EXHIBIT 13

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

                    The  Company's  common stock  trades on the Nasdaq  National
Stock Market        market under the trading  symbol of "BFSB".  The daily stock
Information         quotation for Bedford Bancshares,  Inc., is published in The
                    Wall Street Journal and in other local  newspapers under the
                    trading  symbol of "BFSB" or  as "BedfordBc". The  following
                    table  reflects  stock  prices as  published  in the  Nasdaq
                    National Market statistical report, and other related data.
-------------------

                                                  Dividends      Dividends
                                                  Per Share      Per Share
Quarter Ended       High        Low     Volume    Declared         Paid
-------------       ----        ---     ------    --------         ----
December 1995       $ 9.38    $ 8.75    186,752   $0.045         $0.075
March 1996          $ 9.13    $ 8.38    241,940   $0.045         $0.045
June 1996           $ 8.88    $ 7.88    378,812   $0.050         $0.045
September 1996      $ 8.63    $ 8.25    171,182   $0.055         $0.050
December 1996       $ 9.25    $ 8.32    192,478   $0.060         $0.055
March, 1997         $10.00    $ 8.75    163,568   $0.065         $0.060
June 1997           $12.38    $ 9.50    319,064   $0.070         $0.065
September 1997      $12.75    $11.75    186,580   $0.070         $0.070
December 1997       $17.50    $11.50    337,000   $0.070         $0.070
March 1998          $17.38    $14.00    365,200   $0.070         $0.070
June 1998           $16.25    $13.88    198,600   $0.080         $0.070
September 1998      $15.75    $10.25    186,300   $0.080         $0.080
December 1998       $15.00    $10.50    184,500   $0.080         $0.080
March 1999          $13.75    $11.50    109,700   $0.080         $0.080
June 1999           $13.75    $11.50    166,200   $0.090         $0.080
September 1999      $14.50    $12.25    220,800   $0.090         $0.090

                    On  September  30,  1999,  there  were   approximately   562
                    shareholders  of  record  with  approximately  59.1%  of the
                    2,173,050  outstanding  shares  held in nominee  or "street"
                    name   through   various   brokerage   firms.   There   were
                    approximately  eight firms making a market in the  Company's
                    common stock during the month of September 1999.

2
<PAGE>


<TABLE>
<CAPTION>
SELECTED FINANCIAL AND OTHER DATA
-----------------------------------------------------------------------------------------------------
<S>                                           <C>        <C>        <C>        <C>        <C>
Financial Condition (Dollars in Thousands)
------------------------------------------
       ----------------------------------------------------------------------------------------------
       September 30,                               1999       1998       1997       1996       1995
       ----------------------------------------------------------------------------------------------
       Total assets                            $165,737   $158,711   $139,089   $127,201   $115,054
       Loans receivable, net                    147,689    129,744    116,093    108,873     97,669
       Investment securities                      8,129     14,470      9,655      8,006      7,761
       Marketable equity securities               4,575      4,396      4,185      3,879      3,660
       Mortgage-backed securities                    10         15         20        482         31
       Foreclosed real estate, net                 --         --          212       --         --
       Deposits                                 114,720    107,086    103,612     95,378     90,063
       FHLB advances                             28,000     29,000     15,000     12,000      5,000
       Retained earnings                         11,223     10,900      9,763      8,739      8,263
       Total stockholders' equity                21,066     21,248     19,621     18,227     18,685

Summary of Operations (Dollars in Thousands)
--------------------------------------------
       ----------------------------------------------------------------------------------------------
       Years Ended September 30,                   1999       1998       1997       1996       1995
       ----------------------------------------------------------------------------------------------
       Interest income                          $11,894    $11,299    $10,280     $9,264     $8,137
       Interest expense                           6,031      5,809      5,167      4,492      3,778
       Net interest income                        5,863      5,490      5,113      4,772      4,359
       Provision for credit losses                   90         90        100         22         20
       Noninterest income                         1,069        863        593        735        543
       Noninterest expense                        3,328      3,130      3,041      3,429      2,620
       Net income before income taxes             3,514      3,133      2,565      2,056      2,262
       Net income                                 2,191      1,973      1,591      1,302      1,401

Other Selected Data
-------------------
       ----------------------------------------------------------------------------------------------
       Years Ended September 30,                   1999       1998       1997       1996       1995
       ----------------------------------------------------------------------------------------------
       Return on average assets                    1.35%      1.33%      1.19%      1.10%      1.28%
       Return on average equity                   10.13       9.68       8.40       6.98       7.31
       Average equity to average assets           13.72      13.72      14.21      15.69      17.49
       Net interest rate spread                    2.96       3.03       3.27       3.34       3.26
       Nonperforming assets to total assets        0.66       0.34       0.52       0.54       1.14
       Nonperforming loans to total loans          0.74       0.41       0.45       0.63       1.34
       Allowance for credit losses to total loans  0.54       0.59       0.58       0.60       0.63

Per Share Data
--------------
       ----------------------------------------------------------------------------------------------
       Years Ended September 30,                   1999       1998       1997       1996       1995
       ----------------------------------------------------------------------------------------------
       Basic earnings per share                   $1.01      $0.90      $0.74      $0.59       0.60
       Diluted earnings per share                  0.96       0.85       0.70       0.56       0.59
       Book value per share                        9.69       9.25       8.58       7.97       7.75
       Cash dividends declared per share           0.34       0.30       0.27       0.20       0.15

</TABLE>

4

<PAGE>

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


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

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

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

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


--------------------------------------------------------------------------------
General
-------

Net interest  income is the primary source of our earnings.  Net interest income
is affected by the levels of average earning assets and average interest bearing
liabilities,  and the respective  interest rates earned and paid. The difference
between average rates of interest earned on interest  earning assets and average
rates paid on interest  bearing  liabilities  is the "interest rate spread." Our
"net  interest  margin," is defined as our net  interest  income  divided by our
average earning assets,  which serves as an indication of the  effectiveness  of
funds allocation and the management of our interest rate risk.

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

The  Private  Securities  Litigation  Reform Act of 1995  contains  safe  harbor
provisions regarding forward-looking  statements.  When used in this discussion,
the words  "believes",  "anticipates",  "contemplates",  "expects",  and similar
expressions are intended to identify forward-looking statements. Such statements
are subject to certain risks and uncertainties  which could cause actual results
to differ materially from those projected. Those risks and uncertainties include
changes in interest rates, risk associated with the ability to control costs and
expenses,  year 2000 issues and general  economic  conditions.  We  undertake no
obligation   to  publicly   release  the  results  of  any  revisions  to  those
forward-looking  statements which may be made to reflect events or circumstances
after the date hereof or to reflect the occurrence of unanticipated events.


--------------------------------------------------------------------------------
Interest Rate Sensitivity Analysis
----------------------------------

The table that  follows  sets forth the amounts of interest  earning  assets and
interest  bearing  liabilities  outstanding  at September  30,  1999,  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 presented in 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, 1999
------------------------------------------------------------------------------------------------------------------------
                                                       More than  More than  More than  More than
                                               Three    3 months  6 months    1 year    3 years
                                               months      to        to         to         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)                         $14,737    $8,948    $49,756   $32,365    $16,688     $11,554   $134,048
  Other loans(1)                                 5,908       869      1,586     4,686      3,764         830     17,643
  Marketable equity securities(3)                4,628         -          -         -          -           -      4,628
  Federal funds sold and other
    short-term investments                           -         -          -         -          -           -          -
  Investment securities                              -         -        300       985      1,469       3,876      6,630
  Mortgage-backed securities(2)                      -         -          -        10          -           -         10
  FHLB stock                                     1,500         -          -         -          -           -      1,500
                                                ------     -----     ------    ------     ------      ------    -------
    Total interest-earning assets               26,773     9,817     51,642    38,046     21,921      16,260    164,459
Less:
Loans in process                                 2,833     2,834      1,889         -          -           -      7,556
Unearned discount and deferred fees(2)              23        17        164        35         33           -        272
Allowance for credit losses                        109        52        272       196        108          67        804
                                                ------     -----     ------    ------     ------      ------    -------
    Net interest-earning assets                 23,808     6,914     49,317    37,815     21,780      16,193    155,827
                                                ------     -----     ------    ------     ------      ------    -------
Interest-bearing liabilities:
  Money market deposits                          2,339     1,584      1,798       797        379         345      7,242
  Passbook deposits                                725       692      1,291     4,112      2,681       6,425     15,926
  NOW and other demand deposits                  2,208     1,828      3,082     6,407      1,756       4,013     19,294
  Certificate accounts                          10,439         -     30,765    29,918      1,845           -     72,967
  Borrowed funds                                12,000         -          -     6,000     10,000           -     28,000
                                                ------     -----     ------    ------     ------      ------    -------
    Total interest-bearing liabilities          27,711     4,104     36,936    47,234     16,661      10,783    143,429
                                                ------     -----     ------    ------     ------      ------    -------
Interest sensitivity gap(4)                    ($3,903)   $2,810    $12,381   ($9,419)    $5,119      $5,410    $12,398
                                               =======   =======    =======    ======     ======     =======    =======
Cumulative interest sensitivity gap            ($3,903)  ($1,093)   $11,288    $1,869     $6,988     $12,398
                                               =======   =======    =======    ======     ======     =======

