<PAGE>   1
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                   FORM 10-KSB

[ X ]   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
        ACT OF 1934

                      FOR THE YEAR ENDED SEPTEMBER 30, 1996

                                       OR

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
    ACT OF 1934

                         Commission File Number: 0-25328

                         FIRST KEYSTONE FINANCIAL, INC.
             (Exact name of registrant as specified in its charter)

                Pennsylvania                         23-0469351
 (State or other jurisdiction                     (I.R.S. Employer
 of incorporation or organization)               Identification Number)

            22 WEST STATE STREET
            MEDIA, PENNSYLVANIA                             19063
   (Address of principal executive office)                (Zip Code)

       Registrant's telephone number, including area code: (610) 565-6210

           Securities registered pursuant to Section 12(b) of the Act:
                                 NOT APPLICABLE

           Securities registered pursuant to Section 12(g) of the Act:

                     COMMON STOCK (PAR VALUE $.01 PER SHARE)

Indicate by check mark whether the Registrant (1) has filed all reports required
by Section 13 or 15(d) of the Securities 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
                      ---   ---

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-B is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB.

As of December 16, 1996, the aggregate value of the 1,083,038 shares of Common
Stock of the Registrant issued and outstanding on such date, which excludes
209,462 shares held by all directors and officers of the Registrant as a group,
was approximately $21.7 million. This figure is based on the last known trade
price of $20.00 per share of the Registrant's Common stock on December 16, 1996.

Number of shares of Common Stock outstanding as of December 16, 1996:  1,292,500

                       DOCUMENTS INCORPORATED BY REFERENCE

List hereunder the following documents incorporated by reference and the Part of
the Form 10-KSB into which the document is incorporated:

 (1) Portions of the Annual Report to Stockholders for the fiscal year ended
     September 30, 1996 are incorporated into Parts II and III.

 (2) Portions of the definitive proxy statement for the Annual Meeting of
     Stockholders are incorporated into Part III.
<PAGE>   2
PART I.

Item 1.  BUSINESS

GENERAL

     First Keystone Financial, Inc. (the "Company") is a Pennsylvania
corporation and sole shareholder of First Keystone Federal Savings Bank (the
"Bank") which converted to the stock form of organization in January 1995. The
only significant assets of the Company are the capital stock of the Bank, the
Company's loans to its employee stock ownership plan, and the net conversion
proceeds retained by the Company. The business of the Company primarily consists
of the business of the Bank.

     The Bank is a traditional, community oriented federal savings bank
emphasizing customer service and convenience. The Bank's primary business is to
attract deposits from the general public and investing those funds together with
other available sources of funds, such as borrowings, to originate loans. A
substantial portion of the Bank's deposits are comprised of core deposits which
amounted to $90.5 million or 41.3% of the Bank's total deposits at September 30,
1996. The Bank's primary lending emphasis has been, and continues to be, loans
secured by first and second liens on single-family (one-to-four units)
residences located in Delaware and Chester Counties, Pennsylvania and to a
lesser degree, Montgomery County, Pennsylvania and New Castle County, Delaware.
The Bank also lends on single family residences secured by first mortgages for
non-conforming jumbo loans and loans to credit impaired borrowers for sale in
the secondary market. To a lesser extent, the Bank also originates consumer
loans (consisting almost entirely of home equity loans and lines of credit),
loans secured by commercial real estate and multi-family (over four units)
residential properties, construction and land loans, commercial business and
other mortgage loans. The Bank originates mortgage loans for resale into the
secondary market while retaining for its portfolio adjustable-rate mortgage
loans and fixed-rate loans that complement the Bank's asset/liability
strategies. The Bank also sells, servicing released, originations of
non-conforming loans. Although the Bank has not purchased either whole loans or
loan participation interests in the past, depending on market conditions and
portfolio needs, the Bank may consider purchasing loans and participation
interests in the future. The Bank also originates, due to their shorter terms,
adjustable or variable interest rates, higher yields and the Bank's analysis
that the markets have become more stable, loans secured by commercial real
estate properties as well as residential construction loans in the Bank's market
area.

     The Bank's originations of consumer loans has continued to increase as a
direct result of the Bank's emphasis on developing home equity type loan
products. Consumer loans, which consist primarily of home equity loans and home
equity lines of credit, amounted to $24.0 million or 13.5% of the total loan
portfolio at September 30, 1996 as compared to $21.1 million or 12.6% at
September 30, 1995.

     In addition to its deposit gathering and lending activities, the Bank
invests in mortgage-backed and mortgage-related securities, substantially all of
which are issued or guaranteed by U.S. Government agencies and government
sponsored enterprises, as well as U.S. Treasury and federal government agency
obligations and other investment securities. At September 30, 1996, the Bank's
mortgage-related securities (including mortgage-related securities available for
sale) amounted to $83.4 million, or 28.4% of the Company's total assets, and
investment securities amounted to $16.5 million, or 5.6% of total assets.
<PAGE>   3
MARKET AREA

     The Bank's primary market area consists of Delaware County and to a lesser
extent the contiguous counties of Chester and Montgomery Counties, Pennsylvania
and New Castle County, Delaware. Delaware County is part of the Philadelphia
Metropolitan Statistical Area ("MSA") which includes, besides Delaware County,
Bucks, Chester, Montgomery and Philadelphia Counties (as well as three counties
in New Jersey). The Philadelphia area economy is typical of many large northeast
and midwest cities where the traditional manufacturing based economy has
declined to a certain degree and has been replaced with service sector growth.
As a result of such growth, the Philadelphia MSA's economic diversity has
broadened and employment in the area is derived from a number of different
employment sectors. In particular, Delaware County has experienced the
development of companies providing products and services for the health care
market such as Crozer/Keystone Health System, Wyeth-Ayerst Labs, Inc. and Mercy
Health Corp.

     Philadelphia's central location in the northeast corridor, its well
educated and skilled population base, infrastructure and other factors has made
the Bank's market area attractive to many large corporate employers. Such
employers include Boeing, UNISYS, CIGNA, Bell Atlantic, ALCO, Sun Company and
many others. There are also a number of Fortune 500 companies headquartered in
the region surrounding the Philadelphia MSA including E.I. DuPont, Bethlehem
Steel, Union Pacific, Hercules and others.

     Delaware County has experienced somewhat slower population growth than the
Philadelphia MSA, although the growth rates in the outlying areas of Delaware
County have been growing at a rate above that of the Philadelphia MSA. The
annual population growth rate in Delaware County has averaged approximately .2%
since 1990 and is not expected to increase materially during the rest of the
decade. By comparison, median household income in Delaware County is above that
for the Philadelphia MSA (approximately $40,000 as compared to approximately
$32,600 in the 1990 census). Likewise, median home values in Delaware County
were approximately $113,200 as compared to approximately $100,800 for the
Philadelphia MSA. Unemployment rates in the Delaware County have been below
those experienced by the Philadelphia MSA but higher than some of the other
counties comprising the MSA. The average annual unemployment rate for 1996 in
Delaware County was 4.6% as compared to 5.2% for the Philadelphia MSA.

                                        2
<PAGE>   4
ASSET AND LIABILITY MANAGEMENT

     The principal objective of the Company's asset and liability management
function is to evaluate the interest rate risk included in certain balance sheet
accounts, determine the level of risk appropriate given the Company's business
focus, operating environment, capital and liquidity requirements and performance
objectives, establish prudent asset concentration guidelines and manage the risk
consistent with Board approved guidelines. Through such management, the Company
seeks to reduce both the vulnerability of its operations to changes in interest
rates and to manage the ratio of interest-rate sensitive assets to interest-rate
sensitive liabilities within specified maturities or repricing dates. The
Company's actions in this regard are taken under the guidance of the
Asset/Liability Committee ("ALCO"), which is chaired by the Chief Financial
Officer and comprised of members of the Company's senior and middle management.
The ALCO meets quarterly to review, among other things, the sensitivity of the
Company's assets and liabilities to interest rate changes, the book and market
values of assets and liabilities, unrealized gains and losses, purchase and sale
activity and maturities of investments and borrowings. In connection therewith,
the ALCO generally reviews the Company's liquidity, cash flow needs, maturities
of investments, deposits and borrowings, current market conditions and interest
rates. In addition, the pricing of the Company's residential loans and deposits
is reviewed at least weekly while the pricing of loans originated for sale in
the secondary market is reviewed daily. The ALCO reports to the Company's Board
of Directors on a quarterly basis.

     The Company's primary ALCO monitoring tool is asset/liability simulation
models, which are prepared on a quarterly basis and are designed to capture the
dynamics of balance sheet, rate and spread movements and to quantify variations
in net interest income under different interest rate environments. The Company
also utilizes market value analysis, which addresses the change in equity value
arising from movements in interest rates. The market value of equity is
estimated by valuing the Company's assets and liabilities. The extent to which
assets have gained or lost value in relation to the gains or losses of
liabilities determines the appreciation or depreciation in equity on a market
value basis. Market value analysis is intended to evaluate the impact of
immediate and sustained shifts of the current yield curve upon the market value
of the current balance sheet.

     A more conventional but limited ALCO monitoring tool involves an analysis
of the extent to which assets and liabilities are "interest rate sensitive" and
measures an institution's interest rate sensitivity "gap." An asset or liability
is said to be interest rate sensitive within a specific time period if it will
mature or reprice within that time period. The interest rate sensitivity "gap"
is defined as the difference between interest-earning assets and
interest-bearing liabilities maturing or repricing within a given time period. A
gap is considered positive when the amount of interest rate sensitive assets
exceeds the amount of interest rate sensitive liabilities. A gap is considered
negative when the amount of interest rate sensitive liabilities exceeds interest
rate sensitive assets. During a period of rising interest rates, a negative gap
would tend to adversely affect net interest income, while a positive gap would
tend to result in an increase in net interest income. During a period of falling
interest rates, a negative gap would tend to result in an increase in net
interest income, while a positive gap would tend to affect net interest income
adversely. While a conventional gap measure may be useful, it is limited in its
ability to predict trends in future earnings. It makes no presumptions about
changes in prepayment tendencies, deposit or loan maturity preferences or
repricing time lags that may occur in response to a change in the interest rate
environment.

                                        3
<PAGE>   5
     The following table summarizes the anticipated maturities or repricing of
the Bank's interest-earning assets and interest-bearing liabilities as of
September 30, 1996, based on the information and assumptions set forth in the
notes.

<TABLE>
<CAPTION>
                                                                                   More Than       More Than
                                               Within              Six to           One Year         Three
                                                 Six               Twelve           to Three        Years to
                                               Months              Months            Years         Five Years
                                               ------              ------            -----         ----------
                                                                    (Dollars in thousands)
<S>                                          <C>                <C>             <C>             <C>
Interest-earning assets(1):
  Loans receivable(2):
    Mortgage loans:
      Residential                              $ 28,589         $ 19,098         $ 29,759         $ 14,192
      Commercial and multi-family                 4,040            3,604            1,256            1,197
      Construction and land                      11,314
      Consumer and commercial
        business loans                            6,326            2,177            7,091            5,272
                                               --------         --------         --------         --------
        Total loans receivable                   50,269           24,879           38,106           20,661
  Mortgage-related securities(3)                 31,732            7,205           23,945           18,621
  Assets held for sale                            2,447
  Investment securities(4)                        1,000            1,492            1,125
  Interest-earning deposits                       9,824
                                               --------         --------         --------         --------
      Total interest-earning assets            $ 95,272         $ 33,576         $ 63,176         $ 39,282
                                               ========         ========         ========         ========

Interest-bearing liabilities:
  Deposits(5)                                  $ 66,688         $ 55,590         $ 71,528         $ 25,399
  FHLB advances                                  30,900           10,000            5,000              350
                                               --------         --------         --------         --------
      Total interest-bearing liabilities       $ 97,588         $ 65,590         $ 76,528         $ 25,749
                                               ========         ========         ========         ========

Excess (deficiency) of interest-
  earning assets over interest-bearing
  liabilities                                  $ (2,316)        $(32,014)        $(13,352)        $ 13,533
                                               ========         ========         ========         ========

Cumulative excess (deficiency) of
  interest-earning assets over interest-
  bearing liabilities                          $ (2,316)        $(34,330)        $(47,682)        $(34,149)
                                               ========         ========         ========         ========

Cumulative excess (deficiency) of
  interest-earning assets over interest-
  bearing liabilities as a percentage of
  total assets                                     (.79)%         (11.67)%         (16.21)%         (11.61)%
                                               ========         ========         ========         ========
</TABLE>


<TABLE>
<CAPTION>
                                               Over
                                               Five
                                              Years              Total
                                              -----              -----

                                              <C>             <C>
Interest-earning assets(1):
  Loans receivable(2):
    Mortgage loans:
      Residential                              $ 29,166        $120,804
      Commercial and multi-family                   977          11,074
      Construction and land                                      11,314
      Consumer and commercial
        business loans                            2,256          23,122
                                               --------        --------
        Total loans receivable                   32,399         166,314
  Mortgage-related securities(3)                  1,929          83,432
  Assets held for sale                                            2,447
  Investment securities(4)                       15,151          18,768
  Interest-earning deposits                                       9,824
                                               --------        --------
      Total interest-earning assets            $ 49,479        $280,785
                                               ========        ========

Interest-bearing liabilities:
  Deposits(5)                                  $               $219,205
  FHLB advances                                     490          46,740
                                               --------        --------
      Total interest-bearing liabilities       $    490        $265,945
                                               ========        ========

Excess (deficiency) of interest-
  earning assets over interest-bearing
  liabilities                                  $ 48,989        $ 14,840
                                               ========        ========

Cumulative excess (deficiency) of
  interest-earning assets over interest-
  bearing liabilities                          $ 14,840
                                               ========

Cumulative excess (deficiency) of
  interest-earning assets over interest-
  bearing liabilities as a percentage of
  total assets                                     5.04%
                                               ========
</TABLE>
                                            (footnotes on following page)





                                        4
<PAGE>   6
 (1) Adjustable-rate loans are included in the period in which interest rates
     are next scheduled to adjust rather than in the period in which they are
     due, and fixed-rate loans are included in the periods in which they are
     scheduled to be repaid, based on scheduled amortization, in each case as
     adjusted to take into account estimated prepayments based on assumptions
     estimating the prepayments in the expected interest rate environment.
     Annual prepayment speeds for loans range from 5% to 15%. Annual prepayment
     speeds for mortgage-related securities and investment securities range from
     9% to 15%.

 (2) Balances have been reduced for non-accruing loans, which amounted to $5.4
     million at September 30, 1996 and, with respect to construction loans, the
     amount of loans in process.

 (3) Includes mortgage-related securities available for sale.

 (4) Includes $2.3 million of stock in the FHLB of Pittsburgh.

 (5) Management believes that the assumptions used by it to evaluate the
     vulnerability of the Bank's operations to changes in interest rates are
     conservative and consider them reasonable. However, the interest rate
     sensitivity of the Bank's assets and liabilities as portrayed in the table
     above could vary substantially if different assumptions were used or actual
     experience differs from the assumptions used in the table. Passbook and
     statement savings accounts are assumed to decay at a rate of 30.0%, 30.0%,
     and 40.0% in the first three years, respectively. MMDA and NOW accounts are
     assumed to decay at a rate of 75% and 25%, in one year or less and over one
     year, respectively. The percentages used in the first year are equally
     divided over the two six month periods. First Keystone's passbook,
     statement savings, MMDA and NOW accounts are generally subject to immediate
     withdrawal. However, management considers a portion of these deposits to be
     core deposits having significantly longer effective maturities based upon
     the Bank's retention of such deposits in changing interest rate
     environments.


                                        5
<PAGE>   7
     Lending Activities

     Loan Portfolio Composition. The following table sets forth the composition
of the Bank's loan portfolio by type of loan at the dates indicated (excluding
loans held for sale).

