<SUBMISSION>
<ACCESSION-NUMBER>0001005150-00-001408
<TYPE>10KSB
<PUBLIC-DOCUMENT-COUNT>3
<PERIOD>20000630
<FILING-DATE>20000928
<FILER>
<COMPANY-DATA>
<CONFORMED-NAME>AF BANKSHARES INC
<CIK>0001064025
<ASSIGNED-SIC>6770
<IRS-NUMBER>562098545
<FISCAL-YEAR-END>0630
</COMPANY-DATA>
<FILING-VALUES>
<FORM-TYPE>10KSB
<ACT>34
<FILE-NUMBER>000-24479
<FILM-NUMBER>730142
</FILING-VALUES>
<BUSINESS-ADDRESS>
<STREET1>206 SOUTH JEFFERSON AVENUE
<STREET2>PO BOX 26
<CITY>WEST JEFFERSON
<STATE>NC
<ZIP>28694
<PHONE>3362464344
</BUSINESS-ADDRESS>
<MAIL-ADDRESS>
<STREET1>206 SOUTH JEFFERSON AVENUE
<STREET2>PO BOX 26
<CITY>WEST JEFFERSON
<STATE>NC
<ZIP>28694
</MAIL-ADDRESS>
</FILER>
<DOCUMENT>
<TYPE>10KSB
<SEQUENCE>1
<FILENAME>0001.txt
<DESCRIPTION>FORM 10-KSB
<TEXT>


                       Securities and Exchange Commission
                             Washington, D.C. 20549


                                   FORM 10-KSB


              Annual Report Pursuant to Section 13 or 15(d) of the
                         Securities Exchange Act of 1934


                     For the fiscal year ended June 30, 2000

                          Commission File No.: 0-24479

                               AF BANKSHARES, INC.
        (Exact name of small business issuer as specified in its charter)


      Federally Chartered                                   56-2098545
    State of Incorporation                             IRS Employer Number

                               21 East Ashe Street
                      West Jefferson, North Carolina 28694
                    (Address of Principal Executive Offices)

Issuer's telephone, including area code:  (336) 246-4344

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

                     Common Stock, par value $0.01 per share
                                 Title of Class

     Indicate  by check  mark  whether  the  issuer  (1) has filed  all  reports
required to be filed 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 issuer
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 there is no disclosure of delinquent filers pursuant
to Item 405 of  Regulation  S-B  contained  herein or any amendment to this Form
10-KSB. /X/

     The  revenues  for the  issuer's  fiscal  year  ended  June  30,  2000  are
$11,214,209.

     The issuer had 1,049,378  shares of common stock  outstanding  as of August
31, 2000. The aggregate value of the voting stock held by  non-affiliates of the
issuer, computed by reference to the price at which the common stock was sold on
August 31, 2000 was $8.75.

     Transitional Small Business Disclosure Format. Yes / / No /X/
                      DOCUMENTS INCORPORATED BY REFERENCE.
     Portions of the Annual Report to  Stockholders  for the year ended June 30,
2000 are incorporated by reference into Part I and II of this Form 10-KSB.

     Portions of the Proxy Statement for the 2000 Annual Meeting of Stockholders
are incorporated by reference into Part III of this Form 10-KSB.


<PAGE>


                                TABLE OF CONTENTS

<TABLE>
<S>                  <C>                                                                                       <C>
PART I
         ITEM 1.     DESCRIPTION OF BUSINESS......................................................................1
         ITEM 2.     PROPERTIES..................................................................................31
         ITEM 3.     LEGAL PROCEEDINGS...........................................................................32
         ITEM 4.     SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.........................................32

PART II
         ITEM 5.     MARKET FOR COMMON STOCK AND RELATED STOCKHOLDER MATTERS.....................................32
         ITEM 6.     MANAGEMENT'S DISCUSSION AND ANALYSIS........................................................32
         ITEM 7.     FINANCIAL STATEMENTS........................................................................32
         ITEM 8.     CHANGES IN AND DISAGREEMENT WITH ACCOUNTANTS ON ACCOUNTING
                     AND FINANCIAL DISCLOSURE....................................................................33

PART III
         ITEM 9.     DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS................................33
         ITEM 10.    EXECUTIVE COMPENSATION......................................................................33
         ITEM 11.    SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT..............................33
         ITEM 12.    CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS..............................................33
         ITEM 13.    EXHIBITS AND REPORTS ON FORM 8-K............................................................33


SIGNATURES.......................................................................................................35
</TABLE>



<PAGE>


                                     PART I


ITEM 1.  DESCRIPTION OF BUSINESS

GENERAL

     AF Bankshares,  Inc. (the "Company") is a federally chartered stock holding
company  which owns 100% of the common stock of AF Bank (the  "Bank"),  formerly
Ashe Federal  Bank,  AF Insurance  Services,  Inc.  and AF  Brokerage,  Inc. The
Company  has no  operations  and  conducts  no  business  of its own other  than
ownership  of its  subsidiaries  and  investing  in  securities.  The  Bank is a
federally  chartered  stock savings bank which  conducts  business from its main
office located in West Jefferson,  North  Carolina,  branches in West Jefferson,
Jefferson and Warrensville,  North Carolina  operating under the trade name Ashe
Federal Bank; one branch in Alleghany County, North Carolina operating under the
trade name Alleghany First Bank and one branch in Watauga County, North Carolina
operating under the trade name  Appalachian  First Bank. The Bank was founded in
1939 as a building and loan association.  In the early 1980s, the Bank converted
from a North  Carolina  chartered  building  and loan to a  federally  chartered
mutual  savings  and loan  association,  and in  August of 1995  converted  to a
federally  chartered  mutual  savings bank.  During  fiscal year 1997,  the Bank
converted  from  a  federally  chartered  mutual  savings  bank  to a  federally
chartered stock savings bank which is majority owned by AsheCo, M.H.C., a mutual
holding company.  On June 16, 1998, the Bank completed its reorganization into a
two-tier  mutual  holding  company and became a wholly owned  subsidiary  of the
Company.  See "Management's  Discussion and Analysis -- The Reorganization." The
Bank's deposits are insured by the Savings  Association  Insurance Fund ("SAIF")
of the Federal Deposit Insurance  Corporation (the "FDIC") to the maximum extent
permitted by law. At June 30, 2000, the Bank had total assets of $133.4 million,
total deposits of $102.7 million and equity of $12.5 million.

     The  historical  operations  of the  Company  have been that of a portfolio
mortgage  lender,  providing  fixed rate loans for the residents of Ashe County,
North Carolina.  Management has recently expanded the market area of the Company
to include  Alleghany and Watauga counties and has diversified its product lines
by  engaging in  non-mortgage  lending and  offering  non-traditional  financial
services,  such as insurance and brokerage  products.  More specifically,  since
1996,  the  Company has made a major  commitment  to small  business  commercial
lending  and  consumer  lending  as a means to  increase  the  yield on its loan
portfolio  and  attract  lower  cost  deposit  accounts.  As a  result  of  this
commitment,  commercial  loans  increased  by 163.0%  and  consumer  loans  have
increased  by 109.8%  since June 30, 1998.  In  addition,  since July 1997,  the
Company has offered traditional property and casualty, life and health insurance
products through AF Insurance Services,  Inc., a wholly-owned  subsidiary of the
Company,  which operates under the trade name AF Ashelande  Insurance Service in
West  Jefferson,  AF Brown  Insurance  Agency in Wilkesboro,  AF Blair Insurance
Agency in Lenoir,  AF Insurance  Services,  Inc. in Sparta,  West  Jefferson and
Jefferson, and AF Insurance Service Center in Elkin, North Carolina. The Company
also has a brokerage subsidiary,  operating as AF Brokerage, Inc., which serves,
Ashe,  Alleghany,  Wilkes and Watauga  counties.  AF  Brokerage  offers  various
uninsured investment  products,  including fixed-rate and variable annuities and
mutual  funds.  The Company  believes  that its strategy of expanding its market
area and  diversifying  its product lines will enhance its  franchise  value and
strengthen earnings in the future.

     The Company's  operating results are primarily  dependent upon net interest
income, fees and charges and insurance  commissions.  Net interest income is the
difference  between interest earned on loans,  investments and  interest-earning
deposits  at other  financial  institutions  and the  interest  paid on  savings
deposits and borrowings of the company.  The primary  interest-earning  asset of
the Company is its mortgage loan  portfolio  representing  79.2% of total loans,
with approximately  36.0% of portfolio mortgage loans at fixed rates at June 30,
2000. The net interest  income of the Company is affected by changes in economic
conditions that influence  market  interest  rates.  This exposure to changes in
interest rates contributes to a moderate degree of interest rate risk because of
the negative  impact of increasing  rates to the Bank's  earnings and to the net
market value of its assets and liabilities.  Additionally,  the Company receives
fee  income  primarily  from loan  origination  fees,  late loan  payment  fees,
commissions  from  the sale of  credit  life,  accident  and  health  insurance,
insurance  commissions  generated  from the insurance  agency  subsidiary and in
payment for other  services  provided to the customer by the Company.  The major
non-interest costs to the Company include  compensation and benefits,  occupancy
and equipment and


                                       1

<PAGE>

data processing costs.  Other external factors that affect the operating results
of the Company include changes in government and accounting  regulations,  costs
of  implementing  information  technology,  and  changes  in  the  competition's
emphasis within the Company's market.

     As of June 30,  2000,  $86.2  million,  or 79.2% of the  Bank's  total loan
portfolio  consisted  of real  estate  loans.  Total loans at June 30, 2000 were
$114.0  million of which  $68.8  million or 63.3% were  secured by one-  to-four
family residences.  Total mortgage loans,  including construction loans, totaled
$86.2  million as of June 30,  2000.  Of that amount,  approximately  37.5% were
adjustable rate loans, or had remaining terms of 5 years of less. This change in
the  composition  of the mortgage  loan  portfolio  results  from the  Company's
strategy  of  selling  long  term,  fixed-rate  mortgages  while  retaining  the
servicing.  The  reduction  in the level of fixed rate  mortgages  has served to
reduce the Company's exposure to interest rate risk.

     The Bank also invests in consumer  loans and commercial  loans.  As of June
30, 2000, the Bank's  consumer loans and commercial  loan  portfolios were $27.8
million,  or 25.6% of total loans.  Commercial  loans totaled $10.5 million,  or
9.6% of the  Bank's  total  loan  portfolio.  The Bank  invests a portion of its
assets in debt and equity  securities  issued by the FHLB and the  Federal  Home
Loan Mortgage  Corporation (the "FHLMC") and began investing in  mortgage-backed
securities during fiscal 1996.  Mortgage-backed  securities totaled $3.2 million
or 2.4% of  total  assets  at June 30,  2000,  and  FHLB  and  FHLMC  securities
investments totaled $36.6 million, or 2.7%, of total assets at June 30, 2000.

REORGANIZATION

     On October 4, 1996, the Bank  reorganized  into the mutual holding  company
form  of  organization.  Members  of  the  mutual  holding  company  consist  of
depositors  of the  Bank,  who have the sole  authority  to elect  the  board of
directors  of the  mutual  holding  company  for as long as it remains in mutual
form. Initially, the mutual holding company's principal assets are the shares of
the Bank's  common  stock  received  in the  reorganization  and on its  initial
capitalization  of $100,000 in cash.  The mutual holding  company,  which by law
must own in  excess of 50% of the stock of the  Bank,  was  issued  stock in the
Reorganization  resulting in a majority ownership interest of 53.8% of the Bank.
The remaining shares of common stock of the Bank were sold to the depositors and
borrowers  of  the  Bank.  By  virtue  of its  ownership  of a  majority  of the
outstanding shares of the Bank, the mutual holding company can generally control
the  outcome  of most  matters  presented  to the  stockholders  of the Bank for
resolution  by vote except for  certain  matters  related to stock  compensation
plans, a vote regarding  conversion of the mutual holding company to stock form,
or others  matters which require a vote only by the minority  stockholders.  The
mutual holding  company has registered as a savings and loan holding company and
its subject to regulation,  examination, and supervision by the Office of Thrift
Supervision (OTS).

     On June 16, 1998,  the Bank  completed its  reorganization  into a two-tier
mutual  holding  company,  pursuant to the agreement and plan of  reorganization
approved  by  the  Bank's   shareholders   on   December  8,  1997.   Under  the
reorganization,  the Bank became the  wholly-owned  subsidiary of AF Bankshares,
Inc., a newly formed stock holding  company (the  "Company")  and holders of the
Bank's common stock became  holders of the Company's  common stock,  on an equal
share for shares exchange.

MARKET AREA AND COMPETITION

     During the year ended June 30, 1998, AsheCo, MHC's ownership of the company
decreased to 51.1% due to shares  issued  under the  recognition  and  retention
plan.  AsheCo,  MHC's  ownership  increased to 51.29% due to the  repurchase  of
shares held in treasury during the year ended June 30, 1999.

     Previously,  the Bank's  market area for deposit  gathering and lending has
been concentrated in Ashe County, North Carolina.  However,  management believes
that the Company  must expand its market base to build value for the Company and
its  shareholders.  In March  1998,  the  Company  opened a branch of AF Bank in
Alleghany  County and operates the branch under the trade name  Alleghany  First
Bank.  At the same time, an insurance  agency  branch of AF Insurance  Services,
Inc.,  was opened in the same location.  The staff of Alleghany  First came from
the local banking  community and is attuned to the needs and habits of Alleghany
citizens. The


                                       2
<PAGE>


insurance  agency  personnel  direct  their  attention  to the special  needs of
Alleghany  County  citizens  as well.  On March 1, 1999,  the Bank also opened a
branch  office  in  Boone,   North  Carolina  operating  under  the  trade  name
Appalachian  First Bank. In April 1999, the Company added an insurance agency in
Lenoir,  North Carolina  operating under the name AF Blair Insurance Agency and,
in December 1999, the Company  acquired an agency in Elkin,  North Carolina that
operates as AF  Insurance  Center.  Entry into the Boone and  Alleghany  markets
significantly  expands the Company's potential to market its banking,  insurance
and  noninsured  investment  products  to a  larger  and  more  diverse  market.
Management  now believes that it is delivering  the same  personalized  customer
service to the new markets  that it has  historically  delivered to Ashe County.
Management   believes  that  penetration   into  other  markets   increases  the
opportunity  to deliver  products  from all of the Company's  subsidiaries  to a
broader  market and will make the  insurance  and  brokerage  subsidiaries  more
profitable  investments  by increasing  the economies of scale and adding to the
products that are available for delivery to the Company's customers. The Company
continues  to seek  opportunities  to increase  its market  penetration  for its
services.

     Management  believes  that  the  Company's  customers  perceive  "financial
services" to include five broad categories:  funds transfer  including  checking
accounts;  insured savings instruments;  credit/lending services;  insurance and
securities  brokerage.  Further,  management  believes  that  failure  to  offer
insurance  and  brokerage  services  will impair the  Company's  growth and make
retention of existing  customers more  difficult.  During the three month period
ending  September  30, 1998,  the Company  established  a  securities  brokerage
subsidiary,  AF Brokerage,  Inc., which currently conducts brokerage services in
Ashe,  Alleghany,  Wilkes and Watauga  counties.  AF Brokerage,  Inc. applied to
become a member of the National Association of Securities Dealers, Inc. ("NASD")
in the third quarter of 1998 and was granted  membership on October 22, 1999. AF
Brokerage,  Inc.  commenced  operation  in the  fourth  quarter  of  2000  as an
independent  broker/dealer.  Management  continues to evaluate  acquisitions and
business  opportunities  that it believes  will provide  access to customers and
markets that  enhance the  Company's  value and  earnings  potential in the long
term.

     The Bank faces substantial competition for both the deposits it accepts and
the loans it makes.  Management  believes  that the Bank has the second  largest
deposit base in Ashe County,  and the second largest deposit base in the part of
Ashe County which  comprises its primary zip code,  28694.  Located  within Ashe
County are  branches  of six other  depository  institutions,  four of which are
commercial  banks and two of which are  credit  unions.  The Bank  competes  for
deposits  by  offering a variety of customer  services  and deposit  accounts at
competitive  interest  rates.  The Bank,  like its  competitors,  is affected by
general economic conditions, particularly changes in market interest rates, real
estate market values,  government policies and regulatory  authorities' actions.
Changes in the ratio of the demand for loans  relative  to the  availability  of
credit may affect the level of competition from financial institutions which may
have greater  resources than the Bank,  but which have not generally  engaged in
lending activities in the Bank's market area in the past, and from credit unions
that can expand into the Bank's  market area and compete for  customers  without
the level of taxation experienced by the Company.  Competition may also increase
as a result of the  lifting of  restrictions  on the  interstate  operations  of
financial institutions. See "--Regulation."

LENDING ACTIVITIES

     Loan Portfolio Composition. The Bank's loan portfolio consists primarily of
mortgage loans. The Bank also makes consumer and commercial loans.

     The types of loans that the Bank may  originate  are subject to federal and
state  laws and  regulations.  Interest  rates  charged by the Bank on loans are
affected by the demand for such loans, the supply of money available for lending
purposes  and the  rates  offered  by  competitors.  These  factors  are in turn
affected by, among other things,  economic conditions,  monetary policies of the
federal  government,  including  the  Federal  Reserve  Board (the  "FRB"),  and
legislative tax policies.


                                       3
<PAGE>


     The following  table sets forth the  composition of the Bank's mortgage and
other loan portfolios in dollar amounts and percentages at the dates indicated.

<TABLE>
<CAPTION>
                                                                    AT JUNE 30,
                                                                    -----------
                                                2000                                              1999
                                   -------------------------------                   -------------------------------
                                                             % OF                                              % OF
                                   AMOUNT                    TOTAL                   AMOUNT                    TOTAL
                                   ------                    -----                   ------                    -----
<S>                           <C>                        <C>                     <C>                         <C>
                                                                (DOLLARS IN THOUSANDS)
Mortgage loans:
  One- to four-family...       $   68,813                   63.26%                 $ 48,433                    59.68%
  Multi-family..........            2,277                    2.09%                      316                     0.39%
  Non-residential.......            8,577                    7.89%                    2,068                     2.55%
  Land..................            2,440                    2.24%                    1,258                     1.55%
  Construction..........            4,059                    3.73%                    5,082                     6.26%
                               ----------                  ------                  --------                   ------
   Total mortgage loans.           86,166                   79.21%                   57,157                    70.43%
                               ----------                  ------                  --------                   ------

Other loans:
  Commercial............           10,456                    9.62%                   18,261                    22.50%
  Consumer loans........           17,376                   15.97%                   12,144                    14.96%
                               ----------                  ------                  --------                   ------
   Total other loans....           27,832                   25.59%                   30,405                    37.46%
                               ----------                  ------                  --------                   ------
  Gross loans...........          113,998                  104.80%                   87,562                   107.89%
                               ----------                  ------                  --------                   ------

Less:
  Undisbursed loan funds           3,993                     3.67%                    5,033                     6.20%
  Deferred loan fees....             248                     0.23%                      249                     0.31%
  Allowance for loan
   losses...............             979                     0.90%                    1,123                     1.38%
                               ----------                  ------                  --------                   ------
                                   5,220                     4.80%                    6,405                     7.89%
                               ----------                  ------                  --------                   ------
   Loans, net...........       $ 108,778                   100.00%                 $ 81,157                   100.00%
                               ==========                  ======                  ========                   ======
Loans serviced for
others:
  One-to four-family and
   cooperative apartment.      $  22,613                   100.00%                 $ 20,657                   100.00%
                               ----------                  ------                  --------                   ------
    Total loans serviced
      for others.........      $  22,613                   100.00%                 $ 20,657                   100.00%
                               ==========                  ======                  ========                   ======
</TABLE>


                                       4
<PAGE>
     Loan  Maturity.  The  following  table  shows  the  maturity  or  period to
repricing  of the  Bank's  loan  portfolio  at June 30,  2000.  Loans  that have
adjustable  rates are shown using scheduled  principal  amortization.  The table
does not consider estimated prepayments of principal.

<TABLE>
<CAPTION>
                                                                             AT JUNE 30, 2000
                                                                              MORTGAGE LOANS
                                                                             ----------------
                                        ONE- TO
                                         FOUR-     MULTI-      NON-                               COMMERCIAL   CONSUMER      TOTAL
                                        FAMILY     FAMILY   RESIDENTIAL     LAND    CONSTRUCTION     LOANS       LOANS       LOANS
                                        -------    ------   -----------     ----    ------------  ----------   --------      -----
                                                                              (IN THOUSANDS)
<S>                                     <C>       <C>         <C>         <C>         <C>          <C>          <C>        <C>
Amount due:
   One year or less................     $21,641    $  813     $  1,257    $  694      $   4,059    $  7,660    $  3,467    $ 39,591
                                        -------    ------   -----------    -----    ------------  ----------   --------    --------
 After one year:
   One to three years..............       4,941       358        2,331       290              0         812       7,633      16,365
   More than three years to five
     years.........................      12,809       190        2,230       467              0         981       3,549      20,226
   More than five years to ten
     years.........................       8,625       836        1,039       375              0         948       2,218      14,041
   More than ten years to
     twenty years..................      17,858        80        1,634       297              0          55         509      20,433
   Over twenty years...............       2,939         0           86       317              0           0           0       3,342
                                        -------    ------   -----------    -----    ------------  ----------   --------    --------
 Total due or repricing after one
   year............................      47,172     1,464        7,320     1,746              0       2,796      13,909      74,407
                                        -------    ------   -----------    -----    ------------  ----------   --------    --------
 Total amounts due or repricing,
   gross...........................     $68,813   $ 2,277     $  8,577    $2,440      $   4,059    $ 10,456     $17,376    $113.998
                                        =======    ======   ===========    =====    ============  ==========   ========    ========
</TABLE>

     The following  table sets forth the dollar amounts in each loan category at
June 30,  2000 that are due after June 30,  2001,  and  whether  such loans have
fixed or adjustable interest rates.

<TABLE>
<CAPTION>
                                                                     DUE AFTER JUNE 30, 2001
                                                                     -----------------------
                                                         FIXED              ADJUSTABLE                TOTAL
                                                         -----              ----------                -----
<S>                                                   <C>                 <C>                     <C>
                                                                           (IN THOUSANDS)
Mortgage loans:
  One- to four-family.......................          $ 39,923              $   7,249              $  47,172
  Multi-family..............................             1,244                    220                  1,464
  Non-residential...........................             7,320                      0                  7,320
  Land......................................               812                    934                  1,746
Commercial loans............................               919                  1,877                  2,796
Consumer loans..............................            13,277                    632                 13,909
                                                      --------              ---------              ---------
                                                      $ 63,495              $  10,912              $  74,407
                                                      ========              =========              =========
</TABLE>

     Origination,  Purchase,  Sale and  Servicing of Loans.  The Bank's  lending
activities  are  conducted  through its branches in Ashe,  Alleghany and Watauga
counties,  North Carolina.  The Bank originates both  adjustable-rate  loans and
fixed-rate  mortgage  loans for portfolio and for sale in the secondary  market.
Adjustable-rate  mortgage  loans  carried in portfolio and  fixed-rate  mortgage
loans carry  maximum  maturities of 30 years and 15 years,  respectively.  Fixed
rate loans originated for sale in the secondary  market have maximum  maturities
of 30  years.  Historically,  the  Bank  held  for its  portfolio  all  loans it
originated. The Bank now sells all qualified fixed-rate loans to Fannie Mae, but
retains the  servicing  rights.  The  determination  to sell loans is based upon
management's  efforts to reduce  interest rate risk. At June 30, 2000,  the Bank
serviced approximately $22.6 million of loans for Fannie Mae.

     One- to Four-Family  Mortgage Lending.  The Bank offers both fixed-rate and
adjustable-rate  mortgage  loans,  with  maturities  up to 30  years,  which are
secured by one- to four-family  residences,  which generally are owner-occupied.
Fixed-rate  loans held in the Bank's  portfolio  have higher  interest rates and
shorter  terms than those loans sold to Fannie Mae. Most are secured by property
located  in  Ashe,  Alleghany  and  Watauga  counties,   North  Carolina.   Loan
originations are generally  obtained from existing or past customers and members
of the local communities.  See "--Origination,  Purchase,  Sale and Servicing of
Loans."

                                       5
<PAGE>


     The Bank offers three to five year call loans,  which are either  called or
modified  based on the Bank's  interest  rates  currently  in effect at the call
date.  These  loans  are  similar  to  adjustable  rate  loans in that the loans
generally  amortize  over  terms of up to 30 years  but are not  indexed  to any
widely recognized rate, such as the one year U.S. Treasury  securities rate, and
do not have  interest rate caps or floors.  Instead,  the majority of such loans
are  modified at the call date and the rate is  adjusted  to the Bank's  current
rate offered for similar loans being  originated on such dates.  For purposes of
the tabular presentations throughout this document, such loans are considered to
be adjustable.

     In view of its operating  strategy,  the Bank adheres to its Board approved
underwriting guidelines for loan originations, which, though prudent in approach
to credit risk and evaluation of collateral,  allows management flexibility with
respect to documentation of certain matters and certain credit requirements.  As
a result,  such underwriting  guidelines in certain lending  situations are less
rigid than comparable Fannie Mae underwriting  guidelines.  The Bank's loans are
typically originated under terms, conditions and documentation which permit them
to be sold to U.S.  government  sponsored  agencies such as Fannie Mae. The Bank
sells all qualifying  fixed-rate loans to Fannie Mae, while retaining  servicing
rights.  The  Bank's  policy is to  originate  one- to  four-family  residential
mortgage  loans in amounts up to 80% of the lower of the appraised  value or the
selling price of the property securing the loan. The Bank offers products with a
higher  loan-to-value  ratio in  conjunction  with private  mortgage  insurance.
Mortgage loans  originated by the Bank  generally  include  due-on-sale  clauses
which provide the Bank with the contractual  right to deem the loan  immediately
due and payable in the event the  borrower  transfers  ownership of the property
without  the Bank's  consent.  Due-on-sale  clauses  are an  important  means of
adjusting the rates on the Bank's  fixed-rate  mortgage  loan  portfolio and the
Bank has generally exercised its rights under these clauses.

     Construction  Lending. The Bank originates  construction loans primarily to
finance construction of one- to four-family homes to the individuals who will be
the owners and occupants upon  completion of  construction  in the Bank's market
area.  At June 30, 2000,  that Bank's  portfolio  contained  approximately  $4.1
million,  or 3.7%, of construction  loans. The Bank's policy is to disburse loan
proceeds as construction  progresses and as periodic inspections warrant.  These
loans are made primarily to the individuals who will ultimately occupy the home,
and are  structured to guarantee  the  permanent  financing to the Bank as well.
Thus construction loans typically "roll" into permanent financing.  Construction
loans are made for a maximum of 12 months,  by which  time  permanent  financing
must be obtained.

     Construction  lending is generally considered to involve a higher degree of
credit risk than long-term financing of residential properties.  The Bank's 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  of  construction.  If  the  estimate  of
construction cost proves to be inaccurate,  the Bank may be compelled to advance
additional funds to complete construction.

     Non-Residential  Mortgage  Lending.  The Bank  originates  commercial  real
estate mortgage loans that are generally secured by properties used for business
purposes and retail facilities, such as small office buildings and church loans.
The Bank's underwriting  procedures provide that non-residential  mortgage loans
may be made,  based on debt  service  coverage or in amounts up to the lesser of
(i) 80% of the lesser of the appraised  value or purchase  price of the property
or  (ii)  the  Bank's  current  loans-to-one-borrower  limit.  These  loans  are
generally  originated as three to five year call loans with amortization periods
of up to 15 years. The Bank considers factors such as the borrower's  expertise,
credit history, profitability,  cash flow, and the value of the collateral while
underwriting these loans. At June 30, 2000, the Bank's non-residential  mortgage
loan portfolio was $8.6 million, or 7.9% of total loans outstanding. The largest
non-residential  mortgage  loan in the  Bank's  portfolio  at June 30,  2000 was
approximately $1.5 million and is secured by a commercial property.

     Mortgage  loans  secured by  non-residential  properties  can be larger and
therefore may involve a greater  degree of credit risk than one- to  four-family
residential   mortgage  loans.  This  risk  is  attributable  to  the  uncertain
realization  of  projected  income-producing  cash flows  which are  affected by
vacancy rates, the ability to maintain rent levels against  competitively-priced
properties  and the  ability to  collect  rent from  tenants on a timely  basis.
Because  payments  on loans  secured  by  non-residential  properties  are often
dependent on the successful operation


                                       6
<PAGE>


or  management  of the  properties,  repayment of such loans may be subject to a
greater  extent to adverse  conditions in the real estate market or the economy.
The Bank seeks to minimize these risks through its underwriting standards, which
require  such loans to be qualified  on the basis of the  property's  income and
debt service ratio.

     Other  Mortgage  Lending.  The Bank also offers  loans  secured by land and
multi-family  residences.  Land loans generally consist of residential  building
lots  for  which  the  borrower  intends  to  ultimately  construct  residential
properties,  but may also include tracts  purchased for  agricultural  use and a
minor amount for speculative  purposes.  Multi-family loans generally consist of
residential  properties  with more than four units,  typically  small  apartment
complexes,  located in the Bank's  primary  lending area. At June 30, 2000,  the
Bank's total land loan portfolio was $2.4 million or 2.2% of total loans and its
multi-family loan portfolio was $2.3 million or 2.1% of total loans.

     The  Bank  requires  appraisals  of  all  mortgage  loans.  Appraisals  are
performed by  independent  appraisers  designated by the Bank. The appraisals of
such  properties  are then reviewed by the Bank's  management.  The  independent
appraisers used by the Bank are reviewed annually by management and the Board of
Directors.

     The Bank  originates  multi-family  residential  loans  with both fixed and
adjustable  interest  rates which vary as to maturity.  Such loans are typically
income-producing   investment   loans.  Loan  to  value  ratios  on  the  Bank's
multi-family  residential  loans are  generally  limited to 80%.  As part of the
criteria for  underwriting  these loans, the Bank's general policy is to require
principals of corporate  borrowers to become  co-borrowers or to obtain personal
guarantees from the principals of corporate borrowers.

     Multi-family  residential lending generally entails significant  additional
risks as compared with single-family  residential  property lending.  Such loans
typically  involve large loan balances to single  borrowers or groups of related
borrowers.  The payment  experience on such loans is typically  dependent on the
successful operation of the real estate project. The success of such projects is
sensitive  to  changes  in supply  and  demand,  conditions  in the  market  for
multi-family  residential  properties  as  well  as  to  regional  and  economic
conditions, generally.

     Consumer Loans.  Subject to the restrictions  contained in federal laws and
regulations,  the Bank also is  authorized  to make loans for a wide  variety of
personal or consumer purposes.  As of June 30, 2000, $17.4 million, or 16.0%, of
the Bank's total loan  portfolio  consisted of consumer  loans  (including  home
equity credit line loans and second mortgage  loans).  The primary  component of
the Bank's  consumer  loan  portfolio  was $9.3 million of auto loans.  Consumer
loans are available at fixed or variable interest rates.

     Consumer  loans  generally  involve  more credit risk than  mortgage  loans
because of the type and nature of the collateral. In addition,  consumer lending
collections are dependent on the borrower's continuing financial stability,  and
thus are more likely to be adversely affected by job loss, divorce, illness, and
personal bankruptcy.  In many cases, any repossessed collateral resulting from a
defaulted  consumer loan will not provide an adequate source of repayment of the
outstanding  loan  balance  because  of  depreciation  and  improper  repair and
maintenance of the underlying security.

     As of June  30,  2000,  the  Bank  had no  non-performing  consumer  loans.
Charge-offs for consumer loans totaled  $194,000 and $37,000 for the years ended
June 30, 2000 and 1999, respectively.

     The Bank  also  offers  loans  secured  by  savings  accounts  at the Bank.
Interest  rates  charged  on such  loans  are  tied to the  prime  rate  and are
available  in amounts  up to 90% of the value of the  account.  Savings  account
loans are reviewed and approved in  conformity  with  standards  approved by the
Bank's Board of Directors.  At June 30, 2000,  the Bank's  savings  account loan
portfolio totaled $367,000 or 0.32% of the total loans outstanding.

     The Bank offers  adjustable rate home equity credit lines tied to the prime
interest rate. The home equity portfolio amounted to $4.7 million or 4.1% of the
total  loan  portfolio  as of June 30,  2000.  The home  equity  credit  line is
available  on  any  owner-occupied   one-to-four  family  home,  townhouse,   or
condominium in the Bank's  lending area provided the homeowner  meets the Bank's
lending  criteria.  A home equity loan is an adjustable  rate mortgage  which is
based on the equity in the home,  and is generally  secured by a first or second
mortgage on the


                                       7
<PAGE>


residence.  The  current  maximum  term is 180  months.  The Bank may offer home
equity  loans up to 100% of the value of the  collateral  to  certain  customers
meeting a higher level of credit criteria.

