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

                                    FORM 10-Q

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

          For the quarterly period ended    March 31, 1997
                                                                  Or
  [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE            
 SECURITIES EXCHANGE ACT OF 1934

         For the transition period from__________ to____________________

                         Commission File Number: 0-21083

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

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

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

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

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

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

As of April 25, 1997 there were issued and outstanding 4,496,500 shares of the
Registrant's common stock, no par value.
<PAGE>
 
                   SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY


                                      INDEX

<TABLE> 
   <S>                                                                                              <C> 
   PART I - FINANCIAL INFORMATION

       Item 1.  Financial Statements

         Consolidated  statements  of  financial  condition  at March 31,  1997                       1                          
         (Unaudited)  and  September 30, 1996                                                                                      
                                                                                                                                   
         Consolidated statements of income for the three months ended                                 2                            
         March 31, 1997 and 1996 (Unaudited)                                                                                       
                                                                                                                                   
         Consolidated statements of income for the six months ended                                   3                            
         March 31, 1997 and 1996 (Unaudited)                                                                                       
                                                                                                                                   
         Consolidated statements of cash flows for the six months                                                                  
         ended March 31, 1997 and 1996 (Unaudited)                                                  4-5                            
                                                                                                                                   
                                                                                                                                   
         Notes to consolidated financial statements (Unaudited)                                     6-8                            
                                                                                                                                   
                                                                                                                                   
                                                                                                                                   
                                                                                                   
Item 2.  Management's Discussion and Analysis of Financial Condition                                                               
                and Results of Operations                                                          9-13                  
                                                                                                                                   
                                                                                                                                   
 PART II - OTHER INFORMATION                                                                                                     
                                                                                                                                 
       Item 1.  Legal Proceedings                                                                    14                            
                                                                                                                                   
       Item 2.  Changes in Securities                                                                14                            
                                                                                                                                   
       Item 3.  Defaults upon Senior Securities                                                      14                            
                                                                                                                                   
       Item 4.  Submission of Matters to a Vote of Security Holders                                  14                            
                                                                                                                                   
       Item 5.  Other Information                                                                    14                            
                                                                                                                                   
       Item 6.  Exhibits and Reports on Form 8-K                                                     14                             
                                                                                                                         
       Signatures                                                                                    15                  
</TABLE> 
<PAGE>
 
SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
March 31, 1997 and September 30, 1996


<TABLE> 
<CAPTION> 

                                                                                       March 31,            September 30,
ASSETS                                                                                   1997                   1996
----------------------------------------------------------------------------------------------------------------------------
                                                                                      (Unaudited)             (Note)*
<S>                                                                           <C>                      <C> 
Cash and cash equivalents:
     Noninterest-bearing deposits                                             $            2,498,000   $          2,787,000
     Interest-bearing deposits                                                             8,982,000             59,348,000
Securities held to maturity                                                               23,669,000              5,496,000
Securities available for sale                                                             86,456,000             34,784,000
Federal Home Loan Bank stock                                                               2,705,000              1,346,000
Loans receivable, net                                                                    110,692,000            109,858,000
Real estate acquired in settlement of loans                                                   18,000                 18,000
Accrued interest receivable                                                                2,261,000              1,165,000
Office properties and equipment, net                                                       1,196,000              1,238,000
Prepaid expenses and other assets                                                            314,000              1,914,000
                                                                              ----------------------------------------------
                     Total assets                                             $          238,791,000   $        217,954,000
                                                                              ==============================================

