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

<PAGE>

SELECTED FINANCIAL AND OTHER DATA
--------------------------------------------------------------------------------

<TABLE>
<CAPTION>
        Financial Condition (Dollars in Thousands)
           <S>                                 <C>          <C>         <C>         <C>          <C>
              September 30,                           2001        2000        1999         1998        1997
              -------------                           ----        ----        ----         ----        ----
              Total assets                        $214,305    $187,541    $165,737     $158,711    $139,089
              Loans receivable, net                184,405     169,592     147,689      129,744     116,093
              Investment securities                  9,936       9,201       8,129       14,470       9,655
              Marketable equity securities              --          50       4,575        4,396       4,185
              Foreclosed real estate, net               94          --          --           --         212
              Deposits                             149,167     129,770     114,720      107,086     103,612
              FHLB advances                         40,000      34,000      28,000       29,000      15,000
              Retained earnings                     13,275      12,503      11,223       10,900       9,763
              Total stockholders' equity            23,303      22,556      21,066       21,248      19,621


        Summary of Operations (Dollars in Thousands)

               Years Ended September 30,              2001        2000        1999         1998        1997
               -------------------------              ----        ----        ----         ----        ----
               Interest income                     $14,996     $13,368     $11,894      $11,299     $10,280
               Interest expense                      8,261       7,125       6,031        5,809       5,167
               Net interest income                   6,735       6,243       5,863        5,490       5,113
               Provision for credit losses             150         120          90           90         100
               Noninterest income                    1,137       1,040       1,069          863         593
               Noninterest expense                   3,976       3,484       3,328        3,130       3,041
               Net income before taxes               3,746       3,679       3,514        3,133       2,565
               Net income                           $2,325      $2,249      $2,191       $1,973      $1,591


        Other selected Data

              Years Ended September 30,               2001        2000        1999         1998        1997
              -------------------------               ----        ----        ----         ----        ----
              Return on average assets                1.17%       1.26%       1.35%        1.33%       1.19%
              Return on average equity               10.05       10.37       10.13         9.68        8.40
              Average equity to average assets       10.87       12.11       13.72        14.21       15.69
              Net interest rate spread                2.74        2.85        2.96         3.03        3.27
              Nonperforming assets to assets           .28         .51         .66          .34         .52
              Nonperforming loans to loans             .28         .57         .74          .41         .45
              Allowance for credit losses to
                 Loans                                 .53         .50         .54          .59         .58


        Per Share Data

              Years Ended September 30,               2001         2000        1999        1998        1997
              -------------------------               ----         ----        ----        ----        ----
              Basic earnings                        $ 1.13       $ 1.08      $ 1.01       $ .90       $ .74
              Diluted earnings                        1.09         1.04         .96         .85         .70
              Book value                             11.29        10.49        9.69        9.25        8.58
              Cash dividends declared                  .43          .39         .34         .30         .27
</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,  2001,  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>
<CAPTION>
                                                         At September 30, 2001
------------------------------------------------------------------------------------------------------------
                                                        (Dollars in Thousands)

                                                             Six
                                    Three       Three     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)            $13,653      $9,997    $77,336    $35,798    $13,208     $9,227   $159,219
 Other loans (1)                    7,551       1,128      2,057      6,052      8,624        416     25,828
 Marketable equity                     53          --         --         --         --         --         53
securities(3)
 Federal funds sold and other
  short-term investments           11,933          --         --         --         --         --     11,933
 Investment securities                 --          --      6,450      1,048         --         --      7,498
 Mortgage-backed securities (2)        --          --          4         --         --         --          4
 FHLB stock                         2,300          --         --         --         --         --      2,300
                                  -------      ------    -------    -------    -------     ------   --------
   Total interest earning          35,490      11,125     85,847     42,898     21,832      9,643    206,835
assets

Less:
 Loans in process                   2,973       1,652      1,982         --         --         --      6,607
 Unearned discount and
  deferred fees(2)                     30          16        112         59         31         14        262
  Allowance for credit losses         180          53        289        225        197         37        981
                                  -------      ------    -------    -------    -------     ------   --------
   Net interest-earning assets     32,307       9,404     83,464     42,614     21,604      9,592    198,985
                                  -------      ------    -------    -------    -------     ------   --------
Interest bearing liabilities:
 Money market deposits              3,264       2,210      2,509      1,112        529        481     10,105
 Passbook deposits                    691         660      1,231      3,922      2,557      6,252     15,313
 NOW and other demand deposits      1,344       1,197      2,017      4,172      1,116      2,472     12,318
 Certificate accounts              14,307          --     52,613     28,750      2,247         --     97,917
 Borrowed funds                        --      11,000      5,000     24,000         --         --     40,000
                                  -------      ------    -------    -------    -------     ------   --------
  Total interest bearing
    liabilities                    19,606      15,067     63,370     61,956      6,449      9,205    175,653
                                  -------      ------    -------    -------    -------     ------   --------

Interest sensitivity gap(4)       $12,701    $(5,663)    $20,094  $(19,342)    $15,155       $387    $23,332
                                  =======    ========    =======  =========    =======       ====    =======

Cumulative interest
  sensitivity gap                 $12,701      $7,038    $27,132     $7,790    $22,945    $23,332
                                  =======      ======    =======     ======    =======    =======

Cumulative interest
 sensitivity gap as a
 percent of total assets             5.93%       3.28%     12.66%      3.64%     10.71%     10.89%

Cumulative net interest bearing
 assets as a percent of interest
 bearing liabilities               164.78%      62.41%    131.71%     68.78%    335.00%    104.20%

</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>
<CAPTION>
                                                               Year Ended September 30
                                         -------------------------------------------------------------------
                                                      2001                                 2000
                                         ------------------------------       ------------------------------
                                           Average              Yield/          Average             Yield/
                                           Balance   Interest    Cost           Balance   Interest   Cost
                                           -------   --------    ----           -------   --------   ----
                                                                 (Dollars in Thousands)
<S>                                    <C>         <C>        <C>           <C>         <C>       <C>
    Assets:
      Interest earning assets:
        Mortgage loans (1)                $146,336    $11,024   7.53%          $133,380    $ 9,828   7.37%
        Other loans (1)                     33,823      3,084   9.12             28,519      2,680   9.40
        Interest-earning deposits (2)           --         --     --              1,399         79   5.66
        Federal Funds sold and
         other short-term investments        2,980        177   5.96              1,170        130  11.07
        Investment securities                7,157        559   7.81              6,958        514   7.38
        FHLB stock                           2,141        152   7.09              1,695        137   8.04
                                          --------    -------                  --------    -------
         Total interest earning assets     192,437     14,996   7.79            173,121     13,368   7.72
                                                      -------                              -------
        Noninterest earning assets           6,636                                6,038
                                          --------                             --------
          Total assets                    $199,073                             $179,159
                                          ========                             ========