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


                                                        1996                    1995                     1994
                                               ----------------         ----------------        ---------------------


                                                 Amount        %         Amount         %        Amount         %
                                               --------     ------      -------      ------     --------     --------
                                                                         (Dollars in thousands)
<S>                                             <C>         <C>          <C>        <C>          <C>          <C>

Real estate loans:
  Single-family                                  $122,270     68.68%      $115,225   69.01%       $105,728      69.77%
  Multi-family and commercial                      11,129      6.25         11,789     7.06         12,700       8.38
  Construction and land                            17,682      9.93         16,343     9.79         13,805       9.11
                                                  -------   -------        -------   ------        -------     ------
      Total real estate loans                     151,081     84.86        143,357    85.86        132,233      87.26
                                                  -------   -------        -------   ------        -------     ------

Consumer:
  Home equity loans and lines
   of credit                                       20,444     11.48         18,229    10.92         15,603      10.30
  Deposit                                             457       .26            350      .21            374        .25
  Education                                           917       .52          1,010      .60            697        .46
  Other                                             2,212      1.24          1,491      .89            332        .22
                                                  -------   -------        -------   ------        -------    -------
    Total consumer loans                           24,030     13.50         21,080    12.62         17,006      11.23
                                                  -------   -------        -------   ------        -------    -------
Commercial business loans (1)                       2,923      1.64          2,533     1.52          2,288       1.51
                                                  -------   -------        -------   ------        -------    -------
      Total loans receivable                      178,034   100.00%        166,970   100.00%       151,527     100.00%
                                                  -------   ======         -------   ======        -------    ======

Less:

  Loans in process (construction                    6,368                    6,070                   6,698
    and land)
  Deferred loan origination fees
    and discounts                                   1,512                    1,411                   1,063
  Allowance for loan losses                         2,624                    1,487                   1,540
                                                  -------                  -------                 -------
                                                   10,504                    8,968                   9,301
                                                  -------                  -------                 -------
    Total loans receivable, net                  $167,530                 $158,002                $142,226
                                                  =======                  =======                 =======
</TABLE>









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


                                                1993                          1992
                                        ---------------------        ---------------------


                                          Amount           %           Amount          %
                                        ---------     ----------     -------      ---------
<S>                                       <C>            <C>          <C>           <C>

Real estate loans:
  Single-family                            $107,999       74.72%       $116,380       74.39%
  Multi-family and commercial                13,069         9.04         13,873        8.87
  Construction and land                      11,675         8.08         17,369       11.10
                                             ------       ------        -------      ------
      Total real estate loans               132,743        91.84        147,622       94.36
                                            -------       ------        -------      ------

Consumer:
  Home equity loans and lines
   of credit                                  7,995         5.53          6,824        4.36
  Deposit                                       477          .33            460         .29
  Education                                     669          .46            650         .41
  Other                                          39          .04             27         .02
                                            -------      -------        -------     -------
    Total consumer loans                      9,180         6.36          7,961        5.08
                                            -------      -------        -------     -------
Commercial business loans (1)                 2,608         1.80            870         .56
                                            -------      -------        -------     -------
      Total loans receivable                144,531       100.00%       156,453      100.00%
                                            -------      =======        --------     =======

Less:

  Loans in process (construction              4,984                       5,291
    and land)
  Deferred loan origination fees
    and discounts                             1,096                       1,273
  Allowance for loan losses                   1,265                       2,150
                                            -------                     -------
                                              7,345                       8,714
                                            -------                     -------
    Total loans receivable, net            $137,186                    $147,739
                                            =======                     =======
</TABLE>
-----------------------------

 (1) Consists as of September 30, 1996 of $1.6 million and $2.2 million of
     consumer and commercial business loans, respectively purchased from the
     Bennett Funding Companies. See "-Asset Quality - Non-Performing Assets."

                                        6
<PAGE>   8
     Contractual Principal Repayments. The following table sets forth the
scheduled contractual maturities of the Bank's loans held to maturity at
September 30, 1996. Demand loans, loans having no stated schedule of repayments
and no stated maturity and overdraft loans are reported as due in one year or
less. The amounts shown for each period do not take into account loan
prepayments and normal amortization of the Bank's loan portfolio held to
maturity.

<TABLE>
<CAPTION>
                                                                           Real Estate Loans
                                                      ---------------------------------------------------------
                                                                        Multi-family
                                                                            and        Construction
                                                      Single-family     Commercial       and Land       Total
                                                      -------------     ----------       --------      --------
                                                                      (In Thousands)                   
<S>                                                    <C>                <C>           <C>            <C>
Amounts due in:
  One year or less                                      $  5,618           $   488       $11,942       $ 18,048
  After one year through three years                      12,429             1,111         4,922         18,462
  After three years through five years                     8,897             1,319           818         11,034
  After five years through ten years                      21,961             3,822                       25,783
  After ten years through twenty
    years                                                 43,198             4,389                       47,587
  Over twenty years                                       30,167                                         30,167
                                                        --------           -------       -------       --------
    Total(1)                                            $122,270           $11,129       $17,682       $151,081
                                                        ========           =======       =======       ========

Interest rate terms on amounts due after one year:

  Fixed                                                                                                $ 70,113
  Adjustable                                                                                             62,920
                                                                                                       --------
    Total(1)                                                                                           $133,033
                                                                                                       ========
</TABLE>

<TABLE>
<CAPTION>
                                             Consumer and
                                               Commercial
                                            Business Loans              Total
                                           ----------------      ----------------
<S>                                          <C>                      <C>

Amounts due in:                                             
  One year or less                           $  8,424                  $ 26,472
  After one year through three years            6,281                    24,743
  After three years through five years          5,088                    16,122
  After five years through ten years            4,936                    30,719
  After ten years through twenty
    years                                       2,224                    49,811
  Over twenty years                                                      30,167
                                             --------                  --------
    Total(1)                                 $ 26,953                  $178,034
                                             ========                  ========

Interest rate terms on amounts due after one year:

  Fixed                                      $ 18,529                  $ 88,642    
  Adjustable                                                             62,920    
                                             --------                  --------     

    Total(1)                                 $ 18,529                  $151,562  
                                             ========                  ========    
</TABLE>

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

(1) Does not include adjustments relating to loans in process, allowances for
loan losses and deferred fee income.

                                        7
<PAGE>   9
     Scheduled contractual amortization of loans does not reflect the expected
term of the Bank's loan portfolio. The average life of loans is substantially
less than their contractual terms because of prepayments and due-on-sale
clauses, which give the Bank the right to declare a conventional loan
immediately due and payable in the event, among other things, that the borrower
sells the real property subject to the mortgage and the loan is not repaid. The
average life of mortgage loans tends to increase when current mortgage loan
rates are higher than rates on existing mortgage loans and, conversely, decrease
when rates on existing mortgage loans are lower than current mortgage loan rates
(due to refinancings of adjustable-rate and fixed-rate loans at lower rates).
Under the latter circumstances, the weighted average yield on loans decreases as
higher yielding loans are repaid or refinanced at lower rates.

     Loan Origination, Purchase and Sales Activity. The following table shows
the loan origination, purchase and sale activity of the Bank during the periods
indicated.

<TABLE>
<CAPTION>
                                                                                  Year Ended September 30,
                                                                                  ------------------------

                                                                        1996                 1995                1994
                                                                        ----                 ----                ----
                                                                                        (In thousands)

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

Gross loans at beginning of period(1)                                     $167,027             $151,695            $145,776
                                                                          --------             --------            --------
Loan originations for investment:
  Real estate:

    Residential                                                             23,766               24,562              19,163
    Commercial and multi-family                                                399                                      925
    Construction                                                            15,875               16,523              13,970
                                                                            ------              -------             -------
      Total real estate loans originated
        for investment                                                      40,040               41,085              34,058
   Consumer                                                                  9,738                9,063              11,540
   Commercial business                                                         875                2,872                 426
                                                                            ------              -------             -------
      Total loans originated for
        investment                                                          50,653               53,020              46,024
Loans originated for resale                                                 30,239                5,501              27,996
                                                                           -------              -------              ------
      Total originations                                                    80,892               58,521              74,020
                                                                           -------              -------             -------
Deduct:
  Principal loan repayments and
    prepayments                                                           (37,811)             (36,077)            (38,745)
  Transferred to real estate owned                                         (1,768)                (507)               (283)
  Loans sold in secondary market                                          (27,849)              (6,605)            (29,073)
                                                                          -------               ------             -------
      Subtotal                                                            (67,428)             (43,189)            (68,101)
                                                                          -------              -------             -------
Net increase  in loans(1)                                                  13,464               15,332               5,919
                      --                                                   ------               ------               -----

Gross loans at end of period(1)                                          $180,491             $167,027            $151,695
                                                                          =======              =======             =======
</TABLE>



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

(1) Includes loans held for sale of $2.4 million, $57,000 and $168,000 at
September 30, 1996, 1995 and 1994, respectively.

                                        8
<PAGE>   10
     The lending activities of the Bank are subject to written underwriting
standards and loan origination procedures established by the Bank's Board of
Directors and management. Applications for all types of loans are taken at all
of the Bank's branch offices by the branch manager or other designated loan
officers. Applications for single-family residential mortgage loans also are
obtained through loan originators who are employees of the Bank. The Bank's loan
originators will take loan applications outside of the Bank's offices at the
customer's convenience and are compensated on a commission basis. The Mortgage
Lending Department supervises the process of obtaining credit reports,
appraisals and other documentation involved with a loan. The Bank generally
requires that a property appraisal be obtained in connection with all new
mortgage loans. Property appraisals generally are performed by an independent
appraiser from a list approved by the Bank's Board of Directors. The Bank
requires that title insurance (other than with respect to home equity loans) and
hazard insurance be maintained on all security properties and that flood
insurance be maintained if the property is within a designated flood plain.

     Residential mortgage loan applications are primarily developed from
referrals from real estate brokers and builders, existing customers and walk-in
customers. Residential mortgage loans also are originated through
correspondents. Commercial and multi-family real estate loan applications are
obtained primarily from previous borrowers, direct solicitations by Bank
personnel, as well as referrals. Consumer loans originated by the Bank are
obtained primarily through existing and walk-in customers who have been made
aware of the Bank's programs by advertising and other means.

     Applications for residential mortgage loans which are originated for resale
in the secondary market or loans designated for portfolio retention that conform
to the requirements for resale into the secondary market and do not exceed
Federal National Mortgage Association ("FNMA")/Federal Home Loan Mortgage
Corporation ("FHLMC") limits are approved by the Bank's Chief Lending Officer or
in his absence, by the Senior Loan Underwriter or Loan Committee (a committee
comprised of three directors and the Bank's Chief Lending Officer). All other
first mortgage loans (commercial and multi-family residential real estate and
construction loans) and residential mortgage loans in excess of FNMA/FHLMC
maximum amounts, currently $203,150, but less than $500,000 must be approved by
the Loan Committee. All first mortgage loans in excess of $500,000 must be
approved by the Board or the Executive Committee thereof. All mortgage loans
which do not require approval by the Bank's Board of Directors are submitted to
the Board at its next meeting for review and ratification. Home equity loans and
lines of credit up to $50,000 can be approved by the Chief Lending Officer, the
Vice President of Construction Loans and the Senior Loan Underwriter. Loans in
excess of such amount must be approved by the Loan Committee.

     Applications for non-conforming residential real estate loans, submitted by
correspondents and sold servicing released into the secondary market, are
packaged and submitted for pre-approval to the buyer prior to closing. The Bank,
from time to time, also originates non-conforming loans in accordance with the
buyers' underwriting standards and sells them in bulk into the secondary market.

     Single-Family Residential Loans. Substantially all of the Bank's
single-family residential mortgage loans consist of conventional loans.
Conventional loans are loans that are neither insured by the Federal Housing
Administration or partially guaranteed by the Department of Veterans Affairs.
The vast majority of the Bank's single-family residential mortgage loans are
secured by properties located in Pennsylvania, primarily in the Delaware and
Chester Counties, and are originated under terms and documentation which permit
their sale to the FHLMC or FNMA. The Bank, consistent with its asset/liability
management strategies, sells some of its newly originated longer term fixed-rate
residential mortgage loans and to a limited degree, existing longer term
fixed-rate residential mortgage loans while retaining adjustable-rate mortgage
loans and shorter term fixed-rate residential mortgage loans. See "-
Mortgage-Banking Activities."

     The single-family residential mortgage loans offered by the Bank currently
consist of fixed-rate loans, including bi-weekly and balloon loans, and
adjustable-rate loans. Fixed-rate loans generally have maturities ranging from
15 to 30 years and are fully amortizing with monthly loan payments sufficient to
repay the total amount of the loan with interest by the end of the loan term.
The Bank's fixed-rate loans are originated under terms, conditions and
documentation which permit them to be sold to U.S. Government-sponsored
agencies, such as the FHLMC and the FNMA, and other investors in the secondary
mortgage market. The Bank also offers bi-weekly loans under the terms of which
the borrower makes payments every two weeks. Although such loans have a 30 year
amortization schedule, due to the bi-weekly payment schedule, such loans repay
substantially more rapidly than a standard monthly

                                        9
<PAGE>   11
amortizing 30-year fixed-rate loan. The Bank also offers five and seven year
balloon loans which provide that the borrower can conditionally renew the loan
at a to-be-determined rate for the remaining 25 or 23 years, respectively, of
the amortization period. At September 30, 1996, $69.4 million, or 56.7%, of the
Bank's single-family residential mortgage loans were fixed-rate loans, including
$21.3 million of bi-weekly fixed-rate residential mortgage loans.

     The adjustable-rate loans currently offered by the Bank have interest rates
which adjust every one or three years in accordance with a designated index,
such as U.S. Treasury obligations, adjusted to a constant maturity ("CMT"), plus
a stipulated margin. The Bank's adjustable-rate single-family residential real
estate loans generally have a cap of 2% on any increase or decrease in the
interest rate at any adjustment date, and a cap of 6% over the life of the loan.
In order to increase acceptance of adjustable-rate loans, the Bank recently has
been originating loans which are fixed for a period of ten years and then
convert to a one-year adjustable-rate loan. The Bank's adjustable-rate loans
require that any payment adjustment resulting from a change in the interest rate
of an adjustable-rate loan be sufficient to result in full amortization of the
loan by the end of the loan term and, thus, do not permit any of the increased
payment to be added to the principal amount of the loan, or so-called negative
amortization. Although the Bank does offer adjustable-rate loans with initial
rates below the fully indexed rate, such loans are underwritten using methods
approved by FHLMC and FNMA which allow borrowers to be qualified at 2% above the
discounted loan rate. At September 30, 1996, $52.9 million or 43.3% of the
Bank's single-family residential mortgage loans were adjustable-rate loans.

     Adjustable-rate loans decrease the risks associated with changes in
interest rates but involve other risks, primarily because as interest rates
increase the loan payment by the borrower increases to the extent permitted by
the terms of the loan, thereby increasing the potential for default. Moreover,
as with fixed-rate loans, as interest rates increase, the marketability of the
underlying collateral property may be adversely affected by higher interest
rates. The Bank believes that these risks, which have not had a material adverse
effect on the Bank to date because of the generally stable interest rate
environment in recent years, generally are less than the risks associated with
holding fixed-rate loans in an increasing interest rate environment.

     For conventional residential mortgage loans held in the portfolio and also
for those loans originated for sale in the secondary market, the Bank's maximum
loan-to-value ratio is 95%, and is based on the lesser of sales price or
appraised value. On all loans with a loan-to-value ratio of over 80%, private
mortgage insurance is required in an amount which reduces the Bank's exposure to
75%.

     Commercial and Multi-Family Residential Real Estate Loans. The Bank has
maintained a relative constant investment in commercial and multi-family lending
for many years. The Bank continues to maintain its involvement in commercial
real estate lending and intends to moderately increase the amount of such loans
in the Bank's portfolio. Such loans are being extended primarily to small and
medium-sized businesses located in the Bank's primary market area, a portion of
the market that the Bank believes has been underserved in recent years. Loans
secured by commercial and multi-family real estate amounted to $11.1 million, or
6.3%, of the Bank's total loan portfolio, at September 30, 1996. The Bank's
commercial multi-family residential real estate loans are secured by
professional office buildings, small retail establishments, warehouses and
apartment buildings (with 36 units or less) located in the Bank's market area.

     The Bank's multi-family residential and commercial real estate loans
generally are either one-year or three-year adjustable-rate loans indexed to the
CMT plus a margin. Generally, fees of 1% to 3% of the principal loan balances
are charged to the borrower upon closing. Although terms for multi-family
residential and commercial real estate loans may vary, the Bank's underwriting
standards generally provide for terms of up to 25 years with amortization of
principal over the term of the loan and loan-to-value ratios of not more than
75%. Generally, the Bank obtains personal guarantees of the principals of the
borrower as additional security for any commercial real estate and multi-family
residential loans and requires that the borrower have at least a 25% equity
investment in any such property.

     The Bank evaluates various aspects of commercial and multi-family
residential real estate loan transactions in an effort to mitigate risk to the
extent possible. In underwriting these loans, consideration is given to the
stability of the property's cash flow history, future operating projections,
current and projected occupancy, position in the market, location and physical
condition. In recent periods, the Bank has also generally imposed a debt
coverage ratio (the ratio of net cash from operations before payment of debt
service to debt service) of not less than 110%. The

                                       10
<PAGE>   12
underwriting analysis also includes credit checks and a review of the financial
condition of the borrower and guarantor, if applicable. An appraisal report is
prepared by a state-licensed and certified appraiser (generally MAI qualified)
commissioned by the Bank to substantiate property values for every commercial
real estate and multi-family loan transaction. All appraisal reports are
reviewed by the Bank prior to the closing of the loan.

     Multi-family and commercial real estate lending entails different and
significant risks when compared to single-family residential lending because
such loans often involve large loan balances to single borrowers and because the
payment experience on such loans is typically dependent on the successful
operation of the project or the borrower's business. These risks can also be
significantly affected by supply and demand conditions in the local market for
apartments, offices, warehouses or other commercial space. The Bank attempts to
minimize its risk exposure by limiting such lending to proven developers/owners,
only considering properties with existing operating performance which can be
analyzed, requiring conservative debt coverage ratios, and periodically
monitoring the operation and physical condition of the collateral.

     Construction Loans. Substantially all of the Bank's construction loans have
consisted of loans to construct single-family properties extended either to
individuals or to selected developers with whom the Bank is familiar to build
such properties on a pre-sold or limited speculative basis. With respect to
loans to individuals, such loans have a maximum term of six months, have
variable rates of interest based upon the prime rate published in the Wall
Street Journal ("Prime Rate") plus a margin, have loan-to-value ratios of 80% or
less of the appraised value upon completion and generally do not require the
amortization of principal during the term. Upon completion of construction, the
loans convert to permanent residential mortgage loans.