LIABILITIES AND STOCKHOLDERS' EQUITY
----------------------------------------------------------------------------------------------------------------------------
Liabilities:
    Deposits                                                                  $          141,030,000   $        146,398,000
    Deposits, stock offering                                                                  -                  46,601,000
    Special SAIF Assessment                                                                   -                     838,000
    Advance payments by borrowers for taxes and insurance                                    351,000                115,000
    Accounts payable and other liabilities                                                 1,440,000              2,148,000
    Advances from Federal Home Loan Bank                                                  35,000,000                 -
    Checks outstanding on disbursement account                                               623,000                987,000
                                                                              ----------------------------------------------
                     Total liabilities                                                   178,444,000            197,087,000
                                                                              ----------------------------------------------
Stockholders' equity:
     Preferred stock, no par value, authorized 5,000,000 shares;
         no shares issued                                                                    -                       -
     Common stock, no par value, authorized 20,000,000 shares;
         issued 4,496,500 shares March 31, 1997 and no shares
         September 30, 1996                                                                  -                       -
     Additional paid-in capital                                                           43,645,000                 -
     Unrealized gain (loss) on securities available for
         sale, net of tax                                                                  (417,000)               (35,000)
     Note receivable, ESOP                                                               (4,399,000)                 -
     Retained earnings, substantially restricted                                          21,518,000             20,902,000
                                                                              ----------------------------------------------
                     Total stockholders' equity                                           60,347,000             20,867,000
                                                                              ----------------------------------------------
                     Total liabilities and stockholders' equity               $          238,791,000   $        217,954,000
                                                                              ==============================================
</TABLE> 

*NOTE: The Consolidated Statement of Financial Condition as of September 30,
1996 has been taken from the audited financial statements of Home Savings Bank
of Albemarle, S.S.B. at that date. South Street Financial Corp. completed its
stock offering on October 2, 1996 and then acquired all of the common stock of
Home Savings Bank of Albemarle, S.S.B.

See Notes to Consolidated Financial Statements.

                                       1
<PAGE>
 
SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
Three Months Ended March 31, 1997 and 1996

<TABLE> 
<CAPTION> 
                                                                                 1997                  1996
--------------------------------------------------------------------------------------------------------------------
                                                                                        (Unaudited)
<S>                                                                     <C>                         <C> 
Interest income:
   Loans                                                                $       2,454,000           $     2,415,000
   Mortgage-backed certificates                                                   522,000                   108,000
   Securities                                                                   1,191,000                   460,000
   Other interest-bearing deposits                                                102,000                   199,000
                                                                        --------------------------------------------
                                                                                4,269,000                 3,182,000
Interest expense on deposits and borrowed funds                                 2,187,000                 1,923,000
                                                                        --------------------------------------------
       Net interest income                                                      2,082,000                 1,259,000
Provision for loan losses                                                            -                      300,000
                                                                                             
                                                                        --------------------------------------------
       Net interest income after provision for loan losses                      2,082,000                   959,000
                                                                        --------------------------------------------
Noninterest income, other                                                          30,000                    29,000
                                                                        --------------------------------------------
                                                                                             
                                                                                             
Noninterest expenses:                                                                        
   Compensation and benefits                                                      661,000                   489,000
   Net occupancy                                                                   51,000                    74,000
   Federal insurance premium expenses                                              25,000                    78,000
   Data processing                                                                 56,000                    55,000
   Other                                                                          157,000                   284,000
                                                                        --------------------------------------------
                                                                                  950,000                   980,000
                                                                        --------------------------------------------
       Income before income taxes                                               1,162,000                     8,000
Income taxes                                                                      433,000                     3,000
                                                                        --------------------------------------------
                                                                                             
       Net Income                                                       $         729,000           $         5,000
                                                                        ============================================



Primary earnings per share                                              $            0.17           $        n/a
                                                                        ============================================
                                                                                             
Dividends declared per share                                            $            0.10           $        n/a
                                                                        ============================================
                                                                                             
Average number of common shares outstanding                             $       4,149,876                    n/a
                                                                        ============================================
</TABLE> 


See Notes to Consolidated Financial Statements.

