<PAGE>
 
               UNITED STATES SECURITIES AND EXCHANGE COMMISSION
                             Washington  D.C. 20549

                                   FORM 10-Q

 [X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

     For the quarterly period ended    March 31, 1998
                                    -----------------
                                       Or
 [____] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

     For the transition period from_____________________to____________________


                        Commission File Number: 0-21083

                          South Street Financial Corp.
                          ----------------------------
             (Exact name of registrant as specified in its charter)

         North Carolina                                 56-1973261
         --------------                                 ----------
       (State or other jurisdiction of      (I.R.S. Employer Identification No.)
        incorporation or organization)

                             155 West South Street
                        Albemarle, North Carolina 28001
                        -------------------------------
               (Address of principal executive office) (Zip code)

                                 (704)-982-9184
                                 --------------
                        (Registrant's telephone number)

                                      N/A
                                      ---
   (Former name, former address and former fiscal year, if changed since last
                                    report)

Indicate by check [X] whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities and Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes    X      No   
                                      --------     --------      

As of May 10, 1998 there were issued and outstanding 4,676,720 shares of the
Registrant's common stock, no par value.
<PAGE>
 
                  SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY
                                        

                                     INDEX
                                        

 PART I - FINANCIAL INFORMATION

   Item 1.  Financial Statements

<TABLE>
<S>                                                                  <C>
     Consolidated statements of financial condition at March 31, 1998
     (Unaudited) and September 30, 1997                                    1
 
 
     Consolidated statements of income for the three months ended
     March 31, 1998 and 1997 (Unaudited)                                   2
 
 
     Consolidated statements of income for the six months ended
     March 31, 1998 and 1997 (Unaudited)                                   3
 
     Consolidated statements of cash flows for the six months
     ended March 31, 1998 and 1997 (Unaudited)                           4-5
 
     Notes to consolidated financial statements (Unaudited)              6-8
</TABLE>


Item 2.  Management's Discussion and Analysis of Financial Condition
         and Results of Operations                                      9-13

Item 3.  Quantitative and Qualitative disclosures about Market Risk       14
<TABLE>
<CAPTION>
 
 
PART II - OTHER INFORMATION
<S>                                                                <C>
 
     Item 1.  Legal Proceedings                                        15-16
 
     Item 2.  Changes in Securities and Use of Proceeds                15-16
  
     Item 3.  Defaults upon Senior Securities                          15-16
 
     Item 4.  Submission of Matters to a Vote of Security Holders      15-16
 
     Item 5.  Other Information                                        15-16
 
     Item 6.  Exhibits and Reports on Form 8-K                         15-16
 
     Signatures                                                        17-18
</TABLE>
<PAGE>
 
SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
March 31, 1998 and September 30, 1997
<TABLE>
<CAPTION>
 
 
                                                                       March 31,       September 30,
ASSETS                                                                    1998              1997
----------------------------------------------------------------------------------------------------
                                                                      (Unaudited)         (Note)*
<S>                                                                <C>             <C>
Cash and cash equivalents:
  Noninterest-bearing deposits                                     $    2,454,000   $      2,457,000
  Interest-bearing deposits                                            31,929,000         19,257,000
  Federal Funds sold                                                    5,430,000          5,930,000
Securities held to maturity                                            18,126,000         21,661,000
Securities available for sale                                          44,177,000         73,886,000
Federal Home Loan Bank stock                                            1,707,000          2,250,000
Loans receivable, net                                                 110,284,000        111,990,000
Real estate acquired in settlement of loans                                18,000             18,000
Accrued interest receivable                                             1,373,000          1,903,000
Office properties and equipment, net                                    1,103,000          1,158,000
Prepaid expenses and other assets                                         376,000            551,000
                                                                    --------------------------------
      Total assets                                                 $  216,977,000   $    241,061,000
                                                                 ===================================
 
LIABILITIES AND STOCKHOLDERS' EQUITY
----------------------------------------------------------------------------------------------------
Liabilities:
 Deposits                                                          $  146,882,000   $    141,755,000
 Advance payments by borrowers for taxes and insurance                    338,000            131,000
 Accounts payable and other liabilities                                 2,206,000          2,189,000
 Advances from Federal Home Loan Bank                                  15,000,000         35,000,000
 Notes payable                                                         18,000,000                  -
 Checks outstanding on disbursement account                               111,000            292,000
                                                                 -----------------------------------
       Total liabilities                                              182,537,000        179,367,000
                                                                 -----------------------------------
 