Cumulative interest sensitivity gap
  as a percent of total assets                   -2.35%    -0.66%      6.81%     1.13%      4.22%       7.48%
Cumulative net interest-bearing
  assets as a percent of
  interest-bearing liabilities                   85.92%    96.56%    116.42%   101.61%    105.27%     108.64%

</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 our average
balance sheet and reflects the interest earned on assets and interest expense of
liabilities  for the periods  indicated and the average  yields earned and rates
paid.  Such yields and costs are  derived by  dividing  income or expense by the
average  balance  of  assets  or  liabilities,  respectively,  for  the  periods
presented. Average balances are derived from daily balances.
<TABLE>
<CAPTION>

                                                                Year Ended September 30,
                                       ---------------------------------------------------------------
                                                   1999                         1998
                                       -----------------------------  --------------------------------
                                         Average             Yield/    Average               Yield/
                                         Balance   Interest   Cost     Balance    Interest     Cost
                                         -------   --------   ----     -------    --------   ------
                                        (Dollars in Thousands)       (Dollars in Thousands)
<S>                                 <C>          <C>      <C>      <C>          <C>        <C>
Assets:
  Interest-earning assets:
    Mortgage loans(1)                   $113,255    $8,386   7.40%    $103,502     $8,044     7.77%
    Other loans(1)                        23,379     2,161   9.25       19,188      1,861     9.70
    Interest-earning deposits(2)           4,605       241   5.24        4,239        242     5.72
    Federal funds sold and other
      short-term investments               2,304       148   6.44        3,785        280     7.41
    Investment securities                 12,391       844   6.81       12,454        782     6.28
    FHLB stock                             1,523       114   7.48        1,264         90     7.11
                                         -------    ------             -------     ------
      Total interest-earning assets      157,457    11,894   7.52      144,432     11,299     7.82
                                                    ------                         ------
Noninterest-earning assets                 4,848                         4,041
                                        --------                      --------
      Total assets                      $162,305                      $148,473
                                        ========                      ========

Liabilities and equity:
  Interest-bearing liabilities:
    Money market deposits                 $5,769       209   3.62%      $4,378        149     3.40%
    Passbook deposits                     16,230       407   2.51       15,217        454     2.98
    NOW and other demand deposits          9,987       137   1.37        8,908        182     2.04
    Certificate accounts                  71,435     3,694   5.17       70,337      3,779     5.37
                                          ------     -----              ------      -----
  Total deposit accounts                 103,421     4,447   4.30       98,840      4,564     4.62
    Borrowed funds                        28,484     1,584   5.50       22,487      1,245     5.54
                                          ------     -----            --------      -----
      Total interest-bearing liabilities 131,905     6,031   4.56      121,327      5,809     4.79
                                                     -----                          -----
Noninterest-bearing liabilities            8,774                         6,769
Equity                                    21,626                        20,377
                                        --------                      --------
      Total liabilities and equity      $162,305                      $148,473
                                        ========                      ========
Net interest income                                 $5,863                         $5,490
                                                    ======                         ======
Interest rate spread(3)                                      2.96%                            3.03%
Net interest margin(4)                                       3.73%                            3.80%
Interest-earning asset to
  interest-bearing liabilities           119.37%                       119.04%
                                         ======                        ======
</TABLE>

     ------------------
(1)  Amount is net of  deferred  loan fees and  discounts,  loans in process and
     includes accrued interest.
(2)  Includes assets held for sale.
(3)  Net interest rate spread  represents  the  difference  between the yield on
     average  interest-earning  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 our
interest  income and  expense for the periods  indicated.  For each  category of
interest-earning  assets  and  interest-bearing   liabilities,   information  is
provided on changes due to (1) changes in volume (change in average volume times
the old  rate);  (2)  changes  in rate  (change  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,
                                             ----------------------------------------------
                                                  1999 vs. 1998       1998 vs. 1997
                                             ----------------------   ---------------------
                                             Volume    Rate     Net   Volume   Rate    Net
                                             ------    ----     ---   ------   ----    ---
                                                         (Dollars in Thousands)
 <S>                                       <C>     <C>      <C>      <C>     <C>    <C>
   Interest-earning assets:
      Mortgage loans                           $758   ($416)   $342     $383  ($155)  $228
      Other loans                               406    (106)    300      466    (86)   380
      Interest-earning deposits                  21     (22)     (1)      15     10     25
      Federal funds sold and other short-term
        investments                            (110)    (22)   (132)     247    (86)   161
      Investment securities, net                 (4)     66      62      345   (113)   232
      FHLB stock                                 18       6      24       23     (1)    22
                                              -----    -----    ---    -----   ----- -----
        Total interest-earning assets         1,089    (494)    595    1,479   (431) 1,048
                                              -----    -----    ---    -----   ----- -----

    Interest-bearing liabilities:
      Money market deposits                      47      13      60       (7)    13      6
      Passbook deposits                          30     (77)    (47)      17     (9)     8
      NOW and other demand deposits              22     (67)    (45)      17    (31)   (14)
      Certificate accounts                       59    (144)    (85)     241     21    262
      Borrowed funds                            332       7     339      500   (120)   380
                                               ----   ------   ----     ----  ------  ----
        Total interest-bearing liabilities      490    (268)    222      768   (126)   642
                                               ----   ------   ----     ----  ------  ----
    Net change in net interest income          $599   ($226)   $373     $711  ($305)  $406
                                               ====   =====    ====     ====  =====   ====
</TABLE>


Comparison of Financial  Condition for Fiscal Years Ended
September 30, 1999 and 1998
--------------------------------------------------------------------------------
The  Company's  total  assets were $165.7  million at  September  30,  1999,  an
increase of $7.0 million or 4.43%,  from $158.7  million at September  30, 1998.
The asset growth was primarily due to growth of net loans receivable.

Net loans  receivable  increased  $17.9 million,  or 13.8%, to $147.7 million at
September 30, 1999 from $129.8 million at September 30, 1998.  The  continuation
of new home construction within the markets Bedford Federal serves combined with
growth of both  commercial  and consumer loans during fiscal 1999 were the major
factors  in the  expansion  of loans.  This  increase  was funded  primarily  by
principal  repayments of the loan portfolio,  increased deposits,  maturities of
investment  securities  available for sale and a reduction in our cash position.
Because lending is directly affected by interest rates, a rise in interest rates
could cause a slow down in new loan originations.

Investment  securities  held to maturity  decreased $1.3 million,  or 61.7%,  to
$810,000  at  September  30,  1999 from $2.1  million  at  September  30,  1998.
Investment  securities  available for sale decreased $6.4 million,  or 37.8%, to
$10.5  million at September  30, 1999 from $16.8  million at September 30, 1998.
The decrease in both of these portfolios were the result of maturing investments
and were primarily used to supplement the growth of the loan portfolio.




                                                                               9


<PAGE>

Deposits  increased  $7.6 million to $114.7  million at September  30, 1999 from
$107.1  million at September 30, 1998.  The increase was primarily the result of
special  certificate nof deposit  promotions  during fiscal 1999, as well as the
closing of branches by our competitors which resulted in new deposit inflows.

Total stockholders'  equity was $21.1 million on September 30, 1999,  relatively
unchanged  from the $21.2 million at September 30, 1998.  During fiscal 1999. we
repurchased 132,200 shares of its common stock in open market transactions at an
average price of $13.36 per share. The aggregate price of the repurchased shares
was $1.8 million which offset the amount of retained income.

Comparison  of  Operating  Results for Years Ended  September  30, 1999 and 1998
--------------------------------------------------------------------------------
Net  Income.  Net  income  increased  $218,000,   to  $2.2  million  for  fiscal
Net9incomefincreased8$218,000, toc$2.2emillion for fiscal 1999 from fiscal 1998.
A  6.8%  increase  in  net  interest  income,  combined  with a  23.9%  rise  in
noninterest income, accounted for the improvement in profitability.