     The Bank also provides construction loans and lines of credit to
developers. The majority of such loans consist of loans to selected local
developers with whom the Bank is familiar to build single-family dwellings on a
pre-sold or, to a significantly lesser extent, on a speculative basis. The Bank
generally limits to two the number of unsold units which a developer may have
under construction in a project. Such loans generally have terms of 24 months or
less, have maximum loan-to-value ratios of 75% of the appraised value upon
completion and generally do not require the amortization of the principal during
the term. The loans are made with floating rates of interest based on the Prime
Rate plus a margin adjusted on a monthly basis. The Bank also receives
origination fees, which generally range from 1.0% to 3.0% of the commitment. The
borrower is required to fund a portion of the project's costs, the exact amount
determined on a case-by-case basis. Loan proceeds are disbursed in stages after
inspections of the project indicate that such disbursements are for costs
already incurred and which have added to the value of the project. Only interest
payments are due during the construction phase and the Bank may provide the
borrower with an interest reserve from which it can pay the stated interest due
thereon. The Bank's construction loans include loans to the developers to
acquire the necessary land, develop the site and construct the residential units
("ADC loans"). At September 30, 1996, construction loans included $851,000 of
ADC loans. At September 30, 1996, Paine Webber Group Inc. residential
construction loans totalled $10.6 million, or 5.9%, of the total loan portfolio,
of which $8.8 million consisted of construction loans to developers.

     The Bank also will originate ground or land loans, both to individuals to
purchase a building lot on which he intends to build his primary residence, as
well as to developers to purchase lots to build speculative homes at a later
date. Such loans have terms of 36 months or less with a maximum loan-to-value
ratio of 75% of the lower of appraised value or sale price with respect to loans
to individuals and 65% of the lower of appraised value or sales price with
respect to loans to developers. The loans are made with floating rates based on
the Prime Rate plus a margin. The Bank also receives origination fees, which
generally range between 1.0% and 3.0% of the loan amount. At September 30, 1996,
land loans (including loans to acquire and develop land) totalled $7.1 million
or 4.0% of the total loan portfolio.

     Prior to making a commitment to fund a construction loan, the Bank requires
an appraisal of the property by an independent state-licensed and qualified
appraiser approved by the Board of Directors. In addition, during the term of
the construction loan, the project is inspected by an independent inspector.

     Construction financing is generally considered to involve a higher degree
of risk of loss than long-term financing on improved, owner-occupied real
estate. Risk of loss on a construction loan is dependent largely upon the
accuracy of the initial estimate of the property's value at completion of
construction or development and the estimated cost

                                       11
<PAGE>   13
(including interest) of construction. During the construction phase, a number of
factors could result in delays and cost overruns. If the estimate of value
proves to be inaccurate, the Bank may be confronted, at or prior to the maturity
of the loan, with a project, when completed, having a value which is
insufficient to assure full repayment. Loans on lots may run the risk of adverse
zoning changes, environmental or other restrictions on future use.

     Consumer Lending Activities. The Bank offers consumer loans in order to
provide a full range of retail financial services to its customers. At September
30, 1996, $24.0 million, or 13.5%, of the Bank's total loan portfolio was
comprised of consumer loans. The Bank originates substantially all of such loans
in its primary market area.

     The largest component of the Bank's consumer loan portfolio consists of
home equity loans and home equity lines of credit (a form of revolving credit),
both of which are secured by the underlying equity in the borrower's primary
residence. Home equity loans are amortizing loans with fixed interest rates and
maximum terms of 15 years while equity lines of credit have adjustable interest
rates indexed to the Prime Rate. Generally home equity loans or home equity
lines do not exceed $100,000. The Bank's home equity loans and lines of credit
generally require combined loan-to-value ratios of 80% or less. At September 30,
1996, home equity loans amounted to $20.4 million, or 11.5%, of the Bank's total
loan portfolio.

     At September 30, 1996, the remaining portion of the Bank's consumer loan
portfolio was comprised of education, deposit and other consumer loans. At
September 30, 1996, the Bank had $917,000 or .52% of education loans, all of
which were underwritten to conform with the standards of the Pennsylvania Higher
Education Agency. Deposit loans and other consumer loans totalled $2.7 million,
or 1.5%, of the Bank's total loan portfolio at September 30, 1996. In April,
1995 the Bank introduced their own credit card program. The credit cards were
offered to only the Bank's most creditworthy customers. At September 30, 1996,
these loans totalled $465,000 or .26% of the total loan portfolio. Consumer
loans also included certain consumer leases purchased from the Bennett Funding
Group of $1.6 million. See "-Asset Quality - Non-Performing Assets" for a
discussion of the Bank's non-performing consumer loans.

     Consumer loans generally have shorter terms and higher interest rates than
mortgage loans but generally involve more credit risk than mortgage loans
because of the type and nature of the collateral and, in certain cases, the
absence of collateral. These risks are not as prevalent in the case of the
Bank's consumer loan portfolio, however, because a high percentage of the
portfolio is comprised of home equity loans and home equity lines of credit
which are secured by real estate and underwritten in a manner such that they
result in a lending risk which is substantially similar to single-family
residential loans.

     Commercial Business Loans. At September 30, 1996, lease financing
receivables amounted to $2.2 million or 1.2% of the Bank's total loan portfolio.
The remainder of commercial business loans consist of a limited number of
commercial lines of credit secured by real estate. A majority of such portfolio
consisted of office equipment and other leases purchased from the Bennett
Funding Group, a leasing company located in Syracuse, New York. Such lines
totalled $763,000 or .43% of the Bank's total loan portfolio at September 30,
1996. See "-Asset Quality - Non- Performing Assets" for a discussion of the
Bank's non-performing commercial business loans.

The Bank is in the process of developing a commercial business lending policy
and procedures for small businesses located in the Bank's primary market area.
The Bank is expected to moderately grow this portfolio in the coming year.

     Mortgage-Banking Activities. Due to customer preference for fixed-rate
loans, especially during the stable mortgage interest rate environment in 1996
and 1995, the Bank has continued to originate fixed-rate loans. Long term,
generally 30 years, fixed rate loans not taken into portfolio for
asset/liability purposes are sold into the secondary market. In addition, the
Bank has developed a product for sale in the secondary market for non-conforming
jumbo and impaired credit loans. The Bank sold a substantial amount of the
long-term 30 year, fixed-rate conforming and non-conforming mortgage loans
originated during fiscal 1996 and 1994 and, to a lesser extent, during fiscal
1995. The Bank's net gain on sales of mortgage loans amounted to $209,000,
$53,000 and $350,000 during the years ended September 30, 1996, 1995 and 1994,
respectively. Due to the general increases in rates in fiscal 1995, mortgage
originations declined significantly for both the Bank and the mortgage industry.
The development of non-conforming loan products, whose loan rates generally do
not fluctuate during the interest rate

                                       12
<PAGE>   14
cycles, should smooth out originations over various interest rate cycles. The
Bank had $2.4 million and $57,000 of mortgage loans held for sale at September
30, 1996 and 1995, respectively.

     The Bank's conforming mortgage loans sold to others are sold, generally
with servicing retained, on a loan-by-loan basis primarily to the FHLMC and the
FNMA. A period of less than five days generally lapses between the closing of
the loan by the Bank and its purchase by the investor. Mortgages with
established interest rates generally will decrease in value during periods of
increasing interest rates. Accordingly, fluctuations in prevailing interest
rates may result in a gain or loss to the Bank as a result of adjustments to the
carrying value of loans held for sale or on sale of loans. The Bank attempts to
protect itself from these market fluctuations through the use of forward
commitments at the time of the rate lock-in by the borrower. These commitments
are mandatory delivery contracts with FHLMC and FNMA within a certain time frame
and within certain dollar amounts and a price determined at the commitment date.
Market risk does exist as non-refundable points paid by the borrower may not be
sufficient to offset fees associated with closing the forward commitment
contract. Non-conforming mortgage loans sold to others are sold, servicing
released, on a loan-by-loan basis and are generally pre-approved by the buyer
prior to closing.

     Borrowers are generally charged an origination fee, which is a percentage
of the principal balance of the loan. In accordance with the provisions of
Statement of Financial Accounting Standards ("SFAS") No. 91, "Accounting for
Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and
Initial Direct Costs of Leases," the various fees received by the Bank in
connection with the origination of loans are deferred and amortized as a yield
adjustment over the lives of the related loans using the interest method.
However, when such loans are sold, the remaining unamortized fees (which is all
or substantially all of such fees due to the relatively short period during
which such loans are held) are recognized on the sale of loans held for sale.

     The Bank, for conforming loan products, generally retains the servicing on
all loans sold to others. In addition, the Bank services substantially all of
the loans which it retains in portfolio. Loan servicing includes collecting and
remitting loan payments, accounting for principal and interest, making advances
to cover delinquent payments, making inspections as required of mortgaged
premises, contacting delinquent mortgagors, supervising foreclosures and
property dispositions in the event of unremedied defaults and generally
administering the loans. Funds that have been escrowed by borrowers for the
payment of mortgage-related expenses, such as property taxes and hazard and
mortgage insurance premiums, are maintained in noninterest-bearing accounts at
the Bank.

                                       13
<PAGE>   15
     The following table presents information regarding the loans serviced by
the Bank for others at the dates indicated. Substantially all the loans were
secured by properties in Pennsylvania. A small percentage of the loans are
secured by properties located in Delaware, Maryland and New Jersey.

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

                                                        1996               1995                1994
                                                        ----               ----                ----
                                                                       (In thousands)
<S>                                                    <C>                 <C>                 <C>
Loans originated by the Bank
and serviced for:
  FNMA                                                  $  5,817            $  6,513            $  7,612
  FHLMC                                                  121,029             127,831             132,980
  Others                                                     383                 293                 312
                                                        --------            --------            --------
    Total loans serviced for others                     $127,229            $134,637            $140,904
                                                        ========            ========            ========
</TABLE>


     The Bank receives fees for servicing mortgage loans, which generally amount
to 0.25% per annum on the declining principal balance of mortgage loans. Such
fees serve to compensate the Bank for the costs of performing the servicing
function. Other sources of loan servicing revenues include late charges. For
years ended September 30, 1996, 1995 and 1994, the Bank earned gross fees of
$331,000, $357,000 and $375,000, respectively, from loan servicing. The Bank
retains a portion of funds received from borrowers on the loans it services for
others in payment of its servicing fees received on loans serviced for others.
In July 1994, the Bank acquired the servicing rights related to $25.0 million of
single-family residential mortgage loans for $337,000. Such loans consist
primarily of long-term, fixed-rate loans secured by owner occupied properties
located in Eastern Pennsylvania.

     Loans-to-One Borrower Limitations. Regulations impose limitations on the
aggregate amount of loans that a savings institution could make to any one
borrower, including related entities. Under such regulations, the permissible
amount of loans-to-one borrower follows the national bank standard for all loans
made by savings institutions, which generally does not permit loans-to-one
borrower to exceed 15% of unimpaired capital and surplus. Loans in an amount
equal to an additional 10% of unimpaired capital and surplus also may be made to
a borrower if the loans are fully secured by readily marketable securities. At
September 30, 1996, the Bank's five largest loans or groups of loans-to-one
borrower, including related entities, ranged from an aggregate of $1.1 million
to $3.8 million (loans to Bennett Funding Group - See "-Asset Quality -
Non-Performing Assets") , and the Bank's loans-to-one borrower limit was $3.8
million at such date.

ASSET QUALITY

     General. As a part of the Bank's efforts to improve its asset quality, it
has developed and implemented an asset classification system. All of the Bank's
assets are subject to review under the classification system, but particular
emphasis is placed on the review of multi-family and commercial real estate
loans, construction loans and commercial business loans. All assets of the Bank
are periodically reviewed and the classification recommendations submitted to
the Asset Classification Committee at least monthly. The Asset Classification
Committee is composed of the President and Chief Executive Officer, the Chief
Financial Officer, the Chief Lending Officer, the Vice President of Loan
Administration and one outside director. All assets are placed into one of four
categories -Pass, Substandard, Doubtful and Loss. The criteria used to review
and establish each asset's classification are substantially identical to the
asset classification system used by the Office of Thrift Supervision (the "OTS")
in connection with the examination process. As of September 30, 1996, the Bank
did not have any assets which it had classified as doubtful and loss. See "-
Non-Performing Assets" and "- Other Classified Assets" for a discussion of
certain of the Bank's assets which have been classified as substandard and of
the regulatory classification standards generally.

                                       14
<PAGE>   16
     When a borrower fails to make a required payment on a loan, the Bank
attempts to cure the deficiency by contacting the borrower and seeking payment.
Contacts are generally made 30 days after a payment is due. In most cases,
deficiencies are cured promptly. If a delinquency continues, late charges are
assessed and additional efforts are made to collect the loan. While the Bank
generally prefers to work with borrowers to resolve such problems, when the
account becomes 90 days delinquent, the Bank institutes foreclosure or other
proceedings, as necessary, to minimize any potential loss.

     Loans are placed on non-accrual status when, in the judgment of management,
the probability of collection of interest is deemed to be insufficient to
warrant further accrual. When a loan is placed on non-accrual status, previously
accrued but unpaid interest is deducted from interest income. As a matter of
policy, the Bank does not accrue interest on loans past due 90 days or more. See
Note 1 of the Notes to Consolidated Financial Statements included in the
Company's Annual Report to Stockholders' for the year ended September 30, 1996
set forth as Exhibit 13 hereto ( "Annual Report").

     Real estate acquired by the Bank as a result of foreclosure or by
deed-in-lieu of foreclosure are classified as real estate owned until sold. Real
estate owned is initially recorded at the lower of fair value minus estimated
costs to sell the property, or cost (generally the balance of the loan on the
property at the date of acquisition). After the date of acquisition, all costs
incurred in maintaining the property are expenses and costs incurred for the
improvement or development of such property are capitalized up to the extent of
their net realizable value.

     Under GAAP, the Bank is required to account for certain loan modifications
or restructuring as "troubled debt restructuring." In general, the modification
or restructuring of a debt constitutes a troubled debt restructuring if the Bank
for economic or legal reasons related to the borrower's financial difficulties
grants a concession to the borrower that the Bank would not otherwise consider
under current market conditions. Debt restructuring or loan modifications for a
borrower do not necessarily always constitute troubled debt restructuring,
however, and troubled debt restructuring do not necessarily result in
non-accrual loans.

                                       15
<PAGE>   17
     Delinquent Loans. The following table sets forth information concerning
delinquent loans at the dates indicated, in dollar amounts and as a percentage
of each category of the Bank's loan portfolio. The amounts presented represent
the total outstanding principal balances of the related loans, rather than the
actual payment amounts which are past due.

<TABLE>
<CAPTION>
                                                     September 30, 1996
                            ---------------------------------------------------------------------      
                                        30-59 Days                            60-89 Days               
                            -----------------------------         -------------------------------      
                                                   Percent                              Percent        
                                                      of                                   of          
                                                     Loan                                 Loan         
                                 Amount            Category           Amount            Category       
                            -------------      -------------      -------------     -------------      
                                                    (Dollars in thousands)
<S>                                <C>              <C>                 <C>              <C>           

Real estate loans:
  Single-family
    residential                       $928            63.60%               $614            99.84%      
  Commercial and
   multi-family
  Construction                         528             36.19                                           
Consumer loans                           2               .14
Commercial business
  loans                                  1               .07                  1               .16
                                     -----         ---------               ----           -------      

    Total                          $ 1,459           100.00%               $615           100.00%      
                                    ======           ======                 ===           ======        
</TABLE>

<TABLE>
<CAPTION>
                                                     September 30, 1995
                              ---------------------------------------------------------------        
                                          30-59 Days                          60-89 Days
                              ----------------------------        ---------------------------  
                                                  Percent                            Percent
                                                    of                                 of
                                                   Loan                               Loan
                                   Amount        Category           Amount          Category
                              -------------   ------------        -------------    -----------   
                                                (Dollars in thousands)
<S>                                 <C>           <C>              <C>             <C>

Real estate loans:
  Single-family
    residential                       $1,335        75.68%           $74             66.07%
  Commercial and
   multi-family                                                                                      
  Construction                           429         24.32            37             33.04
Consumer loans
Commercial business
  loans                                                                1               .89
                                     -------     ---------          ----            -------

    Total                            $ 1,764       100.00%          $112            100.00%
                                      ======       =======           ===            ======
</TABLE>

                                       16
<PAGE>   18
         Non-Performing Assets. The following table sets forth the amounts and
categories of the Bank's non-performing assets at the dates indicated. The Bank
did not have any accruing loans more than 90 days delinquent at any of the
periods presented.