Stockholders' equity:
  Preferred stock, no par value, authorized 5,000,000 shares;
   no shares issued                                                             -                  -
  Common stock, no par value, authorized 20,000,000 shares;
   issued 4,676,360 shares March 31, 1998 and 4,496,500
   shares at September 30, 1997                                                 -                  -
  Additional paid-in capital                                           19,048,000         43,684,000
  Unearned Management Recognition Plan                                 (1,995,000)                 -
  Unrealized gain (loss) on securities available for
   sale, net of tax                                                        15,000             69,000
  Note receivable, ESOP                                                (4,186,000)        (4,258,000)
  Retained earnings, substantially restricted                          21,558,000         22,199,000
                                                                 -----------------------------------
     Total stockholders' equity                                        34,440,000         61,694,000
                                                                 -----------------------------------
     Total liabilities and stockholders' equity                    $  216,977,000   $    241,061,000
                                                                 =================================== 
</TABLE>

*NOTE:  The Consolidated Statement of Financial Condition as of September 30,
1997 has been taken from the audited financial statements of South
Street Financial Corp. and Subsidiary at that date.

See Notes to Consolidated Financial Statements.

                                       1
<PAGE>
 
SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
Three Months Ended March 31, 1998 and 1997

<TABLE>
<CAPTION>
 
                                                                              1998              1997
-------------------------------------------------------------------------------------------------------
                                                                                    (Unaudited)
<S>                                                            <C>                     <C>        
Interest income:
   Loans                                                       $            2,383,000  $      2,454,000
   Mortgage-backed certificates                                               457,000           522,000
   Securities                                                                 875,000         1,191,000
   Other interest-bearing deposits                                            330,000           102,000
                                                             ------------------------------------------
                                                                            4,045,000         4,269,000
Interest expense on deposits and borrowed funds                             2,459,000         2,187,000
                                                             ------------------------------------------
       Net interest income                                                  1,586,000         2,082,000
Provision for loan losses                                                           -                 -
                                                             ------------------------------------------
       Net interest income after provision for loan losses                  1,586,000         2,082,000
                                                             ------------------------------------------
Noninterest income, other                                                      67,000            30,000
                                                             ------------------------------------------
 
Noninterest expenses:
   Compensation and benefits                                                  875,000           661,000
   Net occupancy                                                               63,000            51,000
   Federal insurance premium expenses                                          22,000            25,000
   Data processing                                                             56,000            56,000
   Other                                                                      198,000           157,000
                                                             ------------------------------------------
                                                                            1,214,000           950,000
                                                             ------------------------------------------
       Income before income taxes                                             439,000         1,162,000
Income taxes                                                                  179,000           433,000
                                                             ------------------------------------------
 
       Net Income                                              $              260,000  $        729,000
                                                             ==========================================
 
 
Basic earnings per share                                       $                 0.06  $           0.18
                                                             ==========================================

Diluted earnings per share                                                       0.06  $           0.18
                                                             ==========================================
 
Dividends declared per share                                   $                 0.10  $           0.10
                                                             ==========================================
 
Average number of Basic shares outstanding                     $            4,170,349  $      4,149,876
                                                             ==========================================
 
Average number of Diluted shares outstanding                   $            4,170,349  $      4,149,876
                                                             ==========================================
</TABLE>


See Notes to Consolidated Financial Statements.

                                       2
<PAGE>
 
SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
Six Months Ended March 31, 1998 and 1997

<TABLE>
<CAPTION>
 
 
                                                                            1998                 1997
--------------------------------------------------------------------------------------------------------
                                                                                    (Unaudited)
<S>                                                            <C>                     <C>       
Interest income:
   Loans                                                       $            4,779,000  $      4,930,0000
   Mortgage-backed certificates                                               983,000            718,000
   Securities                                                               1,981,000          2,051,000
   Other interest-bearing deposits                                            593,000            423,000
                                                             -------------------------------------------
                                                                            8,336,000          8,122,000
Interest expense on deposits and borrowed funds                             4,746,000          4,123,000
                                                             -------------------------------------------
       Net interest income                                                  3,590,000          3,999,000
Provision for loan losses                                                           -                  -
                                                             -------------------------------------------
       Net interest income after provision for loan losses                  3,590,000          3,999,000
                                                             -------------------------------------------
Noninterest income, other                                                      84,000             58,000
                                                             -------------------------------------------
 