     Commercial  Business Loans. The Bank offers commercial  business loans that
are generally  provided to various types of closely held  businesses  located in
the Bank's primary market area.  Commercial  business loans generally have terms
of three years or less and  interest  rates which float in  accordance  with the
prime rate although the Bank occasionally  originates  commercial business loans
with  fixed  rates of  interest.  The Bank  performs  a cash  flow  analysis  in
underwriting  these loans. The Bank's  commercial loans generally are secured by
equipment,  machinery  or other  corporate  assets  including  real  estate  and
receivables.  The Bank  requires  principals  of  corporate  borrowers to become
co-borrowers or obtains personal  guarantees from the principals of the borrower
with respect to all commercial business loans.

     Commercial business lending generally entails  significantly greater credit
risk than residential real estate lending.  The repayment of commercial business
loans  typically  is dependent on the  successful  operations  and income of the
borrower.  Such risks can be significantly  affected by economic conditions.  In
addition,  commercial business lending generally requires  substantially greater
oversight efforts compared to residential real estate lending.

     As of June 30,  2000,  the Bank had $286,000 of  non-performing  commercial
business loans.  Charge-offs for commercial  business loans totaled $115,000 for
the year  ended  June 30,  2000.  The Bank had no  charge-offs  with  respect to
commercial business loans in the year ended June 30, 1999.

     Loan Approval Procedures and Authority.  The Board of Directors establishes
the lending  policies of the Bank.  The Board of Directors has  established  the
following  lending  authority:  the Bank's Chief  Executive  Officer and lending
officers may approve loans in amounts within assigned  lending  limits,  and the
Loan Committee,  comprised of the Executive  Committee of the Board of Directors
may approve loans up to the Bank's loans-to-one-borrower limit. In addition, the
staff loan committee,  comprised of the chief executive officer, chief financial
officer,  chief  lending  officer and  collection  officer meets twice a week to
review all loan  applications  that meet all lending policy criteria.  The staff
loan committee can approve lending relationships up to $750,000.  Larger amounts
must be approved  by the  Executive  Committee  of the Board of  Directors.  The
foregoing  lending limits are reviewed  annually and, as needed,  revised by the
Board of Directors. The Board generally ratifies all loans on a monthly basis.

     For all loans  originated  by the Bank,  upon  receipt of a completed  loan
application from a prospective  borrower, a credit report is ordered and certain
other  information  supporting the borrower's  ability to repay is required.  An
appraisal performed by a Bank approved independent appraiser is required for all
real property  intended to secure the proposed loan. The Board annually approves
the independent  appraisers  used by the Bank and approves the Bank's  appraisal
policy.  It is the Bank's  policy to obtain  title  insurance on all real estate
loans of $50,000 or more and hazard insurance on all improved real estate loans.
In connection  with a borrower's  request for a renewal of a mortgage  loan, the
Bank evaluates both the borrower's  ability to service the renewed loan applying
an interest rate that reflects  prevailing  market conditions and the customer's
payment history, as well as the value of the underlying collateral property.

ASSET QUALITY

     Non-Performing  Loans.  Loans are considered  non-performing if they are in
foreclosure  or are 90 or more  days  delinquent.  Management  and the  Board of
Directors perform a monthly review of all delinquent loans. The actions taken by
the Bank with respect to delinquencies  vary depending on the nature of the loan
and period of delinquency. The Bank's policies generally provide that delinquent
mortgage  loans be reviewed and that a written  late charge  notice be mailed no
later  than  the 17th day of  delinquency.  The  Bank's  policies  provide  that
telephone  contact  and  further  written  notification  will  be  attempted  to
ascertain  the reasons for  delinquency  and the  prospects of  repayment.  When
contact is made with the  borrower  at any time prior to  foreclosure,  the Bank
attempts  to obtain  full  payment  or work out a  repayment  schedule  with the
borrower to avoid foreclosure.


                                       8
<PAGE>


     It is the Bank's general policy to reserve all accrued  interest due on all
loans that are 90 days or more past due.

     Real Estate Owned. Property acquired by the Bank as a result of foreclosure
on a mortgage loan is classified as real estate owned ("REO"). At June 30, 2000,
the Bank held $289,000 in REO, while non-performing loans, defined as loans that
are 90 days or more delinquent,  totaled  $411,000.  The Bank's REO is initially
recorded  at the fair value of the  related  assets at the date of  foreclosure.
Thereafter,  if there is a further  deterioration in value, the Bank provides an
REO valuation  allowance and charges operations for the diminution in value less
cost to sell.  It is the policy of the Bank to obtain an  appraisal  on all real
estate acquired through  foreclosure as soon as practicable  after it determines
that foreclosure is imminent.  The Bank generally reassesses the value of REO at
least annually thereafter. The policy for loans is to establish loss reserves in
accordance  with the Bank's  asset  classification  process,  based on Generally
Accepted Accounting Principles ("GAAP").



















                                       9
<PAGE>


     Non-performing Assets. The following table sets forth information regarding
the Bank's non-performing assets at the dates indicated.

<TABLE>
<CAPTION>
                                                                       AT JUNE 30,
                                                                       -----------
                                                         2000                              1999
                                                         ----                              ----
<S>                                                    <C>                               <C>
                                                                 (DOLLARS IN THOUSANDS)
Non-accrual mortgage loans:
    One- to four-family.......................         $  125                            $   52
    Multi-family..............................             --                                --
    Non-residential...........................             --                                --
    Land......................................             --                                --
    Construction..............................             --                                --
                                                       ------                            ------
        Total mortgage loans..................            125                                52
                                                       ------                            ------
    Commercial................................            286                                --
    Consumer Loans............................             --                                 8
                                                       ------                            ------
      Total non-accruing loans................         $  411                            $   60
                                                       ------                            ------
Loans delinquent 90 or more days for which
  interest is fully reserved and still
  accruing:
    One- to four-family.......................         $   --                            $   --
    Multi-family..............................             --                                --
    Non-residential...........................             --                                --
    Land......................................             --                                --
    Construction..............................             --                                --
                                                       ------                            ------
       Total mortgage loans...................             --                                --
                                                       ------                            ------
    Commercial................................             --                                --
    Consumer Loans............................             --                                --
                                                       ------                            ------
Total loans delinquent 90 or more days for
  which interest has been fully reserved......             --                                --
                                                       ------                            ------
Total non-performing loans....................         $  411                            $   60
                                                       ------                            ------

Total real estate owned.......................            289                                59
                                                       ------                            ------

    Total non-performing assets...............         $  700                            $  119
                                                       ------                            ------

Total non-performing loans to loans, gross....           0.36%                             0.07%
Total non-performing assets to total assets...           0.53%                             0.11%
</TABLE>


     Classified  Assets.  Federal  regulations and the Bank's  Classification of
Assets Policy require the Bank to use an internal asset classification system as
a means  of  reporting  problem  and  potential  problem  assets.  The  Bank has
incorporated  the OTS  internal  asset  classifications  as a part of its credit
monitoring system.  The Bank currently  classifies problem and potential problem
assets as "Special  Mention,"  "Substandard,"  "Doubtful" or "Loss"  assets.  An
asset is considered "Substandard" if it is inadequately protected by the current
equity and paying capacity of the obligor or of the collateral  pledged, if any.
"Substandard"  assets include those characterized by the "distinct  possibility"
that the insured  institution  will sustain "some loss" if the  deficiencies are
not  corrected.  Assets  classified  as  "Doubtful"  have all of the  weaknesses
inherent in those classified  "Substandard" with the added  characteristic  that
the weaknesses present make "collection or liquidation in full," on the basis of
currently


                                       10
<PAGE>


existing facts,  conditions,  and values,  "highly questionable and improbable."
Assets  classified as "Loss" are those  considered  "uncollectible"  and of such
little value that their  continuance  as assets without the  establishment  of a
specific loss reserve is not warranted. Assets which do not currently expose the
insured  institution to sufficient risk to warrant  classification in one of the
aforementioned  categories but possess  weaknesses are required to be designated
"Special Mention."

     The Bank's management  reviews and classifies the Bank's assets monthly and
reports the results to the Bank's  Board of Directors  on a monthly  basis.  The
Bank classifies  assets in accordance with the management  guidelines  described
above.  At June  30,  2000,  the Bank  had  $555,000  of  assets  classified  as
Substandard,  $40,000  of  assets  designated  as  Special  Mention,  no  assets
classified as Loss and no assets classified as Doubtful.

     Allowance  for Loan  Losses.  The  Allowance  for Loan  Losses  ("ALL")  is
established through a provision for loan losses based on management's evaluation
of the risks inherent in the Bank's loan portfolio and the general economy.  The
ALL is  maintained  at an amount  management  considers  adequate  to cover loan
losses which are deemed  probable and  estimable.  The allowance is based upon a
number of factors,  including asset classifications,  economic trends,  industry
experience  and  trends,  industry  and  geographic  concentrations,   estimated
collateral  values,  management's  assessment of the credit risk inherent in the
portfolio,   historical  loan  loss  experience,  and  the  Bank's  underwriting
policies. At June 30, 2000, the Bank's ALL was $979,000, or 0.9% of total loans,
as  compared  to  $1.1  million  or  1.3%,  at  June  30,  1999.  The  Bank  had
non-performing loans of $411,000 and $60,000 at June 30, 2000 and June 30, 1999,
respectively. The Bank will continue to monitor and modify its ALL as conditions
dictate.  Various regulatory agencies,  as an integral part of their examination
processes,  periodically  review the Bank's ALL.  These agencies may require the
Bank to establish additional valuation  allowances,  based on their judgments of
the information available at the time of the examination.











                                       11
<PAGE>


     The  following  table sets forth  activity  in the Bank's ALL at or for the
dates indicated.

<TABLE>
<CAPTION>
                                                                  AT OR FOR THE YEAR ENDED JUNE 30,
                                                                  ---------------------------------
                                                                 2000                          1999
                                                                 ----                          ----
<S>                                                           <C>                         <C>
                                                                         (DOLLARS IN THOUSANDS)
Total loans outstanding at end of period............         $   113,998                   $    87,562
Average total loans outstanding.....................             100,228                        76,597

Balance at beginning of year........................               1,123                         1,164
                                                             -----------                   -----------
Provision for loan losses...........................                  88                            20
                                                             -----------                   -----------
Charge-offs:
   One- to four-family residential..................                 (19)                           (4)
   Multi-family residential.........................                  --                            --
   Non-residential and land.........................                  --                           (33)
   Construction.....................................                  --                            --
   Commercial.......................................                (115)                           --
   Consumer loans...................................                (194)                          (37)
                                                             -----------                   -----------
     Total charge-offs..............................                (328)                          (74)
                                                             -----------                   -----------

Recoveries..........................................                  96                            13
                                                             -----------                   -----------

Balance at end of year..............................         $       979                   $     1,123
                                                             ===========                   ===========

Allowance for loan losses to total loans
  at end of period..................................                0.86%                        1.28%
                                                             ===========                   ===========

Allowance for loan losses to total non-performing
   assets at end of period..........................              139.86%                      943.70%
                                                             ===========                   ===========

Allowance for loan losses to total non-performing
   loans at end of period...........................              238.20%                     1,871.14%
                                                             ===========                   ===========

Ratio of net charge-offs during the period
   To average loans outstanding during period.......                0.23%                         0.08%
                                                             ===========                   ===========
</TABLE>




                                       12
<PAGE>


     The  following  table sets forth the Bank's ALL  allocated by loan category
and the percent of loans in each category to total loans at the dates indicated.

<TABLE>
<CAPTION>
                                                               AT JUNE 30,
                                                               -----------
                                         2000                                             1999
                                         ----                                             ----
                                                       PERCENT OF                                       PERCENT OF
                                                        LOANS IN                                         LOANS IN
                                      PERCENT OF          EACH                          PERCENT OF         EACH
                                       ALLOWANCE        CATEGORY                         ALLOWANCE       CATEGORY
                       ALLOWANCE        TO TOTAL         TO TOTAL       ALLOWANCE         TO TOTAL        TO TOTAL
                        AMOUNT         ALLOWANCE          LOANS           AMOUNT         ALLOWANCE         LOANS
                        ------        -----------      ----------       ---------       ----------       ----------
<S>                   <C>            <C>              <C>             <C>              <C>              <C>
                                                        (DOLLARS IN THOUSANDS)
Mortgage loans:
  One- to
   four-family....     $  559             57.10%           60.37%         $  456            40.61%           55.32%
  Multi-family....         15              1.53%            2.00%             10             0.89%            0.36%
  Non-residential
   and land.......         60              6.13%            9.66%             61             5.43%            3.80%
  Construction....         19              1.94%            3.56%             14             1.25%            5.80%
Other:
  Consumer.....           255             26.05%            9.17%            442            39.36%           13.87%
  Commercial...            71              7.25%           15.24%            140            12.46%           20.85%
                        ------        -----------      ----------       ---------       ----------       ----------
  Total........        $  979            100.00%          100.00%         $1,123           100.00%          100.00%
                        ======        ===========      ==========       =========       ==========       ==========
</TABLE>


INVESTMENT ACTIVITIES

         The Bank's  investment  policy permits it to invest in U.S.  government
obligations,  certain  securities of various  government-sponsored  agencies and
municipal obligations, including mortgage-backed securities issued/guaranteed by
Fannie Mae, the FHLMC and the Government National Mortgage Association ("GNMA"),
certificates  of deposit of  insured  banks,  federal  funds,  mutual  funds and
overnight  deposits at the FHLB. At June 30, 2000, the Bank held $9.8 million in
investment securities.

         The  following  table sets  forth  activity  in the  Bank's  investment
securities portfolio for the periods indicated:

<TABLE>
<CAPTION>
                                                                         FOR THE YEAR ENDED JUNE 30,
                                                                         ----------------------------
                                                                         2000                    1999
                                                                         ----                    ----
  <S>                                                                <C>                    <C>
                                                                                (IN THOUSANDS)
     Amortized cost at beginning of period..................         $  11,464              $    8,533
     Purchases, net.........................................              (228)                  4,122
     Principal payments from mortgage backed securities.....            (1,387)                 (1,333)
     Gain on sales..........................................                95                     166
     Premium and discount amortization, net.................               (62)                    (24)
                                                                    ----------              ----------
     Amortized cost at end of period........................             9,882                  11,464
     Net unrealized gain(1).................................               (47)                    334
     Total securities, net..................................        $    9,835              $   11,798
                                                                    ==========              ==========
</TABLE>

(1)  The net unrealized  gain at June 30, 2000 and relates to available for sale
     securities in accordance with Statement of Financial  Accounting  Standards
     ("SFAS")  No.  115.  The net  unrealized  gain is  presented  in  order  to
     reconcile the "Amortized  Cost" of the Bank's  securities  portfolio in the
     "Carrying Cost," as reflected in the Statements of Financial Condition.


                                       13
<PAGE>

     The  following  table sets forth the  amortized  cost and fair value of the
Bank's securities at the dates indicated.

<TABLE>
<CAPTION>
                                                                    AT JUNE 30,
                                                                    -----------
                                                   2000                                    1999
                                                   ----                                    ----
                                      AMORTIZED                                AMORTIZED
                                        COST             FAIR VALUE              COST            FAIR VALUE
                                        ----             ----------              ----            ----------
<S>                                 <C>                 <C>                  <C>                <C>
                                                                     (IN THOUSANDS)
Mortgage-backed securities:
  Fannie Mae and Government
  National Mortgage Association...    $  3,205            $ 3,155               $ 4,626            $  4,672
                                      --------            --------              -------             -------
Other debt securities:
  U.S. Treasury and Agency........       4,515              4,428                 4,624               4,589
  Other...........................         382                370                   480                 459
                                      --------            --------              -------             -------
Total debt securities.............       4,897              4,798                 5,104               5,048
                                      --------            --------              -------             -------
Equity securities(1)..............       1,004              1,106                 1,210               1,554
Federal Home Loan Bank Stock......         776                776                   524                 524
Net unrealized gain (loss)(2).....         (47)                --                   334                  --
                                      --------            --------              -------             -------
Total securities, net.............    $  9,835            $ 9,835               $11,798             $11,798
                                      ========            =======               =======             =======
</TABLE>
-----------------------
(1)  Equity securities consist of FHLMC common stock.
(2)  The net  unrealized  gain  (loss)  at June 30,  2000 and  1999  relates  to
     available  for sale  securities  in  accordance  with SFAS No.115.  The net
     unrealized gain is presented in order to reconcile the "Amortized  Cost" of
     the Bank's securities portfolio in the "Carrying Cost," as reflected in the
     Statements of Financial Condition.

     The  following  table sets forth the  amortized  cost and fair value of the
Bank's securities,  by accounting classification and by type of security, at the
dates indicated.

<TABLE>
<CAPTION>
                                                                       AT JUNE 30,
                                                                       -----------
                                                  2000                     1999                         1998
                                                  ----                     ----                         ----
                                         AMORTIZED                AMORTIZED                    AMORTIZED
                                           COST      FAIR VALUE     COST       FAIR VALUE        COST       FAIR VALUE
                                           ----      ----------     ----       ----------        ----       ----------
<S>                                     <C>         <C>          <C>          <C>             <C>          <C>
                                                                     (IN THOUSANDS)
Held to Maturity
   Other debt securities.............     $  100      $   100      $  100       $   100         $  100        $  100
                                          ------      -------      ------       -------         ------        ------
         Total held to maturity......        100          100         100           100            100           100
                                          ------      -------      ------       -------         ------        ------
Available-for-Sale:
   Mortgage-backed securities........      3,205        3,155       4,626         4,672          2,174         2,235
   Other debt securities:............      4,698        4,599       4,806         4,750          5,430         5,422
   Equity securities.................      1,004        1,106       1,210         1,554              7           438
   Net unrealized gain (loss) (1)....        (47)          --         334            --            484            --
                                          ------      -------      ------       -------         ------        ------
         Total available-for-sale....      8,860        8,860      10,976        10,976          8,095         8,095
                                          ------      -------      ------       -------         ------        ------

Certificates of deposit..............         99           99         198           198            198           198
                                          ------      -------      ------       -------         ------        ------
Federal Home Loan Bank Stock.........        776          776         524           524            624           624
                                          ------      -------      ------       -------         ------        ------

   Total securities, net.............     $9,835       $9,835     $11,798       $11,798         $9,017        $9,017
                                          ======       ======     =======       =======         ======        ======
</TABLE>

(1)  The net unrealized  gains (loss) at June 30, 2000,  1999 and 1998 relate to
     available  for sale  securities  in  accordance  with SFAS No. 115. The net
     unrealized  gain (loss) is presented in order to reconcile  the  "Amortized
     Cost"  of the  Bank's  securities  portfolio  in the  "Carrying  Cost,"  as
     reflected in the Statements of Financial Condition.

                                       14
<PAGE>


     The following table sets forth certain information  regarding the amortized
cost,  fair value and weighted  average  yield of the Bank's debt  securities at
June 30, 2000,  by remaining  period to  contractual  maturity.  With respect to
mortgage-backed  securities,  the entire  amount is  reflected  in the  maturity
period that includes the final security payment date and, accordingly, no effect
has been given to periodic repayments or possible prepayments.

<TABLE>
<CAPTION>
                                                                           AT JUNE 30, 2000
                                                                           ----------------
                                                      HELD-TO-MATURITY                           AVAILABLE FOR SALE
                                                      ----------------                           ------------------
                                                                       WEIGHTED                                   WEIGHTED
                                            AMORTIZED      FAIR         AVERAGE       AMORTIZED       FAIR         AVERAGE
                                              COST         VALUE         YIELD          COST          VALUE         YIELD
                                              ----         -----         -----          ----          -----         -----
<S>                                          <C>             <C>          <C>            <C>             <C>         <C>
                                                                       (DOLLARS IN THOUSANDS)
Debt Securities
Mortgaged-backed securities:
  Due within 1 year......................    $ --            $ --           --%          $   --          $   --        --%
  Due after 1 year but within 5 years....      --              --           --               64              65      7.29
  Due after 5 years but within 10 years..      --              --           --               --              --        --
  Due after 10 years.....................      --              --           --            3,141           3,090      6.71
                                             ----            ----                        ------          ------
         Total...........................      --              --           --            3,205           3,155      6.72
                                             ----            ----                        ------          ------
U.S. Treasury and Agency:
  Due within 1 year......................      --              --           --               --              --        --
  Due after 1 year but within 5 years....     100             100         5.50            3,270           3,220      5.77
  Due after 5 years but within 10 years..      --              --           --              500             492      7.55
  Due after 10 years.....................      --              --           --              645             616      5.85
                                             ----            ----                        ------          ------
         Total...........................     100             100         5.50            4,415           4,328      5.99
                                             ----            ----                        ------          ------
Corporate & Other:
  Due within 1 year......................      --              --           --               --              --        --
  Due after 1 year but within 5 years....      99              99         7.25               --              --        --
  Due after 5 years but within 10 years..      --              --           --               --              --        --
  Due after 10 years.....................      --              --           --              283             271      4.60
                                             ----            ----                        ------          ------
         Total...........................      99              99         7.25              283             271      4.60
                                             ----            ----                        ------          ------
Equity Securities........................      --              --           --            1,004           1,106        --
                                             ----            ----                        ------          ------
Total:
  Due within 1 year......................      --              --           --               --              --        --
  Due after 1 year but within 5 years....     199             199         6.37            3,334           3,285      5.80
  Due after 5 years but within 10 years..      --              --           --              500             492      7.55
  Due after 10 years.....................      --              --           --            4,069           3,977      6.45
  Equity Securities......................      --              --           --            1,004           1,106        --
                                             ----            ----                        ------          ------
                                              199             199         6.37            8,907           8,860      6.23
                                             ----            ----                        ------          ------
  Federal Home Loan Bank Stock...........     776             776           --               --              --        --
                                             ----            ----                        ------          ------
         Total...........................    $975            $975         6.37%          $8,907          $8,860      6.23%
                                             ====            ====                        ======          ======
</TABLE>


                                       15

<PAGE>

SOURCES OF FUNDS

     General.  Deposits, loan and security repayments and prepayments,  proceeds
of refinanced  loans sold to Fannie Mae and cash flows generated from operations
are the  primary  sources of the Bank's  funds for use in lending  and for other
general purposes.

     Deposits.  The Bank  offers a variety of deposit  accounts  with a range of
interest  rates and terms.  The Bank's  deposits  consist of regular  (passbook)
savings accounts,  checking accounts,  money market deposit accounts,  statement
savings  accounts,  IRAs and certificates of deposit.  In recent years, the Bank
has offered  certificates of deposit with maturities of up to 48 months. At June
30,  2000,  the Bank's core  deposits  (which the Bank  considers  to consist of
checking  accounts,  regular savings  accounts and statement  savings  accounts)
constituted  44.4%  of  total  deposits.  The  flow of  deposits  is  influenced
significantly  by general  economic  conditions,  changes in money market rates,
prevailing  interest  rates and  competition.  The Bank's  deposits are obtained
predominantly  from  Ashe,  Alleghany  and  Watauga  counties.  The Bank  relies
primarily on customer service and long-standing  relationships with customers to
attract and retain these  deposits;  however,  market  interest  rates and rates
offered by  competing  financial  institutions  significantly  affect the Bank's
ability to attract and retain deposits.

     The  following  table  presents  the  deposit  activity of the Bank for the
periods indicated.

<TABLE>
<CAPTION>
                                                               FOR THE YEAR ENDED JUNE 30,
                                                               ---------------------------
                                                                2000                        1999
                                                                ----                        ----
                                                                           (IN THOUSANDS)
<S>                                                       <C>                         <C>
Total deposits at beginning of period,
  including accrued interest.......................       $  93,106                   $  82,488
Net increase before interest credited..............           5,505                       6,848
Interest credited..................................           4,069                       3,770
                                                          ---------                   ---------
Total deposits at end of period....................       $ 102,680                   $  93,106
                                                          =========                   =========
</TABLE>

     At June 30,  2000,  the  Bank  had  approximately  $17.1  million  in Jumbo
certificate of deposits (accounts in amounts over $100,000) maturing as follows:

<TABLE>
<CAPTION>
                                                                                            WEIGHTED
                                                      AMOUNT                              AVERAGE RATE
                                                      ------                              ------------
                                                                            (IN THOUSANDS)
<S>                                                    <C>                                  <C>
Maturity Period
   Within three months.......................          $   5,568                            5.81%
   After three but within six months.........              4,749                            5.99%
   After six but within 12 months............              4,720                            6.08%
   After 12 months...........................              2,044                            5.58%
                                                       ---------                            -----
                  Total......................          $  17,081                            5.89%
                                                       =========                            =====
</TABLE>


                                       16
<PAGE>

     The  following  table sets  forth the  distribution  of the Bank's  deposit
accounts and the related weighted average interest rates at the dates indicated.

<TABLE>
<CAPTION>
                                                                           AT JUNE 30,
                                                                           -----------
                                                     2000                                               1999
                                                     ----                                               ----
                                                    PERCENT         WEIGHTED                           PERCENT
                                                   OF TOTAL          AVERAGE                          OF TOTAL
                                                   DEPOSITS           RATE            AMOUNT          DEPOSITS          AMOUNT
                                                   --------           ----            ------          --------          ------
                                                                     (DOLLARS IN THOUSANDS)
<S>                            <C>                  <C>                 <C>       <C>                 <C>                  <C>
Noninterest bearing
checking accounts.........     $  3,960               3.86%            0.00%      $ 3,914                4.20%               --%

Interest bearing checking/
Money Market accounts.....       18,589              18.10%            1.92%       15,425              16.57%              2.28%

Savings...................       23,032              22.43%            3.83%       21,841              23.46%              3.05%

Certificates of deposit...       56,937              55.45%            5.71%       51,788              55.62%              4.94%

Accrued interest..........          162               0.16%            0.00%           38               0.15%                --%
                               --------             -------            -----           --               -----              ----

        Totals                 $102,680             100.00%            4.34%      $93,106             100.00%              4.29%
                               ========             ======             =====      =======             ======               ====
</TABLE>

     The  following  table  presents,  by interest  rate  ranges,  the amount of
certificate accounts outstanding at June 30, 2000 and the period to maturity.

<TABLE>
<CAPTION>
                                         PERIOD TO MATURITY AT JUNE 30, 2000
                                         -----------------------------------
                                          LESS THAN             ONE TO              FOUR TO
       INTEREST RATE RANGE                ONE YEAR            THREE YEARS         FIVE YEARS           TOTAL
       -------------------                --------            -----------         ----------           -----
                                                                  (DOLLARS IN THOUSANDS)
<S>                                         <C>                  <C>                 <C>               <C>
4.00% to 5.99%                              $33,438              $5,261              $224              $38,923
6.01% to 7.99%..................             14,523               3,344               147               18,014
                                            -------              ------              ----              -------
              Total.............            $47,961              $8,605              $371              $56,937
                                            =======              ======              ====              =======
</TABLE>

     Borrowings.  The Bank  historically  has not used borrowings as a source of
funds.  However, the Bank may obtain advances from the FHLB as an alternative to
retail  deposit  funds  and may do so in the  future  as  part of its  operating
strategy.  These  advances would be  collateralized  primarily by certain of the
Bank's mortgage loans and secondarily by the Bank's  investment in capital stock
of the FHLB. See  "Regulation--Regulation of Federal Savings Banks--Federal Home
Loan Bank  System."  Such  advances  may be made  pursuant to several  different
credit  programs,  each  of  which  has its  own  interest  rate  and  range  of
maturities.   The  maximum   amount  that  the  FHLB  will   advance  to  member
institutions,  including  the Bank,  fluctuates  from time to time in accordance
with the  policies  of the OTS and the FHLB.  As of June 30,  2000,  the maximum
amount of FHLB advances  available to the Bank was $46.6  million.  The Bank had
short term advances of $15.5 million at June 30, 2000 from the FHLB. Interest is
payable at rates ranging from 6.13% to 6.95%. $4,000,000 of the advances are due
in June 2001,  $862,500 are due by August 2002,  $150,507 are due January  2007,
$5,000,000  are due August  2009,  and  $3,00,000  is due  September  2009.  The
remaining  $2,500,000 is an advance borrowed under the Daily Rate Credit Program
at the FHLB and has no maturity date.

SUBSIDIARY ACTIVITIES

     AF Insurance Services,  Inc., a wholly owned subsidiary of the Company, was
formed in July 1997 upon the purchase of two independent  insurance agencies for
the sole purpose of selling traditional  property and casualty,  life and health
insurance.  Additional  insurance  agencies were  purchased in April of 1999 and
December 1999. AF


                                       17
<PAGE>

Insurance  Services,  Inc. offers these services in a segregated location at the
Bank's executive offices, Sparta, Lenoir, Jefferson, North Wilkesboro and Elkin,
North Carolina.

AF BROKERAGE, INC.

     AF Brokerage, Inc., a wholly owned subsidiary of the Company, was formed in
August 1998 for the purpose of selling brokerage and investment products through
a  third-party  vendor.  During  the 2000  fiscal  year,  AF  Brokerage,  Inc.'s
application for registration was accepted by the NASD and the brokerage  company
began selling  investment  products  directly.  AF Brokerage,  Inc. offers these
services in a  segregated  location at the Bank's  executive  offices and branch
locations.

PERSONNEL

     As of June 30, 2000, the Company had 81 full-time employees.  The employees
are not represented by a collective  bargaining  unit and the Company  considers
its relationship with its employees to be good. See "Executive Compensation" for
a description of certain compensation and benefit programs offered to the Bank's
employees.

                                   REGULATION

GENERAL

     The Company and the Bank are subject to extensive  regulation,  examination
and  supervision  by the OTS, as their  chartering  agency.  The Bank's  deposit
accounts are insured up to  applicable  limits by the FDIC and it is a member of
the FHLB of Atlanta.  The Bank must file  reports  with the OTS  concerning  its
activities and financial condition and it must obtain regulatory approvals prior
to entering into certain transactions, such as mergers with, or acquisitions of,
other depository institutions.  The OTS conducts periodic examinations to assess
the Bank's compliance with various regulatory requirements.  This regulation and
supervision  establishes  a  comprehensive  framework of  activities  in which a
savings  institution can engage and is intended  primarily for the protection of
the  insurance  fund and  depositors.  The Company and the Holding  Company,  as
savings and loan holding  companies,  are required to file certain reports with,
and otherwise comply with, the rules and regulations of the OTS.

     The OTS has significant discretion in connection with their supervisory and
enforcement activities and examination policies, including policies with respect
to the  classification  of assets and the  establishment  of adequate  loan loss
reserves for regulatory  purposes.  Any change in such policies,  whether by the
OTS or the  Congress,  could  have a  material  adverse  impact  on the  Holding
Company, the Company or the Bank.

     The  following  discussion  is  intended  to be a summary  of the  material
statutes and regulations  applicable to savings  institutions  and their holding
companies, and it does not purport to be a comprehensive description of all such
statutes and regulations.

REGULATION OF FEDERAL SAVINGS BANKS

     Business  Activities.  The Bank derives its lending and  investment  powers
from  the  Home  Owner's  Loan  Act  ("HOLA")  and  the  regulations  of the OTS
thereunder.  Under these laws and  regulations,  the Bank may invest in mortgage
loans secured by residential  and  non-residential  real estate,  commercial and
consumer loans,  certain types of debt securities and certain other assets.  The
Bank may also establish  service  corporations that may engage in activities not
otherwise  permissible  for the  Bank,  including  certain  real  estate  equity
investments and securities and insurance brokerage.  These investment powers are
subject  to  various  limitations,  including  (a)  a  prohibition  against  the
acquisition  of any corporate debt security that is not rated in one of the four
highest rating  categories;  (b) a limit of 400% of an association's  capital on
the aggregate amount of loans secured by  non-residential  real estate property;
(c) a limit of 20% of an association's  assets on commercial  loans; (d) a limit
of 35% of an association's  assets on the aggregate amount of consumer loans and
acquisitions  of  certain  debt  securities;  (e) a  limit  of 5% of  assets  on
non-conforming  loans (loans in excess of the specific limitations of HOLA); and
(f) a limit of


                                       18
<PAGE>

the greater of 5% of assets or an association's  capital on certain construction
loans  made for the  purpose  of  financing  what is or is  expected  to  become
residential property.

     Loans to One  Borrower.  Under HOLA,  savings  associations  are  generally
subject to the same  limits on loans to one  borrower as are imposed on national
banks. Generally,  under these limits, a savings institution may not make a loan
or extend  credit to a single or related  group of borrowers in excess of 15% of
the  association's  unimpaired  capital and surplus.  Additional  amounts may be
lent, not exceeding 10% of the association's  unimpaired capital and surplus, if
such  loans and  extensions  of credit are fully  secured by  readily-marketable
collateral.  Such  collateral  is  defined to  include  certain  debt and equity
securities and bullion,  but generally does not include real estate. At June 30,
2000, the Bank's limit on loans to one borrower was approximately  $1.6 million.
At June 30, 2000, the Bank's largest  aggregate  amount of loans to one borrower
was $1.5 million and is secured by a mix of one- to four-family  and multifamily
properties.   The  second   largest   borrower  had  an  aggregate   balance  of
approximately $1.4 million, secured by an multifamily complex. At June 30, 2000,
all of the  loans in both of these  lending  relationships  were  performing  in
accordance with their terms.