                                       2
<PAGE>
 
SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
Six Months Ended March 31, 1997 and 1996


<TABLE> 
<CAPTION> 

                                                                                1997                  1996
-------------------------------------------------------------------------------------------------------------------
                                                                                       (Unaudited)
<S>                                                                    <C>                          <C> 
Interest income:
    Loans                                                              $           4,930,000        $    4,844,000
   Mortgage-backed certificates                                                      718,000               196,000
   Securities                                                                      2,051,000               938,000
   Other interest-bearing deposits                                                   423,000               373,000
                                                                       --------------------------------------------
                                                                                   8,122,000             6,351,000
Interest expense on deposits and borrowed funds                                    4,123,000             3,831,000
                                                                       --------------------------------------------
       Net interest income                                                         3,999,000             2,520,000
Provision for loan losses                                                             -                    300,000
                                                                       --------------------------------------------
       Net interest income after provision for loan losses                         3,999,000             2,220,000
                                                                       --------------------------------------------
Noninterest income, other                                                             58,000                62,000
                                                                       --------------------------------------------


Noninterest expenses:
   Compensation and benefits                                                       1,315,000               943,000
   Net occupancy                                                                     139,000               140,000
   Federal insurance premium expenses                                                 25,000               155,000
   Data processing                                                                   111,000               106,000
   Other                                                                             346,000               450,000
                                                                       -------------------------------------------- 
                                                                                   1,936,000             1,794,000
                                                                       --------------------------------------------
       Income before income taxes                                                  2,121,000               488,000
Income taxes                                                                         761,000               189,000
                                                                       --------------------------------------------

       Net Income                                                      $           1,360,000        $      299,000
                                                                       ============================================



Primary earnings per share                                             $                0.32        $       n/a
                                                                       ============================================
                                                                                                    
Dividends declared per share                                           $                0.10        $       n/a
                                                                       ============================================


Average number of common shares outstanding                                        4,149,876                n/a
                                                                       ============================================
</TABLE> 


See Notes to Consolidated Financial Statements.

                                       3
<PAGE>
 
SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Six Months Ended March 31, 1997 and 1996


<TABLE> 
<CAPTION> 
                                                                                        1997                  1996
---------------------------------------------------------------------------------------------------------------------------
                                                                                               (Unaudited)
<S>                                                                             <C>                    <C> 
Cash Flows from Operating Activities
   Net income                                                                   $          1,360,000   $           299,000
   Adjustments to reconcile net income to net cash provided by
       (used in) operating activities:
       Provision for loan losses                                                               -                   300,000
      Net accretion of premiums and discounts on securities                                  (8,000)              (14,000)
      Amortization of deferred loan fees                                                    (33,000)              (68,000)
      Gain on sale of real estate acquired in settlement of loans                              -                  (12,000)
      Gain on sale of fixed assets                                                           (4,000)                 -
      Provision for depreciation                                                              56,000                50,000
      Deferred Income Taxes                                                                (256,000)             (172,000)
      (Increase) Decrease in  assets:
           Accrued interest receivable                                                   (1,096,000)               (1,000)
           Prepaid and other assets                                                        1,600,000             (148,000)
           Income tax refund receivable                                                       -                     48,000
    Increase (Decrease) in liabilities:
           Accounts payable and other liabilities                                        (1,960,000)                75,000
           Interest payable                                                                   82,000                27,000
           Checks outstanding on disbursement accounts                                     (364,000)                74,000
                                                                               --------------------------------------------
                Net cash provided by (used in) operating activities                        (623,000)               458,000
                                                                               --------------------------------------------



Cash Flows from Investing Activities
    Purchases of securities held to maturity                                            (19,307,000)           (1,954,000)
    Purchases of securities available for sale                                          (56,264,000)           (8,916,000)
    Purchase of FHLB stock                                                               (1,359,000)                 -
    Proceeds from maturities and recalls of securities available
                     for sale                                                              4,000,000             9,960,000
    Principal collected on securities held to maturity                                     1,596,000               493,000
    Loan originations and principal payments on loans, net                                 (796,000)             1,673,000
    Purchase of office properties and equipment                                             (33,000)               (4,000)
    Proceeds from sale of fixed assets                                                        30,000                 -
    Proceeds from sale of foreclosed real estate                                              -                     56,000
                                                                               --------------------------------------------
              Net cash provided by (used in) investing activities                       (72,133,000)             1,308,000
                                                                               --------------------------------------------
                                                          (Continued)
</TABLE> 