Noninterest expenses:
   Compensation and benefits                                                2,568,000          1,315,000
   Net occupancy                                                              123,000            139,000
   Federal insurance premium expenses                                          44,000             25,000
   Data processing                                                            107,000            111,000
   Other                                                                      394,000            346,000
                                                             -------------------------------------------
                                                                            3,236,000          1,936,000
                                                             -------------------------------------------
       Income before income taxes                                             438,000          2,121,000
Income taxes                                                                  179,000            761,000
                                                             -------------------------------------------
 
       Net Income                                              $              259,000  $       1,360,000
                                                             ===========================================
 
 
Basic earnings per share                                       $                 0.06  $            0.33
                                                             ===========================================
 
Diluted earnings per share                                     $                 0.06  $            0.33
                                                             ===========================================
 
Dividends declared per share                                   $                 0.20  $            0.18
                                                             ===========================================
 
Average number of Basic shares outstanding                                  4,157,224          4,149,876
                                                             ===========================================
 
Average number of Diluted shares outstanding                                4,157,224          4,149,876
                                                             ===========================================
</TABLE>


See Notes to Consolidated Financial Statements.

                                       3
<PAGE>
 
SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Six Months Ended March 31, 1998 and 1997


<TABLE>
<CAPTION>
 
                                                                                   1998                   1997
----------------------------------------------------------------------------------------------------------------
                                                                                            (Unaudited)
<S>                                                                 <C>                       <C>       
Cash Flows from Operating Activities
 Net income                                                              $          259,000   $        1,360,000
 Adjustments to reconcile net income to net cash provided by
    (used in) operating activities:
    Provision for loan losses                                                             -                    -
   Net accretion of premiums and discounts on securities                           (125,000)              (8,000)
   Amortization of deferred loan fees                                               (78,000)             (33,000)
   Gain on sale of fixed assets                                                           -               (4,000)
   Provision for depreciation                                                        56,000               56,000
   Vested ESOP expense                                                              219,000                    -
   Vested Management Recognition Plan                                             1,198,000                    -
   Deferred Income Taxes                                                            125,000             (256,000)
   (Increase) Decrease in  assets:
     Accrued interest receivable                                                    530,000           (1,096,000)
     Prepaid and other assets                                                       175,000            1,600,000
  Increase (Decrease) in liabilities:
     Accounts payable and other liabilities                                          17,000           (1,960,000)
      Interest payable                                                                6,000               82,000
     Checks outstanding on disbursement
        accounts                                                                   (181,000)            (364,000)
                                                                  ----------------------------------------------
       Net cash provided (used) by operating activities                           2,201,000             (623,000)
                                                                  ----------------------------------------------

  
Cash Flows from Investing Activities
  Purchases of securities held to maturity                                                -          (19,307,000)
  Purchases of securities available for sale                                     (8,072,000)         (56,264,000)
  Redemption (Purchase) of FHLB stock                                               543,000           (1,359,000)
  Proceeds from maturities and recalls of securities available
      for sale                                                                   37,854,000            4,000,000
  Principal collected on securities held to maturity                              3,500,000            1,596,000
  Loan originations and principal payments on loans, net                          1,738,000             (796,000)
  Purchase of office properties and equipment                                        (2,000)             (33,000)
  Proceeds from sale of fixed assets                                                      -               30,000
                                                                  ----------------------------------------------
         Net cash provided (used) by investing activities                        35,561,000          (72,133,000)
                                                                  ----------------------------------------------

                                               (Continued)
</TABLE>

                                       4
<PAGE>
 
SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY (CONTINUED)
CONSOLIDATED STATEMENT OF CASH FLOWS
Six Months Ended March 31, 1998 and 1997


<TABLE>
<CAPTION>
 
                                                                               1998                 1997
-----------------------------------------------------------------------------------------------------------
<S>                                                                 <C>                  <C>       
Cash Flows from Financing Activities
  Net increase (decrease) in deposits                               $        5,121,000   $      (52,051,000)
  Net increase (decrease) in advance payments by borrowers for
       taxes and insurance                                                     207,000              236,000
  Proceeds received from issuance of common stock
       net of stock issuance costs incurred                                          -           43,645,000
  Principal receipts for ESOP debt                                              72,000              129,000
  Note receivable originated to ESOP                                                 -           (4,528,000)
  Proceeds from issuance of short-term debt                                 18,000,000                    -
  Dividends paid to stockholders                                           (28,993,000)            (330,000)
  Proceeds from Federal Home Loan Bank borrowings                          (20,000,000)          35,000,000
                                                                  -----------------------------------------
       Net cash provided (used) by financing activities                    (25,593,000)          22,101,000
                                                                  -----------------------------------------
 