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

                                        1996           1995           1994        1993         1992
                                        ----           ----           ----        ----         ----
                                                            (Dollars in thousands)
<S>                                  <C>            <C>             <C>          <C>           <C>
Non-performing loans:

  Single-family residential             $1,466        $1,986        $1,907        $1,649        $1,973

  Commercial and multi-
   family(1)                                55            22         2,400         2,686         2,800
  Construction(2)                                        888           872         1,027           258
  Consumer                               1,666             2             1             1             1
  Commercial business                    2,165           258           196           121            
                                        ------        ------        ------        ------        ------
    Total non-performing loans           5,352         3,156         5,376         5,484         5,032
                                        ------        ------        ------        ------        ------

REO                                      1,557           465           503           971         2,084
    Total non-performing assets         $6,909        $3,621        $5,879        $6,455        $7,116
                                        ======        ======        ======        ======        ======

Troubled debt restructuring (1)                       $2,348                           
                                        ======        ======        ======        ======        ======

Total non-performing loans and
  troubled debt restructuring
  as a percentage of gross loans

  receivable (3)                          3.10%         3.45%         3.73%         3.92%         3.32%
                                        ======        ======        ======        ======        ======

Total non-performing assets
  as a percentage of total assets         2.35%         1.29%         2.43%         2.76%         3.06%
                                        ======        ======        ======        ======        ======

Total non-performing assets and
  troubled debt restructuring as
  percentage of total assets              2.35%         2.12%         2.43%         2.76%         3.06%
                                        ======        ======        ======        ======        ======
</TABLE>




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

 (1)     Consist of two loans and one loan at September 30, 1996 and 1995,
         respectively. For fiscal 1994 and earlier years, consists primarily of
         one loan restructured during fiscal 1995. The loan has been performing
         in accordance with the terms of the agreement since the restructuring.

 (2)     Consist of two loans at September 30, 1995 and one loan at September
         30, 1994 and 1993.

 (3)     Includes loans receivable and loans available for sale, less
         construction and land loans in process and deferred loan origination
         fees and discounts.



                                       17
<PAGE>   19
         The Bank's total non-performing assets and troubled debt restructuring
have increased from $6.0 million, or 2.12%, at September 30, 1995 to $6.9
million, or 2.35% at September 30, 1996. The primary reason for the increase was
the addition of certain consumer and commercial lease financings related to the
Bennett Funding Group ("Bennett Funding").

         Between September 1992 and March 1996, the Company purchased 16
separate pools of lease financings from Bennett Funding and its affiliates with
a total balance outstanding as of September 30, 1996 of $3.8 million. Included
in the total balance were $890,00 in equipment leases (some of which are insured
by a private insurer), $800,000 in interim contract financings for equipment
leases which have not yet been pooled and sold and $380,00 in consumer
financings. Also included in the Company's total balance were $1.3 million in
consumer receivables issued by Resort Funding, Inc., an affiliate of Bennett
Funding, secured by timeshare financing contracts and $475,000 in equipment
leases from Aloha Capital Corp., another affiliate of Bennett Funding. On March
29, 1996, Bennett Funding filed for Chapter 11 bankruptcy protection. On April
24, 1996, Aloha Capital Corp. and certain other Bennett Funding affiliates,
including affiliates who act as the processor for payments due holders of lease
and loans issued by Bennett Funding and its affiliates, also filed for Chapter
11 bankruptcy protection. Although the Company is continuing to receive payments
on the $1.3 million in consumer receivables (approximately $100,000 in principal
reduction had been received through September 30, 1996) from Resort Funding,
Inc., the Company has chosen to place the entire $3.8 million on non-accrual
status and has classified the credits as substandard. Although the Company has
not established any specific reserves or charged off any portion of the
financings, the Company , in accordance with its policy regarding classified
assets, has provided an additional $1.1 million in reserves and has allocated
approximately $1.4 million of its unallocated general loss allowance. The
Company is actively monitoring the bankruptcy proceedings and is vigorously
pursuing all options available to protect its interest. However, no assurance
can be given that significant additional provisions or charge offs will not be
required or that losses will not be incurred in connection with the resolution
of the situation.

         The $1.5 million of non-performing single-family residential loans at
September 30, 1996 consisted of 39 loans, with principal balances ranging from
$3,400 to $216,000 with an average of approximately $38,000. Many of such loans
are involved in bankruptcy proceedings which increases the period of time it
takes the Bank to resolve such assets.

         At September 30, 1996, the $1.6 million of REO consisted of four
single-family residential properties with an average carrying value of
approximately $91,100 and one former construction loan project. The loan was for
the acquisition and development of a 107-lot residential townhouse project
located in Pennsylvania.. The project currently has 13 units under varying
stages of development and 23 building lots. The Company has hired a developer to
complete the project and is actively marketing the units.

         Other Classified Assets. Federal regulations require that each insured
savings association classify its assets on a regular basis. In addition, in
connection with examinations of insured institutions, federal examiners have
authority to identify problem assets and, if appropriate, classify them. There
are three classifications for problem assets: "substandard," "doubtful" and
"loss." Substandard assets have one or more defined weaknesses and are
characterized by the distinct possibility that the insured institution will
sustain some loss if the deficiencies are not corrected. Doubtful assets have
the weaknesses of substandard assets with the additional characteristic that the
weaknesses make collection or liquidation in full, on the basis of currently
existing facts, conditions and values questionable, and there is a high
possibility of loss. An asset classified loss is considered uncollectible and of
such little value that continuance as an asset of the institution is not
warranted.

         At September 30, 1996, the Bank had $6.9 million of assets classified
as substandard and no assets classified as doubtful or loss. Substantially all
classified assets are also non-performing, except for the Resort Funding
consumer receivable loans discussed above that are performing according to their
contract terms but have been placed on non-accrual status due to the uncertainty
surrounding the bankruptcy.

         Allowance for Loan Losses. The Bank's policy is to establish reserves
for estimated losses on delinquent loans when it determines that losses are
expected to be incurred on such loans and leases. The allowance for losses on
loans is maintained at a level believed adequate by management to absorb
potential losses in the portfolio. Management's determination of the adequacy of
the allowance is based on an evaluation of the portfolio, past loss experience,
current

                                       18
<PAGE>   20
economic conditions, volume, growth and composition of the portfolio, and other
relevant factors. The allowance is increased by provisions for loan losses which
are charged against income. The activity in the Bank's allowance for loan losses
has remained relatively stable (other than the charge-off in fiscal 1993 related
to the Bank's largest non-performing construction loan) and the level of
provisions has been relatively small with the exception in fiscal 1996 of an
additional $1.1 million provision related to the Bennett Funding Group. As shown
in the table below, at September 30, 1995, the Bank's allowance for loan losses
amounted to 49.03% and 1.57% of the Bank's non-performing loans and gross loans
receivable, respectively.

         Effective December 21, 1993, the OTS, in conjunction with the Office of
the Comptroller of the Currency, the FDIC and the Federal Reserve Board, issued
a joint policy statement ("Policy Statement") regarding an institution's
allowance for loan and lease losses. The Policy Statement, which reflects the
position of the issuing regulatory agencies and does not necessarily constitute
GAAP, includes guidance (i) on the responsibilities of management for the
assessment and establishment of an adequate allowance and (ii) for the agencies'
examiners to use in evaluating the adequacy of such allowance and the policies
utilized to determine such allowance. The Policy Statement also sets forth
quantitative measures for the allowance with respect to assets classified
substandard and doubtful and with respect to the remaining portion of an
institution's loan portfolio. While the Policy Statement sets forth quantitative
measures, such guidance is not intended as a "floor" or "ceiling." The review of
the Policy Statement did not result in a material adjustment to the Bank's
policy for establishing loan losses.

                                       19
<PAGE>   21
         The following table summarizes changes in the allowance for loan losses
and other selected statistics for the periods presented.

<TABLE>
<CAPTION>
                                                                        Year Ending September 30,
                                              ---------------------------------------------------------------------------


                                                  1996            1995             1994            1993          1992
                                              -----------     -----------     -----------     -----------     -----------
                                                                          (Dollars in thousands)
<S>                                             <C>              <C>              <C>             <C>          <C>
Non-performing loans:
  Single-family residential                       $  (113)         $ (163)          $ (141)        $  (121)     $    (77)
  Construction                                                                                      (1,154)
  Commercial and multi-family
        residential

  Consumer and commercial business                                     (5)
                                                   -------         -------          -------         -------        ------ 
    Total charged-off loans                          (113)           (168)            (141)         (1,275)          (77)
                                                   -------         -------          -------         -------        ------
Recoveries on loans previously charged off:

  Residential real estate                                              12 

  Construction                                                         43                                             23
  Commercial and multi-
     family residential                                                 8 

  Consumer and business
                                                   -------         -------          -------         -------       ------
    Total recoveries                                                   63                                             23
                                                   -------         -------          -------         -------       ------

Net loans charged-off                                (113)           (105)            (141)         (1,275)          (54)
Provision for loan losses                           1,250              52              416             390           120
                                                   -------         -------          -------         -------       ------
Allowance for loan losses, end of
period                                             $2,624          $1,487           $1,540          $1,265        $2,150
                                                   ======          ======           ======          ======        ======

Net loans charged-off to average
  interest-earning loans(1)                           .07%            .07%             .10%            .89%          .03%
                                                   ======          ======           ======          ======        ======
Allowance for loan losses
  to gross loans receivable(1)                       1.57%            .93%            1.07%            .91%         1.42%
                                                   ======          ======           ======          ======        ======
Allowance for loan losses
  to non-performing loans                           49.03%          47.12%           28.65%          23.07%        42.72%
                                                   ======          ======           ======          ======        ======

Net loans charged-off to
 allowance for loan losses                           4.31%           7.06%            9.16%         100.79%         2.51%
                                                   ======          ======           ======          ======        ======
Recoveries to charge-offs                                %          37.50%                %            .87%        29.87%
                                                   ======          ======           ======          ======        ======
</TABLE>


(1)      Gross loans receivable and average interest-earning loans receivable
         include loans receivable and loans available for sale, less
         construction and land loans in process and deferred loan origination
         fees and discounts.

                                       20
<PAGE>   22
         The following table presents the Bank's allocation of the allowance for
loan losses to the total amount of loans in each category listed at the dates
indicated.

<TABLE>
<CAPTION>
                                                                   September 30,
                           -----------------------------------------------------------------------------------------
                                       1996                          1995                           1994
                                       ----                          ----                           ----
                                           % of Loans                    % of Loans                     % of Loans
                                            in Each                        in Each                        in Each
                                           Category to                   Category to                    Category to
                             Amount       Total Loans       Amount       Total Loans       Amount       Total Loans
                           ---------     -----------      ---------     -----------     ----------     -----------
                                                             (Dollars in thousands)
<S>                         <C>              <C>           <C>             <C>            <C>             <C>

Single-family residential     $  204           68.68%        $  226          69.01%         $  280          69.77%
Commercial and multi-
 family residential                3             6.25            12            7.06            243            8.38
Construction                     290             9.93           615            9.79            481            9.11
Consumer                         370            13.50           100           12.62             79           11.23
Commercial business            1,152             1.64            55            1.52             45            1.51
Unallocated                      605                            479                            412
                              ------          -------        ------         -------         ------         -------
    Total allowance for
      loan losses             $2,624          100.00%        $1,487         100.00%         $1,540         100.00%
                               =====          ======          =====         ======           =====         ======
</TABLE>




<TABLE>
<CAPTION>
                                                      September 30,
                                  ------------------------------------------------------
                                             1993                            1992
                                             ----                            ----



                                                  % of Loans                  % of Loans
                                                    in Each                    in Each
                                                  Category to                Category to
                                     Amount       Total Loans      Amount    Total Loans
                                   ---------     -----------     ---------   -----------
                                                  (Dollars in thousands)
<S>                                  <C>          <C>          <C>            <C>

Single-family residential             $  282        74.72%     $  324           74.39%
Commercial and multi-                    243         9.04         231            8.87
 family residential                      546         8.08         444           11.10
Construction                              43         6.36          31            5.08
Consumer                                  55         1.80           7             .56
Commercial business                       96                    1,113
Unallocated                          -------      -------      ------         -------

    Total allowance for               $1,265       100.00%     $2,150          100.00%
      loan losses                      =====       ======       =====          ======
</TABLE>

                                       21
<PAGE>   23
         Management of the Bank presently believes that its allowance for loan
losses is adequate to cover any potential losses in the Bank's loan portfolio.
However, future adjustments to this allowance may be necessary, and the Bank's
results of operations could be adversely affected if circumstances differ
substantially from the assumptions used by management in making its
determinations in this regard.

MORTGAGE-RELATED SECURITIES AND INVESTMENT SECURITIES

         Mortgage-Related Securities. Federally chartered savings institutions
have authority to invest in various types of liquid assets, including United
States Treasury obligations, securities of various federal agencies and of state
and municipal governments, certificates of deposit at federally-insured banks
and savings and loan associations, certain bankers' acceptances and Federal
funds. Subject to various restrictions, federally chartered savings institutions
may also invest a portion of their assets in commercial paper, corporate debt
securities and mutual funds, the assets of which conform to the investments that
federally chartered savings institutions are otherwise authorized to make
directly.

         The Bank maintains a significant portfolio of mortgage-related
securities as a means of investing in housing-related mortgage instruments
without the costs associated with originating mortgage loans for portfolio
retention and with limited credit risk of default which arises in holding a
portfolio of loans to maturity. Mortgage-related securities (which also are
known as mortgage participation certificates or pass-through certificates)
represent a participation interest in a pool of single-family or multi-family
mortgages. The principal and interest payments on mortgage-backed securities are
passed from the mortgage originators, as servicer, through intermediaries
(generally U.S. Government agencies and government-sponsored enterprises) that
pool and repackage the participation interests in the form of securities, to
investors such as the Bank. Such U.S. Government agencies and government
sponsored enterprises, which guarantee the payment of principal and interest to
investors, primarily include the FHLMC, the FNMA and the Government National
Mortgage Association ("GNMA"). The Bank also invests to a limited degree in
certain privately issued, credit enhanced mortgage-related securities rated AAA
by national securities rating agencies.

         The FHLMC is a public corporation chartered by the U.S. Government and
owned by the 12 Federal Home Loan Banks ("FHLBs") and federally insured savings
institutions. The FHLMC issues participation certificates backed principally by
conventional mortgage loans. The FHLMC guarantees the timely payment of interest
and the ultimate return of principal on participation certificates. The FNMA is
a private corporation chartered by the U.S. Congress with a mandate to establish
a secondary market for mortgage loans. The FNMA guarantees the timely payment of
principal and interest on FNMA securities. FHLMC and FNMA securities are not
backed by the full faith and credit of the United States, but because the FHLMC
and the FNMA are U.S. Government-sponsored enterprises, these securities are
considered to be among the highest quality investments with minimal credit
risks. The GNMA is a government agency within the Department of Housing and
Urban Development which is intended to help finance government-assisted housing
programs. GNMA securities are backed by FHA-insured and VA-guaranteed loans, and
the timely payment of principal and interest on GNMA securities are guaranteed
by the GNMA and backed by the full faith and credit of the U.S. Government.
Because the FHLMC, the FNMA and the GNMA were established to provide support for
low- and middle-income housing, there are limits to the maximum size of loans
that qualify for these, programs which limit is currently $203,150.

         Mortgage-related securities typically are issued with stated principal
amounts, and the securities are backed by pools of mortgages that have loans
with interest rates that are within a range and have varying maturities. The
underlying pool of mortgages can be composed of either fixed-rate or
adjustable-rate loans. As a result, the risk characteristics of the underlying
pool of mortgages, (i.e., fixed-rate or adjustable rate) as well as prepayment
risk, are passed on to the certificate holder. The life of a mortgage-backed
pass-through security thus approximates the life of the underlying mortgages.

         The Bank's mortgage-related securities include regular interests in
collateralized mortgage obligations ("CMOs"). CMOs have been developed in
response to investor concerns regarding the uncertainty of cash flows associated
with the prepayment option of the underlying mortgagor and are typically issued
by governmental agencies, governmental sponsored enterprises and special purpose
entities, such as trusts, corporations or partnerships, established by financial
institutions or other similar institutions. A CMO can be collateralized by loans
or securities which are insured or guaranteed by the FNMA, the FHLMC or the
GNMA. In contrast to pass-through mortgage-related securities, in which cash
flow is received

                                       22
<PAGE>   24
pro rata by all security holders, the cash flow from the mortgages underlying a
CMO is segmented and paid in accordance with a predetermined priority to
investors holding various CMO classes. By allocating the principal and interest
cash flows from the underlying collateral among the separate CMO classes,
different classes of bonds are created, each with its own stated maturity,
estimated average life, coupon rate and prepayment characteristics.

         The short-term classes of a CMO usually carry a lower coupon rate than
the longer term classes and, therefore, the interest differential cash flow on a
residual interest is greatest in the early years of the CMO. As the early coupon
classes are extinguished, the residual income declines. Thus, the longer the
lower coupon classes remain outstanding, the greater the cash flow accruing to
CMO residuals. As interest rates decline, prepayments accelerate, the interest
differential narrows, and the cash flow from the CMO declines. Conversely, as
interest rates increase, prepayments decrease, generating a larger cash flow to
residuals.

         A senior-subordinated structure often is used with CMOs to provide
credit enhancement for securities which are backed by collateral which is not
guaranteed by FNMA, FHLMC or GNMA. These structures divide mortgage pools into
various risk classes: a senior class and one or more subordinated classes. The
subordinated classes provide protection to the senior class. When cash flow is
impaired, debt service goes first to the holders of senior classes. In addition,
incoming cash flows also may go into a reserve fund to meet any future
shortfalls of cash flow to holders of senior classes. The holders of
subordinated classes may not receive any funds until the holders of senior
classes have been paid and, when appropriate, until a specified level of funds
has been contributed to the reserve fund.

         Certain CMOs can be classified as "high-risk mortgage securities" under
OTS Thrift Bulletin 52 ("TB 52") and its predecessor. Pursuant to TB 52, a
savings institution such as the Bank generally may only acquire high-risk
mortgage securities, which are defined as any CMO that at the time of purchase,
or at any subsequent date, meets any of the three tests set forth therein, to
reduce its overall interest rate risk, although an institution with strong
capital and earnings and adequate liquidity and that has a closely supervised
trading department may acquire such securities if they are reported as trading
assets or held for sale at market value. The three tests are an average life
test, an average life sensitivity test and a price sensitivity test.