     QTL Test.  HOLA requires a savings  institution to meet a Qualified  Thrift
Lender  ("QTL")  test.  A  savings  institution  may  satisfy  the  QTL  test by
maintaining at least 65% of its "portfolio  assets" in certain "qualified thrift
investments" in at least 9 months of the most recent 12-month period. "Portfolio
assets" means,  in general,  an  association's  total assets less the sum of (a)
specified  liquid  assets up to 20% of total  assets,  (b) certain  intangibles,
including  goodwill and credit card and purchased  mortgage servicing rights and
(c) the value of property used to conduct the association's  business.  The term
"qualified  thrift  investments"  includes  various  types  of  loans  made  for
residential  and  housing  purposes,   investments  related  to  such  purposes,
including  certain  mortgage-backed  and  related  securities,   and  loans  for
personal,  family,  household and certain other purposes up to a limit of 20% of
an association's  portfolio assets.  Recent  legislation  broadened the scope of
"qualified thrift  investments" to include 100% of an institution's  credit card
loans, education loans, and small business loans. A savings association may also
satisfy the QTL test by qualifying as a "domestic building and loan association"
as defined in the  Internal  Revenue Code of 1986.  At June 30,  2000,  the Bank
maintained 71.6% of its portfolio assets in qualified  thrift  investments.  The
Bank  had  also  satisfied  the QTL test in each of the  prior  12  months  and,
therefore, was a qualified thrift lender.

     A savings  institution  that fails the QTL test must either  operate  under
certain restrictions on its activities or convert to a bank charter. The initial
restrictions  include  prohibitions against (a) engaging in any new activity not
permissible  for a national bank,  (b) paying  dividends not  permissible  under
national  bank  regulations,  (c)  obtaining  new advances from any FHLB and (d)
establishing any new branch in a location not permissible for a national bank in
the association's home state. In addition, within one year of the date a savings
institution ceases to meet the QTL test, any company controlling the association
would have to register  under,  and become subject to the  requirements  of, the
Bank  Holding  Company  Act of 1956,  as amended  ("BHC  Act").  If the  savings
institution  does not requalify under the QTL test within the three-year  period
after it failed the QTL test, it would be required to terminate any activity and
to dispose of any investment not  permissible for a national bank and would have
to repay as  promptly as  possible  any  outstanding  advances  from an FHLB.  A
savings  institution  that has failed the QTL test may  requalify  under the QTL
test and be free of such limitations, but it may do so only once.

     Capital  Requirements.  The OTS regulations require savings associations to
meet three minimum capital  standards:  a tangible capital ratio  requirement of
1.5% of total assets as adjusted  under the OTS  regulations,  a leverage  ratio
requirement of 3% of core capital to such adjusted total assets and a risk-based
capital  ratio  requirement  of 8% of core and  supplementary  capital  to total
risk-weighted  assets.  The OTS and the federal banking regulators have proposed
amendments  to their  minimum  capital  regulations  to provide that the minimum
leverage  capital ratio for a depository  institution that has been assigned the
highest composite rating of 1 under the Uniform Financial  Institutions  Ratings
System  will be 3% and that the  minimum  leverage  capital  ratio for any other
depository  institution  will be 4%, unless a higher  leverage  capital ratio is
warranted by the  particular  circumstances  or risk  profile of the  depository
institution.  In determining compliance with the risk-based capital requirement,
a savings  association must compute its risk-weighted  assets by multiplying its
assets and certain off-balance sheet items by risk-weights,  which range from 0%
for cash and obligations  issued by the United States Government or


                                       19
<PAGE>

its agencies to 100% for consumer and commercial  loans,  as assigned by the OTS
capital regulation based on the risks OTS believes are inherent in the assets.

     Tangible  capital is defined,  generally,  as common  stockholders'  equity
(including retained earnings),  certain non-cumulative perpetual preferred stock
and  related  earnings  and  minority  interests  in  equity  accounts  of fully
consolidated  subsidiaries,   less  intangibles  (other  than  certain  mortgage
servicing  rights)  and  investments  in and loans to  subsidiaries  engaged  in
activities  not  permissible  for a  national  bank.  Core  capital  is  defined
similarly to tangible capital, but core capital also includes certain qualifying
supervisory   goodwill  and  certain   purchased   credit  card   relationships.
Supplementary   capital  currently  includes   cumulative  and  other  perpetual
preferred  stock,  mandatory  convertible  securities,   subordinated  debt  and
intermediate  preferred  stock and the allowance for loan and lease losses.  The
allowance for loan and lease losses  includable in supplementary  and capital is
limited  to a  maximum  of 1.25% of  risk-weighted  assets,  and the  amount  of
supplementary  capital that may be included as total  capital  cannot exceed the
amount of core capital.

     The federal banking agencies,  including the OTS, have adopted  regulations
to require  an  assessment  of an  institution's  exposure  to  declines  in the
economic  value of a bank's  capital  due to  changes  in  interest  rates  when
assessing the bank's capital adequacy.  Under such a risk assessment,  examiners
will evaluate a bank's capital for interest rate risk on a  case-by-case  basis,
with  consideration of both quantitative and qualitative  factors.  According to
the agencies, applicable considerations include:

o    the quality of the bank's interest rate risk management process;
o    the overall financial condition of the bank; and
o    the level of other risks at the bank for which capital is needed.

     Institutions  with  significant  interest rate risk may be required to hold
additional capital.  The agencies also issued a joint policy statement providing
guidance  on  interest  rate risk  management,  including  a  discussion  of the
critical  factors  affecting the  agencies'  evaluation of interest rate risk in
connection with capital adequacy.

     The table below presents the Bank's  regulatory  capital as compared to the
OTS regulatory capital requirements at June 30, 2000:

<TABLE>
<CAPTION>
                                                                           CAPITAL            EXCESS
                                                          AMOUNT        REQUIREMENTS          CAPITAL
                                                          ------        ------------          -------
                                                                       (IN THOUSANDS)
<S>                                                      <C>             <C>                 <C>
          Core capital...........................        $11,717         $5,270              $6,447

          Risk-based capital.....................         11,688          8,427               4,151
</TABLE>

     A reconciliation  between  regulatory  capital and GAAP capital at June 30,
2000 in the accompanying financial statements is presented below:

<TABLE>
<CAPTION>
                                                                                              RISK-
                                                                            CORE              BASED
                                                                           CAPITAL           CAPITAL
                                                                           -------           -------
<S>                                                                       <C>               <C>
            GAAP capital..........................................        $11,688           $11,668

            Net unrealized loss on available for
              sale investment securities, net of tax..............             29                29

            Allowance for loan losses included as
              supplementary capital...............................             --               979

            Equity investment and other assets....................             --              (118)
                                                                          -------           -------

            Regulatory capital....................................        $11,717           $12,578
                                                                          =======           =======
</TABLE>


                                       20
<PAGE>

     Limitation  on Capital  Distributions.  Effective  April 1,  1999,  the OTS
amended its capital  distribution  regulations to reduce  regulatory  burdens on
savings  associations.  The  regulations  being  replaced,  which were effective
throughout 1998,  established  limitations upon capital distributions by savings
associations,  such as cash  dividends,  payments  to  repurchase  or  otherwise
acquire its shares, payments to shareholders of another institution in a cashout
merger,  and other  distributions  charged  against  capital.  At least  30-days
written notice to the OTS was required for a proposed capital  distribution by a
savings association,  and capital  distributions in excess of specified earnings
or by certain  institutions  were subject to approval by the OTS. An association
that  had  capital  in  excess  of  all  fully  phased  in  regulatory   capital
requirements  before and after a proposed capital  distribution and that was not
otherwise restricted in making capital distributions,  could, after prior notice
but  without  the  approval  of the OTS,  make  capital  distributions  during a
calendar  year  equal to the  greater  of (a) 100% of its net  earnings  to date
during the calendar  year plus the amount that would reduce by half its "surplus
capital   ratio"  (the  excess   capital   over  its  fully  phased  in  capital
requirements)  at the  beginning  of the  calendar  year,  or (b) 75% of its net
earnings for the previous four quarters.  Any additional  capital  distributions
would  require  prior OTS  approval.  Under the  amendments  adopted by the OTS,
certain  savings  associations  will be permitted  to pay capital  distributions
during a calendar year that do not exceed the  association's net income for that
year plus its retained net income for the prior two years, without notice to, or
the approval of, the OTS. However, a savings association subsidiary of a savings
and loan  holding  company,  such as the Bank,  will  continue to have to file a
notice unless the specific  capital  distribution  requires an  application.  In
addition,  the OTS can  prohibit  a  proposed  capital  distribution,  otherwise
permissible under the regulation, if the OTS has determined that the association
is in need of more than normal  supervision or if it determines  that a proposed
distribution by an association  would constitute an unsafe or unsound  practice.
Furthermore,  under the OTS prompt corrective action regulations, the Bank would
be prohibited from making any capital  distribution if, after the  distribution,
the Bank failed to meet its minimum capital  requirements,  as described  above.
See "--Prompt Corrective Regulatory Action."

     Liquidity.  The Bank is required to  maintain an average  daily  balance of
liquid assets (cash,  certain time  deposits,  bankers'  acceptances,  specified
United States Government, state or federal agency obligations, shares of certain
mutual funds and certain  corporate debt securities and commercial  paper) equal
to a  monthly  average  of not  less  than a  specified  percentage  of its  net
withdrawable  deposit  accounts  plus  short-term  borrowings.   This  liquidity
requirement may be changed from time to time by the OTS to any amount within the
range of 4% to 10% depending  upon economic  conditions and the savings flows of
member institutions,  and is currently 4%. Monetary penalties may be imposed for
failure to meet these liquidity requirements. The Bank's average liquidity ratio
for the month ended June 30, 2000 was  approximately  11.8% which  exceeded  the
applicable  requirements.  The Bank has never been subject to monetary penalties
for failure to meet its liquidity requirements.

     Assessments.  The OTS has adopted amendments to its regulations,  effective
January 1, 1999,  that are  intended to assess  savings  associations  on a more
equitable  basis. The new regulations will base the assessment for an individual
savings association on three components:  the size of the association,  on which
the basic assessment would be based; the  association's  supervisory  condition,
which would result in an  additional  assessment  based of a  percentage  of the
basic assessment for any savings  institution with a composite rating of 3, 4 or
5 in its most recent safety and soundness examination; and the complexity of the
association's  operations,  which would result in an additional assessment based
of a percentage of the basic assessment for any savings association that managed
over $1.0 billion in trust assets,  serviced for others loans  aggregating  more
than $1.0 billion, or had certain off-balance sheet assets aggregating more than
$1.0 billion. In order to avoid a disproportionate impact on the smaller savings
institutions,  which are those whose total assets never exceeded $100.0 million,
the new  regulations  provide that the portion of the assessment  based on asset
size will be the lesser of the assessment  under the amended  regulations or the
regulations  before the  amendment.  Management  believes that any change in its
rate of OTS assessments under the amended regulations will not be material.

     Branching.  Subject to certain  limitations,  HOLA and the OTS  regulations
permit federally  chartered  savings  institutions to establish  branches in any
state of the  United  States.  The  authority  to  establish  such a  branch  is
available  (a)  in  states  that   expressly   authorize   branches  of  savings
institutions  located in another  state and (b) to an  association  that  either
satisfies  the  "QTL"  test for a  qualified  thrift  lender or  qualifies  as a
"domestic building and loan association" under the Internal Revenue Code of 1986
(the "Code"), which imposes qualification


                                       21
<PAGE>

requirements  similar to those for a "qualified  thrift  lender" under HOLA. See
"--QTL Test." The authority for a federal  savings  institution  to establish an
interstate branch network would facilitate a geographic  diversification  of the
association's  activities.  This  authority  under HOLA and the OTS  regulations
preempts  any state law  purporting  to regulate  branching  by federal  savings
institutions.

     Community  Reinvestment.  Under the Community  Reinvestment Act ("CRA"), as
implemented  by OTS  regulations,  a savings  institution  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 association'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  association.  The CRA also  requires  all  institutions  to make public
disclosure of their CRA ratings.  The Bank received a "Satisfactory"  CRA rating
in its most recent examination on January 20, 1998.

     The  CRA  regulations   establish  an  assessment   system  that  bases  an
association's  rating on its actual  performance in meeting  community needs. In
particular, the assessment system focuses on three tests: (a) a lending test, to
evaluate the  institution's  record of making loans in its assessment areas; (b)
an  investment  test,  to evaluate  the  institution's  record of  investing  in
community development projects, affordable housing, and programs benefitting low
or moderate  income  individuals  and  businesses;  and (c) a service  test,  to
evaluate the institution's delivery of services through its branches,  ATMs, and
other offices.

     Transactions  with  Related  Parties.  The  Bank's  authority  to engage in
transactions  with its  "affiliates"  is limited by the OTS  regulations  and by
Sections  23A and  23B of the  Federal  Reserve  Act  ("FRA").  In  general,  an
affiliate of the Bank is any company that controls the Bank or any other company
that is  controlled  by a company that  controls the Bank,  excluding the Bank's
subsidiaries other than those that are insured depository institutions.  The OTS
regulations  prohibit  a  savings  institution  (a) from  lending  to any of its
affiliates  that is  engaged in  activities  that are not  permissible  for bank
holding  companies under Section 4(c) of the BHC Act and (b) from purchasing the
securities  of any  affiliate  other than a  subsidiary.  Section 23A limits the
aggregate  amount of  transactions  with any individual  affiliate to 10% of the
capital  and surplus of the savings  institution  and also limits the  aggregate
amount of transactions  with all affiliates to 20% of the savings  institution's
capital and  surplus.  Extensions  of credit to  affiliates  are  required to be
secured by collateral  in an amount and of a type  described in Section 23A, and
the purchase of low quality  assets from  affiliates  is  generally  prohibited.
Section 23B provides that certain transactions with affiliates,  including loans
and asset purchases, must be on terms and under circumstances,  including credit
standards,  that are  substantially  the same or at  least as  favorable  to the
association  as those  prevailing at the time for comparable  transactions  with
non-affiliated  companies.  In the  absence  of  comparable  transactions,  such
transactions  may only occur under  terms and  circumstances,  including  credit
standards,   that  in  good  faith  would  be  offered  to  or  would  apply  to
non-affiliated companies.

     The Bank's authority to extend credit to its directors, executive officers,
and 10%  shareholders,  as well as to entities  controlled by such  persons,  is
currently  governed by the  requirements  of Sections 22(g) and 22(h) of the FRA
and Regulation O of the FRB  thereunder.  Among other things,  these  provisions
require  that  extensions  of credit to  insiders  (a) be made on terms that are
substantially  the same as, and follow credit  underwriting  procedures that are
not less stringent  than,  those  prevailing for  comparable  transactions  with
unaffiliated  persons  and that do not  involve  more  than the  normal  risk of
repayment  or present  other  unfavorable  features  and (b) not exceed  certain
limitations on the amount of credit extended to such persons,  individually  and
in the  aggregate,  which  limits  are  based,  in part,  on the  amount  of the
association's  capital.  In addition,  extensions of credit in excess of certain
limits must be approved by the association's board of directors.

     Enforcement.  Under the Federal Deposit  Insurance Act ("FDI Act"), the OTS
has primary  enforcement  responsibility  over savings  institutions and has the
authority  to  bring  enforcement  action  against  all  "institution-affiliated
parties,"  including any controlling  stockholder or any shareholder,  attorney,
appraiser  or  accountant  who  knowingly  or  recklessly  participates  in  any
violation of applicable law or regulation or breach of


                                       22
<PAGE>

fiduciary  duty or certain  other  wrongful  actions that causes or is likely to
cause a more  than a  minimal  loss or other  significant  adverse  effect on an
insured  savings  institution.  Civil penalties cover a wide range of violations
and actions and range from $5,000 for each day during which  violations  of law,
regulations,  orders, and certain written agreements and conditions continue, up
to $1 million per day for such  violations if the person  obtained a substantial
pecuniary gain as a result of such violation or knowingly or recklessly caused a
substantial loss to the institution.  Criminal  penalties for certain  financial
institution  crimes include fines of up to $1 million and imprisonment for up to
30  years.  In  addition,   regulators  have  substantial   discretion  to  take
enforcement  action  against  an  institution  that  fails  to  comply  with its
regulatory requirements,  particularly with respect to its capital requirements.
Possible  enforcement  actions  range from the  imposition of a capital plan and
capital  directive  to  receivership,  conservatorship,  or the  termination  of
deposit insurance. Under the FDI Act, the FDIC has the authority to recommend to
the  Director  of OTS  that  enforcement  action  be  taken  with  respect  to a
particular  savings  institution.  If action is not taken by the Director of the
OTS, the FDIC has authority to take such action under certain circumstances.

     Standards for Safety and Soundness.  Pursuant to the FDI Act, as amended by
Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") and the
Riegle Community Development and Regulatory  Improvement Act of 1994 ("Community
Development  Act"),  the OTS,  together with the other  federal bank  regulatory
agencies,   adopted  a  set  of  guidelines  prescribing  safety  and  soundness
standards.  The  guidelines  establish  general  standards  relating to internal
controls and information  systems,  internal audit systems,  loan documentation,
credit  underwriting,  interest  rate  exposure,  asset growth,  asset  quality,
earnings  standards,  and  compensation,  fees and  benefits.  In  general,  the
guidelines  require,  among other things,  appropriate  systems and practices to
identify and manage the risks and  exposures  specified in the  guidelines.  The
guidelines prohibit excessive compensation as an unsafe and unsound practice and
describe  compensation  as excessive when the amounts paid are  unreasonable  or
disproportionate  to the services performed by an executive  officer,  employee,
director or principal  shareholder.  The OTS and the other  agencies  determined
that stock  valuation  standards  were not  appropriate.  In  addition,  the OTS
adopted  regulations  that  authorize,  but do not require,  the OTS to order an
institution  that has been given notice by the OTS that it is not satisfying any
of such safety and soundness  standards to submit a compliance  plan.  If, after
being so notified,  an institution fails to submit an acceptable compliance plan
or fails in any material  respect to implement an accepted  compliance plan, the
OTS must issue an order directing action to correct the deficiency and may issue
an order  directing  other  actions  of the  types to which an  undercapitalized
association  is subject  under the  "prompt  corrective  action"  provisions  of
FDICIA.  If an institution  fails to comply with such an order, the OTS may seek
to  enforce  such  order in  judicial  proceedings  and to  impose  civil  money
penalties.

     Real  Estate  Lending  Standards.  The OTS and the  other  federal  banking
agencies  adopted  regulations  to prescribe  standards for extensions of credit
that (a) are secured by real estate or (b) are made for the purpose of financing
the  construction of improvements  on real estate.  The OTS regulations  require
each savings  institution to establish and maintain written internal real estate
lending  standards that are consistent with safe and sound banking practices and
appropriate to the size of the  association and the nature and scope of its real
estate  lending   activities.   The  standards  also  must  be  consistent  with
accompanying  OTS  guidelines,   which  include  loan-to-value  ratios  for  the
different types of real estate loans. Banks are also permitted to make a limited
amount of loans that do not conform to the proposed loan-to-value limitations so
long as such exceptions are reviewed and justified appropriately. The guidelines
also  list  a  number  of  lending   situations  in  which   exceptions  to  the
loan-to-value standards are justified.

     Prompt Corrective Regulatory Action. Under the OTS prompt corrective action
regulations,  the OTS is required to take  certain,  and is  authorized  to take
other, supervisory actions against  undercapitalized  savings institutions.  For
this purpose,  a savings  institution  would be placed in one of five categories
based on the association's capital.  Generally, a savings institution is treated
as "well  capitalized" if its ratio of total capital to risk-weighted  assets is
at least 10.0%,  its ratio of core capital to  risk-weighted  assets is at least
6.0%,  its ratio of core capital to total assets is at least 5.0%, and it is not
subject to any order or directive by the OTS to meet a specific capital level. A
savings institution will be treated as "adequately  capitalized" if its ratio of
total  capital  to  risk-weighted  assets  is at least  8.0%,  its ratio of core
capital to risk-weighted  assets is at least 4.0%, and its ratio of core capital
to total assets is at least 4.0% (3.0% if the  association  receives the highest
rating on the CAMEL financial institutions rating system). A savings institution
that has a total  risk-based  capital of less than 8.0% or a leverage ratio or a
Tier 1  capital  ratio  that is less  than  4.0%  (3.0%  leverage  ratio  if the
association receives the highest rating on the CAMEL financial


                                       23
<PAGE>

institutions  rating system) is considered to be  "undercapitalized."  A savings
institution  that has a total  risk-based  capital of less than 6.0% or a Tier 1
risk-based  capital ratio or a leverage ratio of less than 3.0% is considered to
be "significantly  undercapitalized."  A savings institution that has a tangible
capital  to assets  ratio  equal to or less than 2% is deemed to be  "critically
undercapitalized."  The elements of an association's capital for purposes of the
prompt corrective action regulations are defined generally as they are under the
regulations for minimum capital requirements.  See "--Capital  Requirements." At
June   30,   2000,   the   Bank   met  the   criteria   for   being   considered
"well-capitalized."

     Where  appropriate,  the OTS can impose  corrective action by a savings and
loan holding company under the "prompt corrective action" provisions of FDICIA.

     Insurance of Deposit  Accounts.  The Bank is a member of the SAIF,  and the
Bank pays its deposit insurance assessments to the SAIF. The FDIC also maintains
another  insurance  fund, the Bank Insurance Fund (the "BIF"),  which  primarily
insures the deposits of banks and state chartered savings banks.

     Pursuant to FDICIA, the FDIC established a new risk-based assessment system
for  determining  the  deposit  insurance  assessments  to be  paid  by  insured
depository  institutions.  Under the  assessment  system,  the FDIC  assigns  an
institution  to one of  three  capital  categories  based  on the  institution's
financial  information as of the reporting period ending seven months before the
assessment period. The three capital categories consist of (a) well capitalized,
(b) adequately  capitalized,  or (c) undercapitalized.  The FDIC also assigns an
institution to one of three supervisory subcategories within each capital group.
The  supervisory  subgroup  to which an  institution  is  assigned is based on a
supervisory evaluation provided to the FDIC by the institution's primary federal
regulator  and  information  that  the FDIC  determines  to be  relevant  to the
institution's  financial  condition and the risk posed to the deposit  insurance
funds.  An  institution's  assessment  rate depends on the capital  category and
supervisory  category to which it is assigned.  Under the regulation,  there are
nine assessment risk classifications  (i.e.,  combinations of capital groups and
supervisory   subgroups)  to  which  different  assessment  rates  are  applied.
Assessment rates currently range from 0.0% of deposits for an institution in the
highest category (i.e.,  well-capitalized  and financially  sound,  with no more
than a few minor  weaknesses)  to 0.27% of deposits  for an  institution  in the
lowest category (i.e.,  undercapitalized and substantial  supervisory  concern).
The FDIC is  authorized to raise the  assessment  rates as necessary to maintain
the required reserve ratio of 1.25%. As a result of the Deposit  Insurance Funds
Act of 1996 (the "Funds Act"),  both the BIF and the SAIF currently  satisfy the
reserve ratio  requirement.  If the FDIC determines that assessment rates should
be increased,  institutions in all risk categories  could be affected.  The FDIC
has exercised this authority several times in the past and could raise insurance
assessment  rates in the future.  If such action is taken by the FDIC,  it could
have an adverse effect on the earnings of the Bank.

     The Funds Act also amended the FDIA to expand the  assessment  base for the
payments on the FICO bonds.  Beginning  January 1, 1997, the assessment base for
the FICO bonds included the deposits of both BIF- and SAIF-insured institutions.
Until  December  31,  1999,  or such  earlier  date on which  the  last  savings
association ceases to exist, the rate of assessment for BIF-assessable  deposits
shall be one-fifth of the rate imposed on SAIF-assessable  deposits.  The annual
assessment  for the  payments  on the FICO  bonds for the  fiscal  year 2000 was
$36,365.

     Under the FDI Act, insurance of deposits may be terminated by the FDIC upon
a finding that the institution has engaged in unsafe or unsound practices, is in
an unsafe or unsound  condition  to  continue  operations  or has  violated  any
applicable law, regulation,  rule, order or condition imposed by the FDIC or the
OTS.  The  management  of the Bank does not know of any  practice,  condition or
violation that might lead to termination of deposit insurance.

     Federal Home Loan Bank System. The Bank is a member of the FHLB of Atlanta,
which is one of the regional FHLBs composing the FHLB System. Each FHLB provides
a central credit facility primarily for its member institutions.  The Bank, as a
member of the FHLB of Atlanta, is required to acquire and hold shares of capital
stock in the FHLB of Atlanta in an amount equal to 1% of the aggregate principal
amount of its unpaid  residential  mortgage loans,  home purchase  contracts and
similar obligations, but not less than $500. The Bank was


                                       24
<PAGE>

in compliance with this  requirement with an investment in FHLB of Atlanta stock
at June 30,  2000,  of  $776,000.  Any  advances  from a FHLB must be secured by
specified types of collateral,  and all long-term  advances may be obtained only
for the purpose of providing funds for residential housing finance.

     For the fiscal years ended June 30, 2000, 1999 and 1998, dividends from the
FHLB  of  Atlanta  to  the  Bank  amounted  to  $46,000,  $45,000  and  $43,000,
respectively.  If dividends  were  reduced,  or interest on future FHLB advances
increased, the Bank's net interest income would likely also be reduced.

     Federal  Home Loan Bank System  Modernization  Act of 1999.  Title 6 of the
Gramm-Leach-Bliley Act, entitled the Federal Home Loan Bank System Modernization
Act of 1999 (FHLB  Modernization  Act), has amended the FHLB Act by allowing for
voluntary membership and modernizing the capital structure and governance of the
FHLB system. The new capital structure  established under the FHLB Modernization
Act sets  forth  new  leverage  and  risk-based  capital  requirements  based on
permanence of capital. It also requires some minimum investment in FHLB stock of
all member  entities.  Capital will include  retained  earnings and two forms of
stock:  Class A stock redeemable  within six months,  written notice and Class B
stock redeemable within five years,  written notice.  The FHLB Modernization Act
provides  a  transition  period to the new  capital  regime,  which  will not be
effective until the FHLB enacts implementing regulations. The FHLB Modernization
Act also  reduces  the period of time in which a member  exiting the FHLB system
must stay out of the system.

     Federal  Reserve  System.  The Bank is subject to provisions of the FRA and
the FRB's regulations pursuant to which depositary  institutions may be required
to maintain  non-interest-earning  reserves  against their deposit  accounts and
certain  other  liabilities.  Currently,  reserves  must be  maintained  against
transaction  accounts  (primarily NOW and regular  checking  accounts).  The FRB
regulations generally require that reserves be maintained in the amount of 3% of
the  aggregate  of  transaction  accounts  up to $46.5  million.  The  amount of
aggregate  transaction accounts in excess of $46.5 million are currently subject
to a reserve  ratio of 10%,  which ratio the FRB may adjust  between 8% and 12%.
The FRB  regulations  currently  exempt  $4.9  million of  otherwise  reservable
balances from the reserve  requirements,  which exemption is adjusted by the FRB
at the end of each year.  The Bank is in compliance  with the foregoing  reserve
requirements. Because required reserves must be maintained in the form of either
vault cash,  a  non-interest-bearing  account at a Federal  Reserve  Bank,  or a
pass-through  account  as  defined  by the  FRB,  the  effect  of  this  reserve
requirement  is to reduce  the  Bank's  interest-earning  assets.  The  balances
maintained  to meet the reserve  requirements  imposed by the FRB may be used to
satisfy liquidity  requirements imposed by the OTS. FHLB System members are also
authorized  to  borrow  from the  Federal  Reserve  "discount  window,"  but FRB
regulations  require  such  institutions  to  exhaust  all FHLB  sources  before
borrowing from a Federal Reserve Bank.

REGULATION OF THE HOLDING COMPANY

     General.  The  Holding  Company  and  the  Company  are  holding  companies
chartered  pursuant to Section 10(o) of the HOLA. As such,  the Holding  Company
and  the  Company  are  registered  with  and  subject  to OTS  examination  and
supervision as well as certain reporting requirements.  In addition, the OTS has
enforcement  authority  over the Company and the Holding  Company and any of its
non-savings institution subsidiaries. Among other things, this authority permits
the OTS to restrict or prohibit  activities  that are determined to be a serious
risk to the financial safety,  soundness,  or stability of a subsidiary  savings
institution. Unlike bank holding companies, federal mutual holding companies are
not subject to any  regulatory  capital  requirements  or to  supervision by the
Federal Reserve System.

     Restrictions Applicable to Activities of Mutual Holding Companies. Pursuant
to Section  10(o) of the HOLA, a mutual  holding  company may engage only in the
following activities: (i) investing in the stock of a savings institution;  (ii)
acquiring a mutual  association  through the merger of such  association  into a
savings  institution  subsidiary of such holding  company or an interim  savings
institution  subsidiary of such holding company; (iii) merging with or acquiring
another holding  company,  one of whose  subsidiaries is a savings  institution;
(iv)  investing in a  corporation  the capital  stock of which is available  for
purchase  by a savings  institution  under  federal  law or under the law of any
state where the subsidiary  savings  institution or associations have their home
offices;  (v)  furnishing  or  performing  management  services  for  a  savings
institution subsidiary of such holding company;


                                       25
<PAGE>

(vi) holding,  managing,  or liquidating assets owned or acquired from a savings
institution  subsidiary  of such company;  (vii) holding or managing  properties
used or occupied by a savings  institution  subsidiary of such  company;  (viii)
acting as trustee  under a deed of trust;  (ix) any other  activity (a) that the
FRB, by regulation,  has determined to be permissible for bank holding companies
under  Section  4(c)  of the  BHC  Act,  unless  the  Director  of the  OTS,  by
regulation,  prohibits or limits any such  activity for savings and loan holding
companies,  or (b) in which  multiple  savings and loan holding  companies  were
authorized  by  regulation  to  directly  engage  on  March  5,  1987;  and  (x)
purchasing,  holding,  or  disposing  of stock  acquired  in  connection  with a
qualified  stock issuance if the purchase of such stock by such holding  company
is approved by the Director of the OTS. If a mutual holding company  acquires or
merges with another holding company, the holding company acquired or the holding
company  resulting from such merger or acquisition may only invest in assets and
engage in activities listed above, and it has a period of two years to cease any
non-conforming activities and divest any non-conforming investments.

     Restrictions Applicable to All Savings and Loan Holding Companies. The HOLA
prohibits a savings and loan holding company, including a federal mutual holding
company,  directly or  indirectly,  from acquiring (i) control (as defined under
HOLA) of another  savings  institution  (or a holding  company  parent  thereof)
without  prior OTS  approval;  (ii) more than 5% of the voting shares of another
savings   institution  (or  holding  company  parent  thereof)  that  is  not  a
subsidiary,  subject to certain exceptions; (iii) through merger, consolidation,
or purchase of assets, another savings institution or a holding company thereof,
or acquiring all or  substantially  all of the assets of such  institution (or a
holding  company  thereof)  without prior OTS  approval;  or (iv) control of any
depository institution not insured by the FDIC (except through a merger with and
into the holding  company's savings  institution  subsidiary that is approved by
the OTS).

     A savings and loan holding company may not acquire as a separate subsidiary
an insured  institution  that has a principal  office outside of the state where
the principal office of its subsidiary institution is located, except (i) in the
case of certain  emergency  acquisitions (as defined under HOLA) approved by the
FDIC; (ii) if such holding  company  controls a savings  institution  subsidiary
that  operated a home or branch office in such  additional  state as of March 5,
1987, and (iii) if the laws of the state in which the savings  institution to be
acquired is located  specifically  authorize a savings institution  chartered by
that state to be acquired by a savings institution  chartered by the state where
the acquiring savings institution or savings and loan holding company is located
or by a holding  company that controls such a state chartered  association.  The
conditions  imposed  upon  interstate  acquisitions  by those  states  that have
enacted   authorizing   legislation  vary.  Some  states  impose  conditions  of
reciprocity,  which have the effect of requiring that the laws of both the state
in which the acquiring holding company is located (as determined by the location
of its subsidiary savings institution) and the state in which the association to
be acquired is  located,  have each  enacted  legislation  allowing  its savings
institutions to be acquired by out-of-state  holding  companies on the condition
that the laws of the other state  authorize such  transactions  on terms no more
restrictive  than  those  imposed  on the  acquirer  by the state of the  target
association.  Some of these  states  also  impose  regional  limitations,  which
restrict such acquisitions to states within a defined geographic  region.  Other
states allow full nationwide banking without any condition of reciprocity.  Some
states do not authorize  interstate  acquisitions  of savings  institutions.  In
evaluating an application by a holding company to acquire a savings institution,
the OTS  must  consider  the  financial  and  managerial  resources  and  future
prospects  of the company and savings  institution  involved,  the effect of the
acquisition on the risk to the insurance funds, the convenience and needs of the
community, and competitive factors.