    Liabilities and equity:
      Interest bearing liabilities:
        Money market deposits             $  7,515        233   3.09           $  7,090        252   3.55
        Savings deposits                    14,817        302   2.04             15,315        388   2.53
        NOW and other demand deposits       11,406        102   0.90             10,424        130   1.25
        Certificate accounts                91,091      5,358   5.88             79,415      4,304   5.42
                                          --------     ------                  --------     ------
      Total deposit accounts               124,829      5,995   4.80            112,244      5,074   4.52
        Borrowed funds                      38,766      2,266   5.85             34,104      2,051   6.02
                                          --------     ------                  --------     ------
         Total interest bearning
           liabilities                     163,595      8,261   5.05            146,348      7,125   4.87
                                                       ------                               ------
     Noninterest bearing liabilities        12,339                               11,120
     Equity                                 23,139                               21,691
                                          --------                             --------
         Total liabilities and equity     $199,073                             $179,159
                                          ========                             ========
    Net interest income                                $6,735                              $6,243
                                                       ======                              ======

    Interest rate spread(3)                                     2.74%                               2.85%
    Net interest margin(4)                                      3.50%                               3.61%
    Interest earning assets to
      interest bearing liabilities          117.63%                              118.29%
                                            =======                              =======

</TABLE>

----------------
(1)  Amount is net of  deferred  loan fees and  discounts,  loans in process and
     includes accrued interest.
(2)  Includes assets held for sale.
(3)  Net interest rate spread  represents  the  difference  between the yield on
     average  interest  earning assets and the cost of average  interest bearing
     liabilities.
(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>
<CAPTION>
                                                             Year Ended September 30,
                                        --------------------------------------------------------------
                                              2001 versus 2000                 2000 versus 1999
                                        -----------------------------    -----------------------------
                                         Volume     Rate        Net       Volume     Rate        Net
                                        -------    -------    -------    -------    -------    -------
                                                             (Dollars in Thousands)
<S>                                   <C>        <C>        <C>        <C>        <C>        <C>
Interest earning assets:
  Mortgage loans                        $   955    $   241    $ 1,196    $ 1,490    $   (48)   $ 1,442
  Other loans                               498        (94)       404        475         44        519
  Interest earning deposits                 (79)         0        (79)      (168)         6       (162)
  Federal funds sold and other
   short-term investments                   201       (154)        47        (73)        55        (18)
  Investment securities, net                 15         30         45       (370)        40       (330)
  FHLB stock                                 36        (21)        15         13         10         23
                                        -------    -------    -------    -------    -------    -------
    Total interest earning assets         1,626          2      1,628      1,367        107      1,474
                                        -------    -------    -------    -------    -------    -------

Interest bearing liabilities:
  Money market deposits                      15        (34)       (19)        48         (5)        43
  Savings deposits                          (13)       (73)       (86)       (23)         4        (19)
  NOW and other demand deposits              12        (40)       (28)         6        (13)        (7)
  Certificate accounts                      633        421      1,054        413        197        610
  Borrowed funds                            280        (65)       215        313        154        467
                                        -------    -------    -------    -------    -------    -------
    Total interest bearing liabilites       928        208      1,136        757        337      1,094
                                        -------    -------    -------    -------    -------    -------
Net change in net interest income       $   698    $  (206)   $   492    $   610    $  (230)   $   380
                                        =======    =======    =======    =======    =======    =======
</TABLE>


--------------------------------------------------------------------------------
Comparison of
Financial
Condition for
Fiscal Years Ended
September 30,
2001 and 2000
------------------

The  Company's  total  assets were $214.3  million at  September  30,  2001,  an
increase of $26.8  million or 14.3%,  from the $187.5  million at September  30,
2000. The asset  expansion was primarily due to growth of Federal funds sold and
other short-term investments and net loans receivable.

At September 30, 2001, cash, Federal funds sold and other short-term investments
were $11.9 million  compared to $1.1 million at September 30, 2000.  The Company
experienced  strong  deposit growth during the fourth quarter of fiscal 2001 and
these funds were invested in interest bearing deposit accounts.  The Company had
entered into  commitments  to purchase $9.0 million in investment  securities at
September 30, 2001 with settlement scheduled for October of 2001.

Net loans  receivable  increased  $14.8  million,  or 8.7%, to $184.4 million at
September 30, 2001 from $169.6 million at September 30, 2000. Increases of 34.4%
and  14.2%,  respectively,  in the  commercial  and  consumer  loan  portfolios,
respectively, during fiscal 2001, as well as, continued growth of mortgage loans
within the markets  served by Bedford  Federal  were the primary  factors in the
expansion of loans.  This increase was funded primarily by principal  repayments
of existing loans, increased deposits, and advances from the FHLB.

<PAGE>

Deposits  increased  $19.4 million to $149.2  million at September 30, 2001 from
$129.8  million at September 30, 2000. The increase was reflected in all deposit
categories with  certificates of deposit up $12.5 million,  NOW accounts up $3.3
million and money market accounts up $3.2 million. Continued merger activity and
branch closings and sales combined with effective marketing were primary factors
in the growth.

Total  stockholders'  equity was $23.3  million at September  30,  2001,  up $.7
million or 3.3% from the $22.6  million at  September  30, 2000.  During  fiscal
2001,  the  Corporation  repurchased  117,334  shares of its common  stock at an
aggregate price of $1.3 million.


--------------------------------------------------------------------------------
Comparison of
Operating Results
for Years Ended
September 30,
2001 and 2000
-----------------

Net Income.  Net income  increased 3.4%, or $76,000,  to $2.3 million for fiscal
2001 from fiscal 2000. A 7.9% rise in net interest income and a 9.3% increase in
noninterest income,  partially offset by a 14.1% increase in noninterest expense
accounted for the improvement in profitability.

Interest Income. Interest income totaled $15.0 million for the fiscal year ended
September 30, 2001, a 12.2% increase from the $13.4 million  recorded for fiscal
2000. The $1.6 million  increase is primarily due to the 11.2% growth of average
earning assets.

