EXHIBIT 13


                  Annual Report to Stockholders for Fiscal Year
                            Ended September 30, 1997


<PAGE>
                         [LOGO]    Bedford
                                Bancshares, Inc.


          o    YOUR HOMETOWN BANK OF CHOICE

               o    HIGH QUALITY EARNINGS

                    o    SOLID DIVIDEND GROWTH

                         o    STRONG COMMITMENT TO SHAREHOLDERS


                               1997 ANNUAL REPORT
<PAGE>


                 BEDFORD BANCSHARES, INC. - 1997 ANNUAL REPORT

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

Table of Contents
-----------------


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

Letters to Stockholders...................................................     3

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

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

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

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

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

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






                                                                               1
<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 was organized as a Virginia  corporation in March
          1994  at the  direction  of the  Savings  Bank to  acquire  all of the
          capital stock that Bedford Federal issued upon its conversion from the
          mutual to stock form of ownership  (the  "Conversion")  in  connection
          with a $12.6 million initial public  offering  completed on August 19,
          1994. The Company is a unitary savings and loan holding company which,
          under  exisiting  laws,  generally is not  restricted  in the types of
          business activities in which it may engage,  provided that the Savings
          Bank  retains  a  specified  amount of its  assets in  housing-related
          investments.  At the present time,  since the Company does not conduct
          any active business, the Company does not intend to employ any persons
          other than officers,  but utilizes the support staff and facilities of
          the Savings Bank from time to time.

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

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

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

          The Company's  common stock trades on the Nasdaq  National Maket under
          the trading  symbol of "BFSB".  The daily stock  quotation for Bedford
          Bancshares, Inc., is published in The Wall Street Journal and in other
          local  newspapers  under the trading symbol of "BFSB" or "Bedford Bc".
          The following  table reflects the stock price  published by the Nasdaq
          National Market statisical report.
<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              $0.15            --
June 1995                           $16.25          $12.25      298,726                --           $0.15
September 1995                      $18.75          $15.50      209,914              $0.15            --
December 1995                       $18.75          $17.50       93,376              $0.09          $0.15
March 1996                          $18.25          $16.75      120,970              $0.09          $0.09
June 1996                           $17.75          $15.75      189,406              $0.10          $0.09
September 1996                      $17.25          $16.50       85,591              $0.11          $0.10
December 1996                       $18.50          $16.63       96,239              $0.12          $0.11
March 1997                          $20.00          $17.50       81,784              $0.13          $0.12
June 1997                           $24.75          $19.00      159,532              $0.14          $0.13
September 1997                      $25.50          $23.50       93,290              $0.14          $0.14
</TABLE>

          On September 30, 1997,  there were  approimately  685  shareholders of
          record with  approximately  51.3% of the 1,142,425  outstanding shares
          held in nominee or "street"  name  through  various  brokerage  firms.
          There were six firms making a market in the Corporation's common stock
          during the month of September 1997.

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

            To Our Stockholders:

            For Bedford Bancshares,  Inc., fiscal 1997 proved to be another year
            of solid growth and enhanced  performance.  For the year, net income
            amounted to $1.6  million,  or $1.47 per share,  generating  a 1.19%
            return  on  average  assets.  Our  focus  continues  to be on strong
            internal  growth  and  the  delivery  of  consistent,   high-quality
            earnings.  The Company is committed  to  maintaining  excellence  in
            quality  products and services,  and a credit  culture that balances
            opportunity  for profits with prudent loan  underwriting  practices.
            Our goal is to carry  forward the long  tradition of producing  high
            quality, steadily increasing earnings.

            As a result of the  increased  profitability  experienced  in fiscal
            1997,  Bedford  Bancshares,  Inc. increased total dividends declared
            during the year to $.53 per share,  a 36%  increase  over  dividends
            declared in fiscal  1996.  Since our  conversion  in Augsut of 1994,
            dividends  have have risen by almost  77% and grown at a  compounded
            rate of over 20% per year.

            In  addition  to the very  attractive  dividend  growth  rates,  the
            closing  price  per  share of  Bedford  Bancshares  common  stock on
            September 30, 1997 was $24.50, a 145% rise from the initial offering
            price of $10.00  per  share.  Stockholders  who  acquired  the stock
            during the  initial  offering  at $10.00 per share have  realized an
            annualized  total  return  (dividends  plus stock  appreciation)  of
            almost 37% per year. Bedford Bancshares  consistently invests in its
            future   through  a  conservative   strategic   approach  to  market
            expansion, improving service levels for our customers, and expanding
            our product offerings. Perhaps most importantly,  Bedford Bancshares
            employees and directors own over 20% of the Company's  common stock,
            so our  business  conduct is parallel to the  interests of all other
            owners and is guided everyday by the goal of increasing  shareholder
            value.

            Bedford  Bancshares  has grown with Bedford and the families we have
            served  since our  founding  in 1935.  The  Company is the only bank
            headquartered  in  Bedford,  the  fastest  growing  county  west  of
            Richmond. Bedford is home to most of our customers and shareholders.
            Our 63 year  history in Bedford has allowed us to know and serve the
            people and needs of our  communities  extremely well. Our directors,
            officers  and  employees  take great pride in and are  dedicated  to
            improving  the quality of service to the families and  businesses we
            are fortunate to serve.  And as we deliver on that  commitment,  our
            stockholders  can  know  that we do so  with a  continued  focus  on
            maximizing the value of your investment.

            Total assets of your company amounted to $139.1 million at September
            30,  1997,  an $11.9  million,  or 9.3%  increase  over the previous
            fiscal  year end.  Net  loans  receivable  increased  6.6% to $116.1
            million and deposits  totaled $103.6 million at year end for an 8.6%
            increase  over year end 1996.  Our  continued  progress  is  further
            detailed in this report.

            We owe our success to the loyalty and support of our  customers  and
            stockholders,  and the  determination,  commitment and pride of your
            Board  of  Directors,  management  and  staff.  We look  forward  to
            continued  success  as we  serve  the  needs  of our  customers  and
            stockholders, and thank you for your business and support.

            Sincerely,


            /s/Harld K. Neal
            Harold K. Neal
            President and Chief Executive Officer
            December 15, 1997

                                                                               3

<PAGE>

SELECTED FINANCIAL AND OTHER DATA
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>

          Financial Condition (Dollars in Thousands)
                September 30,                                      1997        1996       1995        1994       1993      
                --------------------------------------------------------------------------------------------------------
<S>                                                            <C>         <C>        <C>         <C>         <C>       
                Total assets                                   $139,089    $127,201   $115,054    $105,217    $96,933   
                Loans receivable, net                           116,093     108,873     97,669      89,309     80,995   
                Investment securities                             9,655       8,006      7,761       7,651      5,915   
                Marketable equity securities                      4,185       3,879      3,660       3,360      3,289   
                Mortgage-backed securities                           20         482         31          37         47   
                Foreclosed real estate, net                         212           -          -           -         31   
                Deposits                                        103,612      95,378     90,063      84,841     89,187   
                FHLB advances                                    15,000      12,000      5,000       1,000      1,000   
                Retained earnings                                 9,763       8,739      8,263       7,519      6,144   
                Total stockholders' equity                       19,621      18,227     18,685      18,659          -   
                                                                          
          Summary of Operations (Dollars in Thousands)                    
                Year Ended September 30,                           1997        1996       1995        1994       1993   
                --------------------------------------------------------------------------------------------------------
                Interest income                                 $10,280      $9,264     $8,137      $6,964     $7,095   
                Interest expense                                  5,167       4,492      3,778       3,478      3,740   
                Net interest income                               5,113       4,772      4,359       3,486      3,355   
                Provision for credit losses                         100          22         20          51        234   
                Noninterest income                                  593         735        543         554        497   
                Noninterest expense                               3,041       3,429 (3   2,620       2,238      2,089   
                Net income before income taxes and                        
                  cumulative effect of change in                          
                  accounting principle                            2,565       2,056      2,262       1,751      1,529   
                Net income                                        1,591       1,302      1,401       1,445        925   
                                                                          
          Other Selected Data                                             
                Year Ended September 30,                           1997        1996       1995        1994(1)    1993   
                --------------------------------------------------------------------------------------------------------
                Return on average assets                           1.19%       1.10%      1.28%       1.12%      0.97%  
                Return on average equity                           8.40        6.98       7.31       12.89      16.25   
                Average equity to average assets                  14.21       15.69      17.49        8.71       5.98   
                Net interest rate spread                           3.27        3.34       3.26        3.28       3.39   
                Nonperforming assets to total assets               0.52        0.54       1.14        1.07       0.40   
                Nonperforming loans to total loans                 0.45        0.63       1.34        1.26       0.44   
                Allowance for credit losses to total loans         0.58        0.60       0.63        0.71       0.73   
                                                                          
          Per Share Data                                                  
                Year Ended September 30,                           1997        1996       1995        1994(2)    1993   
                --------------------------------------------------------------------------------------------------------
                Net income per share                             $ 1.47      $ 1.17     $ 1.20    $   1.23        N/A   
                Book value per share                              17.17       16.95      16.81       15.84        N/A   
                Cash dividends declared per share                   .53         .39        .30        -           N/A   
</TABLE>                                                                  
                                                                          
          -------------                                                 
          (1)  Income and  related  ratios  exclude the  cumulative  effect of a
               change in accounting principle of $323,000 in fiscal year 1994.
          (2)  Annualized
          (3)  Includes a one-time, special assessment of approximately $555,000
               to recapitalize the "SAIF."