     If the savings  institution  subsidiary of a federal mutual holding company
fails  to meet  the QTL  test  set  forth  in  Section  10(m)  of the  HOLA  and
regulations of the OTS, the holding company must register with the FRB as a bank
holding  company under the BHC Act within one year of the savings  institution's
failure to so  qualify.  For  additional  information  in this  regard,  see "--
Regulation of Federal Savings Banks -- QTL Test."

     For a description of certain  restrictions on transactions between the Bank
and its affiliates,  including, without limitation, the Holding Company, see "--
Regulation of Federal Savings Banks -- Transactions with Related Parties."


                                       26
<PAGE>

REGULATION OF INSURANCE ACTIVITIES

     The  Company  offers  various  insurance   products  through  AF  Insurance
Services, Inc., a wholly owned subsidiary of the Company. AF Insurance Services,
Inc. is licensed and  regulated by the North  Carolina  Department  of Insurance
(the  "Department").  As such AF  Insurance  Services,  Inc.  is  subject to the
supervision,  examination  and reporting  requirements of the Department and its
activities  are  governed  by the laws  and  regulations  of the  State of North
Carolina.

REGULATION OF SECURITIES BROKERAGE ACTIVITIES

     The Company offers brokerage and investment  products through AF Brokerage,
Inc., a wholly owned  subsidiary of the Company.  AF Brokerage,  Inc. is a North
Carolina  corporation which is registered as a broker-dealer under Section 15 of
the Securities Exchange Act of 1934, as amended, and is a member of the National
Association  of Securities  Dealers,  Inc. (the "NASD").  As such, AF Brokerage,
Inc. is subject to the  supervision,  examination and reporting  requirements of
the SEC, the NASD and the various states in which it conducts business.

FEDERAL SECURITIES LAWS

     The  Common  Stock of the  Company  is  registered  with the SEC  under the
Exchange  Act. The Company is subject to the  information,  proxy  solicitation,
insider  trading  restrictions  and  other  requirements  of the SEC  under  the
Exchange Act.

                           FEDERAL AND STATE TAXATION

FEDERAL TAXATION

     General.  The  following  discussion is intended only as a summary and does
not purport to be a comprehensive description of the tax rules applicable to the
Bank,  Mutual  Company or Stock  Company.  The Bank has not been audited for the
last eight years.

     For federal  income tax purposes,  the Bank reports its income on the basis
of a taxable year ending June 30, using the accrual method of accounting, and is
subject to federal income taxation in the same manner as other corporations with
some  exceptions,  including  particularly the Bank's tax reserve for bad debts,
discussed  below.  The Bank and Stock Company  constitute an affiliated group of
corporations  and,  therefore,   are  eligible  to  report  their  income  on  a
consolidated  basis.  Because the Mutual  Company  will own less than 80% of the
Common Stock, it will not be a member of such  affiliated  group and will report
its income on a separate return.

     Bad Debt  Reserves.  The Bank, as a "small bank" (one with assets having an
adjusted  tax basis of $500  million or less) is permitted to maintain a reserve
for bad debts with respect to "qualifying  loans," which, in general,  are loans
secured by certain  interests in real property,  and to make,  within  specified
formula  limits,  annual  additions  to the  reserve  which are  deductible  for
purposes of computing the Bank's taxable income.  Pursuant to the Small Business
Job  Protection Act of 1996,  the Bank is now  recapturing  (taking into income)
over a multi-year  period a portion of the balance of its bad debt reserve as of
June 30,  1996.  Since the Bank has already  provided a deferred  tax  liability
equal to the amount of such recapture,  the recapture will not adversely  impact
the Bank's financial condition or results of operations.

     Distributions.   To  the   extent   that  the  Bank   makes   "non-dividend
distributions" to shareholders,  such distributions will be considered to result
in  distributions  from the Bank's "base year reserve,"  i.e., its reserve as of
June 30, 2000, to the extent thereof and then from its supplemental  reserve for
losses on loans, and an amount based on the amount  distributed will be included
in the Bank's taxable income.  Non-dividend  distributions include distributions
in  excess  of  the  Bank's  current  and  accumulated   earnings  and  profits,
distributions  in redemption of stock and  distributions  in partial or complete
liquidation.  However,  dividends  paid out of the Bank's current or accumulated
earnings and profits,  as calculated for federal  income tax purposes,  will not
constitute  non-dividend  distributions and, therefore,  will not be included in
the Bank's income.


                                       27
<PAGE>

     The  amount  of  additional  taxable  income  created  from a  non-dividend
distribution  is equal  to the  lesser  of the  Bank's  base  year  reserve  and
supplemental reserve for losses on loans; or an amount that, when reduced by the
tax  attributable  to the  income,  is equal to the amount of the  distribution.
Thus,  in  certain   situations   approximately   one  and  one-half  times  the
non-dividend distribution would be includable in gross income for federal income
tax purposes, assuming a 34% federal corporate income tax rate.

     Corporate  Alternative  Minimum Tax. The Internal  Revenue Code of 1986, as
amended  (the  "Code"),  imposes a tax ("AMT") on  alternative  minimum  taxable
income  ("AMTI")  at a rate  of  20%.  Only  90% of AMTI  can be  offset  by net
operating  loss  carryovers of which the Bank  currently has none.  AMTI is also
adjusted by  determining  the tax  treatment  of certain  items in a manner that
negates the deferral of income resulting from the regular tax treatment of those
items.  Thus,  the Bank's  AMTI is  increased  by an amount  equal to 75% of the
amount  by  which  the  Bank's  adjusted   current  earnings  exceeds  its  AMTI
(determined  without  regard to this  adjustment  and prior to reduction for net
operating  losses).  Although the  corporate  environmental  tax of 0.12% of the
excess of AMTI (with certain modifications) over $2.0 million has expired, under
current Administration  proposals, such tax will be retroactively reinstated for
taxable years beginning after December 31, 1996 and before January 2008.

     Elimination of Dividends;  Dividends Received Deduction.  The Stock Company
may exclude from its income 100% of dividends received from the Bank as a member
of the same affiliated group of corporations.  Because,  following completion of
the  Reorganization,  Mutual  Company  will not be a member  of such  affiliated
group,  it will not  qualify  for such  100%  dividends  exclusion,  but will be
entitled to deduct 80% of the  dividends it receives  from Stock Company so long
as it owns more than 20% of the Common Stock.

STATE TAXATION

     Under  North  Carolina  law,  the  corporate  income tax is 7.0% of federal
taxable  income as  computed  under  the Code,  subject  to  certain  prescribed
adjustments. An annual state franchise tax is imposed at a rate of .0015 applied
to the greatest of the  institution's  (i) capital stock,  surplus and undivided
profits,  (ii) investment in tangible property in North Carolina or (iii) 55% of
the appraised valuation of property in North Carolina.


                                       28
<PAGE>

ITEM 2. PROPERTIES

     The Company conducts its business through its main office,  located in West
Jefferson, North Carolina, and its branches located in Warrensville,  Jefferson,
Sparta,  Wilkesboro,  Elkin, Lenoir and Boone, North Carolina.  The Company owns
the main office, corporate offices and the Jefferson Branch. Management believes
that  the  Bank's  current  facilities  are  adequate  to meet the  present  and
immediately foreseeable needs of the Bank and the Holding Company.

<TABLE>
<CAPTION>
                                                                DATE                 LEASE             NET BOOK
                                           LEASED OR          LEASED OR           EXPIRATION           VALUE AT
                                             OWNED            ACQUIRED               DATE            JUNE 30, 2000
                                             -----            --------               ----            -------------
                                                                  (DOLLARS IN THOUSANDS)
<S>                                        <C>               <C>                <C>                     <C>
Corporate Offices................          Owned              06/15/00              --                 $ 1,700
21 East Ashe Street
West Jefferson, NC  28694

Insurance and Brokerage Offices..          Owned              06/30/97               --                    599
206 S. Jeferrson Avenue
West Jefferson, NC 28694

West Jefferson Branch............          Owned              06/30/63               --                    195
205 S Jefferson Avenue
West Jefferson, NC 28694

Jefferson Branch.................          Owned              05/18/94               --                    519
840  E. Main Street
Jefferson, NC 28640

Warrensville Branch..............          Leased             08/31/98           08/31/2000*               --
4951 NC Hwy. 88 West
Warrensville, NC 28693

Alleghany First..................          Leased             01/09/98           12/31/2000**              --
403 South Main Street
Sparta, NC 28675

Appalachian First................          Leased             02/26/99           02/26/2003***             --
285 Hwy 105 Ext.
Boone, NC 28607

AF Brown Insurance...............          Leased             09/01/97           08/31/1999****            --
315 Main Street
North Wilkesboro, NC 28659

AF Blair.........................          Leased             04/01/99           03/31/2004                --
324 Morganton Blvd., SW
Lenior, NC 28645

AF Insurance Center of Elkin.....          Leased             12/01/99           11/30/2002**              --
277 A West Main Street
Elkin, NC 28621
</TABLE>

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

* Option to renew for two additional  five-year periods.
** Option to renew for an additional three-year period.
*** Option to renew two additional one-year periods.
**** Option to renew for three additional one-year periods.


                                       29
<PAGE>

ITEM 3. LEGAL PROCEEDINGS

     At June 30, 2000,  there were no material  legal  proceedings  to which the
Company or any of its  subsidiaries  was a party or to which any of its property
was subject.

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

     Not applicable.

                                     PART II

ITEM 5. MARKET FOR COMMON STOCK AND RELATED STOCKHOLDER MATTERS

     Information  relating  to the market  for  Registrant's  common  equity and
related  stockholder  matters  appears under "Common  Stock" and "Market for the
Common Stock" in the Registrant's 2000 Annual Report to Stockholders on page 56,
and is incorporated herein by reference.

     Information  relating to the payment of dividends by the Registrant appears
under "Common Stock" and "Market for the Common Stock" in the Registrant's  2000
Annual  Report  to  Stockholders  on page  56,  and is  incorporated  herein  by
reference.  A  dividend  declared  by the  Board  of  Directors  of the  Bank is
considered a capital  distribution from the Bank to the stockholders,  including
AsheCo,  M.H.C., its mutual holding company.  Under the requirements of the OTS,
there  are  certain  restrictions  on the  ability  of the Bank to pay a capital
distribution. See "Regulation--Limitation on Capital Distributions."

     The Company paid cash dividends  totaling $.20 per share during each of the
years ended June 30, 2000 and 1999.

ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS

     Certain  of  the   above-captioned   information  appears  under  "Selected
Financial and Other Data of the Company" "Management's  Discussion and Analysis"
and in the Registrant's 2000 Annual Report to Stockholders on pages 1 through 2,
and 5 through 18 and is incorporated herein by reference.

ITEM 7. FINANCIAL STATEMENTS

     The Financial  Statements of AF Bankshares,  Inc., together with the report
thereon by  McGladrey  & Pullen,  LLP  appears in the  Registrant's  2000 Annual
Report to  Stockholders  on pages 19 through 53 and are  incorporated  herein by
reference.

<TABLE>
<CAPTION>
                                                                                             Page(s) in
                                                                                            Annual Report
                                                                                          ------------------
<S>                                                                                              <C>
        o        Independent Auditor's Report.........................................           19
        o        Consolidated Statements of Financial Condition,
                    June 30, 2000 and 1999............................................           20
        o        Consolidated Statements of Income
                    Years Ended June 30, 2000 and 1999.................................          21
        o        Consolidated Statements of Stockholders' Equity,
                    Years Ended June 30, 2000 and 1999.................................          22
        o        Consolidated Statements of Cash Flows,
                    Years Ended June 30, 2000 and 1999.................................          24
        o        Notes to Consolidated Financial Statements............................          26
</TABLE>


                                       30
<PAGE>

ITEM 8. CHANGES IN AND DISAGREEMENT WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
        DISCLOSURE

     Not applicable.

                                    PART III

ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS

     The information relating to Directors and Executive Officers of the Company
is  incorporated  herein by reference to the Company's  Proxy  Statement for the
Annual Meeting of Stockholders to be held on November 6, 2000.

ITEM 10. EXECUTIVE COMPENSATION

     The information  relating to executive  compensation is incorporated herein
by  reference  to the  Company's  Proxy  Statement  for the  Annual  Meeting  of
Stockholders to be held on November 6, 2000.

ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

     The information relating to security ownership of certain beneficial owners
and  management  is  incorporated  herein by  reference to the  Company's  Proxy
Statement for the Annual Meeting of Stockholders to be held on November 6, 2000.

ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     The information relating to certain  relationships and related transactions
is  incorporated  herein by reference to the Company's  Proxy  Statement for the
Annual Meeting of Stockholders to be held on November 6, 2000.

ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K

     (a)  Exhibits
          --------
          2.1               Agreement and Plan of Reorganization dated September
                            15,  1997  by  and  among  Ashe  Federal   Bank,  AF
                            Bankshares,  Inc.  and  Ashe  Interim  Savings  Bank
                            (incorporated   by  reference  to  the  Registration
                            Statement on Form 8-A, as filed with the SEC on June
                            16, 1998 (the "Form 8-A")).

          3.1               Federal Stock  Charter of the Company  (Incorporated
                            by reference to Exhibit 3.1 of the Form 8-A).

          3.2               Bylaws of the Company  (Incorporated by reference to
                            Exhibit 3.2 of the Form 8-A).

          4.1               Common    Stock    Certificate    of   the   Company
                            (Incorporated  by  reference  to Exhibit  4.3 of the
                            Form 8-A).

          10.1              Employment  Agreement with James A. Todd,  President
                            and  Chief  Executive   Officer   (incorporated   by
                            reference  to the 10-KSB for the year ended June 30,
                            1998).*

          10.2              Employment  Agreement with Melanie  Paisley  Miller,
                            Executive Vice President,  Chief Financial  Officer,
                            Secretary and Treasurer  (incorporated  by reference
                            to the 10-KSB for the year ended June 30, 1998).*

          10.3              Employment  Agreement with Martin G. Little,  Senior
                            Vice    President   and   Chief   Lending    Officer
                            (incorporated  by  reference  to the  10-KSB for the
                            year ended June 30, 1998).*


                                       31
<PAGE>

          10.4              Employee  Stock  Ownership Plan of Ashe Federal Bank
                            (incorporated  by reference to the Company's  Annual
                            Report on Form  10-KSB  for the year  ended June 30,
                            1998).*

          13.1              2000  Annual  Report  to   Stockholders,   is  filed
                            herewith.

          21.1              Subsidiary  Information  is  incorporated  herein by
                            reference to "Part I - Subsidiary Activities."

          27.1              Financial Data Schedule.**

(b) REPORTS ON FORM 8-K
     No reports on Form 8-K were filed  during the fourth  quarter of the fiscal
year ended June 30, 2000.

*Incorporated by reference to the Company's Annual Report on Form 10-KSB for the
year ended June 30, 1998 as filed with the SEC on September 29, 1998.

**Filed in electronic format only.


                                       32
<PAGE>

                                   SIGNATURES

     Pursuant  to the  Requirements  of  Section  13 or 15(d) of the  Securities
Exchange  Act of 1934,  the Bank has duly caused this report to be signed on its
behalf by the undersigned, thereto duly authorized.

                                                 AF BANKSHARES, INC.
                                                 (Small Business Issuer)



Date:  September 22, 2000             By:  /s/James A. Todd
       ------------------------            ----------------------------
                                           James A. Todd
                                           President and Chief Executive Officer

     In  accordance  with the Exchange Act, this report has been signed below by
the following  persons on behalf of the  registrant and in the capacities and on
the dates indicated.

<TABLE>
<CAPTION>
                                                                            Date
                                                                            ----
<S>                                                                    <C>
/s/James A. Todd                                                       September 22, 2000
------------------------------------------------------------
James A. Todd
President, Chief Executive Officer
     and Director
(Principal Executive Officer)

 /s/Melanie Paisley Miller                                             September 22, 2000
-----------------------------------------------------------
Melanie Paisley Miller
Executive Vice President, Secretary, Treasurer
     and Chief Financial Officer
(Principal Financial Officer)

/s/James A. Todd                                                       September 22, 2000
------------------------------------------------------------
Jan R. Caddell - Director

/s/Jan R. Caddell                                                      September 22, 2000
--------------------------------------------------------------
Kenneth R. Greene - Director

/s/William O. Ashley, Jr.                                              September 22, 2000
----------------------------------------------------------
William O. Ashley, Jr. - Director

/s/Wayne R. Burgess Director                                           September 22, 2000
------------------------------------------------------
Wayne R. Burgess - Director
</TABLE>


                                       33
<PAGE>
<TABLE>
<CAPTION>
<S>                                                                    <C>
/s/Frank E. Roland                                                     September 22, 2000
--------------------------------------------------------
Frank E. Roland - Director

/s/Jerry L. Roten                                                      September 22, 2000
----------------------------------------------------------
Jerry L. Roten - Director

/s/John D. Weaver                                                      September 22, 2000
--------------------------------------------------------
John D. Weaver - Director
</TABLE>





                                       34
</TEXT>
</DOCUMENT>
<DOCUMENT>
<TYPE>EX-13
<SEQUENCE>2
<FILENAME>0002.txt
<DESCRIPTION>EXHIBIT 13
<TEXT>


                                                                      EXHIBIT 13


              SPECIAL ANNUAL REPORT COVER TO BE PUBLISHED BY CLIENT







                      AF BANKSHARES, INC. AND SUBSIDIARIES

                          CONSOLIDATED FINANCIAL REPORT

                                  JUNE 30, 2000



<PAGE>

                                    CONTENTS


Selected Financial Data                                                    1 - 2


President's Message                                                            3


Operational Review                                                             5


Management's Discussion and Analysis of Financial Condition
   and Results of Operations                                              6 - 18


Independent Auditor's Report                                                  19


Financial Statements                                                     20 - 53


Corporate Information                                                    54 - 56

<PAGE>

                  SELECTED FINANCIAL AND OTHER DATA OF THE BANK

       The  following  tables  set  forth  certain  information  concerning  the
financial position and results of operations of the Company at the dates and for
the years  indicated.  The selected  financial  condition  data and the selected
operating data for the years then ended were derived from the audited  financial
statements of the Company.  The information  should be read in conjunction  with
the Financial Statements of the Bank presented elsewhere.



<TABLE>
<CAPTION>
                                                                                              AT JUNE 30,
                                                                 -------------------------------------------------------------------
                                                                   2000          1999            1998            1997         1996
                                                                 --------       -------       ---------        -------       -------
                                                                                            (IN THOUSANDS)
<S>                                                              <C>            <C>           <C>              <C>           <C>
SELECTED FINANCIAL CONDITION DATA:
Total assets .............................................       $133,370       109,931       $ 100,074        $82,024       $72,318
Loans receivable, net (1) ................................        108,778        81,157          72,628         70,236        62,485
Investment securities (2) ................................          9,835        11,798           9,017          6,937         5,560
Cash and cash equivalents(3) .............................          7,423        12,395          14,789          2,533         1,830
Savings deposits .........................................        102,680        93,106          82,488         68,218        63,468
FHLB advances ............................................         15,513         2,564           4,116          1,654         1,250
Equity ...................................................         12,540        12,218          11,486         10,979         7,238
Book value per share .....................................          11.95         11.64           10.90          10.98           N/A
</TABLE>
<TABLE>
<CAPTION>
                                                                                     FOR THE YEAR ENDED JUNE 30,
                                                                 -------------------------------------------------------------------
                                                                   2000          1999           1998            1997           1996
                                                                 --------       -------       ---------        -------       -------
                                                                                           (IN THOUSANDS)
<S>                                                              <C>            <C>           <C>              <C>           <C>
SELECTED OPERATING DATA:
Interest  income and dividends ...........................       $  9,393         7,879       $   7,356        $ 6,213       $ 5,683
Interest expense .........................................          4,685         3,967           3,795          3,245         3,204
                                                                 --------       -------       ---------        -------       -------
       Net interest income ...............................          4,708         3,912           3,561          2,968         2,479
Provision for  loan losses ...............................             88            20             (25)            20            57
                                                                 --------       -------       ---------        -------       -------
       Net interest income after provision for
            loan losses ..................................          4,620         3,892           3,586          2,948         2,422
Non-interest income ......................................          1,821         1,206             991            169           142
Non-interest expense .....................................          5,660         4,348           3,448          2,556         1,809
                                                                 --------       -------       ---------        -------       -------
Income before income tax expense and cumulative
       effect of change in accounting principles .........            781           749           1,089            561           755
Income tax expense .......................................            328           235             381            218           301
                                                                 --------       -------       ---------        -------       -------
       Net income ........................................       $    453           514       $     708        $   343       $   454
                                                                 ========       =======       =========        =======       =======



Basic earnings per share (4) .............................       $   0.45          0.52       $    0.73        $  0.44       $   N/A
                                                                 ========       =======       =========        =======       =======
Diluted earnings per shares (4) ..........................       $   0.45          0.52       $    0.72        $  0.44       $   N/A
                                                                 ========       =======       =========        =======       =======
Dividends per share ......................................       $   0.20          0.20       $    0.20        $  0.10       $   N/A
                                                                 ========       =======       =========        =======       =======
</TABLE>

(1)      Loans  receivable,  net is comprised of total loans less  allowance for
         loan losses, undisbursed loan funds, and deferred loan fees.
(2)      Includes FHLB stock, certificates of deposit and investment securities.
(3)      Includes  interest-earning  deposit  balances  of  $2.6  million,  $4.2
         million,  $11.8 million,  $1.2 million, and $840,000, at June 30, 2000,
         1999, 1998, 1997 and 1996, respectively.
(4)      Earnings per share has been calculated in accordance with the Statement
         of Financial  Accounting  Standards No. 128, Earnings Per Share, and is
         based on net  income  for the year,  divided  by the  weighted  average
         number  of shares  outstanding  for the year.  In  accordance  with the
         AICPA's  SOP  93-6,   unallocated   ESOP  shares  were   deducted  from
         outstanding  shares  used in the  computation  of  earnings  per share.
         Diluted earnings per share includes the effect of dilutive common stock
         equivalents in the weighted average number of shares outstanding.


                                       1
<PAGE>


<TABLE>
<CAPTION>
                                                                                AT OR FOR THE YEAR ENDED JUNE 30,
                                                                    ----------------------------------------------------------
                                                                     2000        1999          1998        1997         1996
                                                                    ------      -------       ------      ------       ------
<S>                                                                 <C>         <C>           <C>         <C>          <C>
SELECTED FINANCIAL RATIOS AND OTHER DATA: (1)
PERFORMANCE RATIOS:
       Return on average assets (1) .............................     0.37%        0.49%        0.78%       0.44%        0.65%
       Return on average equity (1) .............................     3.99%        4.47%        6.31%       3.64%        6.50%
       Average equity to average assets .........................     9.21%       11.02%       12.21%      12.10%       10.05%
       Equity to total assets at end of period ..................     9.40%       11.11%       11.48%      13.39%       10.01%
       Interest rate spread (2) .................................     3.66%        3.64%        3.64%       3.34%        3.38%
       Average interest-earning assets to
            to average interest-bearing liabilities .............   108.18%      110.20%      111.95%     114.40%      107.79%
       Net interest margin (3) ..................................     4.18%        4.06%        4.17%       3.96%        3.76%
       Non-interest expense to average assets ...................     4.59%        4.17%        3.80%       3.28%        2.62%
       Efficiency ratio (4) .....................................    86.69%       84.96%       76.63%      81.48%       69.20%
       Dividend payout ratio (6) ................................    44.44%       38.46%       27.40%      22.73%         N/A

REGULATORY CAPITAL RATIOS (5):
       Tangible capital .........................................     8.89%       10.00%       10.90%      12.90%        9.80%
       Core capital .............................................     8.89%       10.00%       10.90%      12.90%        9.80%
       Total risk-based capital .................................    11.94%       17.40%       20.40%      26.30%       19.80%

ASSET QUALITY RATIOS AND OTHER DATA:
       Ratios:
            Nonperforming loans to total loans ..................     0.36%        0.07%        0.03%       0.18%        0.27%
            Nonperforming loans and real estate owned
               total assets .....................................     0.53%        0.11%        0.06%       0.16%        0.24%
            Allowance for loan losses to:
               Nonperforming loans ..............................   238.20%     1871.14%      851.10%     787.02%      629.89%
               Total loans ......................................     0.86%        1.28%        1.60%       1.42%        1.70%
       Number of full service branches ..........................        5            5            4           3            3
</TABLE>

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

(1)      With the  exception  of end of period  ratios,  all ratios are based on
         average monthly or quarterly balances during the indicated periods, and
         are annualized where  appropriate.  Asset Quality Ratios and Regulatory
         Capital Ratios are end of period ratios.
(2)      The  interest  rate  spread  represents  the  difference   between  the
         weighted-average  yield on  interest-bearing  assets and the  weighted-
         average cost of interest-bearing liabilities.
(3)      The net interest margin  represents net interest income as a percent of
         average interest-earning assets.
(4)      The efficiency ratio represents  noninterest expense as a percentage of
         the sum of net interest income and noninterest income.
(5)      For  definitions  and  further  information   relating  to  the  Bank's
         regulatory  capital  requirements,  see  "Regulation  -  Regulation  of
         Federal  Savings  Associations  - Capital  Requirements"  and Note 7 of
         Notes to the Consolidated Financial Statements.
(6)      The  dividend  payout  ratio  represents   dividends  per  share  as  a
         percentage of basic earnings per share.
         Earnings per share has been calculated in accordance with the Statement
         of Financial  Accounting  Standards No. 128, Earnings Per Share, and is
         based on net  income  for the year,  divided  by the  weighted  average
         number  of shares  outstanding  for the year.  In  accordance  with the
         AICPA's  SOP  93-6,   unallocated   ESOP  shares  were   deducted  from
         outstanding shares used in the computation of earnings per share.


                                       2
<PAGE>

PRESIDENT'S MESSAGE



Dear Shareholder,

Your  Company  closes  Fiscal Year 2000 and  officially  enters the 21st Century
prepared to offer our customers more financial solutions than ever before, along
with the broadest  array of financial  products in our 60+ year history.  During
the year, we continued our growth plan that will allow us to support the cost of
delivering the products expected by our Customers.

Preparations  for Y2K  dampened  our  earnings  but even so, we had a good year.
Detailed  financial  statements  are  contained  elsewhere  in this report but I
believe that one measure of our success is the 51% growth in non-interest income
during our 2000 year reflecting the growing  contributions  of our insurance and
brokerage  business.  Non-interest income totaled $1,821,239 in 2000 compared to
$1,205,759  during the 1999 fiscal year.  Asset growth continues during the past
year as well ending the year at just over $133 million,  a 21% increase over the
proceeding  year-end.  Most of this growth was driven by a 34% increase in loans
outstanding during the year.

We have  offered a growing menu of banking  products for the past 61 years.  The
2000  fiscal year marked the third year of our  offering  insurance  and annuity
products through AF Insurance  Services.  During the year, we added AF Insurance
Service  Center in Elkin and during July 2000 the  Company  executed a letter of
intent to acquire an agency in Boone.  Not only do these  acquisitions  complete
our  market  penetration,  we now  have  more  companies  with a wider  range of
products plus the volume to receive better rates from our insurance companies.

The  newest  segment  of  our  financial  solutions  is AF  Brokerage,  Inc.  AF
Brokerage, Inc. received final approval from NASD to operate as a fully licensed
broker/dealer during the 2000 year becoming the only locally owned broker/dealer
in our marketplace.  We no longer have to rely on a third party provider for our
non-insured, non-traditional banking investments allowing local people to assist
local people in building their future.

With the addition of AF Brokerage  and the  expansion of the  insurance  agency,
your Company has the products to be the premier  financial  services provider in
every market we serve. The difference is now performance. I lead every member of
the AF Team in  committing  that  performance  is the primary  objective  in the
coming year;  improving  upon our  non-interest  income and out  performing  our
competitors--both local, out of town and out of state.

Thank you for your continued  support and guidance.  As always,  your questions,
comments and suggestions are most welcome.



Sincerely,


James A. Todd
President & CEO


                                       3
<PAGE>












                      (This page intentionally left blank)














                                       4
<PAGE>

AF BANKSHARES 2000 OPERATIONAL REVIEW



During Fiscal Year 2000, the Company made significant  strides in expanding it's
traditional banking business and it's broader financial services capabilities.

Continuing  emphasis on checking  accounts and selected FDIC insured  investment
savings  vehicles  throughout  the year  resulted in a 10% increase in deposits,
from  $93,106,090 at June 30, 1999 to $102,679,834 at June 30, 2000. At the same
time, the aggressive  marketing of home equity lines and other loans in response
to borrowing  needs of  individuals,  families,  and businesses in the Company's
markets produced a 34% boost in total loans receivable.

Growth  of  the  Boone  bank,   Appalachian  First  Bank,   continued  with  the
introduction of a major  television,  newspaper,  and radio campaign  throughout
Watauga County. Of particular note is the significant growth in commercial loans
at Appalachian First.

On December 1, 1999, the Company  purchased an insurance agency in Elkin,  North
Carolina,  now known as AF Insurance Service Center. A longstanding  independent
agency in Elkin,  AF  Insurance  Service  Center  has  already  begun  producing
additional incremental business for the company. It is well worth noting that in
Fiscal Year 2000, the Company's  insurance  commissions from all agencies almost
doubled, from $499.9 million to $991.3 million.

On October 22, 1999, AF Brokerage,  Inc.  received approval of its membership in
the  National  Association  of  Securities  Dealers  (NASD).  Subsequently,   AF
Brokerage  began  operations in the fourth  quarter of 2000 as a fully  licensed
independent  broker/dealer -- the first broker/dealer  actually headquartered in
Ashe County.

Also,  plans were  finalized in Fiscal Year 2000 to improve the  Company's  data
processing and computer  systems by implementing a new operating system provided
by Fiserv,  Atlanta.  The new system will be fully operational by the end of the
first quarter Fiscal Year 2001; which should increase  customer  responsiveness,
while reducing  processing  times and aiding the customer  service effort by the
point of sale.

Other noteworthy events during Fiscal Year 2000 include:

         o        The  opening  of  the   Company's   new   administrative   and
                  headquarters building in downtown West Jefferson.

         o        The successful  preparations  for Y2K, which while the problem
                  turned out to be negligible,  helped  underscore the Company's
                  commitment to our customers.

         o        Continuing employee development and training programs designed
                  to make our  outstanding  customer  representatives  even more
                  successful.

All in all,  Fiscal Year 2000 was an excellent start for your Company in the new
millennium.



                                       5
<PAGE>

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

This  discussion  contains  certain  forward-looking  statements  consisting  of
estimates  with respect to the financial  condition,  results of operations  and
other  business of the Company 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.  The  information  contained  in  this  section  should  be read in
conjunction with the Consolidated  Financial Statements,  the accompanying Notes
to the  Consolidated  Financial  Statements and the other sections  contained in
this document.

REORGANIZATION

AF  Bankshares,  Inc.  (the  "Company") is a federally  chartered  stock holding
company for AF Bank (the "Bank")  which  conducts  business from its main office
located in West Jefferson, North Carolina, branches in West Jefferson, Jefferson
and  Warrensville,  North Carolina  operating  under the trade name Ashe Federal
Bank; one branch in Alleghany County,  North Carolina  operating under the trade
name  Alleghany  First Bank;  and one branch in Watauga  County,  North Carolina
operating  under the trade name  Appalachian  First  Bank.  The  Company  has an
insurance  subsidiary  operating  under the trade names AF  Ashelande  Insurance
Service,  in West Jefferson;  AF Brown Insurance Agency in Wilkesboro;  AF Blair
Insurance  Agency in  Lenior;  AF  Insurance  Service  Center  in Elkin;  and AF
Insurance  Services,  Inc.  in  Sparta,  West  Jefferson  and  Jefferson,  North
Carolina.  The Company  has a  brokerage  service  subsidiary,  operating  as AF
Brokerage, Inc., which serves Ashe, Alleghany, Wilkes and Watauga Counties.

On April 15, 1996, the Board of Directors of Ashe Federal Bank adopted a Plan of
Reorganization  and the related  Stock  Issuance Plan pursuant to which the Bank
exchanged  its federal  mutual  savings bank charter for a federal stock savings
bank charter,  conducted a minority stock  offering,  and formed  AsheCo,  MHC a
mutual  holding  company which owned more than 50% of the common stock issued by
the Bank.  The Bank  conducted its minority stock offering in July and August of
1996 and the closing  occurred on October 4, 1996.  The Bank sold 461,779 shares
of common stock in the minority stock  offering,  which  includes  36,942 shares
sold to its Employee  Stock  Ownership  Plan (the  "ESOP"),  and issued  538,221
shares to the mutual holding company.

