EXHIBIT 13


                 Annual Report to Stockholders for Fiscal Year
                           Ended September 30, 1996



<PAGE>

                                [CORPORATE LOGO]

                            BEDFORD BANCSHARES, INC.

                               1996 ANNUAL REPORT
                ------------------------------------------------





<PAGE>




                 BEDFORD BANCSHARES, INC. - 1996 ANNUAL REPORT

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


TABLE OF CONTENTS
------------------------------------------------------------------------------




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

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

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

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


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


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


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


Office Locations..........................................................  51




<PAGE>




Corporate Profile and Related Information

Bedford  Bancshares,  Inc.  (the  "Company")  is the  parent  company of Bedford
Federal Savings Bank ("Bedford Federal" or the "Savings Bank"). The Company 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  Savings  Bank  retains a  specified  amount of its assets in
housing-related  investments.  At the present  time,  since the Company does not
conduct any active  business,  the Company does not intend to employ any persons
other than  officers,  but  utilizes  the support  staff and  facilities  of the
Savings Bank from time to time.

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

      The Savings Bank attracts  deposits from the general  public and uses such
deposits, together with borrowings and other funds, primarily to originate loans
secured by first mortgages on  owner-occupied,  one-to-four family residences in
its market area and to invest in mortgage-backed and investment securities. To a
lesser extent,  Bedford Federal also originates  construction loans,  commercial
real estate and consumer loans.

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 local  newspapers
under the trading symbol of "BFSB" or "Bedford Bc". The following table reflects
the stock price as published by the Nasdaq National Market statistical report.

<TABLE>
<CAPTION>

                                                                       Dividends     Dividends
                                                                       Per Share     Per Share
Quarter Ended                    High           Low         Volume     Declared        Paid
-----------------------------------------------------------------------------------------------
<S>                             <C>           <C>          <C>           <C>           <C>                  
December 1994                   $11.75        $10.25       153,965         --            --
March 1995                      $13.00        $10.75        90,995       $.15            --
June 1995                       $16.25        $12.25       298,726         --          $.15
September 1995                  $18.75        $15.50       209,914       $.15            --
December 1995                   $18.75        $17.50        93,376       $.09          $.15
March 1996                      $18.25        $16.75       120,970       $.09          $.09
June 1996                       $17.75        $15.75       189,406       $.10          $.09
September 1996                  $17.25        $16.50        85,591       $.11          $.10

</TABLE>

      On September 30, 1996, there were approximately 651 shareholders of record
with approximately 51.6% of the 1,143,669  outstanding shares held in nominee or
"street" name through various  brokerage firms.  There were seven firms making a
market in the Company's common stock during the month of September 1996.

      The Savings  Bank may not  declare or pay a cash  dividend on its stock if
the effect thereof would cause the regulatory  capital of the Savings Bank to be
reduced below (1) the amount required for the liquidation account established in
connection with the Savings Bank's  conversion from mutual to stock form, or (2)
the regulatory capital  requirements imposed by the Office of Thrift Supervision
("OTS"). 

2


<PAGE>



Letter from the Chief Executive Officer

To Our Stockholders:

I  am  pleased  to  report  that  Bedford  Bancshares,  Inc.  experienced  solid
performance  and growth during fiscal 1996. The year was highlighted by a record
level of loan  closings,  strong  growth of core  earnings,  a 30%  increase  in
dividends declared and the resolution of the deposit insurance premium disparity
between the Savings  Association  Insurance Fund ("SAIF") and the Bank Insurance
Fund ("BIF").

During  the  fourth  quarter  of fiscal  1996,  federal  legislation  was passed
imposing a one-time  assessment  on all members of the SAIF,  including  Bedford
Federal, in order to recapitalize the SAIF to the congressionally mandated ratio
of  1.25%.  The  assessment,  based on the  level of an  institution's  domestic
deposits at March 31, 1995,  amounted to approximately  $555,000 ($344,000 on an
after-tax basis) for Bedford Federal. As a result of the one-time assessment, we
anticipate a reduction in future SAIF premiums.

Reflecting  the impact of the  one-time  assessment,  net income for fiscal 1996
amounted to $1.3  million  compared to $1.4  million for fiscal  1995.  On a per
share  basis,   earnings  for  fiscal  1996  and  1995  were  $1.17  and  $1.20,
respectively.  The return on average  assets  for the year ended  September  30,
1996, was 1.10% compared to a return of 1.28% for the previous year. The returns
on average  equity were 6.98% and 7.31% for fiscal 1996 and 1995,  respectively.
Without the one-time assessment,  net income for fiscal 1996 would have exceeded
$1.6 million, or $1.48 per share.

Total assets were $127.2  million on September 30, 1996, up 10.5% from the level
one year earlier.  The asset growth was focused in net loans  receivable,  which
increased  11.5% in fiscal 1996 over fiscal 1995.  During  fiscal 1996, a record
$29.6 million of mortgage  loans were closed  representing a 38.1% increase over
fiscal 1995. As a result, total mortgage loans at September 30, 1996, were 9.40%
above the level at the end of fiscal 1995.  In addition,  home equity loans were
up 46.4% and installment loans were up 23.6% from fiscal year end 1995 to fiscal
year  end  1996.  These  increases  reflect  the  fairly  stable  interest  rate
environment  experienced during fiscal 1996, as well as the continuing growth in
the markets served by Bedford Federal.

Stockholders'  equity  ended  fiscal 1996 at $18.2  million,  down 2.5% from the
$18.6 million on September 30, 1995. The modest decrease  primarily reflects the
repurchase  of 65,390 shares of the  Corporation's  common stock at an aggregate
price of $1.1 million and dividend  declarations  of $457,000  (.$39 per share),
mostly offset by net income of $1.3 million.

We were deeply  saddened by the death of T. Glenn Bradley on September 23, 1996.
Mr.  Bradley had served as a director  for 30 years and as Chairman of the Board
since 1983. Mr. Bradley was a valuable asset to Bedford Bancshares, Inc., and we
will all miss his keen insight,  wisdom and kindness.  Mr. Hugh Bond was elected
Chairman of the Board to fill the vacancy left by Mr.  Bradley's death. Mr. Bond
has been a director for 33 years and had served as president since 1970.

This report  provides  details of our progress in fiscal 1996.  The successes we
enjoyed reflect the loyalty and support of our customers and  stockholders,  and
the dedication,  commitment and pride of your Board of Directors, management and
staff. We thank you and look forward to continued success in the future.

Sincerely,


/s/ Harold K. Neal
Harold K. Neal
President and Chief Executive Officer
December 16, 1996                            

                                                                              3


<PAGE>

<TABLE>
<CAPTION>


SELECTED FINANCIAL AND OTHER DATA
---------------------------------------------------------------------------------------------
Financial Condition (Dollars in Thousands)
---------------------------------------------------------------------------------------------
At September 30,                          1996       1995        1994       1993       1992
---------------------------------------------------------------------------------------------
<S>                                    <C>         <C>        <C>         <C>        <C>    
Total assets.......................    $127,201    115,054    $105,217    $96,933    $94,723
Loans receivable, net..............     108,873     97,669      89,309     80,995     77,211
Investment securities..............       8,006      7,761       7,651      5,915      5,867
Marketable equity securities.......       3,879      3,660       3,360      3,289      3,091
Mortgage-backed securities.........         482         31          37         47         59
Foreclosed real estate, net........          --         --          --         31        329
Deposits...........................      95,378     90,063      84,841     89,187     88,745
FHLB advances......................      12,000      5,000       1,000      1,000         --
Retained earnings..................       8,739      8,263       7,519      6,144      5,219
Total stockholders equity..........      18,227     18,685      18,659         --         --

Summary of Operations (Dollars in Thousands)
---------------------------------------------------------------------------------------------
Year Ended September 30,                  1996       1995        1994       1993       1992
---------------------------------------------------------------------------------------------
Interest income....................      $9,264     $8,137      $6,964     $7,095     $7,905
Interest expense...................       4,492      3,778       3,478      3,740      4,929
Net interest income................       4,772      4,359       3,486      3,355      2,976
Provision for credit losses........          22         20          51        234        182
Non-interest income................         735        543         554        497        508
Non-interest expense...............       3,429(1)   2,620       2,238      2,089      2,081
Net income before income taxes and
  cumulative effect of change in
  accounting principle.............       2,056      2,262       1,751      1,529      1,221
Net income.........................       1,302      1,401       1,445        925        677

Other Selected Data
---------------------------------------------------------------------------------------------
Year Ended September 30,                 1996       1995      1994(2)       1993       1992
---------------------------------------------------------------------------------------------
Return on average assets...........        1.10%      1.28%       1.12%       .97%       .72%
Return on average equity...........        6.98       7.31       12.89      16.25      13.82
Average equity to average assets...       15.69      17.49        8.71       5.98       5.25
Net interest rate spread...........        3.34       3.26        3.28       3.39       3.07
Non-performing assets to total assets       .54       1.14        1.07        .40        .88
Non-performing loans to total loans         .63       1.34        1.26        .44        .66
Allowance for loan losses to total loans    .60        .63         .71        .73       1.02

Per Share Data
---------------------------------------------------------------------------------------------
Year Ended September 30,                   1996       1995      1994(2)       1993       1992
---------------------------------------------------------------------------------------------
Net income per share...............      $ 1.17    $  1.20     $  1.23        N/A        N/A
Book value per share...............       16.95      16.81       15.84        N/A        N/A
Cash dividends declared per share..         .39        .30          --        N/A        N/A

</TABLE>


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


4


<PAGE>

Total Assets [Graphics Omitted - Plotting Points Below]

     Bar graph showing  Total Assets in thousands of  dollars for the year ended
September 30. The horizontal  axis shows the years 1992 to 1996 and the vertical
axis shows  amounts  from $0 to $140,000.  Graph  values are  $94,723,  $96,933,
$105,217, $115,054, $127,201 for 1992, 1993, 1994, 1995, and 1996, respectively.

Loan Portfolio Composition [Graphics Omitted - Plotting Points Below]

     Pie Chart showing Loan Portfolio  Composition  identifying the type of loan
and in  percentages  At September  30,  1996.  1-4 Family  Residential  (76.7%),
Commercial  &  Multi-Family  Real Estate  (5.4%),  Consumer/Commercial  Business
(8.1%), Construction (6.0%), Land (3.8%).

Deposit Portfolio Composition [Graphics Omitted - Plotting Points Below]

     Pie Chart showing  Deposit  Portfolio  Composition  identifying the type of
deposit and in percentages At September 30, 1996. Certificates (65.5%), Checking
(13.7%), Savings (16.0%), Money Market (4.8%).

Net Interest Incom [Graphics Omitted - Plotting Points Below]

     Bar graph showing Net Interest  Income in thousands of dollars for the year
ended  September  30. The  horizontal  axis shows the years 1992 to 1996 and the
vertical axis shows amounts from $0 to $5000.  Graph values are $2,976,  $3,355,
$3,486, $4,359, $4,772 for 1992, 1993, 1994, 1995, and 1996, respectively.
 