       Increase (decrease) in cash and cash equivalents                     12,169,000          (50,655,000)
Cash and cash equivalents:
  Beginning                                                                 27,644,000           62,135,000
                                                                  -----------------------------------------
  Ending                                                            $       39,813,000   $       11,480,000
                                                                  =========================================
 
Supplemental Disclosures of Cash Flow Information
  Cash and cash equivalents:
      Cash and short-term investments:
             Noninterest-bearing                                    $        2,454,000   $        2,498,000
             Interest-bearing                                               31,929,000            4,722,000
             Federal Funds Sold                                              5,430,000            4,260,000
                                                                  -----------------------------------------
                                                                    $       39,813,000   $       11,480,000
                                                                  =========================================
 
 
Net change in unrealized (gain) loss on securities available 
      for sale, net of deferred taxes (credits)                     $          (54,000)  $         (382,000)
                                                                  =========================================
 
 
See Notes to Consolidated Financial Statements.
</TABLE>

                                       5
<PAGE>
 
SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)


Note 1.     Nature of Business

Prior to October 2, 1996, Home Savings Bank of Albemarle, Inc., S.S.B. (the
"Bank") operated as a mutual North Carolina-chartered savings bank.  On October
2, 1996, the Bank converted from a North Carolina-chartered mutual savings bank
to a North Carolina-chartered savings bank (the "Conversion").  In connection
with the Conversion, all of the issued and outstanding capital stock of the Bank
was acquired by South Street Financial Corp., a North Carolina corporation (the
"Company") which was organized to become the holding company for the Bank.  At
that time, the Company had an initial public offering of its common stock, no
par value (the "Common Stock").

The Company is a bank holding company registered with the Board of Governors of
the Federal Reserve System (the "Federal Reserve") under the Bank Holding
Company Act of 1956, as amended (the "BHCA") and the savings bank holding
company laws of North Carolina.  The Company's office is located at 155 West
South Street,  Albemarle, North Carolina.  The Company's activities consist of
investing the proceeds of its initial public offering which half of proceeds
were retained at the holding company level, holding the indebtedness outstanding
from the Home Savings Bank of Albemarle, Inc., SSB Employee Stock Ownership Plan
(the "ESOP") and owning the Bank.  The Company's principal sources of income are
earnings on its investments and interest payments received from the ESOP with
respect to the ESOP loan.  In addition, the Company will receive any dividends
which are declared and paid by the Bank on its capital stock.

The Bank was originally chartered in 1911.  It has been a member of the Federal
Home Loan Bank ("FHLB") system since 1954 and its deposits are federally insured
up to allowable limits.  The Bank is engaged primarily in the business of
attracting retail deposits from the general public and using such deposits to
make mortgage loans secured by real estate.  The Bank makes mortgage loans
secured by residential real property, including one-to-four family residential
real estate loans, home equity line of credit loans and other subordinate lien
loans, loans secured by improved nonresidential real property, loans secured by
undeveloped real property and construction loans.  The Bank also makes a limited
number of loans which are not secured by real property, such as loans secured by
savings accounts.  The Bank's primary source of revenue is interest income from
its lending activities.  The Bank's other major sources of revenue are interest
and dividend income from investments and mortgage backed securities, interest
income from its interest-bearing deposit balances in other depository
institutions and fee income from its lending and deposit activities.  The major
expenses of the Bank are interest on deposits and noninterest expenses such as
compensation and fringe benefits, federal deposit insurance premiums, data
processing expenses and branch occupancy and related expenses.

                                       6
<PAGE>
 
SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)


Note 2.   Basis of Presentation

The accompanying unaudited consolidated financial statements (except for the
statement of financial condition at September 30, 1997, which is taken from
audited financial statements) have been prepared in accordance with generally
accepted accounting principles for interim financial information and with the
instructions to Form 10-Q of Regulation S-X.  Accordingly, they do not include
all of the information and footnotes required by generally accepted accounting
principles for complete financial statements.  In the opinion of management, all
adjustments (none of which were other than normal recurring accruals) necessary
for a fair presentation of the financial position and results of operations for
the periods presented have been included.  The financial statements of the
Company are presented on a consolidated basis with those of Home Savings Bank.
The results of operations for the three and six month periods ended March 31,
1998 are not necessarily indicative of the results of operations that may be
expected for the year ended September  30, 1998.

The accounting policies of the company followed are as set forth in Note 1 of
the Notes to Financial Statements in the 1997 Home Savings financial statements.