4
<PAGE>
                   [GRAPHICS OMITTED - INFORMATION AS FOLLOWS]


                                  Total Assets
                              Dollars in Thousands

                              1993           $96,933
                              1994           $105,217
                              1995           $115,054
                              1996           $127,201
                              1997           $139,089

                              Year Ended September 30



Loan Portfolio Composition                        Deposit Portolio Composition
  At September 30, 1997                              At September 30, 1997

1-4 Family Residential                 70.8%      Certificates        68.4%  
Land                                    8.8%      Money Market         5.7%
Construction                            7.1%      Savings             14.4%
Consumer/Commercial Business            9.7%      Checking            11.5%
Commercial & Multi-Family (Real Estate) 3.6%

                                                                      


 Net Interest Income                                Net Income
(Dollars in Thousands)                         (Dollars in Thousands)

1993      $3,355                                  1993      $  925
1994      $3,486                                  1994      $1,445
1995      $4,359                                  1995      $1,401
1996      $4,772                                  1996      $1,302
1997      $5,113                                  1997      $1,591

Year Ended September 30                        Year Ended September 30



                        Return on Average Assets

                           1993         0.97%
                           1994         1.12%
                           1995         1.28%
                           1996         1.10%
                           1997         1.19%

                        Year Ended September 30

                                                                               5
<PAGE>

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

--------------------------------------------------------------------------------
  
Management Strategy
-------------------

          The  Company's  management  strategy is to  maintain a strong  capital
          position through  controlled growth and enhanced  profitability.  This
          has been accomplished 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  fixed-rate  mortgage  loans,  commercial 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 rate 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,
          but, from time to time, also borrows from the FHLB.

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

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

          The table that  follows  sets forth the  amounts of  interest  earning
          assets and interest bearing  liabilities  outstanding at September 30,
          1997,  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, 1997
----------------------------------------------------------------------------------------------------------------------------
                                            Three    More than   More than   More than   More than 
                                           months  3 Months to 6 Months to   1 Year to  3 Years to    More than 
                                          or less     6 Months      1 Year     3 Years     5 Years      5 Years        Total
                                          -------     --------      ------     -------     -------      -------    ---------
                                                                          (Dollars in Thousands)
<S>                                      <C>          <C>         <C>         <C>          <C>          <C>         <C>     
Interest-earning assets:
  Mortgage loans(1)(2)                   $  6,339     $  6,092    $ 66,168    $  9,232     $  3,831     $ 15,542    $107,204
  Other loans(1)                            5,116          666       1,347       3,506        1,848           --      12,483
  Marketable equity securities(3)           4,185           --          --          --           --           --       4,185
  Federal funds sold and other
    short-term investments                  2,791           --          --          --           --           --       2,791
` Investment securities                        --          500       1,000       4,600        2,517        1,038       9,655
  Mortgage-backed securities(2)                --           --          --          20           --           --          20
  FHLB stock                                  932           --          --          --           --           --         932
                                         --------     --------    --------    --------     --------     --------    --------
    Total interest-earning assets          19,363        7,258      68,515      17,358        8,196       16,580     137,270
                                         --------     --------    --------    --------     --------     --------    --------
Less:
Loans in process                            1,314        1,315          --          --           --           --       2,629
Unearned discount and deferred fees(2)         26           20         167          38           36           --         287
Allowance for credit losses                    56           43         410          82           24           63         678
                                         --------     --------    --------    --------     --------     --------    --------
    Net interest-earning assets            17,967        5,880      67,938      17,238        8,136       16,517     133,676
                                         --------     --------    --------    --------     --------     --------    --------
Interest-bearing liabilities:
  Money market deposits                     1,893        1,282       1,456         645          306          280       5,862
  Passbook deposits                           857          643       1,199       3,821        2,491        5,969      14,980
  NOW and other demand deposits               917          817       1,376       2,847          762        1,687       8,406
  Certificate accounts                     11,511           --      32,274      18,165        8,910           --      70,860
  Borrowed funds                            3,000        1,000       2,000       9,000           --           --      15,000
                                         --------     --------    --------    --------     --------     --------    --------
    Total interest-bearing liabilities     18,178        3,742      38,305      34,478       12,469        7,936     115,108
                                         --------     --------    --------    --------     --------     --------    --------
Interest sensitivity gap(4)              ($   211)    $  2,138    $ 29,633    $(17,240)    $ (4,333)    $  8,581    $ 18,568
                                         ========     ========    ========    ========     ========     ========    ========
Cumulative interest sensitivity gap      ($   211)    $  1,927    $ 31,560    $ 14,320     $  9,987     $ 18,568
                                         ========     ========    ========     ========     ========    ========
Cumulative interest sensitivity gap
  as a percent of total assets             (-0.15)%       1.39%      22.69%       10.30%        7.18%      13.35%
Cumulative net interest-bearing
  assets as a percent of
  interest-bearing liabilities              98.84%      108.79%     152.40%      115.12%      109.32%     116.13%
</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.
(4)  Interest   sensitivity   gap   represents   the   difference   between  net
     interest-earning assets and interest-bearing liabilities.

                                                                               7
<PAGE>
--------------------------------------------------------------------------------

Analysis of Net Interest Income
-------------------------------

          The  following  table sets forth certain  information  relating to the
          Savings Bank's average  balance sheet and reflects the interest earned
          on  assets  and  interest  expense  of  liabilities  for  the  periods
          indicated and the average  yields  earned and rates paid.  Such yields
          and costs are  derived by  dividing  income or expense by the  average
          balance  of  assets  or  liabilities,  respectively,  for the  periods
          presented. Average balances are derived from daily balances.
<TABLE>
<CAPTION>
                                                                 For the Year Ended September 30,
                                      ---------------------------------------------------------------------------------
                                                          1997                                       1996
                                      -------------------------------------      --------------------------------------
                                            Average                    Yield/          Average                   Yield/
                                            Balance     Interest        Cost           Balance     Interest       Cost
                                            -------     --------        ----           -------     --------       ----
                                                                       (Dollars in Thousands)                   
<S>                                       <C>           <C>           <C>           <C>          <C>            <C>  
  Interest-earning assets:
    Mortgage loans(1)                       $98,666       $7,816         7.92%         $91,605      $7,408         8.09%
    Other loans(1)                           14,600        1,481        10.15            9,305         972        10.45
    Interest-earning deposits(2)              3,966          217         5.47            3,718         225         6.05
    Federal funds sold and other
      short-term investments                  1,231          119         9.69            1,050          93         8.86
    Investment securities                     7,643          549         7.18            7,112         479         6.74
    Mortgage-backed securities, net             431           30         6.85              287          20         6.97
    FHLB stock                                  932           68         7.19              932          67         7.19
                                                ---           --                           ---          --
      Total interest-earning assets         127,469       10,280         8.07          114,009       9,264         8.13
                                                          ------                                     -----
Noninterest-earning assets                    5,667                                      4,807
                                              -----                                      -----
      Total assets                         $133,136                                   $118,816
                                           ========                                   ========