                                       4
<PAGE>
 
SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY (CONTINUED)
CONSOLIDATED STATEMENTS OF CASH FLOWS
Six Months Ended March 31, 1997 and 1996


<TABLE> 
<CAPTION> 

                                                                                       1997                 1996
-------------------------------------------------------------------------------------------------------------------------
<S>                                                                           <C>                      <C> 
Cash Flows from Financing Activities
    Net increase (decrease) in deposits                                       $        (52,051,000)    $       6,608,000
    Net increase (decrease) in advance payments by borrowers for
           taxes and insurance                                                              236,000              208,000
    Proceeds received from issuance of common stock
           net of stock issuance costs incurred                                          43,645,000               -
    Principal receipts for ESOP debt                                                        129,000               -
    Note receivable originated to ESOP                                                  (4,528,000)               -
    Dividends paid to stockholders                                                        (330,000)               -
    Proceeds from Federal Home Loan Bank borrowings                                      35,000,000               - 
                                                                              -------------------------------------------
           Net cash provided by financing activities                                     22,101,000            6,816,000
                                                                              -------------------------------------------

           Increase (decrease) in cash and cash equivalents                            (50,655,000)            8,582,000
Cash and cash equivalents:
    Beginning                                                                            62,135,000           11,494,000
                                                                              -------------------------------------------
    Ending                                                                    $          11,480,000    $      20,076,000
                                                                              ===========================================

Supplemental Disclosures of Cash Flow Information
    Cash and cash equivalents:
           Cash and short-term investments:
                     Noninterest-bearing                                      $           2,498,000    $       8,145,000
                     Interest-bearing                                                     8,982,000           11,931,000
                                                                              -------------------------------------------
                                                                              $          11,480,000    $      20,076,000
                                                                              ===========================================


Transfer from loans to real estate acquired in settlement of loans            $              -         $          89,000
                                                                              ===========================================

Net change in unrealized (gain) loss on securities available for sale,
           net of deferred taxes (credits)                                    $           (382,000)    $         (5 ,000)
                                                                              ===========================================

Loans originated to finance the sale of real estate
           acquired in settlement of loans                                    $              -         $         107,000
                                                                              ===========================================
</TABLE> 

See Notes to Consolidated Financial Statements.

                                       5
<PAGE>
 
SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)


Note 1.     Nature of Business

South Street Financial Corp. (the "Company") was incorporated under the laws of
the State of North Carolina for the purpose of becoming the holding company for
Home Savings of Albemarle, S.S.B. (the "Bank" or "Home Savings") in connection
with the Bank's conversion from a North Carolina chartered mutual savings bank
to a North Carolina chartered stock savings bank on October 2, 1996, pursuant to
its Plan of Conversion. A subscription and community offering of the Company's
shares closed on October 2, 1996, at which time the Company acquired all of the
shares of the Bank and commenced operations.

Note 2.    Basis of Presentation

The accompanying unaudited consolidated financial statements (except for the
statement of financial condition at September 30, 1996, which is audited) have
been prepared in accordance with generally accepted accounting principles for
interim financial information and with the instructions to Form 10-Q of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (none of
which were other than normal recurring accruals) necessary for a fair
presentation of the financial position and results of operations for the periods
presented have been included. The financial statements of the Company are
presented on a consolidated basis with those of Home Savings, although the
Company did not own any shares of the Bank and had no assets, liabilities,
equity or operations at any date prior to October 2, 1996. Therefore, although
certain financial statements presented in this Form 10-Q include periods prior
to October 2, 1996, such statements for all periods prior to October 2, 1996
include only the accounts and operations of Home Savings. The results of
operations for the three and six month periods ended March 31, 1997 are not
necessarily indicative of the results of operations that may be expected for the
year ended September 30, 1997.

The accounting policies of the Company followed are as set forth in Note 1 of
the Notes to Financial Statements in the 1996 Home Savings financial statements.

