<SUBMISSION>
<ACCESSION-NUMBER>0000928385-01-501902
<TYPE>10KSB40
<PUBLIC-DOCUMENT-COUNT>2
<PERIOD>20010630
<FILING-DATE>20010928
<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>10KSB40
<ACT>34
<FILE-NUMBER>000-24479
<FILM-NUMBER>1747245
</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>10KSB40
<SEQUENCE>1
<FILENAME>d10ksb40.txt
<DESCRIPTION>FORM 10-KSB40
<TEXT>
<PAGE>

                      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, 2001

                         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 and no disclosure will
be contained, to the best of registrant's knowledge in definitive proxy or
information statements incorporated by reference in part III of this Form 10-
KSB, or any amendment to this Form 10-KSB. [X]

         The revenues for the issuer's fiscal year ended June 30, 2001 are
$14,141,648.

         The issuer had 1,049,379 shares of common stock outstanding as of
August 31, 2001. 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, 2001 was $5,650,445.

                      Documents Incorporated by Reference.
         Portions of the Annual Report to Stockholders for the year ended June
30, 2001 are incorporated by reference into Part I and II of this Form 10-KSB.

         Portions of the Proxy Statement for the 2001 Annual Meeting of
Stockholders are incorporated by reference into Part III of this Form 10-KSB.

         Transitional Small Business Disclosure Format.       Yes [_]    No [X]
<PAGE>

                                TABLE OF CONTENTS

<TABLE>
<CAPTION>

<S>                                                                                                                 <C>
PART I...........................................................................................................    2
------
   Item 1.     Description of Business...........................................................................    2
   -------     -----------------------
   Item 2.     Properties........................................................................................   32
   -------     ----------
   Item 3.     Legal Proceedings.................................................................................   33
   -------     -----------------
   Item 4.     Submission of Matters to a Vote of Security Holders...............................................   33
   -------     ---------------------------------------------------

PART II..........................................................................................................   33
-------
   Item 5.     Market for Common Stock and Related Stockholder Matters...........................................   33
   -------     -------------------------------------------------------
   Item 6.     Management's Discussion and Analysis..............................................................   33
   -------     ------------------------------------
   Item 7.     Financial Statements..............................................................................   33
   -------     --------------------
   Item 8.     Changes in and Disagreement with Accountants on Accounting and Financial Disclosure...............   34
   -------     -----------------------------------------------------------------------------------

PART III.........................................................................................................   34
--------
   Item 9.     Directors, Executive Officers, Promoters and Control Persons......................................   34
   -------     ------------------------------------------------------------
   Item 10.    Executive Compensation............................................................................   34
   --------    ----------------------
   Item 11.    Security Ownership of Certain Beneficial Owners and Management....................................   34
   --------    --------------------------------------------------------------
   Item 12.    Certain Relationships and Related Transactions....................................................   34
   --------    ----------------------------------------------
   Item 13.    Exhibits and Reports on Form 8-K..................................................................   34
   --------    --------------------------------

SIGNATURES.......................................................................................................   36
----------
</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"), 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, with branches in Boone, Jefferson, Sparta, Warrensville and West
Jefferson, North Carolina. 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,
2001, the Bank had total assets of $153.4 million, total deposits of $120.1
million and equity of $13.0 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 211.4% and consumer loans have
increased by 69.7% 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, headquartered in West Jefferson, North Carolina and operating in Boone,
Elkin, Jefferson, Lenoir, Sparta, West Jefferson and Wilkesboro, North Carolina.
The Company also has a brokerage subsidiary, 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 79.9% of total
loans, with approximately 56.0% of portfolio mortgage loans at fixed rates at
June 30, 2001. 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 changing 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.

                                       2
<PAGE>

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.

         As of June 30, 2001, $105.0 million, or 79.9% of the Bank's total loan
portfolio consisted of real estate loans. Total loans at June 30, 2001 were
$131.4 million of which $79.5 million or 63.7% were secured by one- to-four
family residences. Total mortgage loans, including construction loans, totaled
$105.0 million as of June 30, 2001. Of that amount, approximately 44.0% was
adjustable rate loans, or had remaining terms of one year or less. The Company's
strategy is to sell 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, 2001, the Bank's consumer loans and commercial loan portfolios were
$26.4 million, or 21.2% of total loans. Commercial loans totaled $12.4 million,
or 9.9% 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 $2.0 million
or 1.3% of total assets at June 30, 2001, and FHLB and FHLMC securities
investments totaled $3.8 million, or 2.5%, of total assets at June 30, 2001.

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. At June 30, 2001, the mutual holding company owned
51.3% of the Company.

Market Area and Competition

         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

                                       3
<PAGE>

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 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, in December 1999, the Company acquired an agency in
Elkin, North Carolina and in November 2000, the Company acquired an agency in
Boone, North Carolina. 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 in addition to traditional "banking only"
services would impair the Company's growth and make retention of existing
customers more difficult. The Company continues to seek opportunities to
increase market penetration for its products and services, primarily in
northwestern North Carolina. 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 which would enhance the
Company's long-term value and earnings potential.

         On November 1, 2000, the Company purchased the assets of an insurance
agency in Boone, North Carolina, adding insurance products to the banking
services offered by the Company in Watauga County. Management believes that
penetration into new (especially contiguous) markets increases the opportunity
to deliver products from all of the Company's subsidiaries to a broader market
base, thereby making the insurance and brokerage subsidiaries more profitable
investments by increasing the economies of scale, as well as improving the
economies of scope, and at the same time adding to the products that are
available for delivery to the Company's customers. Of course, management is
equally committed to protecting and expanding the Company's market share in
existing markets. As evidence of this continuing commitment, the Company
executed a definitive agreement to allow AF Bank to be the only financial
institution located inside the new Wal-Mart superstore under construction in
West Jefferson, North Carolina. The Company also plans to build a freestanding,
full-service branch adjacent to Wal-Mart offering full service banking, full
line property and casualty, life and health insurance as well as mutual funds
and annuities. Thus, customers will enjoy the convenience of banking where they
shop --as well as having access to a comprehensive array of financial services
at the free-standing branch office (including ATM drive-through lanes, and a
commercial depository). The Company continues to seek opportunities to increase
the market penetration of its services.

         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

                                       4
<PAGE>

within Ashe County are branches of seven other depository institutions, five 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.

                                       5
<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>
                                                                           June 30,
                                         ------------------------------------------------------------------------------
                                                      2001                                           2000
                                         --------------------------------                ------------------------------
                                              Amount        % of Total                       Amount       % of Total
                                         --------------   ---------------                -------------   --------------
                                                                    (Dollars in thousands)
<S>                                      <C>              <C>                            <C>              <C>
Mortgage loans:
   One-to four-family...............      $  79,465              63.74%                   $  68,813            63.26%
   Multi-family.....................          3,507               2.81%                       2,277             2.09%
   Non-residential..................          8,359               6.70%                       8,577             7.89%
   Land.............................          8,298               6.66%                       2,440             2.24%
   Construction.....................          5,344               4.29%                       4,059             3.73%
                                          ---------            -------                    ---------          -------
     Total mortgage loans...........        104,973              84.20%                      86,166            79.21%
                                          ---------            -------                    ---------          -------

Other loans:
   Commercial.......................         12,378               9.93%                      10,456             9.62%
   Consumer loans...................         14,051              11.27%                      17,376            15.97%
                                         ----------            -------                   ----------          -------
     Total other loans..............         26,429              21.20%                      27,832            25.59%
                                         ----------            -------                   ----------          -------
   Gross loans......................        131,402             105.40%                     113,998           104.80%
                                         ----------            -------                   ----------          -------

Less:
   Undisbursed loan funds...........          5,479               4.39%                       3,993             3.67%
   Deferred loan fees...............            227               0.18%                         248             0.23%
   Allowance for loan losses........          1,022               0.82%                         979             0.90%
                                          ---------            -------                    ---------      -----------
                                              6,728               5.40%                       5,220             4.80%
                                          ---------            -------                    ---------          -------
   Loans, net.......................      $ 124,674             100.00%                   $ 108,778           100.00%
                                          =========            =======                    =========          =======

   Loans serviced for others:
   One-to four-family and
     cooperative apartment..........      $  25,196             100.00%                   $  22,613           100.00%
                                          ---------            -------                    ---------          -------
         Total loans serviced
         for others                       $  25,196             100.00%                   $  22,613           100.00%
                                          =========            =======                    =========          =======
</TABLE>

                                       6
<PAGE>

         Loan Maturity. The following table shows the maturity or period to
repricing of the Bank's loan portfolio at June 30, 2001. 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, 2001

                                   One- to
                                    Four-     Multi-      Non-                                  Commercial   Consumer
                                   Family     Family    Residential    Land      Construction     Loans        Loans    Total Loans
                                  --------   --------  -------------  ------    --------------   -------      -------  -------------
                                                                            (In thousands)
<S>                               <C>        <C>       <C>            <C>       <C>             <C>           <C>       <C>

Amount due:
  One year or less................  $  6,822    $     -    $  1,706   $   970      $   3,930     $   5,533   $   2,289   $   21,250
                                    --------    -------    --------   -------      ---------     ---------   ---------   ----------

After one year:
  One to three years..............    16,265      1,476       2,970     3,052          1,414         2,656       7,676       35,509
  More than three years to five
  years...........................     8,855        488         821       688              -         1,723       3,281       15,856
  More than five years to ten
  years...........................     9,218        880         790     1,446              -         1,453         486       14,273
  More than ten years to
  twenty years....................    38,305        663       2,072     2,142              -         1,013         286        4,481
  Over twenty years...............         -          -           -         -              -             -          33           33
                                     -------    -------    --------   -------      ---------     ---------   ---------   ----------
Total due or repricing after one
year..............................    72,643      3,507       6,653     7,328          1,414         6,845      11,762      110,152
                                    --------    -------    --------   -------      ---------     ---------   ---------   ----------
Total amounts due or repricing,
   gross..........................  $ 79,465    $ 3,507    $  8,359   $ 8,298      $   5,344     $  12,378   $  14,051   $  131,402
                                    --------    -------    --------   -------      ---------     ---------   ---------   ----------
</TABLE>

         The following table sets forth the dollar amounts in each loan category
at June 30, 2001 that are due after June 30, 2002, and whether such loans have
fixed or adjustable interest rates.

<TABLE>
<CAPTION>
                                                                         Due after June 30, 2002
                                                    -----------------------------------------------------------------
                                                         Fixed                 Adjustable                 Total
                                                    ------------------      -----------------     -------------------
                                                                             (In thousands)
<S>                                                 <C>                     <C>                   <C>
Mortgage loans:
   One- to four-family.........................     $       46,517          $       26,126         $         72,643
   Multi-family................................                354                   3,153                    3,507
   Non-residential.............................              6,653                       -                    6,653
   Land........................................              4,946                   2,382                    7,328
   Construction................................                348                   1,066                    1,414
Commercial loans...............................              3,350                   3,495                    6,845
Consumer loans.................................             11,040                     722                   11,762
                                                    --------------          --------------         ----------------
                                                    $       73,208          $       36,944         $        110,152
                                                    ==============          ==============         ================
</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, 2001, the Bank
serviced approximately $25.2 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

                                       7
<PAGE>

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."

         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, 2001, that Bank's portfolio contained approximately $5.3
million, or 4.3%, 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, 2001 the Bank's non-residential mortgage
loan portfolio was $8.4 million, or 6.7% of total loans outstanding.

                                       8
<PAGE>

The largest non-residential mortgage loan in the Bank's portfolio at June 30,
2001 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 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, 2001, the
Bank's total land loan portfolio was $8.3 million or 6.7% of total loans and its
multi-family loan portfolio was $3.5 million or 2.8% 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, 2001, $14.1 million, or 11.3%, 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 $9.2 million of auto loans. Consumer
loans are available at fixed or variable interest rates.

         The Bank offers adjustable rate home equity credit lines tied to the
prime interest rate. The home equity portfolio amounted to $6.9 million or 5.3%
of the total loan portfolio as of June 30, 2001. 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 residence. The current maximum term is 180 months. The

                                       9
<PAGE>

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.

         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, 2001, the Bank's savings account loan
portfolio totaled $356,000 or 0.3% of the total loans outstanding.

         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, 2001, the Bank had $68,000 in non-performing consumer
loans. Charge-offs for consumer loans totaled $128,000 and $194,000 for the
years ended June 30, 2001 and 2000, respectively.

         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, 2001, the Bank had no non-performing commercial business
loans. Charge-offs for commercial business loans totaled $172,000 and $115,000
for the year ended June 30, 2001 and 2000, respectively.

         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, credit analyst 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.

                                       10
<PAGE>

         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.

         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, 2001, the Bank held $248,000 in REO, while non-performing loans,
defined as loans that are 90 days or more delinquent, totaled $479,000. 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").