Liabilities and equity:
  Interest-bearing liabilities:
    Money market deposits                    $4,603          143         3.11%          $5,011        $154         3.07%
    Passbook deposits                        14,675          446         3.04           15,400         458         2.97
    NOW and other demand deposits             8,203          196         2.40            7,316         203         2.77
    Certificate accounts                     65,834        3,517         5.34           60,093       3,313         5.51
                                             ------        -----                        ------       -----
  Total deposit accounts                     93,315        4,302         4.61           87,820       4,128         4.70
    Borrowed funds                           14,249          865         6.07            6,018         364         6.05
                                             ------          ---                         -----         ---
      Total interest-bearing liabilities    107,564        5,167         4.80           93,838       4,492         4.79
                                                           -----                                     -----
Noninterest-bearing liabilities               6,610                                      6,336
Equity                                       18,962                                     18,642
                                             ------                                     ------
      Total liabilities and equity         $133,136                                   $118,816
                                           ========                                   ========
Net interest income                                       $5,113                                    $4,772
                                                          ======                                    ======
Interest rate spread(3)                                                  3.27%                                      3.34%
Net interest margin(4)                                                   4.02%                                      4.19%
Interest-earning asset to
  interest-bearing liabilities               118.51%                                    121.50%
</TABLE>

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

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

          The following table sets forth certain  information  regarding changes
          in interest  income and  expense of the  Savings  Bank for the periods
          indicated.   For  each   category  of   interest-earning   assets  and
          interest-bearing  liabilities,  information is provided on changes due
          to (1)  changes  in volume  (change in  average  volume  times the old
          rate);  (2)  changes in rate  (changes  in rate times the new  average
          volume);  and (3) net change. The change  attributable to the combined
          impact of volume and rate have been allocated  proportionately  to the
          changes due to volume and the changes due to rate.
<TABLE>
<CAPTION>
                                                                                 Year Ended September 30,
                                                           ---------------------------------------------------------------------
                                                                    1997 vs. 1996                        1996 vs. 1995
                                                           --------------------------------     --------------------------------
                                                               Volume       Rate       Net          Volume      Rate        Net
                                                           --------------------------------     --------------------------------
                                                                                  (Dollars in Thousands)
<S>                                                              <C>       <C>        <C>             <C>       <C>        <C> 
    Interest-earning assets:
      Mortgage loans                                             $567      ($159)     $408            $432      $344       $776
      Other loans                                                 545        (36)      509             195        41        236
      Interest-earning deposits                                    15        (23)       (8)             15        (1)        14
      Federal funds sold and other short-term
        investments                                                16         10        26               9        26         35
      Investment securities, net                                   36         34        70              24        25         49
      Mortgage-backed securities, net                              10          -        10              18        (1)        17
      FHLB stock                                                    1          -         1               -         -          -
                                                                    -          -         -               -         -          -
                                                                -----      -----    -----             ----       ---      -----
        Total interest-earning assets                           1,190       (174)    1,016             693       434      1,127
                                                                -----      -----    -----             ----       ---      -----

    Interest-bearing liabilities:
      Money market deposits                                       (12)         1       (11)            (29)        2        (27)
      Passbook deposits                                           (22)        10       (12)            (49)       (9)       (58)
      NOW and other demand deposits                                22        (29)       (7)             38        (3)        35
      Certificate accounts                                        316       (112)      204             406       210        616
      Borrowed funds                                              498          3       501             146         2        148
                                                                  ---       ----       ---             ---       ---        ---
        Total interest-bearing liabilities                        802       (127)      675             512       202        714
                                                                  ---       -----      ---             ---       ---        ---
    Net change in net interest income                            $388       ($47)     $341            $181      $232       $413
                                                                 ====       =====     ====            ====      ====       ====
</TABLE>
--------------------------------------------------------------------------------

Comparison of Financial  Condition for Fiscal Years Ended September 30, 1997 and
1996
--------------------------------------------------------------------------------

          The  Corporation's  total assets were $139.1  million at September 30,
          1997,  an increase of $11.9 million or 9.35%,  from $127.2  million at
          September 30, 1996. The asset growth was primarily due to a 6.63% rise
          in net loans receivable and a 20.60% increase in investment securities
          from the end of fiscal 1996.

          The  continuaton of new home  construction  within the markets Bedford
          Federal  serves  combined with growth of both  commercial and consumer
          loans during  fiscal 1997 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  $1,649,000,  marketable  equity securities rose
          $306,000  , while  mortgage-backed  securities  declined  $433,000  in
          fiscal 1997 compared to fiscal 1996.

          Deposits  totaled $103.6 million at September 30, 1997, an increase of
          $8.2 million from $95.4  million on September  30, 1996.  The increase
          was partially  attributable  to the success of the Bank's "Freedom CD"
          promtion   (discussed   later)  combined  with  the  healthy  economic
          environment in the areas served by Bedford Federal.  Advances from the
          FHLB  increased  $3 million as the Savings  Bank  utilized  additional
          borrowings to meet funding needs.

                                                                               9
<PAGE>
          Total stockholders' equity was $19.6 million on September 30, 1997, an
          increase of $1.4  million  from the $18.2  million one year  previous.
          This increase reflects the continued  profitability of the Corporation
          which  allowed  Bedford  Bancshares to increase the level of dividends
          declared from $.39 in fiscal 1996 to $.53 in 1997, a 35.9% increase.

Comparison of Operating Results for Years Ended September 30, 1997 and 1996
--------------------------------------------------------------------------------

          Net Income. Net income increased $289,000,  to $1.6 million for fiscal
          1997 from  fiscal  1996.  An increase  in net income  combined  with a
          reduction in noninterest expense,  offset somewhat by a lower level of
          noninterest  income and an increase in the  provision for loan losses,
          accounted  for the  improvement  in  profitability.  During the fourth
          quarter of 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).

          Interest Income.  Interest income totaled $10.3 million for the fiscal
          year ended  September 30, 1997, a 11.0% increase from the $9.3 million
          recorded  for fiscal  1996.  The $1.0  million  expansion  of interest
          income is due to the 11.6% growth of average earning assets, primarily
          loans,  slightly  offset by a 6 basis point decline in the rate earned
          on  average  earning  assets.  The table on page 8 provides a detailed
          analysis of the changes in interest income due to volume and rate.

          Interest Expense. Interest expense increase $675,000 from $4.5 million
          for the year ended  September  30, 1996 to $5.2 million for the fiscal
          year ended  September 30, 1997. The level of average  interest-bearing
          liabilities  rose 14.6% to $107.6  million  for fiscal 1997 from $93.8
          for fiscal 1996.  There was virtually no change in the overall cost of
          interest  bearing  liabilities  in fiscal 1997 over fiscal  1996.  The
          table  on page 8  provides  a  detailed  analysis  of the  changes  in
          interest expense due to the changes in volume and rate.

          Net Interest Income.  Net interest income totaled $5.1 million for the
          year ended September 30, 1997, up 7.1% from the $4.8 million  realized
          in fiscal 1996.  The  increase is  primarily  due to the growth of and
          improvement  in mix of  earning  assets.  The  growth of net  interest
          income was restrained somewhat by the increases in average certificate
          accounts  and  borrowed  funds.  A detailed  analysis of net  interest
          income is presented on pages 8 and 9 of this report.

          Provisions  for Credit  Losses.  Provisions  for credit losses for the
          year ended September 30, 1997 increased  $78,000 to $100,000  compared
          to the provisions recorded in fiscal 1996. The increase in fiscal 1997
          was  attributable  to the loan growth of both  commercial and consumer
          loans.  At September  30, 1997,  the  allowance  for credit losses was
          $678,000,  representing  .58% of loans  receivable,net,  and 92.81% 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  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, 1997, noninterest
          income amounted to $593,000, down $142,000 from the $735,000 earned in
          fiscal 1996.  Service charges and fees on loans were down $107,000 due
          to a moderation in the number and dollar volume of loan  originations,
          and a change in pricing.  All other  categories of noninterest  income
          reflceted a net decrease of $35,000 primarily due to a gain of $28,000
          on the sale of  foreclosed  during  fiscal 1996  compared to a gain of
          $4,000 in fiscal 1997.

                                                                              10
<PAGE>

          Noninterest Expense.  Noninterest expense totaled $3.0 million for the
          year ended  September  30, 1997  compared  to $3.4  million for fiscal
          1996. The decrease was primarily due to the imposition,  during fiscal
          1996,  by the  FDIC on  SAIF  members  of the  one-time  assesment  to
          recapitalize  the SAIF. In the fourth quarter of fiscal 1996, The Bank
          recorded  the  charge  of  approximately  $555,000.  Compensation  and
          employee  benefits  were up $217,000  in fiscal  1997  compared to the
          prior year due to staff increases, merit increases and higher benefits
          costs. Increases in benefits costs were primarily due to benefit plans
          which have expenses  tied to the market price of the Company's  common
          stock.  The Federal  insurance  of accounts  decreased  $119,000  from
          fiscal 1996 to fiscal 1997 due to the special assessment discussed and
          the  ensuing  reduction  in the annual  assessment  rate.  Advertising
          expense increased 60.9%, or $53,000, in fiscal 1997over the prior year
          due to large  promotions  for the  introduction  of the  Bank's  voice
          response system , to increase equity line  commitments and to market a
          new certificate of deposit, the "Freedom CD," which helped raise funds
          for the National D-Day Foundation. All three of these promtions proved
          very successful.