Note 3.   Earnings Per Share

The Company's Basic earnings per share for the three and six month periods ended
March 31, 1998 and 1997 is based on net income earned divided by the weighted
average number of shares outstanding from the beginning of the three and six
months period to the end of the three and six month periods and diluted earnings
per share is adjusted for the conversion, exercise or issuance of all potential
common stock instruments. For purposes of this computation, the number of shares
of common purchased by the Bank's employee stock ownership plan which have not
been allocated to participant accounts are not assumed to be outstanding.

Note 4.   Dividends Declared

On March 9, 1998, the Board of Directors of South Street Financial Corp.
declared a dividend of $ .10 a share for stockholders of record as of March 25,
198 and payable on April 8, 1998.  In addition, on March 9, 1998, the Board of
Directors of Home Savings declared an upstream dividend of $467,636 to South
Street Financial Corp.

                                       7
<PAGE>

SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 
Note 5.      Notes Payable and Advances From Federal Home Loan Bank
<TABLE> 
<S>                                                                        <C> 
Notes payable at March 31, 1998 consist of the following:

  Note payable to Bankers' Bank, interest at 8.00%, due December, 1998     $     18,000,000

Advances from the Federal Home Loan Bank ("FHLB") at March 31, 1998 consist of the following:

  Advances due FHLB, interest at 5.98%, due June, 1998                     $     15,000,000
</TABLE> 


Note 6.  Stock Option Plan and the Bank's Management Recognition Plan

The Company's stockholders approved the Company's Stock Option Plan and the
Bank's Management Recognition Plan and the Trust (the "MRP") on October 15,
1997.  The Stock Option Plan reserves for issuance up to 449,650 stock options
to all officers, directors, and employees at the time of the adoption either in
the form of incentive stock options or non-incentive stock options.  The
exercise price of the stock options may not be less than the fair value of the
Company's common stock at date of grant.  The options awarded to employees,
which have not yet been granted will vest at the rate of 25% annually beginning
at the date of grant.  Options granted to non-employee directors will vest
immediately on the date of grant.  As permitted under the generally accepted
accounting principles, grants under the plan will be accounted for following the
provisions of APB Opinion No. 25 and its related interpretations.  Accordingly,
no compensation cost will be recognized on the grant date of any options.

The MRP reserved for issuance 179,860 shares of common stock to all officers,
directors, and employees at the time of adoption.  The Bank issued shares to
fund the MRP in October of 1997.  The restricted common stock under the MRP
vests at the rate of 25% annually beginning at the date of grant.

                                       8
<PAGE>
 
SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

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


This Form contains certain forward-looking statements consisting of estimates
with respect to the financial condition, results of operations and other
business of the Bank that are subject to various factors which could cause
actual results to differ materially from those estimates. Factors which could
influence the estimates include changes in general and local market conditions,
legislative and regulatory conditions and an adverse interest rate environment.

Comparison of Financial Condition at March 31, 1998 and September 30, 1997:

Total assets decreased by $24.1 million or 10.0%, to $216.9 million at March 31,
1998 from $241.0 million at September 30, 1997.  The decrease in assets was
primarily attributable to a decrease in liquidity and investment securities
which were used for repayment of the advances from Federal Home Loan Bank in the
amount of $20.0 million.

Net loans receivable decreased by $1.7 million or 1.5% to $110.3 million at
March 31, 1998 from $111.9 million at September 30, 1997.  Investment securities
held to maturity decreased $3.5 million or 16.3%, to $18.1 million at March 31,
1998 from $21.6 million at September 30, 1997.  Likewise, investment securities
classified as available for sale decreased $29.7 million or 40.2%, to $44.1
million at March 31, 1998 from $73.8 million at September 30, 1997. The decrease
was primarily due to the repayment of $20 million in borrowing from the FHLB.
The Bank had borrowings of $33.0 million outstanding at the end of the three
month period ended March 31, 1998 and $35.0 million at the end of September 30,
1997.  The borrowings of $15.0 million were used to finance the purchase of
investment securities which management has determined will provide a profitable
return as an arbitrage.  The Company also borrowed $18.0 million to help pay a
special one time dividend of $28.0 million to its stockholders.  These funds
will be repaid in October 1998.  The Bank has guaranteed the repayment of the
ESOP's note payable to the Company which it incurred on October 2, 1996 in order
to purchase 359,720 shares of stock in the Company.  The Company's note
receivable from the ESOP totaling $4.2 million, net of $72,000 principal
repayment made during the six months ended March 31, 1998, is reported as a
reduction of stockholders' equity.  Retained earnings decreased by $641,000 to
$21.6 million at March 31, 1998, which is attributable to the Company's
dividends accrued at March 31, 1998 of 468,000.  Additional paid-in capital
decreased by $24.6 million to $19.0 million at March 31, 1998 from $43.6 million
at September 30, 1997.  The decrease was primarily attributable to a one time
special dividend (return of capital) paid on January 8, 1998 in the amount of
$28.0 million.