Interest   Income.   Interest  income  totaled  $11.9  million  for  the  fiscal
yeaInterestSincomeetotaled9$11.9 millioncforsthe fiscal year ended September 30,
1999, a 5.3%  increase  from the $11.3  million  recorded  for fiscal 1998.  The
$595,000  expansion  of  interest  income is due to the 9.0%  growth of  average
earning  assets,  including  average loan growth of 10.7%,  offset by a 30 basis
point decline in the rate earned on average earning assets.

Interest Expense.  Intereeest  expense increased  $222,000 from $5.8 million for
the year ended September 30, 1998, to $6.0 Interest expense  increased  $222,000
from $5.8 million for the year ended  September 30, 1998 to $6.0 million for the
fiscal year ended  September  30,  1999.  The level of average  interest-bearing
liabilities  rose 8.7% to $131.9  million for fiscal 1999 from $121.3 for fiscal
1998.  Offsetting  this  increase  was a 23 basis  point  decline in the cost of
interest- bearing liabilities in fiscal 1999 compared to fiscal 1998.

Net Interest Income.  Net interst income totaled $5.9 million for the year ended
September  30, 1999, up 6.8% from Net interest  income  totaled $5.9 million for
the year ended  September  30, 1999,  up 6.8% from the $5.5 million  realized in
fiscal  1998.  The  increase is  primarily  due to the higher  volume of average
earning  assets,  primarily  loans,  and to an  improved  mix  within  the  loan
portfolio. Restraining the expansion of net interest income was a 30 basis point
decline in the yield on earning assets.

Provision  for Loan  Losses.  The  provision  for loan losses for the year ended
September 30, 1999 was $90,000, The provision for loan losses for the year ended
September 30, 1999 was $90,000, unchanged from the provisions recorded in fiscal
1998. At September 30, 1999, the allowance for loan losses was $804,000 equal to
 .54% of loans receivable, net, and 73.9% of non-performing loans. Based upon the
quality of the Bank's loan portfolio,  the relatively stable local economy,  and
favorable  interest rate environment,  management  believes the 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, 1999,  noninterest income
amounted to $1.1 million, an For the year ended September 30, 1999,  noninterest
income  amounted to $1.1  million,  an increase  of $206,000  from the  $863,000
earned in fiscal 1998. Service charges and fees on loans were up $189,000 due to
an increase  in both the number and dollar  volume of loan  originations.  Other
customer  service fees and commissions  reflected an increase of $16,000,  while
gains on the sales of loans,  investments  and  foreclosed  real  estate were up
$20,000.

Noninterest Expense. Noninterest expense totaled $3.3 million for the year ended
September 30, 1999, compared to Noninterest expense totaled $3.3 million for the
year ended  September  30, 1999  compared to $3.1 million for fiscal  1998.  The
increase  was  primarily  due to an 8.6%  rise in the cost of  compensation  and
employee  benefits and a 12.1% increase in data processing  expense.  The higher
1999 expense for compensation  and employee  benefits was primarily due to merit
increases and additional staffing, while the increase in data processing expense
was due to a pricing increase.



10
<PAGE>



Income Taxes. The provision for income taxes increased $163,000, to $1.3 million
in fiscal  1999 from $1.2  million in fiscal  The  provision  for  income  taxes
increased  $163,000 to $1.3  million in fiscal 1999 from $1.2  million in fiscal
1998 due to the increased level of taxable income.

Liquidity and Capital Resources
--------------------------------------------------------------------------------
Our  liquidity  is  a  measure  of  our  ability  to  fund  loans,  pay  deposit
withdrawals, and other cash outflows in an efficient, cost effective manner. Our
primary sources of funds are deposits and scheduled  amortization and prepayment
of loans.  During the past several years,  we have used such funds  primarily to
fund maturing time deposits, pay savings withdrawals,  fund lending commitments,
purchase new investments,  and increase liquidity. We also borrow funds from the
Federal  Home Loan Bank  ("FHLB") of Atlanta.  As of September  30,  1999,  such
borrowed funds totaled $28.0 million. Loan payments and maturing investments are
greatly   influenced  by  general  interest  rates,   economic   conditions  and
competition.

We are required under Federal  regulations to maintain certain  specified levels
of "liquid assets," which include certain United States  government  obligations
and other approved investments. Current regulations require that our subsidiary,
Bedford Federal Savings Bank ("Bedford  Savings")  maintain liquid assets of not
less  than  4% of net  withdrawable  accounts  plus  short-term  borrowings.  At
September 30, 1999, Bedford Savings' regulatory liquidity was 8.5%.

The amount of certificate accounts which are scheduled to mature within one year
is approximately  $41.0 million. We believe that we can replace these funds with
other deposits,  excess liquidity,  FHLB advances,  or other borrowings if these
deposits do not remain with us. It has been our  experience  that a  substantial
portion of such maturing deposits remain with us. In addition,  at September 30,
1999, we had  commitments  to fund loans of $12.9  million,  and $7.6 million of
loans in process.

Net cash provided by operating  activities  for fiscal 1999 totaled $3.1 million
which was primarily due to net income of $2.2 million.

Net cash absorbed by investing activities for fiscal 1999 totaled $10.6 million,
a  decrease  from  fiscal  1998 of $8.7  million.  The  decrease  was  primarily
attributable  to a $9.6 million  increase in cash  proceeds  from  maturities of
investments  and a $3.9 million  decrease in  purchases  of  available  for sale
securities, offset by a $18.0 million increase in net loans to customers.

Net cash provided by financing  activities for the year ended September 30, 1999
totaled  $4.6  million.  This is a result of a net  increase in deposits of $7.6
million,  which was  partially  offset by a decrease  in FHLB  advances  of $1.0
million,  stock  repurchases of $1.8 million and dividend  payments of $774,000.
The  increase  in  deposits  was used  primarily  to fund the  increase  in loan
originations.

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

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





                                                                              11
<PAGE>


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

During fiscal 1998, we established a Y2K Committee (the "Committee") and adopted
a Y2K Compliance Plan (the "Plan"). The purpose of the Committee and Plan was to
identify  the systems  that could be affected by the Y2K issues and to determine
the activity  required to prepare for the proper  recognition  and processing of
date sensitive  information  on or after January 1, 2000. The Federal  Financial
Institutions  Examination  Council  required  that the plan include five phases:
Awareness,  Assessment,   Renovation,   Validation  and  Implementation.  As  of
September 30, 1999, we have completed all five phases of testing.

We currently  estimate that our total cost for the Y2K issue will be $125,000 to
$150,000.  Through  September  30,  1999,  we have  incurred  charges of $66,000
related  to Y2K  issues,  including  $28,000  during  the year  ended  September
30,1999.   These  charges   include  costs  necessary  to  modify  our  computer
information  systems,  both  internal and vendor  maintained,  to enable  proper
processing of transactions  relative to the year 2000 and beyond,  Additionally,
we have  incurred  costs in  connection  with training of employees and customer
communications   necessary  to  adequately  explain  our  Y2K  requirements  and
readiness.  During the third  quarter of fiscal  1999,  we ordered two  electric
generators to be used in the event of an electrical disruption. These generators
were  delivered  in  October  of  1999.   The  cost  of  these   generators  was
approximately $31,000.

A Contingency  and Business  Resumption  Plan was approved by the Board in July,
1999. This plan addresses perceived risks associated with the year 2000 problem.
These activities  include  contingency  planning  intended to mitigate any risks
associated with unforeseen  system glitches,  system failure,  increased demands
for cash,  or processes  outside of our control.  The  remainder of 1999 will be
used to further validate the plan.

We  continue  to focus on the  awareness  phase with its  efforts  on  providing
customers,  our  shareholders  and employees with up-to-date  information on our
state of  preparedness  for the year 2000.  For the  remainder of 1999,  we will
focus on employee training to insure continued,  uninterrupted  customer service
in the new year.

Despite  our best  efforts to address  this  issue,  the vast number of external
entities that have direct and indirect business  relationships  with us, such as
customers,  vendors,  payment systems providers,  utility  companies,  and other
financial institutions,  makes it impossible to assure that a failure to achieve
compliance by one or more of these entities would not have a material  impact on
our financial statements. Additionally, Y2K issues could effect our liquidity if
customer  withdrawals in anticipation of the year 2000 are greater than expected
or if lenders are unable to provide us with funds when needed.












