.


30

<PAGE>




                            Bedford Bancshares, Inc.
                                and Subsidiaries

                   Notes to Consolidated Financial Statements
                                   (continued)


11.  Retirement Plan 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. The Savings Bank
matches,  for each $1 up to 4% of salary,  $.50 for employees with less than ten
years of  service,  $.75 for  employees  with  between  ten and twenty  years of
service  and $1 for  employees  with over  twenty  years of  service.  Effective
October 1, 1993, a money  purchase plan was adopted  which  provides for a fixed
percentage  contribution for each employee's salary.  This percentage was 5% for
each of the three years ended September 30, 2002. The total expense for the plan
was $114,000,  $90,000 and $89,000 for the years ended  September 30, 2002, 2001
and 2000, 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  130,666  and  114,666  shares  of  Common  Stock as of
September 30, 2002 and 2001,  respectively.  The Company recognized $182,000 and
$143,000 of  compensation  cost for the years ended September 30, 2002 and 2001,
respectively.  The fair  value of  unearned  ESOP  shares  totaled  $458,000  at
September 30, 2002. 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.


31

<PAGE>



                            Bedford Bancshares, Inc.
                                and Subsidiaries

                   Notes to Consolidated Financial Statements
                                   (continued)


11.  Retirement Plan and Employee Benefit Programs (continued)

Recognition and Retention Plan (continued)

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 this
plan is 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,  2002 and 2001,  the amount
included in  compensation  expense  was $3,000 and  $12,000,  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, 2000            $9.04         8,394        3,000

Granted                                     -              -            -
Vested                                    8.88             -       (2,000)
-----------------------------------------------------------------------------

Balance at September 30, 2001             9.37         8,394        1,000

Granted                                     -              -            -
Vested                                    9.37             -       (1,000)
-----------------------------------------------------------------------------

Balance at September 30, 2002             $  -         8,394            -
=============================================================================


32

<PAGE>



                            Bedford Bancshares, Inc.
                                and Subsidiaries

                   Notes to Consolidated Financial Statements
                                   (continued)


11.  Retirement Plan 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:


<TABLE>
                                        Weighted
                                        Average
                                        Exercise   Available      Options      Vested and
                                         Price     for Grant    Outstanding    Exercisable
---------------------------------------------------------------------------------------------
<S>                                    <C>         <C>           <C>            <C>

Balance at September 30, 2000             $6.40       20,994        195,764        188,264

Granted                                        -           -              -              -
Vested                                         -           -              -          5,000
Exercised                                  5.50            -        (31,517)       (31,517)
---------------------------------------------------------------------------------------------

Balance at September 30, 2001              5.95       20,994        164,247        161,747

Granted                                        -           -              -              -
Vested                                         -           -              -          2,500
Exercised                                  5.69            -        (36,187)       (36,187)
---------------------------------------------------------------------------------------------

Balance at September 30, 2002             $6.11       20,994        128,060        128,060
=============================================================================================

</TABLE>



33


<PAGE>



                            Bedford Bancshares, Inc.
                                and Subsidiaries

                   Notes to Consolidated Financial Statements
                                   (continued)


12.  Commitments and Contingencies

The Savings Bank is lessee under a one year operating lease expiring August 2003
for the land at its  Moneta  branch at a monthly  rental of $400 and a five year
operating  lease expiring August 31, 2005 for the New London branch at an annual
rental of $35,700.  The Savings  Bank also leases ATM space in Moneta,  one year
lease  expiring  September  2003 at a monthly  rental of $200 and in Huddleston,
under month to month lease at an annual rental of $1,200 and in Bedford, under a
five year lease expiring in September 2004 at an annual rental of $3,300.

The current minimum annual rental  commitments  under  non-cancelable  operating
leases in effect at September 30, 2002 are as follows:

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

                             2003                    $  42,500
                             2004                       35,700
                             2005                       29,700
                  -----------------------------------------------

                                                      $107,900
                  ===============================================

Rent expense was approximately $44,000,  $43,000 and $18,600 for the years ended
September 30, 2002, 2001 and 2000, 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.