Net Income [Graphics Omitted - Plotting Points Below]

     Bar graph  showing  Net Income in  thousands  of dollars for the year ended
September 30. The horizontal  axis shows the years 1992 to 1996 and the vertical
axis  shows  amounts  from $0 to $1500.  Graph  values are $677,  $925,  $1,445,
$1,401, $1,302 for 1992, 1993, 1994, 1995, and 1996, respectively.

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

     Bar graph showing Return On Average  Assets stated in  percentages  for the
year ended  September 30. The  horizontal  axis shows the years 1992 to 1996 and
the vertical  axis shows  amounts  from 0.00% to 1.50%.  Graph values are 0.72%,
0.97%, 1.12%, 1.28%, 1.10% for 1992, 1993, 1994, 1995, and 1996, respectively.

                                                                             5
<PAGE>


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


Management Strategy
          The Company's  management strategy is to maintain  profitability and a
          strong  capital  position  through  controlled  growth.  This has been
          accomplished  in the  past  by  the  Savings  Bank's  focus  upon  the
          origination  of  traditional  one-  to  four-family,  adjustable  rate
          mortgage loans which are retained in its loan  portfolio.  To a lesser
          extent, the Savings Bank originates 10 to 15 year, fixed-rate mortgage
          loans,  and consumer  loans,  including  home equity,  automobile  and
          personal  loans.  This  strategy,   along  with  prudent  underwriting
          standards,  is  designed  to  reduce  the risk of loss in the  Savings
          Bank's loan portfolio as well as to reduce the interest risk exposure.

          Management  has  increased the interest  rate  sensitivity  of Bedford
          Federal's  earning  assets to  better  match  the  sensitivity  of its
          interest bearing  liabilities,  while  maintaining high asset quality.
          This  has  been  accomplished  by:  (1)  originating   adjustable-rate
          mortgage loans and shorter term consumer loans for its portfolio,  (2)
          emphasizing  the  solicitation  and  retention of core  deposits  from
          within the Savings  Bank's  market area,  (3)  investing in short- and
          intermediate-term  investments, (4) adhering to sound underwriting and
          investment standards, and (5) effectively managing interest rates paid
          on deposits.

          In its efforts to manage the interest  rates it pays on deposits,  the
          Savings  Bank  focuses  on  maintaining  a stable  deposit  base while
          providing   efficient   and   quality   service   to  its   customers.
          Historically, Bedford Federal has relied primarily upon the cash flows
          from its deposits and mortgage payments as its major sources of funds,
          however,  in recent  years the bank has utilized  borrowings  from the
          Federal   Home  Loan  Bank   ("FHLB")   to  meet   increased   lending
          requirements.


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

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


Interest Rate Sensitivity Analysis
          As rates on sources of funds have  become  deregulated  and subject to
          competitive pressures, financial institutions have become increasingly
          concerned  with the extent to which they are able to match  maturities
          of  interest-earning  assets and  interest-bearing  liabilities.  Such
          matching is  facilitated  by examining the extent to which such assets
          and  liabilities  are "interest rate  sensitive" and by monitoring the
          interest rate  sensitivity  "gap." The "gap" represents the difference
          between  interest-earning  assets  and  interest-bearing   liabilities
          maturing or repricing  within a specific  time period.  The  following
          table sets forth the amounts of interest  earning  assets and interest
          bearing  liabilities  outstanding  at September  30,  1996,  which are
          expected  to  reprice  or mature in each of the  future  time  periods
          shown. It is important to note that certain  shortcomings are inherent
          in the  method  of  analysis  presented  in the  table.  For  example,
          although certain assets and liabilities may have similar maturities or
          periods of repricing,  they may react in different  degrees to changes
          in market interest rates. Also, the interest rates on certain types of
          assets and  liabilities  may fluctuate in advance of changes in market
          rates,  while  interest rates on other types may lag behind changes in
          market rates.  Additionally,  certain assets,  such as adjustable-rate
          mortgage loans have features which restrict  changes in interest rates
          on a  short-term  basis  over the life of the  assets.  Further in the
          event of a change in interest rates, prepayment levels and decay rates
          on core  deposits  may  deviate  significantly  from those  assumed in
          calculating the table.

6


<PAGE>



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

<TABLE>
<CAPTION>



                                                                         At September 30, 1996
                                            ----------------------------------------------------------------------------------
                                            Three       More than 3  More than 6  More than   More than
                                            Months       Months to     Months     1 Year to   3 Years to   More Than
                                            or Less      6 Months     to 1 Year    3 Years     5 Years      5 Years     Total
                                            -------     -----------  -----------  ---------   ----------   ----------   -----
                                                                            (Dollars in Thousands)
Interest-earning assets:
<S>                                        <C>          <C>          <C>         <C>          <C>          <C>         <C>     
  Mortgage loans(1)(2) .................   $  7,409     $  8,506     $ 64,760    $  8,541     $  3,152     $  9,259    $101,627
  Other loans(1) .......................      3,830          526          957       5,238          843           --      11,394
  Marketable equity securities(3) ......      3,879           --           --          --           --           --       3,879
  Federal funds sold and other short- .. 
    term investments ...................        223           --           --          --           --           --         223
  Investment securities ................         --           --           --       2,708        1,883        2,483       7,074
  Mortgage-backed securities(2) ........         --           --           --          25           --          457         482
  FHLB stock ...........................        932           --           --          --           --           --         932
                                           --------     --------     --------    --------     --------     --------    --------
    Total interest-earning assets            16,273        9,032       65,717      16,512        5,878       12,199     125,611
                                           --------     --------     --------    --------     --------     --------    --------
Less:
  Loans in process .....................      1,600        1,599           --          --           --           --       3,199
  Unearned discount and deferred fees(2)         26           20          179          38           11           25         299
  Allowance for credit losses ..........         56           43          390          82           24           55         650
                                           --------     --------     --------    --------     --------     --------    --------
    Net interest-earning assets ........     14,591        7,370       65,148      16,392        5,843       12,119     121,463
                                           --------     --------     --------    --------     --------     --------    --------
Interest-bearing liabilities:
  Money market deposits ................      1,479        1,001        1,137         504          240          218       4,579
  Passbook deposits ....................        679          648        1,209       4,225        2,511        6,018      15,290
  NOW and other demand deposits ........        829          738        1,244       2,573          689        1,525       7,598
  Certificate accounts .................     11,197           --       22,624      26,071        2,560           --      62,452
  Borrowed funds .......................      2,000           --       10,000          --           --           --      12,000
                                           --------     --------     --------    --------     --------     --------    --------
    Total interest-bearing liabilities       16,184        2,387       36,214      33,373        6,000        7,761     101,919
                                           --------     --------     --------    --------     --------     --------    --------
Interest sensitivity gap(4) ............   $ (1,593)    $  4,983     $ 28,934    $(16,981)    $   (157)    $  4,358    $ 19,544
                                           ========     ========     ========    ========     ========     ========    ========
Cumulative interest sensitivity            $ (1,593)    $  3,390     $ 32,324    $ 15,343     $ 15,186     $ 19,544
                                           ========     ========     ========    ========     ========     ========    
Cumulative interest sensitivity gap as
  a percent of total assets ............      (1.25)%       2.67%      25.41%       12.06%       11.94%      15.36%
Cumulative net interest-bearing assets
  as a percent of interest-bearing
  liabilities ..........................      90.16 %     118.25%     159.00%      117.40%      116.13%     119.18%

</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
     pro rated for mortgage loans and mortgage backed securities.
(3)  Includes assets held for sale.


                                                                            7




<PAGE>



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

<TABLE>
<CAPTION>

                                                                  For the Year Ended September 30,
                                               ----------------------------------------------------------------------
                                                             1996                                1995
                                               ----------------------------------    --------------------------------
                                                                          Yield/                              Yield/
                                               Average                    Average    Average                 Average
                                               Balance     Interest        Cost      Balance    Interest       Cost
                                               -------     --------       -------    -------    --------     --------
                                                                        (Dollars in Thousands)
Assets:
  Interest-earning assets:
<S>                                           <C>         <C>             <C>      <C>        <C>             <C>  
    Mortgage loans(1) .....................   $ 91,605    $  7,408         8.09%   $ 86,126   $  6,632        7.70%
    Other loans(1) ........................      9,305         972        10.45       7,413        736        9.93
    Interest-earning deposits(2) ..........      3,718         225         6.05       3,472        211        6.08
    Federal funds sold and                                                         
      other short-term investments ........      1,050          93         8.86         924         58        6.28
    Investment securities .................      7,112         479         6.74       6,743        430        6.38
    Mortgage-backed securities, net .......        287          20         6.97          35          3        8.57
    FHLB stock ............................        932          67         7.19         932         67        7.19
                                               -------      ------                  -------      -----
      Total interest-earning assets            114,009       9,264         8.13     105,645      8,137        7.70
                                                            ------                               -----
  Noninterest earning assets ..............      4,807                                3,886
                                               -------                              -------
      Total assets ........................   $118,816                             $109,531
                                               =======                              =======

Liabilities and equity:                                                            
  Interest-bearing liabilities:                                                    
    Money market deposits .................   $  5,011    $    154         3.07%   $  5,957   $    181        3.04%
    Passbook deposits .....................     15,400         458         2.97      17,045        516        3.03
    NOW and other demand deposits .........      7,316         203         2.77       5,971        168        2.81
    Certificate accounts ..................     60,093       3,313         5.51      52,529      2,697        5.13
                                               -------      ------                  -------      -----
  Total savings accounts ..................     87,820       4,128         4.70      81,502      3,562        4.37
    Borrowed funds ........................      6,018         364         6.05       3,596        216        6.01
                                               -------      ------                  -------      -----
      Total interest-bearing liabiliies         93,838       4,492         4.79      85,098      3,778        4.44
                                                            ------                               -----
Noninterest-bearing liabilities ...........      6,336                                5,278                 
Equity ....................................     18,642                               19,155                 
                                               -------                              -------
      Total liabilities and equity            $118,816                             $109,531
                                               =======                              =======
Net interest income .......................               $  4,772                            $  4,359                 
                                                            ======                               =====
Interest rate spread(3) ...................                                3.34%                              3.26%
Net interest margin(4) ....................                                4.19%                              4.13%
Ratio of interest-earning assets                                                   
  interest-bearing liabilities ............     121.50%                              124.15%
</TABLE>

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

8


<PAGE>

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

<TABLE>
<CAPTION>
                                                              Year Ended September 30,
                                             --------------------------------------------------------------
                                                   1995 vs. 1996                     1994 vs. 1995
                                             -----------------------------    -----------------------------
                                                 Increase (Decrease)              Increase (Decrease)
                                                         Due to                         Due to
                                             -----------------------------    -----------------------------
                                               Volume     Rate       Net       Volume     Rate        Net
                                             ---------- --------   -------    ---------  ------     --------
                                                                 (Dollars In Thousands)
Interest-earning assets:
<S>                                          <C>        <C>        <C>        <C>        <C>        <C>    
  Mortgage loans .........................   $   432    $   344    $   776    $   501    $   324    $   825
  Other loans ............................       195         41        236        190         16        206
  Interest-earning deposits ..............        15         (1)        14          6         60         66
  Federal funds sold and other short-term
    investments ..........................         9         26         35         11        (13)        (2)
  Investment securities, net .............        24         25         49         73         (8)        65
  Mortgage-backed securities, net ........        18         (1)        17         (1)        --         (1)
  FHLB stock .............................        --         --         --         --         14         14
                                             -------    -------    -------    -------    -------    -------
      Total interest-earning assets ......       693        434      1,127        780        393      1,173
                                             -------    -------    -------    -------    -------    -------