12

<PAGE>

                            Bedford Bancshares, Inc.
                                and Subsidiaries

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

                        Consolidated Financial Statements

                      As of September 30, 1999 and 1998 and
              For the Years Ended September 30, 1999, 1998 and 1997

                    Bedford Bancshares Inc. and Subsidiaries


                                                                              13
<PAGE>
[LOGO]              BDO Seidman, LLP              300 Arboretum Place, Suite 520
                    Accountants and Consultants   Richmond, Virginia 23236
                                                  Telephone (804) 330-3092
                                                  FAX (804) 330-7753


Report of Independent Certified Public Accountants



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

We have audited the consolidated balance sheets of Bedford Bancshares,  Inc. and
subsidiaries  (the "Company") as of September 30, 1999 and 1998, and the related
consolidated statements of operations,  stockholders' equity, and cash flows for
each of the three years ended September 30, 1999. These financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audit.

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

In our opinion, the consolidated  financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Bedford
Bancshares,  Inc. and  subsidiaries  as of September 30, 1999 and 1998,  and the
results of their  operations  and their  cash flows for each of the three  years
ended  September  30, 1999 in  conformity  with  generally  accepted  accounting
principles.



                                             /s/ BDO Seidman, LLP



October 28, 1999

                                                                              15
<PAGE>

                                                        Bedford Bancshares, Inc.
                                                                and Subsidiaries

                                                     Consolidated Balance Sheets
                                                                  (in thousands)


=========================================================================
September 30,                                     1999           1998
-------------------------------------------------------------------------

     Assets

Cash (including interest bearing deposits of
   approximately $3,650 - 1998)               $  2,744       $  5,666
Securities (Note 1)
   Held-to-maturity                                810          2,114
   Available for sale                           10,458         16,820
Investment in Federal Home Loan Bank stock,
   at cost (Note 6)                              1,500          1,550
Loans receivable, net (Notes 2, 6 and 14)      147,689        129,744
Property and equipment, net (Note 4)             1,105          1,160
Accrued interest receivable                        924            996
Deferred income taxes (Note 8)                     225             95
Other assets                                       282            566
-------------------------------------------------------------------------

Total assets                                  $165,737       $158,711
=========================================================================


16
<PAGE>
                                                        Bedford Bancshares, Inc.
                                                                and Subsidiaries

                                                     Consolidated Balance Sheets
                                                                  (in thousands)

================================================================================
September 30,                                                 1999        1998
--------------------------------------------------------------------------------

     Liabilities and Stockholders' Equity

Liabilities
   Deposits (Note 5)                                      $114,720    $107,086
   Advances from Federal Home Loan Bank (Note 6)            28,000      29,000
   Advances from borrowers for taxes and insurance             605         528
   Dividends payable                                           196         184
   Other liabilities                                         1,150         665
--------------------------------------------------------------------------------

Total liabilities                                          144,671     137,463
--------------------------------------------------------------------------------

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

Stockholders' equity
   Preferred stock, par value $.10, authorized 250,000
     shares, none outstanding                                    -           -
   Common stock, par value $.10, authorized 2,750,000
     shares, 2,173,050 and 2,297,900 shares,
     issued and outstanding                                    217         230
   Additional paid-in capital                               10,497      10,939
   Retained earnings, substantially restricted (Note 10)    11,223      10,900
   Accumulated other comprehensive (loss) income              (151)         60
   Stock required by ESOP and RRP (Note 11)                   (720)       (881)
--------------------------------------------------------------------------------

Total stockholders' equity                                  21,066      21,248
--------------------------------------------------------------------------------

Total liabilities and stockholders' equity                $165,737    $158,711
================================================================================
                                 See accompanying summary of accounting policies
                                 and notes to consolidated financial statements.

                                                                              17
<PAGE>

                                                        Bedford Bancshares, Inc.
                                                                and Subsidiaries

                                           Consolidated Statements of Operations
                                                                  (in thousands)

<TABLE>
<CAPTION>
=========================================================================================
Year Ended September 30,                                     1999      1998       1997
-----------------------------------------------------------------------------------------

Interest income
<S>                                                      <C>       <C>        <C>
   Loans                                                  $10,547   $ 9,905    $ 9,297
   U.S. government obligations, including agencies          1,141     1,055        796
   Other investments                                          206       339        187
-----------------------------------------------------------------------------------------

Total interest income                                      11,894    11,299     10,280
-----------------------------------------------------------------------------------------

Interest expense
   Deposits (Note 5)                                        4,447     4,564      4,302
   Borrowed money                                           1,584     1,245        865
-----------------------------------------------------------------------------------------

Total interest expense                                      6,031     5,809      5,167
-----------------------------------------------------------------------------------------

Net interest income                                         5,863     5,490      5,113

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

Net interest income after provision for
   loan losses                                              5,773     5,400      5,013
-----------------------------------------------------------------------------------------

Noninterest income
   Service charges and fees on loans                          648       459        296
   Other customer service fees and commissions                336       320        242
   Gain on sale of loans, investments and
     foreclosed real estate                                    30        10         16
   Other                                                       55        74         39
-----------------------------------------------------------------------------------------

Total noninterest income                                    1,069       863        593
-----------------------------------------------------------------------------------------
</TABLE>
                                                                    continued...


18
<PAGE>

                                                        Bedford Bancshares, Inc.
                                                                and Subsidiaries

                                           Consolidated Statements of Operations
                                                                  (in thousands)
                                                                     (continued)

================================================================================
Year Ended September 30,                         1999        1998        1997
--------------------------------------------------------------------------------

Noninterest expense
   Compensation and employee benefits         $ 1,860     $ 1,712     $ 1,684
   Occupancy and equipment                        319         321         318
   Data processing                                397         354         341
   Federal insurance of accounts                   63          64          88
   Advertising                                    115         111         140
   Professional fees                              200         201         120
   Other                                          374         367         350
--------------------------------------------------------------------------------

Total noninterest expense                       3,328       3,130       3,041
--------------------------------------------------------------------------------

Income before income taxes                      3,514       3,133       2,565

Provision for income taxes (Note 8)             1,323       1,160         974
--------------------------------------------------------------------------------

Net income                                    $ 2,191     $ 1,973     $ 1,591
================================================================================

Basic earnings per share (Note 16)             $ 1.01      $  .90     $   .74

Diluted earnings per share (Note 16)           $  .96      $  .85     $   .70
================================================================================
                                 See accompanying summary of accounting policies
                                 and notes to consolidated financial statements.

                                                                              19


<PAGE>

                                                        Bedford Bancshares, Inc.
                                                                and Subsidiaries

                                 Consolidated Statements of Stockholders' Equity
                                                                  (in thousands)

<TABLE>
<CAPTION>
======================================================================================================================
                                                                              Accumulated
                                                   Additional                    Other         Acquired
                                        Common      Paid-in     Retained     Comprehensive     By ESOP
                                         Stock      Capital     Earnings        Income         and RRP      Total
----------------------------------------------------------------------------------------------------------------------

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

Comprehensive income
   Net income                                 -             -       1,591           -                 -        1,591
   Change in unrealized loss
     on securities available for
     sale (Note 9)                            -             -           -          55                 -           55
                                                                                                          ------------

Total comprehensive income                    -             -           -           -                 -        1,646
                                                                                                          ------------

   Allocated/earned ESOP
     shares (Note 11)                         -           147          49           -                80          276
   Purchase of RRP shares
     (Note 11)                                -           (12)        (11)          -                 -          (23)
   Dividends declared ($.27
     per share)                               -             -        (605)          -                 -         (605)
   RRP vesting (Note 11)                      -           (72)          -           -               172          100
----------------------------------------------------------------------------------------------------------------------

Balance, September 30, 1997                 114        10,836       9,763          22            (1,114)      19,621

Comprehensive income
   Net income                                 -             -       1,973           -                 -        1,973
   Change in unrealized loss
     on securities available for
     sale (Note 9)                            -             -           -          38                 -           38
                                                                                                          ------------

Total comprehensive income                    -             -           -           -                 -        2,011
                                                                                                          ------------

   Allocated/earned ESOP
     shares (Note 11)                         -            96          16           -                69          181
   Purchase of RRP shares
     (Note 11)                                -           (29)        (57)          -                 -          (86)
   Effect of 2 to 1 stock split             115             -        (115)          -                 -            -
   Dividends declared ($.30
     per share)                               -             -        (689)          -                 -         (689)
   Exercise of options (Note 11)              1            93           9           -                 -          103
   RRP vesting (Note 11)                      -           (57)          -           -               164          107
----------------------------------------------------------------------------------------------------------------------
</TABLE>
                                                                    continued...