At the Bank's annual meeting held on December 8, 1997, the  shareholders of Ashe
Federal Bank  approved  the Ashe  Federal Bank 1997 Stock Option Plan;  the Ashe
Federal Bank 1997 Recognition and Retention Plan; a change in the Bank's federal
stock  charter,  changing the  corporate  name to AF Bank and approved a plan of
reorganization  providing for the  establishment  of AF  Bankshares,  Inc., as a
federally  chartered stock holding company parent of the Bank. On June 16, 1998,
the Bank completed its reorganization into a two-tier mutual holding company and
became a  wholly  owned  subsidiary  of the  Company  and the  Company  became a
majority owned subsidiary of AsheCo, MHC.

During the year ended June 30, 1999, the Company repurchased 6,300 shares of its
common stock for a total price of  $113,750,  and then  reissued  2,000 of these
shares.  Management  does not plan to acquire  additional  shares until it has a
specific purpose for additional stock purchases.

GENERAL

The Company had net income of approximately  $453,000 and $514,000 for the years
ended June 30, 2000 and 1999, respectively.  The Company's operating results are
primarily  dependent  upon net interest  income,  fees and charges and insurance
commissions.  Net interest income is the difference  between  interest earned on
loans, investments and interest-earning deposits at other financial institutions
and the cost of  interest-bearing  savings  deposits and other  borrowings.  The
primary  interest-earning  asset of the Company is its residential mortgage loan
portfolio  representing  60.0%  of  total  loans,  with  approximately  36.0% of
portfolio  mortgage  loans at fixed  rates at June 30,  2000.  The net  interest
income of the


                                       6
<PAGE>

Company is affected  by changes in economic  conditions  that  influence  market
interest  rates.  This exposure to changes in interest  rates  contributes  to a
moderate  degree of  interest  rate  risk,  because  of the  negative  impact of
increasing  rates to the  Bank's  earnings  and to the net  market  value of its
assets and liabilities.  Additionally, the Company receives fee income primarily
from loan origination fees, late loan payment fees, commissions from the sale of
credit life, accident and health insurance,  deposit transaction fees, insurance
commissions  generated from the insurance  agency  subsidiary,  income generated
from the  Company's  brokerage  subsidiary  and for  payment  of other  services
provided  to  customers  by the  Company.  The major  non-interest  costs to the
Company  include  compensation  and  benefits,  occupancy and equipment and data
processing  costs.  Other external factors that affect the operating  results of
the Company include changes in government and accounting  regulations,  costs of
implementing  information technology,  and changes in the competition's emphasis
within the Company's market area. For the year ended June 30, 2000, there was an
unusual nonrecurring  expenditure related to the Company's  preparations for the
anticipated  Y2K computer  problem;  this  expenditure  directly  and  adversely
affected net earnings for the period.

MANAGEMENT STRATEGY

On March 18, 1998 the Bank opened a new office, Alleghany First Bank, in Sparta,
North Carolina.  Additionally,  the Bank's  insurance agency  subsidiary  offers
property,  casualty,  health and life  insurance  products  within the Alleghany
facility. On March 1, 1999, the Bank opened a new branch office, in Boone, North
Carolina,  operating under the trade name  Appalachian  First Bank. Entry in the
Boone and Alleghany  markets  significantly  expands the Company's  potential to
market its banking,  insurance and non-insured  investment  products to a larger
and more diverse market.

On April 1, 1999 the Company  purchased  an  insurance  agency in Lenoir,  North
Carolina  that  operates  under the trade name, AF Blair  Insurance  Agency.  On
December 1, 1999 the  Company  purchased  an  insurance  agency in Elkin,  North
Carolina that operates  under the trade name, AF Insurance  Service  Center.  On
July 17, 2000 the Company signed a letter of intent to purchase the assets of an
insurance  agency in Boone,  North  Carolina.  If  consummated,  the purchase is
expected  to close in the second  quarter of the 2001  fiscal  year.  Management
believes that  penetration  into other  markets  increases  the  opportunity  to
deliver products from all of the Company's  subsidiaries to a broader market and
will make the insurance and brokerage  subsidiaries more profitable  investments
by  increasing  the  economies  of scale  and  adding to the  products  that are
available for delivery to the Company's customers. The Company continues to seek
opportunities to increase its market penetration for its services.

Management believes that the Company's  customers perceive "financial  services"
to include three  elements:  funds  transfer,  including  checking  accounts and
savings instruments,  insurance and securities  brokerage.  Further,  management
believes that the ability to offer insurance and brokerage services improves the
Company's  competitive  position;  enhances the Company's growth;  and increases
both the scope and scale of the Company's marketing efficiency.  During the year
ended June 30, 1999, the Company established a securities brokerage  subsidiary,
AF  Brokerage,  Inc.,  which  applied  to the NASD for  membership  in the third
quarter of 1998 and was granted  membership  on October 22, 1999.  AF Brokerage,
Inc.  commenced  operation  in the  fourth  quarter  of 2000  as an  independent
broker/dealer.  Management  continues to evaluate  acquisitions,  expansion  and
business  opportunities  that it believes  will provide  access to customers and
markets that  enhance the  Company's  value and  earnings  potential in the long
term.



                                       7
<PAGE>

During 1995,  management  introduced  fixed rate mortgage loans with  provisions
allowing the Bank to "call the loan due" after three or five year periods,  thus
reducing  the  period of time that the  Company  is  exposed  to a fixed rate of
interest in order to reduce  interest rate risk.  The call provision is now used
primarily  where  the  fixed  rate  mortgage  does not  qualify  for sale in the
secondary  market  and  where  the  borrower  has  no  desire  for  an  ARM.  At
approximately  the  same  time,  the  Company  began to  offer  consumer  loans,
including automobile and home improvement loans. In June 1998, the Company began
funding automobile loans originated by selected dealers in its market area where
the Company's loan officers have final  underwriting  authority to determine the
acceptability  of the  borrowers  to the Company.  At the end of June 2000,  the
Company had closed approximately $4.7 million of these loans. At the end of June
2000,  consumer loans  constituted  approximately  15.2% of portfolio  loans. In
1994, the Company began offering  commercial  loans to small  businesses in Ashe
County and has continued that business to include Alleghany County,  and Watauga
County.  Commercial  loans  generally  have  rates  based on the  prime  rate of
interest  that  more  closely  reflects  market  interest  rates.  Additionally,
consumer and  commercial  loans  generally  have shorter  terms and thus greater
interest rate sensitivity than mortgage loans.  Management has pursued the above
mortgage and  non-mortgage  loan strategies as primary  strategies to reduce the
level of interest rate risk  inherent in the Bank's loan  portfolio and maintain
acceptable  levels of credit risk.  Funding for the loan  originations  has been
provided  by  aggressively   marketing   savings  and  checking  accounts  while
maintaining  competitive  pricing on  certificates  of deposits and by borrowing
from the Federal Home Loan Bank of Atlanta  ("FHLB").  Deposits  increased  $9.6
million and FHLB advances increased $12.9 million during 2000.

In  addition  to  loans,   the  Bank  invests  in  federal  agency   securities,
certificates of deposit (generally with terms of five years or less),  overnight
deposits  with the FHLB,  equity  securities  in the Federal Home Loan  Mortgage
Corporation (FHLMC),  municipal bonds and mortgage-backed  securities secured by
adjustable  rate  mortgages  and  issued  by the  Government  National  Mortgage
Association (GNMA) and Fannie Mae. Management does not engage in the practice of
trading  securities,   rather,  the  Company's   investment  portfolio  consists
primarily of securities  designated as available for sale. Management intends to
maintain  investment  securities to meet liquidity  needs as a supplement to its
lending  activities and as a means to reduce  interest rate risk and credit risk
of its asset base in exchange for lower rates of return than would  typically be
available with other lending activities.

During the first quarter of the 2001 fiscal year,  the Company is switching data
processing service providers for the Company to Fiserv, Atlanta. Fiserv, Atlanta
offers a  system  that is more  versatile  then the  Company's  current  system.
Management  believes  this switch will enable the Company to provide an improved
level of customer service by improving the delivery capability of its system and
allowing the Company to provide  additional  products in order to met  customers
needs.  Management does not expect substantial  increases in its data processing
costs to result from this switch.

Management  believes it is important to view the annual financial results of the
Company within the larger context of the Company's  long-term strategic business
plan.  Doing so  helps  keep  short-term  results  in  better  perspective,  and
underscores  management's  commitment to the long-term profitability and success
of the Company.

It has long  been  management's  view  that the  Company's  success  in the 21st
Century  will  depend in large part upon its  ability to compete  far beyond the
narrow boundaries  imposed upon banking during the majority of the 20th Century.
In fact, the transition from "banking" to financial  services  provider impacted
every major competitor of the Company. The Financial Services  Modernization Act
is  an  excellent  example  of  regulatory  and  governmental  support  of  this
viewpoint.

Management believes that the Company's  customers perceive "financial  services"
to encompass five broad categories:  funds transfer including checking accounts;
insured savings instruments;  credit/lending services; insurance; and securities
brokerage. Preparing the Company to compete on a competitively superior basis in
all these categories has had a negative impact on short-term earnings.



                                       8
<PAGE>

Added to these planned  investments in the Company's future were several factors
outside the control of management:

         o        The costs of regulatory  compliance with, and preparations for
                  the possible Year 2000 computer problem (which in hard dollars
                  cost the Company more than $250,000);

         o        The recent  tightening  of  short-term  interest  rates by the
                  Federal Reserve in an effort to contain inflation; and

         o        The resulting  inverted yield curve between higher  short-term
                  interest rates and lower  long-term  rates that existed during
                  the majority of the 2000 fiscal year.

All these  factors  tended to exert  additional  downward  pressure  on earnings
during the most recent fiscal year ended June 30, 2000.

However,  it is  well  worth  noting  that  --  given  both  these  planned  and
uncontrollable dampening factors -- the Company's earnings for the most recently
completed year remain positive.

         o        An increase in net loans of $27.6 million or 34.0%;

         o        Asset growth of $23.4 million or 21.3%,  resulting in enhanced
                  leveraging the Company's capital;

         o        Continued  growth  in  non  interest  income,  reflecting  the
                  Company's  continuing  emphasis in the areas of insurance  and
                  securities services;

         o        Approval of the Company's broker/dealer license;

         o        The addition of the Company's  fourth  insurance agency to the
                  AF Insurance network;

         o        Adding  additional  insurance  markets with major  emphasis in
                  commercial  property and casualty business,  thereby providing
                  the  Company  with an even  better mix  between  personal  and
                  commercial coverages; and

         o        The  completion  of  the  Company's  new   administrative  and
                  corporate headquarters building.

Therefore,  management is optimistic  about the future of the Company.  Overall,
management  and the board of directors  are indeed  pleased  with the  continued
positive  short-term  earnings  of the  Company,  particularly  in  light of the
investments  required (i.e.,  slightly lower short-term  earnings) to accomplish
the goals of the long-term strategic plan.



                                       9
<PAGE>

COMPARISON OF FINANCIAL CONDITION AT JUNE 30, 2000 AND 1999:

At June 30,  2000 and 1999 assets  totaled  $133.4  million and $109.9  million,
respectively.  Total assets  increased  by $23.4  million or 21.3% from June 30,
1999 to June 30, 2000,  primarily a result of an increase of $27.6  million,  or
34.0%,  in net loans  receivable  and an  increase  of $1.6  million or 64.4% in
office properties and equipment.  These increases are partially offset by a $5.0
million  decrease in cash and cash  equivalents.  Management  believes  that the
increase  in  net  loans   receivable   is   primarily  a  result  of  increased
concentration in the commercial  market,  which tends to yield larger loans. The
loan growth was  primarily  funded by increases in FHLB  advances and in savings
deposits.  The Company's level of advances from the FHLB increased $12.9 million
from $2.6  million  at June 30,  1999 to $15.5  million  at June 30,  2000.  The
Company's deposits increased by $9.6 million from $93.1 million at June 30, 1999
to $102.7  million at June 30, 2000.  Management  believes  that the increase in
deposits is attributable to its marketing  efforts directed  towards  increasing
balances in savings and transaction accounts.

The principal category of earning assets is loans and during the year ended June
30, 2000 loans receivable,  net,  increased by $27.6 million compared to an $8.5
million  increase  for the year ended June 30,  1999.  The increase in net loans
receivable is typical for the Company,  which  operates in lending  markets that
have had sustained loan demand over the past several years.

The Company's level of non-performing  assets, defined as loans past due 90 days
or more and repossessed  assets,  increased slightly from .14% of total loans at
June 30,  1999,  to .64% of  total  loans at June  30,  2000.  The low  level of
non-performing  assets is attributable  to  comprehensive  lending  policies and
exceptional  collection efforts. The Company's level of non-performing loans has
remained  consistently  low  in  relation  to  prior  periods  and  total  loans
outstanding.  The Company had net charge offs of $231,000 during year ended June
30,  2000  compared  to net charge  offs of $62,000  for the year ended June 30,
1999.  As a result  and based on  management's  analysis  of its  allowances,  a
provision for additional loan loss allowance of $88,000 was made during the year
ended June 30, 2000.

The Company's net investment in office  properties and equipment  increased $1.6
million to $4.2  million at June 30,  2000 from $2.5  million at June 30,  1999,
primarily a result of acquiring  and  renovating  a building  located at 21 East
Ashe Street in West  Jefferson,  purchase  of  equipment  for the new  insurance
agency and  equipment  for  additional  employees.  The building at 21 East Ashe
Street is used for the  Company's  corporate  offices as well as the  electronic
banking and loan  servicing  divisions.  The corporate  offices were  previously
located at 206 South  Jefferson  Avenue,  which is now occupied by the Company's
Insurance and Brokerage subsidiaries.

At June 30, 2000 retained earnings  increased  $358,000 or 4.5% to $8.3 million,
from $8.0  million at June 30,  1999,  as a result of earnings of  $453,000,  an
increase  for a fair  market  value  adjustment  for ESOP stock in the amount of
$74,000 and offset by dividends of $206,000.  Unrealized gain/loss on securities
available for sale decreased by $232,000 or 114.5% at June 30, 2000. At June 30,
2000 the Bank's  regulatory  capital amounted to $12.6 million compared to $12.0
million at June 30,  1999,  which as a  percentage  of total assets was 8.9% and
10.0% and was in excess of regulatory capital requirements at such dates.



                                       10
<PAGE>


         The following  table  analyzes the dollar amount of changes in interest
income and interest expense for major components of interest-earning  assets and
interest-bearing  liabilities.  The  table  distinguishes  between  (i)  changes
attributable to volume (changes in volume multiplied by the prior period's rate)
(ii)  changes  attributable  to rate  (changes in rate  multiplied  by the prior
period's  volume)  and (iii) mixed  changes  (changes  in volume  multiplied  by
changes in rate). Rate/volume variances are allocated to the rate/volume column.


<TABLE>
<CAPTION>
                                                             YEAR ENDED                                  YEAR ENDED
                                                            JUNE 30, 1999                               JUNE 30, 1998
                                                             COMPARED TO                                 COMPARED TO
                                                             YEAR ENDED                                  YEAR ENDED
                                                            JUNE 30, 2000                               JUNE 30, 1999
                                                ----------------------------------------   --------------------------------------
                                                          INCREASE/(DECREASE)                         INCREASE/(DECREASE)
                                                                DUE TO                                     DUE TO
                                                ----------------------------------------   --------------------------------------
                                                                      RATE/                                       RATE/
                                                VOLUME      RATE      VOLUME      NET         VOLUME     RATE     VOLUME     NET
                                                -------     -----     ------    -------       ------     -----    ------    -----
                                                                                   (IN THOUSANDS)
<S>                                             <C>         <C>       <C>       <C>            <C>       <C>       <C>      <C>
ASSETS:
      Interest-earning assets:
          Interest-bearing deposits ........    $  (399)    $  56     $ (39)    $  (382)       $ 285     $   9     $ 10     $ 304
          Investment securities ............        (23)      133        (6)        104          171       (66)     (26)       79
          Loans receivable .................      2,103      (238)      (73)      1,792          277      (132)      (5)      140
                                                -------     -----     -----     -------        -----     -----     ----     -----
              Total ........................      1,681       (49)     (118)      1,514          733      (189)     (21)      523
                                                -------     -----     -----     -------        -----     -----     ----     -----
LIABILITIES:
      Interest-bearing liabilities:
          NOW and MMDA accounts ............         67       (12)       (3)         52           59       (95)     (16)      (52)
          Passbook savings .................        128         4         1         133          248       (61)     (27)      160
          Certificates of deposit ..........        152       (36)       (2)        114          234      (105)      (9)      120
          Borrowed funds ...................        495       (22)      (54)        419          (66)       13       (3)      (56)
                                                -------     -----     -----     -------        -----     -----     ----     -----
              Total ........................        842       (66)      (58)        718          475      (248)     (55)      172
                                                -------     -----     -----     -------        -----     -----     ----     -----
          Net interest income ..............    $   839     $  17     $ (60)    $   796        $ 258     $  59     $ 34     $ 351
                                                =======     =====     =====     =======        =====     =====     ====     =====
</TABLE>



                                       11
<PAGE>

     The following table provides information concerning the Company's yields on
interest-earning  assets and cost of funds on interest-bearing  liabilities over
the years ended June 30, 2000 and 1999.

<TABLE>
<CAPTION>
                                                                                       FOR THE YEAR ENDED JUNE 30,
                                                      AT JUNE 30,      -----------------------------------------------------------
                                                         2000                     2000                            1999
                                                  -------------------  ----------------------------   ----------------------------
                                                             AVERAGE                        AVERAGE                        AVERAGE
                                                    ACTUAL    YIELD/    AVERAGE              YIELD/    AVERAGE              YIELD/
                                                   BALANCE     RATE     BALANCE    INTEREST   RATE     BALANCE   INTEREST    RATE
                                                  ---------   -----    --------   --------   -----    --------   --------    -----
                                                                             (DOLLARS IN THOUSANDS)
<S>                                               <C>          <C>     <C>        <C>         <C>     <C>        <C>          <C>
ASSETS:
   Interest-earning assets:
      Interest-bearing deposits ...............   $  2,599     5.63%   $  2,939   $    189    6.43%   $  9,741   $    571     5.86%
      Investment securities ...................      9,835     6.24%      9,523        605    6.35%      9,975        501     5.02%
      Loans receivable(1) .....................    108,778     8.63%    100,228      8,599    8.58%     76,597      6,807     8.89%
                                                  --------    -----    --------   --------            --------   --------

          Total interest-earning assets .......    121,212     8.37%    112,690      9,393    8.34%     96,313      7,879     8.18%
                                                                                  --------                       --------

      Non-interest-earning assets .............     12,158               10,645                          8,002
                                                  --------             --------                       --------

                           Total assets .......   $133,370             $123,335                       $104,315
                                                  ========             ========                       ========

LIABILITIES AND EQUITY:
   Interest-bearing liabilities:
      NOW and MMDA accounts ...................   $ 18,589     1.92%   $ 16,015        353    2.20%   $ 13,160        301     2.29%
      Savings .................................     23,032     3.83%     22,857        831    3.64%     19,257        698     3.62%
      Certificates of deposit .................     56,937     5.71%     54,800      2,885    5.26%     51,995      2,771     5.33%
      FHLB Advances and notes payable .........     16,443     5.65%     10,495        616    5.87%      2,988        197     6.59%
                                                  --------    -----    --------   --------            --------   --------

        Total interest-bearing liabilities.....    115,001     4.71%    104,167      4,685    4.50%     87,400      3,967     4.54%
                                                                                  --------                       --------

      Other non-interest-bearing liabilities...      5,829                7,811                          5,424

      Equity ..................................     12,540             $ 11,357                         11,491
                                                  --------             --------                       --------
           Total liabilities and equity .......   $133,370             $123,335                        104,315
                                                  ========             ========                       ========

Net interest income and
   interest rate spread(2) ....................                3.66%              $  4,708    3.84%              $  3,912     3.64%
                                                                                  ========                       ========
Net interest=earning assets and
   net interest margin (3) ....................   $  6,211             $  8,523               4.18%   $  8,913                4.06%
                                                  ========             ========                       ========
Ratio of interest-earning assets to
   interest-bearing liabilities ...............              105.40%                        108.18%                         110.20%
<FN>
-------------------------------
(1)      Balance is net of deferred loan fees and loans in process. Non-accrual loans are included in the balances.
(2)      Average interest rate spread represents the difference between the yield on average interest-earning assets and the cost of
         average interest-bearing liabilities.
(3)      Net interest margin represents net interest income divided by average total interest-earning  assets. With the exception of
         end of period ratios, all ratios are based on monthly balances during the indicated years. Management does not believe that
         the use of month end balances instead of daily balances has caused a material difference in the information presented.
</FN>
</TABLE>


                                       12
<PAGE>

COMPARISON  OF  OPERATING  RESULTS FOR THE FISCAL  YEARS ENDED JUNE 30, 2000 AND
1999:

GENERAL.  Net income for the years ended June 30, 2000 and 1999 was $453,000 and
$514,000,   respectively.  The  decrease  of  $61,000  or  11.8%  was  primarily
attributable to decreased  interest income on interest  bearing  deposits due to
the increased level of non-interest bearing deposits that the Bank maintained to
prepare for potential  customer  withdrawals  resulting from year 2000 concerns.
Changes were also attributable to costs associated with the Bank's branch office
in  Watagua  County,  Appalachian  First  Bank,  the costs  associated  with the
purchase  of AF  Insurance  Service  Center,  in Elkin  North  Carolina  and the
addition of  employees  in order to prepare  the  Company for future  expansion.
Management  believes that these initial costs of expansion will better  position
the  Company  for  the  future.  In  management's  opinion,  there  has  been an
improvement  in the level of  interest  rate risk from the end of the  Company's
most recent fiscal year.

NET INTEREST  INCOME.  Net interest  income  increased by $796,000 or 20.3% from
$3.9  million  for year ended June 30,  1999 to $4.7  million for the year ended
June 30,  2000.  The  increase  is  primarily  attributed  to the $27.6  million
increase in net loans  receivable  from $81.1 million at June 30, 1999 to $108.8
million at June 30,  2000,  resulting in an increase of $1.8 million in interest
income from loans. This increase was partially offset by an increase of $718,000
in interest expense.

INTEREST INCOME. Interest income increased by $1.5 million, or a 19.2% increase,
from $7.9 million during the year ended June 30, 1999 to $9.4 million during the
year end June 30, 2000. This increase was attributable to a change in the volume
and mix of the Company's loan portfolio.

INTEREST  EXPENSE.  Interest  expense for the year ended June 30, 2000 increased
$718,000  to $4.7  million.  The  increase  is the result of an  increase in the
average  outstanding  balance in the level of deposits and FHLB advances for the
year ended June 30, 2000 as compared to the similar period in 1999.

PROVISION FOR LOAN LOSSES.  Management made $88,000 of additional provisions for
loan losses  during the year ended June 30, 2000.  The Company  experienced  net
charge offs of  $231,000  during the year ended June 30,  2000.  During the year
ended June 30, 1999,  provision of $20,000 was made and the Company  experienced
net charge offs of $62,000.  Provisions,  which are  charged to  operations  and
resulting loan loss  allowances,  are amounts that  management  believes will be
adequate to absorb losses on existing loans that may become uncollectible. Loans
are  charged  off  against  the   allowance   when   management   believes  that
collectibility  is  unlikely.   The  evaluation  to  increase  or  decrease  the
provisions and resulting  allowances is based both on 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
Company's level of non-performing loans remained consistently low in relation to
prior periods and total loans  outstanding  during the year ended June 30, 2000.
At June 30, 2000, the Company's level of general  valuation  allowances for loan
losses amounted to $979,000 which management  believes is adequate to absorb any
losses that may exist in its loan portfolio.

NON-INTEREST  INCOME.  Non-interest income increased by $615,000 or 51.0% during
fiscal year 2000. The increase was primarily  attributed to increased  insurance
commissions  generated  by the  insurance  agency  and income  generated  by the
Company's brokerage  subsidiary.  Both these areas of growth and widening market
penetration  are  expected  to  continue to produce  increases  in  non-interest
income.


                                       13
<PAGE>

NON-INTEREST  EXPENSE.  Non-interest  expense increased by $1.3 million or 30.2%
from $4.3  million for the year ended June 30, 1999 to $5.7 million for the year
ended June 30, 2000.  Increases for non-interest expense for the year ended June
30, 2000 are primarily  attributable to compensation and employee benefit costs,
occupancy,  and data processing costs.  Compensation costs increased by $761,000
for the year ended June 30, 2000, primarily as the result of the addition of new
employees in the Company and insurance agency in order to service current growth
and to prepare the Company for future  expansion.  Occupancy  cost  increased by
$77,000 for the year ended June 30, 2000,  primarily  because of the addition of
the insurance  location in Elkin,  and, costs associated with renovations on the
new corporate and administrative building.

INCOME TAXES. Income taxes resulted from applying normal,  expected tax rates on
income earned  during the year ended June 30, 2000 and 1999.  Income tax expense
was  $328,000  and  $236,000,  for the  years  ended  June 30,  2000  and  1999,
respectively.  The  effective tax rate applied was higher than the statutory tax
rates  for 2000,  primarily  due to  permanent  differences  resulting  from the
decrease  in the  market  price of  shares  vesting  under the  recognition  and
retention plan in the current year.

IMPACT OF THE YEAR 2000.  The Company is pleased to report  that no  significant
difficulties were encountered.

COMPARISON  OF  OPERATING  RESULTS FOR THE FISCAL  YEARS ENDED JUNE 30, 1999 AND
1998:

GENERAL.  Net income for the years ended June 30, 1999 and 1998 was $514,000 and
$708,000,  respectively.  The  decrease  of  $195,000  or  27.5%  was  primarily
attributable to the cost  associated with  establishing a bank branch in Watauga
County,  costs  associated  with  obtaining a broker dealer license and costs to
acquire additional insurance agencies.  Management believes that these costs are
indicative of growth and  necessary in order to provide  access to customers and
markets that  enhance the  Company's  value and  earnings  potential in the long
term. In  management's  opinion,  there has been an  improvement in the level of
interest rate risk from the end of the Company's most recent fiscal year.

NET INTEREST INCOME. Net interest income increased by $351,000 or 9.8% from $3.6
million for year ended June 30, 1998 to $3.9 million for the year ended June 30,
1999.  The increase is a result of  increased  average  outstanding  balances in
interest-earning  assets,  partially  offset by the decline in the prime rate of
interest  during the year.  The decline in rates  between June 30, 1998 and 1999
reduced  interest  income by  approximately  $189,000.  Volume  accounted for an
annualized  increase  in interest  income of  approximately  $733,000.  Interest
expense on deposits  declined  approximately  $248,000  based on a reduction  in
rates while  interest  expense  increased  by  $475,000  based on an increase in
volume.

INTEREST INCOME.  Interest income increase by $523,000, or a 7.1% increase, from
$7.4 million during the year ended June 30, 1998 to $7.9 million during the year
end June 30, 1999. This increase was  attributable to a change in the volume and
mix of  the  Company's  loan  portfolio  and  an  increase  in  the  average  of
interest-bearing deposits.

INTEREST  EXPENSE.  Interest  expense for the year ended June 30, 1999 increased
$172,000  to $4.0  million.  The  increase  is the result of an  increase in the
average  outstanding  balances in the level of deposits  for the year ended June
30, 1999 as compared to the similar  period in 1998.  However,  the average rate
for deposits was lower at June 30, 1999 than for the comparable  period in 1998,
and was an offsetting factor to interest expense.


                                       14
<PAGE>

PROVISION FOR LOAN LOSSES. Management made additional provisions for loan losses
during the year ended June 30, 1999,  of $20,000.  The Company  experienced  net
charge  offs of $62,000  during the year  ended June 30,  1999.  During the year
ended June 30, 1998, no provisions were made;  however,  the Company experienced
net  recoveries  of  $158,000  that  served to  increase  the level of loan loss
reserves.  Provisions,  which are charged to operations  and resulting loan loss
allowances,  are amounts that the Company's management believes will be adequate
to absorb  potential  losses on  existing  loans that may become  uncollectible.
Loans are charged  off  against the  allowance  when  management  believes  that
collectibility  is  unlikely.   The  evaluation  to  increase  or  decrease  the
provisions and resulting  allowances is based both on 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
Company's level of non-performing loans remained consistently low in relation to
prior periods and total loans  outstanding  during the year ended June 30, 1999.
At June 30, 1999 the Company's  level of general  valuation  allowances for loan
losses amounted to $1.1 million which management  believes is adequate to absorb
any losses that may exist in its loan portfolio.

NON-INTEREST  INCOME.  Non-interest income increased by $214,000 or 21.6% during
the fiscal year 1999. The increase was primarily  attributable  to a gain on the
sale of FHLMC stock of $148,000,  insurance commissions of $500,000 generated by
the  insurance  agency,   and  income  generated  by  the  Company's   brokerage
subsidiary.

NON-INTEREST  EXPENSE.  Non-interest expense increased by $860,000 or 24.7% from
$3.5 million for the year ended June 30, 1998 to $4.3 million for the year ended
June 30, 1999. Increases for non-interest expense are primarily  attributable to
compensation  and employee benefit costs,  occupancy,  data processing costs and
legal expenses. Compensation costs increased by $460,000 for the year ended June
30, 1999,  primarily as the result of  additional  insurance  agency  employees'
salaries,  the addition of  Appalachian  First Bank employee  salaries,  and the
addition of salaries  paid to AF Brokerage,  Inc.  Occupancy  cost  increased by
$98,000 for the year ended June 30, 1999, due to increased  depreciation expense
resulting from the new branch location in Boone, computer equipment acquired for
the new insurance office in Lenior and for the brokerage subsidiary.  Additional
legal  costs  during  the  current  period  were the  result of  applying  for a
broker/dealer registration.

INCOME TAXES. Income taxes resulted from applying normal,  expected tax rates on
income earned  during the year ended June 30, 1999 and 1998.  Income tax expense
was  $236,000  and  $381,000,  for the years ended June 30,  1999 and 1998.  The
effective  tax rate applied was  slightly  lower than the  statutory  tax rates,
primarily due to qualifying  investment income that was exempt from state income
taxes.  Legislated  decreases are expected in the North  Carolina  corporate tax
rate in future periods, which would lower the overall effective tax rate.

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.  At June  30,  2000,  cash  and  cash
equivalents, a significant source of liquidity, totaled $7.4 million.


                                       15
<PAGE>

As a federally  chartered  savings bank,  the Bank must maintain a daily average
balance of liquid assets equal to at least 4% of withdrawable deposits and short
term borrowings.  The Bank's liquidity ratio at June 30, 2000, as computed under
OTS  regulations,  was  considerably in excess of such  requirements.  Given its
excess liquidity and its ability to borrow from the FHLB, the Bank believes that
it will  have  sufficient  funds  available  to  meet  anticipated  future  loan
commitments, unexpected deposit withdrawals, and other cash requirements.

The Company's capital position is in excellent shape, by any objective benchmark
or comparison.

ASSET/LIABILITY MANAGEMENT

The Company's asset/liability  management is focused primarily on evaluating and
managing the Company's net interest income in relation to various risk criteria.
Factors beyond the Company's  control,  such as the effects of changes in market
interest  rates and  competition,  may also have an impact on the  management of
interest rate risk.

In the absence of other factors, the Company's overall yield on interest-earning
assets  will  increase  as  will  its  cost  of  funds  on its  interest-bearing
liabilities  when  market  rates  increase  over an  extended  period  of  time.
Inversely,  the  Company's  yields and cost of funds will  decrease  when market
rates decline.  The Company is able to manage these  fluctuations to some extent
by   attempting   to  control   the   maturity  or  rate   adjustments   of  its
interest-earning  assets and interest-bearing  liabilities over given periods of
time.  One  of  the  Company's  tools  to  monitor  interest  rate  risk  is the
measurement  of  sensitivity  of its net portfolio  value to changes in interest
rates.

In order to minimize the  potential  effects of adverse  material and  prolonged
increases in market interest rates on the Company's  operations,  management has
implemented  an  asset/liability  program  designed  to  improve  the  Company's
interest  rate risk  exposure.  The  program  emphasizes  that  originations  of
five-year fixed rate balloon mortgages,  adjustable rate mortgages, selling long
term  fixed  rate loans to the  secondary  market,  shorter  term  consumer  and
commercial  loans,  the investment of excess cash in short or intermediate  term
interest-earning  assets,  and the  solicitation of deposit accounts that can be
repriced rapidly.

Although the Company's  asset/liability  management program has generally helped
to decrease the exposure of its earnings to interest rate increases, the Company
continues to be susceptible to increased  levels of interest  rates,  which will
adversely affect earnings during prolonged  periods of rising interest rates and
positively affect earnings during prolonged periods of interest rate declines.