At March 31, 1998, the Company's stockholders' equity amounted to $34.4 million,
or 15.9% of total assets.  As a North Carolina chartered stock savings bank, the
Bank is required to meet various capital standards established by federal and
state banking agencies.

                                       9
<PAGE>
 
SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

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


Comparison of Financial Condition at March 31, 1998 and September 30, 1997:
(Continued)

The Bank's level of nonperforming loans, defined as loans past due 90 days or
more was $468,000  and $510,000 at March 31, 1998 and September 30, 1997,
respectively.  During the three month periods ended March 31, 1998 and 1997, the
Bank's level of nonperforming loans remained consistently low in relation to
prior periods and to total loans outstanding, and the Bank's charge-offs of
loans was minimal. Management determined based on their analysis that no loan
loss provisions were necessary during the first two quarters of fiscal 1998.

The Company's stockholders approved the Company's Stock Option Plan and the
Bank's Management Recognition Plan and Trust (the"MRP") on October 15, 1997.
The Stock Option Plan reserves for issuance up to 449,650 stock options to all
officers, directors, and employees at the time of the adoption in the form of
incentive stock options or non-incentive stock options.  The exercise price of
the stock options was set at $12.00 per share by The Stock Option Plan Committee
on January 20, 1998, determined to be fair value at that date. The options
awarded to employees will vest at the rate of 25% annually. On January 20, 1998,
the date of grant, 89,930 options were granted to employees. Options granted to
nonemployee directors immediately on that date amounted to 89,930.  As permitted
under the generally accepted accounting principles, grants under the plan will
be accounted for following the provisions of APB Opinion No. 25 and its related
interpretations.  Accordingly, no compensation cost will be recognized on the
grant date of any options.  The MRP reserved for issuance 179,860 shares of
common stock to all officers, directors, and employees at the time of the
adoption.  The Bank issued shares to fund the MRP in October of 1997.  The
restricted common stock under the MRP vests at the rate of 25% annually
beginning at the date of grant.

                                       10
<PAGE>
 
SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

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


Comparison of Operating Results for the Three and Six Months Ended March 31,
1998 and 1997:

General.  Net income for the three month and six month periods ended March 31,
1998 was $260,000 and $259,000 respectively, or $469,000 and $1.1 million less
than the $729,000 and $1.3 million earned during the same period in 1997. As
discussed below, the decrease in net income was primarily attributable to the
expensing of the cost of the Management Recognition Plan (MRP) shares in the
amount of $200,000 for the three months period ended March 31, 1998 and in the
amount of $1.2 million for the six months period ended March 31, 1998.  This
expense represents the immediate vesting of 25% of the MRP shares in October
1997, and six months accruals of the next 25% vesting period.  The monthly
recognition of the MRP expense over the next three years will be $66,000.

Interest income.  Interest income decreased by $224,000 from $4.2 million for
the three months ended March 31, 1997 to $4.0 million for the three months ended
March 31, 1998.  Interest income increased by $214,000 from $8.1 million for the
six months ended March 31, 1997 to $8.3 million for the six months ended March
31, 1998. The increases were attributable in part to a slight overall increase
in market interest rates but were principally affected by a change in the volume
of interest-earning assets outstanding.

Interest Expense.  Interest expense on deposits and borrowed funds increased by
$272,000 from $2.18 million for the three months ended March 31, 1997 to $2.45
million for the three months ended March 31, 1998.  Interest expense on deposits
and borrowed funds increased by $623,000 from $4.12 million for the six months
ended March 31, 1997 to $4.74 million for the six months ended March 31, 1998.
The increase was primarily due to an increase in the volume of interest-bearing
deposits and borrowed funds for the six months ended March 31, 1998 compared to
the same period in 1997.  Home Savings prices its deposits to be at or near the
top of the market because of its dependence on the local market for funds
availability.  Interest expense incurred from the Federal Home Loan Bank
advances amounted to $298,000 for the quarter ended March 31, 1998 compared to
$386,000 for the quarter ended March 31, 1997.

Net interest income.  Net interest income decreased by $496,000 from $2.1
million for the three months ended March 31, 1997 to $1.6 million for the three
months ended March 31, 1998.  Net interest income decreased by $409,000 from
$4.0 million for the six months ended March 31, 1997 to $3.6 million for the six
months ended March 31, 1998.  These decreases were results of increases in the
volume of interest-bearing deposits and borrowed funds. The Bank's interest rate
spread decreased primarily because its deposits were more rate sensitive than
its interest earning assets, while overall market interest rates were higher
during the three month period ended March 31, 1998 as compared to the same
period in 1997.