Interest Expense.  Interest expense increased $1.1 million from $7.1 million for
the year ended September 30, 2000, to $8.3 million for fiscal 2001. The level of
average interest  bearing  liabilities rose 11.8% to $163.6 million for the year
ended  September 30, 2001,  from $146.3 million for fiscal 2000, and the cost of
average  interest  bearing  liabilities  rose 18 basis  points  in  fiscal  2001
compared to fiscal 2000. The increased cost of funds was primarily due to higher
average rates paid on certificates of deposit.

Net Interest Income. Net interest income totaled $6.7 million for the year ended
September 30, 2001, up 7.9% from the $6.2 million  realized in fiscal 2000.  The
increase is due to the higher volume of average interest earning assets,  offset
somewhat  by  the  increase  in  both  volume  and  cost  of  interest   bearing
liabilities.

Provision  for Loan  Losses.  The  provision  for loan losses for the year ended
September  30, 2001,  was $150,000,  up $30,000 from the  provision  recorded in
fiscal 2000.  The  increases in the  commercial  and  consumer  loan  portfolios
precipitated  the increase in the  provision  for loan losses for the year ended
September  30, 2001.  Based upon the 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 at September 30, 2001. 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, 2001,  noninterest income
amounted to $1.1 million, an increase of $97,000 from the $1.0 million earned in
fiscal 2000.  During the fourth  quarter of fiscal 2001,  the Bank  recognized a
gain of $88,000 from the sale of real estate,  which  accounted  for the rise in
noninterest income.

Noninterest Expense. Noninterest expense totaled $4.0 million for the year ended
September 30, 2001, as compared to $3.5 million for fiscal 2000. The

<PAGE>
increase  was  primarily  due to an 8.9%  rise in the cost of  compensation  and
employee benefits,  a 38.5% increase in occupancy and equipment expense, a 13.8%
rise in data processing  expense and a 78.4% increase in professional  fees. The
higher 2001 expense for compensation and employee  benefits was primarily due to
merit  increases  and  additional  staffing.  Occupancy  and  equipment  expense
reflects costs associated with the branch opened in the fourth quarter of fiscal
2000 and expenses  related to the upgrading of data processing  equipment.  Data
processing expenses were up due to a higher volume of accounts and transactions.
Professional fees rose primarily due to an increase in legal expenses.

Income taxes.  The  provision for income taxes for the year ended  September 30,
2001 was $1.4 million,  relatively unchanged from the provision for income taxes
recorded in fiscal 2000.

--------------------------------------------------------------------------------
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, 2001,  such  borrowed  funds  totaled  $40.0  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  $66.9 million. We believe that we can replace these funds with
other deposits, excess liquidity, FHLB borrowings , or other borrowings if these
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, 2001, we had
commitments to fund loans of $19.1million, and $6.6 million of loans in process.
In addition,  we had  committed to purchase  $9.0 million of available  for sale
securities.

Net cash provided by operating activities for fiscal 2001, totaled $3.1 million,
which was primarily due to net income of $2.3 million.

Net cash absorbed by investing activities for fiscal 2001 totaled $15.5 million,
a decrease  of $3.4  million  from  fiscal  2000.  The  decrease  was  primarily
attributable  to a $7.4 million  reduction in net loans to customers,  partially
offset by a decrease of $4.6 million in proceeds from the sales of available for
sale securities.

Net cash provided by financing activities for the year ended September 30, 2001,
totaled $23.7  million.  This is a result of a net increase in deposits of $19.4
million,  and a net increase in FHLB advances of $6.0 million.  These  increases
were used primarily to fund the increase in loan  originations  and the increase
in Federal funds sold and other short-term investments.

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.

<PAGE>

--------------------------------------------------------------------------------
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>




Report of Independent Certified Public Accountants



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

We have audited the consolidated balance sheets of Bedford Bancshares,  Inc. and
subsidiaries  (the "Company") as of September 30, 2001 and 2000, and the related
consolidated statements of operations,  stockholders' equity, and cash flows for
each of the three years in the period ended September 30, 2001.  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, 2001 and 2000,  and the
results of their  operations and their cash flows for each of the three years in
the period ended  September 30, 2001 in conformity  with  accounting  principles
generally accepted in the United States of America.



/s/BDO Seidman, LLP
-------------------

Richmond, Virginia
November 1, 2001



<PAGE>

                                                        Bedford Bancshares, Inc.
                                                                and Subsidiaries


                                                     Consolidated Balance Sheets
                                                                  (in thousands)

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

     Assets

Cash (including interest bearing deposits of
   approximately $11,933 - 2001, $1,136 - 2000)        $  16,761   $   5,512
Securities (Note 1)
   Held-to-maturity                                          504         507
   Available for sale                                      7,132       6,905
Investment in Federal Home Loan Bank stock,
   at cost (Note 6)                                        2,300       1,900
Loans receivable, net (Notes 2, 6 and 14)                184,405     169,592
Property and equipment, net (Note 4)                       1,273       1,365
Accrued interest receivable                                1,093       1,133
Deferred income taxes (Note 8)                               159         270
Other assets                                                 678         357
--------------------------------------------------------------------------------

Total assets                                            $214,305    $187,541
--------------------------------------------------------------------------------

<PAGE>

                                                        Bedford Bancshares, Inc.
                                                                and Subsidiaries


                                                     Consolidated Balance Sheets
                                                                  (in thousands)

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

     Liabilities and Stockholders' Equity

Liabilities
   Deposits (Note 5)                                       $149,167   $129,770
   Advances from Federal Home Loan Bank (Note 6)             40,000     34,000
   Advances from borrowers for taxes and insurance              717        694
   Dividends payable                                            227        215
   Other liabilities                                            891        306
--------------------------------------------------------------------------------

Total liabilities                                           191,002    164,985
--------------------------------------------------------------------------------

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, 2,063,453 and 2,149,270 shares,
     issued and outstanding                                     206        215
   Additional paid-in capital                                10,171     10,466
   Retained earnings, substantially restricted (Note 10)     13,275     12,503
   Accumulated other comprehensive (loss) income                 60       (122)
   Stock acquired by ESOP and RRP (Note 11)                    (409)      (506)
--------------------------------------------------------------------------------

Total stockholders' equity                                   23,303     22,556
--------------------------------------------------------------------------------

Total liabilities and stockholders' equity                 $214,305   $187,541
--------------------------------------------------------------------------------
                                 (See accompanying summary of accunting policies
                                 and notes to consolidated finanical statements.
<PAGE>
                                                        Bedford Bancshares, Inc.
                                                                and Subsidiaries


                                           Consolidated Statements of Operations
                                                                  (in thousands)
                                                                     (continued)