NET PORTFOLIO VALUE

All  federally  regulated  financial  institutions  are  required to measure the
exposure to changes in  interest  rates.  Institutions  with assets of less than
$500 million may rely on outside sources of measurement such as that provided by
the OTS and the FHLB.  The purpose is to determine how changes in interest rates
affect  the  estimated  value or Net  Portfolio  Value  ("NPV")  of the  insured
institution's  statement  of  financial  condition  under  several  immediate or
"shock" changes in market rates. Since the timing of repricing opportunities for
interest-earning  assets and  interest-bearing  liabilities  are different,  the
impact of shock changes will have a negative,  neutral or positive impact on the
NPV of the bank based on the  structure  of the bank's  assets and  liabilities.
Thus, NPV is the difference between incoming and outgoing  discounted cash flows
from assets,  liabilities and off-balance sheet contracts.  Generally, the level
of interest  rate risk is measured in a 200 basis point shock  environment  that
has the most negative impact on the Company's NPV.


                                       16
<PAGE>

The Company's  banking  subsidiary,  AF Bank, has  historically  been a mortgage
lender which means that it  generally  has longer  terms  before  repricing  its
assets  than  does  its  interest  bearing   liabilities  or  deposit  accounts;
therefore,  a rising rate  environment will have the most negative impact on the
NPV of the Company.  Management has implemented a strategy of limiting the terms
of mortgage  loans that it cannot sell in the secondary  market,  increasing the
level of loans  tied more  closely  to market  interest  rates such as the prime
rate,  and  generally  reducing  the terms of loans that the Company  offers for
portfolio.  The following  table presents the Company's NPV at June 30, 2000, as
calculated by the OTS, based on information provided to the OTS by the Company.

As a result  of  management's  actions,  at June 30,  2000,  the  estimated  NPV
declined by 7% in a 300 basis point rising interest rate shock scenario compared
to a loss in NPV of 4% in a falling rate scenario. This compares to a decline of
13%  under a  similar  rise  and a gain of 12% in a  similar  decline  one  year
earlier.  The improvement in interest rate risk is further measured by the basis
point  decline  in  the  ratio  of  NPV to  the  PV of  assets,  defined  as the
Sensitivity Measure by the OTS. At June 30, 2000, the decline of the sensitivity
measure  was 54 basis  points  with a 300 basis  point  shock  increase in rates
compared to a decline of 128 basis points at June 30, 1999.

<TABLE>
<CAPTION>
                                                                                        NPV as $ of PV (5)
                              Net Portfolio Value                                            of Assets
-------------------------------------------------------------------------------   ---------------------------------

   Changes in Rates             $ Amount     $ Change (1)          % of Change (2)           Ratio (3)   Change (4)
   ----------------             --------     ------------          ---------------           ---------   ----------
                            (Dollars in Thousands)
<S>                              <C>             <C>                      <C>                   <C>         <C>
       +300 bp                   13,945           (1118)                 (7.00)%                 10.68%       (54)
       +200 bp                   14,478            (585)                 (4.00)%                 10.98%       (24)
       +100 bp                   14,888            (176)                  1.00 %                 11.18%        (4)
         0 bp                    15,063              --                     --                   11.22%        --
       -100 bp                   14,842            (222)                 (1.00)%                 10.99%       (23)
       -200 bp                   14,312            (752)                 (5.00)%                 10.56%       (66)
       -300 bp                   14,426            (638)                 (4.00)%                 10.55%       (66)
<FN>
(1)      Represents the excess  (deficiency) of NPV assuming the indicated change in interest rates minus the estimated NPV assuming
         no change in interest rates.
(2)      Calculated as the amount of change in the estimated NPV divided by the estimated NPV assuming no change in interest rates.
(3)      Calculated as the estimated NPV divided by average total assets.
(4)      Calculated as the excess  (deficiency) of the NPV ratio assuming the indicated  change in interest rates over the estimated
         NPV ratio assuming no change in interest rates.
(5)      PV means present value.
</FN>
</TABLE>

The  following  chart  provided  by the OTS  reflects  further  measures  of the
Company's interest rate risk.

   RISK MEASURES: 200BP RATE SHOCK:                 June 30, 2000  June 30, 1999
                                                    -------------  -------------
   Pre-Shock NPV Ratio: NPV as a % of PV of Assets      11.22%         12.40%
   Exposure Measure: Post Shock NPV Ratio               10.56%         11.72%
   Sensitivity Measure: Change in NPV                   -66 bp         -68 bp



                                       17
<PAGE>

Certain  shortcomings  are inherent in the methodology  used in the above table.
Modeling changes in NPV requires the making of certain assumptions that may tend
to  oversimplify  the manner in which actual yields and costs respond to changes
in market interest rates.  First,  the models assume that the composition of the
Bank's interest sensitive assets and liabilities  existing at the beginning of a
period  remains  constant  over the period being  measured.  Second,  the models
assume that a particular change in interest rates is reflected  uniformly across
the yield curve  regardless of the duration to maturity or repricing of specific
assets and liabilities. Accordingly, although the NPV measurements do provide an
indication of the Company's interest rate risk exposure at a particular point in
time, such  measurements  are not intended to provide a precise  forecast of the
effect of changes in market interest rates on the Company's net interest income.
Furthermore,  in times of  decreasing  interest  rates,  the value of fixed-rate
assets  could  increase  in value  and the lag in  repricing  of  interest  rate
sensitive assets could be expected to have a positive effect on the Company.

Management  believes that the NPV method of assessing the Company's  exposure to
interest rate risk and potential  reductions in net interest  income is a useful
tool for measuring  risk.  Management  also believes that the charts reflect the
positive  impact of  strategies to reduce  interest rate risk as evidenced  most
prominently  by the  relatively  low level of  interest  rate  sensitivity  that
reflected a decline of 66 basis  points and 68 basis  points for the years ended
June 30, 2000 and 1999, respectively. The strategies that have reduced the level
of interest  rate risk under an  increasing  rate  assumption  will  continue to
reduce the impact or rising rates as long term  mortgages  are sold and replaced
with shorter term mortgage and nonmortgage loans with rates that can be adjusted
to more closely  simulate market rates of interest.  Management  believes that a
strong equity capital  position and the existence of the corporate  authority to
raise  additional  capital as necessary act as valuable tools to absorb interest
rate risk.

FUTURE REPORTING REQUIREMENTS

The FASB has issued SFAS No. 133,  Accounting  for  Derivative  Instruments  and
Hedging Activities,  which the Company has not been required to adopt as of June
30, 2000.  This  Statement,  which is effective for fiscal years beginning after
June 15, 2000,  establishes  accounting  and reporting  standards for derivative
instruments,   including  certain  derivative   instruments  embedded  in  other
contracts, (collectively referred to as derivatives) and for hedging activities.
It  requires  that an entity  recognize  all  derivatives  as  either  assets or
liabilities in the statement of financial position and measure those instruments
at fair value.  If certain  conditions are met, a derivative may be specifically
designated  as (a) a hedge of the  exposure  to  changes  in the fair value of a
recognized asset or liability or an unrecognized firm commitment, (b) a hedge of
the exposure to variable cash flows of a forecasted transaction,  or (c) a hedge
of the foreign currency exposure of a net investment in a foreign operation,  an
unrecognized  firm  commitment,  an available  for sale  security,  or a foreign
currency denominated forecasted  transaction.  This Statement is not expected to
have a significant impact on the Company.

IMPACT OF INFLATION AND CHANGING PRICES

The  financial  statements  and  accompanying  footnotes  have been  prepared in
accordance with GAAP,  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 Bank are  primarily  monetary  in nature and
changes in the market  interest  rates  have a greater  impact on the  Company's
performance than do the effects of inflation.



                                       18
<PAGE>

                          INDEPENDENT AUDITOR'S REPORT

To the Board of Directors
AF Bankshares, Inc. and Subsidiaries
West Jefferson, North Carolina

We have audited the accompanying  consolidated statements of financial condition
of AF Bankshares,  Inc. and  Subsidiaries  as of June 30, 2000 and 1999, and the
related consolidated statements of income,  stockholders' equity, and cash flows
for the years then ended.  These financial  statements are the responsibility of
the Company's  management.  Our responsibility is to express an opinion on these
financial statements based on our audits.

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

In our opinion,  the financial  statements  referred to above present fairly, in
all  material  respects,  the  financial  position of AF  Bankshares,  Inc.  and
Subsidiaries  as of June 30, 2000 and 1999, and the results of their  operations
and their cash flows for the years then  ended,  in  conformity  with  generally
accepted accounting principles.




Charlotte, North Carolina
July 28, 2000



                                       19
<PAGE>

AF BANKSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
JUNE 30, 2000 AND 1999

<TABLE>
<CAPTION>
ASSETS                                                                               2000                1999
---------------------------------------------------------------------------------------------------------------------
<S>                                                                               <C>               <C>
Cash and cash equivalents:
   Interest-bearing deposits                                                      $  2,599,071      $  4,173,311
   Noninterest-bearing deposits                                                      4,823,781         8,221,749
Certificates of deposit, at cost                                                        99,000           198,000
Securities held to maturity (fair value $100,000 in 2000 and
   1999) (Note 2)                                                                      100,000           100,000
Securities available for sale (Note 2)                                               8,860,452        10,976,170
Federal Home Loan Bank stock (Notes 2 and 6)                                           775,700           523,600
Loans receivable, net (Notes 3 and 6)                                              108,778,257        81,156,766
Real estate owned                                                                      289,441            59,000
Office properties and equipment, net (Note 4)                                        4,183,610         2,544,777
Accrued interest receivable on loans                                                   605,749           398,918
Accrued interest receivable on investment securities                                    82,647            97,598
Prepaid expenses and other assets                                                      562,317           546,721
Deferred income taxes, net (Note 12)                                                   499,045           425,100
Intangible assets, net of accumulated amortization of
   $156,882 in 2000 and $76,284 in 1999                                              1,111,333           509,716
                                                                                  ------------------------------
             TOTAL ASSETS                                                         $133,370,403      $109,931,426
                                                                                  ==============================

LIABILITIES AND STOCKHOLDERS' EQUITY
---------------------------------------------------------------------------------------------------------------------
Liabilities:
   Savings deposits (Note 5)                                                      $102,679,834      $ 93,106,090
   Note payable (Note 6)                                                               700,000                --
   Note payable - ESOP (Note 9 and 17)                                                 229,878           255,420
   Advances from Federal Home Loan Bank (Note 6)                                    15,513,007         2,564,358
   Accounts payable and other liabilities (Note 10)                                  1,630,313         1,636,362
   Redeemable common stock held by the ESOP, net of
      unearned ESOP shares (Notes 9 and 17)                                             77,116           150,942
                                                                                  ------------------------------
            TOTAL LIABILITIES                                                      120,830,148        97,713,172
                                                                                  ------------------------------
Commitments and Contingencies (Notes 10 and 13)
Stockholders' equity (Note 17):
   Common stock, par value $.01 per share; authorized 5,000,000
      shares; 1,053,678 issued and 1,049,378 outstanding shares
      shares at 2000 and 1999 (Note 7)                                                  10,537            10,537
   Additional paid-in capital                                                        4,591,555         4,593,516
   Retained earnings, substantially restricted (Notes 7 and 12)                      8,331,965         7,974,373
   Recognition and retention plan (Note 11)                                           (281,344)         (479,960)
   Accumulated other comprehensive income (loss) (Note 2)                              (28,608)          203,638
                                                                                  ------------------------------
                                                                                    12,624,105        12,302,104
   Less cost of 4,300 shares of treasury stock                                         (83,850)          (83,850)
                                                                                  ------------------------------
            TOTAL STOCKHOLDERS' EQUITY                                              12,540,255        12,218,254
                                                                                  ------------------------------
            TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY                            $133,370,403      $109,931,426
                                                                                  ==============================

</TABLE>

See Notes to Consolidated Financial Statements.


                                       20

<PAGE>

AF BANKSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED JUNE 30, 2000 AND 1999

<TABLE>
<CAPTION>
                                                                                    2000                1999
--------------------------------------------------------------------------------------------------------------------
<S>                                                                         <C>                     <C>
Interest income:
   Loans                                                                    $         8,598,994    $     6,806,902
   Investment securities                                                                605,189            501,410
   Interest-bearing deposits                                                            188,787            570,867
                                                                            -------------------    ---------------
                                                                                      9,392,970          7,879,179
                                                                            -------------------    ---------------

Interest expense:
   Deposits (Note 5)                                                                  4,069,009          3,769,899
   Federal Home Loan Bank advances (Note 6)                                             569,966            175,451
   Note payable                                                                          22,462                 --
   Note payable, ESOP                                                                    23,761             21,918
                                                                            -------------------    ---------------
                                                                                      4,685,198          3,967,268
                                                                             -------------------    --------------
           NET INTEREST INCOME                                                        4,707,772          3,911,911
Provision for loan losses (Note 3)                                                       88,000             20,000
                                                                             -------------------    --------------
           NET INTEREST INCOME AFTER PROVISION FOR
            LOAN LOSSES                                                               4,619,772          3,891,911
                                                                             -------------------    --------------
Noninterest income
   Insurance commissions                                                                 991,301           499,845
   Gain on sale on investments available for sale                                         94,603           165,505
   Other                                                                                 735,335           540,409
                                                                             -------------------    --------------
                                                                                       1,821,239         1,205,759
                                                                             -------------------    --------------
Noninterest expenses
   Compensation and employee benefits (Notes 8, 9, 10 and 11)                          3,022,254         2,261,079
   Occupancy and equipment                                                               502,700           426,161
   Deposit insurance premiums                                                             36,365            48,918
   Computer processing charges                                                           273,202           209,018
   Amortization                                                                           80,598            41,294
   Other                                                                               1,745,089         1,361,826
                                                                             -------------------    --------------
                                                                                       5,660,208         4,348,296
                                                                             -------------------    --------------
           INCOME BEFORE INCOME TAXES                                                    780,803           749,374
Income taxes (Note 12)                                                                   327,595           235,540
                                                                             -------------------    --------------
           NET INCOME                                                        $           453,208    $      513,834
                                                                             ===================    ==============
Basic earning per share (Note 14)                                            $              0.45    $         0.52
                                                                             ===================    ==============
Diluted earnings per share (Note 14)                                         $              0.45    $         0.52
                                                                             ===================    ==============
Cash dividends per share                                                     $              0.20    $         0.20
                                                                             ===================    ==============
</TABLE>

See Notes to Consolidated Financial Statements.


                                       21

<PAGE>

AF BANKSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED JUNE 30, 2000 AND 1999

<TABLE>
<CAPTION>
                                                                Common            Additional           Retained
                                                                 Stock         Paid-In Capital         Earnings
------------------------------------------------------------------------------------------------------------------
<S>                                                        <C>             <C>                    <C>
Balance, June 30, 1998                                     $      10,537   $         4,580,151    $      7,279,694
   Vesting of recognition and retention plan                          --                    --                  --
   Transfer from redeemable common stock net of
      unearned ESOP shares                                            --                    --             357,127
   ESOP contribution                                                  --                13,365              33,723
   Cash dividend, $.20 per share                                      --                    --            (205,105)
   Purchase of common stock for treasury                              --                    --                  --
   Issuance of common stock from treasury                             --                    --              (4,900)
   Net income                                                         --                    --             513,834
   Other comprehensive income, net of tax:
      Unrealized holding losses arising during
        period, net of taxes $(82,485) (Note 2)                       --                    --                  --
      Less:  reclassification adjustment for
        gains included in net income,
        net of taxes of $51,969 (Note 2)                              --                    --                  --
      Other comprehensive loss                                        --                    --                  --
   Comprehensive income                                               --                    --                  --
                                                           -------------   -------------------    ----------------
Balance, June 30, 1999                                            10,537             4,593,516           7,974,373
   Vesting of recognition and retention plan                          --                    --                  --
   Transfer from redeemable common stock net of
      unearned ESOP shares                                            --                    --              73,826
   ESOP contribution                                                  --                (1,961)             37,000
   Cash dividend, $.20 per share                                      --                    --            (206,442)
   Net income                                                         --                    --             453,208
   Other comprehensive income, net of tax:
      Unrealized holding losses arising during
        period, net of taxes $(192,664) (Note 2)                      --                    --                  --
      Less:  reclassification adjustment for
        gains included in net income,
        net of taxes of $36,536 (Note 2)                              --                    --                  --
      Other comprehensive loss                                        --                    --                  --
   Comprehensive income                                               --                    --                  --
                                                           -------------   -------------------    ----------------
Balance, June 30, 2000                                     $      10,537   $         4,591,555    $      8,331,965
                                                           =============   ===================    ================
</TABLE>

See Notes to Consolidated Financial Statements.


                                       22

<PAGE>

<TABLE>
<CAPTION>
                       Accumulated Other                                Total
  Recognition and        Comprehensive            Treasury          Stockholders'
   Retention Plan        Income (Loss)              Stock              Equity
----------------------------------------------------------------------------------
<S>                     <C>                    <C>                 <C>
  $     (678,576)       $       294,380        $          --       $    11,486,186
         198,616                     --                   --               198,616

              --                     --                   --               357,127
              --                     --                   --                47,088
              --                     --                   --              (205,105)
              --                     --             (113,750)             (113,750)
              --                     --               29,900                25,000
              --                     --                   --               513,834

              --               (204,278)                  --                    --

              --                113,536                   --                    --
                        ---------------
              --                (90,742)                  --               (90,742)
                                                                   ---------------
              --                     --                   --               423,092
  --------------        ---------------        -------------       ---------------
        (479,960)               203,638              (83,850)           12,218,254
         198,616                     --                   --               198,616

              --                     --                   --                73,826
              --                     --                   --                35,039
              --                     --                   --              (206,442)
              --                     --                   --               453,208

              --               (290,313)                  --                    --

              --                 58,067                   --                    --
                        ---------------
              --               (232,246)                  --              (232,246)
                                                                   ---------------
              --                     --                   --               220,962
   --------------        ---------------        -------------       ---------------
   $     (281,344)       $      (260,854)       $     (83,850)      $   12,540,255
   ==============        ===============        =============       ===============
</TABLE>


                                       23

<PAGE>

AF BANKSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED JUNE 30, 2000 AND 1999

<TABLE>
<CAPTION>
                                                                                     2000                1999
-----------------------------------------------------------------------------------------------------------------
<S>                                                                             <C>                 <C>
Cash Flows from Operating Activities
   Net income                                                                   $     453,208       $     513,834
   Adjustments to reconcile net income to net cash
      provided by operating activities:
        Provision for loan losses                                                      88,000              20,000
        Loss on disposal of office properties and equipment                                --                 607
        Loss on sale of other real estate owned                                        10,962                  --
        Gain on sale of investments available for sale                                (94,603)           (165,505)
        Provision for depreciation                                                    380,547             320,575
        Amortization of goodwill and noncompete covenants                              80,598              41,294
        Amortization of deferred loan fees                                           (175,794)           (156,603)
        Amortization of premium/discount on investments                                62,153              23,823
        Amortization of unearned ESOP shares                                           37,000              33,723
        ESOP fair value adjustment                                                     (1,961)             13,365
        Vesting of recognition and retention plan                                     198,616             198,616
        Stock compensation                                                                 --              25,000
        Proceeds from sale of loans held for sale                                   3,823,079          12,133,119
        Origination of loans held for sale                                         (3,831,520)        (12,120,263)
        (Gain) loss on sale of loans held for sale                                      8,441             (12,856)
        Deferred income taxes                                                          74,916             (59,165)
        Increase in operating assets:
           Accrued interest receivable                                               (191,880)            (86,957)
           Prepaid expenses and other assets                                          (15,596)           (107,058)
        Increase (decrease) in liabilities:
           Accounts payable and other liabilities                                      (6,049)            456,048
                                                                                -------------       -------------
             NET CASH PROVIDED BY OPERATING ACTIVITIES                                900,117           1,071,597
                                                                                -------------       -------------
Cash Flows from Investing Activities
   Purchases of securities available for sale                                      (1,500,000)         (9,501,897)
   (Increase) decrease in FHLB stock                                                 (252,100)            100,400
   Proceeds from calls of securities available for sale                             1,580,000           4,950,000
   Proceeds from sale of securities available for sale                                300,528             329,423
   Principal payments received on securities available for sale                     1,386,533           1,333,342
   Purchase of securities held to maturity                                           (100,000)                 --
   Proceeds from maturity of security held to maturity                                199,000                  --
   Net originations of loans receivable                                           (27,863,180)         (8,467,343)
   Purchase of office properties and equipment                                     (2,016,787)           (717,171)
   Proceeds from sale of properties and equipment                                      15,192              11,995
   Proceeds from sale of other real estate owned                                       88,080              54,165
   Purchase of goodwill and noncompete agreement                                           --            (266,000)
                                                                                -------------       -------------
             NET CASH USED IN INVESTING ACTIVITIES                                (28,162,734)        (12,173,086)
                                                                                -------------       -------------
</TABLE>
                                   (Continued)


                                       24

<PAGE>

AF BANKSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
YEARS ENDED JUNE 30, 2000 AND 1999

<TABLE>
<CAPTION>
                                                                                     2000                1999
---------------------------------------------------------------------------------------------------------------------
<S>                                                                              <C>                  <C>
Cash Flows from Financing Activities
   Net increase in savings deposits                                              $     9,573,744      $    10,617,874
   Net borrowings (payments) on FHLB advances                                         12,948,649           (1,551,238)
   Purchase of common stock for treasury                                                      --             (113,750)
   Principal payments on borrowings                                                      (25,542)             (40,000)
   Cash dividends paid                                                                  (206,442)            (205,105)
                                                                                 ---------------      ---------------
          NET CASH PROVIDED BY FINANCING ACTIVITIES                                   22,290,409            8,707,781
                                                                                 ---------------      ---------------
          NET DECREASE IN CASH AND CASH EQUIVALENTS                                   (4,972,208)          (2,393,708)

Cash and cash equivalents:
   Beginning                                                                          12,395,060           14,788,768
                                                                                 ---------------      ---------------
   Ending                                                                        $     7,422,852      $    12,395,060
                                                                                 ===============      ===============

Supplemental Schedule of Cash and Cash Equivalents
   Interest-bearing deposits                                                     $     2,599,071      $     4,173,311
   Noninterest-bearing                                                                 4,823,781            8,221,749
                                                                                 ---------------      ---------------
                                                                                 $     7,422,852      $    12,395,060
                                                                                 ===============      ===============

Supplemental Disclosures of Cash Flow Information
   Cash payments for:
      Interest                                                                   $      4,585,898     $     3,996,665
      Income taxes                                                                        241,907             335,333

Supplemental Disclosure of Noncash Investing and Financing
   Activities
      Net change in unrealized gain (loss) on securities available
        for sale, net of tax                                                     $       (232,246)    $      (90,742)
      Transfer from loans receivable to real estate owned                                 329,483            104,563
      Originations of loans to facilitate sale of real estate owned                            --            (29,513)
      Fair value of ESOP shares in excess of unearned ESOP shares                          36,826            323,404
      Transfer to retained earnings to redeemable common stock                             73,826            357,127
      Note payable issued for purchase of insurance agency                                700,000                 --
      Fair value of office equipment received in purchase of
        insurance agency                                                                  (17,785)                --
      Intangible assets recorded on purchase of insurance agency                         (682,215)                --
</TABLE>

See Notes to Consolidated Financial Statements.


                                       25

<PAGE>

AF BANKSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

NOTE 1.  NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Nature of  business:  AF  Bankshares,  Inc.  (the  "Company")  is a bank holding
company  which owns 100% of the common stock of AF Bank (the  "Bank"),  formerly
Ashe Federal Bank. The Company has no operations and conducts no business of its
own other than ownership of its  subsidiaries  and investing in securities.  The
Bank is a federally  chartered  stock savings bank which conducts  business from
its main office located in West  Jefferson,  North Carolina and four branches in
Sparta,  Jefferson,  Boone  and  Warrensville,  North  Carolina.  The  principal
activities  of the Bank consist of  obtaining  savings  deposits  and  providing
credit to customers  in its primary  market area,  Ashe,  Alleghany  and Watauga
Counties.  On April 15, 1996,  the Board of Directors of the Bank adopted a Plan
of  Reorganization  and a related Stock Issuance Plan pursuant to which the Bank
exchanged  its federal  mutual  savings bank charter for a federal stock savings
bank charter,  conducted a minority stock offering, and formed AsheCo, M.H.C., a
mutual holding company which owned 53.8% of the common stock issued by the Bank.
The Bank  conducted its minority  stock  offering in July and August of 1996 and
the closing  occurred on October 4, 1996. The Bank sold 461,779 shares of common
stock in the  minority  stock  offering,  including  36,942  shares  sold to its
Employee  Stock  Ownership  Plan (the "ESOP"),  and issued 538,221 shares to the
mutual holding company.  See Note 16 for additional  information  concerning the
minority stock offering and the reorganization.

On June 16, 1998,  the Board of Directors  approved the  formation of a mid-tier
holding company, AF Bankshares,  Inc. which became a 100% owner of the Bank in a
stock swap with AsheCo,  M.H.C., which was accounted for similar to a pooling of
interests. At June 30, 1998, AsheCo,  M.H.C.'s ownership of AF Bankshares,  Inc.
decreased to 51.10% due to the shares issued under the recognition and retention
plan discussed in Note 11. During the year ended June 30, 1999, AsheCo, M.H.C.'s
ownership  of AF  Bankshares,  Inc.  increased  to 51.29% due to the purchase of
shares held in treasury. No additional changes in AsheCo,  M.H.C.'s ownership of
AF Bankshares, Inc. occurred during the year ended June 30, 2000.

On July 1, 1997, the Bank purchased two insurance  agencies to form AF Insurance
Services,  Inc.,  which became a wholly owned  subsidiary of the Bank. A plan of
reorganization  was  completed  during  the  year  ended  June  30,  1999 and AF
Insurance Services, Inc. became a wholly owned subsidiary of AF Bankshares, Inc.
On April 1, 1999 and again on  December 1, 1999,  AF  Insurance  Services,  Inc.
purchased  additional insurance agencies.  AF Insurance Services,  Inc. operates
from its main office in West  Jefferson,  North  Carolina and branch  offices in
Lenoir,  North  Wilkesboro,  Jefferson,  Elkin and Sparta,  North Carolina.  The
transactions were recorded under the purchase method of accounting. Revenues are
not material to the financial information.

On August 5, 1998,  the Company  formed AF  Brokerage,  Inc.,  which is a wholly
owned  subsidiary of the Company.  Prior to receiving its approval from the NASD
to become a registered  broker/dealer,  AF Brokerage,  Inc. operated through the
use of a third party clearing broker.  AF Brokerage,  Inc. began operating as an
independent  broker/dealer  in  May,  2000.  Revenues  are not  material  to the
financial information.


                                       26

<PAGE>

AF BANKSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

NOTE 1.  NATURE OF  BUSINESS  AND  SUMMARY OF  SIGNIFICANT  ACCOUNTING  POLICIES
(CONTINUED)

The following is a description of the  significant  accounting  policies used in
the preparation of the accompanying financial statements.

Principles of consolidation:  The consolidated  financial statements include the
accounts of AF Bankshares,  Inc. and its wholly owned subsidiaries,  AF Bank, AF
Insurance  Services,  Inc. and AF Brokerage,  Inc. All significant  intercompany
transactions and balances have been eliminated in consolidation.

Basis of financial statement presentation: The accounting and reporting policies
of the Company conform to generally accepted  accounting  principles and general
practices  within the financial  services  industry.  In preparing the financial
statements, management is required to make estimates and assumptions that affect
the reported  amounts of assets and  liabilities  and  disclosure  of contingent
assets  and  liabilities  as of the  date of the  financial  statements  and the
reported revenues and expenses for the period.  Actual results could differ from
those estimates.

Cash and cash  equivalents:  For purposes of reporting  the  statements  of cash
flows,  the Company includes cash on hand and demand deposits at other financial
institutions  with  terms less than 90 days as cash and cash  equivalents.  Cash
flows from loans, loans held for sale and deposits are reported net. The Company
maintains  amounts due from banks which, at times, may exceed federally  insured
limits. The Company has not experienced any losses in such accounts.

Investment  securities:  The Company and the Bank have  investments  in debt and
equity securities.  Debt securities consist primarily of U.S.  Government agency
securities,  Federal Home Loan Bank bonds,  Fannie Mae and  Government  National
Mortgage Association  securities and certificates of deposit.  Equity securities
consist of  Federal  Home Loan  Mortgage  Corporation  (FHLMC)  stock and mutual
funds.

Management  classifies  all debt  securities  and certain  equity  securities as
trading,  available  for sale,  or held to  maturity  as  individual  investment
securities   are  acquired,   and  thereafter   the   appropriateness   of  such
classification  is reassessed  at each  statement of financial  condition  date.
Because  the Company  does not buy  investment  securities  in  anticipation  of
short-term  fluctuations in market prices, none of the investment securities are
classified as trading in accordance with Statement 115. All securities have been
classified as either available for sale or held to maturity.

Securities available for sale:  Securities  classified as available for sale are
those  securities that the Company  intends to hold for an indefinite  period of
time but, as in the case of debt  securities,  not necessarily to maturity.  Any
decision to sell a security  classified  as available for sale would be based on
various factors,  including  significant movements in interest rates, changes in
the maturity  mix of the  Company's  assets and  liabilities,  liquidity  needs,
regulatory  capital  considerations,   and  other  similar  factors.  Securities
available  for sale are  carried  at fair  value.  Premiums  and  discounts  are
amortized  using the interest  method over the  securities'  contractual  lives.
Unrealized gains or losses are reported as increases or decreases in equity, net
of the related deferred tax effect. Realized gains or losses,  determined on the
basis of the cost of specific securities sold, are included in income.


                                       27

<PAGE>

AF BANKSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

NOTE 1.  NATURE OF  BUSINESS  AND  SUMMARY OF  SIGNIFICANT  ACCOUNTING  POLICIES
(CONTINUED)

Declines  in the fair  value  of  individual  securities  classified  as  either
available  for sale or held to  maturity  below  their  amortized  cost that are
determined to be other than  temporary  result in  write-downs of the individual
securities  to their fair  value  with the  resulting  write-downs  included  in
current earnings as realized losses.

Securities held to maturity: Securities classified as held to maturity are those
securities  for which the  Company  has both the intent  and  ability to hold to
maturity regardless of changes in market conditions,  liquidity needs or changes
in general  economic  conditions.  These securities are carried at cost adjusted
for amortization of premium and accretion of discount,  computed by the interest
method over their contractual lives.  Based on the Company's  financial position
and  liquidity,  management  believes  the Company has the ability to hold these
securities to maturity.

Investment in Federal Home Loan Bank stock: The Bank, as a member of the Federal
Home Loan Bank (FHLB)  system,  is required to maintain an investment in capital
stock of the FHLB in an amount  equal to the  greater  of 1% of its  outstanding
home loans or 5% of advances  from the FHLB. No ready market exists for the FHLB
stock, and it has no quoted market value.

Loans receivable: Loans receivable are stated at unpaid principal balances, less
the allowance for loan losses,  the undisbursed  portion of construction  loans,
and net  deferred  loan-origination  fees and costs.  The Bank's loan  portfolio
consists  principally of mortgage loans  collateralized  by first trust deeds on
single family residences,  other residential  property,  commercial property and
land.

Allowance for loan losses: The allowance for loan losses is increased by charges
to income and decreased by charge-offs  (net of recoveries)  based on the Bank's
evaluation of the  potential and inherent risk of losses in its loan  portfolio.
Management's  periodic  evaluation  of the adequacy of the allowance is based on
the Bank's past loan loss experience, known and inherent risks in the portfolio,
adverse  situations  that may  affect  the  borrower's  ability  to  repay,  the
estimated value of any underlying  collateral,  and current economic conditions.
While management uses the best information available to make evaluations, future
adjustments may be necessary,  if economic or other conditions  differ or change
substantially from the assumptions used.

Impaired loans: SFAS No. 114,  Accounting by Creditors for Impairment of a Loan,
requires that the Bank  establish a specific loan  allowance on an impaired loan
if the  present  value of the  future  cash  flows  discounted  using the loan's
effective interest rate is less than the carrying value of the loan. An impaired
loan can also be valued  based upon its fair  value or the  market  value of the
underlying  collateral if the loan is primarily collateral  dependent.  The Bank
assesses for impairment all loans delinquent more than 90 days. See Note 3 for a
further information.


                                       28

<PAGE>

AF BANKSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

NOTE 1.  NATURE OF  BUSINESS  AND  SUMMARY OF  SIGNIFICANT  ACCOUNTING  POLICIES
(CONTINUED)

Interest  income:  SFAS No. 118,  Accounting  by Creditors  for  Impairment of a
Loan--Income  Recognition and  Disclosures,  which amended SFAS No. 114 requires
disclosure of the Bank's method of  accounting  for interest  income on impaired
loans. The Bank does not accrue interest on loans delinquent 90 days or more. In
addition,  interest accrued up to 90 days is reversed by the  establishment of a
reserve for uncollected interest, if in the opinion of management collectibility
is uncertain.  Such interest, if ultimately collected,  is credited to income in
the period  received.  The Bank anticipates that it will account for interest on
impaired  loans in a similar  fashion in the future if and when it has  impaired
loans.

Loan-origination  fees and  related  costs:  Loan fees and  certain  direct loan
origination  costs are  deferred,  and the net fee or cost is  recognized  as an
adjustment  to interest  income using the interest  method over the  contractual
life of the loans, adjusted for actual prepayments.