At September 30, 2002, the Savings Bank had entered into a forward commitment to
purchase  $3,500,000  of  government   securities.   These  securities  will  be
classified as available for sale.


34

<PAGE>

                            Bedford Bancshares, Inc.
                                and Subsidiaries

                   Notes to Consolidated Financial Statements
                                   (continued)


12.  Commitments and Contingencies (continued)

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, 2002 and 2001.  The  Savings  Bank uses the same
credit policies in making commitments and conditional obligations as it does for
on-balance-sheet instruments.

<TABLE>

September 30,                                                                               2002          2001
----------------------------------------------------------------------------------------------------------------
<S>                                                                                   <C>         <C>

Financial instruments, in thousands, whose contract amounts represent credit risk
   Unfunded commercial credit line                                                       $14,581      $  8,642
   Unfunded home equity lines of credit                                                   10,195         7,799
   Commitments to finance real estate acquisitions and construction                       15,618         2,672
----------------------------------------------------------------------------------------------------------------

                                                                                          40,394        19,113

Financial instruments whose contract amount represent interest rate risk
   Forward commitment to purchase government securities                                  $ 3,500      $  9,000
================================================================================================================

</TABLE>


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.

The  Company  is  defendant  in various  lawsuits  incidental  to its  business.
Management is of the opinion that its financial  position will not be materially
affected by the ultimate resolution of any pending or threatened litigation.


35

<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, 2002,  2001 and 2000 are  approximately  $1,616,000,
$1,312,000 and $714,000, respectively.

The following is a summary of loan  transactions  with  directors,  officers and
other related parties:

                    September 30, 2002
                    --------------------------------------------------

                    Balance at beginning of year         $1,312,000
                    Additional loans                        548,000
                    Loan reductions                        (244,000)
                    --------------------------------------------------

                    Balance at end of year               $1,616,000
                    ==================================================


36

<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, 2002 and 2001.  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>

                            Amount            Percent            Actual              Actual            Excess
September 30, 2002         Required          Required            Amount             Percent            Amount
--------------------------------------------------------------------------------------------------------------------
<S>                    <C>                   <C>             <C>                   <C>             <C>

Tangible Capital          $  3,828,000          1.50%           $21,618,000           8.47%           $17,790,000
Core Capital                10,210,000          4.00             21,618,000           8.47             11,426,000
Risk-based Capital          12,824,000          8.00             22,812,000          14.23              9,988,000

                            Amount            Percent            Actual              Actual            Excess
September 30, 2001         Required          Required            Amount             Percent            Amount
--------------------------------------------------------------------------------------------------------------------

Tangible Capital          $  3,210,000          1.50%           $21,288,000           9.95%           $18,078,000
Core Capital                 8,561,000          4.00             21,288,000           9.95             12,727,000
Risk-based Capital          10,546,000          8.00             22,088,000          16.76             11,542,000

</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.


37

<PAGE>

                            Bedford Bancshares, Inc.
                                and Subsidiaries

                   Notes to Consolidated Financial Statements
                                   (continued)


16.  Earnings Per Share

During the years  ended  September  30,  2002 and 2001,  the Board of  Directors
authorized  a  stock  repurchase  program  under  which  up to 10%  of the  then
outstanding  shares of the  Company's  stock may be  repurchased.  During  2002,
86,556  shares  were  repurchased  for  an  aggregate  amount  of  approximately
$1,239,000.