Interest-bearing liabilities:
  Money market deposits ..................       (29)         2        (27)        --          4          4
  Passbook deposits ......................       (49)        (9)       (58)      (119)        --       (119)
  NOW and other demand deposits ..........        38         (3)        35          9         (7)         2
  Certificate accounts ...................       406        210        616        (35)       273        238
  Borrowed funds .........................       146          2        148        140         35        175
                                             -------    -------    -------    -------    -------    -------
      Total interest-bearing liabilities..       512        202        714         (5)       305        300
                                             -------    -------    -------    -------    -------    -------
Net change in interest income ............   $   181    $   232    $   413    $   785    $    88    $   873
                                             =======    =======    =======    =======    =======    =======

</TABLE>

Comparison of Financial  Condition for Fiscal Years Ended September 30, 1996 and
1995.
          The  Corporation's  total assets were $127.2  million at September 30,
          1996,  an increase of 10.5% from the $115.1  million on September  30,
          1995.  The asset  growth was  primarily  due to a 11.47% rise in loans
          receivable,  net, from $97.7 million at fiscal year-end 1995 to $108.9
          at fiscal year-end 1996.

          An  increase  in new home  construction  within  the  markets  Bedford
          Federal serves combined with the stable interest rate environment that
          continued  during  fiscal 1996 were the major factors in the expansion
          of loans.  This increase was funded primarily by principal  repayments
          of the loan portfolio,  increased deposits, and FHLB advances. Because
          lending is directly  affected by  interest  rates,  a rise in interest
          rates  could  cause a slow down in new loan  originations.  Investment
          securities  increased  $245,000,  marketable  equity  securities  rose
          $219,000 and mortgage-backed  securities were up $451,000 in 1996 over
          1995.

          At September 30, 1995 and 1996, the Corporation's total investments in
          loans  receivable,  net, and  securities  equalled  94.8% and 95.3% of
          total assets, respectively. Effective October 1, 1994, the Corporation
          adopted SFAS 115,  "Accounting  for Certain  Investments in Debt 3 and
          Equity  Securities."  SFAS 115 requires that all  investments  in debt
          securities and all investments in equity  securities that have readily
          determinable   fair  values  be  classified  into  three   categories.
          Securities  that  management  has positive  intent and ability to hold
          until maturity will be classified as held to maturity. Securities that
          are purchased and held  specifically for the purpose of selling in the
          near  future  will be  classified  as  trading  securities.  All other
          securities will be classified as available for sale. Securities
                                                                             9


<PAGE>



          classified as trading and available for sale will be carried at market
          value. Unrealized holding gains and losses for trading securities will
          be included in current income. Unrealized holding gains and losses for
          available  for sale  securities  will be reported as a net amount in a
          separate  component  of  stockholders'   equity  until  realized.   At
          September 30, 1996,  Bedford Bancshares had $5.2 million of securities
          held to maturity and $6.2 million of securities available for sale. In
          addition,  at September  30, 1996,  the Bank had $932,000  invested in
          Federal Home Loan Bank ("FHLB") stock.

          Deposits  totaled  $95.4 million at September 30, 1996, an increase of
          $5.3 million from $90.1  million at September  30, 1995.  The increase
          was partially attributable to the higher rates paid on deposits during
          fiscal 1996  combined  with the healthy  economic  environment  in the
          areas served by Bedford  Federal.  Advances  from the FHLB totaled $12
          million at  September  30,  1996,  an increase  of $7 million  from $5
          million at September 30, 1995. The increase was primarily used to fund
          the increase in the loan portfolio.

          Total  stockholders'  equity was $18.2  million on September 30, 1996,
          down $458,000 from the $18.7 million one year  previous.  This planned
          reduction   reflects  the   acquisition   of  65,390   shares  of  the
          Corporation's  common stock at an aggregate cost of $1.1 million under
          the stock buy back program  conducted  during 1996.  In addition,  the
          Corporation  declared  $457,000 of  dividends  during  fiscal 1996 and
          realized  net income of $1.3  million.  The  equity-to-asset  ratio at
          September 30, 1996 stood at 14.3% down from 16.2% one year earlier.

Comparison of Operating Results for Years Ended September 30, 1996 and 1995
          Net Income.  Net income  decreased  $99,000 in fiscal 1996 from fiscal
          1995.  During the fourth  quarter of fiscal  1996,  the FDIC imposed a
          one-time   assessment   on  all  members  of  the  SAIF  in  order  to
          recapitalize  the SAIF to the federally  mandated level of 1.25%.  The
          assessment  amounted to  approximately  $555,000  for Bedford  Federal
          ($344,000  on an  after  tax  basis).  Excluding  the  impact  of  the
          assessment,  net income would have been $1.6 million,  or 14.2% higher
          than fiscal 1995.

          Interest  Income.  Interest income totaled $9.3 million for the fiscal
          year ended  September 30, 1996, a 13.9% increase from the $8.1 million
          recorded  for fiscal  1995.  The $1.2  million  expansion  of interest
          income is due to the 7.9% growth of average earning assets,  primarily
          loans,  coupled  with the  overall  improvement  in the rate earned on
          average  earning  assets.  The  table on page 9  provides  a  detailed
          analysis of the changes in interest income due to volume and rate.

          Interest  Expense.  Interest  expense  increased  $714,000  from  $3.8
          million for the year ended  September 30, 1995 to $4.5 million for the
          fiscal  year  ended  September  30,  1996.  Both the level and cost of
          average  interest-bearing  liabilities rose in fiscal 1996 over fiscal
          1995.  Average  interest-bearing  liabilities  rose 10.2% and the cost
          increased 35 basis  points in fiscal 1996 over fiscal 1995,  primarily
          due to a 38 basis point increase in  certificate  accounts due to more
          aggressive pricing and a larger balance of FHLB advances which tend to
          have higher  costs than  deposit  accounts.  The table on the previous
          page  provides a detailed  analysis of the change in interest  expense
          due the changes in volume and rate.

          Net Interest Income.  Net interest income totaled $4.8 million for the
          year ended September 30, 1996, up 9.5% from the $4.4 million  realized
          in fiscal 1995.  An 8 basis point  improvement  in the  interest  rate
          spread and a more favorable mix of earning  assets  contributed to the
          improved  level of net  interest  income.  The growth of net  interest
          income was somewhat  restrained  by the  increase in average  borrowed
          funds  and the rise in the  cost of  interest-bearing  liabilities.  A
          detailed  analysis of net interest income is presented earlier in this
          report.

          Provisions  for Credit  Losses.  Provisions  for credit losses for the
          year ended September 30, 1996 increased  $2,000 to $22,000 compared to
          the provisions recorded in fiscal 1995. The amount of the

10


<PAGE>
          provisions reflects  management's  assessment of loan loss reserves on
          non-classified  loans. At September 30, 1996, the allowance for credit
          losses was $650,000,  representing .60% of loans  receivable,net,  and
          95.03% of non-performing  loans. Based upon the quality of the Savings
          Bank's loan  portfolio,  the  relatively  stable  local  economy,  and
          favorable interest rate environment, management presently believes the
          Savings  Bank's  allowance for credit losses is adequate to absorb any
          anticipated  credit  losses.   Management   currently  expects  future
          provisions for credit losses to be based  primarily upon growth in the
          loan portfolio and other factors. However,  assessment of the adequacy
          of  the  allowance  for  credit  loss  involves  subjective  judgments
          regarding  future  events  and thus  there  can be no  assurance  that
          additional provisions for credit losses will not be required in future
          periods.

          Noninterest Income. For the year ended September 30, 1996, noninterest
          income  amounted to  $735,000,  up 35.4% from the  $543,000  earned in
          fiscal 1995.  Service charges and fees on loans were up $58,000 due to
          an  increase  in the number and  dollar  volume of loan  originations.
          Other customer  service fees and commissions  reflected a $77,000 rise
          primarily  due  to  an  increase  in  customer  deposit  activity.  In
          addition,  the Savings Bank  realized a gain of $27,000 on the sale of
          foreclosed property during fiscal 1996 compared to a loss of $4,000 in
          fiscal 1995.

          Noninterest Expense.  Noninterest expense totaled $3.4 million for the
          year ended  September  30, 1996  compared  to $2.6  million for fiscal
          1995.  This change was primarily due to the  imposition by the FDIC on
          members  of  the  SAIF  of  the   one-time   assessment   designed  to
          recapitalize the SAIF. The charge to Bedford Federal was approximately
          $555,000.  Compensation  and  employee  benefits  were up $87,000  due
          primarily to merit  increases and higher  benefits costs. In addition,
          occupancy and  equipment  expense  increased  $77,000 due primarily to
          expenses related to the installation and operation of three ATMs.

          Income Taxes.  The provision  for income taxes  decreased  $107,000 to
          $754,000 in fiscal 1996 from  $861,000 in fiscal 1995 due to the lower
          level of taxable income.

Liquidity and Capital Resources
          Under applicable federal  regulations,  Bedford Federal is required to
          maintain specified levels of "liquid  investments" in qualifying types
          of U.S.  Government,  federal  agency  and other  investments,  having
          maturities of five years or less. Current OTS regulations require that
          a savings  association  maintain  liquid assets of not less than 5% of
          its average daily  balance of net  withdrawable  deposit  accounts and
          borrowings  payable in one year or less,  of which  short-term  liquid
          assets must  consist of not less than 1%. At September  30, 1996,  the
          Savings Bank's  liquidity,  as measured for regulatory  purposes,  was
          8.55% which was $3.3 million in excess of the minimum OTS requirement.
          The Savings Bank  adjusts its  liquidity  as  appropriate  to meet its
          asset/liability objectives.

          Primary   funding   sources  for  the  Savings   Bank  are   deposits,
          amortization  and prepayments of loans,  FHLB advances,  maturities of
          investment  securities  and  funds  provided  from  operations.  While
          scheduled loan repayments are a relative  predictable source of funds,
          deposit flows and loan  prepayments  are  significantly  influenced by
          general  interest  rates,  economic  conditions  and  competition.  In
          addition,  Bedford Federal invests excess funds in overnight  deposits
          which provide liquidity to meet funding requirements.

          The Savings  Bank's most liquid assets are cash and cash  equivalents,
          which include investments in highly liquid short-term investments. The
          level of these assets is dependent  on the Savings  Bank's  operating,
          financing  and  investing  activities  during  any  given  period.  At
          September 30, 1996, cash and cash equivalents totaled $3.1 million.