                                       11
<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,
                                                                             --------------------------------
                                                                                2001                 2000
                                                                             ----------          -----------
                                                                                   (Dollars in thousands)
<S>                                                                          <C>                 <C>
Non-accrual mortgage loans:
     One-to four-family................................................      $      -             $    125
     Multi-family......................................................             -                    -
     Non-residential...................................................             -                    -
     Land..............................................................             -                    -
     Construction......................................................             -                    -
                                                                             --------             --------
         Total mortgage loans..........................................             -                  125
                                                                             --------             --------
     Commercial........................................................             -                  286
     Consumer Loans....................................................             -                    -
                                                                             --------             --------
         Total non-accruing loans                                            $      -             $    411
                                                                             --------             --------

Loans delinquent 90 or more days for which
     interest is fully reserved and still accruing:
     One-to four-family................................................      $    383             $      -
     Multi-family......................................................            28                    -
     Non-residential...................................................             -                    -
     Land..............................................................             -                    -
     Construction......................................................             -                    -
                                                                             --------             --------
         Total mortgage loans..........................................           411                    -
                                                                             --------             --------
     Commercial........................................................             -                    -
     Consumer Loans....................................................            68                    -
                                                                             --------             --------
Total loans delinquent 90 or more days for which
     interest has been fully reserved..................................             -                    -
                                                                             --------             --------
Total non-performing loans.............................................      $    479             $    411
                                                                             --------             --------

Total real estate owned................................................           248                  289
                                                                             --------             --------
     Total non-performing assets.......................................      $    727             $    700
                                                                             --------             --------

Total non-performing loans to loans, gross.............................          0.36%                0.36%
Total non-performing assets to total assets............................          0.47%                0.53%
</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.
Additionally, the Bank places assets on an internal "Watch List" when those
assets demonstrate characteristics that if not corrected or that deteriorate
further would lead to a more severe classification. 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 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."

                                       12
<PAGE>

         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, 2001, the Bank had $614,000 of assets classified as
Substandard, $2.0 million 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, 2001, the Bank's ALL was $1.0 million, or 0.8% of total
loans, as compared to $979,000 or 0.9%, at June 30, 2000. The Bank had
non-performing loans of $479,000 and $411,000 at June 30, 2001 and June 30,
2000, 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.

                                       13
<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,
                                                                             ------------------------------------
                                                                                 2001                    2000
                                                                             --------------        --------------
                                                                                    (Dollars in thousands)
<S>                                                                          <C>                   <C>
Total loans outstanding at end of period..............................        $   131,402           $   113,998
Average total loans outstanding.......................................            119,965               100,228

Balance at beginning of year..........................................                979                 1,123
                                                                              -----------           -----------
Provision for loan losses.............................................                225                    88
                                                                              -----------           -----------

Charge-offs:
     One- to four-family residential..................................                  -                   (19)
     Multi-family residential.........................................                  -                     -
     Non-residential and land.........................................                 (5)                    -
     Construction.....................................................                  -                     -
     Commercial.......................................................               (172)                 (115)
     Consumer loans...................................................               (126)                 (194)
                                                                              -----------           -----------
         Total charge-offs............................................               (303)                 (328)
                                                                              -----------           -----------

Recoveries............................................................                121                    96
                                                                              -----------           -----------

Balance at end of year................................................        $     1,022           $       979
                                                                              ===========           ===========

Allowance for loan losses to total loans
     at end of period.................................................               0.78%                 0.86%
                                                                              ===========           ===========

Allowance for loan losses to total non-performing
     assets at end of period..........................................             140.58%               139.86%
                                                                              ===========           ===========

Allowance for loan losses to total non-performing
     loans at end of period........................................                213.36%               238.20%
                                                                              ===========           ===========

Ratio of net charge-offs during the period
     to average loans outstanding during period.......................               0.15%                 0.23%
                                                                              ===========           ===========
</TABLE>

                                       14
<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,
                                     ---------------------------------------------------------------------------------------------
                                                         2001                                           2000
                                     --------------------------------------------  -----------------------------------------------
                                                     Percent of      Percent of                                       Percent of
                                                    Allowance to   Loans in Each                     Percent of     Loans in Each
                                       Allowance        Total       Category to      Allowance      Allowance to     Category to
                                        Amount        Allowance     Total Loans       Amount      Total Allowance    Total Loans
                                     ------------  --------------  --------------  ------------  -----------------  --------------
                                                                        (Dollars in thousands)
<S>                                  <C>           <C>             <C>             <C>           <C>                <C>
Mortgage Loans:
   One-to four family............        $  572           55.97%         60.47%        $  559           57.10%            60.37%
   Multi-family..................            15            1.47%          2.67%            15            1.53%             2.00%
   Non-residential and land......            61            5.97%         12.68%            60            6.13%             9.66%
   Construction..................            15            1.47%          4.07%            19            1.94%             3.56%
Other:
   Consumer......................           284           27.79%         10.69%           255           26.05%             9.17%
   Commercial....................            75            7.34%          9.42%            71            7.25%            15.24%
                                         ------         -------        -------         ------         -------           -------
   Total.........................        $1,022          100.00%        100.00%        $  979          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, 2001, the Bank held $7.7 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
                                                            --------------------------------------
                                                                 2001                    2000
                                                            -----------------   ------------------
                                                                        (In thousands)
<S>                                                         <C>                 <C>
Amortized cost at beginning of period...............          $   9,882               $  11,464
Proceeds, net.......................................             (1,132)                   (228)
Principal payments from mortgage backed
   securities.......................................             (1,184)                 (1,387)
Gain on sales.......................................                104                      95
Premium and discount amortization, net..............                 10                     (62)
                                                              ---------               ---------

Amortized cost at end of period.....................              7,680                   9,882
Net unrealized gain (loss) (1)......................                164                     (47)
                                                              ---------               ---------
Total securities, net...............................          $   7,844               $   9,835
                                                              =========               =========
</TABLE>

__________________________
(1)    The net unrealized gain (loss) at June 30, 2001and 2000 relates to
       available for sale securities in accordance with Statement of Financial
       Accounting Standards ("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.

                                       15
<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,
                                              ---------------------------------------------------------------------
                                                              2001                                2000
                                              ---------------------------------------------------------------------
                                                Amortized Cost      Fair Value     Amortized Cost      Fair Value
                                              ------------------  --------------  ----------------   --------------
                                                                          (In thousands)
<S>                                           <C>                 <C>             <C>                <C>
Mortgage-backed securities:

   Fannie Mae and Government National
   Mortgage Association....................         $  1,987           $   1,993       $  3,205           $   3,155
                                                    --------           ---------       --------           ---------
Other debt securities:
   U.S. Treasury and Agency................            3,259               3,267          4,515               4,428
   Other...................................              382                 385            382                 370
                                                    --------           ---------       --------           ---------
Total debt securities......................            3,641               3,652          4,897               4,798
                                                    --------           ---------       --------           ---------
Equity securities(1).......................            1,003               1,150          1,004               1,106
Federal Home Bank Stock....................            1,049               1,049            776                 776
Net unrealized gain (loss)(2)..............              164                   -            (47)                  -
                                                    --------           ---------       --------           ---------
Total securities, net......................         $  7,844           $   7,844       $  9,835           $   9,835
                                                    ========           =========       ========           =========
</TABLE>

-----------------
(1)  Equity securities consist of FHLMC common stock and mutual fund securities.
(2)  The net unrealized gain (loss) at June 30, 2001 and 2000 relates 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.


         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,
                                        ----------------------------------------------------------------------------
                                                 2001                      2000                       1999
                                        ----------------------    -----------------------    -----------------------
                                        Amortized                 Amortized                  Amortized
                                          Cost      Fair Value      Cost       Fair Value      Cost       Fair Value
                                        ---------   ----------    ---------   -----------   ----------    ----------
                                                                      (In thousands)
<S>                                    <C>          <C>          <C>          <C>           <C>           <C>
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.....       1,987        1,993        3,205        3,155         4,626        4,672
     Other debt securities..........       3,442        3,453        4,698        4,599         4,806        4,750
     Equity securities:.............       1,003        1,150        1,004        1,106         1,210        1,554
     Net unrealized gain (loss)(1)..         164            -          (47)           -           334            -
                                         -------      -------      -------      -------       -------      -------
         Total available-for-sale...       6,596        6,596        8,860        8,860        10,976       10,976
                                         -------      -------      -------      -------       -------      -------

Certificates of deposit.............          99           99           99           99           198          198
                                         -------      -------      -------      -------       -------      -------
Federal Home Loan Bank Stock........       1,049        1,049          776          776           524          524
                                         -------      -------      -------      -------       -------      -------

     Total securities, net..........     $ 7,844      $ 7,844      $ 9,835      $ 9,835       $11,798      $11,798
                                         =======      =======      =======      =======       =======      =======
</TABLE>

-----------------
(1)      The net unrealized gains (loss) at June 30, 2001, 2000 and 1999 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.

                                       16
<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, 2001, 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, 2001
                                             --------------------------------------------------------------------------------
                                                        Held-to-Maturity                       Available for Sale
                                             -------------------------------------  -----------------------------------------
                                                                         Weighted
                                               Amortized      Fair       Average      Amortized                 Weighted
                                                  Cost        Value       Yield         Cost      Fair Value  Average Yield
                                             -----------    --------   -----------  ------------  ----------  -------------
                                                                         (Dollars in thousands)
<S>                                          <C>            <C>        <C>          <C>           <C>         <C>
Debt Securities
Mortgaged-backed securities:
   Due within 1 year.......................     $      -      $     -           -%     $      -     $      -            -%
   Due after 1 year but within 5 years.....            -            -           -            63           64         7.29
   Due after 5 years but within 10 years...            -            -           -             -            -            -
   Due after 10 years......................            -            -           -         1,924        1,929         6.76
                                                --------      -------                  --------     --------
           Total...........................            -            -           -         1,987        1,993         6.78
                                                --------      -------                  --------     --------

U.S. Treasury and Agency:
   Due within 1 year.......................            -            -        6.01           500          506         6.42
   Due after 1 year but within 5 years.....          100          100           -         1,992        2,014         5.59
   Due after 5 years but within 10 years...            -            -           -             -            -            -
   Due after 10 years......................            -            -        6.01           666          647         5.90
                                                --------      -------                  --------     --------
           Total...........................          100          100                     3,158        3,167         5.78
                                                --------      -------                  --------     --------

Corporate & Other:
   Due within 1 year.......................           99           99         7.25            -            -            -
   Due after 1 year but within 5 years.....            -            -            -            -            -            -
   Due after 5 years but within 10 years...            -            -            -            -            -            -
   Due after 10 years......................            -            -            -          284          286         4.60
                                                --------      -------                  --------     --------
           Total...........................           99           99         7.25          284          286         4.60
                                                --------      -------                  --------     --------

Equity Securities:                                     -            -            -        1,003        1,150            -
                                                --------      -------                  --------     --------

Total:
   Due within 1 year.......................           99           99         7.25          500          508         6.42
   Due after 1 year but within 5 years.....          100          100         6.01        2,055        2,078         5.64
   Due after 5 years but within 10 years...            -            -            -            -            -            -
   Due after 10 years......................            -            -            -        2,874        2,862         6.35
   Equity Securities.......................            -            -            -        1,003        1,150            -
                                                --------      -------                  --------     --------
                                                     199          199         6.63        6,432        6,596         6.09
                                                --------      -------                  --------     --------
Federal Home Loan Bank Stock...............        1,049        1,049            -            -            -            -
                                                --------      -------                  --------     --------
   Total...................................     $  1,248      $ 1,248         6.63%    $  6,432     $  6,596         6.09%
                                                ========      =======                  ========     ========
</TABLE>

                                       17
<PAGE>

Sources of Funds

         General. Deposits, loans 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, 2001, the Bank's core deposits (which the Bank considers to consist of
checking accounts, regular savings accounts and statement savings accounts)
constituted 42.4% 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,
                                                                 -----------------------     ----------------------
                                                                          2001                        2000
                                                                 -----------------------     ----------------------
                                                                                   (In thousands)
<S>                                                                  <C>                          <C>
Total deposits at beginning of period,
   including accrued interest.............................           $   102,680                  $    93,106
Net increase before interest credited.....................                12,164                        5,505
Interest credited.........................................                 5,230                        4,069
                                                                     -----------                  -----------
Total deposits at end of period...........................           $   120,074                  $   102,680
                                                                     ===========                  ===========
</TABLE>

         At June 30, 2001, the Bank had approximately $22.3 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..............................           $     4,951                         5.91%
         After three but within six months................                 6,292                         6.03%
         After six but within 12 months...................                 6,454                         5.58%
         After 12 months..................................                 4,618                         6.60%
                                                                     -----------
                  Total...................................           $    22,315                         5.99%
                                                                     ===========
</TABLE>

                                       18
<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,
                                 ---------------------------------------------------------------------------------------
                                                   2001                                         2000
                                 -----------------------------------------     -----------------------------------------
                                               Percent of      Weighted                       Percent        Weighted
                                                  Total         Average                       of Total        Average
                                   Amount       Deposits         Rate           Amount        Deposits         Rate
                                ------------ ------------- ---------------     --------      ----------   --------------
                                                               (Dollars in thousands)
<S>                             <C>          <C>           <C>               <C>           <C>          <C>
Noninterest bearing
checking accounts........       $    8,502           7.08%            0.00%   $    6,474          6.31%             0.00%

Interest bearing checking /
Money Market accounts....           20,597          17.15%            2.38%       16,075         15.65%             1.92%

Savings..................           21,823          18.17%            3.63%       23,032         22.43%             3.83%

Certificates of deposit..           68,909          57.39%            5.79%       56,937         55.45%             5.71%

Accrued interest.........              243           0.20%            0.00%          162          0.16%             0.00%
                                ----------    -----------       ----------    ----------   -----------        ----------

         Totals                 $  120,074         100.00%            4.39%   $  102,680        100.00%             4.34%
                                ----------    ===========       ==========    ----------   ===========        ==========
</TABLE>

         The following table presents, by interest rate ranges, the amount of
certificate accounts outstanding at June 30, 2001 and the period to maturity.