--------------------------------------------------------------------------------
Year Ended September 30,                                  2001    2000      1999
--------------------------------------------------------------------------------

Interest income
   Loans                                               $14,108 $12,508   $10,547
   U.S. government obligations, including agencies         826     687     1,141
   Other investments                                        62     173       206
--------------------------------------------------------------------------------

Total interest income                                   14,996  13,368    11,894
--------------------------------------------------------------------------------

Interest expense
   Deposits (Note 5)                                     5,995   5,074     4,447
   Borrowed money                                        2,266   2,051     1,584
--------------------------------------------------------------------------------

Total interest expense                                   8,261   7,125     6,031
--------------------------------------------------------------------------------

Net interest income                                      6,735   6,243     5,863

Provision for loan losses (Note 2)                         150     120        90
--------------------------------------------------------------------------------

Net interest income after provision for
   loan losses                                           6,585   6,123     5,773
--------------------------------------------------------------------------------

Noninterest income
   Service charges and fees on loans                       549     562       648
   Other customer service fees and commissions             421     403       336
   Gain on sale of loans, investments and
     foreclosed real estate                                101       8        30
   Other                                                    66      67        55
--------------------------------------------------------------------------------

Total noninterest income                                 1,137   1,040     1,069
--------------------------------------------------------------------------------

                                                                    continued...

<PAGE>
                                                        Bedford Bancshares, Inc.
                                                                and Subsidiaries

                                           Consolidated Statements of Operations
                                                                  (in thousands)
                                                                     (continued)



--------------------------------------------------------------------------------
Year Ended September 30,                      2001         2000         1999
--------------------------------------------------------------------------------
Noninterest expense
   Compensation and employee benefits      $ 2,140      $ 1,966      $ 1,860
   Occupancy and equipment                     471          340          319
   Data processing                             485          426          397
   Federal insurance of accounts                25           38           63
   Advertising                                 129          129          115
   Professional fees                           298          167          200
   Other                                       428          418          374
--------------------------------------------------------------------------------

Total noninterest expense                    3,976        3,484        3,328
--------------------------------------------------------------------------------

Income before income taxes                   3,746        3,679        3,514

Provision for income taxes (Note 8)          1,421        1,430        1,323
--------------------------------------------------------------------------------

Net income                                 $ 2,325      $ 2,249      $ 2,191
--------------------------------------------------------------------------------

Basic earnings per share (Note 16)         $  1.13      $  1.08      $  1.01

Diluted earnings per share (Note 16)       $  1.09      $  1.04      $   .96
--------------------------------------------------------------------------------
                                 (See accompanying summary of accunting policies
                                 and notes to consolidated finanical statements.

<PAGE>
                                                        Bedford Bancshares, Inc.
                                                                and Subsidiaries


                                 Consolidated Statements of Stockholders' Equity
                                                                  (in thousands)

<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------------------------
                                                                              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, 1998                $230      $10,939      $10,900      $    60           $(881)     $ 21,248

Comprehensive income
   Net income                                 -            -        2,191            -               -         2,191
   Change in unrealized loss
     on securities available for
     sale (Note 9)                            -            -            -         (211)              -          (211)
                                                                                                          ------------
Total comprehensive income                    -            -            -            -               -         1,980
                                                                                                          ------------
   Allocated/earned ESOP
     shares (Note 11)                         -          195           17            -              40           252
   Repurchase of stock (132,200
     shares)                                (13)        (648)      (1,103)           -               -        (1,764)
   Dividends declared ($.34
     per share)                               -            -         (786)           -               -          (786)
   Exercise of options (Note 11)              -           36            4            -               -            40
   RRP vesting (Note 11)                      -          (25)           -            -             121            96
----------------------------------------------------------------------------------------------------------------------

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)
----------------------------------------------------------------------------------------------------------------------
                                                                                                          continued...
</TABLE>

<PAGE>
                                                        Bedford Bancshares, Inc.
                                                                and Subsidiaries

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


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

Balance, September 30, 2001                $206      $10,171      $13,275       $   60           $(409)      $23,303
----------------------------------------------------------------------------------------------------------------------
                                                                       (See accompanying summary of accunting policies
                                                                       and notes to consolidated finanical statements.

</TABLE>
<PAGE>
                                                        Bedford Bancshares, Inc.
                                                                and Subsidiaries


                                           Consolidated Statements of Cash Flows
                                                                  (in thousands)

<TABLE>
<CAPTION>
Year Ended September 30,                                                  2001               2000             1999
--------------------------------------------------------------------------------------------------------------------
<S>                                                                <C>                <C>              <C>
Operating activities
   Net income                                                        $   2,325          $   2,249        $   2,191
   Adjustments to reconcile net income to
     net cash provided by operating activities
       Provision for loan losses                                           150                120               90
       Provision for depreciation and amortization                         213                149              147
       (Increase) decrease in deferred income taxes                        111                (45)            (130)
       Gain on sale of loans, investments, and
         foreclosed real estate                                           (101)                (8)             (30)
       Loans originated for sale                                             -                  -           (1,464)
       Proceeds from sale of loans originated for sale                       -                  -            1,464
       (Increase) decrease in interest receivable                           39               (209)              72
       (Increase) decrease in other assets                                (228)               (75)             285
       Increase (decrease) in other liabilities                            587               (845)             485
--------------------------------------------------------------------------------------------------------------------

Net cash provided by operating activities                                3,096              1,336            3,110
--------------------------------------------------------------------------------------------------------------------

Investing activities
   Proceeds from maturities of securities                                8,500              1,300           17,055
   Proceeds from sales of available for sale securities                     50              4,664                -
   Purchase of available for sale securities                            (8,500)            (2,021)          (9,658)
   Principal collected on mortgage-backed securities                         3                  3                4
   Net increase in loans to customers                                  (14,944)           (22,337)         (18,036)
   Net proceeds from sales of foreclosed real estate                         -                293               83
   Purchases of premises, equipment and leasehold
     improvements                                                         (209)              (439)             (92)
   Sale (purchase) of FHLB stock                                          (400)              (400)              50
--------------------------------------------------------------------------------------------------------------------

Net cash absorbed by investing activities                              (15,500)           (18,937)         (10,594)
--------------------------------------------------------------------------------------------------------------------
                                                                                                        continued...
</TABLE>



<PAGE>
                                                        Bedford Bancshares, Inc.
                                                                and Subsidiaries