          A great deal of  information  has been  disseminated  about the global
          computer year 2000. Many computer  programs that can only  distinguish
          the  final  two  digits  of the year  entered  ( a common  programming
          practice in earlier  years) are  expected to read entries for the year
          2000 as the year 1900 and compute  payment,  interest  or  delinquency
          based on the  wrong  date or are  expected  to be  unable  to  compute
          payment,  interest or delinquency.  Rapid and accurate data processing
          is essential to the operation of the Savings Bank.  Data processing is
          also  essential to most other  financial  institutions  and many other
          companies.  All of the material  data  processing  of the Savings Bank
          that could be  affected  by this  problem is provided by a third party
          service bureau.  This service bureau has advised the Savings Bank that
          it expects to resolve  this  potential  problem  before the year 2000.
          However,  if the service  bureau is unable to resolve  this  potential
          problem in time, the Savings Bank would likely experience  significant
          data processing delays,  mistakes or failures.  These delays, mistakes
          or failures  could have a significant  adverse impact on the financial
          condition and results of operations of the Savings Bank.

          Income Taxes.  The provision  for income taxes  increased  $220,000 to
          $974,000  in fiscal  1997  from  $754,000  in  fiscal  1996 due to the
          increased 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, 1997,  the
          Savings Bank's  liquidity,  as measured for regulatory  purposes,  was
          12.28%   which  was  $8.4   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, 1997, cash and cash equivalents totaled $5.4 million.

                                                                              11
<PAGE>

          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, 1997, the Savings Bank had $15.0
          million in  advances  outstanding  from the FHLB of  Atlanta.  Bedford
          Federal  anticipates  that it will have sufficient  funds available to
          meet its current commitments.  At September 30, 1997, the Savings Bank
          had  commitments  to fund loans of $7.0  million  and $2.6  million of
          loans in process.


          Certificates  of deposit  scheduled to mature  within one year totaled
          $43.8  million  September  30,  1997.  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 a result no
          adverse liquidity effects are expected.

          Net cash provided by operating activities for fiscal 1997 totaled $1.4
          million.

          Net cash  absorbed by  investing  activities  for fiscal 1997  totaled
          $10.0  million,  a decrease  from  fiscal  1996 of $2.2  million.  The
          decrease was primarily attributable to a decrease in cash used for net
          loan  originations  of  $3.7  million,  offset  by cash  used  for net
          purchase of investments of $1.5 million.

          Net cash provided by financing activities for the year ended September
          30, 1997 totaled $11.0 million.  This is a result of a net increase in
          deposits of $8.2 million, an increase in FHLB advances of $3.0 million
          and  dividends  paid of  $571,000.  The  increase in deposits  and net
          borrowings   were  used   primarily  to  fund  the  increase  in  loan
          originations and investment securities.

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


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

Impact of Inflation and Changing Prices
---------------------------------------

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

12
<PAGE>
                    Bedford Bancshares, Inc. and Subsidiaries

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




                        Consolidated Financial Statements


                      As of September 30, 1997 and 1996 and
              For the Years Ended September 30, 1997, 1996 and 1995
                    Bedford Bancshaes, Inc. and Subsidiaries



                                                                              13
<PAGE>
{LOGO]          BDO Seidman                       300 Arboretun 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 sheets of Bedford Bancshares,  Inc. and
subsidiaries  (the "Company") as of September 30, 1997 and 1996, and the related
consolidated statements of operations,  stockholders' equity, and cash flows for
the years 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,  were
audited by other  auditors  whose  report dated  October 27, 1995,  expressed an
unqualified opinion on those statements.

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

In our opinion, the 1997 and 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, 1997
and 1996, and the results of their operations and their cash flows for the years
then ended in conformity with generally accepted accounting principles.



                                          /s/BDO Seidman, LLP


 October 29, 1997

                                                                           
14                                                              
<PAGE>
                                       Bedford Bancshares, Inc. and Subsidiaries

                                                     Consolidated Balance Sheets
                                                                  (in thousands)
<TABLE>
<CAPTION>

==============================================================================================================================
September 30,                                                                                     1997                 1996
------------------------------------------------------------------------------------------------------------------------------

<S>                                                                                          <C>                   <C>     
   Assets

Cash (including interest bearing deposits of
  approximately $2,791 and $223)                                                             $   5,446             $  3,075
Securities (Notes 1 and 6)
  Held-to-maturity                                                                               4,616                5,239
  Available for sale                                                                             9,244                6,196
Investment in Federal Home Loan Bank stock,
  at cost (Note 6)                                                                                 932                  932
Loans receivable, net (Notes 2, 6 and 14)                                                      116,093              108,873
Foreclosed real estate, net                                                                        212                 -
Property and equipment, net (Note 4)                                                             1,214                1,238
Accrued interest receivable                                                                        847                  662
Deferred income taxes (Note 9)                                                                      58                  438
Other assets                                                                                       427                  548
------------------------------------------------------------------------------------------------------------------------------













                                                                                              $139,089             $127,201
==============================================================================================================================
</TABLE>




                                                                              15
<PAGE>

                                       Bedford Bancshares, Inc. and Subsidiaries

                                                     Consolidated Balance Sheets
                                                                  (in thousands)

<TABLE>
<CAPTION>
===================================================================================================================
September 30,                                                                           1997                 1996
-------------------------------------------------------------------------------------------------------------------

<S>                                                                                 <C>                  <C>     
   Liabilities and Stockholders' Equity

Liabilities
  Deposits (Note 5)                                                                 $103,612             $ 95,378
  Advances from Federal Home Loan Bank (Note 6)                                       15,000               12,000
  Advances from borrowers for taxes and insurance                                        502                  539
  Dividends payable                                                                      160                  126
  Other liabilities (Note 8)                                                             194                  931
-------------------------------------------------------------------------------------------------------------------

Total liabilities                                                                    119,468              108,974
-------------------------------------------------------------------------------------------------------------------

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, 1,142,425 and 1,143,669 shares, issued and
    outstanding                                                                          114                  114
  Additional paid-in capital                                                          10,836               10,773
  Retained earnings, substantially restricted (Note 10)                                9,763                8,739
  Unrealized gain (loss) on securities available for sale (Note 1)                        22                  (33)
  Stock acquired by ESOP and RRP (Note 11)                                            (1,114)              (1,366)
-------------------------------------------------------------------------------------------------------------------

Total stockholders' equity                                                            19,621               18,227
-------------------------------------------------------------------------------------------------------------------


                                                                                    $139,089             $127,201
===================================================================================================================
</TABLE>

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

16                                                                             
<PAGE>



                                       Bedford Bancshares, Inc. and Subsidiaries

                                           Consolidated Statements of Operations
                                                                  (in thousands)

<TABLE>
<CAPTION>
===================================================================================================================
Year Ended September 30,                                               1997                1996              1995
-------------------------------------------------------------------------------------------------------------------
<S>                                                                 <C>                  <C>               <C>   
Interest income
  Loans                                                             $ 9,297              $8,380            $7,368
  U.S. government obligations, including agencies                       796                 748               708
  Other investments                                                     187                 136                61
-------------------------------------------------------------------------------------------------------------------

Total interest income                                                10,280               9,264             8,137
-------------------------------------------------------------------------------------------------------------------

Interest expense
  Deposits (Note 5)                                                   4,302               4,128             3,562
  Borrowed money                                                        865                 364               216
-------------------------------------------------------------------------------------------------------------------

Total interest expense                                                5,167               4,492             3,778
-------------------------------------------------------------------------------------------------------------------

Net interest income                                                   5,113               4,772             4,359

Provision for loan losses (Note 2)                                      100                  22                20
-------------------------------------------------------------------------------------------------------------------

Net interest income after provision for
  loan losses                                                         5,013               4,750             4,339
-------------------------------------------------------------------------------------------------------------------

Noninterest income
  Service charges and fees on loans                                     296                 403               345
  Other customer service fees and commissions                           242                 257               180
  Gain (loss) on sale of loans, investments
    and foreclosed real estate                                           16                  30                (4)
  Other                                                                  39                  45                22
-------------------------------------------------------------------------------------------------------------------

Total noninterest income                                                593                 735               543
-------------------------------------------------------------------------------------------------------------------

Noninterest expense
  Compensation and employee benefits                                  1,684               1,467             1,380
  Occupancy and equipment                                               318                 336               259
  Data processing                                                       341                 311               302
  Federal insurance of accounts                                          88                 207               197
  Advertising                                                           140                  87                85
  Professional fees                                                     120                 115               149
  BIF/SAIF premium disparity assessment (Note 8)                        -                   555               -
  Other                                                                 350                 351               248
-------------------------------------------------------------------------------------------------------------------

Total noninterest expense                                             3,041               3,429             2,620
-------------------------------------------------------------------------------------------------------------------
</TABLE>
                                                                    continued...