<TABLE>
<CAPTION>
                                                             Period to Maturity at June 30, 2001
                                           ------------------------------------------------------------------------
                                             Less than            One to           Four to Five
         Interest Rate Range                  One Year          Three years           Years               Total
         -------------------               --------------      -------------   --------------------    ------------
                                                                    (Dollars in thousands)
<S>                                        <C>                 <C>             <C>                     <C>
4.00% to 5.99%                               $   35,152          $    3,754         $       76          $   38,982
6.01% to 7.99%....................               22,181               6,477              1,269              29,927
                                             ----------          ----------         ----------          ----------
              Total...............           $   57,333          $   10,231         $    1,345          $   68,909
                                             ==========          ==========         ==========          ==========
</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, 2001, the maximum
amount of FHLB advances available to the Bank was $26.3 million. The Bank had
advances of $17.0 million at June 30, 2001 from the FHLB. Interest is payable at
rates ranging from 4.30% to 6.87%. Advances of $813,000 are due August 2002,
$149,000 are due January 2007, $5.0 million are due September 2010, $7.0 million
are due November 2010, and $4.0 million are due January 2011.

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

                                       19
<PAGE>

of 1999, December 1999 and November 2000. AF Insurance Services, Inc. offers
these services in a segregated location at the Bank's executive offices, Boone,
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, 2001, the Company had 98 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

                                       20
<PAGE>

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 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. At June 30, 2001, the Bank's limit on loans to one borrower was
approximately $1.6 million. At June 30, 2001, 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, 2001, 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, 2001, 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.

         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 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.

                                       21
<PAGE>

         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 table below presents the Bank's regulatory capital as compared to
the OTS regulatory capital requirements at June 30, 2001:

<TABLE>
<CAPTION>
                                                          Capital          Excess
                                          Amount       Requirements        Capital
                                         --------     --------------      ---------
                                                      (In thousands)
<S>                                      <C>          <C>                 <C>
Core Capital......................        12,665          6,048            6,617

Risk-based capital................        13,654          8,896            4,758
</TABLE>

         A reconciliation between regulatory capital and GAAP capital at June
30, 2001 in the accompanying financial statements is presented below:

<TABLE>
<CAPTION>
                                                                Core          Risk-Based
                                                               Capital         Capital
                                                              ---------     --------------
<S>                                                           <C>           <C>
GAAP capital...........................................       $  12,765     $     12,765

Net unrealized loss on available for
   sale investment securities, net of tax..............            (100)            (100)

Allowance for loan losses included as
   supplementary capital...............................               -            1,022

Equity investment and other assets.....................               -              (33)

Regulatory capital.....................................       $  12,665     $     13,654
                                                              =========     ============
</TABLE>

         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 cash
out 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

                                       22
<PAGE>

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, 2001 was approximately 14.9%, 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 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

                                       23
<PAGE>

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 benefiting 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 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.

                                       24
<PAGE>

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

                                       25
<PAGE>

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 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, 2001, 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 2001
was $36,365.

                                       26
<PAGE>

         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
in compliance with this requirement with an investment in FHLB of Atlanta stock
at June 30, 2001, of $1.0 million. 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, 2001, 2000 and 1999, dividends from
the FHLB of Atlanta to the Bank amounted to $66,000, $46,000 and $45,000,
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.

                                       27
<PAGE>

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; (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

                                       28
<PAGE>

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."

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.

                                       29
<PAGE>

                          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 by
the Internal Revenue Service 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.

         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.

                                       30
<PAGE>

         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 6.9% 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.

                                       31
<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, the Lenoir office and the
Jefferson Branch. Additionally, the Company entered an agreement with Wal-Mart
to lease the banking facilities inside the Super Wal-Mart to open during the
fourth calendar quarter of 2001 and to purchase an out parcel on which a full
service branch will be completed prior to the end of the 2002 fiscal year.
Management believes that the Bank's current and planned facilities are adequate
to meet the present and immediately foreseeable needs of the Bank and the
Holding Company.

<TABLE>
<CAPTION>
                                                                                                        Net Book
                                                                    Date Leased        Lease            Value at
                                                  Leased or Owned   or Acquired   Expiration Date    June 30, 2001
                                                 ----------------- ------------- -----------------  ---------------
                                                                         (Dollars in thousands)
<S>                                              <C>               <C>           <C>                 <C>
Corporate Offices...........................           Owned        06/15/2000            --          $1,689,234
21 East Ashe Street
West Jefferson, NC 28694

Insurance and Brokerage Offices.............           Owned         06/30/97             --          $ 369,344
206 S. Jefferson Avenue
West Jefferson, NC 28694

AF Bank.....................................           Owned         06/30/63             --          $ 159,705
205 S. Jefferson Avenue
West Jefferson, NC 28694

AF Bank.....................................           Owned         05/18/94             --          $ 490,169
840 E. Main Street
Jefferson, NC 28640

AF Bank.....................................          Leased         08/31/98     08/31/2003*                --
4951 NC Hwy. 88 West
Warrensville, NC 28693

AF Bank.....................................          Leased         01/09/98     12/31/2003*                --
403 South Main Street
Sparta, NC 28675

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

AF Insurance Services, Inc..................          Leased         09/01/97     08/31/2002****             --
315 Main Street
North Wilkesboro, NC 28659

AF Insurance Services, Inc..................           Owned        07/03/2000            --          $ 101,211
324 Morganton Blvd., SW
Lenoir, NC 28645

AF Insurance Services, Inc..................          Leased         12/01/99     11/30/2002**               --
277 A West Main Street
Elkin, NC 28621

AF Insurance Services, Inc..................          Leased         12/01/00     09/30/2007                 __
400 Shadowline Drive
Boone, NC 28607
</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.

                                       32
<PAGE>

Item 3.        Legal Proceedings

         At June 30, 2001, 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 Holder

         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 2001 Annual Report to Stockholders on page
60, 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 2001 Annual Report to Stockholders on page [ ], 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, 2001 and 2000.

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 2001 Annual Report to Stockholders on pages 1 through 2,
and 6 through 19 and is incorporated herein by reference.

Item 7.        Financial Statements
s
         The Financial Statements of AF Bankshares, Inc., together with the
report thereon by McGladrey & Pullen, LLP appears in the Registrant's 2001
Annual Report to Stockholders on pages 21 through 57 and are incorporated
herein by reference.

<TABLE>
<CAPTION>
                                                                           Page(s) in
                                                                         Annual Report
                                                                         -------------
<S>                                                                      <C>
 .  Independent Auditor's Report.......................................        21
 .  Consolidated Statements of Financial Condition,
     June 30, 2001 and 2000...........................................       22-23
 .  Consolidated Statements of Income
     Years Ended June 30, 2001 and 2000...............................        24
 .  Consolidated Statements of Stockholders' Equity,
     Years Ended June 30, 2001 and 2000...............................        25
 .  Consolidated Statements of Cash Flows,
     Years Ended June 30, 2001 and 2000...............................       27-28
 .  Notes to Consolidated Financial Statements.........................       29-57
</TABLE>

                                       33
<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 5, 2001.

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 5, 2001.

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 5, 2001.

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 5, 2001.

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).*

                                       34
<PAGE>

                  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).*

                  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       2001 Annual Report to Stockholders, is filed
                             herewith.

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

         (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, 2001.

*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.

                                       35
<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 21, 2001               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 21, 2001
-----------------------------------------------
James A. Todd
President, Chief Executive Officer and Director
(Principal Executive Officer)


/s/ Melanie Paisley Miller                                 September 21, 2001
-----------------------------------------------
Melanie Paisley Miller
Executive Vice President, Secretary, Treasurer
     and Chief Financial Officer
(Principal Financial Officer)


/s/ Jan R. Caddell                                         September 21, 2001
-----------------------------------------------
Jan R. Caddell - Director


/s/ Kenneth R. Greene                                      September 21, 2001
-----------------------------------------------
Kenneth R. Greene - Director


/s/ Wayne R. Burgess                                       September 21, 2001
-----------------------------------------------
Wayne R. Burgess - Director


/s/ Jimmy D. Reeves                                        September 21, 2001
-----------------------------------------------
Jimmy D. Reeves - Director


/s/ Frank E. Roland                                        September 21, 2001
-----------------------------------------------
Frank E. Roland - Director


/s/ Jerry L. Roten                                         September 21, 2001
-----------------------------------------------
Jerry L. Roten - Director


/s/ John D. Weaver                                         September 21, 2001
-----------------------------------------------
John D. Weaver - Director
</TABLE>

</TEXT>
</DOCUMENT>
<DOCUMENT>
<TYPE>EX-13.1
<SEQUENCE>3
<FILENAME>dex131.txt
<DESCRIPTION>EXHIBIT - 13.1
<TEXT>
<PAGE>

                                    CONTENTS

<TABLE>
<S>                                                                      <C>
Selected Financial Data                                                    1 - 2

Letter to Shareholders                                                     3 - 4

Operational Review                                                             5

Management's Discussion and Analysis of Financial Condition and
   Results of Operations                                                  6 - 19

Independent Auditor's Report                                                  21

Consolidated Financial Statements                                        22 - 28

Notes to Consolidated Financial Statements                               29 - 57

Corporate Information                                                    58 - 60
</TABLE>
<PAGE>

               SELECTED FINANCIAL AND OTHER DATA OF THE COMPANY

     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 Company presented elsewhere.

<TABLE>
<CAPTION>
                                                                               At June 30,
                                                   ----------------------------------------------------------------
                                                      2001           2000         1999         1998         1997
                                                   ---------------------------------------------------------------
<S>                                                <C>           <C>           <C>          <C>           <C>
                                                                             (In Thousands)
Selected Financial Condition Data:
Total assets                                       $ 153,448     $  133,370    $ 109,931    $ 100,074     $ 82,024
Loans receivable, net /(1)/                          124,675        108,778       81,157       72,628       70,236
Investment securities /2)/                             7,844          9,835       11,798        9,017        6,937
Cash and cash equivalents /(3)/                       12,568          7,423       12,395       14,789        2,533
Savings deposits                                     120,074        102,680       93,106       82,488       68,218
FHLB advances                                         16,962         15,513        2,564        4,116        1,654
Equity                                                13,027         12,540       12,218       11,486       10,979
Book value per share                                   12.41          11.95        11.64        10.90        10.98

<CAPTION>
                                                                       For the Year Ended June 30,
                                                   ---------------------------------------------------------------
                                                      2001           2000          1999         1998         1997
                                                   ---------------------------------------------------------------
<S>                                                <C>           <C>           <C>          <C>           <C>
                                                                              (In Thousands)
Selected Operating Data:
Interest income and dividends                      $  11,648     $    9,393    $   7,879    $   7,356     $  6,213
Interest expense                                       6,355          4,685        3,967        3,795        3,245
                                                   ---------------------------------------------------------------
   Net interest income                                 5,293          4,708        3,912        3,561        2,968
Provision for recovery of loan losses                    225             88           20          (25)          20
                                                   ---------------------------------------------------------------
   Net interest income after provision for
      loan losses                                      5,068          4,620        3,892        3,586        2,948
Non-interest income                                    2,493          1,821        1,206          991          169
Non-interest expense                                   6,757          5,660        4,348        3,448        2,556
                                                   ---------------------------------------------------------------
Income before income tax expense                         804            781          749        1,089          561
Income tax expense                                       315            328          235          381          218
                                                   ---------------------------------------------------------------
   Net income                                      $     489     $      453    $     514    $     708     $    343
                                                   ===============================================================

Basic earnings per share /(4)/                      $   0.48     $     0.45    $    0.52    $    0.73     $   0.44
Diluted earnings per share /(4)/                        0.48           0.45         0.52         0.72         0.44
Dividends per share                                     0.20           0.20         0.20         0.20         0.10
</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 $7.8 million, $2.6 million,
       $4.2 million, $11.8 million, and $1.2 million, at June 30, 2001, 2000,
       1999, 1998, and 1997, 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>
                                                                    For the Year Ended June 30,
                                               --------------------------------------------------------------------
                                                   2001           2000          1999         1998         1997
                                               --------------------------------------------------------------------
<S>                                                <C>           <C>           <C>          <C>           <C>
Selected Financial Ratios and Other Data: /(1)/
Performance Ratios:
  Return on average assets /(1)/                       0.34%          0.37%        0.49%        0.78%        0.44%
  Return on average equity /(1)/                       3.80%          3.99%        4.47%        6.31%        3.64%
  Average equity to average assets                     8.83%          9.21%       11.02%       12.21%       12.10%
  Equity to total assets at end of period              8.49%          9.40%       11.11%       11.48%       13.39%
  Interest rate spread /(2)/                           3.56%          3.84%        3.64%        3.64%        3.34%
  Average interest-earning assets to
    to average interest-bearing liabilities          108.48%        108.18%      110.20%      111.95%      114.40%
  Net interest margin /(3)/                            3.97%          4.18%        4.06%        4.17%        3.96%
  Non-interest expense to average assets               4.64%          4.59%        4.17%        3.80%        3.28%
  Efficiency ratio /(4)/                              86.78%         86.69%       84.96%       76.63%       81.48%
  Dividend payout ratio /(6)/                         41.67%         44.44%       38.46%       27.40%       22.73%

Regulatory Capital Ratios: /(5)/
  Tangible capital                                     8.37%          8.89%       10.00%       10.90%       12.90%
  Core capital                                         8.37%          8.89%       10.00%       10.90%       12.90%
  Total risk-based capital                            12.28%         11.94%       17.40%       20.40%       26.30%

Asset Quality Ratios and Other Data:
  Ratios:
    Nonperforming loans to total loans                 0.36%          0.36%        0.07%        0.03%        0.18%
    Nonperforming loans and real estate owned
       to total assets                                 0.47%          0.53%        0.11%        0.06%        0.16%
    Allowance for loan losses to:
       Nonperforming loans                           213.36%        238.20%     1871.14%      851.10%      787.02%
       Total loans                                    78.00%          0.86%        1.28%        1.60%        1.42%
Number of full service branches                           5              5            5            4            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 non-interest expense as a percentage of
       the sum of net interest income and non-interest 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 Valued Shareholder,

Thank you for helping to make Fiscal Year 2001 a successful year for AF
Bankshares, Inc. Without our customers, employees and valued shareholders like
you, your company's accomplishments during the past year would not have been
possible.