Note 3.  Plan of Conversion

On October 2, 1996, pursuant to a Plan of Conversion which was approved by its
members and regulators, Home Savings converted from a North Carolina-chartered
mutual savings bank to a North Carolina-chartered stock savings bank (the
"Conversion"), and became a wholly-owned subsidiary of South Street Financial
Corp. The Company was formed to acquire all of the common stock of the Bank upon
its conversion to stock form. The Company has no operations and conducts no
business of its own other than owning Home Savings, investing its portion of the
net proceeds received in the Conversion, and lending funds to the Employee Stock
Ownership Plan (the "ESOP") which was formed in connection with the Conversion.
The closing of the offering occurred on October 2, 1996 and resulted in a stock
issuance of 4,496,500 shares of common stock at a price of $10.00 per share for
proceeds of $43,661,000 (including $4,528,000 in shares purchased by the ESOP
and net of $1,320,000 in conversion costs). The Company transferred $19,558,000
of the net proceeds to Home Savings for purchase of all of the capital stock of
the Bank.

                                       6
<PAGE>

SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 
Note 3.     Plan of Conversion (Continued)

Concurrent with the Conversion, the Bank established a liquidation account in an
amount equal to its net worth as reflected in its latest statement of financial
condition contained in the definition prospectus used in connection with the
Company's initial public offering. The liquidation account will be maintained
for the benefit of eligible deposit account holders and supplemental eligible
deposit account holders that continue to maintain their deposit accounts in the
Bank after conversion. Only in the event of a complete liquidation will eligible
deposit account holders and supplemental eligible deposit account holders be
entitled to receive a liquidation distribution from the liquidation account in
the amount of the then-current adjusted sub account balance for deposit accounts
then held before any liquidation distribution may be made with respect to common
stock. Dividends paid by the Bank subsequent to the Conversion cannot be paid
from this liquidation account.

The Bank may not declare or pay a cash dividend on or repurchase any of its
common stock if its net worth would thereby be reduced below either the
aggregate amount then required for the liquidation account. In addition, as a
North Carolina-chartered stock savings bank, Home Savings may not declare or pay
a cash dividend on, or repurchase any of its capital stock if the effect of such
transaction would be to reduce the net worth of Home Savings to an amount which
is less than the minimum amount required by applicable federal and state
regulations. For a period of five years after its conversion from mutual to
stock form, Home Savings must obtain a written approval from the Administrator
of the North Carolina Savings Institutions Division before declaring or paying a
cash dividend on its capital stock in an amount in excess of one-half of the
greater of (i) Home Savings net income for the most recent fiscal year end, or
(ii) the average of Home Saving's net income after dividends for the most recent
year end and not more than two of the immediately preceding fiscal year ends.

Note 4.   Earnings Per Share

The Company's earnings per share for the three and six month periods ended March
31, 1997 is based on 4,149,876 shares assumed to be outstanding for the period.
Earnings per share has been calculated in accordance with Statement of Position
93-6 "Employers' Accounting for Employee Stock Ownership Plans." Earnings per
share for the six month period ended March 31, 1997 is reported based upon the
assumption that such shares had been outstanding from the beginning of the six
month period. Earnings per share for the six month period ended March 31, 1996
have not been presented in the consolidated statements of income because the
Bank had not converted to stock form and the Company had not completed its stock
offering at any time during that period.

Note 5.   Dividends Declared

On March 10, 1997, the Board of Directors of South Street Financial Corp.
declared a dividend of $ .10 a share for stockholders of record as of March 21,
1997 and payable on April 4, 1997. In addition, on March 10, 1997, the Board of
Directors of Home Savings declared an upstream dividend of $224,650 to South
Street Financial Corp., which was paid on April 1, 1997.