         Mortgage-related securities generally yield less than the loans which
underlie such securities because of their payment guarantees or credit
enhancements which offer nominal credit risk. In addition, mortgage-related
securities are more liquid than individual mortgage loans and may be used to
collateralize certain obligations of the Bank. At September 30, 1996, $6.5
million of the Bank's mortgage-related securities were pledged to secure various
obligations of the Bank, primarily public deposits. Mortgage-related securities
issued or guaranteed by the FNMA or the FHLMC (except interest-only securities
or the residual interests in CMOs) are weighted at no more than 20.0% for
risk-based capital purposes, compared to a weight of 50.0% to 100.0% for
residential loans. See "Regulation - The Bank - Capital Requirements."

         The Bank's mortgage-related securities are classified as either "held
to maturity" or "available for sale" based upon the Bank's intent and ability to
hold such securities to maturity at the time of purchase, in accordance with
GAAP. As of September 30, 1996, the Bank had an aggregate of $83.4 million, or
28.4%, of total assets invested in mortgage-related securities, net, of which
$23.2 million was held to maturity and $60.2 million was available for sale. The
tables below present the Bank's mortgage-related securities on the basis of
these classifications, which were included in the Bank's Consolidated Financial
Statements beginning in fiscal 1995. The mortgage-related securities of the Bank
which are held to maturity are carried at cost, adjusted for the amortization of
premiums and the accretion of discounts using a method which approximates a
level yield, while mortgage-related securities available for sale are carried at
the current market value. See Notes 1 and 4 of the Notes to Consolidated
Financial Statements in the Annual Report.

                  In November 1995, the Financial Accounting Standards Board
(the "FASB") issued a special report, "A Guide to Implementation of Statement
115 on Accounting for Certain Investments in Debt and Equity Securities", (the
"Guide"), which discussed through a question and answer format many of the
implementation questions that have arisen since the adoption of SFAS 115.
Concurrent with the initial adoption of this implementation guidance but no
later than December 31, 1995, an enterprise was permitted to reassess the
appropriateness of the classifications of all securities held at that time and
account and disclose resulting reclassifications in accordance with SFAS 115.
The Guide further states that

                                       23
<PAGE>   25
reclassifications from the held-to-maturity category that result from this
one-time assessment will not call into question the intent of an enterprise to
hold other debt securities to maturity in the future. In December 1995, in
accordance with the Guide, the Company reclassified certain securities with an
aggregated amortized cost of $50.5 million from held to maturity to available
for sale.

The following table sets forth the composition of the Bank's mortgage-related
securities portfolio, both held to maturity and available for sale, at the dates
indicated.

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

                                                                                1996               1995              1994
                                                                                ----               ----              ----
Held to maturity:
                                                                                              (In thousands)
<S>                                                                             <C>                 <C>              <C>
Mortgage-backed securities:
  FHLMC                                                                           $ 3,631            $ 8,743           $10,073
  FNMA                                                                             11,383             26,014            28,836
                                                                                   ------             ------            ------
    Total mortgage-backed securities                                               15,014             34,757            38,909
                                                                                   ------             ------            ------
Collateralized mortgage obligations:
    FHLMC                                                                           2,238              8,337            10,959
    FNMA                                                                            5,789             16,968            18,184
    Other                                                                             180                232               317
                                                                                   ------             ------            ------
     Total collateralized mortgage obligations                                      8,207             25,537            29,460
                                                                                   ------             ------            ------
    Total mortgage-related securities, amortized cost                             $23,221            $60,294           $68,369
                                                                                   ======             ======            ======
    Total market value(1)                                                         $22,060            $59,010           $64,880
                                                                                   ======             ======            ======





Available for sale:

Mortgage-backed securities:
  FHLMC                                                                        $ 12,852           $ 3,935
  FNMA                                                                           11,079             2,913
  GNMA                                                                            8,355             1,136
                                                                                 ------             -----
    Total mortgage-backed securities                                             32,286             7,984
                                                                                 ------             -----
Collateralized mortgage obligations:
    FHLMC                                                                         7,298                                  $251
    FNMA                                                                         18,594             9,682
    GNMA                                                                          1,593
    Other                                                                         1,131             1,640
                                                                                 ------            ------
     Total collateralized mortgage obligations                                   28,616            11,322                 251
                                                                                 ------            ------                 ---
    Total mortgage-related securities, amortized cost                           $60,902           $19,306                $251
                                                                                 ======            ======                 ===
    Total market value(1)                                                       $60,211           $19,538                $252
                                                                                 ======            ======                 ===
</TABLE>



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

(1)  See Note 4 of the Notes to Consolidated Financial Statements in the Annual
     Report.

                                       24
<PAGE>   26
     The following table sets forth the purchases, sales and principal
repayments of the Bank's mortgage-related securities for the periods indicated.

<TABLE>
<CAPTION>
                                                                                               Year Ended September 30,
                                                                                        -----------------------------------

                                                                                      1996            1995           1994
                                                                                      ----            ----           ----
<S>                                                                                 <C>            <C>             <C>
Mortgage-related securities, beginning of period(1)                                  $79,832        $68,620         $65,159
                                                                                     -------        -------         -------
Purchases:
  Mortgage-backed securities - held to maturity                                        1,938                         20,237
  CMO-held to maturity                                                                 2,000                         11,825
  Mortgage-backed securities - available for sale                                     15,471          8,094
  CMO - available for sale                                                             9,997         13,824
Sales:

  Mortgage-backed securities - available for sale                                     (6,422)        (2,250)
  CMO -available for sale                                                             (6,374)
Repayments and prepayments:

  Mortgage-backed securities                                                          (6,467)        (4,241)         (8,538)
  CMO                                                                                 (5,788)        (4,216)        (19,909)
Increase (decrease) in net premium                                                       169           (231)           (154)
Change in net unrealized gain (loss) on mortgage-related securities
    available for sale                                                                  (924)           232
                                                                                     -------        -------        --------
Net increase in mortgage-related securities                                            3,600         11,212           3,461
                                                                                     -------        -------        --------
Mortgage-related securities, end of period(1)                                        $83,432        $79,832         $68,620
                                                                                     =======        =======         =======
</TABLE>

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

(1)  Includes mortgage-related securities available for sale.

     At September 30, 1996, the weighted average contractual maturity of the
Bank's fixed-rate mortgage-backed securities was approximately 15.0 years. The
actual maturity of a mortgage-backed security is less than its stated maturity
due to prepayments of the underlying mortgages. Prepayments that are faster than
anticipated may shorten the life of the security and adversely affect its yield
to maturity. The yield is based upon the interest income and the amortization of
any premium or discount related to the mortgage-backed security. In accordance
with GAAP, premiums and discounts are amortized over the estimated lives of the
loans, which decrease and increase interest income, respectively. The prepayment
assumptions used to determine the amortization period for premiums and discounts
can significantly affect the yield of the mortgage-backed security, and these
assumptions are reviewed periodically to reflect actual prepayments. Although
prepayments of underlying mortgages depend on many factors, including the type
of mortgages, the coupon rate, the age of mortgages, the geographical location
of the underlying real estate collateralizing the mortgages and general levels
of market interest rates, the difference between the interest rates on the
underlying mortgages and the prevailing mortgage interest rates generally is the
most significant determinant of the rate of prepayments. During periods of
rising mortgage interest rates, if the coupon rates of the underlying mortgages
are less than the prevailing market interest rates offered for mortgage loans,
refinancings generally decrease and slow the prepayment of the underlying
mortgages and the related securities. Conversely, during periods of falling
mortgage interest rates, if the coupon rates of the underlying mortgages exceed
the prevailing market interest rates offered for mortgage loans, refinancing
generally increases and accelerates the prepayment of the underlying mortgages
and the related securities. Under such circumstances, the Bank may be subject to
reinvestment risk because to the extent that the Bank's mortgage-related
securities amortize or prepay faster than anticipated, the Bank may not be able
to reinvest the proceeds of such repayments and prepayments at a comparable
yield. At September 30, 1996, of the $23.2 million of mortgage-related
securities held to maturity, an aggregate of $12.4 million were secured by
fixed-rate securities and an aggregate of $10.8 million were secured by
adjustable-rate securities.

                                       25
<PAGE>   27
     Investment Securities. The following table sets forth information regarding
the carrying and market value of the Bank's investment securities at the dates
indicated.

<TABLE>
<CAPTION>
                                                                        At September 30,
                                  ----------------------------------------------------------------------------------
                                          1996                      1995                        1994
                                          ----                      ----                        ----

                                  Carrying     Fair        Carrying         Fair         Carrying         Fair
                                    Value      Value         Value          Value          Value          Value
                                    -----      -----         -----          -----          -----          -----
                                                                (In thousands)
<S>                             <C>           <C>           <C>           <C>             <C>         <C>

FHLB stock                       $ 2,337       $ 2,337       $ 1,492       $ 1,492       $ 1,370       $ 1,370
U.S. Government and agency
 obligations                      16,500        16,388        10,565        10,505        12,000        11,725
Municipal securities                 145           144           145           145           145           140
                                 -------       -------       -------       -------       -------       -------
    Total                        $18,982       $18,869       $12,202       $12,142       $13,515       $13,235
                                 =======       =======       =======       =======       =======       =======
</TABLE>





     At September 30, 1996, all of the Bank's investment securities had a
contractual maturity of between one and ten years and such portfolio had a
weighted average yield of 6.62%.

SOURCES OF FUNDS

     General. The Bank's principal source of funds for use in lending and for
other general business purposes has traditionally come from deposits obtained
through the Bank's branch offices. The Bank also derives funds from contracted
payments and prepayments of outstanding loans and mortgage-related securities,
from sales of loans, from maturing investment securities and from advances from
the FHLB of Pittsburgh and other borrowings. Loan repayments are a relatively
stable source of funds, while deposits inflows and outflows are significantly
influenced by general interest rates and money market conditions. The Bank uses
borrowings to supplement its deposits as a source of funds.

     Deposits. The Bank's current deposit products include passbook accounts,
NOW accounts, MMDA, certificates of deposit ranging in terms from 30 days to
five years and noninterest-bearing personal and business checking accounts. The
Bank's deposit products also include Individual Retirement Account ("IRA")
certificates and Keogh accounts.

     The Bank's deposits are obtained primarily from residents in Delaware and
Chester Counties in southeastern Pennsylvania. The Bank attracts local deposit
accounts by offering a wide variety of accounts, competitive interest rates, and
convenient branch office locations and service hours. The Bank utilizes
traditional marketing methods to attract new customers and savings deposits,
including print media and radio advertising and direct mailings. However, the
Bank does not solicit funds through deposit brokers nor does it pay any
brokerage fees if it accepts such deposits. The Bank participates in the
regional ATM network known as MAC(R).

     The Bank has been competitive in the types of accounts and in interest
rates it has offered on its deposit products but does not necessarily seek to
match the highest rates paid by competing institutions. With the significant
decline in interest rates paid on deposit products, the Bank in recent years has
experienced disintermediation of deposits into competing investment products.

                                       26
<PAGE>   28
     The following table shows the distribution of, and certain information
relating to, the Bank's deposits by type of deposit as of the dates indicated.

<TABLE>
<CAPTION>
                                                                  September 30,
                             -------------------------------------------------------------------------------------
                                         1996                           1995
                                         ----                           ----
                                Amount          Percent         Amount        Percent         Amount        Percent
                                ------          -------         ------        -------         ------        -------
                                                              (Dollars in thousands)
<S>                             <C>             <C>          <C>              <C>         <C>                <C>
Passbook and statement
 savings accounts                $ 41,504           18.93%    $ 43,088           19.25%    $ 53,124           24.59%
MMDA                               16,159            7.37       17,892            8.00       24,818           11.49
NOW accounts                       28,085           12.81       26,621           11.90       24,685           11.42
Certificates of deposit           128,747           58.73      126,985           56.75      110,696           51.23
Noninterest-bearing
 deposits                           4,710            2.16        9,167            4.10        2,742            1.27%
                                 --------          ------     --------          ------     --------          ------
  Total deposits at end of
    period                       $219,205          100.00%    $223,753          100.00%    $216,065          100.00%
                                 ========          ======     ========          ======     ========          ======
</TABLE>





The following table sets forth the net savings flows of the Bank during the
periods indicated.

<TABLE>
<CAPTION>
                                                 Year Ended September 30,
                                                 ------------------------
                                       1996               1995            1994
                                       ----               ----            ----
<S>                                   <C>                 <C>          <C>

                                                      (In thousands)

Decrease before interest credited       $(13,152)       $ (1,040)       $(12,170)

Interest credited                          8,604           8,728           9,874
                                        --------        --------        --------

Net savings increase (decrease)         $ (4,548)       $  7,688        $ (2,296)
                                        ========        ========        ========
</TABLE>



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


     The following table sets forth maturities of the Bank's certificates of
deposit of $100,000 or more at September 30, 1996 by time remaining to maturity.

<TABLE>
<CAPTION>
                                                                    Amounts in
                                                                     Thousands
                                                                     ---------
<S>                                                                    <C>
Three months or less                                                     $2,915
Over three months through six months                                        842
Over six months through twelve months                                     3,669
Over twelve months                                                        2,400
                                                                         ------
                                                                         $9,826
                                                                         ======
</TABLE>


                                       27
<PAGE>   29
     The following table presents, by various interest rate categories, the
amount of certificates of deposit at September 30, 1996 and 1995, and the
amounts at September 30, 1996 which mature during the periods indicated.

<TABLE>
<CAPTION>

                                                             Amounts at September 30, 1996
                             September 30,                            Maturing Within
                        -----------------------       ---------------------------------------------------
 Certificates of
    Deposit               1996           1995         One Year     Two Years     Three Years   Thereafter
                        --------       --------       --------     ---------     -----------   ----------
                                                          (In thousands)

<S>                     <C>            <C>            <C>           <C>           <C>          <C>
 4.0% or less           $  1,740       $  6,094       $ 1,740
 4.01% to 6.0%           103,038         67,685        63,588       $19,856       $4,024       $15,570
 6.01% to 8.0%            21,092         30,430         7,815         1,618        1,863         9,796
 8.01% to 10.0%            2,877         22,776                       1,986          891
                        --------       --------       -------       -------       ------       -------
Total certificate
  accounts              $128,747       $126,985       $73,143       $23,460       $6,778       $25,366
                        ========       ========       =======       =======       ======       =======
</TABLE>

The following table presents the average balance of each deposit type and the
average rate paid on each deposit type for the periods indicated.

<TABLE>
<CAPTION>

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

                                        1996                          1995                         1994
                               ------------------------      -----------------------       -----------------------
                                               Average                      Average                        Average
                               Average          Rate         Average          Rate         Average            Rate
                               Balance         Paid          Balance          Paid         Balance           Paid
                              --------       --------        --------       --------       --------       --------
                                                             (Dollars in thousands)
<S>                           <C>                <C>         <C>                <C>         <C>                <C>
Passbook and statement

 savings accounts             $ 42,270           2.44%       $ 47,058           2.48%       $ 53,607           2.58%
Money market accounts           18,358           2.65          19,997           2.68          25,490           2.55
Certificates of deposit        128,384           5.82         120,106           6.32         111,596           5.97
NOW accounts                    27,098            .37          25,904           1.68          24,232           1.72
Noninterest-bearing

  deposits                       4,193                          3,446                          3,413
                              --------       --------        --------       --------        --------       --------
    Total deposits            $220,303           4.25%       $216,511           4.49%       $218,338           4.17%
                              ========       ========        ========       ========        ========       ========
</TABLE>



                                       28
<PAGE>   30
Borrowings. The Bank may obtain advances from the FHLB of Pittsburgh upon the
security of the common stock it owns in that bank and certain of its residential
mortgage loans and securities held to maturity, provided certain standards
related to creditworthiness have been met. Such advances are made pursuant to
several credit programs, each of which has its own interest rate and range of
maturities. The Bank, during fiscal 1996 and 1995 increased its FHLB borrowings
to fund asset growth thereby leveraging some of the capital raised during the
year ended September 30, 1995. At September 30, 1996, the Bank had $46.7 million
in outstanding FHLB advances. See Note 10 of the Notes to Consolidated Financial
Statements in the Annual Report.

     The Bank has in the past occasionally entered into agreements to sell
securities under terms which require it to repurchase the same or substantially
similar securities by a specified date. Repurchase agreements are considered
borrowings which are secured by the sold securities and generally are short-term
(90 days or less) in nature. At September 30, 1996, the Bank did not have any
repurchase agreements outstanding.

SUBSIDIARIES

     The Bank is permitted to invest up to 2% of its assets in the capital stock
of, or secured or unsecured loans to, subsidiary corporations, with an
additional investment of 1% of assets when such additional investment is
utilized primarily for community development purposes. Under such limitations,
as of September 30, 1996, the Bank was authorized to invest up to approximately
$8.8 million in the stock of, or loans to, service corporations. As of September
30, 1996, the net book value of the Bank's investment in stock, unsecured loans,
and conforming loans to its service corporations was $1.2 million.