For the year ended June 30, 2001, after-tax earnings totaled $489,360, and
assets topped the $153.4 million mark. Banking deposits stood at $120.1 million,
and loans grew 14.6% to end the year at $124.7 million in total loans
outstanding. Plus, we closed Fiscal Year 2001 with $2.5 million in non-interest
income, largely attributable to continued growth in our insurance and brokerage
businesses. Detailed financials are shown later in this report. However, a
number of significant events are worthy of comment, in addition to the good
financial performance of the Company.

In the latter part of calendar year 2000, we acquired our sixth insurance agency
in Boone, North Carolina. A well-established local agency, now known as AF
Insurance Services, Boone, this acquisition extends our entry into the Watauga
market and enhances the presence of AF Appalachian First Bank there.

Over the past year we brought all the insurance agencies under one uniform name
and corporate identity: AF Insurance Services. So your company now operates six
agencies known as AF Insurance Services of Boone, Elkin, Lenoir, North
Wilkesboro, Sparta, and West Jefferson. In the upcoming year, we plan to do the
same with our banks, bringing them all under the corporate umbrella name "AF
Bank".

A new web site for AF Bank was developed and introduced towards the end of the
year, increasing the convenience of doing business with us over the internet. As
the site becomes fully operational, you'll be able to access banking, brokerage,
and insurance information from the comfort of your own home or office. Speaking
of convenience, the use of our telephone banking service continues to grow by
leaps and bounds.

Lastly, we have enhanced the quality of service of AF Brokerage, Inc. by adding
a new executive vice president and sales principal, and an experienced
registered representative with strong local ties. We are in the process of
improving our reach into existing markets, as well as marketing brokerage
services to other, non-competitive financial institutions throughout the state.

Looking forward to next year, we are particularly pleased that AF Bank has been
selected by Wal-Mart to be the exclusive banking location inside their new
superstore in Ashe County. The opening of our Wal-Mart branch in the second
quarter will bring the number of AF banking offices in Ashe County to four,
literally fulfilling the definition of `one-stop shopping' for all our banking
customers who will be shopping at Wal-Mart.

Of course, no president's message would be complete without a comment on the
state of the economy and the recent (and many) reductions in interest rates by
the Federal Reserve. We believe both the economic slowdown and the decrease in
interest rates were necessary to prepare the country for renewed economic
progress on a sustainable basis. The combination has produced a less than
positive impact in our banking business; nevertheless, the resulting negative
short-term environment serves to underscore our commitment to fee-based,
non-interest income as a vital component of our future success.

                                       3
<PAGE>

Your company's unique organizational structure has allowed us to build a
diversified financial services network. Entering next year, our focus is on
integrating our various subsidiaries into a comprehensive delivery system better
able to meet the full range of our customers' financial demands. And in so
doing, our watchwords will continue to be Integrity, Performance, and Service.

Perhaps the most important part of my letter to you is to ask for your business
- whether your needs include banking, investments, insurance, or any combination
of the three. Your Company wants you, your friends and your associates as
customers.

Again, thank you for your continued support. Many of you are customers, and I am
especially grateful to you. For those of you who are not yet customers, please
accept my personal invitation to try us. I firmly believe you will find the
finest in banking, brokerage, and insurance available to you right here with
your Company.

Your comments, questions, and support are always welcome.

For your Company,



James A. Todd
President & Chief Executive Officer

                                       4
<PAGE>

AF Bankshares 2001 Operational Review

Fiscal Year 2001 results reflect your Company's continuing progress toward
becoming a complete financial services provider in its primary market areas.

Principally due to our checking accounts marketing and increased insurance
business, along with growing investment services, non-interest income for the
year reached $2,493,000 - a 37% gain over FY 2000. At the same time, loans
receivable grew from $108,778,000 at June 30, 2000 to $124,675,000 at June 30,
2001. And total assets now stand at $153,448,000, the highest in our history.

On November 1, 2000, the Company purchased an insurance agency located in Boone,
North Carolina, serving all of Watauga County. Along with the Company's banking
operation in Boone, this expands the scope of financial services now offered in
that highly attractive market. Most significantly, the Company's insurance
commissions from all agencies topped $1,699,000, up from $991,000 at the end of
FY 2000.

Also, the Company executed an exclusive agreement to be the sole financial
institution located inside the new Wal-Mart set to open in West Jefferson during
the fall of 2001. Additionally, plans call for a full-service AF Bank office to
be located adjacent to the Wal-Mart site, thereby enhancing access for our
customers and neighbors.

During the latter part of the year, a new executive vice president and sales
principal of AF Brokerage was hired; a financial professional with extensive
experience in the securities industry. An additional registered representative,
with strong ties in two of the Company's local markets, was added, too. At June
30, 2001, AF Brokerage is well staffed and equipped to extend that firm's
services in meeting the investment demands of customers throughout the Company's
marketplaces.

As shown in the financial section, and in more detail in Management's Discussion
and Analysis, other noteworthy events during FY 2001 include:

     .    An increase in net loans of $15.9 million or 14.6% over FY 2000.

     .    Growth in stockholders' equity to $13,027,000, from $12,540,000 at
          June 30, 2000.

     .    An increase in net income to $489,360 at June 30, 2001, compared to
          $453,208 for the year ended June 30, 2000.

     .    A 17% increase in FDIC insured deposits to $120,074,000 at June 30,
          2001, from $102,680,000 at June 30, 2000.

In summary, FY 2001 operations produced a stronger, better prepared Company . .
 . more able than ever to fulfill its future potential as the premier financial
services resource for the individuals, families, and businesses within its
markets.

                                       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 the estimates. These factors
include changes in general and local market conditions, development of an
adverse interest rate environment, and depositor and borrower preferences. 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, with branches in Boone, Jefferson,
Sparta, Warrensville, and West Jefferson North Carolina. The Company has an
insurance subsidiary headquartered in West Jefferson, North Carolina, operating
as AF Insurance Services, Inc, in Boone, Elkin, Jefferson, Lenoir, Sparta, West
Jefferson, and Wilkesboro, North Carolina. The Company has a brokerage service
subsidiary headquartered in West Jefferson, North Carolina, 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 and 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 as the Company
became a majority owned subsidiary of AsheCo, MHC.

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

                                       6
<PAGE>

General

The Company realized net income of $489,000 and $453,000 for the years ended
June 30, 2001 and 2000, 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 mortgage
loan portfolio, representing 84.2% of total loans; with approximately 44.1% of
portfolio mortgage loans at fixed rates as of June 30, 2001. 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, deposit transaction
fees, insurance commissions generated from the insurance agency subsidiary,
commission 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
competitive dynamics within the Company's market area.

Management Strategy

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. Further, management believes that failure to offer insurance and
brokerage services in addition to traditional `banking only' services would
impair the Company's growth and make retention of existing customers more
difficult. The Company continues to seek opportunities to increase market
penetration for its products and services, primarily in northwestern North
Carolina. During the three-month period ending September 30, 1998, the Company
established a securities brokerage subsidiary, AF Brokerage, Inc. that currently
conducts brokerage services from offices in West Jefferson and Jefferson, and by
appointment in the Company's other office locations. AF Brokerage, Inc. 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 and business opportunities that will provide access to new
customers and expanded markets, which would enhance the Company's long term
value and earnings potential.

On November 1, 2000, the Company purchased the assets of an insurance agency in
Boone, North Carolina, adding insurance products to the banking services offered
by the Company in Watauga County. Management believes that penetration into new
(especially contiguous) markets increases the opportunity to deliver products
from all of the Company's subsidiaries to a broader market base, thereby making
the insurance and brokerage subsidiaries more profitable investments by
increasing the economies of scale, as well as improving the economies of scope,
and at the same time adding to the products that are available for delivery to
the Company's customers. Of course, management is equally committed to
protecting and expanding the Company's market share in existing markets. As
evidence of this continuing commitment, we have executed a definitive agreement
to allow AF Bank to be the only financial institution located inside the new
Wal-Mart under construction in West Jefferson, North Carolina. Also, plans call
for the bank to build a freestanding, full-service branch adjacent to Wal-Mart.
Thus, customers will enjoy the convenience of banking where they shop - as well
as having access to a comprehensive array of financial services at the
freestanding branch office (including an ATM, drive-through lanes, and a
commercial depository). The Company continues to seek opportunities to increase
the market penetration of its services.

                                       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,
reducing the period of time the Bank 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 adjustable rate mortgage. At
approximately the same time, the Bank began to offer consumer loans, including
automobile and home improvement loans. At June 30, 2001, consumer loans
constituted approximately 11.3% of portfolio loans.

In 1994, the Bank began offering commercial loans to small businesses in Ashe
County and expanded its commercial lending to include small businesses in
Alleghany County and Watauga County. Commercial loans generally have rates based
on the prime rate of interest that more closely reflects prevailing market
interest rates than do fixed rate products or other rate indices. Additionally,
consumer and commercial loans generally have shorter terms and greater interest
rate sensitivity than mortgage loans. Management has pursued the preceding
mortgage and non-mortgage loan strategies to reduce the level of interest rate
risk inherent in the Bank's loan portfolio, while maintaining acceptable levels
of credit risk. Funding for loan originations has been provided by aggressively
marketing savings and checking accounts, competitively pricing certificates of
deposits, and borrowing from the Federal Home Loan Bank of Atlanta ("FHLB").
Deposits increased $17.4 million and FHLB advances increased $1.4 million during
the year ended June 30, 2001.

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 Bank'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.

As noted previously, 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. However, it is well worth noting that - given
these planned and unavoidable dampening factors - the Company's earnings for the
most recently completed quarter remain positive and represent an increase over
the similar period in the prior year.

Management has long recognized the dramatically changing dynamics of the
delivery system for financial services in this country. Both individuals and
businesses now look to a broadening array of sources for needed (or wanted)
financial products. Individuals and families are opening FDIC insured savings
accounts at brokerage houses, they're purchasing mutual funds and annuities
through offices of banking organizations, and they're using the services of
independent financial planners to plan their retirements. Companies are
increasingly taking their cash management function to independent brokers or
insurance company representatives, they are investing idle cash through discount
brokerages on the internet, and they are establishing letters and lines of
credit with investment bankers, indirect credit companies, and others.

                                       8
<PAGE>

We now have the foundation to successfully compete in our established markets.
In all AF Bank markets, we have the capability to deliver comprehensive
insurance services through our insurance subsidiary - along with the added
potential to deliver non-deposit investment services through AF Brokerage, Inc.
The challenge facing us is to provide the most economical, efficient - and most
importantly - desirable platform to offer our customers, clients, and prospects
these services. It is a challenge management is working hard to meet. In coming
years, it is management's firm belief that the Company's established foundation
and emerging platform will drive the Company's long-term viability as a
competitively superior financial service provider in all markets.

There are a number of significantly positive factors and recent events, which
reflect the Company's progress toward its long-term goals in the year ended June
30, 2001:

     .    An increase in net loans of $15.9 million or 14.6%;

     .    Asset growth of $20.1 million or 15.1%;

     .    An increase of $672,000 or 36.9% in non-interest income, as compared
          to the corresponding twelve month period ended June 30, 2000,
          reflecting the Company's continuing emphasis in the areas of insurance
          and securities services;

     .    Growth in stockholders' equity to $13,027,000 at June 30, 2001 from
          $12,540,000 at June 30, 2000.

     .    The addition of new insurance markets with major emphasis in
          commercial property and casualty business, providing the Company with
          an even better mix between personal and commercial lines of business.

     .    The execution of an exclusive agreement to allow AF Bank to be the
          sole financial institution located inside the new Wal-Mart now under
          construction in West Jefferson

     .    Plans for a full-service AF Bank branch adjacent to the Wal-Mart
          property that will offer local individuals families, and businesses
          enhanced access and convenience unparalleled by other financial
          services providers in Ashe County.

Management is optimistic about the future of the Company. Overall, management
and the board of directors are pleased with the continuing positive short-term
earnings of the Company. These positive short-term earnings are particularly
satisfying in light of the investments required to accomplish the goals of the
Company's long-term strategic plan, the kinds of investments that lower
short-term earnings in order to build long-term value and sustainable future
earnings.

Comparison of Financial Condition at June 30, 2001 and 2000

At June 30, 2001 and 2000 assets totaled $153.4 million, and $133.4 million,
respectively. Total assets increased by $20.1 million or 15.1% from June 30,
2000 to June 30, 2001, primarily a result of an increase of $15.9 million, or
14.6%, in net loans receivable and an increase of $5.1 million or 69.3% in cash
and cash equivalents from June 30, 2000 to June 30, 2001.

                                       9
<PAGE>

These increases are partially offset by a $2.3 million decrease in securities
available for sale. Management believes the increase in net loans receivable is
primarily the result of increased emphasis on commercial loans, which tend to
have larger loan balances. Loan growth was primarily funded by increases in
savings deposits and FHLB advances. The Company's deposits increased by $17.4
million from $102.7 million at June 30, 2000, to $120.1 million at June 30,
2001. The Company's level of advances from the FHLB increased $1.4 million from
$15.5 million at June 30, 2000, to $17.0 million at June 30, 2001.