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

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------------------------------
Year Ended September 30,                                                  2001               2000             1999
--------------------------------------------------------------------------------------------------------------------
<S>                                                                  <C>                <C>               <C>
Financing activities
   Net increase in deposits                                            $19,397            $15,050           $7,635
   Net increase (decrease) in advance payments
     from borrowers                                                         23                 89               77
   Proceeds from FHLB advances                                          19,000             80,000           11,000
   Principal payments of FHLB advances                                 (13,000)           (74,000)         (12,000)
   Allocation of ESOP and RRP shares                                       267                314              348
   Repurchase of stock                                                  (1,311)              (264)          (1,764)
   Dividends paid                                                         (896)              (820)            (774)
   Issuance of common stock                                                173                  -               40
--------------------------------------------------------------------------------------------------------------------

Net cash provided by financing activities                               23,653             20,369            4,562
--------------------------------------------------------------------------------------------------------------------

Increase (decrease) in cash and cash equivalents                        11,249              2,768           (2,922)

Cash and cash equivalents - beginning of year                            5,512              2,744            5,666
--------------------------------------------------------------------------------------------------------------------

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


Cash payments of interest expense                                      $ 8,295            $ 7,508          $ 6,015
--------------------------------------------------------------------------------------------------------------------

Cash payments of income taxes                                          $ 1,457            $ 1,246          $ 1,282
--------------------------------------------------------------------------------------------------------------------

Transfer of loans to foreclosed real estate                            $    94            $   316          $    88
--------------------------------------------------------------------------------------------------------------------
                                                                     (See accompanying summary of accunting policies
                                                                     and notes to consolidated finanical statements.
</TABLE>

<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.

<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.

<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,  2001,  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.

<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.

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.

<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 June 1998,  the Financial  Accounting  Standards  Board issued  Statements of
Financial  Accounting  Standards No. 133, Accounting for Derivative  Instruments
and Hedging Activities ("SFAS 133"). SFAS 133 as amended by SFAS 137 and 138, is
effective for all fiscal quarters of fiscal years beginning after June 15, 2000.
SFAS  133  establishes   accounting  and  reporting   standards  for  derivative
instruments,   including  certain  derivative   instruments  embedded  in  other
contracts,  and for  hedging  activities.  SFAS  133  requires  that  an  entity
recognize all  derivatives  as either assets or  liabilities in the statement of
financial  position  and measure  those  instruments  at fair value.  If certain
requirements are met, a derivative may be specifically designated as a hedge and
an entity that elects to apply hedge  accounting is required to establish at the
inception of the hedge the method it will use for assessing the effectiveness of
the  hedging  derivative  and  the  measurement  approach  for  determining  the
ineffective  aspect of the hedge.  Those  methods  must be  consistent  with the
entity's  approach to managing  risk.  The  adoption of SFAS 133 did not have an
effect on the Company's financial statements.

In July 2001, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards No. 141 ("SFAS 141"), "Business Combinations",
which is  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 Company believes the adoption
of SFAS 141 will not have an effect on the Company's financial statements.

<PAGE>
                                                        Bedford Bancshares, Inc.
                                                                and Subsidiaries


                                                  Summary of Accounting Policies
                                                                     (continued)

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

Accounting Pronouncements (continued)

In July 2001, the FASB issued  Statement of Financial  Accounting  Standards No.
142 ("SFAS 142"),  "Goodwill and Other  Intangible  Assets",  which is 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  Company  believes  the  adoption of SFAS 142 will not have an effect on the
Company's financial statements.

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.

On July 6,  2001the SEC issued  Staff  Accounting  Bulletin No. 102 ("SAB 102"),
"Selected  Loan  Loss  Allowance  Methodology  and  Documentation  Issues".  The
bulletin  expresses  the  SEC's  views  on the  development,  documentation  and
application of a systematic  methodology for determining allowances for loan and
lease losses in accordance with generally accepted accounting  principles.  This
includes  for each period  reported  the "books and  records of the  registrants
engaged  in  lending  activities   include   documentation  of:  (a)  systematic
methodology to be employed each period in determining  the amount of loan losses
to be reported,  and (b) rationale  supporting each period's  determination that
the amounts reported were adequate."  Management believes that its documentation
and methodologies are compliant with SAB 102.

<PAGE>
                                                        Bedford Bancshares, Inc.
                                                                and Subsidiaries


                                                  Summary of Accounting Policies
                                                                     (continued)

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

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.

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.

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

                                                Gross        Gross     Estimated
                                 Amortized   Unrealized   Unrealized     Market
                                    Cost        Gains       Losses       Value
--------------------------------------------------------------------------------

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


Gross gains of approximately $8,000, $0 and $0 and gross losses of approximately
$5,000, $0 and $0 were realized on sales of securities available for sale during
the years ended September 30, 2001, 2000 and 1999, respectively.

<PAGE>
                                                        Bedford Bancshares, Inc.
                                                                and Subsidiaries


                                      Notes to Consolidated Financial Statements
                                                                     (continued)

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

1.      Securities (continued)

September 30, 2000
--------------------------------------------------------------------------------

                                                  Gross       Gross    Estimated
                                   Amortized    Unrealized   nrealized    Market
                                      Cost         Gains      Losses      Value

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

Held to Maturity

   United States government
     and agency obligations           $  500         $ -        $  1      $  499

   Mortgage-backed securities              7           -           -           7
--------------------------------------------------------------------------------

                                         507           -           1         506
--------------------------------------------------------------------------------

Available for Sale

   United States government
     and agency obligations            7,000           -         198       6,802

   Marketable Equity securities           48           2           -          50

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

                                       7,101           2         198       6,905
--------------------------------------------------------------------------------

                                      $7,608        $  2        $199      $7,411
--------------------------------------------------------------------------------




<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, 2001, by contractual maturity, were as follows:

                                                                    Estimated
                                            Amortized                 Market
                                              Cost                    Value

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

Held to Maturity

   Due in one year or less                     $    -                   $    -
   Due in one through five years                  500                      524
   Due after five years                             -                        -
--------------------------------------------------------------------------------


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

                                                  504                      528
--------------------------------------------------------------------------------

Available for Sale
   Due in one year or less                      5,982                    6,030
   Due in one through five years                1,000                    1,049
   Due after five years                             -                        -
--------------------------------------------------------------------------------

                                                6,982                    7,079

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

                                                7,035                    7,132
--------------------------------------------------------------------------------

                                               $7,539                   $7,660
--------------------------------------------------------------------------------

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.