Loans held for sale: Loans held for sale are those loans the Bank has the intent
to sell in the  foreseeable  future.  They are carried at the lower of aggregate
cost or market  value.  Gains and  losses  on sales of loans are  recognized  at
settlement dates and are determined by the difference between the sales proceeds
and the carrying value of the loans.  All sales are made without  recourse.  The
Bank has no loans held for sale at June 30, 2000 or 1999.

Real estate owned: Real estate owned is initially recorded at the estimated fair
value at the date of foreclosure,  establishing a new cost basis.  Subsequent to
foreclosure, valuations of the property are periodically performed by management
and the  real  estate  is  carried  at the  lower  of cost or fair  value  minus
estimated  costs to sell.  Costs  relating to  improvement  of the  property are
capitalized,  while  holding costs of the property are charged to expense in the
period incurred.

Office  properties and equipment:  Office properties and equipment are stated at
cost less accumulated  depreciation  computed  principally by the  straight-line
method over estimated useful lives.

Intangible  assets:  Goodwill  is the  cost of the  investment  in AF  Insurance
Services, Inc. in excess of the fair value of net assets at the date of purchase
and is being  amortized  by the  straight  line  method over a period of fifteen
years.  Noncompete  agreements are stated at cost less accumulated  amortization
computed by the straight-line method over a period of seven years.

Pension plans: The Bank has a 401(k)  retirement plan available to substantially
all employees.  The Bank matches certain portions of voluntary  contributions by
participating employees.

The Bank has  deferred  compensation  and  retirement  plan  agreements  for the
benefit of the Board of Directors.  Both plans are unfunded and the  liabilities
are being accrued over the terms of active  service of the  directors.  The Bank
also has an ESOP which covers substantially all of it's employees. Contributions
to the plan are based on amounts necessary to fund the amortization requirements
of the ESOP's debt to an unrelated third party financial institution, subject to
compensation  limitations,  and are expensed  based on the AICPA's  Statement of
Position 93-6, Employers' Accounting for Employee Stock Ownership Plans.


                                       29

<PAGE>

AF BANKSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

NOTE 1.  NATURE OF  BUSINESS  AND  SUMMARY OF  SIGNIFICANT  ACCOUNTING  POLICIES
(CONTINUED)

Additionally,  the  Company  has  implemented  a  qualified  stock  option  plan
authorizing  the grant of up to 21,322  stock  options to certain  officers  and
directors,  either in the form of incentive stock options or non-incentive stock
options.  The Bank has also  implemented  a recognition  and  retention  plan by
reserving  53,678  shares of common stock for  issuance to certain  officers and
directors.

Advance  payments by borrowers for taxes and insurance:  Certain  borrowers make
monthly payments,  in addition to principal and interest, in order to accumulate
funds from which the Bank can pay the  borrowers'  property  taxes and insurance
premiums.

Income  taxes:  Deferred  taxes are  provided on an asset and  liability  method
whereby deferred tax assets are recognized for deductible temporary  differences
and operating loss and tax credit  carryforwards,  and deferred tax  liabilities
are recognized for taxable temporary differences.  Temporary differences are the
differences between the reported amounts of assets and liabilities and their tax
bases.  Deferred tax assets are reduced by a valuation  allowance  when,  in the
opinion of  management,  it is more likely than not that some  portion or all of
the  deferred  tax  assets  will  not  be  realized.  Deferred  tax  assets  and
liabilities are adjusted for the effects of changes in tax laws and rates on the
date of enactment.

Off-statement  of  financial  condition  risk:  The Bank is a party to financial
instruments with  off-statement of financial  condition risk such as commitments
to extend credit and home equity lines of credit.  Management  assesses the risk
related to these instruments for potential losses on an ongoing basis.

Earnings per share: SFAS No. 128, Earnings Per Share,  requires the presentation
of earnings per share by all entities that have common stock or potential common
stock,  such as options,  warrants and convertible  securities  outstanding that
trade in a public market. Those entities that have only common stock outstanding
are  required to present  basic  earnings  per-share  amounts.  Basic  per-share
amounts  are   computed  by  dividing   net  income  (the   numerator)   by  the
weighted-average  number of common shares  outstanding  (the  denominator).  All
other  entities are  required to present  basic and diluted  per-share  amounts.
Diluted  per-share  amounts assume the  conversion,  exercise or issuance of all
potential  common stock  instruments  unless the effect is to reduce the loss or
increase  the income  per common  share  from  continuing  operations.  For both
computations,  the number of shares of common stock  purchased by the  Company's
employee  stock  ownership  plan,  which have not been  allocated to participant
accounts, are not assumed to be outstanding.

Comprehensive income: SFAS No. 130, Reporting Comprehensive Income,  establishes
standards for reporting and display of  comprehensive  income and its components
(revenues,  expenses,  gains  and  losses)  in a  full  set  of  general-purpose
financial statements. This statement requires that all items that are recognized
under accounting  standards as components of comprehensive income be reported in
a  financial  statement  that is  displayed  with the same  prominence  as other
financial statements.


                                       30

<PAGE>

AF BANKSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

NOTE 1.  NATURE OF  BUSINESS  AND  SUMMARY OF  SIGNIFICANT  ACCOUNTING  POLICIES
(CONTINUED)

Fair value of financial  instruments:  The estimated fair values  required under
SFAS No. 107, Disclosures About Fair Value of Financial  Instruments,  have been
determined by the Company using  available  market  information  and appropriate
valuation methodologies.  However,  considerable judgment is required to develop
the estimates of fair value.  Accordingly,  the estimates presented for the fair
value of the Company's financial  instruments are not necessarily  indicative of
the amounts the Company could realize in a current market  exchange.  The use of
different  market  assumptions or estimation  methodologies  may have a material
effect on the estimated fair market value amounts.

The fair value estimates presented are based on pertinent  information available
to management as of June 30, 2000 and 1999.  Although management is not aware of
any factors that would  significantly  affect the  estimated  fair value amount,
such  amounts  have not been  comprehensively  revalued  for  purposes  of these
financial  statements since that date and therefore,  current  estimates of fair
value may differ significantly from the amounts presented herein.

NOTE 2. DEBT AND EQUITY SECURITIES

Debt and equity  securities  have been classified in the statements of financial
condition  according to management's  intent.  The carrying amount of securities
and approximate fair values at June 30 were as follows:

<TABLE>
<CAPTION>
                                                                                  2000
                                                -----------------------------------------------------------------
                                                                     Gross            Gross
                                                  Amortized        Unrealized       Unrealized          Fair
                                                    Cost              Gains            Losses           Value
                                                -----------------------------------------------------------------
<S>                                              <C>                <C>             <C>               <C>
Available for sale securities:
   Debt securities:
      U.S. Government agency securities          $ 4,415,595        $   1,348       $  (88,558)       $ 4,328,385
      Fannie Mae and Government
        National Mortgage Association              3,204,715            5,348          (54,836)         3,155,227
      Municipals                                     282,930               --          (11,559)           271,371
   Equity securities:
      Mutual Funds                                 1,000,000               --          (98,655)           901,345
      Federal Home Loan Mortgage
        Corporation Common Stock                       4,200          199,924               --            204,124
                                                 ----------------------------------------------------------------
                                                   8,907,440          206,620         (253,608)         8,860,452
Held to maturity securities:
   Debt securities:
      Federal Home Loan Bank                         100,000               --               --            100,000
Other investments:
   Federal Home Loan Bank stock                      775,700               --               --            775,700
                                                 ----------------------------------------------------------------
                                                 $ 9,783,140        $ 206,620       $ (253,608)       $ 9,736,152
                                                 ================================================================
</TABLE>


                                       31

<PAGE>

AF BANKSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

NOTE 2. DEBT AND EQUITY SECURITIES (CONTINUED)

<TABLE>
<CAPTION>
                                                                           1999
                                               --------------------------------------------------------------
                                                                    Gross         Gross
                                                Amortized        Unrealized     Unrealized           Fair
                                                   Cost             Gains         Losses             Value
                                               --------------------------------------------------------------
<S>                                            <C>               <C>            <C>              <C>
Available for sale securities:
   Debt securities:
      U.S. Government agency securities        $  4,524,263      $   3,125      $  (39,229)      $  4,488,159
      Fannie Mae and Government
        National Mortgage Association             4,625,811         49,513          (3,080)         4,672,244
      Municipals                                    281,977                        (20,493)           261,484
   Equity securities:
      Mutual Funds                                1,205,216         61,939         (45,792)         1,221,363
      Federal Home Loan Mortgage
        Corporation Common Stock                      4,784        328,136              --            332,920
                                                -------------------------------------------------------------
                                                 10,642,051        442,713        (108,594)        10,976,170

Held to maturity securities:
   Debt securities:
      Federal Home Loan Bank                        100,000             --              --            100,000
Other investments:
   Federal Home Loan Bank stock                     523,600             --              --            523,600
                                               --------------------------------------------------------------
                                               $ 11,265,651      $ 442,713      $ (108,594)      $ 11,599,770
                                               ==============================================================
</TABLE>

The amortized cost and estimated fair value of debt securities at June 30, 2000,
by  contractual  maturity are shown below.  Fannie Mae and  Government  National
Mortgage  Association  securities  are not included in the  maturity  categories
because they do not have a single maturity date. Additionally, equity securities
and mutual funds are not included in the maturity categories because they do not
have contractual maturities.

                                       32

<PAGE>

AF BANKSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

NOTE 2.     DEBT AND EQUITY SECURITIES (CONTINUED)

<TABLE>
<CAPTION>
                                               Held to maturity securities:  Available for sale securities:
                                               ------------------------------------------------------------
                                                Amortized                      Amortized
                                                  Cost          Fair Value        Cost           Fair Value
                                               ------------------------------------------------------------
<S>                                            <C>             <C>             <C>              <C>
Due from one year to five years                $ 100,000        $ 100,000       $ 3,269,590     $ 3,219,813
Due from five years to ten years                      --               --           500,000         492,187
Due after ten years                                   --               --           928,935         887,756
Fannie Mae and Government
   National Mortgage Association
   debt securities                                    --               --         3,204,715       3,155,227
Mutual funds                                          --                          1,000,000         901,345
Equity securities                                     --               --             4,200         204,124
                                               ------------------------------------------------------------
                                               $ 100,000        $ 100,000       $ 8,907,440     $ 8,860,452
                                               ============================================================
</TABLE>

Sales of securities are summarized as follows for the years ended June 30:

<TABLE>
<CAPTION>

                                                                                2000            1999
                                                                            ----------------------------
<S>                                                                         <C>              <C>
Proceeds from calls of securities available for sale                        $ 1,580,000      $ 4,950,000
Proceeds from sale of securities available for sale                             300,528          329,423
                                                                            ----------------------------
                                                                              1,880,528        5,279,423
Realized gain on sale of securities available for sale                          (94,603)        (165,505)
                                                                            ----------------------------
Cost of securities sold                                                     $ 1,785,925      $ 5,113,918
                                                                            ============================

</TABLE>

The change in accumulated other comprehensive  income (loss),  which consists of
unrealized  gains (losses) on securities  available for sale for the years ended
June 30, are as follows:

<TABLE>
<CAPTION>
                                                                                2000            1999
                                                                            ----------------------------
<S>                                                                         <C>              <C>
Balance, beginning                                                          $   203,638      $   294,380
Change in net unrealized gains                                                 (381,107)        (149,383)
Change in deferred income taxes                                                 148,861           58,641
                                                                            ----------------------------
Balance, ending                                                             $   (28,608)     $   203,638
                                                                            ============================
</TABLE>


                                       33

<PAGE>

AF BANKSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

NOTE 3. LOANS RECEIVABLE

Loans receivable at June 30, consist of the following:

<TABLE>
<CAPTION>
                                                                                2000            1999
                                                                            ----------------------------
<S>                                                                         <C>             <C>
   One to four-family                                                       $ 68,813,143    $ 48,432,985
   Multifamily                                                                 2,277,623         316,111
   Non residential                                                             8,577,554       2,068,070
   Land                                                                        2,439,602       1,258,481
   Construction loans                                                          4,058,901       5,081,781
   Commercial loans                                                           10,455,888      18,261,202
   Consumer loans                                                             17,375,621      12,143,508
                                                                            ----------------------------
                                                                             113,998,332      87,562,138

Less:
   Undisbursed loan funds                                                     (3,992,983)     (5,033,086)
   Deferred loan fees                                                           (247,824)       (249,605)
   Allowance for loan losses                                                    (979,268)     (1,122,681)
                                                                            ----------------------------
                                                                            $108,778,257    $ 81,156,766
                                                                            ============================
</TABLE>

The  following  is an  analysis of the  allowance  for loan losses for the years
ended June 30:

<TABLE>
<CAPTION>
                                                                                2000            1999
                                                                            ----------------------------
<S>                                                                         <C>             <C>

Balance, beginning                                                          $ 1,122,681      $ 1,164,263
   Provisions charged to operations                                              88,000           20,000
   Charge-offs                                                                 (327,835)         (74,034)
   Recoveries                                                                    96,422           12,452
                                                                            ----------------------------
Balance, ending                                                             $   979,268      $ 1,122,681
                                                                            ============================

</TABLE>

SFAS No. 114,  Accounting by Creditors  for  Impairment of a Loan, as amended by
SFAS No. 118 Accounting by Creditors for Impairment of a Loan-Income Recognition
and  Disclosure,  requires  that the Bank  establish  a  specific  allowance  on
impaired  loans and  disclosure of the Bank's method of accounting  for interest
income on impaired  loans.  The Bank assesses all loans  delinquent more than 90
days for  impairment  and such loans  amounted  to  approximately  $411,000  and
$60,000  at June 30,  2000 and 1999,  respectively.  These  loans are  primarily
collateral   dependent  and  management  has  determined   that  the  underlying
collateral value is in excess of the carrying amounts. As a result, the Bank has
determined  that specific  allowances on these loans are not required.  Interest
income foregone during 2000 and 1999 was $16,249 and $4,313,  respectively.  The
Bank established reserves for uncollectible interest totaling $10,911 and $4,313
at June 30, 2000 and 1999, respectively.


                                       34

<PAGE>

AF BANKSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

--------------------------------------------------------------------------------
NOTE 3. LOANS RECEIVABLE (CONTINUED)

Loan  activity to officers and  directors of the Company  during the years ended
June 30, 2000 and 1999, is summarized as follows:

<TABLE>
<CAPTION>
                                       2000            1999
                                   ----------------------------
<S>                                <C>              <C>
Balance, beginning                 $ 1,035,605      $   943,194
Disbursements                          470,177          672,300
Payments received                     (180,609)         579,890
                                   ----------------------------
Balance, ending                    $ 1,325,173      $ 1,035,604
                                   ============================
</TABLE>

Mortgage loans serviced for others consist of FNMA loans and are not included in
the  accompanying  statements of financial  condition.  Mortgage loan portfolios
serviced for Fannie Mae were  approximately  $22,613,000 and $20,657,000 at June
30, 2000 and 1999, respectively.

There were no loans held for sale or outstanding commitments to sell loans as of
June 30, 2000 or 1999.

NOTE 4. OFFICE PROPERTIES AND EQUIPMENT

Office properties and equipment at June 30 consist of the following:

<TABLE>
<CAPTION>
                                       2000            1999
                                   ----------------------------
<S>                                <C>              <C>
Land and land improvements         $   308,329      $   308,329
Buildings                            2,968,811        1,421,055
Furniture and fixtures               1,919,117        1,434,791
Leasehold improvements                 252,120          252,120
Automobiles                             63,409           84,345
                                   ----------------------------
                                     5,511,786        3,500,640
Accumulated depreciation            (1,328,176)        (955,863)
                                   ----------------------------
                                   $ 4,183,610      $ 2,544,777
                                   ============================
</TABLE>


                                       35

<PAGE>

AF BANKSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

NOTE 5. SAVINGS DEPOSITS

Savings deposits at June 30 consist of the following:

<TABLE>
<CAPTION>
                                                                                              2000                         1999
                                                                                         ------------------------------------------
<S>                                                                                      <C>                           <C>
Interest-bearing checking accounts at 1.91% (2.25% 1999)                                 $  17,194,967                 $ 13,831,977
Commercial and free checking (noninterest bearing)                                           3,960,144                    3,914,090
Passbook savings 3.83% (3.05% 1999)                                                         23,032,283                   21,840,801
Money market demand accounts 2.00% (2.50% 1999)                                              1,393,563                    1,593,041
                                                                                         ------------------------------------------
                                                                                            45,580,957                   41,179,909
                                                                                         ------------------------------------------
Certificates of Deposit:
   weighted average rate of 5.71% (4.94% 1999)
      4.00% to 5.99%                                                                        38,922,959                   49,488,579
      6.00% to 7.99%                                                                        18,014,374                    2,299,181
                                                                                         ------------------------------------------
                                                                                            56,937,333                   51,787,760
                                                                                         ------------------------------------------
Accrued interest payable                                                                       161,544                      138,421
                                                                                         ------------------------------------------
                                                                                         $ 102,679,834                 $ 93,106,090
                                                                                         ==========================================
Weighted average cost of savings deposits                                                         4.34%                        4.29%
                                                                                         ==========================================

</TABLE>

At June 30,  2000,  scheduled  maturities  of  certificates  of  deposit  are as
follows:

<TABLE>
<CAPTION>
                                2001              2002              2003              2004             After               Total
                            -------------------------------------------------------------------------------------------------------
<S>                         <C>               <C>               <C>                <C>             <C>                  <C>
4.00% to 5.99%              $33,438,122       $3,899,891        $ 1,022,495        $  338,907       $   223,544         $38,922,959
6.00% to 7.99%               14,523,035        1,681,664          1,612,238            50,000           147,437          18,014,374
                            -------------------------------------------------------------------------------------------------------
                            $47,961,157       $5,581,555        $ 2,634,733        $  388,907       $   370,981         $56,937,333
                            =======================================================================================================
</TABLE>

The  aggregate   amount  of  jumbo   certificates  of  deposit  with  a  minimum
denomination  of $100,000 was  $17,081,469  and $13,910,406 at June 30, 2000 and
1999, respectively. At June 30, 2000, scheduled maturities of jumbo certificates
of deposit are as follows:

<TABLE>
<CAPTION>
                                                                                                                         Weighted
                                                                                               Amount                  Average Rate
                                                                                            ---------------------------------------
<S>                                                                                         <C>                          <C>
Maturity period:
   Within three months                                                                      $ 5,568,024                   5.81%
   Three through six months                                                                   4,748,807                   5.99
   Six through twelve months                                                                  4,719,992                   6.08
   Over twelve months                                                                         2,044,646                   5.58
                                                                                            ---------------------------------------
                                                                                            $17,081,469                   5.89%
                                                                                            =======================================
</TABLE>

                                       36

<PAGE>

AF BANKSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

NOTE 5. SAVINGS DEPOSITS (CONTINUED)

Eligible  savings  accounts  are insured to $100,000 by the Savings  Association
Insurance Fund (SAIF) which is  administered  by the Federal  Deposit  Insurance
Corporation (FDIC).

The Bank has pledged  securities  with a fair value of $100,000 at June 30, 2000
as collateral on treasury tax and loan account.

Interest  expense on savings  deposits  consists of the  following for the years
ended June 30:

<TABLE>
<CAPTION>
                                                                                     2000                1999
                                                                             --------------------=------------------
<S>                                                                          <C>                 <C>
Interest-bearing checking                                                    $        352,730    $     300,521
Passbook savings accounts                                                             831,664          698,461
Certificate accounts                                                                2,884,615        2,770,917
                                                                             ---------------------------------------
                                                                             $      4,069,009    $   3,769,899
                                                                             == ====================================
</TABLE>

NOTE 6. NOTES PAYABLE AND FEDERAL HOME LOAN BANK ADVANCES

Notes payable were entered into by AF Insurance  Services,  Inc. in  conjunction
with the  purchase  of an  insurance  agency in Elkin,  NC and  consists  of the
following at June 30:

<TABLE>
<CAPTION>
                                                                                     2000                 1999
                                                                             ---------------------------------------
<S>                                                                          <C>                 <C>
Notes payable, due in quarterly interest only installments at
   5.50% through December 1, 2004, at which time repayments
   of principal and interest will commence over a period of 60
   months with first payment due on January 1, 2005.                         $        700,000    $                --
                                                                             =======================================
</TABLE>

The Bank had advances outstanding of $15,513,007 and $2,564,358 at June 30, 2000
and 1999, respectively, from the FHLB. Interest is payable at rates ranging from
6.13% to 6.95%.  Pursuant to collateral  agreements with the FHLB,  advances are
collateralized by all the Bank's stock in the FHLB and qualifying first mortgage
loans.  $4,000,000  of the  advances  are due in June 2001,  $862,500  is due by
August 2002,  $150,507 is due January 2007,  $5,000,000 is due August 2009,  and
$3,000,000  is due  September  2009.  The  remaining  $2,500,000  is an  advance
borrowed  under the Daily Rate  Credit  Program at the FHLB and has no  maturity
date.  Interest  expense was  $569,966 and $175,451 for the years ended June 30,
2000 and 1999, respectively.


                                       37

<PAGE>

AF BANKSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

NOTE 7. STOCKHOLDERS' EQUITY

The Bank is subject to various regulatory capital  requirements  administered by
the federal banking agencies.  Failure to meet minimum capital  requirements can
initiate certain mandatory -- and possibly  additional  discretionary -- actions
by regulators  that, if undertaken,  could have a direct  material effect on the
Bank's  financial   statements.   Under  capital  adequacy  guidelines  and  the
regulatory  framework for prompt corrective  action, the Bank must meet specific
capital guidelines that involve quantitative  regulatory  accounting  practices.
The Bank's capital amounts and  classifications  are also subject to qualitative
judgments  by the  regulators  about  components,  risk  weightings,  and  other
factors.

The Office of Thrift Supervision (OTS) regulations require  institutions to have
a minimum  regulatory  tangible capital equal to 1.5% of total assets, a minimum
ratio of 3% of total assets is required for the core capital ratio  provided the
institution  receives the highest  rating during the  examination  process.  For
institutions that receive less than the highest rating, the minimum core capital
ratio requirement is 4% of total assets. A minimum of 8% of risk-weighted assets
is required for the  risk-based  capital  ratio.  At June 30, 2000 and 1999, the
Bank exceeded all of the capital requirements.

The  following is a  reconciliation  of the Bank's  capital in  accordance  with
generally  accepted  accounting  principles  (GAAP) to the three  components  of
regulatory capital calculated under the requirements of the OTS at June 30, 2000
and 1999:

<TABLE>
<CAPTION>
                                                       June 30, 2000 Regulatory Capital
                          -------------------------------------------------------------------------------------------
                                              Percent                       Percent                        Percent
                                                 of                            of                            of
                                Tangible      Tangible          Core        Tangible       Risk-based    Risk-based
                                 Capital       Assets          Capital       Assets          Capital       Assets
                          -------------------------------------------------------------------------------------------
<S>                       <C>                   <C>        <C>               <C>       <C>                     <C>
GAAP capital              $      11,688,699                $  11,688,699               $     11,688,699
Unrealized loss on
   securities
   available for sale                28,608                       28,608                         28,608
Equity investment
   and other assets                      --                           --                        (118,575)
Qualifying general
   loan loss
   allowance                             --                           --                         979,268
                          -----------------                -------------               -----------------
Regulatory capital               11,717,307     8.9 %         11,717,307     8.9 %             12,578,000     11.9 %
Minimum capital
   requirement                    1,976,366     1.5            5,270,309     4.0                8,427,471       8.0
                          ------------------------------------------------------------------------------------------
Excess regulatory
   capital                $       9,740,941     7.4 %      $   6,446,998     4.9 %     $        4,150,529      3.9 %
                          ==========================================================================================
</TABLE>


                                       38

<PAGE>

AF BANKSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

NOTE 7. STOCKHOLDERS' EQUITY (CONTINUED)

<TABLE>
<CAPTION>
                                                       June 30, 1999 Regulatory Capital
                          -------------------------------------------------------------------------------------------
                                              Percent                       Percent                        Percent
                                                 of                            of                            of
                                Tangible      Tangible          Core        Tangible       Risk-based    Risk-based
                                 Capital       Assets          Capital       Assets          Capital       Assets
                          -------------------------------------------------------------------------------------------
<S>                       <C>                  <C>      <C>                <C>         <C>                  <C>
GAAP capital              $    11,063,063               $    11,063,063                $    11,063,063
Unrealized gain on
   securities
   available for sale            (165,855)                     (165,855)                     (165,855)
Equity investment
   and other assets                    --                            --                       147,661
Qualifying general
   loan loss
   allowance                           --                            --                       856,113
                          ---------------               ---------------                --------------
Regulatory capital             10,897,208      10.0 %        10,897,208    10.0 %          11,900,982      17.4 %
Minimum capital
   requirement                  1,627,815       1.5           4,340,840     4.0             5,483,920       8.0
                          -------------------------------------------------------------------------------------------
Excess regulatory
   capital                $     9,269,393       8.5 %   $     6,556,368     6.0 %      $    6,417,062       9.4 %
                          ===========================================================================================
</TABLE>

As of June 30, 2000, the most recent  notification  from the OTS categorized the
Bank as well capitalized  under the regulatory  framework for prompt  corrective
action.  To be  categorized  as well  capitalized,  the Bank must maintain total
capital to risk weighted  assets of 10%, Tier I Capital to risk weighted  assets
of 6% and Tier I Capital to total assets of 5% or  $10,534,339,  $6,320,603  and
$6,587,888,   respectively.  There  are  no  conditions  or  events  since  that
notification that management believes have changed the Bank's category.

Under the conversion regulations the Bank may not declare or pay a cash dividend
on any of its stock if the effect  thereof  would cause the Bank's  equity to be
reduced below (1) the amount  required for the liquidation  account;  or (2) the
net worth requirements imposed by the OTS.

The Company paid cash  dividends  totaling $.20 per share during the each of the
years ended June 30, 2000 and 1999. On August 21, 2000,  the Company  declared a
$.05 per share cash dividend for  stockholders of record as of September 1, 2000
to be paid on September 18, 2000.


                                       39

<PAGE>

AF BANKSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

NOTE 8. EMPLOYEE PENSION AND INCENTIVE PLANS

The  Company has a  profit-sharing  plan for the  benefit of  substantially  all
employees.  Contributions  are discretionary and totaled $57,608 and $41,281 for
the years ended June 30, 2000 and 1999, respectively.

The Company also has a discretionary  bonus plan under which bonuses are paid to
all employees if approved by the Board of Directors each year.  Expense  related
to these  incentives  was $113,220 and $36,544 for the years ended June 30, 2000
and 1999, respectively.

In addition,  the Company has a 401(k) retirement plan which contains provisions
for specified matching  contributions by the Bank. The Bank funds  contributions
as they accrue and 401(k) plan  expense  amounted to $92,302 and $70,367 for the
years ended June 30, 2000 and 1999, respectively.

NOTE 9. EMPLOYEE STOCK OWNERSHIP PLAN

As  part  of the  Reorganization,  the  Bank  established  an  ESOP  to  benefit
substantially  all employees.  The ESOP purchased  36,942 shares of common stock
with the proceeds from a loan from a third party financial institution. The note
requires annual principal  payments of 10% of the outstanding  principal balance
plus interest at the lending  institution's  prime rate (9.50% at June 30, 2000)
less .5% with a balloon  payment  due June,  2002.  The Bank is expected to make
quarterly  contributions to the ESOP in amounts  sufficient to allow the ESOP to
make its scheduled  principal and interest payments on the note. The ESOP shares
are  pledged  as  collateral  for the debt.  As the debt is  repaid,  shares are
released from collateral and allocated to active employees,  based on proportion
of debt  service  paid in the year.  The debt of the ESOP is recorded as debt in
the Company's accompanying statement of financial condition.

At June 30, 2000, future principal payments are due as follows:

<TABLE>
<CAPTION>
Year Ending June 30:                                                                                  Amount
-------------------------------------------------------------------------------------------------------------------
<S>                                                                                            <C>
2001                                                                                           $          22,988
2002                                                                                                     206,890
                                                                                               -----------------
                                                                                               $         229,878
                                                                                               =================
</TABLE>

Dividends on unallocated shares may be used by the ESOP to repay the debt to the
Bank and are not reported as dividends in the financial statements. Dividends on
allocated or  committed  to be allocated  shares are credited to the accounts of
the participants and reported as dividends in the financial statements.


                                       40

<PAGE>

AF BANKSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

NOTE 9. EMPLOYEE STOCK OWNERSHIP PLAN (CONTINUED)

Excluding  interest,  expense  of  $35,039  and  $47,088  during  2000 and 1999,
respectively,  has been  incurred  in  connection  with the  ESOP.  The  expense
includes,  in  addition  to the cash  contribution  necessary  to fund the ESOP,
$(1,961) in 2000 and $13,365 in 1999,  which  represents the difference  between
the fair  value of the  shares  which  have been  released  or  committed  to be
released to participants, and the cost of these shares to the ESOP. The Bank has
credited  (charged)  this  amount to  paid-in  capital  in  accordance  with the
provisions of AICPA Statement of Position 93-6.

At June 30, 2000 and 1999,  15,100 and 11,400  shares held by the ESOP have been
released or committed to be released to the plan's  participants for purposes of
computing  earnings per share. The fair value of the unallocated shares amounted
to approximately $175,000 and $281,000 at June 30, 2000 and 1999, respectively.

The Bank has also recorded a liability for a put back option,  which  represents
the excess of the fair market  value of the total number of ESOP shares over the
original cost of the unallocated ESOP shares.  The liability  recorded under the
put  back  option  was  $77,116  and   $150,942  at  June  30,  2000  and  1999,
respectively.

NOTE 10. DEFERRED COMPENSATION AND RETIREMENT PLAN AGREEMENTS

The Bank has an unfunded deferred  compensation  agreement providing retirement,
disability,  and  death  benefits  for  directors.  Vested  benefits  under  the
agreements are payable in monthly  installments  over a ten-year period upon the
director's  death,  disability or retirement.  The Bank has insured the lives of
the directors for amounts  sufficient  to discharge  its  obligations  under the
agreements.  The Bank also has a  retirement  plan for  members  of the Board of
Directors  which the Plan states that outside  directors with at least ten years
of service will  receive an amount equal to their annual  retainer for ten years
after their  retirement from the Board.  The liability for the benefits is being
accrued over the terms of active service of the directors. The amount charged to
expense  under these  plans  amounted to $55,536 and $54,361 for the years ended
June 30, 2000 and 1999, respectively.


                                       41

<PAGE>

AF BANKSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

NOTE 11. RECOGNITION AND RETENTION PLAN AND STOCK OPTION PLAN

The Bank's stockholders  approved the Bank's Recognition and Retention Plan (the
"RRP") and the Bank's  stock  option plan on December 8, 1997.  The stock option
plan provides for the issuance of up to 21,322 stock options to certain officers
and  directors in the form of incentive  stock  options or  non-incentive  stock
options.  The exercise  price of the stock options may not be less than the fair
market value of the Company's common stock at the date of grant.  Under the Plan
21,322 of options,  which vest at the rate of 20% annually beginning at the date
of grant,  were all  granted on December 8, 1997 and expire on December 8, 2007.
As permitted under the generally accepted  accounting  principles,  grants under
the plan are accounted  for  following the  provisions of APB Opinion No. 25 and
its  related  interpretations.   Accordingly,  no  compensation  cost  has  been
recognized for grants made to date. Had compensation  cost been determined based
on the fair value method  prescribed  in FASB  Statement  No. 123, the pro forma
effect on reported net income for the year ended June 30, 2000 and 1999 would be
as follows:

<TABLE>
<CAPTION>
                                                                                   2000                 1999
                                                                           -------------------------------------
<S>                                                                        <C>                   <C>
   Net income
      As reported                                                          $           453,208   $       513,834
      Pro forma                                                                        424,553           485,179
   Earnings per share
      As reported
        Basic                                                              $              0.45   $          0.52
        Diluted                                                                           0.45              0.52
      Pro forma
        Basic                                                                             0.42              0.49
        Diluted                                                                           0.42              0.49
</TABLE>

In determining the fair value of the option grant as prescribed in Statement No.
123,  the  Black-Scholes  option  pricing  model  was used  with  the  following
assumptions:  a risk-free  interest rate of 5.61%,  expected  lives of 10 years,
expected volatility of 17.19% and expected dividends of $0.20 per year.

At June 30,  2000,  21,322  options  have been  granted at an exercise  price of
$18.50, of which 12,793 options are currently exercisable.  No options have been
exercised to date and all options granted are outstanding at June 30, 2000.

The RRP reserved for issuance 53,678 shares of common stock to certain  officers
and  directors.  The Bank issued shares to fund the RRP in December of 1997. The
restricted  common  stock  under  the RRP  vests  at the  rate  of 20%  annually
beginning  at the date of grant.  The expense  related to the vesting of the RRP
totaled $198,616 for each of the years ended June 30, 2000 and 1999.