20

<PAGE>

                                                        Bedford Bancshares, Inc.
                                                                and Subsidiaries

                                 Consolidated Statements of Stockholders' Equity
                                                                  (in thousands)
                                                                     (continued)
<TABLE>
<CAPTION>
======================================================================================================================
                                                                             Accumulated
                                                   Additional                    Other         Acquired
                                        Common      Paid-in     Retained     Comprehensive     By ESOP
                                         Stock      Capital     Earnings        Income         and RRP       Total
----------------------------------------------------------------------------------------------------------------------

<S>                                       <C>       <C>          <C>            <C>             <C>         <C>
Balance, September 30, 1998                $230      $10,939      $10,900        $  60           $(881)      $21,248

Comprehensive income
   Net income                                 -            -        2,191            -               -         2,191
   Change in unrealized loss
     on securities available for
     sale (Note 9)                            -            -            -         (211)              -          (211)
                                                                                                          ------------

Total comprehensive income                    -            -            -            -               -         1,980
                                                                                                          ------------

   Allocated/earned ESOP
     shares (Note 11)                         -          195           17            -              40           252
   Repurchase of stock (132,200
     shares)                                (13)        (648)      (1,103)           -               -        (1,764)
   Dividends declared ($.34
     per share)                               -            -         (786)           -               -          (786)
   Exercise of options (Note 11)              -           36            4            -               -            40
   RRP vesting (Note 11)                      -          (25)           -            -             121            96
----------------------------------------------------------------------------------------------------------------------

Balance, September 30, 1999                $217      $10,497      $11,223        $(151)          $(720)      $21,066
======================================================================================================================
</TABLE>
                                 See accompanying summary of accounting policies
                                 and notes to consolidated financial statements.


                                                                              21
<PAGE>

                                                        Bedford Bancshares, Inc.
                                                                and Subsidiaries

                                           Consolidated Statements of Cash Flows
                                                                  (in thousands)

<TABLE>
<CAPTION>
===============================================================================================
Year Ended September 30,                                        1999         1998        1997
-----------------------------------------------------------------------------------------------

Operating activities
<S>                                                       <C>          <C>         <C>
   Net income                                              $   2,191    $   1,973   $   1,591
   Adjustments to reconcile net income to
     net cash provided by operating activities
       Provision for loan losses                                  90           90         100
       Provision for depreciation and amortization               147          150         159
       (Increase) decrease in deferred income taxes             (130)         (37)        380
       Gain on sale of loans, investments, and
         foreclosed real estate                                  (30)         (11)        (15)
       Loans originated for sale                              (1,464)        (304)       (185)
       Proceeds from sale of loans originated for sale         1,464          304         185
       (Increase) decrease in interest receivable                 72         (149)       (185)
       (Increase) decrease in other assets                       285         (139)        121
       Increase (decrease) in other liabilities                  485          471        (745)
-----------------------------------------------------------------------------------------------

Net cash provided by operating activities                      3,110        2,348       1,406
-----------------------------------------------------------------------------------------------

Investing activities
   Proceeds from maturities of securities                     17,055        7,500       2,090
   Proceeds from sales of available for sale securities            -        1,004       1,000
   Purchase of available for sale securities                  (9,658)     (13,542)     (5,500)
   Principal collected on mortgage-backed securities               4            5          55
   Net increase in loans to customers                        (18,036)     (13,741)     (7,575)
   Net proceeds from sales of foreclosed real estate              83          220          47
   Purchases of premises, equipment and leasehold
     improvements                                                (92)         (96)       (131)
   Sale (purchase) of FHLB stock                                  50         (618)          -
-----------------------------------------------------------------------------------------------

Net cash absorbed by investing activities                    (10,594)     (19,268)    (10,014)
-----------------------------------------------------------------------------------------------
</TABLE>

                                                                    continued...

22
<PAGE>

                                                        Bedford Bancshares, Inc.
                                                                and Subsidiaries

                                           Consolidated Statements of Cash Flows
                                                                  (in thousands)
                                                                     (continued)
<TABLE>
<CAPTION>
------------------------------------------------------------------------------------
------------------------------------------------------------------------------------
Year Ended September 30,                               1999       1998        1997
------------------------------------------------------------------------------------
<S>                                               <C>         <C>        <C>
Financing activities
   Net increase in deposits                        $  7,635   $  3,474    $  8,234
   Net increase (decrease) in advance payments
     from borrowers                                      77         26         (37)
   Proceeds from FHLB advances                       11,000     22,000      23,500
   Principal payments of FHLB advances              (12,000)    (8,000)    (20,500)
   Purchase of stock by ESOP and RRP                      -        (86)        (23)
   Allocation of ESOP and RRP shares                    348        288         376
   Repurchase of stock                               (1,764)         -           -
   Dividends paid                                      (774)      (665)       (571)
   Issuance of common stock                              40        103           -
------------------------------------------------------------------------------------

Net cash provided by financing activities             4,562     17,140      10,979
------------------------------------------------------------------------------------

Increase (decrease) in cash and cash equivalents     (2,922)       220       2,371

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

Cash and cash equivalents - end of year            $  2,744   $  5,666    $  5,446
====================================================================================

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

Cash payments of interest expense                  $  6,015   $  5,880    $  5,387
====================================================================================

Cash payments of income taxes                      $  1,282   $    570    $    823
====================================================================================

Transfer of loans to foreclosed real estate        $     88   $    110    $    255
====================================================================================
</TABLE>
                                 See accompanying summary of accounting policies
                                 and notes to consolidated financial statements.

                                                                              23

<PAGE>

                                                        Bedford Bancshares, Inc.
                                                                and Subsidiaries

                                                  Summary of Accounting Policies

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

Nature of Business and Regulatory Environment

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

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

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

Principles of Consolidation

The  consolidated   financial   statements   include  the  accounts  of  Bedford
Bancshares,  Inc.,  Bedford  Federal  Savings  Bank and CVFS,  its  wholly-owned
subsidiaries,  and First Financial Enterprises,  Inc., a 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

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

24
<PAGE>

                                                        Bedford Bancshares, Inc.
                                                                and Subsidiaries

                                                  Summary of Accounting Policies
                                                                     (continued)

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

Investment Securities (continued)

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

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

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

Loans Held for Sale

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

Loans Receivable

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

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

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

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

                                                                              25
<PAGE>

                                                        Bedford Bancshares, Inc.
                                                                and Subsidiaries

                                                  Summary of Accounting Policies
                                                                     (continued)
================================================================================

Loans Receivable (continued)

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

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

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

As of  September  30,  1999,  the Company had no loans that were  considered  as
impaired.

Real Estate Owned

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

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

Sale of Loans, Participations in Loans

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

26
<PAGE>

                                                        Bedford Bancshares, Inc.
                                                                and Subsidiaries

                                                  Summary of Accounting Policies
                                                                     (continued)
================================================================================

Sale of Loans, Participations in Loans (continued)

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

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

Property, Equipment and Depreciation

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

Income Taxes

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

For tax years beginning prior to January 1, 1996, savings banks that met certain
definitional tests and other conditions  prescribed by the Internal Revenue Code
were allowed, within limitations, to deduct from taxable income an allowance for
bad debts using the "percentage of taxable income" method.

                                                                              27
<PAGE>

                                                        Bedford Bancshares, Inc.
                                                                and Subsidiaries

                                                  Summary of Accounting Policies
                                                                     (continued)

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

Income Taxes (continued)

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

As a  result  of the  Act,  the  Company  must  recapture  into  taxable  income
approximately  $424,821  ratably over six years,  beginning with the year ending
September 30, 1999. If the  residential  loan  requirement  exception is met, as
discussed  above,  the income will be includable  over the third through  eighth
years following the year ended September 30, 1998.

Accounting Pronouncements

In June 1998,  the Financial  Accounting  Standards  Board issued  Statements of
Financial  Accounting  Standards No. 133, Accounting for Derivative  Instruments
and Hedging Activities ("SFAS 133"), which establishes  accounting and reporting
standards for derivative  instruments,  including certain derivative instruments
embedded in other contracts, and for hedging activities.  SFAS 133 requires that
an entity  recognize  all  derivatives  as either assets or  liabilities  in the
statement of financial  position and measure those instruments at fair value. If
certain  requirements are met, a derivative may be specifically  designated as a
hedge and an entity  that  elects  to apply  hedge  accounting  is  required  to
establish at the inception of the hedge the method it will use for assessing the
effectiveness  of the  hedging  derivative  and  the  measurement  approach  for
determining  the  ineffective  aspect  of  the  hedge.  Those  methods  must  be
consistent  with the entity's  approach to managing risk.  SFAS 133 is effective
for all fiscal  quarters  of fiscal  years  beginning  after  June 15,  2000 and
requires application prospectively.