                                                                              17

<PAGE>
                                       Bedford Bancshares, Inc. and Subsidiaries

                                           Consolidated Statements of Operations
                                                                  (in thousands)
                                                                     (continued)
<TABLE>
<CAPTION>
=====================================================================================================================
Year Ended September 30,                                               1997                1996              1995
---------------------------------------------------------------------------------------------------------------------

<S>                                                                  <C>                 <C>               <C>   
Income before income taxes                                           $2,565              $2,056            $2,262

Provision for income taxes (Note 9)                                     974                 754               861
-------------------------------------------------------------------------------------------------------------------

Net income                                                           $1,591              $1,302            $1,401
-------------------------------------------------------------------------------------------------------------------


Primary and fully diluted earnings
  per common share                                                    $1.47             $  1.17           $  1.20
===================================================================================================================

</TABLE>


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


18                                                                   
<PAGE>
                                       Bedford Bancshares, Inc. and Subsidiaries

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

<S>                                      <C>         <C>         <C>            <C>           <C>          <C>    
Balance, September 30, 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)
-------------------------------------------------------------------------------------------------------------------

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>

                                                                    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>    
Net income                              $ -          $   -       $1,591          $ -         $   -         $ 1,591
Change in unrealized loss
  on securities available
  for sale (Note 1)                       -              -          -               55           -              55
Allocated/earned ESOP
  shares (Note 11)                        -              147         49            -              80           276
Purchase of RRP shares
  (Note 11)                               -              (12)       (11)           -             -             (23)
Dividends declared ($.53
  per share)                              -              -         (605)           -             -            (605)
RRP vesting (Note 11)                     -              (72)       -              -             172           100
-------------------------------------------------------------------------------------------------------------------

Balance, September 30, 1997              $114        $10,836     $9,763            $22       $(1,114)      $19,621
===================================================================================================================
</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,                                               1997                1996              1995
-------------------------------------------------------------------------------------------------------------------

<S>                                                                 <C>                 <C>                <C>   
Operating activities
  Net income                                                        $ 1,591             $ 1,302            $1,401
  Adjustments to reconcile net income to
    net cash provided by operating activities
      Provision for loan losses                                         100                  22                20
      Provision for depreciation and amortization                       159                 163               120
      (Increase) decrease in deferred income taxes                      380                (121)              116
      (Gain) loss on sale of loans and securities                       (11)                 (2)                4
      (Gain) loss on sale of foreclosed real estate                      (4)                (28)              -
      Loans originated for sale                                        (185)               (152)             (184)
      Proceeds from sale of loans originated for sale                   185                 153               188
      (Increase) decrease in interest receivable                       (185)                 51              (128)
      (Increase) decrease in other assets                               121                (295)              (84)
      Increase (decrease) in other liabilities                         (745)                356               331
-------------------------------------------------------------------------------------------------------------------

Net cash provided by operating activities                             1,406               1,449             1,784
-------------------------------------------------------------------------------------------------------------------

Investing activities
  Proceeds from maturities of investments                             2,090               2,200             1,200
  Proceeds from sales of investments                                  1,000                 872               394
  Principal collected on mortgage-backed securities                      55                  26                 7
  Purchases of investment securities                                 (5,500)             (4,035)           (1,955)
  Net increase in loans to customers                                 (7,575)            (11,311)           (8,380)
  Net proceeds from sales of foreclosed real estate                      47                 113                -
  Purchases of premises, equipment and leasehold
    improvements                                                       (131)                (88)             (298)
-------------------------------------------------------------------------------------------------------------------

Net cash absorbed by investing activities                           (10,014)            (12,223)           (9,032)
-------------------------------------------------------------------------------------------------------------------
</TABLE>
                                                                    continued...

                                                                              21

<PAGE>
                                       Bedford Bancshares, Inc. and Subsidiaries

                                           Consolidated Statements of Cash Flows
                                                                  (in thousands)
                                                                     (continued)
<TABLE>
<CAPTION>
===================================================================================================================
Year Ended September 30,                                               1997                1996              1995
-------------------------------------------------------------------------------------------------------------------
<S>                                                                 <C>                 <C>                <C>   
Financing activities
  Net increase in deposits                                          $ 8,234             $ 5,315            $5,222
  Net increase (decrease) in advance payments
    from borrowers                                                      (37)                 (6)               72
  Proceeds from advances                                             23,500              11,000             5,000
  Principal payments of advances                                    (20,500)             (4,000)           (1,000)
  Purchase of stock by ESOP and RRP                                     (23)               (483)             (349)
  Allocation of ESOP and RRP shares                                     376                 274               155
  Repurchase of stock                                                   -                (1,115)             (885)
  Dividends paid                                                       (571)               (518)             (183)
  Issuance of common stock                                              -                    45               -
-------------------------------------------------------------------------------------------------------------------

Net cash provided by financing activities                            10,979              10,512             8,032
-------------------------------------------------------------------------------------------------------------------

Increase (decrease) in cash and cash equivalents                      2,371                (262)              784

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

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

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

Cash payments of interest expense                                    $5,387              $4,503            $3,777
===================================================================================================================

Cash payments of income taxes                                          $823                $817              $718
===================================================================================================================

Transfer of loans to foreclosed real estate                            $255              $  -              $  -
===================================================================================================================
</TABLE>
See  accompanying  summary  of  accounting  policies  and notes to  consolidated
financial statements.

22
<PAGE>
                                       Bedford Bancshares, Inc. and Subsidiaries

                                                  Summary of Accounting Policies

================================================================================

Nature of Business and Regulatory Environment

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

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

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

Principles of Consolidation

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

Estimates

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

Investment Securities

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

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

                                                                              23

<PAGE>
                                       Bedford Bancshares, Inc. and Subsidiaries

                                                  Summary of Accounting Policies
                                                                     (continued)

================================================================================

Investment Securities (continued)

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

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

Loans Held for Sale

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

Loans Receivable

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

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

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

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

24                                                                      

<PAGE>
                                       Bedford Bancshares, Inc. and Subsidiaries

                                                  Summary of Accounting Policies
                                                                     (continued)

================================================================================

Loans Receivable (continued)

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

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

As of  September  30,  1997,  the Company had no loans that were  considered  as
impaired.

Real Estate Owned

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


                                                                              25

<PAGE>
                                       Bedford Bancshares, Inc. and Subsidiaries

                                                  Summary of Accounting Policies
                                                                     (continued)

================================================================================
Real Estate Owned (continued)

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

Sale of Loans, Participations in Loans

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

Effective July 1, 1995, the Company  adopted  Statement of Financial  Accounting
Standards  No. 122 (SFAS 122),  "Accounting  for  Mortgage  Servicing  Rights an
Amendment of FASB Statement No. 65." SFAS 122 requries  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 banks 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.

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

Property, Equipment and Depreciation

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

Income Taxes

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

26 
<PAGE>
                                       Bedford Bancshares, Inc. and Subsidiaries

                                                  Summary of Accounting Policies
                                                                     (continued)

================================================================================
Income Taxes (continued)

For tax years beginning prior to January 1, 1996, savings banks that met certain
definitional tests and other conditions  prescribed by the Internal Revenue Code
were allowed, within limitations, to deduct from taxable income an allowance for
bad debts using the "percentage of taxable  income"  method.  The cumulative bad
debt reserve,  upon which no taxes have been paid, was approximately  $1,206,207
at September 30, 1997.

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

As a  result  of the  Act,  the  Company  must  recapture  into  taxable  income
approximately  $421,440 ratably over the next six years, beginning with the year
ending September 30, 1997. If the residential loan requirement exception is met,
as discussed  above, the income will be includable over the third through eighth
years following the year ended September 30, 1997.

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.  The  application of this  pronouncement  did not 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 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.  The  application  of this  pronouncement  did not have a material
effect on the Company's financial statements.

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 was adopted by the Company prospectively  beginning October
1, 1996. Disclosures required by SFAS No. 123 are presented in Note 11.