          Bedford  Federal has other  sources of liquidity if the need for funds
          exceeds the level generated from normal operations.  Included in these
          other sources are  additional  FHLB advances and the ability to borrow
          against securities.  At September 30, 1996, the Savings Bank had $12.0
          million in advances outstanding from the FHLB of Atlanta. At September
          30,  1996,  the  Savings  Bank had  commitments  to fund loans of $1.8
          million,  $3.2  million  of loans in  process,  and $2.0  million  and
          $362,000 of unfunded home equity lines of credit and commercial credit
          loans, respectively.

                                                                            11


<PAGE>



          Certificates  of deposit  scheduled to mature  within one year totaled
          $33.8  million  September  30,  1996.  Based  on  historical   deposit
          withdrawals  and outflows,  and on internal  monthly  deposit  reports
          monitored by management,  management  believes that a majority of such
          maturing deposits will remain in the Savings Bank.

          As of September 30, 1996, Bedford Federal exceeded its tangible,  core
          and  risk-based  capital   requirements  by  10.9%,  9.4%  and  15.1%,
          respectively.  See  Note 14 to the  Company's  Consolidated  Financial
          Statements included in this Annual Report.

Impact of Inflation and Changing Prices
          The  financial  statements  and related  data in this report have been
          prepared in accordance with generally accepted  accounting  principles
          which  require the  measurement  of financial  position and  operating
          results in terms of  historical  dollars,  without  consideration  for
          changes in the relative  purchasing power of money over time caused by
          inflation.

          Unlike industrial companies,  nearly all of the assets and liabilities
          of a  financial  institution  are  monetary  in  nature.  As a result,
          interest  rates  have  a  more  significant   impact  on  a  financial
          institution's  performance than general levels of inflation.  Interest
          rates do not  necessarily  move in the same  direction  or in the same
          magnitude  as the price of goods and  services,  since  such goods and
          services  are  affected by  inflation.  In the current  interest  rate
          environment,  liquidity  and the  maturity  structure  of the  Savings
          Bank's  assets and  liabilities  are  critical to the  maintenance  of
          acceptable performance levels.

Recent Developments
          The Savings Bank's deposits are insured up to the legal maximum by the
          SAIF as  administered  by the FDIC. In the past,  Bedford  Federal and
          most other SAIF members have paid an annual insurance  premium between
          .23%  and .31% of total  deposits  held.  On the  other  hand,  a vast
          majority  of  members of the BIF,  primarily  commercial  banks,  paid
          insurance  premiums on deposits at or near the legal minimum of $2,000
          per year.  Recent  federal  legislation  required the FDIC to impose a
          one-time  assessment  on all members of SAIF in order to  recapitalize
          the SAIF to the  federally  mandated  level of 1.25%.  The  assessment
          equalled .65% of an  institution's  domestic  deposits as of March 31,
          1995  and  was  approximately  $555,000  for  Bedford  Federal.  It is
          anticipated  that  future  SAIF  premiums  will be lowered  which will
          reduce somewhat the competitive  advantage  commercial  banks have had
          regarding deposit insurance premiums.

          On August 20, 1996,  The Small Business Job Protection Act of 1996 was
          signed into law.  Under this law the tax bad debt reserve  method that
          had been available to thrift  institutions  was repealed for tax years
          beginning after 1995. Upon repeal,  a small thrift (under $500 million
          in assets) is required to recapture into income the portion of its bad
          debt  reserves that exceeds the greater of (1) the  experience  method
          reserve computed as if the thrift had always been a small bank, or (2)
          the  lesser  of the base  year  reserve  or the  contracted  base year
          reserve. The impact of this change was immaterial on Bedford Federal.

12



<PAGE>

 
                    Bedford Bancshares, Inc. and Subsidiaries
                    -----------------------------------------




                        Consolidated Financial Statements
                      As of September 30, 1996 and 1995 and
              For the Years Ended September 30, 1996, 1995 and 1994
                   Bedford Bancshares, Inc. and Subsidiaries

















                                                                             13

<PAGE>
                            [BDO SEIDMAN LETTERHEAD]


[LOGO]              BDO Seidman LLP               300 Arboretum Place, Suite 520
                    Accountants and Consultants   Richmond, Virginia 23236
                                                  Telephone: (804) 330-3092
                                                  Fax: (804) 330-7753



Report of Independent Certified Public Accountants 


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

We have audited the consolidated  balance sheet of Bedford Bancshares,  Inc. and
subsidiaries  (the  "Company")  as  of  September  30,  1996,  and  the  related
consolidated statements of operations,  stockholders' equity, and cash flows for
the year then ended.  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. The consolidated  financial statements
of Bedford Bancshares,  Inc. and subsidiaries as of September 30, 1995 and 1994,
were audited by other auditors whose report dated October 27, 1995, expressed an
unqualified opinion on those statements.

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

In our opinion,  the 1996 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, 1996,  and the
results  of their  operations  and their  cash  flows for the year then ended in
conformity with generally accepted accounting principles.

As discussed in the Summary of Accounting Policies to the consolidated financial
statements,  the Company  changed its method of  accounting  for income taxes by
adopting Statement of Financial  Accounting Standards No. 109, effective October
1, 1993.  The Company also changed its method of accounting  for debt and equity
securities  by adopting  Statement of Financial  Accounting  Standards  No. 115,
effective October 1, 1994.


/s/ BDO Seidman, LLP


October 29, 1996

14

<PAGE>
                   Bedford Bancshares, Inc. and Subsidiaries

                                                    Consolidated Balance Sheets
                                                                 (in thousands)

------------------------------------------------------------------------------
September 30,                                            1996          1995
------------------------------------------------------------------------------


   Assets

Cash (including interest bearing deposits of
  approximately $223 and $725)                         $  3,075      $  3,337
Securities (Notes 1 and 6)                               11,435        10,520
Investment in Federal Home Loan Bank stock,
  at cost (Note 6)                                          932           932
Loans receivable, net (Notes 2, 6 and 14)               108,873        97,669
Property and equipment, net (Note 4)                      1,238         1,313
Accrued interest receivable                                 662           713
Deferred income taxes (Note 9)                              438           214
Refundable income taxes                                       -           103
Other assets                                                548           253
-------------------------------------------------------------------------------







                                                       $127,201      $115,054
------------------------------------------------------------------------------

                                                                            15



<PAGE>




                    Bedford Bancshares, Inc. and Subsidiaries

                                                   Consolidated Balance Sheets
                                                                (in thousands)

--------------------------------------------------------------------------------
September 30,                                              1996          1995
--------------------------------------------------------------------------------


   Liabilities and Stockholders' Equity

Liabilities
  Deposits (Note 5)                                       $ 95,378     $ 90,063
  Advances from Federal Home Loan Bank (Note 6)             12,000        5,000
  Advances from borrowers for taxes and insurance              539          545
  Dividends payable                                            126          186
  Other liabilities (Note 8)                                   931          575
--------------------------------------------------------------------------------

Total liabilities                                          108,974       96,369
--------------------------------------------------------------------------------


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


Stockholders' equity
  Preferred stock, par value $.10, authorized 250,000
    shares, none outstanding                                     -            -
  Common stock, par value $.10, authorized 2,750,000
    shares, 1,143,669 and 1,204,875 shares, issued and
    outstanding                                                114          121
  Additional paid-in capital                                10,773       11,366
  Retained earnings, substantially restricted (Note 10)      8,739        8,263
  Unrealized loss on securities available for sale (Note 1)    (33)          (9)
  Less stock acquired by ESOP and RRP (Note 11)             (1,366)      (1,056)
--------------------------------------------------------------------------------


Total stockholders' equity                                  18,227       18,685
--------------------------------------------------------------------------------


                                                          $127,201     $115,054
--------------------------------------------------------------------------------



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


16

<PAGE>




                    Bedford Bancshares, Inc. and Subsidiaries

                                         Consolidated Statements of Operations
                                                                (in thousands)

------------------------------------------------------------------------------
Year Ended September 30,                             1996     1995     1994
------------------------------------------------------------------------------

Interest income
  Loans                                             $8,380   $7,368   $6,337
  U.S. government obligations, including agencies      748      708      563
  Other investments                                    136       61       64
------------------------------------------------------------------------------

Total interest income                                9,264    8,137    6,964
------------------------------------------------------------------------------

Interest expense
  Deposits (Note 5)                                  4,128    3,562    3,437
  Borrowed money                                       364      216       41
------------------------------------------------------------------------------

Total interest expense                               4,492    3,778    3,478
------------------------------------------------------------------------------

Net interest income                                  4,772    4,359    3,486

Provision for loan losses (Note 2)                      22       20       51
------------------------------------------------------------------------------

Net interest income after provision for   
  loan losses                                        4,750    4,339    3,435
------------------------------------------------------------------------------

Noninterest income
  Service charges and fees on loans                    403      345      362
  Other customer service fees and commissions          257      180      169
  Gain (loss) on sale of loans, investments
    and foreclosed real estate                          30       (4)       8
  Other                                                 45       22       15
------------------------------------------------------------------------------

Total noninterest income                               735      543      554
------------------------------------------------------------------------------

Noninterest expense
  Compensation and employee benefits                 1,467    1,380    1,197
  Occupancy and equipment                              336      259      254
  Data processing                                      311      302      260
  Federal insurance of accounts                        207      197      202
  Advertising                                           87       85       73
  Professional fees                                    115      149       84
  BIF/SAIF premium disparity assessment (Note 8)       555        -        -
  Other                                                351      248      168
------------------------------------------------------------------------------

Total noninterest expense                            3,429    2,620    2,238
------------------------------------------------------------------------------


                                                                  continued...

                                                                         17

<PAGE>




                    Bedford Bancshares, Inc. and Subsidiaries

                                         Consolidated Statements of Operations
                                                                (in thousands)
                                                                   (continued)

-----------------------------------------------------------------------------
Year Ended September 30,                            1996      1995      1994  
-----------------------------------------------------------------------------
                                                 
                                                 
Income before income taxes and cumulative        
  effect of change in accounting principle        $2,056    $2,262    $1,751
                                                 
Provision for income taxes (Note 9)                  754       861       629
-----------------------------------------------------------------------------
                                                 
                                                 
Net income before cumulative effect of           
  change in accounting principle                   1,302     1,401     1,122
                                                 
Cumulative effect at October 1, 1993, of         
  change in accounting for income taxes                -         -       323
-----------------------------------------------------------------------------
                                                 
                                                 
Net income                                        $1,302    $1,401    $1,445
-----------------------------------------------------------------------------
                                                 
                                                 
                                                 
Primary and fully diluted earnings per common    
  share                                          
    Income before cumulative effect               $1.17    $  1.20    $  .95
    Cumulative effect of change in accounting    
      principle                                       -          -       .28
-----------------------------------------------------------------------------
                                                 
                                                 
Net income                                        $1.17    $  1.20   $  1.23
-----------------------------------------------------------------------------
                                               


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


18

<PAGE>




                    Bedford Bancshares, Inc. and Subsidiaries

                               Consolidated Statements of Stockholders' Equity
                                                                (in thousands)

<TABLE>
<CAPTION>

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


<S>                                <C>       <C>          <C>            <C>          <C>         <C>     
Balance, September 30, 1993        $  --     $    --      $  6,144       $   --       $   --      $  6,144

Net income                            --          --         1,445           --           --         1,445
Change in unrealized loss
  on marketable equity
  securities                          --          --            --          (70)          --           (70)
Sale of stock (1,256,375
  shares)                            126      11,814            --           --         (800)       11,140

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

Balance, September 30, 1994          126      11,814         7,589          (70)        (800)       18,659

Net income                            --          --         1,401           --           --         1,401
Cumulative effect of change
  in accounting principle             --          --            --           35           --            35
Change in unrealized loss
  on securities available
  for sale (Note 1)                   --          --            --           26           --            26
Allocated/earned ESOP
  shares (Note 10)                    --          62            --           --           93           155
Purchase of RRP shares
  (Note 10)                           --          --            --           --          (349)        (349)
Repurchase of stock
  (51,500 shares)                     (5)       (510)         (370)          --          --           (885)
Dividends declared ($.30
  per share)                          --          --          (357)          --          --           (357)
-----------------------------------------------------------------------------------------------------------
</TABLE>





                                                                  continued...