The principal category of earning assets is loans. During the year ended June
30, 2001 net loans receivable increased by $15.9 million, or 14.6%. The increase
in net loans receivable is typical for the Company, which operates in lending
markets that have experienced 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, decreased slightly from .64% of net loans at
June 30, 2000, to .58% of net loans at June 30, 2001. The low level of
non-performing assets is attributable to comprehensive lending policies and
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 of charge-offs of $183,000 during year ended June 30, 2001,
compared to net charge-offs of $231,000 for the year ended June 30, 2000. As a
result, and based on management's analysis of its allowances, provision was made
for an additional loan loss allowance of $225,000 during the year ended June 30,
2001.

At June 30, 2001 retained earnings increased $162,000 or 1.9% to $8.5 million,
from $8.3 million at June 30, 2000. This increase was largely the combined
result of earnings of $489,000, a decrease for a fair market value adjustment
for ESOP stock in the amount of $120,000; and dividends of $207,000. There was a
$129,000 net increase in unrealized gain on securities available for sale at
June 30, 2001, compared to the year earlier period. At June 30, 2001 the Bank's
regulatory capital amounted to $13.1 million, compared to $12.6 million at June
30, 2000; which represented 8.5% of total assets, well in excess of regulatory
capital requirements at such date.

                                       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 June 30, 2001                      Year Ended June 30, 2000
                                              Compared to Year Ended June 30, 2000          Compared to Year Ended June 30, 1999
                                          ---------------------------------------------  ------------------------------------------
                                                   Increase (Decrease) Due to                    Increase (Decrease) 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               $     55     $   34     $   10     $    99     $  (399)  $    56   $    (39)   $  (382)
    Investment securities                          6        (31)        (1)        (26)        (23)      133         (6)       104
    Loans receivable                           1,693        411         78       2,182       2,103      (238)       (73)     1,792
                                          ---------------------------------------------  ------------------------------------------

      Total                                    1,754        414         87       2,255       1,681       (49)      (118)     1,514
                                          ---------------------------------------------  ------------------------------------------


Liabilities:
  Interest-bearing liabilities:                   55         51          8         114          67       (12)        (3)        52
    NOW and MMDA accounts                        (40)        23         (1)        (18)        128         4          1        133
    Passbook savings                             516        466         83       1,065         152       (36)        (2)       114
    Certificates of deposit                      445         37         27         509         495       (22)       (54)       419
                                          ---------------------------------------------  ------------------------------------------
    Borrowed funds

      Total                                      976        577        117       1,670         842       (66)       (58)       718
                                          ---------------------------------------------  ------------------------------------------

    Net interest income                     $    778     $ (163)    $  (30)    $   585     $   839   $    17   $    (60)   $   796
                                          =============================================  ==========================================
</TABLE>

                                       11
<PAGE>

The following table provides information concerning the Bank's yields on
interest-earning assets and cost of funds on interest-bearing liabilities over
the years ended June 30, 2001 and 2000.

<TABLE>
<CAPTION>
                                             At June 30,                                Year Ended June 30,
                                                                  -----------------------------------------------------------------
                                                2001                          2001                                2000
                                      ------------------------    -----------------------------      ------------------------------
                                                       Average                          Average                            Average
                                          Actual        Yield/     Average              Yield/        Average                Yield/
                                         Balance         Rate      Balance               Rate         Balance     Interest    Rate
                                                                             Interest
                                      ------------------------    -----------------------------      ------------------------------
                                                                       (Dollars in Thousands)
<S>                                   <C>           <C>           <C>        <C>        <C>          <C>          <C>       <C>
Assets:
  Interest earning assets:
      Interest-bearing deposits       $    7,810      5.68%       $   3,799  $    288     7.58%      $   2,939    $   189    6.43%
      Investment securities                7,844      6.28%           9,614       579     6.02%          9,523        605    6.35%
      Loans receivable, net /(1)/        124,675      8.75%         119,965    10,781     8.99%        100,228      8,599    8.58%
                                      ----------    --------      -------------------                --------------------
        Total interest-earning assets    140,329      8.48%         133,378    11,648     8.73%        112,690      9,393    8.34%
                                                                             --------                             -------
  Non-interest-earning assets             13,119                     12,347                             10,645
                                      ----------                  ---------                          ---------
        Total assets                  $  153,448                  $ 145,725                          $ 123,335
                                      ==========                  =========                          =========

Liabilities and Equity:
  Interest-bearing liabilities:
      NOW and MMDA accounts           $   20,597      2.38%          18,505       467     2.52%         16,015        353    2.20%
      Savings                             21,823      3.63%          21,744       813     3.74%         22,857        831    3.64%
      Certificates of deposit             68,909      5.79%          64,618     3,950     6.11%         54,800      2,885    5.26%
      FHLB advances and notes
      payable                             18,668      5.84%          18,081     1,125     6.22%         10,495        616    5.87%
                                      ----------    --------      -------------------                --------------------
        Total interest-bearing
        liabilities                      129,997      4.89%         122,948     6,355     5.17%        104,167      4,685    4.50%
                                                                             --------                             -------
  Non-interest-bearing liabilities        10,424                      9,911                              7,811
  Stockholders' equity                    13,027                     12,866                             11,357
                                      ----------                  ---------                          ---------
        Total liabilities and equity  $  153,448                  $ 145,725                          $ 123,335
                                      ==========                  =========                          =========

Net interest income and interest
      rate spread /(2)/                               3.59%                  $  5,293     3.56%                   $ 4,708    3.84%
                                                                             ========                             =======
Net interest-earning assets and
      net interest margin /(3)/       $   10,332                  $  10,430               3.97%      $   8,523               4.18%
                                      ==========                   ========                          =========
Ratio of interest-earning assets to
      interest-bearing liabilities                  107.95%                             108.48%                            108.18%
</TABLE>

 /(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.

                                       12
<PAGE>

Comparison of Operating Results for the Fiscal Years Ended June 30, 2001 and
2000

General. Net income for the years ended June 30, 2001 and 2000 was $489,000 and
$453,000, respectively. The increase of $36,000 or 8.0% was primarily
attributable to an increase in interest income on loans due to both the
increased volume of the institution's loan portfolio and an increase in
noninterest income due to increased commission income from the insurance
subsidiary. These increases were partially offset by an increase in interest
expense to fund loan growth, and increased compensation and employee benefit
expenses due to the addition of employees to prepare the Company for current and
future expansion. Management believes these initial costs of expansion will
better position the Company for the future. In management's opinion, there has
not been a material change in interest rate risk from the end of the Company's
most recent fiscal year.

Net Interest Income. Net interest income increased by $585,000 or 12.4%, from
$4.7 million for the year ended June 30, 2000, to $5.3 million for the year
ended June 30, 2001. That growth directly reflects increased average outstanding
balances in net loans receivable. Interest income from loans increased at the
rate of 25.4% for the year ended June 30, 2001. During the year ended June 30,
2001, the Federal Reserve Open Market Committee repeatedly reduced certain rates
that it controls, producing a cumulative 2.75% drop in the prime rate of
interest. As a consequence of the overall decrease in the prime rate, the Bank's
yield on loan balances outstanding only increased 41 basis points during the
year ended June 30, 2001.

Interest Income. Interest income increased $2.3 million or 24.0%, from $9.4
million for year ended June 30, 2000 to $11.6 million for the year ended June
30, 2001. The increase was primarily attributed to the $15.9 million increase in
net loans receivable from $108.8 million at June 30, 2000 to $124.7 million at
June 30, 2001, resulting in an increase of $2.2 million in interest income from
loans.

Interest Expense. Interest expense increased by $1.7 million or 35.6%, from $4.7
million at June 30, 2000, to $6.4 million at June 30, 2001. The increase is the
result of both an increase in advances outstanding, and a $17.4 million increase
in savings deposits for the year ended June 30, 2001; both of which were used to
fund loan demand and to increase the balance in cash and cash equivalents.

Provision for Loan Losses. Management allocated an additional $225,000 provision
for loan losses during year ended June 30, 2001, compared to an $88,000
provision for loan losses made during the year ended June 30, 2000. Provisions,
which are charged to operations and resulting loan loss allowances, are amounts
that the Bank's 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 collection 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 Bank's provisions for loan loss allowances during year ended June 30, 2001
were based upon an analysis of the quality of its loan portfolio. The Bank's
level of non-performing loans remained consistently low in relation to prior
periods and total loans outstanding during year ended June 30, 2001, with the
exception of one large commercial loan charge-off; therefore, due to changes in
the mix of the Bank's loan portfolio, management decided it would be prudent to
make an additional provision. At June 30, 2001, the Bank's level of general
valuation allowances for loan losses amounted to $1.0 million, which management
believes is adequate to absorb any existing losses in its loan portfolio.

                                       13
<PAGE>

Non-Interest Income. Non-interest income increased by $672,000, or 36.9%, from
$1.8 million for the year ended June 30, 2000, to $2.5 million for the year
ended June 30, 2001. The increase was primarily attributable to increased
revenues generated from insurance sales and from the gain on sale of investments
available for sale during the year ended June 30, 2001. The increased revenue
generated from insurance sales and income generated from the brokerage
subsidiary are due to widening market penetration, which should continue to
produce growth in non-interest income.

Non-Interest Expense. Non-interest expense increased by $1.1 million or 19.4%,
from $5.7 million for the year ended June 30, 2000, to $6.8 million for the year
ended June 30, 2001. Increases in non-interest expense for the year ended June
30, 2001 are primarily attributable to an increase in compensation costs and
occupancy expenses. Compensation costs increased by $603,000 or 20.0% for the
year ended June 30, 2001. This increase is primarily the result of the addition
of employees in order to prepare the Company for current and future expansion.
Occupancy costs increased by $212,000 or 42.1% for the year ended June 30, 2001,
primarily due to costs associated with the Boone insurance office.

Income Taxes. Income taxes were derived from the application of normal, expected
tax rates on income earned during the year ended June 30, 2001 and 2000. Income
tax expense was $315,000 and $328,000, for the years ended June 30, 2001 and
2000, respectively. The effective tax rate applied was slightly lower than
statutory tax rates, principally due to qualifying investment income that was
exempt from state income taxes.

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 Watauga 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 increase 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.

                                       14
<PAGE>

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. Provision for loan losses, which is 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 during the year ended June 30,
2000, and income generated by the Company's brokerage subsidiary. Both these
areas of growth and widening market penetration should continue to produce
increases in non-interest income.

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 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 Bank and insurance agency in order 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 market price of shares vesting under the recognition and retention
plan in the current year.

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 demand 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.

As of June 30, 2001, cash and cash equivalents, a significant source of
liquidity, totaled $12.6 million. Compared to either regulatory or industry
standards, the Company's capital position and liquidity are in excellent shape.

                                       15
<PAGE>

Asset/Liability Management

The Company's asset/liability management is focused 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.

Absent 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 the sensitivity of its
net portfolio value to changes in interest rates.

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 the originations of three-year and 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
residual effects of reducing the Company's historical exposure to interest rate
increases is a heightened exposure to interest rate decreases. Additionally, a
decline in rates for earning assets may occur more rapidly than a decline in
funding costs. Certificate of Deposits represent the most interest sensitive
funding products and typically have terms ranging from three to thirty six
months. Consequently, the rates paid for these deposits cannot be adjusted until
the maturity date. Loans priced at prime or a margin thereto provide for
adjusting rates immediately when market rates change. In a rising rate
environment, that ability to make immediate rate adjustments serves to protect
the net interest margin against increases in rates at a more rapid speed than
the increase in funding. In a declining rate environment, the rates on prime
rate based loans decrease immediately while certificate rates lag causing the
interest margin to decline until the certificates mature offering an opportunity
for repricing.

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 upon 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.

                                       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 it does repricing 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 books for portfolio. The following table presents the Company's NPV at
June 30, 2001, 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, 2001, the estimated NPV
declined by 14% in a 300 basis point rising interest rate shock scenario
compared to no change in a falling rate scenario. This compares to a decline of
7% under a similar rise and a gain of 4% 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 PV of assets, defined as the Sensitivity Measure
by the OTS. At June 30, 2001, the decline of the sensitivity measure was 144
basis points with a 300 basis point shock increase in rates compared to a
decline of 54 basis points at June 30, 2000.

<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                 17,680              (2,976)              -14.00%           11.51%          (144)
          +200 bp                 18,873              (1,783)               -9.00%           12.12%           (83)
          +100 bp                 19,990                (666)               -3.00%           12.67%           (28)
           0 bp                   20,656                  -                    -             12.95%            -
          -100 bp                 20,656                  -                    -             12.87%            (9)
          -200 bp                 20,629                 (27)                  -             12.76%           (19)
          -300 bp                 20,624                 (32)                  -             12.66%           (29)
</TABLE>

/(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.

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

                                                            June 30,   June 30,
    RISK MEASURES: 200BP RATE SHOCK:                          2001       2000
                                                          ----------------------
    Pre-Shock NPV Ratio: NPV as a % of PV of Assets          12.95%     11.22%
    Exposure Measure: Post Shock NPV Ratio                    1.12%     10.56%
    Sensitivity Measure: Change in NPV                         -83bp      -66bp

                                       17
<PAGE>

Certain shortcomings are inherent in the methodology used in the above table.
Modeling changes in NPV require 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 of the 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. Sensitive assets could be expected to have a positive
effect on the Company.