                                       7
<PAGE>

SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)


 
Note 6.      Advances From Federal Home Loan Bank

Advances from the Federal Home Loan Bank ("FHLB") at March 31, 1997 consist of
the following:

<TABLE> 
<S>                                                                                            <C> 
Advances due FHLB, interest at 5.69%, due December, 1997                                       $          10,000,000
Advances due FHLB, interest at 5.98%, due June, 1998                                                      15,000,000
Advances due FHLB, interest at 6.05%, due March 18, 1998                                                   6,000,000
Advances due FHLB, interest at 5.73%, due July 18, 1997                                                    4,000,000
                                                                                                  ===================
                                                                                               $          35,000,000
                                                                                               ======================
</TABLE> 

                                       8
<PAGE>
 
SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

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


Comparison of Financial Condition at March 31, 1997 and September 30, 1996:

This Form 10Q contains certain forward-looking statements consisting of
estimates with respect to the financial condition, results of operations and
other business of the Bank that are subject to various factors which could cause
actual results to differ materially from those estimates. Factors which could
influence the estimates include changes in general and local market conditions,
legislative and regulatory conditions and an adverse interest rate environment.

Total assets increased by $20.8 million or 9.6%, to $238.8 million at March 31,
1997 from $218.0 million at September 30, 1996. The increase in assets was
attributable to the difference between the proceeds received from advances from
Federal Home Loan Bank of $35.0 million which was used to fund additional
security purchases and a return of $11.6 million in stock offering deposits to
subscribers due to an oversubscription. On October 2, 1996, the Company issued
4,496,500 shares of common stock and received $43.7 million which represented
the actual net proceeds from the offering (including $4.6 million in shares
purchased by the ESOP). The majority of the decrease in deposits of $52.0
million or 26.9% between September 30, 1996 and March 31, 1997 is due to
recording $43.7 million in additional paid-in capital upon closing the offering.
Net cash and short-term cash investments decreased by $50.1 million or 81.5% to
$11.4 million at March 31, 1997 from $62.1 million at September 30, 1996. This
decrease was attributable to reinvestment of the cash received from the stock
offering in higher rate longer term investment securities.

Net loans receivable increased by $834,000 or 1.0% to $110.7 million at March
31, 1997 from $109.8 million at September 30, 1996. Such loan growth has been
typical for the Bank, which operates in a lending market that has sustained
stable loan demand over the past several years. Investment securities held to
maturity increased $18.1 million or 330.6%, to $23.7 million at March 31, 1997
from $5.5 million at September 30, 1996. Likewise, investment securities
classified as available for sale increased $51.6 million or 148.5%, to $86.4
million at March 31, 1997 from $34.8 million at September 30, 1996. The Company
invested the proceeds from the stock offering into U.S. government and mortgage-
backed securities. The Bank had borrowings of $35 million outstanding at the end
of the six month period ended March 31, 1997. No borrowings were outstanding at
September 30, 1996. The borrowings were used to finance the purchase of
investment securities which management has determined will provide a profitable
return. The Bank has guaranteed the repayment of the ESOP's note payable to the
Company which it incurred on October 2, 1996 in order to purchase 359,720 shares
of stock in the Company. The Company's note receivable from the ESOP totaling
$4.4 million, net of $128,875 principal repayment made during the six months
ended March 31, 1997, is reported as a reduction of stockholders' equity.
Retained earnings increased by $616,000 to $21.5 million at March 31, 1997,
which is attributable to the Company's consolidated earnings during the six
months ended March 31, 1997, less dividends paid on February 7, 1997 in the
amount of $330,000 and less dividends accrued at March 31, 1997 in the amount of
$414,000.

At March 31, 1997, the Company's stockholders' equity amounted to $60.3 million,
or 25.3% of total assets. As a North Carolina chartered stock savings bank, the
Bank is required to meet various capital standards established by federal and
state banking agencies. The Bank's stand-alone equity was $40.9 million at March
31, 1997 and was substantially in excess of all such capital requirements.

                                       9
<PAGE>
 
SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

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


Comparison of Financial Condition at March 31, 1997 and September 30, 1996:
(Continued)

The Bank's level of nonperforming loans, defined as loans past due 90 days or
more, as a percentage of loans outstanding, was .80% and .60% at March 31, 1997
and September 30, 1996, respectively. During the three month periods ended March
31, 1997 and 1996, the Bank's level of nonperforming loans remained consistently
low in relation to prior periods and to total loans outstanding, and the Bank's
charge-offs of loans was minimal. Management determined based on their analysis
that no loan loss provisions were necessary during the first two quarters of
fiscal 1997.