                                                                          19

<PAGE>




                    Bedford Bancshares, Inc. and Subsidiaries

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

<TABLE>
<CAPTION>



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

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

Net income                            --          --       1,302          --             --        1,302
Change in unrealized loss
  on securities available
  for sale (Note 1)                   --          --          --         (24)            --          (24)
Allocated/earned ESOP
  shares (Note 11)                    --          55          88          --             26          169
Purchase of RRP shares
  (Note 11)                           --          --          --          --           (483)        (483)
Repurchase of stock
  (65,390 shares)                     (7)       (647)       (461)         --             --       (1,115)
Dividends declared ($.39
  per share)                          --          --        (457)         --             --         (457)
Exercise of options (Note 11)         --          41           4          --             --           45
RRP vesting (Note 11)                 --         (42)         --          --            147          105

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

Balance, September 30, 1996         $114    $ 10,773    $  8,739       $ (33)       $(1,366)     $18,227
=========================================================================================================
</TABLE>



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

20

<PAGE>




                    Bedford Bancshares, Inc. and Subsidiaries

                                         Consolidated Statements of Cash Flows
                                                                (in thousands)
<TABLE>
<CAPTION>

---------------------------------------------------------------------------------------------
Year Ended September 30,                                       1996        1995        1994
---------------------------------------------------------------------------------------------

Operating activities
<S>                                                         <C>         <C>         <C>     
  Net income                                                $  1,302    $  1,401    $  1,445
  Adjustments to reconcile net income to
    net cash provided by operating activities
      Cumulative effect of change in accounting   
        for income taxes                                          --          --        (323)
      Provision for loan losses                                   22          20          51
      Provision for depreciation and amortization                163         120          97
      (Increase) decrease in deferred income taxes              (121)        116          67
      (Gain) loss on sale of loans and securities                 (2)          4          (8)
      (Gain) loss on sale of foreclosed real estate              (28)         --          (4)
      Loans originated for sale                                 (152)       (184)       (301)
      Proceeds from sale of loans originated for sale            153         188         309
      (Increase) decrease in interest receivable                  51        (128)        (50)
      (Increase) decrease in other assets                       (295)        (84)         46
      Increase (decrease) in other liabilities                   356         331          92
---------------------------------------------------------------------------------------------

Net cash provided by operating activities                      1,449       1,784       1,421
---------------------------------------------------------------------------------------------

Investing activities
  Proceeds from maturities of investments                      2,200       1,200       1,700
  Proceeds from sales of investments                             872         394          --
  Principal collected on mortgage-backed securities               26           7          10
  Purchases of investment securities                          (4,035)     (1,955)     (3,579)
  Net increase in loans to customers                         (11,311)     (8,380)     (8,365)
  Net proceeds from sales of foreclosed real estate              113          --         113
  Purchases of foreclosed real estate                             --          --         (78)
  Purchases of premises, equipment and leasehold
    improvements                                                 (88)       (298)        (69)
---------------------------------------------------------------------------------------------


Net cash absorbed by investing activities                    (12,223)     (9,032)    (10,268)
---------------------------------------------------------------------------------------------
</TABLE>








                                                                  continued...

                                                                          21

<PAGE>




                    Bedford Bancshares, Inc. and Subsidiaries

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

<TABLE>
<CAPTION>


--------------------------------------------------------------------------------------------
Year Ended September 30,                                     1996        1995       1994
--------------------------------------------------------------------------------------------

Financing activities
<S>                                                         <C>        <C>         <C>      
  Net increase (decrease) in customer deposits              $ 5,315    $  5,222    $ (4,346)
  Net increase (decrease) in advance payments
    from borrowers                                               (6)         72          23
  Proceeds from advances and other borrowed money            11,000       5,000          --
  Principal payments of advances                             (4,000)     (1,000)         --
  Proceeds from sale of stock                                    --          --      11,940
  Purchase of stock by ESOP and RRP                            (483)       (349)       (800)
  Allocation of ESOP and RRP shares                             274         155          --
  Repurchase of stock                                        (1,115)       (885)         --
  Dividends paid                                               (518)       (183)         --
  Issuance of common stock                                       45          --          --
--------------------------------------------------------------------------------------------

Net cash provided by financing activities                    10,512       8,032       6,817
--------------------------------------------------------------------------------------------

Increase (decrease) in cash and cash equivalents               (262)        784      (2,030)

Cash and cash equivalents - beginning of year                 3,337       2,553       4,583
--------------------------------------------------------------------------------------------

Cash and cash equivalents - end of year                    $  3,075    $  3,337    $  2,553
============================================================================================


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

Cash payments of interest expense                          $  4,503    $  3,777    $  3,480
============================================================================================

Cash payments of income taxes                              $    817    $    718    $    616
============================================================================================

</TABLE>



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


22

<PAGE>




                    Bedford Bancshares, Inc. and Subsidiaries

                                                Summary of Accounting Policies



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

Nature of Business and Regulatory Environment

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

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

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

Principles of Consolidation

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

Estimates

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

Investment Securities

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

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

                                                                             23

<PAGE>




                    Bedford Bancshares, Inc. and Subsidiaries

                                                Summary of Accounting Policies
                                                                   (continued)



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

Investment Securities (continued)

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

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

Loans Held for Sale

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

Loans Receivable

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

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

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

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

24

<PAGE>




                    Bedford Bancshares, Inc. and Subsidiaries

                                                Summary of Accounting Policies
                                                                   (continued)



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

Loans Receivable (continued)

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

Effective October 1, 1995, the Company adopted Statement of Financial Accounting
Standards No. 114 (SFAS 114), "Accounting by Creditors for Impairment of a Loan"
(as  amended by SFAS No. 118,  "Accounting  by  Creditors  for  Impairment  of a
Loan-Income  Recognition  and  Disclosures").  The effect of adopting  these new
accounting  standards was immaterial to the operating results of the Company for
the year ended September 30, 1996.

Under the new accounting  standard,  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.  Prior to October 1, 1995,  the  allowance  for loan  losses for all loans
which would have qualified as impaired  under the new  accounting  standards was
primarily based upon the estimated fair market value of the related collateral.

For impaired  loans that are on nonaccrual  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 nonaccrual  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,  1996,  the Company had no loans that were  considered  as
impaired.

Real Estate Owned

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


                                                                          25

<PAGE>




                    Bedford Bancshares, Inc. and Subsidiaries

                                                Summary of Accounting Policies
                                                                   (continued)


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

Real Estate Owned (continued)

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

Sale of Loans, Participations in Loans

The Company is able to generate  funds by selling  loans and  participations  in
loans to the Federal Home Loan Mortgage  Corporation 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.

Gain or loss on loan  participations  is recognized at the time of the sale. The
gain or loss  recorded is equal to the  present  value of the  estimated  future
interest receipts,  net of allowance for estimated  servicing costs and a normal
servicing profit on the portion sold less the present value of interest payments
to be remitted  to the buyers.  The  resulting  deferred  premium or discount is
amortized or accreted to income  using the level yield  method.  Loan  servicing
income is recorded when earned.  Loan servicing  costs are charged to expense as
incurred.

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

During the year ended  September  30,  1994,  the Company  adopted  Statement of
Financial  Accounting  Standards No. 109,  "Accounting for Income Taxes",  which
required a change from the deferred method to the asset and  liabilities  method
of accounting for income taxes.

Deferred tax assets and  liabilities  are reflected at currently  enacted income
tax  rates  applicable  to the  period  in which  the  deferred  tax  assets  or
liabilities  are  expected to be realized or settled.  As changes in tax laws or
rates are enacted,  deferred tax assets and liabilities are adjusted through the
provision for income taxes.


26

<PAGE>




                    Bedford Bancshares, Inc. and Subsidiaries

                                                Summary of Accounting Policies
                                                                   (continued)


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

Income Taxes (continued)

In computing Federal income taxes,  savings banks that meet certain definitional
tests and other conditions  prescribed by the Internal Revenue Code are allowed,
within  limitations,  to deduct from taxable  income an allowance  for bad debts
based on actual loss experience, a percentage of taxable income (8%) before such
deduction or an amount based on a percentage of eligible  loans.  The cumulative
bad debt reserve, upon which no taxes have been paid, was approximately $212,000
as of September 30, 1996.

As a result of 1996 tax  legislation,  the Company will compute its tax bad debt
deduction  by use  of the  "experience  method",  which  is  based  on a  moving
five-year  average of actual  charge-offs,  for tax years  beginning with fiscal
year 1997.  According to the legislation,  "applicable  excess reserves" must be
recaptured as taxable  income over five years  beginning  with fiscal year 1997.
The amount to be  recaptured  is the excess of the  accumulated  reserves  since
fiscal  year 1987 over the amount  allowed by use of the  experience  method for
those  years.  Management  does not  believe  that the  legislation  will have a
material effect on the Company's financial statements.

The  Company  has  reported  the  cumulative  effect of change in the  method of
accounting  for income taxes as of the  beginning of the 1994 fiscal year in the
consolidated statement of operations.

Accounting Pronouncements

In March 1995, the Financial  Accounting Standards Board issued its Statement of
Financial  Accounting  Standards  No.  121  (SFAS  121),   "Accounting  for  the
Impairment of Long-Lived  Assets and For  Long-Lived  Assets to Be Disposed Of".
SFAS 121 requires that long-lived assets and certain  intangibles to be held and
used by an  entity  be  reviewed  for  impairment  when  events  or  changes  in
circumstances  indicate  that the  carrying  amount may not be  recoverable.  In
addition,  SFAS 121 requires  long-lived  assets and certain  intangibles  to be
disposed of to be  reported  at the lower of carrying  amount or fair value less
costs to sell.  SFAS 121 is effective for fiscal years  beginning after December
15, 1995.  Management does not expect the application of this  pronouncement  to
have a material effect on the Company's financial statements.