Management believes the NPV method of assessing the Company's exposure to
interest 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 risk. The strategies that have
reduced the level of interest rate risk under an increasing rate assumption will
continue to reduce the impact of rising rates as long term mortgages are sold
and replaced with shorter term mortgages and non - mortgage 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

In July, 2001, the Financial Accounting Standards Board issued two statements -
Statement 141, Business Combinations, and Statement 142, Goodwill and Other
Intangible Assets, which will potentially impact the Company's accounting for
its reported goodwill and other intangible assets.

Statement 141:

    . Eliminates the pooling method for accounting for business combinations.
    . Requires that intangible assets that meet certain criteria be reported
      separately from goodwill.
    . Requires negative goodwill arising from a business combination to be
      recorded as an extraordinary gain.

Statement 142:

   .  Eliminates the amortization of goodwill and other intangibles that are
      determined to have an indefinite life.
   .  Requires, at a minimum, annual impairment tests for goodwill and other
      intangible assets that are determined to have an indefinite life.

Upon adoption of these Statements, the Company is required to:

   .  Re-evaluate goodwill and other intangible assets that arose from business
      combinations entered into before July 1, 2001. If the recorded other
      intangibles assets do not meet the criteria for recognition, they should
      be reclassified to goodwill. Similarly, if there are other intangible
      assets that meet the criteria for recognition but were not separately
      recorded from goodwill, they should be reclassified from goodwill.

   .  Reassess the useful lives of intangible assets and adjust the remaining
      amortization periods accordingly.

                                       18
<PAGE>

   .  Write-off any remaining negative goodwill.

The Company has not yet completed its full assessment of the effects of these
new pronouncements on its financial statements and so is uncertain as to the
impact. The standards generally are required to be implemented by the Company in
its 2002 financial statements.

Impact of Inflation and Changing Prices

The financial statements and accompanying footnotes have been prepared in
accordance with accounting principles generally accepted in the United States of
America, 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 market
interest rates have a greater impact on the Bank's performance than do the
effects of inflation.

                                       19
<PAGE>

                     (This page intentionally left blank)

                                       20
<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, 2001 and 2000, 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 auditing standards generally accepted
in the United States of America. 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, 2001 and 2000, and the results of their operations
and their cash flows for the years then ended, in conformity with accounting
principles generally accepted in the United States of America.


/s/ McGladrey & Pullen, LLP


Charlotte, North Carolina
August 3, 2001

                                       21
<PAGE>

AF BANKSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
June 30, 2001 and 2000

<TABLE>
<CAPTION>
ASSETS                                                                                 2001                2000
--------------------------------------------------------------------------------------------------------------------
<S>                                                                                <C>                 <C>
Cash and cash equivalents:
 Interest-bearing deposits                                                        $   7,809,583       $   2,599,071
 Noninterest-bearing deposits                                                         4,758,182           4,823,781
Certificates of deposit, at cost                                                         99,000              99,000
Securities held to maturity (fair value $100,000 in 2001 and
 2000) (Note 2)                                                                         100,000             100,000
Securities available for sale (Note 2)                                                6,596,052           8,860,452
Federal Home Loan Bank stock (Notes 2 and 6)                                          1,049,400             775,700
Loans receivable, net (Notes 3 and 6)                                               124,674,509         108,778,257
Real estate owned                                                                       248,323             289,441
Office properties and equipment, net (Note 4)                                         4,171,804           4,183,610
Accrued interest receivable on loans                                                    859,840             605,749
Accrued interest receivable on investment securities                                     71,188              82,647
Prepaid expenses and other assets                                                       945,079             562,317
Deferred income taxes, net (Note 12)                                                    485,987             499,045
Intangible assets, net of accumulated amortization of
 $284,311 in 2001 and $156,882 in 2000                                                1,578,904           1,111,333
                                                                          ------------------------------------------

                                                                          ------------------------------------------
          Total assets                                                            $ 153,447,851       $ 133,370,403
                                                                          ==========================================
</TABLE>

See Notes to Consolidated Financial Statements.

                                       22
<PAGE>

<TABLE>
<CAPTION>
LIABILITIES AND STOCKHOLDERS' EQUITY                                                   2001                2000
--------------------------------------------------------------------------------------------------------------------
<S>                                                                               <C>                <C>
Liabilities:
  Savings deposits (Note 5)                                                       $ 120,073,932        $102,679,834
  Notes payable (Note 6)                                                              1,525,078             700,000
  Note payable - ESOP (Note 9 and 17)                                                   181,420             229,878
  Advances from Federal Home Loan Bank (Note 6)                                      16,961,533          15,513,007
  Accounts payable and other liabilities (Note 10)                                    1,444,223           1,630,313
  Redeemable common stock held by the ESOP, net of
     unearned ESOP shares (Notes 9 and 17)                                              234,178              77,116
                                                                          ------------------------------------------
          Total liabilities                                                         140,420,364         120,830,148
                                                                          ------------------------------------------
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 2001 and 2000 (Note 7)                                                     10,537              10,537
  Additional paid-in capital                                                          4,589,702           4,591,555
  Retained earnings, substantially restricted (Notes 7 and 12)                        8,493,919           8,331,965
  Recognition and retention plan (Note 11)                                              (82,728)           (281,344)
  Accumulated other comprehensive income (loss) (Note 2)                                 99,907             (28,608)
                                                                          ------------------------------------------
                                                                                     13,111,337          12,624,105
  Less cost of 4,300 shares of treasury stock                                           (83,850)            (83,850)
                                                                          ------------------------------------------
          Total stockholders' equity                                                 13,027,487          12,540,255
                                                                          ------------------------------------------
          Total liabilities and stockholders' equity                              $ 153,447,851        $133,370,403
                                                                          ==========================================
</TABLE>

                                       23
<PAGE>

AF BANKSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME
Years Ended June 30, 2001 and 2000

<TABLE>
<CAPTION>
                                                                                         2001               2000
---------------------------------------------------------------------------------------------------------------------
<S>                                                                          <C>                    <C>
Interest income:
  Loans                                                                              $ 10,781,353      $   8,598,994
  Investment securities                                                                   578,608            605,189
  Interest-bearing deposits                                                               288,208            188,787
                                                                             ----------------------------------------
                                                                                       11,648,169          9,392,970
                                                                             ----------------------------------------
Interest expense:
  Deposits (Note 5)                                                                     5,229,836          4,069,009
  Federal Home Loan Bank advances (Note 6)                                              1,037,411            569,966
  Notes payable                                                                            69,903             22,462
  Note payable, ESOP                                                                       18,174             23,761
                                                                             ----------------------------------------
                                                                                        6,355,324          4,685,198
                                                                              ----------------------------------------
          Net interest income                                                           5,292,845          4,707,772
Provision for loan losses (Note 3)                                                        225,004             88,000
                                                                             ----------------------------------------
          Net interest income after provision for loan losses                           5,067,841          4,619,772
                                                                             ----------------------------------------
Noninterest income:
  Insurance commissions                                                                 1,699,208            991,301
  Gain on sale of investments available for sale                                          104,391             94,603
  Other                                                                                   689,880            735,335
                                                                             ----------------------------------------
                                                                                        2,493,479          1,821,239
                                                                             ----------------------------------------
Noninterest expenses:
  Compensation and employee benefits (Notes 8, 9, 10 and 11)                            3,625,395          3,022,254
  Occupancy and equipment                                                                 714,266            502,700
  Deposit insurance premiums                                                               20,961             36,365
  Computer processing charges                                                             340,919            273,202
  Amortization                                                                            127,429             80,598
  Other                                                                                 1,928,095          1,745,089
                                                                             ----------------------------------------
                                                                                        6,757,065          5,660,208
                                                                             ----------------------------------------
          Income before income taxes                                                      804,255            780,803
Income taxes (Note 12)                                                                    314,895            327,595
                                                                             ----------------------------------------
          Net income                                                                 $    489,360      $     453,208
                                                                             ========================================

Basic earning per share (Note 14)                                                    $       0.48      $        0.45
                                                                             ========================================
Diluted earnings per share (Note 14)                                                 $       0.48      $        0.45
                                                                             ========================================
Cash dividends per share                                                             $       0.20      $        0.20
                                                                             ========================================
</TABLE>

See Notes to Consolidated Financial Statements.

                                       24
<PAGE>

AF BANKSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Years Ended June 30, 2001 and 2000

<TABLE>
<CAPTION>
                                                                                       Additional
                                                                      Common            Paid-In              Retained
                                                                       Stock            Capital              Earnings
-------------------------------------------------------------------------------------------------------------------------
<S>                                                                   <C>              <C>                   <C>
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 $(111,871) (Note 2)                                   -                  -                    -
   Less:  reclassification adjustment for
    gains included in net income,
    net of taxes of $36,990 (Note 2)                                           -                  -                    -
  Other comprehensive loss                                                     -                  -                    -
Comprehensive income                                                           -                  -                    -
                                                            -------------------------------------------------------------
Balance, June 30, 2000                                                    10,537          4,591,555            8,331,965
  Vesting of recognition and retention plan                                    -                  -                    -
  Transfer to redeemable common stock
   net of unearned ESOP shares                                                 -                  -             (157,062)
  ESOP contribution                                                            -             (1,853)              37,000
  Cash dividend, $.20 per share                                                -                  -             (207,344)
  Net income                                                                   -                  -              489,360
  Other comprehensive income, net of tax:
   Unrealized holding gains arising during
    period, net of taxes $123,400 (Note 2)                                     -                  -                    -
   Less:  reclassification adjustment for
    gains included in net income,
    net of taxes of $40,838 (Note 2)                                           -                  -                    -
   Other comprehensive income                                                  -                  -                    -
  Comprehensive income                                                         -                  -                    -
                                                            -------------------------------------------------------------
Balance, June 30, 2001                                                $   10,537        $ 4,589,702          $ 8,493,919
                                                            =============================================================
</TABLE>

See Notes to Consolidated Financial Statements.

                                       25
<PAGE>

<TABLE>
<CAPTION>
                              Accumulated
                                 Other                                   Total
     Recognition and         Comprehensive           Treasury        Stockholders'
      Retention Plan         Income (Loss)            Stock             Equity
----------------------------------------------------------------------------------
<S>                          <C>                   <C>               <C>
         $  (479,960)        $     203,638         $   (83,850)      $  12,218,254
             198,616                     -                   -             198,616

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

                   -              (174,633)                  -                   -

                   -                57,613                   -                   -
                             -------------
                   -              (232,246)                  -            (232,246)
                                                                     -------------

                   -                     -                   -             220,962
----------------------------------------------------------------------------------
            (281,344)              (28,608)            (83,850)         12,540,255
             198,616                     -                   -             198,616

                   -                     -                   -            (157,062)
                   -                     -                   -              35,147
                   -                     -                   -            (207,344)
                   -                     -                   -             489,360

                   -               192,068                   -

                   -                63,553                   -
                             -------------
                   -               128,515                   -             128,515
                                                                     -------------
                   -                     -                   -             617,875
----------------------------------------------------------------------------------
         $   (82,728)        $      99,907         $   (83,850)      $  13,027,487
==================================================================================
</TABLE>

                                       26
<PAGE>

AF BANKSHARES, INC. AND SUBSIDIARIES


CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended June 30, 2001 and 2000

<TABLE>
<CAPTION>
                                                                                       2001                2000
-------------------------------------------------------------------------------------------------------------------
<S>                                                                                 <C>                 <C>
Net income                                                                          $  489,360          $  453,208
 Adjustments to reconcile net income to net cash
 provided by operating activities:
   Provision for loan losses                                                           225,004              88,000
   Loss on disposal of office properties and equipment                                   8,540                   -
   (Gain) loss on sale of real estate owned                                             (2,471)             10,962
   Gain on sale of investments available for sale                                     (104,391)            (94,603)
   Provision for depreciation                                                          572,888             380,547
   Amortization of goodwill and noncompete covenants                                   127,429              80,598
   Amortization of deferred loan fees                                                 (160,713)           (175,794)
   Amortization of premium/discount on investments                                     (9,783)              62,153
   Amortization of unearned ESOP shares                                                 37,000              37,000
   ESOP fair value adjustment                                                           (1,853)             (1,961)
   Vesting of recognition and retention plan                                           198,616             198,616
   Proceeds from sale of loans held for sale                                         5,547,737           3,823,079
   Origination of loans held for sale                                               (5,553,976)         (3,831,520)
   Loss on sale of loans held for sale                                                   6,239               8,441
   Deferred income taxes                                                               (69,504)             74,916
   Increase in operating assets:
     Accrued interest receivable                                                      (242,632)           (191,880)
     Prepaid expenses and other assets                                                (382,762)            (15,596)
   Decrease in liabilities:
     Accounts payable and other liabilities                                           (186,090)             (6,049)
                                                                                  ---------------------------------
        Net cash provided by operating activities                                      498,638             900,117
                                                                                  ---------------------------------
Cash Flows from Investing Activities
 Purchases of securities available for sale                                         (1,600,000)         (1,500,000)
 Purchase of FHLB stock                                                               (273,700)           (252,100)
 Proceeds from calls of securities available for sale                                2,900,000           1,580,000
 Proceeds from sale of securities available for sale                                   105,808             300,528
 Principal payments received on securities available for sale                        1,183,843           1,386,533
 Purchase of securities held to maturity                                              (100,000)           (100,000)
 Proceeds from maturity of security held to maturity                                   100,000             199,000
 Net originations of loans receivable                                              (15,966,925)        (27,863,180)
 Purchase of office properties and equipment                                          (601,572)         (2,016,787)
 Proceeds from sale of properties and equipment                                         31,950              15,192
 Proceeds from sale of real estate owned                                                49,971              88,080
                                                                                  ---------------------------------
        Net cash used in investing activities                                      (14,170,625)        (28,162,734)
                                                                                  ---------------------------------
</TABLE>