                                       10
<PAGE>
 
SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

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


Comparison of Operating Results for the Three and Six Months Ended March 31,
1997 and 1996:

General. Net income for the three month and six month periods ended March 31,
1997 was $729,000 and $1.3 million, respectively, or $724,000 and $1.0 million
more than the $5,000 and $299,000 earned during the same period in 1996. As
discussed below, the increase in net income was primarily attributable to
increases in net interest income for the three and six month periods ended March
31, 1997 as compared to the same period in 1996.

Interest income. Interest income increased by $1.1 million from $3.1 million for
the three months ended March 31, 1996 to $4.2 million for the three months ended
March 31, 1997. Interest income increased by $1.8 million from $6.3 million for
the six months ended March 31, 1996 to $8.1 million for the six months ended
March 31, 1997. These increases were attributable in part to a slight overall
increase in market interest rates but were principally affected by a change in
the volume of interest-earning assets outstanding. Due primarily to an infusion
of cash received in the stock offering, interest-earning assets amounted to
$232.5 million at March 31, 1997 as compared to $155.9 million at March 31,
1996.

Interest Expense. Interest expense on deposits and borrowed funds increased by
$264,000 from $1.92 million for the three months ended March 31, 1996 to $2.18
million for the three months ended March 31, 1997. Interest expense on deposits
and borrowed funds increased by $292,000 from $3.83 million for the six months
ended March 31, 1996 to $4.12 million for the six months ended March 31, 1997.
The increase was primarily due to an increase in the volume of interest-bearing
deposits and borrowed funds for the six months ended March 31, 1997 compared to
the same period in 1996. Home Savings prices its deposits to be at or near the
top of the market because of its dependence on the local market for funds
availability. Interest expense incurred from the Federal Home Loan Bank advances
amounted to $386,000 for the quarter ended March 31, 1997 compared to none for
the quarter ended March 31, 1996.

Net interest income. Net interest income increased by $823,000 from $1.3 million
for the three months ended March 31, 1996 to $2.1 million for the three months
ended March 31, 1997. Net interest income increased by $1.5 million from $2.5
million for the six months ended March 31, 1996 to $4.0 million for the six
months ended March 31, 1997. These increases resulted from the combination of an
increase in the volume of interest-earning assets in excess of an increase in
the volume of interest-bearing liabilities during a period of steady to slightly
decreasing interest rate spreads. The Bank's interest rate spread decreased
primarily because its deposits were more rate sensitive than its interest
earning assets, while overall market interest rates were higher during the three
month period ended March 31, 1997 as compared to the same period in 1996. The
purchase of government obligations with the Federal Home Loan Bank advances
provided net interest income of approximately $37,000 for the six months ended
March 31, 1997.

Provision for loan losses. There were no provisions for loan losses charged to
income during the three and six months ended March 31, 1997. A provision for
loan losses of $300,000 was charged to income during the three and six months
ended March 31, 1996. Provisions, which are charged to operations, and the
resulting loan loss allowances are amounts the Bank's management believes will
be adequate to absorb losses on existing loans that may become uncollectible.

                                       11
<PAGE>
 
SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

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


Provision for loan losses. (Continued)
Loans are charged off against the allowance when management believes that
collectibility is unlikely. The decision to increase or decrease the provision
and resulting allowances is based upon an evaluation of both prior loan loss
experience and other factors, such as changes in the nature and volume of the
loan portfolio, overall portfolio quality, and current economic conditions. The
Bank's level of nonperforming loans has remained consistently low in relation to
prior periods and total loans outstanding, and the Bank's charge-offs of loans
during either of the three and six month periods ended March 31, 1997 and 1996
was minimal.

At March 31, 1997, the Bank's level of general valuation allowances for loan
losses amounted to $428,000, which management believes is adequate to absorb
potential losses in its loan portfolio.