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.  The application of this  pronouncement  did not
have a material effect on the financial statements of the Company.

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

28                                                                   
<PAGE>
                                       Bedford Bancshares, Inc. and Subsidiaries

                                                  Summary of Accounting Policies
                                                                     (continued)

================================================================================

Accounting Pronouncements (continued)

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

Earnings Per Share

Earnings per share of Common Stock for the years ended  September 30, 1997, 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.  Shares  acquired by the employee stock benefit plans
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, 1997,  1996 and 1995,  including  common stock  equivalents,  were
1,082,216, 1,112,697 and 1,165,381 respectively.

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.


                                                                              29

<PAGE>
                                       Bedford Bancshares, Inc. and Subsidiaries

                                      Notes to Consolidated Financial Statements
                                                                     (continued)

================================================================================

1.  Securities

A summary  of the  amortized  cost and  estimated  market  values of  investment
securities, in thousands, is as follows:
<TABLE>
<CAPTION>
September 30, 1997
---------------------------------------------------------------------------------------------------------------------------

                                                                               Gross              Gross          Estimated
                                                          Amortized         Unrealized         Unrealized         Market
                                                            Cost               Gains             Losses            Value
---------------------------------------------------------------------------------------------------------------------------
<S>                                                        <C>                 <C>                <C>              <C>    
Held to Maturity

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

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

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

Available for Sale

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

  Marketable Equity securities                               4,169              16                -                  4,185

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

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

                                                           $13,829             $51                $35              $13,845
===========================================================================================================================
</TABLE>


Proceeds from the sale of  securities  available for sale during the years ended
September 30, 1997 and 1996 were  $1,000,000  and $802,000  respectively.  A net
gain of $4,000  was  realized  on the 1997 sale  while a net gain of $2,000  was
realized  on the 1996 sale,  and a net loss of $8,000 was  realized  on the 1995
sale.

30
<PAGE>
                                       Bedford Bancshares, Inc. and Subsidiaries

                                      Notes to Consolidated Financial Statements
                                                                     (continued)

================================================================================

1.  Securities (continued)
<TABLE>
<CAPTION>
September 30, 1996
---------------------------------------------------------------------------------------------------------------------------


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

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

  United States government
    and agency obligations                                 $ 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>

                                                                              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, 1997, by contractual maturity, were as follows:
<TABLE>
<CAPTION>
                                                                                                                Estimated
                                                                                           Amortized              Market
                                                                                             Cost                  Value
---------------------------------------------------------------------------------------------------------------------------

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

  Due in one year or less                                                                      $1,500                $1,487
  Due in one through five years                                                                 2,596                 2,593
  Due after five years                                                                            500                   501
---------------------------------------------------------------------------------------------------------------------------
                                                                                                4,596                 4,581
  Mortgage-backed securities                                                                       20                    20
---------------------------------------------------------------------------------------------------------------------------

                                                                                                4,616                 4,601
---------------------------------------------------------------------------------------------------------------------------

Available for Sale
  Due in one year or less                                                                         -                     -
  Due in one through five years                                                                 4,497                 4,521
  Due after five years                                                                            494                   485
---------------------------------------------------------------------------------------------------------------------------

                                                                                                4,991                 5,006

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

                                                                                                5,044                 5,059
---------------------------------------------------------------------------------------------------------------------------

                                                                                               $9,660                $9,660
===========================================================================================================================
</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,                                                                                   1997                  1996
---------------------------------------------------------------------------------------------------------------------------

<S>                                                                                         <C>                 <C>     
First mortgage loans                                                                        $ 93,791            $   91,386
Construction loans                                                                             8,597                10,121
Home equity loans                                                                              3,972                 2,636
Loans to depositors, secured by savings                                                          581                   551
Installment loans                                                                              9,041                 5,169
Term notes                                                                                     3,705                 3,158
---------------------------------------------------------------------------------------------------------------------------
                                                                                             119,687               113,021

Less
  Undisbursed loans in process                                                                 2,629                 3,199
  Unearned discount resulting from add-on interest                                                 4                    15
  Deferred loan fees and costs, net                                                              283                   284
  Allowance for credit losses                                                                    678                   650
---------------------------------------------------------------------------------------------------------------------------

                                                                                              $116,093            $108,873
===========================================================================================================================
</TABLE>

Activity in the allowance  for credit  losses,  in  thousands,  is summarized as
follows:
<TABLE>
<CAPTION>
Year Ended September 30,                                                       1997               1996                1995
---------------------------------------------------------------------------------------------------------------------------

<S>                                                                            <C>                <C>                 <C> 
Balance at beginning of year                                                   $650               $640                $636
Provision charged to operations                                                 100                 22                  20
Charge offs net of recoveries                                                   (72)               (12)                (16)
---------------------------------------------------------------------------------------------------------------------------


Balance at end of year                                                         $678               $650                $640
===========================================================================================================================
</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>
September 30,                                                                  1997               1996                1995
---------------------------------------------------------------------------------------------------------------------------
<S>                                                                          <C>                <C>                 <C>   
Federal Home Loan Mortgage Corporation (FHLMC)                               $1,719             $1,472              $1,511
Virginia Housing Development Authority (VHDA)                                 1,184              1,245               1,197
---------------------------------------------------------------------------------------------------------------------------

                                                                             $2,903             $2,717              $2,708
===========================================================================================================================
</TABLE>


4.    Property and Equipment

Property and equipment, in thousands, are summarized as follows:
<TABLE>
<CAPTION>
September 30,                                                                                       1997              1996
---------------------------------------------------------------------------------------------------------------------------

<S>                                                                                               <C>               <C>   
Land                                                                                              $  251            $  251
Office buildings                                                                                   1,195             1,190
Rental buildings                                                                                      48                48
Furniture, fixtures and equipment                                                                    886               755
Automobile                                                                                            16                16
Leasehold improvements                                                                                22                23
---------------------------------------------------------------------------------------------------------------------------
                                                                                                   2,418             2,283
Less accumulated depreciation                                                                      1,204             1,045
---------------------------------------------------------------------------------------------------------------------------

                                                                                                  $1,214            $1,238
===========================================================================================================================
</TABLE>

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,                                                    1997                         1996
                                                        Amount       Percent          Amount      Percent
-----------------------------------------------------------------------------------------------------------

<S>                                                   <C>             <C>            <C>           <C>   
NOW accounts                                          $  11,910        11.49%         $13,057       13.69%
Money market accounts                                     5,862         5.66            4,579        4.80
Savings accounts                                         14,980        14.46           15,290       16.03
Time deposits                                            70,860        68.39           62,452       65.48
-----------------------------------------------------------------------------------------------------------

                                                       $103,612       100.00%         $95,378     100.00%
===========================================================================================================
</TABLE>


The  aggregate  amount  of  certificates  of  deposit  of  $100,000  or more was
approximately  $8,677,000  and  $6,978,000  at  September  30,  1997  and  1996,
respectively.

At September 30, 1997, the scheduled maturities of time deposits,  in thousands,
are as follows:

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

               1998                                     $43,787
               1999                                      14,318
               2000                                       3,846
               2001                                       8,502
        2002 and thereafter                                 407
      --------------------------------------------------------------

                                                        $70,860
      ==============================================================


Interest expense on deposits, in thousands, is summarized as follows:
<TABLE>
<CAPTION>
Year ended September 30,                                                             1997       1996         1995
-------------------------------------------------------------------------------------------------------------------

<S>                                                                                <C>          <C>       <C> 
NOW accounts                                                                       $  194       $  197       $185
Money market account                                                                  145          160        182
Savings account                                                                       445          458        517
Time deposits                                                                       3,518        3,313      2,678
-------------------------------------------------------------------------------------------------------------------

                                                                                   $4,302       $4,128     $3,562
===================================================================================================================
</TABLE>

                                                                              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:
<TABLE>
<CAPTION>
September 30,                                                                                       1997              1996
---------------------------------------------------------------------------------------------------------------------------

<S>                                                                                              <C>               <C>    
Within one year                                                                                  $ 6,000           $12,000
One to two years                                                                                   1,000               -
Two years or more                                                                                  8,000               -
---------------------------------------------------------------------------------------------------------------------------

                                                                                                 $15,000           $12,000
===========================================================================================================================
</TABLE>

The weighted  average  interest  rate on advances at September 30, 1997 and 1996
was 6.01% and 5.77%,  respectively.  These  advances are  collateralized  by the
Company's  investment  in FHLB stock and  qualifying  real estate  loans under a
blanket collateral agreement.