                                  (Continued)

                                       27
<PAGE>

AF BANKSHARES, INC. AND SUBSIDIARIES


CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
Years Ended June 30, 2001 and 2000

<TABLE>
<CAPTION>
                                                                                      2001                2000
-------------------------------------------------------------------------------------------------------------------
<S>                                                                            <C>                     <C>
Cash Flows from Financing Activities
  Net increase in savings deposits                                                $ 17,394,098         $ 9,573,744
  Net borrowings on FHLB advances                                                    1,448,526          12,948,649
  Principal payments on notes payable                                                  (73,380)            (25,542)
  Proceeds from notes payable                                                          255,000                   -
  Cash dividends paid                                                                 (207,344)           (206,442)
                                                                                 ----------------------------------
        Net cash provided by financing activities                                   18,816,900          22,290,409
                                                                                 ----------------------------------
        Net increase (decrease) in cash and
         cash equivalents                                                            5,144,913          (4,972,208)
Cash and cash equivalents:
  Beginning                                                                          7,422,852          12,395,060
                                                                                 ----------------------------------
  Ending                                                                          $ 12,567,765         $ 7,422,852
                                                                                 ==================================

Supplemental Schedule of Cash and Cash Equivalents
  Interest-bearing deposits                                                       $  7,809,583         $ 2,599,071
  Noninterest-bearing                                                                4,758,182           4,823,781
                                                                                 ----------------------------------
                                                                                  $ 12,567,765         $ 7,422,852
                                                                                 ==================================

Supplemental Disclosures of Cash Flow Information
  Cash payments for:
   Interest                                                                       $  6,243,446         $ 4,585,898
   Income taxes                                                                        193,399             241,907

Supplemental Disclosure of Noncash Investing and Financing
 Activities
   Net change in unrealized gain (loss) on securities available
    for sale, net of tax                                                          $    128,515         $  (232,246)
   Transfer from loans receivable to real estate owned                                   6,382             329,483
   Fair value of ESOP shares in excess of unearned ESOP
    shares                                                                            (120,062)             36,826
   Transfer to (from) retained earnings (to) from redeemable
    common stock                                                                      (157,062)             73,826
   Note payable issued for purchase of insurance agency                                595,000             700,000
   Fair value of office equipment received in purchase of
    insurance agency                                                                         -             (17,785)
   Intangible assets recorded on purchase of insurance agency                         (595,000)           (682,215)
</TABLE>

See Notes to Consolidated Financial Statements.

                                       28
<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 or 2001.

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, December 1, 1999 and November 1, 2000, 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, Boone 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.

                                       29
<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 accounting principles generally accepted in the United
States of America 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 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, 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.

                                       30
<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 all loans delinquent more than 90 days for impairment. See Note 3 for
further information.

                                       31
<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.

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, 2001 or 2000.

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 acquired 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.
See Note 18 for further information.

Pension plans: The Company 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 Company 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.

                                       32
<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. See Note 11 for further information.

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. Such
financial instruments are recorded when they are founded.

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. Basic per-share amounts are computed by dividing net
income (the numerator) by the weighted-average number of common shares
outstanding (the denominator). 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.

                                       33
<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, 2001 and 2000. 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>
                                                                               2001
                                               ---------------------------------------------------------------------
                                                                     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              $ 3,158,624        $  27,735       $  (19,261)       $3,167,098
  Fannie Mae and Government
   National Mortgage Association                   1,986,673           18,423          (12,354)        1,992,742
  Municipals                                         283,883            2,473                -           286,356
 Equity securities:
  Mutual Funds                                     1,000,000                -          (77,431)          922,569
  Federal Home Loan Mortgage
   Corporation Common Stock                            2,783          224,504                -           227,287
                                               ---------------------------------------------------------------------
                                                   6,431,963          273,135         (109,046)        6,596,052

Held to maturity securities:
 Debt securities:
  Federal Home Loan Bank                             100,000                -                -           100,000
Other investments:
  Federal Home Loan Bank stock                     1,049,400                -                -         1,049,400
                                               ---------------------------------------------------------------------
                                                 $ 7,581,363        $ 273,135       $ (109,046)       $7,745,452
                                               =====================================================================
</TABLE>

                                       34
<PAGE>

AF BANKSHARES, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

Note 2.  Debt and Equity Securities (Continued)

<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>

The amortized cost and estimated fair value of debt securities at June 30, 2001,
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.

                                       35
<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 within one year                               $         -      $        -       $   500,000      $    506,250
Due from one year to five years                       100,000         100,000         1,992,140         2,013,625
Due after ten years                                         -               -           950,367           933,579
Fannie Mae and Government
   National Mortgage Association
   debt securities                                          -               -         1,986,673         1,992,742
Mutual funds                                                -               -         1,000,000           922,569
Equity securities                                           -               -             2,783           227,287
                                                 ----------------------------------------------------------------
                                                  $   100,000      $  100,000       $ 6,431,963      $  6,596,052
                                                 ================================================================
</TABLE>

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

<TABLE>
<CAPTION>
                                                                                        2001              2000
                                                                                    ------------------------------
<S>                                                                                 <C>                <C>
Proceeds from calls of securities available for sale                                $ 2,900,000        $ 1,580,000
Proceeds from sale of securities available for sale                                     105,808            300,528
                                                                                    ------------------------------
                                                                                      3,005,808          1,880,528
Realized gain on sale of securities available for sale                                 (104,391)           (94,603)
                                                                                    ------------------------------
Cost of securities sold                                                             $ 2,901,417        $ 1,785,925
                                                                                    ==============================
</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:

                                                   2001               2000
                                               ------------------------------
Balance, beginning                             $  (28,608)         $  203,638
Change in net unrealized gains                    211,077            (381,107)
Change in deferred income taxes                   (82,562)            148,861
                                               ------------------------------
Balance, ending                                $   99,907          $  (28,608)
                                               ==============================

                                       36
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AF BANKSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

Note 3.  Loans Receivable

Loans receivable at June 30, consist of the following:

                                                    2001              2000
                                               -------------------------------
  One to four-family                           $ 79,464,827       $ 68,813,143
  Multifamily                                     3,507,406          2,277,623
  Non residential                                 8,358,622          8,577,554
  Land                                            8,297,917          2,439,602
  Construction loans                              5,344,320          4,058,901
  Commercial loans                               12,378,366         10,455,888
  Consumer loans                                 14,050,855         17,375,621
                                               -------------------------------
                                                131,402,313        113,998,332
Less:
  Undisbursed loan funds                         (5,478,702)        (3,992,983)
  Deferred loan fees                               (227,439)          (247,824)
  Allowance for loan losses                      (1,021,663)          (979,268)
                                               -------------------------------
                                               $124,674,509       $108,778,257
                                               ===============================

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

                                                    2001               2000
                                                ------------------------------
Balance, beginning                              $   979,268        $ 1,122,681
  Provisions charged to operations                  225,004             88,000
  Charge-offs                                      (303,952)          (327,835)
  Recoveries                                        121,343             96,422
                                                ------------------------------
Balance, ending                                 $ 1,021,663        $   979,268
                                                ==============================

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 considers all loans delinquent more than 90
days to be impaired and such loans amounted to approximately $479,000 and
$411,000 at June 30, 2001 and 2000, 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 2001 and 2000 was $15,603 and $16,249, respectively. The
Bank established reserves for uncollectible interest totaling $15,603 and
$10,911 at June 30, 2001 and 2000, respectively.

                                       37
<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, 2001 and 2000, is summarized as follows:

                                                   2001               2000
                                               ------------------------------
Balance, beginning                             $ 1,678,623        $ 1,330,111
Disbursements                                    1,305,723            542,327
Payments received                                 (344,971)          (193,815)
                                               ------------------------------
Balance, ending                                $ 2,639,375        $ 1,678,623
                                               ==============================

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 $25,196,000 and $22,613,000 at June
30, 2001 and 2000, respectively.

There were no loans held for sale or outstanding commitments to sell loans as of
June 30, 2001 or 2000.

Note 4.  Office Properties and Equipment

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

                                                   2001               2000
                                               ------------------------------
Land and land improvements                     $   308,329        $   308,329
Buildings                                        3,225,571          2,968,811
Furniture and fixtures                           2,124,806          1,919,117
Leasehold improvements                             256,440            252,120
Automobiles                                              -             63,409
                                               ------------------------------
                                                 5,915,146          5,511,786
Accumulated depreciation                        (1,743,342)        (1,328,176)
                                               ------------------------------
                                               $ 4,171,804        $ 4,183,610
                                               ==============================

                                       38
<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>
                                                                                 2001                  2000
                                                                     ----------------------------------------------
<S>                                                                  <C>                          <C>
Interest-bearing checking accounts at 2.37%
  (1.91% 2000)                                                               $ 19,194,663          $ 14,681,415
Commercial and free checking (noninterest bearing)                              8,502,661             6,473,696
Passbook savings 3.63% (3.83% 2000)                                            21,822,482            23,032,283
Money market demand accounts 2.50% (2.00% 2000)                                 1,402,246             1,393,563
                                                                     ----------------------------------------------
                                                                               50,922,052            45,580,957
                                                                     ----------------------------------------------
Certificates of Deposit:
 weighted average rate of 5.79% (5.71% 2000)
  4.00% to 5.99%                                                               38,981,920            38,922,959
  6.00% to 7.99%                                                               29,927,198            18,014,374
                                                                     ----------------------------------------------
                                                                               68,909,118            56,937,333
                                                                     ----------------------------------------------

Accrued interest payable                                                          242,762               161,544
                                                                     ----------------------------------------------
                                                                             $120,073,932          $102,679,834
                                                                     ==============================================
Weighted average cost of savings deposits                                            4.39 %                4.34 %
                                                                     ==============================================
</TABLE>

At June 30, 2001, scheduled maturities of certificates of deposit are as
follows:

<TABLE>
<CAPTION>
                            2002           2003           2004           2005            After           Total
                     --------------------------------------------------------------------------------------------
<S>                  <C>                <C>            <C>             <C>            <C>            <C>
4.00% to 5.99%          $35,152,429     $2,199,802     $1,345,075      $ 208,313      $   76,301     $38,981,920
6.00% to 7.99%           22,181,041      5,683,174        620,615        173,523       1,268,845      29,927,198
                     --------------------------------------------------------------------------------------------
                        $57,333,470     $7,882,976     $1,965,690      $ 381,836      $1,345,146     $68,909,118
                     ============================================================================================
</TABLE>

The aggregate amount of jumbo certificates of deposit with a minimum
denomination of $100,000 was $22,315,526 and $17,081,469 at June 30, 2001 and
2000, respectively. At June 30, 2001, scheduled maturities of jumbo certificates
of deposit are as follows:

<TABLE>
<CAPTION>
                                                                                                      Weighted
                                                                                Amount              Average Rate
                                                                     ----------------------------------------------
<S>                                                                  <C>                            <C>
Maturity period:
  Within three months                                                        $  4,951,238                  5.91 %
  Three through six months                                                      6,292,205                  6.03
  Six through twelve months                                                     6,454,122                  5.58
  Over twelve months                                                            4,617,961                  6.60
                                                                     ----------------------------------------------
                                                                             $ 22,315,526                  5.99 %
                                                                     ==============================================
</TABLE>

                                       39
<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, 2001
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>
                                                                                         2001              2000
                                                                             --------------------------------------
<S>                                                                           <C>                      <C>
Interest-bearing checking accounts                                                  $   467,158        $   352,730
Passbook savings accounts                                                               812,721            831,664
Certificate accounts                                                                  3,949,957          2,884,615
                                                                             --------------------------------------
                                                                                    $ 5,229,836        $ 4,069,009
                                                                             ======================================
</TABLE>

Note 6.   Notes Payable and Federal Home Loan Bank Advances

Notes payable consist of the following at June 30:

<TABLE>
<CAPTION>
                                                                                      2001                2000
                                                                             -------------------------------------
<S>                                                                          <C>                    <C>
Note payable to AsheCo, M.H.C., due on July 16, 2001 including
 interest at the Federal Home Loan Bank's overnight advances
 rate (4.0% at June 30, 2001).                                                      $   250,000         $        -
Note payable, due in monthly installments of $7,808 including
 interest at the bank's prime rate (6.75% at June 30, 2001) with
 a balloon payment due November 6, 2005.  Collateralized by
 insurance expirations and the right to renew them.                                     575,078                  -
Notes payable, unsecured, 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            700,000
                                                                             -------------------------------------
                                                                                    $ 1,525,078         $  700,000
                                                                             =====================================
</TABLE>

                                       40
<PAGE>

AF BANKSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

Note 6.   Notes Payable and Federal Home Loan Bank Advances (Continued)

FHLB advances consist of the following:

<TABLE>
<CAPTION>
                                                                                      2001               2000
                                                                             --------------------------------------
<S>                                                                           <C>                     <C>
Balance outstanding                                                                $ 16,961,533       $ 15,513,007
Interest rate range                                                                  4.30%-6.87%        6.13%-6.95%
Weighted average interest rate at June 30                                                  5.52%              6.63%
Maximum amount outstanding at any month end                                          19,987,286         15,513,007
Average amount outstanding                                                           17,567,000         10,161,000
Interest expense                                                                      1,037,411            569,966
Weighted average interest rate during the year ended June 30                               5.91%              5.61%
</TABLE>

Notes payable are due in future years as follows:

<TABLE>
<CAPTION>
Year ending June 30,                                                                                      Amount
--------------------                                                                                   -----------
<S>                                                                                                    <C>
   2002                                                                                                $   306,608
   2003                                                                                                     60,550
   2004                                                                                                     64,766
   2005                                                                                                    139,275
   2006                                                                                                    463,879
   Thereafter                                                                                              490,000
                                                                                                       -----------
                                                                                                       $ 1,525,078
                                                                                                       ===========
</TABLE>

Pursuant to collateral agreements with the FHLB, advances are collateralized by
all the Bank's stock in the FHLB and qualifying first mortgage loans. Advances
of $812,500 are due August 2002, $149,033 is due January 2007, $5,000,000 is due
September 2010, $7,000,000 is due November 2010, and $4,000,000 is due January
2011.