                                       42

<PAGE>

AF BANKSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

NOTE 12. INCOME TAX MATTERS

Under  the  Internal  Revenue  code,  the Bank is  allowed  a  special  bad debt
deduction  related to additions  to tax bad debt  reserves  established  for the
purpose of absorbing  losses.  The Bank is required to compute  such  deductions
using an experience  method.  The Bank's tax bad debt deduction was $231,413 and
$61,583 in 2000 and 1999, respectively.

The Bank will have to  recapture  its  excess tax bad debt  reserves  which have
accumulated  since 1988,  amounting  to  approximately  $92,000  over a six year
period.  The tax  associated  with  the  recaptured  reserves  is  approximately
$36,000. The recapture was scheduled to begin with the Bank's 1997 year, but was
delayed  two years  because  the Bank  originated  a required  minimum  level of
mortgage loans.  Deferred income taxes have been previously  established for the
taxes  associated with the recaptured  reserves and the ultimate  payment of the
related  taxes  will not result in a charge to  earnings.  The amount of reserve
recaptured   and  associated   tax  were   approximately   $15,000  and  $6,000,
respectively, for each of the years ended June 30, 2000 and 1999.

Deferred  taxes have been  provided for certain  increases in the Bank's tax bad
debt  reserves  subsequent  to 1987 which are in excess of additions to recorded
loan loss  allowances.  At June 30,  2000,  retained  earnings  contain  certain
historical   additions  to  bad  debt   reserves  for  income  tax  purposes  of
approximately  $870,000,  the  balance at June 30,  1987,  for which no deferred
taxes have been provided  because the Bank does not intend to use these reserves
for purposes other than to absorb losses. If amounts which qualified as bad debt
deductions  are used for  purposes  other  than to  absorb  bad debt  losses  or
adjustments arising from the carryback of net operating losses, income taxes may
be imposed at the then  existing  rates.  The  approximate  amount of unrecorded
deferred  tax  liability   associated   with  these   historical   additions  is
approximately  $340,000. In the future, if the Bank does not meet the income tax
requirements  necessary to permit the  deduction of an allowance  for bad debts,
the Bank's  effective  tax rate would  increase  to the  maximum  percent  under
existing law.


                                       43

<PAGE>

AF BANKSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

NOTE 12. INCOME TAX MATTERS (CONTINUED)

The tax effects of temporary  differences that gave rise to significant portions
of the net deferred tax asset as of June 30 were:

<TABLE>
<CAPTION>
                                                                                    2000                1999
                                                                            ------------------------------------
<S>                                                                         <C>                   <C>
Deferred tax assets:
   Reserve for loan losses                                                  $         376,711     $     435,431
   Reserve for uncollected interest                                                     3,908             1,672
   Unrealized loss on securities available for sale                                    18,378                --
   Deferred compensation                                                              224,030           201,933
   Recognition and retention plan                                                      44,743            44,934
   Deferred loan fees                                                                   6,255                --
   State net economic loss carryforwards                                                8,717                --
                                                                            -----------------------------------
                                                                                      682,742           683,970
                                                                            -----------------------------------
Deferred tax liabilities:
   Reserve for loan losses                                                             17,738            23,752
   Unrealized gain on securities available for sale                                        --           130,483
   Depreciation                                                                       104,051            37,602
   FHLB stock dividends                                                                60,170            60,427
   Prepaid expenses                                                                     1,738                --
   Deferred loan fees                                                                      --             6,606
                                                                            -----------------------------------
                                                                                      183,697           258,870
                                                                            -----------------------------------
            NET DEFERRED TAX ASSET                                          $         499,045     $     425,100
                                                                            ===================================
</TABLE>

At June 30, 2000 and 1999,  no valuation  allowance was recorded on deferred tax
assets.

The provision  for income taxes  charged to operations  for the years ended June
30, 2000 and 1999 consists of the following:

<TABLE>
<CAPTION>
                                                                                    2000                1999
                                                                            ----------------------------------------
<S>                                                                         <C>                    <C>
Current                                                                     $          252,679     $     294,705
Deferred                                                                                74,916           (59,165)
                                                                            ----------------------------------------
                                                                            $          327,595     $     235,540
                                                                            ========================================
</TABLE>

A  reconciliation  of income taxes computed at the statutory  federal income tax
rate to the income tax provision follows:

<TABLE>
<CAPTION>
                                                       2000                                   1999
                                      ------------------------------------------------------------------------------
                                             Amount             Percent             Amount             Percent
                                      ------------------------------------------------------------------------------
<S>                                   <C>                        <C>             <C>                     <C>
Tax at statutory rate                 $          265,473         34.0%           $     254,787           34.0%
State tax, net of federal benefit                 32,928          4.2                   25,834            3.4
Municipal interest income                         (9,231)        (1.2)                 (27,296)          (3.6)
Permanent differences                             42,682         5.50                       --             --
Other                                             (4,257)        (0.5)                 (17,785)          (2.4)
                                      ------------------------------------------------------------------------------
Total                                 $          327,595        42.0%           $      235,540           31.4%
                                      ==============================================================================
</TABLE>


                                       44

<PAGE>

AF BANKSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

NOTE 13. COMMITMENTS AND CONTINGENCIES

The Bank is a party to financial  instruments  with  off-statement  of financial
condition  risk in the normal course of business to meet the financing  needs of
its customers.  These financial instruments include commitments to extend credit
and equity  lines of credit.  Those  instruments  involve,  to varying  degrees,
elements of credit and interest rate risk in excess of the amount  recognized in
the statement of financial condition.  The contract or notional amounts of those
instruments reflect the extent of involvement the Bank has in particular classes
of financial instruments.

A summary of the  contract  amount of the Bank's  exposure to  off-statement  of
financial condition risk, except for undisbursed  construction loan funds, is as
follows at June 30, 2000:

<TABLE>
<CAPTION>
                                                                                                     Notional
                                                                                                      Amount
                                                                                               --------------------
<S>                                                                                            <C>
Financial instruments whose contract amounts represent credit risk:
   Undisbursed home equity lines of credit                                                     $       8,453,000
   Undisbursed commercial letters of credit                                                               25,000
</TABLE>

The Bank evaluates each customer's  credit  worthiness on a case-by-case  basis.
Commitments  to extend  credit are  agreements  to lend to a customer as long as
there is no violation of any condition established in the contract.  Home equity
lines of credit have  variable  rates based on the prime rate of interest.  Home
equity lines are reassessed  every five years.  Because many of the  commitments
are expected to expire without being drawn upon, the total commitment amounts do
not necessarily  represent future cash requirements.  The collateral obtained by
the Bank upon extension of credit is based on management's  credit evaluation of
the customer.  The collateral  held is the underlying  real estate.  Undisbursed
commercial lines of credit have variable rates of prime plus two percent and are
reassessed on an annual basis. Prime at June 30, 2000 was 9.50%.

The  Bank  has  entered  into  operating  leases  for the  branch  locations  in
Warrensville,  Sparta and Boone,  North  Carolina and the two insurance  company
branches  located in Wilkesboro and Lenoir,  North Carolina.  The minimum annual
lease payments are not significant to the Company's operations.


                                       45

<PAGE>

AF BANKSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

NOTE 14. EARNINGS PER SHARE

Earnings per share has been calculated in accordance  with Financial  Accounting
Standards Board Statement No. 128, Earnings Per Share, and Statement of Position
93-6,  Employers' Accounting for Employee Stock Ownership Plans. For purposes of
this  computation,  the number of shares of common stock purchased by the Bank's
employee  stock  ownership  plan which have not been  allocated  to  participant
accounts are not assumed to be outstanding. The following are reconciliations of
the amounts used in the per share calculations:

<TABLE>
<CAPTION>
                                                                       For the Year Ended June 30, 2000
                                                           ---------------------------------------------------------
                                                                  Income            Shares            Per Share
                                                               (Numerator)       (Denominator)         Amount
                                                           ---------------------------------------------------------
<S>                                                        <C>                     <C>               <C>
BASIC AND DILUTED EPS                                      $       453,208         1,009,987         $      0.45
                                                           =========================================================

<CAPTION>
                                                                       For the Year Ended June 30, 1999
                                                           ---------------------------------------------------------
                                                                  Income            Shares            Per Share
                                                               (Numerator)       (Denominator)         Amount
                                                           ---------------------------------------------------------
<S>                                                        <C>                       <C>             <C>
BASIC AND DILUTED EPS                                      $       513,834           995,301         $      0.52
                                                           =========================================================
</TABLE>

NOTE 15. FAIR VALUE OF FINANCIAL INSTRUMENTS

The  following  table  reflects a  comparison  of carrying  amounts and the fair
values of the financial instruments as of June 30, 2000 and 1999:

<TABLE>
<CAPTION>
                                                         2000                                   1999
                                       -------------------------------------------------------------------------------
                                            Carrying              Fair              Carrying              Fair
                                              Value               Value               Value               Value
                                       ------------------- -----------------------------------------------------------
<S>                                    <C>                  <C>                 <C>                 <C>
Financial assets:
   Cash
      Interest-bearing                 $        2,599,071   $   2,599,071       $  4,173,311        $   4,173,311
      Noninterest-bearing
        deposits                                4,823,781       4,823,781          8,221,749            8,221,749
   Certificates of deposit                         99,000          99,000            198,000              198,000
   Investments                                  8,960,452       8,960,452         11,076,170           11,076,170
   Loans receivable                           108,778,257     108,706,482         81,156,766           79,796,954
   Accrued interest receivable                    688,396         688,396            496,516              496,516
   FHLB stock                                     775,700         775,700            523,600              523,600

Financial liabilities:
   Deposits                                   102,679,834     102,513,268         93,106,090           92,924,645
   Advances from FHLB                          15,513,007      15,513,007          2,564,358            2,564,358
   Notes payable                                  700,000         700,000                 --                   --
   Note payable, ESOP                             229,878         229,878            255,420              255,420
</TABLE>


                                       46

<PAGE>

AF BANKSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

NOTE 15. FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)

The fair  values  utilized  in the table  were  derived  using  the  information
described below for the group of instruments listed. It should be noted that the
fair values disclosed in this table do not represent market values of all assets
and liabilities of the Company and, thus, should not be interpreted to represent
the market or liquidation value of the Company.

The following methods and assumptions were used by the Company in estimating the
fair value of its financial instruments:

Cash and certificates of deposits:  The carrying amounts for cash and short-term
instruments approximate their fair values.

Investment  securities:  Fair values for  securities  are based on quoted market
prices, where available. If quoted market prices are not available,  fair values
are based on quoted market prices of similar securities.

Loans receivable: The fair value of fixed rate loans is estimated by discounting
the future cash flows using the current  rates at which  similar  loans would be
made to  borrowers  with  similar  credit  ratings  and for the  same  remaining
maturities.  Certain  prepayment  assumptions have also been made depending upon
the original  contractual  lives of the loans.  The fair value of variable  rate
loans approximates their carrying value as these loans reprice frequently.

Accrued  interest  receivable and accrued  interest  payable:  The fair value of
accrued interest  receivable and payable is the amount  receivable or payable on
demand at the statement of financial condition date.

FHLB stock: The fair value of FHLB stock is the stated value by the FHLB.

Deposits: The fair value of demand deposits,  savings accounts and certain money
market  deposits is the amount  payable on demand at the  statement of financial
condition  date.  The fair value of fixed maturity  certificates  of deposit are
estimated based upon the discounted  value of contractual cash flows using rates
currently offered for deposits with similar remaining maturities.

Advances from FHLB, Notes payable and Note payable,  ESOP: The fair value of the
Advances  from  FHLB,  Notes  payable  and  Note  payable,  ESOP is equal to the
carrying value of the liability.

Off-statement of financial condition instruments:  Fair values for the Company's
off-statement of financial condition instruments (loan commitments) are based on
fees currently charged for similar agreements, taking into account the remaining
terms of the agreements and the counterparties' credit standings. The fair value
for such commitments is nominal.


                                       47

<PAGE>

AF BANKSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

NOTE 16. REORGANIZATION AND MINORITY STOCK OFFERING

On October 4, 1996, the Bank  consummated  its  reorganization,  as explained in
Note 1, and issued 461,779 shares in a minority stock offering (including 36,942
shares  to the  ESOP)  which  resulted  in  gross  proceeds  of  $4,617,790,  or
$3,917,389,  net of conversion  costs of $700,401.  At closing,  such costs were
netted  against  the  stock  proceeds  received  and  shown  as a  reduction  of
stockholders' equity. As a part of the reorganization,  the Bank formed a mutual
holding company,  AsheCo,  M.H.C., which was issued 538,221 shares of the Bank's
common stock. Members of the mutual holding company consist of depositors of the
Bank,  who have the sole authority to elect the board of directors of the mutual
holding company for as long as it remains in mutual form. Initially,  the mutual
holding  company's  principal  assets were the shares of the Bank's common stock
received in the reorganization and on its initial  capitalization of $100,000 in
cash. The mutual holding company,  which by law must own in excess of 50% of the
stock of the  Bank,  was  issued  stock in the  reorganization  resulting  in an
ownership  interest  of 53.8% of the  Bank.  By  virtue  of its  ownership  of a
majority of the  outstanding  shares of the Bank, the mutual holding company can
generally  control the outcome of most matters  presented to the stockholders of
the Bank for  resolution  by vote  except for certain  matters  related to stock
compensation plans, a vote regarding conversion of the mutual holding company to
stock  form,  or  other  matters  which  require  a vote  only  by the  minority
stockholders.  The mutual  holding  company has registered as a savings and loan
holding  company and is subject to regulation,  examination,  and supervision by
the OTS.

The Bank also established an ESOP which was issued 36,942 shares of common stock
in the  reorganization.  The funds used by the ESOP to acquire these shares were
obtained from borrowings from an  unaffiliated  third party lender.  The loan is
reflected in the financial  statements of the Bank which makes  contributions to
the ESOP necessary to amortize the debt. Such  contributions  are expensed based
upon the fair value of the ESOP shares released or committed to be released from
restriction (or no longer debt  financed).  The total number of shares of common
stock issued as a result of the offering and reorganization  were 1,000,000.  On
June 16,  1998,  the Board of  Directors  approved  the  formation of a mid-tier
holding company, AF Bankshares,  Inc. which became a 100% owner of the Bank in a
stock swap with AsheCo,  M.H.C., which was accounted for similar to a pooling of
interests. At June 30, 1998, AsheCo,  M.H.C.'s ownership of AF Bankshares,  Inc.
decreased to 51.1% due to the shares issued under the  recognition and retention
plan discussed in Note 11. At June 30, 1999,  AsheCo,  M.H.C.'s  ownership of AF
Bankshares,  Inc.  increased  to 51.38% due to the  purchase  of shares  held in
treasury.

Concurrent  with the  reorganization,  the Bank has  established  a  liquidation
account in an amount equal to its net worth as reflected in its latest statement
of financial  condition used in its final  offering  circular.  The  liquidation
account will be maintained for the benefit of eligible  deposit  account holders
and supplemental eligible deposit account holders who continue to maintain their
deposit  accounts in the Bank after the  reorganization.  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  reorganization  cannot  be paid  from this
liquidation account.

The Bank may not  declare  or pay a cash  dividend  on its  common  stock if its
stockholders'  equity would thereby be reduced below either the aggregate amount
then  required for the  liquidation  account or the minimum  regulatory  capital
requirements imposed by federal regulations.


                                       48

<PAGE>

AF BANKSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

NOTE 17. MID-TIER HOLDING COMPANY AND MUTUAL HOLDING COMPANY DATA

The following are the condensed financial statements of AF Bankshares, as of and
for the years ended June 30, 2000 and 1999:

<TABLE>
<CAPTION>
                                                AF Bankshares, Inc.
                                             Condensed Balance Sheets
                                              June 30, 2000 and 1999
                                                                                    2000                1999
                                                                             ---------------------------------------
<S>                                                                            <C>                 <C>
Assets:
   Cash                                                                        $            116    $       232,410
   Securities available for sale                                                             --            267,155
   Investment in AF Bankshares                                                       11,688,699         11,063,063
   Investment in AF Insurance Services, Inc.                                            696,028            744,851
   Investment in AF Brokerage, Inc.                                                     241,252            236,758
   Other assets                                                                         259,060            111,930
                                                                             ---------------------------------------
                                                                               $     12,885,155    $    12,656,167
                                                                             =======================================
Liabilities and Equity:
   Liabilities:
      Accounts payable                                                         $         37,906    $        31,551
      Note payable - ESOP                                                               229,878            255,420
      Redeemable common stock held by the ESOP, net of
        unearned ESOP shares                                                             77,116            150,942
                                                                             ---------------------------------------
                                                                                        344,900            437,913
                                                                             ---------------------------------------

   Equity:
      Common stock                                                                       10,537             10,537
      Additional paid-in capital                                                     11,871,250         11,873,210
      Retained earnings                                                               1,052,270            694,679
      Recognition and retention plan                                                   (281,344)          (479,960)
      Accumulated other comprehensive income (loss)                                     (28,608)           203,638
                                                                             ---------------------------------------
                                                                                     12,624,105         12,302,104
      Less cost of 4,300 shares of treasury stock                                       (83,850)           (83,850)
                                                                             ---------------------------------------
                                                                                     12,540,255         12,218,254
                                                                             ---------------------------------------
                                                                             $       12,885,155    $    12,656,167
                                                                             =======================================
</TABLE>


                                       49

<PAGE>

AF BANKSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

NOTE 17. MID-TIER HOLDING COMPANY AND MUTUAL HOLDING COMPANY DATA (CONTINUED)

<TABLE>
<CAPTION>
                                                AF Bankshares, Inc.
                                          Condensed Statements of Income
                                        Years Ended June 30, 2000 and 1999

                                                                                    2000                1999
                                                                             ---------------------------------------
<S>                                                                              <C>               <C>
Interest and investment income                                                   $     65,207      $     18,305
Equity in earnings subsidiaries                                                       577,154           645,031
Income tax credits                                                                     64,344            74,212
Other expense                                                                        (253,497)         (223,714)
                                                                             ----------------------------------------
        Net income                                                               $    453,208      $    513,834
                                                                             ========================================

<CAPTION>
                                                AF Bankshares, Inc.
                                        Condensed Statements of Cash Flows
                                        Years Ended June 30, 2000 and 1999

                                                                                    2000                1999
                                                                             -----------------------------------
<S>                                                                              <C>               <C>
Cash Flows from Operating Activities:
   Net income                                                                    $    453,208      $     513,834
   Change in assets and liabilities:
      Gain on sale of securities                                                      (63,994)           (17,400)
      Stock compensation                                                                   --             25,000
      Equity in earnings of subsidiaries                                             (577,154)          (645,031)
      Increase in accounts payable and other liabilities                               39,883                608
      Increase in other assets                                                       (147,130)          (111,930)
                                                                             -----------------------------------
        Net cash used in operating activities                                        (295,187)          (234,919)
                                                                             -----------------------------------
Cash Flows from Investing Activities:
   Purchase of securities available for sale                                               --           (367,001)
   Proceeds from sales of securities available for sale                               269,335            179,185
   Upstream dividends from AF Bank                                                         --          2,000,000
   Purchase of insurance agency                                                            --           (276,000)
   Capitalization of AF Brokerage, Inc.                                                    --           (250,000)
   Investment in AF Insurance Services, Inc.                                               --           (500,000)
                                                                             -----------------------------------
        Net cash provided by investing activities                                     269,335            786,184
                                                                             -----------------------------------
Cash Flows from Financing Activities:
   Cash dividends paid                                                               (206,442)          (205,105)
   Purchase of common stock for treasury                                                   --           (113,750)
                                                                             -----------------------------------
        Net cash used in financing activities                                        (206,442)          (318,855)
                                                                             -----------------------------------
Net increase (decrease) in cash                                                      (232,294)           232,410
   Cash - beginning                                                                   232,410                 --
                                                                             -----------------------------------
   Cash - ending                                                             $            116      $     232,410
                                                                             ===================================
</TABLE>


                                       50

<PAGE>

AF BANKSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

NOTE 17. MID-TIER HOLDING COMPANY AND MUTUAL HOLDING COMPANY DATA (CONTINUED)

The  following  are the condensed  financial  statements  of the mutual  holding
company, AsheCo, M.H.C., as of and for the years ended June 30, 2000 and 1999:

<TABLE>
<CAPTION>
                                                  AsheCo, M.H.C.
                                             Condensed Balance Sheets
                                              June 30, 2000 and 1999

                                                                                    2000                1999
                                                                            ----------------------------------------
<S>                                                                             <C>                <C>
Assets:
   Cash                                                                         $      281,371     $     222,503
   Investment in AA&G, Inc. and Subsidiary                                              99,090            66,828
   Investment in AF Bankshares, Inc. and Subsidiaries                                6,431,897         6,277,739
   Other assets                                                                         48,588            26,086
                                                                            ----------------------------------------
                                                                                $     686,0946    $    6,593,156
                                                                            ========================================
Liabilities and Equity:
   Liabilities:
      Accrued expenses and other liabilities                                    $       1,000     $        1,000
                                                                            ----------------------------------------
   Equity:
      Additional paid-in-capital                                                    5,797,425          5,768,073
      Retained earnings                                                             1,062,521            824,083
                                                                            ----------------------------------------
                                                                                    6,859,946          6,592,156
                                                                            ----------------------------------------
                                                                                $   6,860,946     $    6,593,156
                                                                            ========================================

<CAPTION>
                                                  AsheCo, M.H.C.
                                          Condensed Statements of Income
                                        Years Ended June 30, 2000 and 1999

                                                                                    2000                1999
                                                                            ----------------------------------------
<S>                                                                              <C>              <C>
Interest income                                                                  $      7,367     $        6,242
Equity in earnings subsidiaries                                                       264,713            296,610
Income tax credits (expense)                                                           (9,661)            14,212
Other expense                                                                         (23,981)           (42,452)
                                                                            ----------------------------------------
        Net income                                                               $     238,438    $      274,612
                                                                            ========================================
</TABLE>


                                       51

<PAGE>

AF BANKSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

NOTE 17. MID-TIER HOLDING COMPANY AND MUTUAL HOLDING COMPANY DATA (CONTINUED)

<TABLE>
<CAPTION>
                                                  AsheCo, M.H.C.
                                         Condensed Statement of Cash Flows
                                        Years Ended June 30, 2000 and 1999

                                                                                    2000                1999
                                                                            ----------------------------------------
<S>                                                                         <C>                     <C>
Cash Flows from Operating Activities:
   Net income                                                               $          238,438      $      274,612
   Change in assets and liabilities:
      Equity in earnings of subsidiaries                                              (264,713)           (296,610)
      Decrease in accounts payable                                                          --             (11,000)
      Increase in other assets                                                         (22,502)             (6,677)
                                                                            ----------------------------------------
        Net cash used in operating activities                                          (48,777)            (39,675)
Cash Flows from Investing Activities:
   Dividends from AF Bankshares, Inc.                                                 (107,645)           (107,644)
                                                                            ----------------------------------------
Net increase in cash                                                                    58,868              67,969
   Cash - beginning                                                                    222,503             154,534
                                                                            ----------------------------------------
   Cash - ending                                                            $          281,371      $      222,503
                                                                            ========================================
</TABLE>

NOTE 18. RECENT ACCOUNTING PRONOUNCEMENTS

The FASB has issued SFAS No. 133,  Accounting  for  Derivative  Instruments  and
Hedging Activities,  which the Company has not been required to adopt as of June
30, 2000.  This  Statement,  which is effective for fiscal years beginning after
June 15, 2000,  establishes  accounting  and reporting  standards for derivative
instruments,   including  certain  derivative   instruments  embedded  in  other
contracts, (collectively referred to as derivatives) and for hedging activities.
It  requires  that an entity  recognize  all  derivatives  as  either  assets or
liabilities in the statement of financial position and measure those instruments
at fair value.  If certain  conditions are met, a derivative may be specifically
designated  as (a) a hedge of the  exposure  to  changes  in the fair value of a
recognized asset or liability or an unrecognized firm commitment, (b) a hedge of
the exposure to variable cash flows of a forecasted transaction,  or (c) a hedge
of the foreign currency exposure of a net investment in a foreign operation,  an
unrecognized  firm  commitment,  an available  for sale  security,  or a foreign
currency denominated forecasted  transaction.  This Statement is not expected to
have a significant impact on the Company.


                                       52

<PAGE>










                      (This page intentionally left blank)










                                       53

<PAGE>

AF BANKSHARES, INC.

CORPORATE INFORMATION

                                    OFFICERS

JAMES A. TODD                                        MELANIE PAISLEY MILLER
  President and Chief Executive Officer                Executive Vice President,
                                                        Secretary/Treasurer,
                                                        Chief Financial Officer

                                    DIRECTORS

JAN R. CADDELL, Chairman                        KENNETH R. GREENE, Vice Chairman

JAMES A. TODD                                   JOHN D. WEAVER

JERRY L. ROTEN                                  WAYNE R. BURGESS

W. O. ASHLEY, JR.                               FRANK E. ROLAND


                                       54

<PAGE>

CORPORATE INFORMATION (Continued)

                                     OFFICES

<TABLE>
<CAPTION>
<S>                                                             <C>
Corporate Offices                                               Insurance and Brokerage Offices
21 East Ashe Street                                             206 S. Jefferson Avenue
West Jefferson, North Carolina 28694                            West Jefferson, North Carolina 28694

West Jefferson Office                                           Jefferson Office
205 S. Jefferson Avenue                                         840 E. Main Street
West Jefferson, North Carolina 28694                            Jefferson, North Carolina 28640

Warrensville Office                                             Sparta Office - d/b/a Alleghany First Bank
4951 NC Hwy. 88 West                                            403 South Main Street
Warrensville, North Carolina 28693                              Sparta, NC 28675

Boone Office - d/b/a Appalachian First Bank                     North Wilkesboro Office - AF Brown Insurance
285 Highway 105                                                 315 Main Street
Boone, NC 28607                                                 North Wilkesboro, NC 28659

Lenoir Office - AF Blair Insurance                              AF Insurance Center of Elkin
324 Morganton Blvd, SW                                          227A West Main Street
Lenoir, NC 28645                                                Elkin, NC 28621

     STOCK TRANSFER AGENT                                                 LEGAL COUNSEL

ChaseMellon Shareholders Services, LLC                          Vannoy & Reeves
Overpeck Centre                                                 306 East Main Street
85 Challenger Road                                              West Jefferson, North Carolina 28694
Ridgefield Park, New Jersey 07660
www.chasemellon.com                                             Thacher Proffitt & Wood
                                                                1700 Pennsylvania Avenue
           AUDITORS                                             Washington, DC 20006
McGladrey & Pullen, LLP
One Morrocroft Centre                                                      FORM 10-KSB
6805 Morrison Boulevard, Suite 200
Charlotte, North Carolina 28211                                 A copy of Form 10-KSB as filed with the
                                                                Office of Thrift Supervision will be
        ANNUAL MEETING                                          furnished without charge to shareholders upon
                                                                written request to James A. Todd, President, AF
The 2000 annual meeting of stockholders of                      Bankshares, Inc., 21 East Ashe Street,
AF Bankshares, Inc. will be held on November 6,                 P.O. Box 26, West Jefferson, NC 28694.
2000 at 6:00 p.m. at the Corporate Office, 21 East
Ashe Street, West Jefferson, North Carolina.
</TABLE>


                                       55

<PAGE>

COMMON STOCK

The Company had 1,049,378 shares of common stock outstanding at August 31, 2000,
which are held by 429  shareholders  of record.  The majority of the outstanding
shares are held by the mutual holding company AsheCo, MHC. The remaining 515,457
shares are owned by minority  shareholders  including the Company's ESOP. Shares
are quoted on the OTC Electronic Bulletin Board under the symbol "ASFE."

MARKET FOR THE COMMON STOCK

There  is no  established  market  for the  Company's  common  stock,  excluding
occasional quotations,  although the Company's common stock is quoted on the OTC
Electronic  Bulletin  Board.  The table  below  reflects  the stock  trading and
dividend payment  frequency of the Company for the years ended June 30, 2000 and
1999.  For further  information  regarding  the  Company's  dividend  policy and
restrictions  on  dividends  paid,  please  refer to note 7 of the  notes to the
consolidated  financial  statements.  Stock  prices  reflect bid prices  between
broker/dealer,  prior to any markups,  markdowns or  commissions,  is based upon
information  provided to management of the Company by certain  securities  firms
effecting  transactions in the Company's stock on an ongoing basis,  and may not
necessarily represent actual transactions.

<TABLE>
<CAPTION>
                                                                                              STOCK PRICE
2000:                                                                  DIVIDENDS          HIGH             LOW
--------------------------------------------------------------------------------------------------------------------
<S>                                                                 <C>                <C>              <C>
First Quarter                                                       $           0.05   $       11.88    $   10.00
Second Quarter                                                                  0.05           12.00         8.13
Third Quarter                                                                   0.05            9.38         8.50
Fourth Quarter                                                                  0.05            8.00         6.13

<CAPTION>
                                                                                              STOCK PRICE
1999:                                                                  DIVIDENDS          HIGH             LOW
------------------------------------------------------------------- -------------------------------- ---------------
<S>                                                                 <C>                <C>              <C>
First Quarter                                                       $           0.05   $       22.00    $   14.00
Second Quarter                                                                  0.05           19.00        11.50
Third Quarter                                                                   0.05           17.25        12.00
Fourth Quarter                                                                  0.05           13.50         9.50
</TABLE>

DISCLAIMER:  This statement has not been reviewed,  or confirmed for accuracy or
relevance, by the Office of Thrift Supervision.


                                       56
</TEXT>
</DOCUMENT>
<DOCUMENT>
<TYPE>EX-27
<SEQUENCE>3
<FILENAME>0003.txt
<DESCRIPTION>EXHIBIT 27
<TEXT>

<TABLE> <S> <C>

<ARTICLE>                                            9
<LEGEND>
     (Replace this text with the legend)
</LEGEND>
<CIK>                         0001064025
<NAME>                        AF BANKSHARES
<MULTIPLIER>                                                 1,000
<CURRENCY>                                                   US DOLLARS

<S>                                            <C>                <C>
<PERIOD-TYPE>                                  YEAR            12-MOS
<FISCAL-YEAR-END>                              JUN-30-2000     JUN-30-1998
<PERIOD-START>                                 JUL-01-1999     JUL-01-1999
<PERIOD-END>                                   JUN-30-2000     JUN-30-1999
<EXCHANGE-RATE>                                1,000           1,000
<CASH>                                         4,824           8,222
<INT-BEARING-DEPOSITS>                         2,599           8,173
<FED-FUNDS-SOLD>                               0               0
<TRADING-ASSETS>                               0               0
<INVESTMENTS-HELD-FOR-SALE>                    8,860           10,976
<INVESTMENTS-CARRYING>                         975             822
<INVESTMENTS-MARKET>                           975             822
<LOANS>                                        108,778         82,280
<ALLOWANCE>                                    979             1,323
<TOTAL-ASSETS>                                 133,370         109,931
<DEPOSITS>                                     102,680         93,106
<SHORT-TERM>                                   0               0
<LIABILITIES-OTHER>                            2,407           1,788
<LONG-TERM>                                    15,742          2,819
<PREFERRED-MANDATORY>                          0               0
<PREFERRED>                                    0               0
<COMMON>                                       11              11
<OTHER-SE>                                     12,529          12,207
<TOTAL-LIABILITIES-AND-EQUITY>                 133,370         109,931
<INTEREST-LOAN>                                8,598           6,807
<INTEREST-INVEST>                              605             501
<INTEREST-OTHER>                               189             571
<INTEREST-TOTAL>                               9,393           7,878
<INTEREST-DEPOSIT>                             4,069           3,770
<INTEREST-EXPENSE>                             4,685           3,957
<INTEREST-INCOME-NET>                          4,708           3,912
<LOAN-LOSSES>                                  (88)            20
<SECURITIES-GAINS>                             95              166
<EXPENSE-OTHER>                                5,660           4,348
<INCOME-PRETAX>                                781             749
<INCOME-PRE-EXTRAORDINARY>                     781             749
<EXTRAORDINARY>                                0               0
<CHANGES>                                      0               0
<NET-INCOME>                                   453             514
<EPS-BASIC>                                    .45             .52
<EPS-DILUTED>                                  .45             .52
<YIELD-ACTUAL>                                 8.62            8.18
<LOANS-NON>                                    411             60
<LOANS-PAST>                                   0               0
<LOANS-TROUBLED>                               40              0
<LOANS-PROBLEM>                                0               0
<ALLOWANCE-OPEN>                               1,123           1,164
<CHARGE-OFFS>                                  (328)           (74)
<RECOVERIES>                                   96              13
<ALLOWANCE-CLOSE>                              979             1,123
<ALLOWANCE-DOMESTIC>                           979             1,123
<ALLOWANCE-FOREIGN>                            0               0
<ALLOWANCE-UNALLOCATED>                        0               0


</TABLE>
</TEXT>
</DOCUMENT>
</SUBMISSION>