     The Bank only has one active, wholly owned subsidiary, First Pointe, Inc.
("First Pointe"), which was formed for the purpose of developing a real estate
parcel received in a deed-in-lieu of foreclosure action. At September 30, 1996,
the Bank's equity investment in First Pointe was a net deficit of $302 and First
Pointe had total assets of $1.2 million consisting of 13 units under development
and 23 building lots. For the year ended September 30, 1996, First Pointe had
total revenue of $255 and a net loss of $10,302. The Bank also has four other
inactive subsidiaries, three of which had been involved in either real estate
development or real estate management. With the Bank's cessation of its
involvement in such activity and the resolution of the various development
projects in which subsidiaries were involved, the Bank's subsidiaries involved
in such activities were placed in an inactive status. The other inactive
subsidiary was formed to engage in title insurance. See "-Asset Quality - Non-
Performing Assets" and Notes 1 and 7 of the Notes to Consolidated Financial
Statements in the Annual Report.

COMPETITION

     The Bank faces strong competition both in attracting deposits and making
real estate loans. Its most direct competition for deposits has historically
come from other savings associations, credit unions and commercial banks located
in its market area including many large financial institutions which have
greater financial and marketing resources available to them. In addition, during
times of high interest rates, the Bank has faced additional significant
competition for investors' funds from short-term money market securities, mutual
funds and other corporate and government securities. The ability of the Bank to
attract and retain savings deposits depends on its ability to generally provide
a rate of return, liquidity and risk comparable to that offered by competing
investment opportunities.

     The Bank experiences strong competition for real estate loans principally
from other savings associations, commercial banks and mortgage banking
companies. The Bank competes for loans principally through the interest rates
and loan fees it charges and the efficiency and quality of services it provides
borrowers and the convenient locations of its branch office network. Competition
may increase as a result of the continuing reduction of restrictions on the
interstate operations of financial institutions.

EMPLOYEES

     The Bank had 72 full-time employees and 22 part-time employees as of
September 30, 1996. None of these employees is represented by a collective
bargaining agreement. The Bank believes that it enjoys excellent relations with
its personnel.

                                       29
<PAGE>   31
REGULATION

     The Company. The Company as a savings and loan holding company within the
meaning of the Home Owners' Loan Act, as amended ("HOLA") is required as such
with the OTS and is subject to OTS regulations, examinations, supervision and
reporting requirements. As a subsidiary of a savings and loan holding company,
the Bank is subject to certain restrictions in its dealings with the Company and
affiliates thereof.

     Federal Activities Restrictions. There are generally no restrictions on the
activities of a savings and loan holding company which holds only one subsidiary
savings association. However, if the Director of the OTS determines that there
is reasonable cause to believe that the continuation by a savings and loan
holding company of an activity constitutes a serious risk to the financial
safety, soundness or stability of its subsidiary savings association, the
Director may impose such restrictions as deemed necessary to address such risk,
including limiting (i) payment of dividends by the savings association; (ii)
transactions between the savings association and its affiliates; and (iii) any
activities of the savings association that might create a serious risk that the
liabilities of the holding company and its affiliates may be imposed on the
savings association. Notwithstanding the above rules as to permissible business
activities of unitary savings and loan holding companies, if the savings
association subsidiary of such a holding company fails to meet a QTL test, then
such unitary holding company also shall become subject to the activities
restrictions applicable to multiple savings and loan holding companies and,
unless the savings association qualifies as a QTL within one year thereafter,
shall register as, and become subject to the restrictions applicable to, a bank
holding company. See "- The Bank - Qualified Thrift Lender Test."

     If the Company were to acquire control of another savings association,
other than through merger or other business combination with the Bank, the
Company would thereupon become a multiple savings and loan holding company.
Except where such acquisition is pursuant to the authority to approve emergency
thrift acquisitions and where each subsidiary savings association meets the QTL
test, as set forth below, the activities of the Company and any of its
subsidiaries (other than the Bank or other subsidiary savings associations)
would thereafter be subject to further restrictions. No multiple savings and
loan holding company or subsidiary thereof which is not a savings association
shall commence or continue for a limited period of time after becoming a
multiple savings and loan holding company or subsidiary thereof any business
activity, other than: (i) furnishing or performing management services for a
subsidiary savings association; (ii) conducting an insurance agency or escrow
business; (iii) holding, managing, or liquidating assets owned by or acquired
from a subsidiary savings association; (iv) holding or managing properties used
or occupied by a subsidiary savings association; (v) acting as trustee under
deeds of trust; (vi) those activities authorized by regulation as of March 5,
1987 to be engaged in by multiple savings and loan holding companies; or (vii)
unless the Director of the OTS by regulation prohibits or limits such activities
for savings and loan holding companies, those activities authorized by the
Federal Reserve Board as permissible for bank holding companies. The activities
described in (i) through (vi) above may only be engaged in after giving the OTS
prior notice and being informed that the OTS does not object to such activities.
In addition, the activities described in (vii) above also must be approved by
the Director of the OTS prior to being engaged in by a multiple savings and loan
holding company.

     Limitations on Transactions with Affiliates. Transactions between savings
associations and any affiliate are governed by Sections 23A and 23B of the
Federal Reserve Act ("FRA"). An affiliate of a savings association is any
company or entity which controls, is controlled by or is under common control
with the savings association. In a holding company context, the parent holding
company of a savings association (such as the Company) and any companies which
are controlled by such parent holding company are affiliates of the savings
association. Generally, Sections 23A and 23B (i) limit the extent to which the
savings association or its subsidiaries may engage in "covered transactions"
with any one affiliate to an amount equal to 10% of such association's capital
stock and surplus, and contain an aggregate limit on all such transactions with
all affiliates to an amount equal to 20% of such capital stock and surplus and
(ii) require that all such transactions be on terms substantially the same, or
at least as favorable, to the association or subsidiary as those provided to a
non-affiliate. The term "covered transaction" includes the making of loans,
purchase of assets, issuance of a guarantee and similar transactions. In
addition to the restrictions imposed by Sections 23A and 23B, no savings
association may (i) loan or otherwise extend credit to an affiliate, except for
any affiliate which engages only in activities which are permissible for bank
holding companies, or (ii) purchase or invest in any stocks, bonds, debentures,
notes or similar obligations of any affiliate, except for affiliates which are
subsidiaries of the savings association.

     In addition, Sections 22(g) and (h) of the FRA place restrictions on loans
to executive officers, directors and principal stockholders. Under Section
22(h), loans to a director, an executive officer and to a greater than 10%
stockholder of a savings institution (a "principal stockholder"), and certain
affiliated interests of either, may not exceed, together with all other
outstanding

                                       30
<PAGE>   32
loans to such person and affiliated interests, the savings institution's loans
to one borrower limit (generally equal to 15% of the institution's unimpaired
capital and surplus). Section 22(h) also requires that loans to directors,
executive officers and principal stockholders be made on terms substantially the
same as offered to employees of the Bank and also requires prior board approval
for certain loans. In addition, the aggregate amount of extensions of credit by
a savings institution to all insiders cannot exceed the institution's unimpaired
capital and surplus. Furthermore, Section 22(g) places additional restrictions
on loans to executive officers. At September 30, 1996, the Bank was in
compliance with the above restrictions.

     Restrictions on Acquisitions. Except under limited circumstances, savings
and loan holding companies are prohibited from acquiring, without prior approval
of the Director of the OTS, (i) control of any other savings association or
savings and loan holding company or substantially all the assets thereof or (ii)
more than 5% of the voting shares of a savings association or holding company
thereof which is not a subsidiary. Except with the prior approval of the
Director of the OTS, no director or officer of a savings and loan holding
company or person owning or controlling by proxy or otherwise more than 25% of
such company's stock, may acquire control of any savings association, other than
a subsidiary savings association, or of any other savings and loan holding
company.

     The Director of the OTS may only approve acquisitions resulting in the
formation of a multiple savings and loan holding company which controls savings
associations in more than one state if (i) the multiple savings and loan holding
company involved controls a savings association which operated a home or branch
office located in the state of the association to be acquired as of March 5,
1987; (ii) the acquiror is authorized to acquire control of the savings
association pursuant to the emergency acquisition provisions of the Federal
Deposit Insurance Act ("FDIA"); or (iii) the statutes of the state in which the
association to be acquired is located specifically permit institutions to be
acquired by the state-chartered associations or savings and loan holding
companies located in the state where the acquiring entity is located (or by a
holding company that controls such state-chartered savings associations).

     FIRREA amended provisions of the Bank Holding Company Act of 1956 ("BHCA")
to specifically authorize the FRB to approve an application by a bank holding
company to acquire control of a savings association. FIRREA also authorized a
bank holding company that controls a savings association to merge or consolidate
the assets and liabilities of the savings association with, or transfer assets
and liabilities to, any subsidiary bank which is a member of the BIF with the
approval of the appropriate federal banking agency and the FRB. As a result of
these provisions, there have been a number of acquisitions of savings
associations by bank holding companies in recent years.

     Federal Securities Laws. The Company's Common Stock is registered with the
Securities and Exchange Commission "SEC" under the Exchange Act. The Company is
subject to the information, proxy solicitation, insider trading restrictions and
other requirements under the Exchange Act.

     Shares of common stock owned by an affiliate of the Company are subject to
the resale restrictions of Rule 144 under the Securities Act of 1933, as amended
("Securities Act"). If the Company meets the current public information
requirements of Rule 144 under the Securities Act, each affiliate of the Company
who complies with the other conditions of Rule 144 (including those that require
the affiliate's sale to be aggregated with those of certain other persons) would
be able to sell in the public market, without registration, a number of shares
not to exceed, in any three-month period, the greater of (i) 1% of the
outstanding shares of the Company or (ii) the average weekly volume of trading
in such shares during the preceding four calendar weeks.

     The Bank. The OTS has extensive regulatory authority over the operations of
savings associations. As part of this authority, savings associations are
required to file periodic reports with the OTS and are subject to periodic
examinations by the OTS. The investment and lending authority of savings
associations are prescribed by federal laws and regulations and they are
prohibited from engaging in any activities not permitted by such laws and
regulations. Those laws and regulations generally are applicable to all
federally chartered savings associations and may also apply to state-chartered
savings associations. Such regulation and supervision is primarily intended for
the protection of depositors.

     The OTS' enforcement authority over all savings associations and their
holding companies was substantially enhanced by FIRREA. This enforcement
authority includes, among other things, the ability to assess civil money
penalties, to issue cease and desist or removal orders and to initiate
injunctive actions. In general, these enforcement actions may be initiated for
violations of laws and regulations and unsafe or unsound practices. Other
actions or inactions may provide the basis for enforcement action, including
misleading or untimely reports filed with the OTS. FIRREA significantly
increased the amount

                                       31
<PAGE>   33
of and grounds for civil money penalties. FIRREA requires, except under certain
circumstances, public disclosure of final enforcement actions by the OTS.

     Insurance of Accounts. The deposits of the Bank are insured to the maximum
extent permitted by the SAIF, which is administered by the FDIC, and are backed
by the full faith and credit of the United States Government. As insurer, the
FDIC is authorized to conduct examinations of, and to require reporting by,
FDIC-insured institutions. It also may prohibit any FDIC-insured institution
from engaging in any activity the FDIC determines by regulation or order to pose
a serious threat to the FDIC. The FDIC also has the authority to initiate
enforcement actions against savings associations, after giving the OTS an
opportunity to take such action.

     The FDIC may terminate the deposit insurance of any insured depository
institution, including the Bank, if it determines after a hearing that the
institution has engaged or is engaging in unsafe or unsound practices, is in an
unsafe or unsound condition to continue operations, or has violated any
applicable law, regulation, order or any condition imposed by an agreement with
the FDIC. It also may suspend deposit insurance temporarily during the hearing
process for the permanent termination of insurance, if the institution has no
tangible capital. If insurance of accounts is terminated, the accounts at the
institution at the time of the termination, less subsequent withdrawals, shall
continue to be insured for a period of six months to two years, as determined by
the FDIC. Management is aware of no existing circumstances which could result in
termination of the Bank's deposit insurance.

The FDIC is authorized to establish separate assessment rates for deposit
insurance for members of the BIF and SAIF. The FDIC may increase assessment
rates for either fund to restore the fund's ratio of reserves to insured
deposits to its statutorily set target level within a reasonable time, and may
decrease such assessment rates if such target level has been met. Until the SAIF
fund meets its target level, savings associations may not transfer to the BIF
fund. Furthermore, any such transfers, when permitted, would be subject to exit
and entrance fees. Under current FDIC regulations, SAIF member institutions are
assigned to one of three capital groups which are based solely on the level of
an institution's capital--"well capitalized," "adequately capitalized," and
"undercapitalized." These three groups are then divided into three subgroups
which reflect varying levels of supervisory concern, from those which are
considered to be healthy to those which are considered to be of substantial
supervisory concern. The matrix so created results in nine assessment risk
classifications, with rates ranging from .23% for well capitalized, healthy
institutions to .31% for undercapitalized institutions with substantial
supervisory concerns. The insurance premium applicable to the Bank as of
September 30, 1996 was .23% of insured deposits.

The BIF fund met its target reserve level in September 1995, but the SAIF was
not expected to meet its target reserve level until at least 2002. Consequently,
in late 1995, the FDIC approved a final rule regarding deposit insurance
premiums which, effective with respect to the semi-annual premium assessment
beginning January 1, 1996, reduced deposit insurance premiums for BIF member
institutions to zero basis points (subject to an annual minimum of $2,000) for
institutions in the lowest risk category, Deposit insurance premiums for SAIF
members were maintained at their existing levels (23 basis points for
institutions in the lowest risk category).

     On September 30, 1996, President Clinton signed into law legislation (the
"Deposit Insurance Funds Act of 1996") which will eliminate the premium
differential between SAIF-insured institutions and BIF-insured institutions by
recapitalizing the SAIF's reserves to the required ratio. The legislation
provides that all SAIF member institutions pay a one-time special assessment to
recapitalize the SAIF, which in the aggregate will be sufficient to bring the
reserve ratio in the SAIF to 1.25% of insured deposits. The legislation also
provides for the merger of the BIF and the SAIF, with such merger being
conditioned upon, among other things, the prior elimination of the federal
thrift charter.

     Effective October 8, 1996, pursuant to the provision of the Deposit
Insurance Fund Act of 1996, FDIC regulations imposed a one-time special
assessment equal to 65.7 basis points for all SAIF-assessable deposits as of
March 31, 1995, which was collected on November 27, 1996. The Bank's one-time
special assessment amounted to approximately $1.4 million. Net of related tax
benefits, the one-time special assessment amounted to $876,000. The payment of
such special assessment had the effect of immediately reducing the Bank's
capital by such an amount. Nevertheless, this one-time special assessment did
not have a material adverse effect on the Bank's consolidated financial
condition nor did it cause non-compliance by the Bank with its regulatory
capital requirements.

     On October 16, 1996, the FDIC proposed to lower assessment rates for SAIF
members to reduce the disparity in the assessment rates paid by BIF and SAIF
members. Beginning October 1, 1996, effective SAIF rates range from zero basis
points

                                       32
<PAGE>   34
to 27 basis points. From 1997 through 1999, SAIF members will pay 6.4 basis
points to fund the Financing Corporation while BIF member institutions will pay
approximately 1.3 basis points. The Bank's insurance premiums, which have
amounted to 23 basis points, will be reduced to 6.4 basis points. Based upon the
$219.2 million of assessable deposits at September 30, 1996, the Bank would
expect to pay $365,000 less in insurance premiums per year.

     Capital requirements. Federally insured savings associations are required
to maintain minimum levels of regulatory capital. Pursuant to FIRREA, the OTS
has established capital standards applicable to all savings associations. These
standards generally must be as stringent as the comparable capital requirements
imposed on national banks. The OTS also is authorized to impose capital
requirements in excess of these standards on individual associations on a
case-by-case basis.

     Current OTS capital standards require savings associations to satisfy three
different capital requirements. Under these standards, savings associations must
maintain "tangible" capital equal to 1.5% of adjusted total assets, "core"
capital equal to 3% of adjusted total assets and "total" capital (a combination
of core and "supplementary" capital) equal to 8.0% of "risk-weighted" assets.
For purposes of the regulation, core capital generally consists of common
stockholders' equity (including retained earnings), noncumulative perpetual
preferred stock and related surplus, minority interests in the equity accounts
of fully consolidated subsidiaries, certain nonwithdrawable accounts and pledged
deposits and "qualifying supervisory goodwill." Tangible capital is given the
same definition as core capital but does not include qualifying supervisory
goodwill and is reduced by the amount of all the savings association's
intangible assets, with only a limited exception for purchased mortgage
servicing rights ("PMSRs"). Both core and tangible capital are further reduced
by an amount equal to a savings association's debt and equity investments in
subsidiaries engaged in activities not permissible for national banks (other
than subsidiaries engaged in activities undertaken as agent for customers or in
mortgage banking activities and subsidiary depository institutions or their
holding companies). At September 30, 1996, the Bank did not have any investment
in subsidiaries engaged in impermissible activities and required to be deducted
from its capital calculation.