Earnings per share is calculated as follows:

<TABLE>


Year ended September 30,                                    2002                      2001                  2000
-------------------------------------------------------------------------------------------------------------------
<S>                                                <C>                       <C>                   <C>

Basic earnings
Income available to common shareholders               $2,939,000                $2,325,000            $2,249,000
===================================================================================================================

Weighted average share outstandings                    1,978,563                 2,054,151             2,076,902
===================================================================================================================

Basic earnings per share                              $    1.49                 $    1.13             $     1.08
===================================================================================================================


Diluted earnings per share

Income available to common shareholders               $2,939,000                $2,325,000            $2,249,000
===================================================================================================================

Weighted average shares outstanding                    1,978,563                 2,054,151             2,076,902

   Dilutive effect of RRP plan shares                          -                       818                 1,619

   Dilutive effect of stock options                       77,973                    87,679                79,656
-------------------------------------------------------------------------------------------------------------------

Total weighted average shares outstanding              2,056,536                 2,142,648             2,158,177
===================================================================================================================

Diluted earnings per share                            $    1.43                 $    1.09             $     1.04
===================================================================================================================

</TABLE>


38

<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,                                         2002            2001
-----------------------------------------------------------------------------

Assets
   Cash and cash equivalents                      $  2,813        $  1,813
   Securities                                           53              53
   Investment in Subsidiaries                       21,644          21,233
   Other assets                                        299             437
-----------------------------------------------------------------------------

Total assets                                       $24,809         $23,536
=============================================================================


Liabilities and stockholders' equity
   Other liabilities                               $     6         $     6
   Dividends payable                                   241             227
   Stockholders' equity                             24,562          23,303
-----------------------------------------------------------------------------

Total liabilities and stockholders' equity         $24,809         $23,536
=============================================================================


39
<PAGE>

                            Bedford Bancshares, Inc.
                                and Subsidiaries

                   Notes to Consolidated Financial Statements
                                   (continued)


17.  Condensed Parent Company Information (continued)

                       Condensed Statements of Operations
                                 (in thousands)

<TABLE>
Year Ended September 30,                                    2002             2001            2000
---------------------------------------------------------------------------------------------------
<S>                                                  <C>              <C>             <C>

Income
   Interest
     Savings Bank's ESOP loan                             $   12           $   18          $   24
     Loan to Savings Bank subsidiary                           -                -               1
   Dividends received from Bank                                -                2               -
   Other                                                      71               71              42
---------------------------------------------------------------------------------------------------

Total income                                                  83               91              67
---------------------------------------------------------------------------------------------------

Expenses
   Compensation and employee benefits                          -                2               4
   Professional fees                                          67               91              57
   Other operating expenses                                   32               46              37
---------------------------------------------------------------------------------------------------

Total expenses                                                99              139              98
---------------------------------------------------------------------------------------------------

Net income (loss) before income taxes and equity in
   undistributed net income of subsidiaries                  (16)             (48)            (31)

Income tax expense (benefit)                                  (6)             (19)             (3)
Equity in undistributed net income of subsidiaries         2,949            2,354           2,277
---------------------------------------------------------------------------------------------------

Net income                                                $2,939           $2,325          $2,249
===================================================================================================

</TABLE>


40

<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)

<TABLE>

Year Ended September 30,                                                2002             2001            2000
---------------------------------------------------------------------------------------------------------------
<S>                                                                <C>              <C>             <C>

Operating activities
   Net income                                                         $2,939           $2,325          $2,249
   Adjustments
     Equity in undistributed net income of subsidiaries               (2,949)          (2,354)         (2,277)
     (Increase) decrease in other assets                                 138              (95)            133
     Increase (decrease) in other liabilities                              -             (225)           (486)
---------------------------------------------------------------------------------------------------------------

Net cash absorbed by operating activities                                128             (349)           (381)
---------------------------------------------------------------------------------------------------------------

Investing activities
   Subsidiary dividend payment                                         2,500            2,500           2,307
   Proceeds from sale of available for sale securities                     -               50               -
   Loans originated, net of principal repayments                           -                -             180
---------------------------------------------------------------------------------------------------------------