Information  related to borrowing activity from the Federal Home Loan Bank is as
follows:
<TABLE>
<CAPTION>
Year Ended September 30,                                                      1997                1996              1995
---------------------------------------------------------------------------------------------------------------------------

<S>                                                                          <C>                 <C>                <C>   
Maximum amount outstanding during the year                                   $16,000             $12,000            $6,000
---------------------------------------------------------------------------------------------------------------------------

Average amount outstanding during the year                                    12,249               6,333             2,817
---------------------------------------------------------------------------------------------------------------------------

Average interest rate during the year                                           6.07%               5.85%             6.15%
---------------------------------------------------------------------------------------------------------------------------
</TABLE>

36
<PAGE>
                                       Bedford Bancshares, Inc. and Subsidiaries

                                      Notes to Consolidated Financial Statements
                                                                     (continued)

================================================================================

7.    Fair Value of Financial Instruments

The estimated fair values of the Company's financial instruments,  in thousands,
are as follows:
<TABLE>
<CAPTION>
September 30,                                                             1997                             1996
---------------------------------------------------------------------------------------------------------------------------

                                                              Carrying            Fair         Carrying             Fair
                                                               Amount             Value         Amount              Value
---------------------------------------------------------------------------------------------------------------------------
<S>                                                          <C>              <C>               <C>               <C>     
Financial assets
  Cash and short-term investments                            $  5,446         $  5,446          $  3,075          $  3,075
  Securities                                                   13,860           13,845            11,435            11,382
  Loans, net of allowance for loan losses                     116,093          117,402           108,873           109,601

Financial liabilities
  Deposits                                                    103,612          103,937            95,378            95,388
  Advances from Federal Home Loan Bank                         15,000           15,000            12,000            12,000

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

Unrecognized financial instruments
  Commitments to extend credit                                  $7,020          $7,020            $4,187            $4,187

</TABLE>

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

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

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

Securities
----------

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

                                                                              37
<PAGE>
                                       Bedford Bancshares, Inc. and Subsidiaries

                                      Notes to Consolidated Financial Statements
                                                                     (continued)

================================================================================

7.    Fair Value of Financial Instruments (continued)

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

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

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

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

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

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

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

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

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

38
<PAGE>
                                       Bedford Bancshares, Inc. and Subsidiaries

                                      Notes to Consolidated Financial Statements
                                                                     (continued)

================================================================================

8. BIF/SAIF Premium Disparity Assessment

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

9.    Income Taxes

The provision for income taxes, in thousands, is summarized as follows:
<TABLE>
<CAPTION>
Year Ended September 30,                                                            1997             1996             1995
---------------------------------------------------------------------------------------------------------------------------
<S>                                                                                 <C>              <C>              <C> 
Current
  Federal                                                                           $517             $816             $656
  State                                                                              152               97               89
---------------------------------------------------------------------------------------------------------------------------
                                                                                     669              913              745
Deferred tax expense (benefit)                                                       305             (159)             116
---------------------------------------------------------------------------------------------------------------------------

Total provision for income taxes                                                    $974             $754             $861
===========================================================================================================================
</TABLE>


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

<TABLE>
<CAPTION>
                                                                                                   Percent of Pre-tax Income
Year Ended September 30,                                                            1997             1996             1995
---------------------------------------------------------------------------------------------------------------------------

<S>                                                                                 <C>              <C>              <C>  
Tax at statutory rate                                                               34.0%            34.0%            34.0%
Increases (decreases) in taxes resulting from:
  State income taxes, net of federal benefit                                         4.5              3.6              2.6
  Other                                                                              (.5)             (.9)             1.5
---------------------------------------------------------------------------------------------------------------------------

                                                                                    38.0%            36.7%            38.1%
==============================================================================================================================
</TABLE>
                                                                              39
<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:
<TABLE>
<CAPTION>
September 30,                                                                                       1997              1996
---------------------------------------------------------------------------------------------------------------------------

<S>                                                                                                 <C>               <C> 
Deferred tax asset
  Bad debts                                                                                         $ 91              $ 81
  Loan fees                                                                                            5                66
  Unrealized loss on securities, available for sale                                                   -                 61
  BIF/SAIF assessment                                                                                 -                211
  Other                                                                                               -                 21
---------------------------------------------------------------------------------------------------------------------------

Total deferred tax asset                                                                              96               440

Deferred tax liability
  Accelerated depreciation                                                                            (8)               (2)
  Unrealized gain on securities, available for sale                                                   (6)               -
  Other                                                                                              (24)               -
---------------------------------------------------------------------------------------------------------------------------

Net deferred tax asset                                                                              $ 58              $438
===========================================================================================================================
</TABLE>



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, 1997,
the  liquidation   account,   unadjusted  for  customer   withdrawals,   totaled
$6,144,000.

40
<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% for the years
ended September 30, 1997, 1996 and 1995, respectively. The total expense for the
plan was $60,000,  $54,000,  and $59,000 for the years ended September 30, 1997,
1996 and 1995, 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  25,333 and 17,333 shares of Common Stock as of September
30, 1997 and 1996, respectively. The Company recognized $196,000 and $135,000 of
compensation  cost for the years ended  September  30,  1997 and 1996.  The fair
value of unearned ESOP shares  totaled  $1,339,000 at September 30, 1997.  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.

                                                                              41
<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 1997 and 1996, 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, 1997 and 1996, the amount  included in compensation  expense
was $87,000 and $72,000,  respectively. The status of the shares in this plan is
summarized as follows:
<TABLE>
<CAPTION>
                                                                                 Weighted
                                                                                  Average
                                                                                   Share      Unawarded            Awarded
                                                                                   Price          Shares           Shares
---------------------------------------------------------------------------------------------------------------------------

<S>                                                                                 <C>             <C>            <C>   
Balance at September 30, 1995                                                       $11.00           9,197          41,058

Granted                                                                              16.75          (2,600)          2,600
Vested                                                                               11.34             -           (11,277)
---------------------------------------------------------------------------------------------------------------------------

Balance at September 30, 1996                                                        16.75           6,597          32,381

Granted                                                                              18.75          (2,500)          2,500
Vested                                                                               11.30             -            (9,668)
---------------------------------------------------------------------------------------------------------------------------

Balance at September 30, 1997                                                       $24.50           4,097          25,213
===========================================================================================================================
</TABLE>

42
<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>
                                                          Weighted
                                                           Average
                                                           Exercise         Available            Options     Vested and
                                                            Price         for Grant          Outstanding     Exercisable
---------------------------------------------------------------------------------------------------------------------------

<S>                                                          <C>               <C>                 <C>         <C>         
Balance at September 30, 1995                                $11.00            22,997              102,640             -

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

Balance at September 30, 1996                                 11.33            16,747               80,705          23,998
---------------------------------------------------------------------------------------------------------------------------

Granted                                                       18.75            (6,250)               6,250             -
Vested                                                        11.30               -                (24,171)         24,171
---------------------------------------------------------------------------------------------------------------------------

Balance at September 30, 1997                                $11.73            10,497               62,784          48,169
===========================================================================================================================
</TABLE>


The remaining  contractual  lives of the options  granted in 1997, 1996 and 1995
are 7.3 years, 8.3 years and 9.3 years,  respectively at September 30, 1997. The
weighted  average  remaining  contractual  life of total options is 7.5 years at
September 30, 1997.