     The Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA") granted the OTS the authority to prescribe rules for the amount of
PMSRs that may be included in a savings association's regulatory capital and
required that the value of readily marketable PMSRs included in the calculation
of a savings association's regulatory capital not exceed 90% of fair market
value and that such value be determined at least quarterly. Under final OTS
rules effective March 4, 1994, (i) PMSRs do not have to be deducted from
tangible and core regulatory capital, provided that they do not exceed 50% of
core capital, (ii) savings associations are required to determine the fair
market value and to review the book value of their PMSRs at least quarterly and
to obtain an independent valuation of PMSRs annually, (iii) savings associations
that desire to include PMSRs in regulatory capital may not carry them at a book
value under GAAP that exceeds the discounted value of their future net income
stream and (iv) for purposes of calculating regulatory capital, the amount of
PMSRs reported as balance sheet assets should amount to the lesser of 90% of
their fair market value, 90% of their original purchase price or 100% of their
remaining unamortized book value. In June 1993, the OTS published a thrift
bulletin on the valuation of PMSRs ("TB 60"). At September 30, 1996, the Bank
had PMSRs totalling $232,000.

     A savings association is allowed to include both core capital and
supplementary capital in the calculation of its total capital for purposes of
the risk-based capital requirements, provided that the amount of supplementary
capital does not exceed the savings association's core capital. Supplementary
capital generally consists of hybrid capital instruments; perpetual preferred
stock which is not eligible to be included as core capital; subordinated debt
and intermediate-term preferred stock; and, subject to limitations, general
allowances for loan losses. Assets are adjusted under the risk-based guidelines
to take into account different risk characteristics, with the categories ranging
from 0% (requiring no additional capital) for assets such as cash to 100% for
repossessed assets or loans more than 90 days past due. Single-family
residential real estate loans which are not past-due or non-performing and which
have been made in accordance with prudent underwriting standards are assigned a
50% level in the risk-weighing system, as are certain privately-issued
mortgage-backed securities representing indirect ownership of such loans.
Off-balance sheet items also are adjusted to take into account certain risk
characteristics.

     In August 1993, the OTS adopted a final rule incorporating an interest-rate
risk component into the risk-based capital regulation. Under the rule, an
institution with a greater than "normal" level of interest rate risk will be
subject to a deduction of its interest rate risk component from total capital
for purposes of calculating risk-based capital requirement. As a result, such an
institution will be required to maintain additional capital in order to comply
with the risk-based capital requirement. An institution with a greater than
"normal" interest rate risk is defined as an institution that would suffer a
loss of net portfolio value exceeding 2.0% of the estimated market value of its
assets in the event of a 200 basis point increase or decrease (with certain
minor exceptions) in interest rates. The interest rate risk component will be
calculated, on a quarterly basis, as one-half of the

                                       33
<PAGE>   35
difference between an institution's measured interest rate risk and 2.0%,
multiplied by the market value of its assets. The rule also authorizes the
Director of the OTS, or his designee, to waive or defer an institution's
interest rate risk component on a case-by-case basis. The final rule became
effective as of January 1, 1994 subject, however, to a two quarter "lag" time
between the reporting date of the data used to calculate an institution's
interest rate risk and the effective date of each quarter's interest rate risk
component. However, in October 1994 the Director of the OTS indicated that it
would waive the capital deductions for institutions with greater than "normal"
risk until the OTS publishes an appeals process. On August 21, 1995, the OTS
released Thrift Bulletin 67 which established (i) and appeals process to handle
:"requests for adjustments" to the interest rate risk component and (ii) a
process by which "well capitalized" institutions may obtain authorization to use
their own interest rate risk model to determine their interest rat risk
component. The Director of the OTS indicated, concurrent with release of Thrift
Bulletin 67, that the OTS will continue to delay the implementation of the
capital deduction for interest rate risk pending the testing of the appeals
process set forth in Thrift Bulletin 67.

                                       34
<PAGE>   36
         The following is a reconciliation of the Bank's equity determined in
accordance with GAAP to regulatory tangible, core, and risk-based capital at
September 30, 1996, 1995 and 1994.

<TABLE>
<CAPTION>
                                          September 30, 1996             September 30, 1995              September 30, 1994
                                   ------------------------------   -----------------------------    ------------------------- 
                                    Tangible    Core   Risk-based  Tangible     Core     Risk-based Tangible   Core   Risk-based
                                    Capital   Capital    Capital    Capital    Capital    Capital    Capital  Capital  Capital
                                   --------   --------   --------   --------   --------   --------   -------  -------  -------
                                                                           (Dollars in thousands)

<S>                                <C>        <C>        <C>        <C>        <C>        <C>        <C>      <C>      <C>    
GAAP equity                        $ 22,608   $ 22,608   $ 22,608   $ 23,129   $ 23,129   $ 23,129   $11,622  $11,622  $11,622

Purchased mortgage servicing                                              (9)        (9)        (9)      (27)     (27)     (27)

Assets required to be deducted(1)                             (55)                             (55)                        (55)

General valuation allowances                                1,775                            1,412                       1,466
                                   --------   --------   --------   --------   --------   --------   -------  -------  -------

Total regulatory capital             22,608     22,608     24,328     23,120     23,120     24,477    11,595   11,595   13,006

Minimum capital requirement per

  FIRREA published guidelines         4,421      8,841     11,289      4,212      8,425     10,986     3,566    7,132   10,272
                                   --------   --------   --------   --------   --------   --------   -------  -------  -------

Excess                             $ 18,187   $ 13,767   $ 13,039   $ 18,908   $ 14,695   $ 13,491   $ 8,029  $ 4,463  $ 2,734
                                   ========   ========   ========   ========   ========   ========   =======  =======  =======
</TABLE>



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

  (1) Consists of equity investment nonincludable in regulatory capital.

                                       35
<PAGE>   37
         Prompt Corrective Action. Under Section 38 of the FDIA as added by the
FDICIA, each federal banking agency is required to implement a system of prompt
corrective action for institutions which it regulates. In early September 1992,
the federal banking agencies, including the OTS, adopted substantially similar
regulations which are intended to implement Section 38 of the FDIA. These
regulations became effective December 19, 1992. Under the regulations, an
institution shall be deemed to be (i) "well capitalized" if it has total
risk-based capital of 10% or more, has a Tier I risk-based capital ratio of 6%
or more, has a Tier I leverage capital ratio of 5% or more and is not subject to
any order or final capital directive to meet and maintain a specific capital
level for any capital measure, (ii) "adequately capitalized" if it has a total
risk-based capital ratio of 8% or more, a Tier I risk-based capital ratio of 4%
or more and a Tier I leverage capital ratio of 4% or more (3% under certain
circumstances) and does not meet the definition of "well capitalized," (iii)
"undercapitalized" if it has a total risk-based capital ratio that is less than
8%, a Tier I risk-based capital ratio that is less than 4% or a Tier I leverage
capital ratio that is less than 4% (3% under certain circumstances), (iv)
"significantly undercapitalized" if it has a total risk-based capital ratio that
is less than 6%, a Tier I risk-based capital ratio that is less than 3% or a
Tier I leverage capital ratio that is less than 3%, and (v) "critically
undercapitalized" if it has a ratio of tangible equity to total assets that is
equal to or less than 2%. Section 38 of the FDIA and the regulations promulgated
thereunder also specify circumstances under which a federal banking agency may
reclassify a well capitalized institution as adequately capitalized and may
require an adequately capitalized institution or an undercapitalized institution
to comply with supervisory actions as if it were in the next lower category
(except that the FDIC may not reclassify a significantly undercapitalized
institution as critically undercapitalized). At September 30, 1996 the Bank was
in the "well capitalized" category.

     Liquidity Requirements. All savings associations are required to maintain
an average daily balance of liquid assets equal to a certain percentage of the
sum of its average daily balance of net withdrawable deposit accounts and
borrowings payable in one year or less. The liquidity requirement may vary from
time to time (between 4% and 10%) depending upon economic conditions and savings
flows of all savings associations. At the present time, the required minimum
liquid asset ratio is 5%. The Bank has consistently exceeded such regulatory
liquidity requirement and, at September 30, 1996, had a liquidity ratio of 8.46%

     Accounting Requirements. FIRREA requires the OTS to establish accounting
standards to be applicable to all savings associations for purposes of complying
with regulations, except to the extent otherwise specified in the capital
standards. Such standards must incorporate GAAP to the same degree as is
prescribed by the federal banking agencies for banks or may be more stringent
than such requirements. Such standards must have been fully implemented by
January 1, 1994 and must be phased in as provided in federal regulations in
effect on May 1, 1989.

     Applicable OTS accounting regulations and reporting requirements apply the
following standards: (i) regulatory reports will incorporate GAAP when GAAP is
used by federal banking agencies; (ii) savings association transactions,
financial condition and regulatory capital must be reported and disclosed in
accordance with OTS regulatory reporting requirements that will be at least as
stringent as for national banks; and (iii) the director of the OTS may prescribe
regulatory reporting requirements more stringent than GAAP whenever the director
determines that such requirements are necessary to ensure the safe and sound
reporting and operation of savings associations.

     The accounting principles for depository institutions are currently
undergoing review to determine whether the historical cost model or market-based
measure of valuation is the appropriate measure for reporting the assets of such
institutions in their financial statements. Such proposal is controversial
because any change in applicable accounting principles which require depository
institutions to carry mortgage-backed securities and mortgage loans at fair
market value could result in substantial losses to such institutions and
increase volatility in their liquidity and operations. Currently, it cannot be
predicted whether there may be any changes in the accounting principles for
depository institutions in this regard beyond those imposed by SFAS 115 or when
any such might become effective.

     Qualified Thrift Lender Test. Under Section 2303 of the Economic Growth and
Regulatory Paper work Reduction Act of 1996, a savings association can comply
with the QTL test by wither meeting the QTL test set forth in the HOLA and
implementing regulation or qualifying as a domestic building and loan
association as defined in Section 7701(a)(19) of the Internal Revenue Code of
1986, as amended ("Code"). A savings institution that does not comply with the
QTL test must either convert to a bank charter or comply with the following
restrictions on its operations: (i) the association may not engage in any new
activity or make any new investment, directly or indirectly, unless such
activity or investment is permissible for a national bank; (ii) the branching
powers of the association shall

                                       36
<PAGE>   38
be restricted to those of a national bank; (iii) the association shall not be
eligible to obtain any advances from its FHLB; and (iv) payment of dividends by
the association shall be subject to the rules regarding payment of dividends by
a national bank. Upon the expiration of three years from the date the
association ceases to be a QTL, it must cease any activity and not retain any
investment not permissible for a national bank and immediately repay any
outstanding FHLB advances (subject to safety and soundness considerations).

     The QTL Test set forth in the HOLA requires that Qualified Thrift
Investments ("QTLs") represent 65% of portfolio assets. Portfolio assets are
defined as total assets less intangibles, property used by a savings association
in its business and liquidity investments in an amount not exceeding 20% of
assets. Generally, QTLs are residential housing relate assets, The 1996
amendments allow small business loans, credit card loans, student loans and
loans for personal, family and household purposes to be included without
limitation as qualified investments. At September 30, 1996, approximately 92.5%
of the Bank's assets were invested in QTLs, which was in excess of the
percentage required to qualify the Bank under the QTL Test in effect at that
time.

     Restrictions on Capital Distributions. OTS regulations govern capital
distributions by savings associations, which include cash dividends, stock
redemptions or repurchases, cash-out mergers, interest payments on certain
convertible debt and other transactions charged to the capital account of a
savings association to make capital distributions. Generally, the regulation
creates a safe harbor for specified levels of capital distributions from
associations meeting at least their minimum capital requirements, so long as
such associations notify the OTS and receive no objection to the distribution
from the OTS. Savings institutions and distributions that do not qualify for the
safe harbor are required to obtain prior OTS approval before making any capital
distributions.

     Generally, savings associations that before and after the proposed
distribution meet or exceed their fully phased-in capital requirements, or Tier
1 associations, may make capital distributions during any calendar year equal to
the higher of (i) 100% of net income for the calendar year-to-date plus 50% of
its "surplus capital ratio" at the beginning of the calendar year or (ii) 75% of
net income over the most recent four-quarter period. The "surplus capital ratio"
is defined to mean the percentage by which the association's ratio of total
capital to assets exceeds the ratio of its fully phased-in capital requirement
to assets. "Fully phased-in capital requirement" is defined to mean an
association's capital requirement under the statutory and regulatory standards
applicable on December 31, 1994, as modified to reflect any applicable
individual minimum capital requirement imposed upon the association. Failure to
meet fully phased-in or minimum capital requirements will result in further
restrictions on capital distributions including possible prohibition without
explicit OTS approval. See "- Capital Requirements."

     In order to make distributions under these safe harbors, Tier 1 and Tier 2
associations must submit written notice to the OTS 30 days prior to making the
distribution. The OTS may object to the distribution during that 30-day period
based on safety and soundness concerns. In addition, a Tier 1 association deemed
to be in need of more than normal supervision by the OTS may be downgraded to a
Tier 2 or Tier 3 association as a result of such a determination. The Bank
currently is a Tier 1 institution for purposes of the regulation dealing with
capital distributions.

     OTS regulations also prohibit the Bank from declaring or paying any
dividends or from repurchasing any of its stock if, as a result, the regulatory
(or total) capital of the Bank would be reduced below the amount required to be
maintained for the liquidation account established by it for certain depositors
in connection with its conversion from mutual to stock form.

     Community Reinvestment. Under the Community Reinvestment Act of 1977, as
amended ("CRA"), as implemented by OTS regulations, a savings association has a
continuing and affirmative obligation consistent with its safe and sound
operation to help meet the credit needs of its entire community, including low
and moderate income neighborhoods. The CRA does not establish specific lending
requirements or programs for financial institutions nor does it limit an
institution's discretion to develop the types of products and services that it
believes are best suited to its particular community, consistent with the CRA.
The CRA requires the OTS, in connection with its examination of a savings
institution, to assess the institution's record of meeting the credit needs of
its community and to take such record into account in its evaluation of certain
applications by such institution. FIRREA amended the CRA to require, effective
July 1, 1990, public disclosure of an institution's CRA rating and require the
OTS to provide a written evaluation of an institution's CRA performance
utilizing a four tiered descriptive rating system in

                                       37
<PAGE>   39
lieu of the existing five-tiered numerical rating system. The Bank received an
"outstanding" rating as a result of its last evaluation in February 1995.

     Policy Statement on Nationwide Branching. Effective May 11, 1992, the OTS
amended and codified its policy statement on branching by federally chartered
savings associations to delete then-existing regulatory restrictions on the
branching authority of such associations and to permit nationwide branching to
the extent allowed by federal statute. (Prior OTS policy generally permitted
interstate branching for federally chartered savings associations only to the
extent allowed state-chartered savings associations in the states where the
association's home office was located and where the branch was sought or if the
branching resulted from OTS approval of a supervisory interstate acquisition of
a troubled institution.) Current OTS policy generally permits a federally
chartered savings association to establish branch offices outside of its home
state if the association meets the domestic building and loan test in Section
7701(a)(19) of the Code or the asset composition test of subparagraph (c) of
that section, and if, with respect to each state outside of its home state where
the association has established branches, the branches, taken alone, also
satisfy one of the two tax tests. An association seeking to take advantage of
this authority would have to have a branching application approved by the OTS,
which would consider the regulatory capital of the association and its record
under the CRA, as amended, among other things.

     Federal Home Loan Bank System. The Bank is a member of the FHLB of
Pittsburgh, which is one of 12 regional FHLBs that administers the home
financing credit function of savings associations. Each FHLB serves as a reserve
or central bank for its members within its assigned region. It is funded
primarily from proceeds derived from the sale of consolidated obligations of the
FHLB System. It makes loans to members (i.e., advances) in accordance with
policies and procedures established by the Board of Directors of the FHLB.

     As a member, the Bank is required to purchase and maintain stock in the
FHLB of Pittsburgh in an amount equal to at least 1% of its aggregate unpaid
residential mortgage loans, home purchase contracts or similar obligations at
the beginning of each year or 5% of its advances from the FHLB of Pittsburgh,
whichever is greater. At September 30, 1996, the Bank had $2.3 million in FHLB
stock, which was in compliance with this requirement.

     The FHLBs are required to provide funds for the resolution of troubled
savings associations and to contribute to affordable housing programs through
direct loans or interest subsidies on advances targeted for community investment
and low- and moderate-income housing projects. These contributions have
adversely affected the level of FHLB dividends paid and could continue to do so
in the future. These contributions also could have an adverse effect on the
value of FHLB stock in the future. For the years ended September 30, 1996 and
1995, dividends paid by the FHLB of Pittsburgh to the Bank totalled
approximately $106,000 and $94,000, respectively.

     Federal Reserve System. The FRB requires all depository institutions to
maintain reserves against their transaction accounts (primarily NOW and Super
NOW checking accounts) and non-personal time deposits. At September 30, 1996,
the Bank was in compliance with applicable requirements. However, because
required reserves must be maintained in the form of vault cash or a
noninterest-bearing account at a Federal Reserve Bank, the effect of this
reserve requirement is to reduce an institution's earning assets.

     Miscellaneous. In addition to requiring a new system of risk-based
insurance assessments and a system of prompt corrective action with respect to
undercapitalized banks, as discussed above, recent legislation requires federal
banking regulators to adopt regulations in a number of areas to ensure bank
safety and soundness, including: internal controls; credit underwriting; asset
growth; management compensation; ratios of classified assets to capital; and
earnings. Recent legislation also restricts the activities of state-chartered
insured banks; amends various consumer banking laws; limits the ability of
"undercapitalized banks" to borrow from the FRB's discount window; and requires
regulators to perform annual on-site bank examinations and set standards for
real estate lending.