Net cash provided by investing activities                              2,500            2,550           2,487
---------------------------------------------------------------------------------------------------------------

Financing activities
   Dividends paid                                                       (935)            (896)           (820)
   Repurchase of stock                                                (1,239)          (1,311)           (264)
   RRP vesting                                                             9               16              38
   ESOP note payment                                                     330              267             204
   Exercise of options                                                   207              173               -
---------------------------------------------------------------------------------------------------------------

Net cash absorbed by financing activities                             (1,628)          (1,751)           (842)
---------------------------------------------------------------------------------------------------------------

Increase (decrease) in cash and cash equivalents                       1,000              450           1,264

Cash and cash equivalents, beginning of year                           1,813            1,363              99
---------------------------------------------------------------------------------------------------------------

Cash and cash equivalents, end of year                                $2,813           $1,813          $1,363
===============================================================================================================

</TABLE>


41

<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:

<TABLE>

                                                       First                Second               Third             Fourth
Year ended September 30, 2002                         Quarter              Quarter              Quarter           Quarter
-------------------------------------------------------------------------------------------------------------------------------
<S>                                                  <C>                  <C>                  <C>                <C>

Total interest income                                   $3,918               $3,884               $3,895             $3,915
Total interest expense                                   2,021                1,991                1,960              1,916
-------------------------------------------------------------------------------------------------------------------------------

Net interest income                                      1,897                1,893                1,935              1,999
Provision for credit losses                                 45                  100                   75                 75
-------------------------------------------------------------------------------------------------------------------------------

Net interest income after provision
   for credit losses                                     1,852                1,793                1,860              1,924

Noninterest income                                         387                  570                  480                406
Noninterest expense                                      1,147                1,094                1,171              1,158
-------------------------------------------------------------------------------------------------------------------------------

Income before income taxes                               1,092                1,269                1,169              1,172
Provision for income taxes                                 415                  429                  444                475
-------------------------------------------------------------------------------------------------------------------------------

Net income                                              $  677              $   840              $   725            $   697
===============================================================================================================================

Cash dividends declared per share                       $  .11              $   .12              $   .12            $  .12
===============================================================================================================================

Basic earnings per share                                $  .33              $   .43              $   .37            $  .36
Diluted earnings per share                              $  .32              $   .41              $   .36            $  .34
===============================================================================================================================
</TABLE>


42

<PAGE>


                            Bedford Bancshares, Inc.
                                and Subsidiaries

                   Notes to Consolidated Financial Statements
                                   (continued)


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

<TABLE>

                                                       First                Second               Third             Fourth
Year ended September 30, 2001                         Quarter              Quarter              Quarter           Quarter
-------------------------------------------------------------------------------------------------------------------------------
<S>                                                  <C>                  <C>                  <C>                <C>

Total interest income                                   $3,600               $3,756               $3,782             $3,858
Total interest expense                                   2,020                2,072                2,075              2,094
-------------------------------------------------------------------------------------------------------------------------------

Net interest income                                      1,580                1,684                1,707              1,764
Provision for credit losses                                 30                   45                   45                 30
-------------------------------------------------------------------------------------------------------------------------------

Net interest income after provision
   for credit losses                                     1,550                1,639                1,662              1,734

Noninterest income                                         226                  245                  291                375
Noninterest expense                                        962                  939                1,044              1,031
-------------------------------------------------------------------------------------------------------------------------------

Income before income taxes                                 814                  945                  909              1,078
Provision for income taxes                                 309                  358                  345                409
-------------------------------------------------------------------------------------------------------------------------------

Net income                                              $  505              $   587              $   564             $  669
===============================================================================================================================

Cash dividends declared per share                       $  .10              $   .11              $   .11             $ .11
===============================================================================================================================

Basic earnings per share                                $  .24              $   .29              $   .27             $ .33
Diluted earnings per share                              $  .23              $   .28              $   .26             $ .32
===============================================================================================================================

</TABLE>


43