In May 1995, the Financial  Accounting  Standards  Board issued its Statement of
Financial  Accounting  Standards  No. 122 (SFAS 122),  "Accounting  for Mortgage
Servicing  Rights an  Amendment  of FASB  Statement  No. 65".  SFAS 122 requires
entities to allocate 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.  In  addition,  SFAS 122  requires  entities  to  assess  its
capitalized  mortgage servicing rights for impairment based on the fair value of
those rights.  SFAS 122 is effective for fiscal years  beginning  after December
15, 1995.  Management does not expect the application of this  pronouncement  to
have a material effect on the Company's financial statements.




                                                                          27

<PAGE>




                    Bedford Bancshares, Inc. and Subsidiaries

                                                Summary of Accounting Policies
                                                                   (continued)


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

Accounting Pronouncements (continued)

In October  1995,  the FASB  issued  SFAS No. 123  "Accounting  for  Stock-Based
Compensation."  SFAS No. 123 allows  companies  to continue to account for their
stock option plans in accordance with APB Opinion 25 but encourages the adoption
of a new  accounting  method based on the estimated fair value of employee stock
options.  Companies  electing  not to follow the new fair value based method are
required  to provide  expanded  footnote  disclosures,  including  pro forma net
income and earnings per share,  determined as if the company had applied the new
method.  SFAS No. 123 is  required  to be adopted by the  Company  prospectively
beginning  October 1, 1996.  Management  does not expect the application of this
pronouncement to have a material effect on the Company's financial statements.

In June 1996, the Financial  Accounting  Standards Board issued its Statement of
Financial Accounting Standards No. 125 (SFAS 125), "Accounting for Transfers and
Servicing  of  Financial  Assets  and  Extinguishments  of  Liabilities".   This
Statement  provides   accounting  and  reporting  standards  for  transfers  and
servicing  of  financial  assets and  extinguishments  of  liabilities.  After a
transfer of financial  assets,  an entity recognizes the financial and servicing
assets it controls and the liabilities it has incurred,  derecognizes  financial
assets when control has been  surrendered,  and  derecognizes  liabilities  when
extinguished.  In  addition,  a  transfer  of  financial  assets  in  which  the
transferor  surrenders  control over those assets is accounted  for as a sale to
the extent that consideration other than beneficial interests in the transferred
assets  is  received  in  exchange.  SFAS 125 is  effective  for  transfers  and
servicing of financial assets and extinguishments of liabilities occurring after
December  31,  1996,  and is to be applied  prospectively.  Management  does not
expect the  application of this  pronouncement  to have a material effect on the
financial statements of the Company.

Earnings Per Share

Earnings  per share of Common Stock for the years ended  September  30, 1996 and
1995 have been determined by dividing the net income for the twelve month period
by the calculated  weighted  average number of shares of Common Stock and common
stock  equivalents.  The September 30, 1994  calculation  was computed as if the
conversion  from mutual  ownership to stock  ownership had occurred on the first
day of the fiscal year rather than on August 19,  1994.  Shares  acquired by the
employee  stock  benefit  plans  are  accounted  for in  accordance  with  AICPA
Statement of Position 93-6 and are not considered in the weighted average shares
outstanding  until the shares have been earned by the employees and/or committed
to  be  released.  The  weighted  average  number  of  shares  of  Common  Stock
outstanding for the years ending  September 30, 1996,  1995 and 1994,  including
common stock equivalents, were 1,112,697, 1,165,381 and 1,176,375, respectively.

28

<PAGE>




                    Bedford Bancshares, Inc. and Subsidiaries

                                                Summary of Accounting Policies
                                                                   (continued)


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

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.

Conversion to Stock Ownership

At a special meeting on August 2, 1994, the members of the Savings Bank approved
management's plan to convert the Savings Bank from a Federal Mutual to a Federal
Stock  Savings Bank.  The plan called for the  formation of Bedford  Bancshares,
Inc.  which would own the stock of the  Savings  Bank upon its  conversion  to a
stock form of ownership.  The stock of the Parent  Company would then be offered
through  a   Subscription   and  Community   Offering  to  the  Savings   Bank's
tax-qualified  employee stock plans,  eligible  account holders and others.  The
transaction was accounted for as a pooling of interests.

On August 19, 1994, the Parent Company issued 1,256,375 shares of $.10 par value
Common Stock at $10 per share and became the parent company of the Savings Bank.
Net proceeds, after deducting conversion expenses and underwriters' discounts of
$624,000,  were  $11,940,000  and are  reflected as Common Stock and  additional
paid-in capital in the accompanying consolidated financial statements.


                                                                          29


<PAGE>




                    Bedford Bancshares, Inc. and Subsidiaries

                                      Notes to Consolidated Financial Statements



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

1.  Investment Securities

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

<TABLE>
<CAPTION>


September 30, 1996
-------------------------------------------------------------------------------------


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


Held to Maturity

  United States government
<S>                                      <C>            <C>         <C>      <C>    
    and agency obligations               $5,214         $24         $ 77     $ 5,161

  Mortgage-backed securities                 25           -            -          25
-------------------------------------------------------------------------------------


                                          5,239          24           77       5,186
-------------------------------------------------------------------------------------


Available for Sale

  United States government
    and agency obligations                1,900           8           48       1,860

  Mortgage-backed securities                490           -           33         457

  Marketable Equity securities            3,909           -           30       3,879
-------------------------------------------------------------------------------------


                                          6,299           8          111       6,196
-------------------------------------------------------------------------------------


                                        $11,538         $32         $188     $11,382
=====================================================================================

</TABLE>


30

<PAGE>




                    Bedford Bancshares, Inc. and Subsidiaries

                                    Notes to Consolidated Financial Statements
                                                                   (continued)


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

1.  Investment Securities (continued)

<TABLE>
<CAPTION>


September 30, 1995
-------------------------------------------------------------------------------------


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


Held to Maturity

  United States government
<S>                                   <C>              <C>         <C>       <C>    
    and agency obligations            $ 5,420          $64         $107      $ 5,377

  Mortgage-backed securities               31            -            -           31
-------------------------------------------------------------------------------------


                                        5,451           64          107        5,408
-------------------------------------------------------------------------------------


Available for Sale

  United States government  
    and agency obligations              1,400            9            -        1,409

  Marketable equity securities          3,684            -           24        3,660
-------------------------------------------------------------------------------------


                                        5,084            9           24        5,069
-------------------------------------------------------------------------------------


                                      $10,535          $73         $131      $10,477
=====================================================================================

</TABLE>



Proceeds from the sale of  securities  available for sale during the years ended
September 30, 1996 and 1995 were $802,000 and $394,000,  respectively. A gain of
$2,000 was  realized on the 1996 sale while a loss of $8,000 was realized on the
1995 sale.

                                                                          31

<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, 1996, by contractual maturity, were as follows:

<TABLE>
<CAPTION>


September 30, 1996
--------------------------------------------------------------------------------------


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


Held to Maturity

<S>                                                          <C>              <C>   
  Due in one year or less                                    $      -         $    -
  Due in one through five years                                 3,481          3,407
  Due after five years                                          1,733          1,754
--------------------------------------------------------------------------------------


                                                                5,214          5,161
  Mortgage-backed securities                                       25             25
--------------------------------------------------------------------------------------


                                                                5,239          5,186
--------------------------------------------------------------------------------------


Available for Sale
  Due in one year or less                                           -              -
  Due in one through five years                                 1,400          1,391
  Due after five years                                            500            469
--------------------------------------------------------------------------------------


                                                                1,900          1,860
  Mortgage-backed securities                                      490            457
--------------------------------------------------------------------------------------


                                                                2,390          2,317
--------------------------------------------------------------------------------------


                                                               $7,629         $7,503
======================================================================================

</TABLE>


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

32

<PAGE>




                    Bedford Bancshares, Inc. and Subsidiaries

                                    Notes to Consolidated Financial Statements
                                                                   (continued)


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

2.  Loans Receivable

Loans receivable, in thousands, are summarized as follows:

<TABLE>
<CAPTION>


September 30,                                                    1996         1995
------------------------------------------------------------------------------------


<S>                                                           <C>          <C>     
First mortgage loans                                          $ 91,386     $ 83,532
Construction loans                                              10,121        9,732
Home equity loans                                                2,636        1,800
Loans to depositors, secured by savings                            551          799
Installment loans                                                5,169        4,183
Term notes                                                       3,158        1,653
------------------------------------------------------------------------------------


                                                               113,021      101,699

Less
  Undisbursed loans in process                                   3,199        2,994
  Unearned discount resulting from add-on interest                  15           60
  Deferred loan fees and costs, net                                284          336
  Allowance for credit losses                                      650          640
------------------------------------------------------------------------------------


                                                              $108,873     $ 97,669
====================================================================================

</TABLE>


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

<TABLE>
<CAPTION>

Year Ended September 30,                             1996         1995         1994
------------------------------------------------------------------------------------


<S>                                                  <C>          <C>          <C> 
Balance at beginning of year                         $640         $636         $595
Provision charged to operations                        22           20           51
Charge offs net of recoveries                         (12)         (16)         (10)
------------------------------------------------------------------------------------


Balance at end of year                               $650         $640         $636
====================================================================================

</TABLE>


                                                                             33

<PAGE>




                    Bedford Bancshares, Inc. and Subsidiaries

                                    Notes to Consolidated Financial Statements
                                                                   (continued)


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

3.  Loan Servicing

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

<TABLE>
<CAPTION>


Year Ended September 30,                             1996         1995         1994
------------------------------------------------------------------------------------


<S>                                                <C>          <C>          <C>   
Federal Home Loan Mortgage Corporation (FHLMC)     $1,472       $1,511       $1,387
Virginia Housing Development Authority (VHDA)       1,245        1,197        1,016
------------------------------------------------------------------------------------


                                                   $2,717       $2,708       $2,403
====================================================================================

</TABLE>



Custodial  escrow  balances  maintained  in connection  with the foregoing  loan
servicing  at  September  30, 1996,  1995 and 1994 were  approximately  $18,000,
$24,000 and $17,000, respectively.


4.  Property and Equipment

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



September 30,                                        1996        1995
----------------------------------------------------------------------


Land                                               $  251      $  251
Office buildings                                    1,190       1,161
Rental buildings                                       48          48
Furniture, fixtures and equipment                     755         841
Automobile                                             16          16
Leasehold improvements                                 23          25
----------------------------------------------------------------------


                                                    2,283       2,342
Less accumulated depreciation                       1,045       1,029
----------------------------------------------------------------------


                                                   $1,238      $1,313
======================================================================


34

<PAGE>




                    Bedford Bancshares, Inc. and Subsidiaries

                                    Notes to Consolidated Financial Statements
                                                                   (continued)

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

5.  Deposits

Deposits, in thousands, are summarized as follows:

<TABLE>
<CAPTION>


September 30,                                      1996                   1995
-------------------------------------------------------------------------------------


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


<S>                                         <C>       <C>          <C>       <C>   
NOW accounts                                $13,057    13.69%      $10,967    12.18%
Money market accounts                         4,579     4.80         5,630     6.25
Savings accounts                             15,290    16.03        15,728    17.46
Time deposits                                62,452    65.48        57,738    64.11
-------------------------------------------------------------------------------------


                                            $95,378   100.00%      $90,063  100.00%
=====================================================================================
</TABLE>


The  aggregate  amount  of  certificates  of  deposit  of  $100,000  or more was
approximately  $6,978,000  and  $4,563,000  at  September  30,  1996  and  1995,
respectively.