28
<PAGE>

                                                        Bedford Bancshares, Inc.
                                                                and Subsidiaries

                                                  Summary of Accounting Policies
                                                                     (continued)

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

Earnings Per Share

Basic earnings per share include no dilution and is computed by dividing  income
available to common shareholders by the weighted average number of common shares
outstanding  for the period.  Diluted  earnings per share reflects the potential
dilution of stock  options that could share in the earnings of the Company.  The
computation of basic and diluted earnings per share is presented in Note 16.

Comprehensive Income

For the year  ended  September  30,  1999,  the  Company  adopted  Statement  of
Financial Accounting Standards No. 130, "Reporting  Comprehensive  Income" (SFAS
130). This statement establishes rules for the reporting of comprehensive income
and its components.  Comprehensive  income consists of net income and unrealized
gains on available  for sale  securities  and is  presented in the  Consolidated
Statements of  Stockholders'  Equity.  The adoption of SFAS 130 had no impact on
total  shareholders'   equity.   Prior  year  financial   statements  have  been
reclassified to conform to SFAS 130 requirements.

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

1.      Securities

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

September 30, 1999
-----------------------------------------------------------------------------------------
                                                     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             $   800        $  2        $   2     $    800

   Mortgage-backed securities                10           -            -           10
-----------------------------------------------------------------------------------------

                                            810           2            2          810
-----------------------------------------------------------------------------------------

Available for Sale

   United States government
     and agency obligations               6,005           -          175        5,830

   Marketable Equity securities           4,648           -           73        4,575

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

                                         10,706           -          248       10,458
-----------------------------------------------------------------------------------------

                                        $11,516        $  2         $250      $11,268
=========================================================================================
</TABLE>


Gross  gains of  approximately  $0,  $3,000  and  $4,000  and  gross  losses  of
approximately  $0, $1,000 and $0 were realized on sales of securities  available
for sale during the years ended September 30, 1999, 1998 and 1997, respectively.

30
<PAGE>

                                                        Bedford Bancshares, Inc.
                                                                and Subsidiaries

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

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

September 30, 1998
-------------------------------------------------------------------------------------
                                                   Gross       Gross      Estimated
                                   Amortized    Unrealized  Unrealized      Market
                                      Cost         Gains      Losses        Value
-------------------------------------------------------------------------------------

Held to Maturity
<S>                                  <C>            <C>          <C>     <C>
   United States government
     and agency obligations           $ 2,099        $ 33         $ -     $ 2,132

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

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

Available for Sale

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

   Marketable Equity securities         4,411           -          15       4,396

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

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

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

                                                                              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, 1999, by contractual maturity, were as follows:

                                                            Estimated
                                                              Market
                                                              Value
                                           Amortized
                                             Cost

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

Held to Maturity

   Due in one year or less                    $   300      $   302
   Due in one through five years                    -            -
   Due after five years                           500          498
------------------------------------------------------------------------

                                                  800          800
   Mortgage-backed securities                      10           10
------------------------------------------------------------------------

                                                  810          810
------------------------------------------------------------------------

Available for Sale
   Due in one year or less                          -            -
   Due in one through five years                4,499        4,359
   Due after five years                         1,506        1,471
------------------------------------------------------------------------

                                                6,005        5,830

Marketable equity securities                    4,648        4,575

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

                                               10,706       10,458
------------------------------------------------------------------------

                                              $11,516      $11,268
========================================================================

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,                                  1999          1998
--------------------------------------------------------------------

<S>                                       <C>           <C>
First mortgage loans                       $112,219      $100,863
Construction loans                           18,506        13,530
Home equity loans                             4,692         3,944
Loans to depositors, secured by savings         452           451
Installment loans                            11,512        10,129
Term notes                                    8,940         6,788
--------------------------------------------------------------------

                                            156,321       135,705
Less
   Undistributed loans in process             7,556         4,906
   Deferred loan fees and costs, net            272           291
   Allowance for credit losses                  804           764
--------------------------------------------------------------------

                                           $147,689      $129,744
====================================================================

</TABLE>


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

Year ended September 30,              1999      1998       1997
------------------------------------------------------------------

Balance at beginning of year           $764      $678       $650
Provision charged to operations          90        90        100
Charge offs net of recoveries           (50)       (4)       (72)
------------------------------------------------------------------

Balance at end of year                 $804      $764       $678
==================================================================

                                                                              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:

September 30,                                      1999     1998     1997
---------------------------------------------------------------------------

Federal Home Loan Mortgage Corporation (FHLMC)   $1,698   $1,361   $1,719
Virginia Housing Development Authority (VHDA)       803    1,097    1,184
---------------------------------------------------------------------------

                                                 $2,501   $2,458   $2,903
================================================================================

4.      Property and Equipment

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

September 30,                                 1999        1998
-----------------------------------------------------------------

Land                                       $   251     $   251
Office buildings                             1,203       1,203
Rental buildings                                68          48
Furniture, fixtures and equipment            1,019         953
Automobile                                      25          25
Leasehold improvements                          25          20
-----------------------------------------------------------------

                                             2,591       2,500
Less accumulated depreciation                1,486       1,340
-----------------------------------------------------------------

                                            $1,105      $1,160
=================================================================


34
<PAGE>
                                                        Bedford Bancshares, Inc.
                                                                and Subsidiaries

                                      Notes to Consolidated Financial Statements
                                                                     (continued)

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

5.      Deposits

Deposits, in thousands, are summarized as follows:

September 30,                   1999                         1998
------------------------------------------------------------------------

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

NOW accounts            $ 18,440      16.07%     $ 15,941    14.89%
Money market accounts      7,241       6.31         4,799     4.48
Savings accounts          16,072      14.01        15,611    14.58
Time deposits             72,967      63.61        70,735    66.05
------------------------------------------------------------------------

                        $114,720     100.00%     $107,086   100.00%
========================================================================

The  aggregate  amount  of  certificates  of  deposit  of  $100,000  or more was
approximately  $13,785,000  and  $10,416,000  at  September  30,  1999 and 1998,
respectively.

At September 30, 1999, the scheduled maturities of time deposits,  in thousands,
are as follows:

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

                                   2000                  $41,057
                                   2001                   28,301
                                   2002                    1,760
                                   2003                    1,201
                                Thereafter                   648
                     ----------------------------------------------
                                                         $72,967
                     ==============================================

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

Year ended September 30,      1999         1998        1997
-------------------------------------------------------------

NOW accounts               $   137      $   182     $   194
Money market account           209          149         145
Savings account                407          454         445
Time deposits                3,694        3,779       3,518
-------------------------------------------------------------

                           $ 4,447      $ 4,564     $ 4,302
=============================================================

                                                                              35
<PAGE>

                                                        Bedford Bancshares, Inc.
                                                                and Subsidiaries

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

6.      Advances from Federal Home Loan Bank

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

September 30,             1999         1998
----------------------------------------------

Within one year        $ 4,000      $ 1,000
One to two years             -        4,000
Two years or more       24,000       24,000
----------------------------------------------

                       $28,000      $29,000
----------------------------------------------

The weighted  average  interest  rate on advances at September 30, 1999 and 1998
was 5.53% and 5.55%,  respectively.  These  advances are  collateralized  by the
Company's  investment  in FHLB stock and  qualifying  real estate  loans under a
blanket collateral  agreement.  Certain advances are subject to call dates which
result in earlier maturities.

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

Year ended September 30,                        1999      1998       1997
-----------------------------------------------------------------------------

Maximum amount outstanding during the year   $31,000   $31,000    $16,000
================================================================================

Average amount outstanding during the year    28,483    22,487     12,249
================================================================================

Average interest rate during the year           5.56%     5.54%      6.07%
================================================================================

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,                                            1999                  1998
--------------------------------------------------------------------------------------------------

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

Financial assets
<S>                                         <C>          <C>           <C>          <C>
   Cash and short-term investments            $   2,744    $   2,744     $   5,666    $   5,666
   Securities                                    11,268       11,268        18,934       18,967
   Loans, net of allowance for loan losses      147,689      148,157       129,744      130,667

Financial liabilities
   Deposits                                     114,720      115,034       107,086      107,530
   Advances from Federal Home Loan Bank          28,000       28,000        29,000       29,000

                                              Notional       Fair        Notional      Fair
                                               Amount        Value        Amount       Value
--------------------------------------------------------------------------------------------------
Unrecognized financial instruments
   Commitments to extend credit               $  12,916    $  12,916     $   8,173    $   8,173
</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 receivable
---------------

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

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

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

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

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

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

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

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

38
<PAGE>

                                                        Bedford Bancshares, Inc.
                                                                and Subsidiaries