<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,                                               2001         2000
--------------------------------------------------------------------------------

First mortgage loans                                    $138,792     $129,140
Construction loans                                        17,701       19,844
Home equity loans                                          6,904        6,345
Loans to depositors, secured by savings                      219          448
Installment loans                                         15,819       13,851
Term notes                                                12,820        9,539
--------------------------------------------------------------------------------

                                                         192,255      179,167
Less
   Undistributed loans in process                          6,607        8,438
   Deferred loan fees and costs, net                         262          287
   Allowance for credit losses                               981          850
--------------------------------------------------------------------------------

                                                        $184,405     $169,592
--------------------------------------------------------------------------------


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

Year ended September 30,                      2001          2000         1999
--------------------------------------------------------------------------------

Balance at beginning of year                  $850          $804         $764
Provision charged to operations                150           120           90
Charge offs net of recoveries                  (19)          (74)         (50)
--------------------------------------------------------------------------------

Balance at end of year                        $981          $850         $804
--------------------------------------------------------------------------------

<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,                                          2001       2000      1999
--------------------------------------------------------------------------------

Federal Home Loan Mortgage Corporation (FHLMC)       $3,226     $1,538    $1,698
Virginia Housing Development Authority (VHDA)             -          -       803
--------------------------------------------------------------------------------

                                                     $3,226     $1,538    $2,501
--------------------------------------------------------------------------------

4.      Property and Equipment

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

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

Land                                                            $  210    $  251
Office buildings                                                 1,261     1,222
Rental buildings                                                     -        48
Furniture, fixtures and equipment                                1,350     1,206
Automobile                                                          25        25
Leasehold improvements                                             254       251
--------------------------------------------------------------------------------

                                                                 3,100     3,003
Less accumulated depreciation                                    1,827     1,638
--------------------------------------------------------------------------------

                                                                $1,273    $1,365
--------------------------------------------------------------------------------

<PAGE>
                                                        Bedford Bancshares, Inc.
                                                                and Subsidiaries


                                      Notes to Consolidated Financial Statements
                                                                     (continued)

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

5.      Deposits

Deposits, in thousands, are summarized as follows:

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

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

NOW accounts                    $ 25,309     16.97%          $ 22,043     16.99%
Money market accounts             10,628      7.12              7,396      5.70
Savings accounts                  15,313     10.27             14,899     11.48
Time deposits                     97,917     65.64             85,432     65.83
--------------------------------------------------------------------------------

                                $149,167    100.00%          $129,770    100.00%
--------------------------------------------------------------------------------

The  aggregate  amount  of  certificates  of  deposit  of  $100,000  or more was
approximately  $20,300,000  and  $14,674,000  at  September  30,  2001 and 2000,
respectively.

At September 30, 2001, the scheduled maturities of time deposits,  in thousands,
are as follows:

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

                       2002                       $66,920
                       2003                        26,973
                       2004                         1,776
                       2005                         1,609
                    Thereafter                        639
           -------------------------------------------------

                                                  $97,917
           -------------------------------------------------

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

Year ended September 30,                       2001          2000         1999
--------------------------------------------------------------------------------

NOW accounts                                 $  102        $  130       $  137
Money market account                            233           252          209
Savings account                                 302           388          407
Time deposits                                 5,358         4,304        3,694
--------------------------------------------------------------------------------

                                             $5,995        $5,074       $4,447
--------------------------------------------------------------------------------

<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,                                     2001                      2000
--------------------------------------------------------------------------------

Within one year                                $16,000                   $19,000
One to two years                                 9,000                     5,000
Two years or more                               15,000                    10,000
--------------------------------------------------------------------------------

                                               $40,000                   $34,000
--------------------------------------------------------------------------------

The weighted  average  interest  rate on advances at September 30, 2001 and 2000
was 5.61% and 6.19%,  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,                           2001        2000        1999
--------------------------------------------------------------------------------

Maximum amount outstanding during the year      $42,000     $38,000     $31,000
--------------------------------------------------------------------------------

Average amount outstanding during the year      $38,766     $34,104     $28,483
--------------------------------------------------------------------------------

Average interest rate during the year              5.85%       6.02%       5.56%
--------------------------------------------------------------------------------

<PAGE>
                                                        Bedford Bancshares, Inc.
                                                                and Subsidiaries


                                      Notes to Consolidated Financial Statements
                                                                     (continued)

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

7.      Fair Value of Financial Instruments

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

<TABLE>
<CAPTION>
September 30,                                                     2001                          2000
--------------------------------------------------------------------------------------------------------------

                                                       Carrying           Fair         Carrying       Fair
                                                        Amount            Value         Amount        Value
--------------------------------------------------------------------------------------------------------------
<S>                                                  <C>              <C>            <C>                <C>
Financial assets
   Cash and short-term investments                      $ 16,761         $ 16,761      $  5,512     $  5,512
   Securities                                              7,636            7,660         7,412        7,412
   Loans, net of allowance for loan losses               184,405          186,276       169,592      165,939

Financial liabilities
   Deposits                                              149,167          150,778       129,770      129,765
   Advances from Federal Home Loan Bank                   40,000           40,000        34,000       34,000

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

Unrecognized financial instruments
   Commitments to extend credit                          $19,094          $19,094       $11,922      $11,922
   Forward commitment to purchase
     Government Securities                                 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.

<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.


<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,                            2001        2000       1999
--------------------------------------------------------------------------------

Current
   Federal                                        $1,273      $1,251     $1,195
   State                                             139         221        211
--------------------------------------------------------------------------------

                                                   1,412       1,472      1,406

Deferred tax expense (benefit)                         9         (42)       (83)
--------------------------------------------------------------------------------

Total provision for income taxes                  $1,421      $1,430     $1,323
--------------------------------------------------------------------------------


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

                                                     Percent of Pre-tax Income
                                                     -------------------------

Year ended September 30,                            2001        2000       1999
--------------------------------------------------------------------------------

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         6.0         5.4
   Other                                             .3        (1.0)       (1.4)
--------------------------------------------------------------------------------

                                                   38.0%       39.0%       38.0%
--------------------------------------------------------------------------------

<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,                                                2001          2000
--------------------------------------------------------------------------------

Deferred tax asset
   Bad debts                                                 $292          $215
   Loan fees                                                   16            21
   Unrealized loss on securities available for sale             -            75
   Other                                                        -            12
--------------------------------------------------------------------------------

Total deferred tax asset                                      308           323
--------------------------------------------------------------------------------

Deferred tax liability
   Unrealized gain on securities available for sale           (36)            -
   Accelerated depreciation                                   (44)          (39)
   Distributive share of income from partnership              (23)          (14)
   Other                                                      (46)            -
--------------------------------------------------------------------------------