At September 30, 1996, the scheduled maturities of time deposits,  in thousands,
are as follows:

                    Year ending September 30,
                    -------------------------
                              1997                       $33,827
                              1998                        21,669
                              1999                         4,399
                              2000                         1,944
                       2001 and thereafter                   613
                    --------------------------------------------
                                                         $62,452
                    ============================================


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

September 30,                              1996       1995        1994
-----------------------------------------------------------------------


NOW accounts                             $  197     $  185      $  166
Money market account                        160        182         177
Savings account                             458        517         635
Time deposits                             3,313      2,678       2,459
-----------------------------------------------------------------------


                                         $4,128     $3,562      $3,437
=======================================================================


                                                                          35

<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,                                    1996        1995
------------------------------------------------------------------


Within one year                                $12,000     $4,000
One to two years                                     -      1,000
------------------------------------------------------------------


                                               $12,000     $5,000
==================================================================



The weighted  average  interest  rate on advances at September 30, 1996 and 1995
was 5.77% and $6.40%,  respectively.  These advances are  collateralized  by the
Company's  investment  in FHLB stock and  qualifying  real estate  loans under a
blanket collateral agreement.

7.  Fair value of Financial Instruments

The estimated fair values of the Company's financial instruments,  in thousands,
as of September 30, 1996, are as follows:

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


Financial assets
  Cash and short-term investments               $  3,075     $  3,075
  Securities                                      11,435       11,382
  Loans, net of allowance for loan losses        108,873      109,601

Financial liabilities
  Deposits                                        95,378       95,388
  Advances from Federal Home Loan Bank            12,000       12,000



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


Unrecognized financial instruments
  Commitments to extend credit                    $4,187       $4,187


36

<PAGE>




                    Bedford Bancshares, Inc. and Subsidiaries

                                    Notes to Consolidated Financial Statements
                                                                   (continued)


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

7.  Fair Value of Financial Instruments (continued)

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 those 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.

Loan receivables

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

Deposit liabilities

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

Advances from Federal Home Loan Bank

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

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

Commitments to extend credit

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

                                                                          37

<PAGE>




                    Bedford Bancshares, Inc. and Subsidiaries

                                    Notes to Consolidated Financial Statements
                                                                   (continued)


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

8. BIF/SAIF Premium Disparity Assessment

Pursuant to the Economic Growth and Paperwork Reduction Act of 1996 (the "Act"),
the FDIC imposed a special  assessment on SAIF members to capitalize the SAIF at
the  designated  reserve level of 1.25% as of September  30, 1996.  Based on the
Company's  deposits as of March 31, 1995,  the date for  measuring the amount of
the  special  assessment  pursuant to the Act,  the Company  will pay of special
assessment of $555,000 on November 27, 1996 to capitalize  the SAIF. The FDIC is
expected  to lower the premium for deposit  insurance  to a level  necessary  to
maintain the SAIF at its required reserve level;  however, the range of premiums
has not been determined.

9.  Income Taxes

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

Year Ended September 30,                  1996       1995       1994
---------------------------------------------------------------------


Current
  Federal                                 $816       $656       $495
  State                                     97         89         67
---------------------------------------------------------------------


                                           913        745        562
Deferred tax expense (benefit)            (159)       116         67
---------------------------------------------------------------------


Total provision for income taxes          $754       $861       $629
=====================================================================



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

                                                  Percent of Pretax Income
                                                 --------------------------
Year Ended September 30,                         1996       1995       1994
----------------------------------------------------------------------------


Tax at statutory rate                            34.0%      34.0%      34.0%
Increases (decreases) in taxes resulting from:
  State income taxes, net of federal benefit      3.6        2.6        2.5
  Other                                           (.9)       1.5        (.6)
----------------------------------------------------------------------------


                                                 36.7%      38.1%     35.9%
============================================================================




38

<PAGE>




                    Bedford Bancshares, Inc. and Subsidiaries

                                    Notes to Consolidated Financial Statements
                                                                   (continued)


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

9.  Income Taxes (continued)

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

September 30,                                             1996        1995
---------------------------------------------------------------------------


Deferred tax asset
  Bad debts                                               $ 81        $141
  Loan fees                                                 66         117
  Pension expense                                            -          15
  Unrealized loss on securities, available for sale         61           5
  BIF/SAIF assessment                                      211           -
  Other                                                     21           -
---------------------------------------------------------------------------


Total deferred tax asset                                   440         278
---------------------------------------------------------------------------


Deferred tax liability
  Accelerated depreciation                                  (2)        (64)
---------------------------------------------------------------------------


Net deferred tax asset                                    $438        $214
===========================================================================



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, 1996,
the  liquidation   account,   unadjusted  for  customer   withdrawals,   totaled
$6,144,000.

                                                                              39

<PAGE>




                    Bedford Bancshares, Inc. and Subsidiaries

                                    Notes to Consolidated Financial Statements
                                                                   (continued)


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

11. Retirement Plans and Employee Benefit Programs

The Savings  Bank has a  retirement  plan under  Internal  Revenue  Code Section
401(k) covering all full-time  employees who have completed one or more years of
continuous  service  and have  reached age 21.  Each  employee  has an option to
voluntarily  contribute  to this plan up to 10% of their  salary and the Savings
Bank will match $.50 for every $1 up to 4% of salary.  During  fiscal 1993,  the
plan also  provided for the Savings Bank to pay into the plan an amount equal to
10% of each  employee's  salary,  subject to  Department of Labor and income tax
limitations. Effective October 1, 1993, this 10% contribution was eliminated and
a new money  purchase  plan was adopted  which  provides for a fixed  percentage
contribution for each employee's salary.  This percentage was 5%, 5% and 10% for
the years ended  September  30,  1996,  1995 and 1994,  respectively.  The total
expense  for the plan was  $54,000,  $59,000  and  $118,000  for the years ended
September 30, 1996, 1995 and 1994, 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 80,000  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  17,333 and 9,333 shares of Common Stock as of September
30, 1996 and 1995, respectively. The Company recognized $135,000 and $146,000 of
compensation  cost for the years ended  September  30,  1996 and 1995.  The fair
value of unearned ESOP shares  totaled  $1,042,000 at September 30, 1996.  There
were no commitments to repurchase ESOP shares.

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

40

<PAGE>




                    Bedford Bancshares, Inc. and Subsidiaries

                                    Notes to Consolidated Financial Statements
                                                                   (continued)


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

11. Retirement Plans and Employee Benefit Programs (continued)

Recognition and Retention Plan

The Board of Directors approved the establishment of a Recognition and Retention
Plan  ("RRP") on January 25, 1995.  The plan states that the Trust,  established
under  the plan,  shall not  purchase  more than 4% of the  aggregate  shares of
Common Stock issued by the Parent Company in the  mutual-to-stock  conversion of
the Savings Bank (50,255  shares).  During 1996 and 1995, the Company  purchased
27,650 and 22,600  shares,  respectively,  of the  Company's  Common Stock at an
average  price of $17.50 and $15.50  per share,  respectively,  to be awarded to
directors,  officers and employees in accordance with the provisions of the RRP.
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, 1996 and 1995, the amount  included in compensation  expense
was $72,000 and $122,000, respectively. The status of the shares in this plan is
summarized as follows:

                                               Per Share Unawarded   Awarded
                                                 Price    Shares     Shares
-----------------------------------------------------------------------------


Total established by plan               $            -     50,255          -
Granted                                          11.00    (41,058)    41,058
Vested                                               -          -          -
-----------------------------------------------------------------------------


Balance at September 30, 1995                    11.00      9,197     41,058

Granted                                          16.75     (2,600)     2,600
Vested                                   11.00 - 16.75          -    (11,277)
-----------------------------------------------------------------------------


Balance at September 30, 1996           $11.00 - 16.75      6,597     32,381
=============================================================================




                                                                          41

<PAGE>




                    Bedford Bancshares, Inc. and Subsidiaries

                                    Notes to Consolidated Financial Statements
                                                                   (continued)


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

11. Retirement Plans and Employee Benefit Programs (continued)

Stock Option Plans

The Company established two stock option plans during 1995, as part of the stock
conversion, 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>


                                            Option   Available    Options     Vested and
                                             Price   for Grant  Outstanding   Exercisable
-----------------------------------------------------------------------------------------


<S>                               <C>                <C>          <C>             <C>
At inception                      $              -    125,637           -          -
Granted                                      11.00   (102,640)    102,640          -
Vested                                           -          -           -          -
-----------------------------------------------------------------------------------------


Balance at September 30, 1995     $          11.00     22,997     102,640          -
-----------------------------------------------------------------------------------------


Granted                           $          16.75     (6,250)      6,250          -
Vested                               11.00 - 16.75          -     (28,185)    28,185
Exercised                                    11.00          -           -     (4,187)
-----------------------------------------------------------------------------------------


Balance at September 30, 1996       $11.00 - 16.75     16,747      80,705     23,998
=========================================================================================

</TABLE>


12. Commitments and Contingencies

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



42

<PAGE>




                    Bedford Bancshares, Inc. and Subsidiaries

                                    Notes to Consolidated Financial Statements
                                                                   (continued)


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

12. Commitments and Contingencies (continued)

The current minimum annual rental  commitments  under  non-cancelable  operating
leases in effect at September 30, 1996 are as follows:

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

                            1997                       $7,200
                            1998                        7,200
                            1999                        7,200
                            2000                        7,200
                         Thereafter                     6,600
                  -------------------------------------------

                                                      $35,400
                  ===========================================


Rent  expense was  approximately  $6,100,  $4,400 and $3,600 for the years ended
September 30, 1996, 1995 and 1994, respectively.

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

The Savings Bank's  exposure to credit loss in the event of  non-performance  by
the other party to the financial  instrument for commitments to extend credit is
represented  by  the  contractual   notional  amount  (in  thousands)  of  those
instruments  at  September  30, 1996 and 1995.  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,                                                                        1996     1995
----------------------------------------------------------------------------------------------------


Financial instruments, in thousands, whose contract amounts represent credit risk
<S>                                                                                 <C>      <C>   
    Unfunded commercial credit line                                                 $  362   $  274
    Unfunded home equity lines of credit                                             2,027    1,443
    Commitments to finance real estate acquisitions and construction                 1,798    1,704
----------------------------------------------------------------------------------------------------

                                                                                    $4,187   $3,421
====================================================================================================

</TABLE>




                                                                              43

<PAGE>




                    Bedford Bancshares, Inc. and Subsidiaries

                                    Notes to Consolidated Financial Statements
                                                                   (continued)


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

12. Commitments and Contingencies (continued)

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.