                                       38
<PAGE>   40
FEDERAL AND STATE TAXATION

     General. The Company and the Bank are subject to the corporate tax
provisions of the Code, as well as certain additional provisions of the Code
which apply to thrift and other types of financial institutions. The following
discussion of tax matters is intended only as a summary and does not purport to
be a comprehensive description of the tax rules applicable to the Company and
the Bank.

     Fiscal Year. For the year ended September 30, 1995 and thereafter, the
Company and the Bank and its subsidiaries file a consolidated federal income tax
return on a fiscal year basis. Prior to September 30, 1995, the Company and the
Bank and its subsidiaries filed consolidated federal income tax returns on a
calendar year basis.

     Method of Accounting. The Bank maintains its books and records for federal
income tax purposes using the accrual method of accounting. The accrual method
of accounting generally requires that items of income be recognized when all
events have occurred that establish the right to receive the income and the
amount of income can be determined with reasonable accuracy, and that items of
expense be deducted at the later of (i) the time when all events have occurred
that establish the liability to pay the expense and the amount of such liability
can be determined with reasonable accuracy or (ii) the time when economic
performance with respect to the item of expense has occurred.

     Bad Debt Reserves. As a "domestic building and loan association," the Bank
is permitted to establish reserves for bad debts and to make annual additions
thereto which qualify as deductions from taxable income. The bad debt deduction
is generally based on a savings institution's actual loss experience (the
"Experience Method"). In addition, provided that certain definitional tests
relating to the composition of assets and the nature of its business are met, a
savings institution may elect annually to compute its allowable addition to its
bad debt reserves for qualifying real property loans (generally loans secured by
improved real estate) by reference to a percentage of its taxable income (the
"Percentage Method").

     Under the Experience Method, the deductible annual addition is the amount
necessary to increase the balance of the reserve at the close of the taxable
year to the greater of (i) the amount which bears the same ratio to loans
outstanding at the close of the taxable year as the total net bad debts
sustained during the current and five preceding taxable years bear to the sum of
the loans outstanding at the close of those six years or (ii) the balance in the
reserve account at the close of the Bank's "base year," which was its tax year
ended December 31, 1987.

     Under the Percentage Method, the bad debt deduction with respect to
qualifying real property loans is computed as a percentage of the Bank's taxable
income before such deduction, as adjusted for certain items (such as capital
gains and the dividends received deduction). Under this method, a qualifying
institution such as the Bank generally may deduct 8% of its taxable income. In
the absence of other factors, the availability of the Percentage Method has
permitted a qualifying savings institution, such as the Bank, to be taxed at an
effective federal income tax rate of 31.28%, as compared to 34% for corporations
generally.

     For taxable years ended on or before December 31, 1988, the Bank has
generally elected to use the Percentage Method to compute the amount of its bad
debt deduction with respect to its qualifying real property loans. For all
taxable years ended after December 31, 1988 with the exception of the September
30, 1996 tax year, the Bank has elected to use the Experience Method to compute
the amount of its bad debt deduction with respect to its qualifying real
property loans. As of September 30, 1996, the Bank's qualified assets
constituted approximately 92.3% of its total assets and the balance of its
accumulated bad debt reserve was 1.0% of its qualifying and non-qualifying
loans. As a result, the Bank does not believe that any of the restrictions
imposed upon the computation of the bad debt deduction would be a limiting
factor.

     The income of the Company or any non-bank subsidiaries would not be subject
to the bad debt deduction allowed the Bank, whether or not consolidated tax
returns are filed.

     In August 1996, the Small Business Job Protection Act (the "Act") was
signed into law. The Act repealed the percentage of taxable income method of
accounting for bad debts for thrift institutions effective for years beginning
after December 31, 1995. The Act will require the Company as of October 1, 1996
to change its method of

                                       39
<PAGE>   41
computing reserves for bad debts to the experience method. The bad debt
deduction allowable under this method is available to small banks with assets
less than $500 million. Generally, this method will allow the Company to deduct
an annual addition to the reserve for bad debts equal to the increase in the
balance of the Company's reserve for bad debts at the end of the year to an
amount equal to the percentage of total loans at the end of the year, computed
using the ratio of the previous six years net charge offs divided by the sum of
the previous six years total outstanding loans at year end.

     A thrift institution required to change its method of computing reserves
for bad debts will treat such change as a change in a method of accounting
determined solely with respect to he "applicable excess reserves" of the
institution. The amount of the applicable excess reserves will be taken into
account ratable over a six-taxable year period, beginning with the first taxable
year beginning after December 31, 1995. The timing of the recapture may be
delayed for a two-year period provided certain residential lending requirements
are met. For financial reporting purposes, the Company will not incur any
additional tax expense. At September 30, 1996, under SFAS No. 109, deferred
taxes were provided on the difference between the book reserve at September 30,
1996 and the applicable excess reserve in an amount equal to the Bank's increase
in the tax reserve from December 31, 1987 to September 30, 1996.

     Distributions. While the Bank maintains a bad debt reserve, if it were to
distribute cash or property to its sole stockholder having a total fair market
value in excess of its accumulated tax-paid earnings and profits, or were to
distribute cash or property to its stockholder in redemption of its stock, the
Bank would generally be required to recognize as income an amount which, when
reduced by the amount of federal income tax that would be attributable to the
inclusion of such amount in income, is equal to the lesser of: (i) the amount of
the distribution or (ii) the sum of (a) the amount of the accumulated bad debt
reserve of the Bank with respect to qualifying real property loans (to the
extent that additions to such reserve exceed the additions that would be
permitted under the experience method) and (b) the amount of the Bank's
supplemental bad debt reserve.

     Minimum Tax. The Code imposes an alternative minimum tax at a rate of 20%
on a base of regular taxable income plus certain tax preferences ("alternative
minimum taxable income" or "AMTI"). The alternative minimum tax is payable to
the extent such AMTI is in excess of an exemption amount. The Code provides that
an item of tax preference is the excess of the bad debt deduction allowable for
a taxable year pursuant to the percentage of taxable income method over the
amount allowable under the experience method. The other items of tax preference
that constitute AMTI include (a) tax-exempt interest on newly-issued (generally,
issued on or after August 8, 1986) private activity bonds other than certain
qualified bonds and (b) for taxable years beginning after 1989, 75% of the
excess (if any) of (i) adjusted current earnings as defined in the Code, over
(ii) AMTI (determined without regard to this preference and prior to reduction
by net operating losses). Net operating losses can offset no more than 90% of
AMTI. Certain payments of alternative minimum tax may be used as credits against
regular tax liabilities in future years.

     Audit by IRS. The Bank's consolidated federal income tax returns for
taxable years through December 31, 1994 have been closed for the purpose of
examination by the IRS.

STATE TAXATION

     The Company is subject to the Pennsylvania Corporate Net Income Tax and
Capital Stock and Franchise Tax. The Corporate Net Income Tax rate for fiscal
1996 is 9.99% and is imposed on the Company's unconsolidated taxable income for
federal purposes with certain adjustments. In general, the Capital Stock Tax is
a property tax imposed at the rate of 1.3% of a corporation's capital stock
value, which is determined in accordance with a fixed formula.

     The Bank is taxed under the Pennsylvania Mutual Thrift Institutions Tax Act
(the ("MTIT"), as amended to include thrift institutions having capital stock.
Pursuant to the MTIT, the Bank's tax rate is 11.5%. The MTIT exempts the Bank
from all other taxes imposed by the Commonwealth of Pennsylvania for state
income tax purposes and from all local taxation imposed by political
subdivisions, except taxes on real estate and real estate transfers. The MTIT is
a tax upon net earnings, determined in accordance with GAAP with certain
adjustments. The MTIT, in computing GAAP income, allows for the deduction of
interest earned on state and federal securities, while disallowing a percentage
of a thrift's interest expense deduction in the proportion of interest income on
those securities to the overall interest income of the Bank. Net operating
losses, if any, thereafter can be carried forward three years for MTIT purposes.

                                       40
<PAGE>   42
ITEM 2.  PROPERTIES

         At September 30, 1996, the Bank conducted business from its executive
         offices located in Media, Pennsylvania and four full-service offices
         located in Delaware County, Pennsylvania. See also Note 8 of the Notes
         to Consolidated Financial Statements in the Annual Report.

         The following table sets forth certain information with respect to the
         Bank's offices at September 30, 1996.

<TABLE>
<CAPTION>
                                                                            Net Book Value
                                                                                  of               Amount of
               Description/Address                    Leased/Owned             Property             Deposits
               -------------------                    ------------             --------             --------
                                                                                      (In thousands)
          <S>                                           <C>                     <C>                  <C>   
          Executive Offices:

          Main Office

          22 West State Street
          Media, Pennsylvania 19063                       Owned                 $1,042               $ 73,041



          Branch Offices:

          3218 Edgmont Avenue
          Brookhaven, Pennsylvania 19015                  Owned                    232                 74,809



          Routes 1 and 100
          Chadds Ford, Pennsylvania 19318               Leased(1)                   84                 17,012



          23 East Fifth Street
          Chester, Pennsylvania 19013                   Leased(2)                  306                 16,327



          330 Dartmouth Avenue
          Swarthmore, Pennsylvania 19081                  Owned                    134                 38,016
                                                                                ------               --------

                                                                                $1,798               $219,205
                                                                                ======               ========
</TABLE>



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

         (1)      Lease expiration date is September 30, 2000. The Bank has two
                  five year renewal options.

         (2)      Lease expiration date is December 31, 2005. The Bank has one
                  ten year renewal option.

                                       41
<PAGE>   43
ITEM 3.  LEGAL PROCEEDINGS.

         In April 1994, a lawsuit was filed in the Court of Common Pleas in
         Delaware County. The lawsuit was brought on behalf of the estates of
         eight individuals arising out of the activities of a now deceased
         attorney who maintained a law practice in Media, Pennsylvania. The
         attorney was accused of misappropriating the funds of such estates for
         which he served as counsel, executor and administrator. During the
         fiscal year ended September 30, 1996, the case settled with all of the
         plaintiffs in the amount of $400,000 with the settlement amount being
         completely covered by insurance, less any deductible.

         Other than the matter discussed above, the Bank is involved in routine
         legal proceedings occurring in the ordinary course of business which,
         in the aggregate, are believed by management to be immaterial to the
         financial condition of the Bank.

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

         Not applicable.

PART II.

ITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.

         The information required herein is incorporated by reference from page
         3 of the Registrant's 1996 Annual Report. At December 16, 1996 there
         were approximately 489 shareholders of record, not including the number
         of persons or entities whose stock is held in nominee or street name
         through various brokerage firms or banks.

ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
        OF OPERATIONS.

         The information required herein is incorporated by reference from pages
         8 to 17 of the Registrant's 1996 Annual Report.

ITEM 7.  FINANCIAL STATEMENTS.

         The information required herein is incorporated by reference form pages
         18 to 39 of the Registrant's 1996 Annual Report.

ITEM 8.  CHANGES IN AND DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.

         Not applicable.

PART III

ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, AND PROMOTORS AND CONTROL PERSONS;
        COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT OF THE REGISTRANT.

         The information required herein is incorporated by reference from pages
         2 to 5 and page 12 of the Registrant's Proxy Statement dated December
         31, 1996 ("Proxy Statement").

                                       42
<PAGE>   44
ITEM 10.  EXECUTIVE COMPENSATION.

          The information required herein is incorporated by reference from
          pages 8 to 12 of the Registrant's Proxy Statement.

ITEM 11.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

          The information required herein is incorporated by reference from
          pages 6 to 7 of the Registrant's Proxy Statement.

ITEM 12.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

          The information required herein is incorporated by reference from page
          12 of the Registrant's Proxy Statement.

ITEM 13.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.

          (a)   Documents filed as part of this Report.

                (1)   The following documents are filed as part of this report
                      and are incorporated herein by reference from the
                      Registrant's Annual Report.

                      Report of Independent Auditors.

                      Consolidated Statements of Financial Condition at
                      September 30, 1996 and 1995.

                      Consolidated Statements of Income for the Years Ended
                      September 30, 1996, 1995 and 1994.

                      Consolidated Statements of Changes in Stockholders' Equity
                      for the Years Ended September 30, 1996, 1995 and 1994.

                      Consolidated Statements of Cash Flows for the Years Ended
                      September 30, 1996, 1995 and 1994.

                      Notes to the Consolidated Financial Statements.

                (2)   All schedules for which provision is made in the
                      applicable accounting regulation of the SEC are omitted
                      because they are not applicable or the required
                      information is included in the Consolidated Financial
                      Statements or notes thereto.

                (3)   The following exhibits are filed as part of this Form 
                      10-KSB, and this list includes the Exhibit Index.


                                       43
<PAGE>   45
<TABLE>
<CAPTION>


No                             Description                                                         Page
--                             -----------                                                         ----

<S>           <C>                                                 
3.1           Amended and Restated Articles of Incorporation of
              First Keystone Financial, Inc. (*)

3.2           Amended and Restated Bylaws of First Keystone Financial, Inc. (*)

4             Specimen Stock Certificate of First Keystone Financial, Inc. (*)

10.1          Employee Stock Ownership Plan and Trust of First Keystone Financial, Inc. (*)

10.2          401(K)/ Profit Sharing Plan of First Keystone Federal Savings Bank *

10.3          Employment Agreement between First Keystone Financial, Inc. and
              Donald S. Guthrie (incorporated by reference from Exhibit 10.3 to
              Registrant's Form 10-KSB for the year ended September 30, 1995).

10.4          Employment Agreement between First Keystone Financial, Inc. and
              Stephen J. Henderson (incorporated by reference from Exhibit 10.4 to
              Registrant's Form 10-KSB for the year ended September 30, 1995).

10.5          Employment Agreement between First Keystone Financial, Inc. and
              Thomas M. Kelly (incorporated by reference from Exhibit 10.5 to
              Registrant's Form 10-KSB for the year ended September 30, 1995).

10.6          Form of Severance Agreement between First Keystone Financial, Inc. and
              Elizabeth M. Mulcahy (incorporated by reference from Exhibit 10.6  to
              Registrant's Form 10-KSB for the year ended September 30, 1995).

10.8          Form of Severance Agreement between First Keystone Financial, Inc. and
              Carol Walsh (incorporated by reference from Exhibit 10.8 to
              Registrant's Form 10-KSB for the year ended September 30, 1995).

10.9          1995 Stock Option Plan (incorporated by reference from Exhibit
              10.9 to Registrant's Form 10-KSB for the year ended September 30,
              1995).
</TABLE>

                                       44
<PAGE>   46
<TABLE>

<S>           <C>                                                 
10.10         1995 Recognition and Retention Plan and Trust Agreement,
              (incorporated by reference from Exhibit 10.10 to Registrants
              Form 10-KSB for the year ended September 30, 1995).

11            Statement re: Computation of Earnings

13            Annual Report to Stockholders

21            Subsidiaries of the Registrant - Reference is made to Item 1
              "Business," for the required information

23            Consent of Experts and Counsel
</TABLE>

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

     (*) Incorporated by reference from the Registration Statement Form S-1
         (Registration No. 33-84824) filed by the Registrant with the SEC on 
         October 6, 1994, as amended.

     (b) Reports filed in Form 8-K.

         None.

                                       45
<PAGE>   47
SIGNATURES

         Pursuant to the requirements of Section 13 or 15 (d) 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.

                                             FIRST KEYSTONE FINANCIAL, INC.

                                             By:/s/ Donald S. Guthrie
                                                -----------------------------
                                             Donald S. Guthrie
                                             President and Chief Executive
                                             Officer

         Pursuant to the requirements of the Securities and Exchange Act of
1934, this report had been signed below by the following persons on behalf of
the Registrant and in the capacities and on the dates indicated.

<TABLE>

<S>                                                                    <C>
/s/ Donald S. Guthrie                                                  December 27, 1996
--------------------------------------------------
Donald S. Guthrie
President and Chief Executive Officer
(Principal Executive Officer)

/s/ Thomas M. Kelly                                                    December 27, 1996
-----------------------------------------------
Thomas M. Kelly
Executive Vice-President and Chief
Financial Officer
(Principal Financial and Accounting Officer)

/s/ Donald A. Purdy                                                    December 27, 1996
------------------------------------------------
Donald A. Purdy
Chairman of the Board

/s/ William K. Betts                                                   December 27, 1996
------------------------------------------------
William K. Betts
Director

/s/ Edward Calderoni                                                   December 27, 1996
------------------------------------------------
Edward Calderoni
Director

/s/ Silvio F. D'Ignazio                                                December 27, 1996
------------------------------------------------
Silvio F. D'Ignazio
Director
</TABLE>

                                       46
<PAGE>   48
<TABLE>
<S>                                                                    <C>
/s/ Olive J. Faulkner                                                  December 27, 1996
------------------------------------------------
Olive J. Faulkner
Director

/s/ Edmund Jones                                                       December 27, 1996
------------------------------------------------
Edmund Jones
Director

/s/ Willard F. Letts                                                   December 27, 1996
------------------------------------------------
Willard F. Letts
Director

/s/ Walter J. Lewicki                                                  December 27, 1996
----------------------------------------------
Walter J. Lewicki
Director

/s/ Charles E. Rankin                                                  December 27, 1996
---------------------------------------------
Charles E. Rankin
Director

/s/ Joan G. Taylor                                                     December 27, 1996
-----------------------------------------------
Joan G. Taylor
Director
</TABLE>

                                       47