Total deferred tax liability                                 (149)          (53)
--------------------------------------------------------------------------------

Net deferred tax asset                                       $159          $270
--------------------------------------------------------------------------------


<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:

Year ended September 30,                                  2001    2000     1999
--------------------------------------------------------------------------------

Unrealized gains (losses) on securities:                  $293     $43    $(269)
   Less:  reclassification adjustment for gains (losses)
     included in net income                                  -      (4)      71
--------------------------------------------------------------------------------

Other comprehensive income (loss) before tax               293      47     (340)

Income tax (expense) benefit related to items of other
   comprehensive income                                   (111)    (18)     129
--------------------------------------------------------------------------------

Other comprehensive income (loss), net of tax             $182     $29    $(211)
--------------------------------------------------------------------------------


10.     Restricted Retained Earnings

In accordance with the current regulations  concerning  conversion from a mutual
to  a  stock  organization,  the  Savings  Bank  was  required  to  establish  a
liquidation  account  equal to its net  worth  as of the  latest  balance  sheet
contained in the final  offering  circular.  Such  liquidation  account is to be
maintained  for the benefit of  depositors,  as of the  eligibility  record date
(September 30, 1993) who continue to maintain their deposits in the Savings Bank
after the  conversion,  in the event of a complete  liquidation  of the  Savings
Bank. If, however,  on any annual closing date of the Savings Bank subsequent to
September 30, 1993, the amount in any deposit account is less than the amount in
such deposit account on September 30, 1993, then the interest in the liquidation
account  relating to such deposit account would be reduced by the amount of such
reduction,  and such  interest  will cease to exist if such  deposit  account is
closed.  The Savings Bank may not declare or pay a cash  dividend or  repurchase
any of its capital stock if the effect  thereof would cause the net worth of the
Savings Bank to be reduced below either the amount  required for the liquidation
account or the minimum regulatory capital  requirements.  At September 30, 2001,
the liquidation account, adjusted for customer withdrawals, totaled $1,880,000.

<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, 2001. The total expense for the plan
was $90,000,  $89,000 and $78,000 for the years ended  September 30, 2001,  2000
and 1999, 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 114,666 and 98,666 shares of Common Stock as of September
30, 2001 and 2000, respectively. The Company recognized $143,000 and $104,000 of
compensation cost for the years ended September 30, 2001 and 2000, respectively.
The fair value of unearned ESOP shares  totaled  $579,000 at September 30, 2001.
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.

<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 these
plans are recorded as unearned  compensation,  a contra equity account,  and are
recognized as an expense in accordance with the vesting  requirements  under the
various  plans.  For the years ended  September  30,  2001 and 2000,  the amount
included in  compensation  expense was $12,000 and  $44,000,  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, 1999                 $5.81          8,394       19,210

Granted                                           -              -            -
Vested                                         5.92              -      (16,210)
--------------------------------------------------------------------------------

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

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

<S>                                     <C>           <C>             <C>           <C>
Balance at September 30, 1999             $6.40         20,994          48,049        147,715

Granted                                       -              -               -              -
Vested                                        -              -         (40,549)        40,549
Exercised                                     -              -               -              -
----------------------------------------------------------------------------------------------

Balance at September 30, 2000              6.40         20,994           7,500        188,264

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

Balance at September 30, 2001             $5.95         20,994           2,500        161,747
----------------------------------------------------------------------------------------------
</TABLE>

The remaining contractual lives of the options granted is 4.3 years at September
30, 2001.

<PAGE>
                                                        Bedford Bancshares, Inc.
                                                                and Subsidiaries


                                      Notes to Consolidated Financial Statements
                                                                     (continued)

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

12.     Commitments and Contingencies

The Savings Bank is lessee under month to month  operating lease 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,  under a month to
month  lease at a  monthly  rental of $200 and in  Huddleston,  under a one year
lease expiring in May 2002 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, 2001 are as follows:

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

                             2002                           $  39,800
                             2003                              39,000
                             2004                              39,000
                             2005                              35,700
                  ------------------------------------------------------

                                                             $153,500
                  ------------------------------------------------------

Rent expense was approximately  $43,000,  $18,600 and $7,200 for the years ended
September 30, 2001, 2000 and 1999, 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 commitment
to purchase government  securities of $9,000,000.  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.

<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, 2001 and 2000.  The  Savings  Bank uses the same
credit policies in making commitments and conditional obligations as it does for
on-balance-sheet instruments.

<TABLE>
<CAPTION>
September 30,                                                                                          2001              2000
-------------------------------------------------------------------------------------------------------------------------------
<S>                                                                                             <C>                <C>
Financial instruments, in thousands, whose contract amounts represent credit risk
   Unfunded commercial credit line                                                                $   8,642          $  3,746
   Unfunded home equity lines of credit                                                               7,799             6,967
   Commitments to finance real estate acquisitions and construction                                   2,672             1,209
-------------------------------------------------------------------------------------------------------------------------------

                                                                                                     19,113            11,922

Financial instruments whose contract amount represent interest rate risk
   Forward commitment to purchase government securities                                            $  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.

<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, 2001,  2000 and 1999 are  approximately  $1,312,000,
$714,000 and $910,000, respectively.

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

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

                    Balance at beginning of year      $   714,000
                    Additional loans                      908,000
                    Loan reductions                      (310,000)
                    ------------------------------------------------

                    Balance at end of year             $1,312,000
                    ------------------------------------------------

<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, 2001 and 2000.  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.

                          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

                          Amount     Percent      Actual     Actual    Excess
September 30, 2000       Required   Required      Amount    Percent    Amount
--------------------------------------------------------------------------------

Tangible Capital        $2,813,000     1.50%   $21,318,000   11.37%  $18,505,000
Core Capital             7,503,000     4.00     21,318,000   11.37    13,815,000
Risk-based Capital       9,384,000     8.00     22,086,000   18.83    12,702,000

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.

<PAGE>
                                                        Bedford Bancshares, Inc.
                                                                and Subsidiaries


                                      Notes to Consolidated Financial Statements
                                                                     (continued)

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

16.     Earnings Per Share

During the years  ended  September  30,  2001 and 2000,  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  2001,
117,334  shares  were  repurchased  for an  aggregate  amount  of  approximately
$1,311,000.