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. The aggregate balances of
such loans which exceed $60,000 in aggregate outstanding amount to any executive
officer or director, in thousands, is summarized as follows:

Year Ended September 30,              1996       1995       1994
-----------------------------------------------------------------


Beginning balance                     $457       $410       $395
Additions                              205        127        128
Repayments                             (21)       (80)      (113)
-----------------------------------------------------------------


Ending balance                        $641       $457       $410
=================================================================




44

<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  (in  thousands)  as follows as of September  30, 1996 and 1995, in
thousands.  Tangible  and core  capital  levels  are  shown as a  percentage  of
adjusted total assets,  and risk-based  capital levels are shown as a percentage
of risk-weighted assets.

<TABLE>
<CAPTION>

                                                                      September 30, 1996
                                          --------------------------------------------------------------------------
                                           GAAP      Tangible                 Core                       Risk-Based
                                          Capital     Capital                 Capital                     Capital
--------------------------------------------------------------------------------------------------------------------


<S>                                       <C>        <C>             <C>     <C>               <C>      <C>             <C>
GAAP capital before adjustments           $15,815
Adjustments
  Other                                        29
                                           ------
GAAP capital as adjusted                 $ 15,844    $ 15,844                $ 15,844                   $  15,844
                                           ======

General credit loss allowance                              --                      --                         650
Land loans greater than 80%                                --                      --                         (77)
                                                     --------                 -------                     -------

Regulatory capital computed                            15,844        12.4%     15,844          12.4%       16,417       23.1%
Minimum capital requirement                             1,918         1.5       3,835           3.0         5,677        8.0
                                                     --------       -----      ------          ----        ------       ----

Regulatory capital excess                           $  13,926        10.9    $ 12,009           9.4%    $  10,740       15.1%
                                                     ========       =====      ======          ====        ======       ====
</TABLE>

<TABLE>
<CAPTION>

                                                            September 30, 1995
                                    -------------------------------------------------------------------
                                     GAAP      Tangible          Core             Risk-Based
                                    Capital    Capital          Capital             Capital
-------------------------------------------------------------------------------------------------------


<S>                                 <C>       <C>        <C>     <C>         <C>    <C>          <C> 
GAAP capital before adjustments     $13,648
Adjustments
  Unpaid ESOP debt and
    unrealized securities loss        1,065
                                     ------
GAAP capital as adjusted            $14,713   $14,713            $14,713            $14,713
                                     ======

General credit loss allowance                       -                  -                640
Land loans greater than 80%                         -                  -               (687)
                                               ------             ------             ------
    
Regulatory capital computed                    14,713    12.8%    14,713     12.8%   14,666     23.7%
Minimum capital requirement                     1,729     1.5      3,458      3.0     4,942      8.0
                                               ------    ----     ------     ----     ------     ----

Regulatory capital excess                     $12,984    11.3%   $11,255      9.8%  $ 9,724     15.7%
                                               ======    ====     ======     ====     ======     ====
</TABLE>
                                                                          45

<PAGE>




                    Bedford Bancshares, Inc. and Subsidiaries

                                    Notes to Consolidated Financial Statements
                                                                   (continued)


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

16. Condensed Parent Company Information

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

                                 Balance Sheets
                                 (in thousands)

Year Ended September 30,                               1996       1995
-----------------------------------------------------------------------


Assets
  Cash and cash equivalents                        $    149   $    526
  Securities                                             42         48
  Investment in Savings Bank subsidiary              15,855     13,648
  Loan to Savings Bank ESOP                             627        707
  Loan to Savings Bank subsidiary                     3,000      4,000
  Other assets                                           83         80
-----------------------------------------------------------------------


Total assets                                        $19,756   $ 19,009
=======================================================================



Liabilities and stockholders' equity
  Accounts payable                                  $     8   $    138
  Dividends payable                                     126        186
  Stockholders' equity                               19,622     18,685
-----------------------------------------------------------------------


Total liabilities and stockholders' equity          $19,756   $ 19,009
=======================================================================




46

<PAGE>




                    Bedford Bancshares, Inc. and Subsidiaries

                                    Notes to Consolidated Financial Statements
                                                                   (continued)


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

16. Condensed Parent Company Information (continued)

                         Condensed Statements of Operations
                                   (in thousands)



<TABLE>
<CAPTION>

Year Ended September 30,                                                1996     1995     1994
----------------------------------------------------------------------------------------------

Income
<S>                                                                   <C>      <C>      <C>   
  Interest from
    Savings Bank's ESOP loan                                          $   44   $   51   $    8
    Loan to Savings Bank subsidiary                                      292      416       23
    Other                                                                 23       --       --
----------------------------------------------------------------------------------------------

Total income                                                             359      467       31
----------------------------------------------------------------------------------------------

Expenses
  Professional fees                                                       44       66       --
  Other operating expenses                                                40       33       --
----------------------------------------------------------------------------------------------

Total expenses                                                            84       99       --
----------------------------------------------------------------------------------------------

Net income before income taxes and equity in
  undistributed net income of Savings Bank subsidiary                    275      368       31

Provision for income taxes                                               104      140       13
Equity in undistributed net income of Savings Bank subsidiary          1,131    1,173    1,427
----------------------------------------------------------------------------------------------

Net income                                                            $1,302   $1,401   $1,445
==============================================================================================
</TABLE>



                                                                             47

<PAGE>
                    Bedford Bancshares, Inc. and Subsidiaries

                                    Notes to Consolidated Financial Statements
                                                                   (continued)

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

16. Condensed Parent Company Information (continued)

                         Condensed Statements of Cash Flows
                                   (in thousands)

<TABLE>
<CAPTION>


Year Ended September 30,                                                        1996        1995        1994
--------------------------------------------------------------------------------------------------------------

Operating activities
<S>                                                                         <C>         <C>         <C>     
  Net income                                                                $  1,302    $  1,401    $  1,445
  Adjustments
    Equity in undistributed net income of Savings Bank subsidiary             (1,131)     (1,173)     (1,427)
    (Increase) decrease in other assets                                           (3)         37         (41)
    Increase (decrease) in other liabilities                                    (130)        102          35
--------------------------------------------------------------------------------------------------------------

Net cash provided by operating activities                                         38         367          12
--------------------------------------------------------------------------------------------------------------

Investing activities
  Loans originated, net of principal repayments                                1,080       1,093      (5,000)
  Purchase of Savings Bank subsidiary stock                                       --          --      (5,970)
  Purchase of investment securities                                               --         (48)         --
--------------------------------------------------------------------------------------------------------------

Net cash provided (absorbed) by investing activities                           1,080       1,045     (10,970)
--------------------------------------------------------------------------------------------------------------

Financing activities
  Proceeds from sale of stock                                                     --          --      11,940
  Purchase of stock, by ESOP                                                      --          --        (800)
  Dividends paid                                                                (518)       (183)         --
  Repurchase of stock                                                         (1,115)       (885)         --
  RRP vesting                                                                    (42)         --          --
  ESOP note payment                                                              135          --          --
  Exercise of option                                                              45          --          --
--------------------------------------------------------------------------------------------------------------

Net cash provided (absorbed) by financing activities                          (1,495)     (1,068)     11,140
--------------------------------------------------------------------------------------------------------------

Increase (decrease) in cash and cash equivalents                                (377)        344         182

Cash and cash equivalents, beginning of year                                     526         182          --
--------------------------------------------------------------------------------------------------------------

Cash and cash equivalents, end of year                                      $    149    $    526    $    182
==============================================================================================================

</TABLE>


48

<PAGE>




                    Bedford Bancshares, Inc. and Subsidiaries

                                    Notes to Consolidated Financial Statements
                                                                   (continued)


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

17. 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, 1996         Quarter     Quarter    Quarter    Quarter
-------------------------------------------------------------------------------


Total interest income                 $2,252      $2,283     $2,323    $2,406
Total interest expense                 1,106       1,083      1,115     1,188
-------------------------------------------------------------------------------


Net interest income                    1,146       1,200      1,208     1,218
Provision for credit losses                -           -          -        22
-------------------------------------------------------------------------------


Net interest income after provision
  for credit losses                    1,146       1,200      1,208     1,196

Noninterest income                       155         162        191       227
Noninterest expense                      728         721        715     1,265
-------------------------------------------------------------------------------


Income before income taxes               573         641        684       158
Provision for income taxes               218         243        260        33
-------------------------------------------------------------------------------


Net income                            $  355      $  398     $  424    $  125
===============================================================================


Net income per share                  $  .32      $  .35     $  .38    $  .12
===============================================================================


Cash dividends declared per share     $  .09      $  .09     $  .10    $  .11
===============================================================================




                                                                              49

<PAGE>



                    Bedford Bancshares, Inc. and Subsidiaries

                                    Notes to Consolidated Financial Statements
                                                                   (continued)


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

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


                                     First      Second      Third     Fourth
Year Ended September 30, 1995       Quarter     Quarter    Quarter    Quarter
-----------------------------------------------------------------------------


Total interest income               $1,885      $1,977     $2,105    $2,170
Total interest expense                 832         884        984     1,078
-----------------------------------------------------------------------------


Net interest income                  1,053       1,093      1,121     1,092
Provision for credit losses              -           7          8         5
-----------------------------------------------------------------------------


Net interest income after provision
  for credit losses                  1,053       1,086      1,113     1,087

Other noninterest income               147         131        137       128
Noninterest expense                    624         631        657       708
-----------------------------------------------------------------------------


Income before income taxes             576         586        593       507
Provision for income taxes             219         223        233       186
-----------------------------------------------------------------------------


Net income                          $  357      $  363     $  360    $  321
=============================================================================


Net income per share                $  .30      $  .31     $  .31    $  .28
=============================================================================


Cash dividends declared per share   $    -      $  .15     $    -    $  .15
=============================================================================




50







<PAGE>

                               OFFICE LOCATIONS

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

                BRANCH OFFICES - BEDFORD FEDERAL SAVINGS BANK
            Moneta Office                         Forest Office
            Rt 655 at Rt 122                      Forest Village Square
            Moneta, VA  24121                     Forest, VA  24551
            (540) 297-1233                        (804) 525-2000


Board of Directors of Bedford Bancshares, Inc. and Bedford Federal Savings Bank

                                 Hugh H. Bond
                            Chairman of the Board

            George N. Cooper                    William T. Powell

            Harry W. Garrett, Jr.               Macon C. Putney

            Harold K. Neal                      W. Henry Walton, Jr.

            William P. Pickett

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

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

         Russell E. Millner                        Nancy T. Snyder
         Vice President                            Secretary

                  ____________________________________________

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

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

                   __________________________________________

Bedford Bancshares,  Inc.'s Annual Report for the year ended September 30, 1996,
filed  with the  Securities  and  Exchange  Commission  on Form  10-KSB  without
exhibits is available  without  charge upon written  request.  For a copy of the
Form 10-KSB or any other  investor  information,  please write or call Harold K.
Neal,  Chief  Executive  Officer at the Company's  Corporate  Office in Bedford,
Virginia. The Annual Meeting of Stockholders will be held on January 22, 1997 at
2:00 p.m. at the Olde Liberty Station, 515 Bedford Avenue, Bedford, Virginia.




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