Noninterest income. Noninterest income increased by $1,000 from $29,000 for the
three month period ended March 31, 1996 to $30,000 for the three month period
ended March 31, 1997. This increase was attributable to an increase in various
small items during the three months ended March 31, 1997 as compared to the same
period in 1996. Noninterest income decreased by $4,000 from $62,000 for the six
month period ended March 31, 1996 to $58,000 for the six month period ended
March 31, 1997.

Noninterest expense. Noninterest expense decreased by $30,000 from $980,000 for
the three month period ended March 31, 1996 to $950,000 for the three month
period ended March 31, 1997. The decrease in noninterest expense is principally
due to a decrease in legal expense associated with the stock conversion. For the
six month period ended March 31, 1997, noninterest expense increased by $142,000
to $1.9 million from $1.8 million for the six month period ended March 31, 1996.
The increase in noninterest expense is principally due to an increase in
benefits expense associated with the establishment of an ESOP as discussed
below.

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

Capital Resources and Liquidity:

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

                                       12
<PAGE>
 
SOUTH STREET FINANCIAL CORP. AND SUBSIDIARY

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


Capital Resources and Liquidity (Continued)

During the six month period ended March 31, 1997, cash and cash equivalents, a
significant source of liquidity, decreased by approximately $50.6 million. This
decrease is a direct result of the Company's stock offering which closed on
October 2, 1996. Cash flow resulting from internal operating activities provided
for a decrease of $623,000 in cash during the three month period ended March 31,
1997. Financing activities, principally net proceeds from the stock offering of
$43.7 million and proceeds of $35.0 million from Federal Home Loan Bank
borrowings reduced by deposit outflows of $52.0 million provided an additional
$22.1 million. A portion of the funding generated by investing activities
provided cash for loan originations and purchases of investment securities for a
total of $72.1 million.

As a state chartered stock savings bank, Home Savings must meet certain
liquidity requirements which are established by the Administrator. Home's
liquidity ratio at March 31, 1997, as computed under such regulations, was
considerably in excess of such requirements. Given its excess liquidity and its
ability to borrow from the Federal Home Loan Bank of Atlanta, Home Savings
believes that it will have sufficient funds available to meet anticipated future
loan commitments, unexpected deposit withdrawals, or other cash requirements.

The FDIC requires Home Savings to have a minimum leverage ratio of Tier I
Capital (principally consisting of retained earnings and any common
stockholders' equity, less any intangible assets) to all assets of at least 3%,
provided that it receives the highest rating during the examination process. For
institutions that receive less than the highest rating, the Tier I capital
requirement is 1% to 2% above the stated minimum. The FDIC also requires the
Bank to have a ratio of total capital to risk-weighted assets of 8%, of which at
least 4% must be in the form of Tier I capital. The Administrator requires a net
worth equal to at least 5% of total assets. Home Savings complied with all of
the capital requirements of both the FDIC and the Administrator at March 31,
1997.

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

                                       13
<PAGE>
 
Part II.  OTHER INFORMATION

          Item 1.    Legal Proceedings

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

          Item 2.    Changes in Securities

                     Not applicable

          Item 3.    Defaults Upon Senior Securities

                     Not applicable

          Item 4.    Submission of Matters to a Vote of Security Holders

                     The Annual Meeting of the stockholders was held on February
                     18, 1997. The purpose of this meeting was to elect
                     directors for the Company for one-year terms and to ratify
                     the selection of McGladrey & Pullen, LLP as the independent
                     auditor for the Company for the fiscal year ending
                     September 30, 1997.

          Item 5.    Other Information

                     Not applicable

          Item 6.    Exhibits and Reports on Form 8-K

                     (a)   Exhibits

                           Exhibit (27) Financial Data Schedule

                     (b)   Reports on Form 8-K

                           Not applicable

                                       14
<PAGE>
 
SIGNATURES

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

                                           South Street Financial Corp.

           Dated     5/7/97                By:    /s/ Carl M. Hill
                -----------------                -----------------
                                                 Carl M. Hill
                                           President and Chief Executive Officer

           Dated     5/7/97                By:    /s/ Christopher F. Cranford
                -----------------                ----------------------------
                                                 Christopher F. Cranford
                                           Treasurer and Controller



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