Provision for loan losses.  There were no provisions for loan losses charged to
income during the three and six months ended March 31, 1998. Provisions, which
are charged to operations, and the resulting loan loss allowances are amounts
the Bank's management believes will be adequate to absorb losses on existing
loans that may become uncollectible.

                                       11
<PAGE>
 
SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

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


Provision for loan losses. (Continued)

Loans are charged off against the allowance when management believes that
collectibility is unlikely. The decision to increase or decrease the provision
and resulting allowances is based upon an evaluation of both prior loan loss
experience and other factors, such as changes in the nature and volume of the
loan portfolio, overall portfolio quality, and current economic conditions.  The
Bank's level of non-performing loans has remained consistently low in relation
to prior periods and total loans outstanding, and the Bank's charge-offs of
loans during either of  the three and six month periods ended March 31, 1998 and
1997 was minimal.

At March 31, 1998, the Bank's level of general valuation allowances for loan
losses amounted to $430,000, which management believes is adequate to absorb
potential losses in its loan portfolio.

Noninterest income.  Noninterest income increased by $37,000 from $30,000 for
the three month period ended March 31, 1997 to $67,000 for the three month
period ended March 31, 1998.  This increase was attributable to an increase in
various small items during the three months ended March 31, 1998 as compared to
the same period in 1997.  Noninterest income increased by $26,000 from $58,000
for the six month period ended March 31, 1997 to $84,000 for the six month
period ended March 31, 1998.

Noninterest expense.  Noninterest expense increased by $264,000 from $950,000
for the three month period ended March 31, 1997 to  $1.2 million for the three
month period ended March 31, 1998 and for the six month period ended March 31,
1998, noninterest expense increased by $1.3 million to $3.2 million from $1.9
million for the six month period ended March 31, 1997.  The increase in
noninterest expense is principally due to an increase in benefits expense
associated with the establishment of an ESOP and the Management Recognition Plan
as discussed below.

As a part of the conversion, the Company established an ESOP that acquired a
total of 359,720 shares of the stock offered in the conversion with funds
provided in the form of a loan from the Company.  The loan is expected to be
repaid over a fifteen year period with funds provided by the Bank sufficient to
amortize the debt.  The expense associated with the ESOP is reported in
accordance with SOP 93-6 "Employers' Accounting for Employee Stock Ownership
Plans."

The MRP reserved for issuance 179,860 shares of common stock to all officers,
directors and employees on the adoption date of October 15, 1997.  The Bank
issued shares to fund the MRP in October of 1997.  The restricted common stock
under the MRP vests at the rate of 25% annually.  The expense recorded in the
six months ended March 31, 1998 represents the immediate vesting of 25% of MRP
shares and six months accrual of the next 25% vesting amount.

Capital Resources and Liquidity:

The term "liquidity" generally refers to an organization's ability to generate
adequate amounts of funds to meet its needs for cash.  More specifically for
financial institutions, liquidity ensures that adequate funds are available to
meet deposit withdrawals, fund loan and capital expenditure commitments,
maintain reserve requirements, pay operating expenses, and provide funds for
debt service, dividends to stockholders, and other institutional commitments.
Funds are primarily provided through financial resources from operating
activities, expansion of the deposit base, borrowings, through the sale or
maturity of investments, the ability to raise equity capital, or maintenance of
shorter term interest-earning deposits.

                                       12
<PAGE>
 
SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

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


Capital Resources and Liquidity (Continued)

During the six month period ended March 31, 1998, cash and cash equivalents, a
significant source of liquidity, increased by approximately $12.2 million.  This
increase is a direct result of the Company's proceeds from maturities and sales
of securities. Cash flow resulting from internal operating activities provided
for a increase of $2.2 million in cash during the six month period ended March
31, 1998.  Financing activities, principally the repayment of Federal Home Loan
Bank borrowings in the amount of $20.0 million and the payment of a one time
special dividend in the amount of $28.0 million provided for a decrease of $25.6
million in cash. Investing activities, principally proceeds from maturities and
sales of securities for $37.9 million provided an additional $35.5 million.