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

8.      Income Taxes

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

Year ended September 30,              1999       1998     1997
----------------------------------------------------------------

Current
   Federal                          $1,195     $1,066     $517
   State                               211        186      152
----------------------------------------------------------------

                                     1,406      1,252      669

Deferred tax expense (benefit)         (83)       (92)     305
----------------------------------------------------------------

Total provision for income taxes    $1,323     $1,160     $974
----------------------------------------------------------------
----------------------------------------------------------------


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

                                                  Percent of Pre-tax Income
                                                  -------------------------
Year ended September 30,                           1999      1998    1997
---------------------------------------------------------------------------

Tax at statutory rate                             34.0%     34.0%    34.0%
Increases (decreases) in taxes resulting from
   State income taxes, net of federal benefit      5.4       5.6      4.5
   Other                                          (1.4)     (2.6)     (.5)
---------------------------------------------------------------------------

                                                  38.0%     37.0%    38.0%
===========================================================================

                                                                              39
<PAGE>

                                                        Bedford Bancshares, Inc.
                                                                and Subsidiaries

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

8.      Income Taxes (continued)

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

September 30,                                                 1999     1998
------------------------------------------------------------------------------

Deferred tax asset
   Bad debts                                                  $171     $130
   Loan fees                                                    37       46
   Unrealized loss on securities available for sale             90        -
------------------------------------------------------------------------------

Total deferred tax asset                                       298      176
------------------------------------------------------------------------------

Deferred tax liability
   Accelerated depreciation                                     (5)     (13)
   Unrealized gain on securities available for sale              -      (35)
   Distributive share of income from partnership               (17)     (18)
   Other                                                       (51)     (15)
------------------------------------------------------------------------------

Total deferred tax liability                                   (73)     (81)
------------------------------------------------------------------------------

Net deferred tax asset                                        $225    $  95
==============================================================================

40

<PAGE>

                                                        Bedford Bancshares, Inc.
                                                                and Subsidiaries

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

9.      Comprehensive Income

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

Year ended September 30,                                    1999    1998   1997
--------------------------------------------------------------------------------

Unrealized gains (losses) on securities:                   $(269)    $61    $89
   Less:  reclassification adjustment for gains (losses)
     included in net income                                   71       -      -
--------------------------------------------------------------------------------

Other comprehensive income (loss) before tax                (340)     61     89

Income tax (expense) benefit related to items of other
   comprehensive income                                      129     (23)   (34)
--------------------------------------------------------------------------------

Other comprehensive income (loss), net of tax              $(211)    $38    $55
================================================================================

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, 1999,
the liquidation account, adjusted for customer withdrawals, totaled $2,235,000.

                                                                              41
<PAGE>

                                                        Bedford Bancshares, Inc.
                                                                and Subsidiaries

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

11.     Retirement Plan and Employee Benefit Programs

The Savings  Bank has a  retirement  plan under  Internal  Revenue  Code Section
401(k) covering all full-time  employees who have completed one or more years of
continuous  service  and have  reached age 21.  Each  employee  has an option to
voluntarily  contribute to this plan up to 10% of their salary. The Savings Bank
matched  $.50 for every $1 up to 4% of salary  for years  prior to fiscal  1999.
Beginning  in fiscal 1999,  the Savings  Bank,  for $1 up to 4% of salary,  will
match $.50 for employees with less than ten years of service, $.75 for employees
with  between  ten and twenty  years of service and $1 for  employees  with over
twenty years of service.  Effective  October 1, 1993, a money  purchase plan was
adopted which provides for a fixed  percentage  contribution for each employee's
salary.  This percentage was 5% for the years ended September 30, 1999, 1998 and
1997,  respectively.  The total expense for the plan was $78,000,  $61,000,  and
$60,000 for the years ended September 30, 1999, 1998 and 1997, respectively.

Employee Stock Ownership Plan

At the time of the stock  conversion,  the Savings Bank  established an Employee
Stock  Ownership Plan (ESOP) covering all full-time  employees,  over the age of
21, with at least one year of service.  The ESOP borrowed  funds from the Parent
Company to  purchase a total of 160,000  shares of the Parent  Company's  Common
Stock, the loan being  collateralized by the Common Stock.  Contributions by the
Savings Bank, along with dividends  received on unallocated  shares, are used to
repay the loan  with  shares  being  released  from the  Parent  Company's  lien
proportional  to the loan  repayments.  Annually on  September  30, the released
shares are allocated to the participants in the same proportion that their wages
bear to the total  compensation  of all of the  participants.  The  Company  has
released and allocated  82,666 and 66,666 shares of Common Stock as of September
30, 1999 and 1998, respectively. The Company recognized $149,000 and $138,000 of
compensation cost for the years ended September 30, 1999 and 1998, respectively.
The fair value of unearned ESOP shares  totaled  $967,000 at September 30, 1999.
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.

42
<PAGE>

                                                        Bedford Bancshares, Inc.
                                                                and Subsidiaries

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

11.     Retirement Plan and Employee Benefit Programs (continued)

Recognition and Retention Plan (continued)

The Board of Directors approved the establishment of a Recognition and Retention
Plan  ("RRP") on January 25, 1995.  The plan states that the Trust,  established
under  the plan,  shall not  purchase  more than 4% of the  aggregate  shares of
Common Stock issued by the Parent Company in the  mutual-to-stock  conversion of
the Savings Bank (100,510  shares).  The costs of the shares awarded under these
plans are recorded as unearned  compensation,  a contra equity account,  and are
recognized as an expense in accordance with the vesting  requirements  under the
various  plans.  For the years ended  September  30,  1999 and 1998,  the amount
included in  compensation  expense was $96,000 and $104,000,  respectively.  The
status of the shares in this plan is summarized as follows:

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

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

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

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

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

Balance at September 30, 1999         $5.81        8,394        19,210
==========================================================================

                                                                              43
<PAGE>

                                                        Bedford Bancshares, Inc.
                                                                and Subsidiaries

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

11.     Retirement Plan and Employee Benefit Programs (continued)

Stock Option Plans

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


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

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

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

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

Granted                             -           -             -            -
Vested                              -           -       (40,550)      40,550
Exercised                           5.50        -             -       (7,350)
-------------------------------------------------------------------------------

Balance at September 30, 1999      $6.40   20,994        48,049      147,715
===============================================================================

The remaining  contractual  lives of the options  granted in 1999, 1998 and 1997
are 5.3 years, 6.3 years and 7.3 years,  respectively at September 30, 1999. The
weighted  average  remaining  contractual  life of total options is 5.5 years at
September 30, 1999.

44
<PAGE>

                                                        Bedford Bancshares, Inc.
                                                                and Subsidiaries

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

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 2001 at an annual  rental of $2,400 and in Bedford,  under a
five year lease expiring in September 2004 at an annual rental of $3,300.

The current minimum annual rental  commitments  under  non-cancelable  operating
leases in effect at September 30, 1999 are as follows:

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

                             2000                     $10,500
                             2001                       9,900
                             2002                       3,300
                             2003                       3,300
                             2004 and thereafter       22,800
                  ----------------------------------------------

                                                      $49,800
                  ==============================================

Rent  expense was  approximately  $7,200,  $7,000 and $7,400 for the years ended
September 30, 1999, 1998, and 1997, 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.

                                                                              45
<PAGE>

                                                        Bedford Bancshares, Inc.
                                                                and Subsidiaries

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

12.     Commitments and Contingencies (continued)

The Savings Bank's  exposure to credit loss in the event of  non-performance  by
the other party to the financial  instrument for commitments to extend credit is
represented  by  the  contractual   notional  amount  (in  thousands)  of  those
instruments  at  September  30, 1999 and 1998.  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,                                                                            1999       1998
----------------------------------------------------------------------------------------------------------
Financial instruments, in thousands, whose contract amounts represent credit risk
<S>                                                                                 <C>          <C>
   Unfunded commercial credit line                                                    $ 2,486     $1,403
   Unfunded home equity lines of credit                                                 5,866      4,978
   Commitments to finance real estate acquisitions and construction                     4,564      1,792
----------------------------------------------------------------------------------------------------------

                                                                                      $12,916     $8,173
==========================================================================================================

</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.

46

<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,  1999,  1998 and 1997 are  approximately  $910,000,
$826,000 and $819,000, respectively.

15.     Regulatory Capital of the Savings Bank

The  Office  of  Thrift   Supervision's   capital   regulations  require  thrift
institutions to maintain capital at least sufficient to meet three requirements:
tangible  capital,   core  capital,  and  risk-based  capital.   Management  has
determined  that the Savings  Bank's capital meets and exceeds all three capital
requirements  as follows as of  September  30, 1999 and 1998.  Tangible and core
capital  levels  are  shown  as a  percentage  of  adjusted  total  assets,  and
risk-based capital levels are shown as a percentage of risk-weighted assets.