                                                                              43
<PAGE>
                                       Bedford Bancshares, Inc. and Subsidiaries

                                      Notes to Consolidated Financial Statements
                                                                     (continued)

================================================================================

11.   Retirement Plans and Employee Benefit Programs (continued)

The Company applies APB Opinion 25 and related interpretations in accounting for
its  plan.   Accordingly,   no  compensation  cost  has  been  recognized.   Had
compensation  cost for the Company's stock option plan been determined  based on
the fair value at the grant date  consistent  with the methods of SFAS 123,  the
Company's net income and net income per share would have been reduced to the pro
forma amounts  indicated  below. In accordance with the transition  provision of
SFAS 123, the pro forma amounts reflect  options with grant dates  subsequent to
April 1, 1996.
<TABLE>
<CAPTION>
Year Ended March 31,                                                             1997                              1996
---------------------------------------------------------------------------------------------------------------------------
<S>                                                                            <C>                               <C>   
Net income
  As reported                                                                  $1,591                            $1,302
  Pro forma                                                                     1,310                             1,020

Net income per share
  As reported                                                                    1.47                              1.17
  Pro forma                                                                      1.21                               .92
</TABLE>

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

12.   Commitments and Contingencies

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

The current minimum annual rental  commitments  under  non-cancelable  operating
leases in effect at September 30, 1997 are as follows:

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

                1998                                     $ 7,200
                1999                                       7,200
                2000                                       7,200
                2001                                       6,600
      -------------------------------------------------------------

                                                         $28,200
      =============================================================

44
<PAGE>
                                       Bedford Bancshares, Inc. and Subsidiaries

                                      Notes to Consolidated Financial Statements
                                                                     (continued)

================================================================================

12.   Commitments and Contingencies (continued)

Rent  expense was  approximately  $7,400,  $6,100 and $4,400 for the years ended
September 30, 1997, 1996, and 1995 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, 1997 and 1996.  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,                                                                                       1997              1996
---------------------------------------------------------------------------------------------------------------------------
<S>                                                                                              <C>                <C>   
Financial instruments, in thousands, whose contract amounts represent credit risk
    Unfunded commercial credit line                                                              $    66            $  362
    Unfunded home equity lines of credit                                                           4,071             2,027
    Commitments to finance real estate acquisitions and construction                               2,883             1,798
---------------------------------------------------------------------------------------------------------------------------

                                                                                                  $7,020            $4,187
===========================================================================================================================
</TABLE>



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

                                                                              45
<PAGE>
                                       Bedford Bancshares, Inc. and Subsidiaries

                                      Notes to Consolidated Financial Statements
                                                                     (continued)

================================================================================

13.   Concentrations of Credit Risk

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

14.   Related Party Transactions

The  Company  has made  loans in the  ordinary  course of  business  to  various
officers and directors  generally  collateralized  by the individual's  personal
residences or by savings  accounts in the Savings Bank.  These loans are made on
substantially  the same  terms as those  prevailing  at the time for  comparable
transactions  with other borrowers.  The aggregate  balances of such loans which
exceed  $60,000 in  aggregate  outstanding  amount to any  executive  officer or
director,  at September  30,  1997,  1996 and 1995 are  approximately  $819,000,
$641,000 and $457,000, respectively.

46
<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, 1997 and 1996, 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, 1997
                                           --------------------------------------------------------------------------------
                                             GAAP            Tangible                  Core                 Risk-Based
                                            Capital           Capital                 Capital                 Capital
---------------------------------------------------------------------------------------------------------------------------

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

GAAP capital before adjustments              $17,313
Adjustments
  Other                                          (12)
                                              ------
GAAP capital as adjusted                     $17,301        $17,301                 $17,301                $17,301
                                             =======

General credit loss allowance                                   -                       -                      678
Land loans greater than 80%                                     -                       -                      (92)
                                                           --------                --------                 -------

Regulatory capital computed                                  17,301   12.4           17,301   12.4          17,887    22.7
Minimum capital requirement                                   2,094    1.5            4,187    3.0           6,296     8.0
                                                             ------   ----           ------   ----          ------    ----

Regulatory capital excess                                   $15,207   10.9%         $13,114    9.4%        $11,591    14.7%
                                                            =======   ====          =======    ===         =======    ====
</TABLE>

<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>

                                                                              47
<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)
<TABLE>
<CAPTION>
September 30,                                                                                        1997             1996
---------------------------------------------------------------------------------------------------------------------------

<S>                                                                                              <C>              <C>     
Assets
  Cash and cash equivalents                                                                      $    715         $    149
  Securities                                                                                          114               42
  Investment in Savings Bank subsidiary                                                            17,300           15,855
  Loan to Savings Bank subsidiary                                                                   2,000            3,000
  Other assets                                                                                        162               83
---------------------------------------------------------------------------------------------------------------------------

Total assets                                                                                      $20,291          $19,129
===========================================================================================================================

Liabilities and stockholders' equity
  Other liabilities                                                                              $    524         $    747
  Dividends payable                                                                                   160              126
  Stockholders' equity                                                                             19,607           18,256
---------------------------------------------------------------------------------------------------------------------------

Total liabilities and stockholders' equity                                                        $20,291          $19,129
===========================================================================================================================
</TABLE>

48
<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,                                                           1997              1996             1995
---------------------------------------------------------------------------------------------------------------------------
<S>                                                                              <C>               <C>              <C>   
Income
  Interest from
    Savings Bank's ESOP loan                                                     $   40            $   44           $   51
    Loan to Savings Bank subsidiary                                                 218               292              416
    Other                                                                            41                23               -
---------------------------------------------------------------------------------------------------------------------------

Total income                                                                        299               359              467
---------------------------------------------------------------------------------------------------------------------------

Expenses
  Professional fees                                                                  42                44               66
  Other operating expenses                                                           36                40               33
---------------------------------------------------------------------------------------------------------------------------

Total expenses                                                                       78                84               99
---------------------------------------------------------------------------------------------------------------------------

Net income before income taxes and equity in
  undistributed net income of Savings Bank subsidiary                               221               275              368

Provision for income taxes                                                           84               104              140
Equity in undistributed net income of Savings Bank subsidiary                     1,454             1,131            1,173
---------------------------------------------------------------------------------------------------------------------------

Net income                                                                       $1,591            $1,302           $1,401
===========================================================================================================================
</TABLE>

                                                                              49
<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,                                                           1997              1996             1995
---------------------------------------------------------------------------------------------------------------------------
<S>                                                                              <C>               <C>              <C>   
Operating activities
  Net income                                                                     $1,591            $1,302           $1,401
  Adjustments
    Equity in undistributed net income of Savings Bank subsidiary                (1,454)           (1,131)          (1,173)
    (Increase) decrease in other assets                                             (79)               (3)              37
    Increase (decrease) in other liabilities                                        189              (130)             102
---------------------------------------------------------------------------------------------------------------------------

Net cash provided by operating activities                                           247                38              367
---------------------------------------------------------------------------------------------------------------------------

Investing activities
  Loans originated, net of principal repayments                                   1,080             1,080            1,093
  Purchase of Savings Bank subsidiary stock                                         -                 -                -
  Purchase of investment securities                                                 (72)              -                (48)
---------------------------------------------------------------------------------------------------------------------------

Net cash provided by investing activities                                         1,008             1,080            1,045
---------------------------------------------------------------------------------------------------------------------------

Financing activities
  Proceeds from sale of stock                                                       -                 -                -
  Purchase of stock, by RRP                                                         (23)              -                -
  Dividends paid                                                                   (571)             (518)            (183)
  Repurchase of stock                                                               -              (1,115)            (885)
  RRP vesting                                                                       (95)              (42)             -
  ESOP note payment                                                                 -                 135              -
  Exercise of option                                                                -                  45              -
---------------------------------------------------------------------------------------------------------------------------

Net cash absorbed by financing activities                                          (689)           (1,495)          (1,068)
---------------------------------------------------------------------------------------------------------------------------

Increase (decrease) in cash and cash equivalents                                    566              (377)             344

Cash and cash equivalents, beginning of year                                        149               526              182
---------------------------------------------------------------------------------------------------------------------------

Cash and cash equivalents, end of year                                           $  715            $  149           $  526
===========================================================================================================================
</TABLE>

50
<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:
<TABLE>
<CAPTION>
                                                                 First            Second           Third          Fourth
Year Ended September 30, 1997                                   Quarter           Quarter         Quarter         Quarter
---------------------------------------------------------------------------------------------------------------------------

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

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

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

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

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

Net income                                                       $  357           $  414          $  407          $  413
===========================================================================================================================

Net income per share                                               $.33             $.38            $.38            $.38
===========================================================================================================================

Cash dividends declared per share                                  $.12             $.13            $.14            $.14
===========================================================================================================================
</TABLE>

                                                                              51
<PAGE>
                                       Bedford Bancshares, Inc. and Subsidiaries

                                      Notes to Consolidated Financial Statements
                                                                     (continued)

================================================================================

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

<TABLE>
<CAPTION>
                                                                 First            Second           Third          Fourth
Year Ended September 30, 1996                                   Quarter           Quarter         Quarter         Quarter
---------------------------------------------------------------------------------------------------------------------------

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

Other 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
===========================================================================================================================
</TABLE>

52
<PAGE>
                                OFFICE LOCATIONS

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

                  BRANCH OFFICE - 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                                          Vice President, Treasurer and
and Chief Executive Officer                              Chief Financial Officer

Russell E. Millner                                               Nancy T. Snyder
Vice President                                                         Secretary

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

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

Special Counsel                                     Transfer Agent and Registrar
Malizia, Spidi, Sloane & Fisch, P.C.                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, 1997,
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 28, 1998 at
2:00 p.m. at the Olde Liberty Station, 515 Bedford Avenue, Bedford, Virginia.


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