Earnings per share is calculated as follows:

Year ended September 30,                          2001        2000         1999
--------------------------------------------------------------------------------

Basic earnings

Income available to common shareholders     $2,325,000  $2,249,000   $2,191,000
--------------------------------------------------------------------------------

Weighted average share outstandings         $2,054,151  $2,076,902    2,167,256
--------------------------------------------------------------------------------

Basic earnings per share                    $    1.13   $    1.08    $     1.01
--------------------------------------------------------------------------------


Diluted earnings per share

Income available to common shareholders     $2,325,000  $2,249,000   $2,191,000
--------------------------------------------------------------------------------

Weighted average shares outstanding         $2,054,151  $2,076,902    2,167,256

   Dilutive effect of RRP plan shares              818       1,619       17,073

   Dilutive effect of stock options             87,679      79,656      100,672
--------------------------------------------------------------------------------

Total weighted average shares outstanding    2,142,648   2,158,177    2,285,001
--------------------------------------------------------------------------------

Diluted earnings per share                  $     1.09  $     1.04   $      .96
--------------------------------------------------------------------------------

<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,                                              2001           2000
--------------------------------------------------------------------------------

Assets
   Cash and cash equivalents                            $ 1,813        $ 1,363
   Securities                                                53            103
   Investment in Subsidiaries                            21,233         21,194
   Other assets                                             437            342
--------------------------------------------------------------------------------

Total assets                                            $23,536        $23,002
--------------------------------------------------------------------------------


Liabilities and stockholders' equity
   Other liabilities                                    $     6        $   231
   Dividends payable                                        227            215
   Stockholders' equity                                  23,303         22,556
--------------------------------------------------------------------------------

Total liabilities and stockholders' equity              $23,536        $23,002
--------------------------------------------------------------------------------

<PAGE>
                                                        Bedford Bancshares, Inc.
                                                                and Subsidiaries


                                      Notes to Consolidated Financial Statements
                                                                     (continued)

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

17.     Condensed Parent Company Information (continued)

                       Condensed Statements of Operations
                                 (in thousands)

Year Ended September 30,                                2001     2000      1999
--------------------------------------------------------------------------------

Income
   Interest
     Savings Bank's ESOP loan                         $   18   $   24    $   29
     Loan to Savings Bank subsidiary                       -        1       108
   Dividends received from Bank                            2        -         -
   Other                                                  71       42        55
--------------------------------------------------------------------------------

Total income                                              91       67       192
--------------------------------------------------------------------------------

Expenses
   Compensation and employee benefits                      2        4         6
   Professional fees                                      91       57        89
   Other operating expenses                               46       37        34
--------------------------------------------------------------------------------

Total expenses                                           139       98       129
--------------------------------------------------------------------------------

Net income (loss) before income taxes and equity in
   undistributed net income of subsidiaries              (48)     (31)       63

Income tax expense (benefit)                             (19)      (3)       27
Equity in undistributed net income of subsidiaries     2,354    2,277     2,155
--------------------------------------------------------------------------------

Net income                                            $2,325   $2,249    $2,191
--------------------------------------------------------------------------------

<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>
<CAPTION>
Year Ended September 30,                                                                2001             2000            1999
-------------------------------------------------------------------------------------------------------------------------------
<S>                                                                                 <C>              <C>             <C>
Operating activities
   Net income                                                                         $2,325           $2,249          $2,191
   Adjustments
     Equity in undistributed net income of Savings Bank subsidiaries                  (2,354)          (2,277)         (2,155)
     (Increase) decrease in other assets                                                 (95)             133            (371)
     Increase (decrease) in other liabilities                                           (225)            (486)            281
-------------------------------------------------------------------------------------------------------------------------------

Net cash absorbed by operating activities                                               (349)            (381)            (54)
-------------------------------------------------------------------------------------------------------------------------------

Investing activities
   Subsidiary dividend payment                                                         2,500            2,307               -
   Proceeds from sale of available for sale securities                                    50                -               -
   Loans originated, net of principal repayments                                           -              180           1,980
   Purchase of Central Virginia Financial Services stock                                   -                -               1
-------------------------------------------------------------------------------------------------------------------------------

Net cash provided by investing activities                                              2,550            2,487           1,981
-------------------------------------------------------------------------------------------------------------------------------

Financing activities
   Purchase of stock, by RRP                                                               -                -               -
   Dividends paid                                                                       (896)            (820)           (774)
   Repurchase of stock                                                                (1,311)            (264)         (1,764)
   RRP vesting                                                                            16               38              96
   ESOP note payment                                                                     267              204             195
   Exercise of options                                                                   173                -              40
-------------------------------------------------------------------------------------------------------------------------------

Net cash absorbed by financing activities                                             (1,751)            (842)         (2,207)
-------------------------------------------------------------------------------------------------------------------------------

Increase (decrease) in cash and cash equivalents                                         450            1,264            (280)

Cash and cash equivalents, beginning of year                                           1,363               99             379
-------------------------------------------------------------------------------------------------------------------------------

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

</TABLE>

<PAGE>
                                                        Bedford Bancshares, Inc.
                                                                and Subsidiaries


                                      Notes to Consolidated Financial Statements
                                                                     (continued)

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

18.     Selected Quarterly Financial Data (Unaudited)

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

                                            First   Second   Third     Fourth
Year ended September 30, 2001              Quarter  Quarter  Quarter   Quarter
--------------------------------------------------------------------------------
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
--------------------------------------------------------------------------------


<PAGE>
                                                        Bedford Bancshares, Inc.
                                                                and Subsidiaries


                                      Notes to Consolidated Financial Statements
                                                                     (continued)

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


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

                                        First      Second    Third       Fourth
Year ended September 30, 2000          Quarter    Quarter   Quarter     Quarter
--------------------------------------------------------------------------------
Total interest income                   $3,108     $3,218    $3,429      $3,613
Total interest expense                   1,613      1,700     1,828       1,984
--------------------------------------------------------------------------------

Net interest income                      1,495      1,518     1,601       1,629
Provision for credit losses                 30         30        30          30
--------------------------------------------------------------------------------

Net interest income after provision
   for credit losses                     1,465      1,488     1,571       1,599

Noninterest income                         285        250       254         251
Noninterest expense                        886        864       826         908
--------------------------------------------------------------------------------

Income before income taxes                 864        874       999         942
Provision for income taxes                 353        329       381         367
--------------------------------------------------------------------------------

Net income                              $  511     $  545    $  618      $  575
--------------------------------------------------------------------------------

Cash dividends declared per share       $  .09     $  .10    $  .10      $  .10
--------------------------------------------------------------------------------

Basic earnings per share                $  .24     $  .27    $  .30      $  .27
Diluted earnings per share              $  .23     $  .26    $  .29      $  .26
--------------------------------------------------------------------------------