                       Amount        Percent   Actual        Actual  Excess
September 30, 1999    Required      Required   Amount       Percent  Amount
--------------------------------------------------------------------------------

Tangible Capital       $2,491,000      1.50%  $19,040,000    11.46% $16,549,000
Core Capital            6,643,000      4.00    19,040,000    11.46   12,397,000
Risk-based Capital      8,270,000      8.00    19,770,000    19.12   11,500,000

                       Amount        Percent   Actual        Actual  Excess
September 30, 1998    Required      Required   Amount       Percent  Amount
--------------------------------------------------------------------------------

Tangible Capital       $2,383,000      1.50%  $19,192,000    12.10% $16,809,000
Core Capital            6,355,000      4.00    19,192,000    12.10   12,837,000
Risk-based Capital      7,353,000      8.00    19,857,000    21.60   12,504,000

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

                                                                              47
<PAGE>

                                                        Bedford Bancshares, Inc.
                                                                and Subsidiaries

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

16.     Earnings Per Share

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

During the year ended  September 30, 1999,  the Board of Directors  authorized a
stock repurchase  program under which up to 10%, or 229,790 shares,  of the then
outstanding  shares of the  Company's  stock may be  repurchased.  During  1999,
132,220  shares  were  repurchased  for an  aggregate  amount  of  approximately
$1,764,000.

Earnings per share is calculated as follows:
<TABLE>
<CAPTION>

Year ended September 30,                            1999          1998           1997
----------------------------------------------------------------------------------------
<S>                                          <C>           <C>            <C>
Basic earnings

Income available to common shareholders       $2,191,000    $1,973,000     $1,591,000
========================================================================================

Weighted average share outstandings            2,167,256     2,182,617      2,164,432
========================================================================================

Basic earnings per share                      $     1.01    $      .90     $       .74
========================================================================================

Diluted earnings per share

Income available to common shareholders       $2,191,000    $1,973,000     $1,591,000
========================================================================================

Weighted average shares outstanding            2,167,256     2,182,617      2,164,432

   Dilutive effect of RRP plan shares             17,073        43,238         41,082

   Dilutive effect of stock options              100,672        93,887         93,601
----------------------------------------------------------------------------------------

Total weighted average shares outstanding      2,285,001     2,319,742      2,299,115
========================================================================================

Diluted earnings per share                    $      .96     $     .85     $      .70
========================================================================================

</TABLE>

48
<PAGE>

                                                        Bedford Bancshares, Inc.
                                                                and Subsidiaries

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

17.     Condensed Parent Company Information

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

                                     Balance Sheets
                                    (in thousands)

September 30,                                             1999          1998
-------------------------------------------------------------------------------

Assets
   Cash and cash equivalents                           $    99       $   379
   Securities                                               90           103
   Investment in Savings Bank subsidiary                18,896        19,251
   Loan to Savings Bank subsidiary                         100         2,000
   Dividend receivable from Savings Bank subsidiary      2,307             -
   Other assets                                            475           123
-------------------------------------------------------------------------------

Total assets                                           $21,967       $21,856
===============================================================================

Liabilities and stockholders' equity
   Other liabilities                                   $   705       $   424
   Dividends payable                                       196           184
   Stockholders' equity                                 21,066        21,248
-------------------------------------------------------------------------------

Total liabilities and stockholders' equity             $21,967       $21,856
===============================================================================

                                                                              49

<PAGE>
                                                        Bedford Bancshares, Inc.
                                                                and Subsidiaries

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

17.     Condensed Parent Company Information (continued)

                                              Condensed Statements of Operations
                                                        (in thousands)
<TABLE>
<CAPTION>
Year Ended September 30,                                           1999      1998        1997
----------------------------------------------------------------------------------------------
Income
   Interest
<S>                                                             <C>       <C>         <C>
     Savings Bank's ESOP loan                                    $   29    $   34      $   40
     Loan to Savings Bank subsidiary                                108       170         218
     Other                                                           55        57          41
----------------------------------------------------------------------------------------------

Total income                                                        192       261         299
----------------------------------------------------------------------------------------------

Expenses
   Compensation and employee benefits                                 6         -           -
   Professional fees                                                 89       108          42
   Other operating expenses                                          34        25          36
----------------------------------------------------------------------------------------------

Total expenses                                                      129       133          78
----------------------------------------------------------------------------------------------

Net income before income taxes and equity in
   undistributed net income of Savings Bank subsidiary               63       128         221

Provision for income taxes                                           27        48          84
Equity in undistributed net income of Savings Bank subsidiary     2,155     1,893       1,454
----------------------------------------------------------------------------------------------

Net income                                                       $2,191    $1,973      $1,591
==============================================================================================

</TABLE>

50
<PAGE>
                                                        Bedford Bancshares, Inc.
                                                                and Subsidiaries

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

17.     Condensed Parent Company Information (continued)

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

Year Ended September 30,                                                 1999      1998       1997
-----------------------------------------------------------------------------------------------------
<S>                                                                     <C>      <C>        <C>
Operating activities
   Net income                                                            $2,191    $1,973     $1,591
   Adjustments
     Equity in undistributed net income of Savings Bank subsidiary       (2,155)   (1,893)    (1,454)
     (Increase) decrease in other assets                                   (371)       50        (79)
     Increase (decrease) in other liabilities                               281       (76)       189
-----------------------------------------------------------------------------------------------------

Net cash provided (absorbed) by operating activities                        (54)       54        247
-----------------------------------------------------------------------------------------------------

Investing activities
   Loans originated, net of principal repayments                          1,980        80      1,080
   Purchase of Central Virginia Financial Services stock                      1         -          -
   Purchase of investment securities                                          -         -        (72)
-----------------------------------------------------------------------------------------------------

Net cash provided by investing activities                                 1,981        80      1,008
-----------------------------------------------------------------------------------------------------

Financing activities
   Purchase of stock, by RRP                                                  -       (86)       (23)
   Dividends paid                                                          (774)     (665)      (571)
   Repurchase of stock                                                   (1,764)        -          -
   RRP vesting                                                               96       (57)       (95)
   ESOP note payment                                                        195       235          -
   Exercise of options                                                       40       103          -
-----------------------------------------------------------------------------------------------------

Net cash absorbed by financing activities                                (2,207)     (470)      (689)
-----------------------------------------------------------------------------------------------------

Increase (decrease) in cash and cash equivalents                           (280)     (336)       566

Cash and cash equivalents, beginning of year                                379       715        149
-----------------------------------------------------------------------------------------------------

Cash and cash equivalents, end of year                                   $   99   $   379    $   715
=====================================================================================================
</TABLE>

                                                                              51
<PAGE>
                                                        Bedford Bancshares, Inc.
                                                                and Subsidiaries

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

18.     Selected Quarterly Financial Data (Unaudited)

Condensed quarterly  consolidated financial data, in thousands (except per share
data), is shown as follows:
<TABLE>
<CAPTION>
                                           First       Second      Third       Fourth
Year ended September 30, 1999             Quarter     Quarter     Quarter     Quarter
-------------------------------------------------------------------------------------------

<S>                                      <C>          <C>        <C>         <C>
Total interest income                     $  2,982     $ 2,946    $  2,961    $   3,005
Total interest expense                       1,531       1,488       1,494        1,518
-------------------------------------------------------------------------------------------

Net interest income                          1,451       1,458       1,467        1,487
Provision for credit losses                     23          22          22           23
-------------------------------------------------------------------------------------------

Net interest income after provision
   for credit losses                         1,428       1,436       1,445        1,464

Noninterest income                             270         258         241          300
Noninterest expense                            848         841         809          830
-------------------------------------------------------------------------------------------

Income before income taxes                     850         853         877          934
Provision for income taxes                     323         323         333          344
-------------------------------------------------------------------------------------------

Net income                                $    527     $   530    $    544    $     590
===========================================================================================

Cash dividends declared per share         $    .08     $   .09    $    .09    $     .09
===========================================================================================

Basic earnings per share                  $    .24     $   .24    $    .25    $     .28
Diluted earnings per share                $    .23     $   .23    $    .24    $     .26
===========================================================================================
</TABLE>

                                                                              52
<PAGE>
                                                        Bedford Bancshares, Inc.
                                                                and Subsidiaries

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

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

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

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

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

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

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

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

Net income                           $    384   $    460    $    512   $    617
================================================================================

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

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

                                                                              53