As a state chartered stock savings bank, Home Savings must meet certain
liquidity requirements which are established by the Administrator.  Home's
liquidity ratio at March 31, 1998, as computed under such regulations, was
considerably in excess of such requirements.  Given its excess liquidity and its
ability to borrow from the Federal Home Loan Bank of Atlanta, Home Savings
believes that it will have sufficient funds available to meet anticipated future
loan commitments, unexpected deposit withdrawals, or other cash requirements.

The FDIC requires Home Savings to have a minimum leverage ratio of Tier I
Capital (principally consisting of retained earnings and any common
stockholders' equity, less any intangible assets) to all assets of at least 3%,
provided that it receives the highest rating during the examination process.
For institutions that receive less than the highest rating, the Tier I capital
requirement is 1% to 2% above the stated minimum.  The FDIC also requires the
Bank to have a ratio of total capital to risk-weighted assets of 8%, of which at
least 4% must be in the form of Tier I capital.  The Administrator requires a
net worth equal to at least 5% of total assets.  Home Savings complied with all
of the capital requirements of both the FDIC and the Administrator at March 31,
1998.

The consolidated financial statements and accompanying footnotes have been
prepared in accordance with generally accepted accounting principles, which
require the measurement of financial position and operating results in terms of
historical dollars without consideration for changes in the relative purchasing
power of money over time due to inflation.  The assets and liabilities of the
Company are primarily monetary in nature and changes in interest rates have a
greater impact on the Company's performance than do the effect of inflation.

Year 2000.  At the turn of the century, computer-based information systems will
be faced with the problems potentially affecting hardware, software, networks,
processing platforms, as well as customer and vendor interdependencies.  The
Company has established a committee and is in the process of assessing the
effect of Year 2000 on the Bank's operating plans and systems.  The Company is
developing a plan for identifying, renovating, testing and implementing its
systems for Year 2000 processing and internal control requirements.  The cost
for becoming Year 2000 compliant has not been determined, however, management
feels it will not be material to the Company's financial statements.

                                       13
<PAGE>
 
SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

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


Item 3.  Quantitative and Qualitative disclosures about Market Risk

The company has not experienced any material changes in its portfolio risk
during the six month period ended March 31, 1998.


                                       14
<PAGE>
 
Part II.  OTHER INFORMATION

    Item 1.  Legal Proceedings

             The Company is not engaged in any legal proceedings at the present
             time. From time to time, the Bank is a party to legal proceedings
             within the normal course of business wherein it enforces its
             security interest in loans made by it, and other matters of a
             similar nature.

    Item 2.  Changes in Securities and Use of Proceeds
 
             Not applicable
 
    Item 3.  Defaults Upon Senior Securities
             
             Not applicable
 
    Item 4.  Submission of Matters to a Vote of Security Holders
 
             The Annual Meeting of the Stockholders was held on February 9,
             1998. The purpose of the meeting was to elect six directors for the
             Company for one-year terms and to ratify the selection of McGladrey
             & Pullen, LLP as the independent auditor of the Company for the
             fiscal year ending September 30, 1998. The following table sets
             forth information as to each of the votes:

<TABLE> 
<CAPTION> 
                                                      Votes Against     Abstentions   
      (1).   Election of Directors        Votes For   or Withheld     Broker Non-votes 
             ---------------------        ---------   -------------   ----------------
             <S>                          <C>         <C>             <C> 
             Caldwell A. Holbrook, Jr.    4,124,693        30,000             0
             Joel A. Huneycutt            4,124,693        30,000             0
             Douglas D. Stokes            4,124,693        30,000             0
             Greg E. Underwood            4,124,693        30,000             0
             Carl M. Hill                 4,124,693        30,000             0
             R. Ronald Swanner            4,124,693        30,000             0

      (2).   Ratify Selection of Auditor  4,146,568         7,050         1,075
             ---------------------------                    
</TABLE> 

                                       15
<PAGE>
 
     Item 5.   Other Information

               Not applicable

     Item 6.   Exhibits and Reports on Form 8-K

               (a)  Exhibits

                    Exhibit (27) Financial Data Schedule

               (b)  Reports on Form 8-K

                                       16
<PAGE>
 
SIGNATURES

    Pursuant to the requirements of the Securities Exchange Act of 1934, the
    Registrant has duly caused this report to be signed on its behalf by the
    undersigned thereunto duly authorized.

                                         South Street Financial Corp.

     Dated     5/11/98                   By:  /s/ Carl M. Hill
          -----------------                   ---------------------------
                                              Carl M. Hill
                                         President and Chief Executive Officer

     Dated     5/11/98                   By:  /s/ Christopher F. Cranford
          -----------------                   ---------------------------
                                              Christopher F. Cranford
                                         Treasurer and Controller

                                       17