Note 7.  Stockholders' Equity

The Company and the Bank are 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 Company and the Bank's financial statements. Under
capital adequacy guidelines and the regulatory framework for prompt corrective
action, the Company and the Bank must meet specific capital guidelines that
involve quantitative regulatory accounting practices. The Company and the Bank's
capital amounts and classifications are also subject to qualitative judgments by
the regulators about components, risk weightings, and other factors. Prompt
corrective action provisions are not applicable to bank holding companies.

The Office of Thrift Supervision (OTS) regulations require institutions to
maintain amounts and ratios of total and Tier 1 capital to risk-weighted assets
and Tier 1 capital to average assets. At June 30, 2001 and 2000, the Company and
the Bank exceeded all of the capital requirements.

                                       41
<PAGE>

AF BANKSHARES, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

Note 7.  Stockholders' Equity (Continued)

As of June 30, 2001, 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 minimum
total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in
the following tables. There are no conditions or events since that notification
that management believes have changed the Bank's category.

<TABLE>
<CAPTION>
                                                                 Minimum Capital         Capitalized Under Prompt
                                         Actual                    Requirement         Corrective Action Provisions
                                      --------------------------------------------------------------------------------
                                         Amount      Ratio      Amount      Ratio        Amount           Ratio
                                      -------------------------------------------------------------------------------
                                                                     (Dollars in Thousands)
<S>                                   <C>            <C>       <C>          <C>          <C>              <C>
June 30, 2001:
Total Capital to Risk
 Weighted Assets:
  Consolidated                         $ 12,337      11.1%     $ 8,896       8.0%        $      -                -
  Bank                                   13,654      12.3%       8,896       8.0%          11,121            10.0%

Tier 1 Capital to Risk
 Weighted Assets:
  Consolidated                           11,349      10.2%       4,448       4.0%               -                -
  Bank                                   12,665      11.4%       4,448       4.0%           6,672              6.0%

Tier 1 Capital to Average Assets:
 Consolidated                            11,349       7.4%       6,138       4.0%               -                -
 Bank                                    12,665       8.4%       6,048       4.0%           7,560              5.0%

June 30, 2000:
Total Capital to Risk
 Weighted Assets:
  Consolidated                           12,319      11.7%       8,427       8.0%               -                -
  Bank                                   12,578      11.9%       8,427       8.0%          10,534             10.0%

Tier 1 Capital to Risk
 Weighted Assets:
  Consolidated                           11,458      10.9%       4,214       4.0%               -                -
  Bank                                   11,717      11.1%       4,214       4.0%           6,321              6.0%

Tier 1 Capital to Average Assets:
 Consolidated                            11,458       8.7%       5,270       4.0%               -                -
 Bank                                    11,717       8.9%       5,270       4.0%           6,588              5.0%
</TABLE>

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.

                                       42
<PAGE>

AF BANKSHARES, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

Note 7.  Stockholders' Equity (Continued)

The Company paid cash dividends totaling $.20 per share during the each of the
years ended June 30, 2001 and 2000. On August 20, 2001, the Company declared a
$.05 per share cash dividend for stockholders of record as of August 30, 2001 to
be paid on September 14, 2001.

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 $97,269 and $57,608 for
the years ended June 30, 2001 and 2000, 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 $76,331 and $113,220 for the years ended June 30, 2001
and 2000, respectively.

In addition, the Company has a 401(k) retirement plan which contains provisions
for specified matching contributions by the Company. The Company funds
contributions as they accrue and 401(k) plan expense amounted to $121,450 and
$92,302 for the years ended June 30, 2001 and 2000, respectively.

Note 9.  Employee Stock Ownership Plan

As part of the Reorganization, the Company 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 (6.75% at June 30, 2001)
less .5% with a balloon payment due June, 2002. The Company 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, 2001, future principal payments are due as follows:


Year Ending June 30:                                                   Amount
--------------------------------------------------------------------------------
2002                                                                  $ 181,420
                                                                     ===========

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.

                                       43
<PAGE>

AF BANKSHARES, INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

Note 9.  Employee Stock Ownership Plan (Continued)

Excluding interest, expense of $35,150 and $35,039 during 2001 and 2000,
respectively, has been incurred in connection with the ESOP. The expense
includes, in addition to the cash contribution necessary to fund the ESOP,
$(1,853) in 2001 and $(1,961) in 2000, 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
charged this amount to paid-in capital in accordance with the provisions of
AICPA Statement of Position 93-6.

At June 30, 2001 and 2000, 18,800 and 15,100 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 $204,000 and $175,000 at June 30, 2001 and 2000, 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 $234,178 and $77,116 at June 30, 2001 and 2000,
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. 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 $(2,235) and $55,536 for the years ended
June 30, 2001 and 2000, respectively.

                                       44
<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, 2001 and 2000 would be
as follows:

                                                            2001         2000
                                                        ------------------------
Net income
 As reported                                             $ 489,360    $ 453,208
 Pro forma                                                 460,705      424,553

Earnings per share
 As reported
  Basic                                                  $    0.48    $    0.45
  Diluted                                                     0.48         0.45
Pro forma
  Basic                                                       0.45         0.42
  Diluted                                                     0.45         0.42

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, 2001, 21,322 options have been granted at an exercise price of
$18.50, of which 17,058 options are currently exercisable. No options have been
exercised to date and all options granted are outstanding at June 30, 2001.

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, 2001 and 2000.

                                       45
<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 $182,605 and
$231,413 in 2001 and 2000, 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, 2001 and 2000.

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, 2001, 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.

                                       46
<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:

                                                            2001       2000
                                                       -------------------------
Deferred tax assets:
 Reserve for loan losses                                $  392,068  $  376,711
 Reserve for uncollected interest                            6,018       3,908
 Unrealized loss on securities available for sale                -      18,378
 Deferred compensation                                     230,228     224,030
 Recognition and retention plan                             44,664      44,743
 Deferred loan fees                                              -       6,255
 Other                                                       3,066           -
 State net economic loss carryforwards                      47,036       8,717
                                                       -------------------------
                                                           723,080     682,742
 Less valuation allowance                                  (36,435)          -
                                                       -------------------------
                                                           686,645     682,742
                                                       -------------------------
Deferred tax liabilities:
 Reserve for loan losses                                    11,838      17,738
 Unrealized gain on securities available for sale           64,184           -
 Depreciation                                               35,089     104,051
 FHLB stock dividends                                       60,170      60,170
 Prepaid expenses                                            1,738       1,738
 Deferred loan fees                                         27,639           -
                                                       -------------------------
                                                           200,658     183,697
                                                       -------------------------
    Net deferred tax asset                              $  485,987  $  499,045
                                                       =========================


During the year ended June 30, 2001, the Company recorded a valuation allowance
of $36,435 on the deferred tax assets to reduce the total to an amount that
management believes will ultimately be realized. Realization of deferred tax
assets is dependent upon sufficient future taxable income during the period that
deductible temporary differences and carryforwards are expected to be available
to deduce taxable income. There was no other activity in the valuation allowance
account during 2001 or 2000.

The provision for income taxes charged to operations for the years ended June
30, 2001 and 2000 consists of the following:

                                                           2001         2000
                                                       -------------------------
Current                                                 $  384,399  $  252,679
Deferred                                                  (69,504)      74,916
                                                       -------------------------
                                                        $  314,895  $  327,595
                                                       =========================

                                       47
<PAGE>

AF BANKSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

Note 12.  Income Tax Matters (Continued)

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

<TABLE>
<CAPTION>
                                                            2001                           2000
                                              ------------------------------------------------------------
                                                    Amount        Percent         Amount         Percent
                                              ------------------------------------------------------------
<S>                                           <C>                 <C>             <C>            <C>
Tax at statutory rate                            $ 273,446         34.0%        $ 265,473         34.0%
State tax, net of federal benefit                   42,162          5.2            32,928          4.2
Municipal interest income                          (43,556)        (5.4)           (9,231)        (1.2)
Permanent differences                               44,301          5.5            42,682          5.5
Other                                               (1,458)        (0.1)           (4,257)        (0.5)
                                              ------------------------------------------------------------
     Total                                       $ 314,895         39.2 %       $ 327,595         42.0 %
                                              ============================================================
</TABLE>

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, 2001:

                                                                       Notional
                                                                        Amount
                                                                     -----------
Financial instruments whose contract amounts represent credit risk:
 Undisbursed home equity lines of credit                             $ 8,624,725
 Undisbursed commercial lines of credit                                3,685,611

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, 2001 was 6.75%.

                                       48
<PAGE>

AF BANKSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

Note 13.  Commitments and Contingencies (Continued)

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

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:

                                          For the Year Ended June 30, 2001
                                   ---------------------------------------------
                                        Income         Shares         Per Share
                                      (Numerator)   (Denominator)       Amount
                                   ---------------------------------------------
Basic and Diluted EPS                 $  489,360      1,024,428        $   0.48
                                   =============================================

                                          For the Year Ended June 30, 2000
                                   ---------------------------------------------
                                        Income         Shares         Per Share
                                      (Numerator)   (Denominator)       Amount
                                   ---------------------------------------------
Basic and Diluted EPS                 $  453,208      1,009,987        $   0.45
                                   =============================================

                                       49
<PAGE>

AF BANKSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

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, 2001 and 2000:

<TABLE>
<CAPTION>
                                              2001                           2000
                                  ---------------------------------------------------------------
                                     Carrying          Fair         Carrying         Fair
                                      Value            Value         Value           Value
                                  ----------------------------------------------------------------
<S>                               <C>                <C>            <C>            <C>
Financial assets:
 Cash
  Interest-bearing                  $   7,809,583  $   7,809,583  $   2,599,071  $   2,599,071
  Noninterest-bearing
   deposits                             4,758,182      4,758,182      4,823,781      4,823,781
 Certificates of deposit                   99,000         99,000         99,000         99,000
 Investments                            6,696,052      6,696,052      8,960,452      8,960,452
 Loans receivable                     124,674,509    122,973,554    108,778,257    108,706,482
 Accrued interest receivable              931,028        931,028        688,396        688,396
 FHLB stock                             1,049,400      1,049,400        775,700        775,700

Financial liabilities:
 Deposits                             120,073,932    119,938,462    102,679,834    102,513,268
 Advances from FHLB                    16,961,533     16,961,533     15,513,007     15,513,007
 Notes payable                          1,525,078      1,525,078        700,000        700,000
 Note payable, ESOP                       181,420        181,420        229,878        229,878
</TABLE>

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.

                                       50
<PAGE>

AF BANKSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

Note 15.  Fair Value of Financial Instruments (Continued)

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.

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 upon 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.

                                       51
<PAGE>

AF BANKSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

Note 16.  Reorganization and Minority Stock Offering (Continued)

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.

                                       52
<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, 2001 and 2000:

                              AF Bankshares, Inc.
                           Condensed Balance Sheets
                            June 30, 2001 and 2000

<TABLE>
<CAPTION>
                                                                 2001               2000
                                                          --------------------------------------
<S>                                                       <C>                       <C>
Assets:
 Cash                                                            $     3,761        $       116
 Investment in AF Bank                                            12,765,063         11,688,699
 Investment in AF Insurance Services, Inc.                           655,114            696,028
 Investment in AF Brokerage, Inc.                                    218,785            241,252
 Other assets                                                         76,702            259,060
                                                          ---------------------------------------
                                                                 $13,719,425        $12,885,155
                                                          ======================================
Liabilities and Equity:
 Liabilities:
  Accounts payable                                               $    26,340        $    37,906
  Note payable                                                       250,000                  -
  Note payable - ESOP                                                181,420            229,878
  Redeemable common stock held by the ESOP, net of
   unearned ESOP shares                                              234,178             77,116
                                                          --------------------------------------
                                                                     691,938            344,900
                                                          --------------------------------------
Equity:
 Common stock                                                         10,537             10,537
 Additional paid-in capital                                       11,869,396         11,871,250
 Retained earnings                                                 1,214,225          1,052,270
 Recognition and retention plan                                      (82,728)          (281,344)
 Accumulated other comprehensive income (loss)                        99,907            (28,608)
                                                          -------------------------------------
                                                                  13,111,337         12,624,105
 Less cost of 4,300 shares of treasury stock                         (83,850)           (83,850)
                                                          --------------------------------------
                                                                  13,027,487         12,540,255
                                                          --------------------------------------
                                                                 $13,719,425        $12,885,155
                                                          ======================================
</TABLE>

                                       53
<PAGE>

AF BANKSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

Note 17.  Mid-Tier Holding Company and Mutual Holding Company Data (Continued)

                              AF Bankshares, Inc.
                        Condensed Statements of Income
                      Years Ended June 30, 2001 and 2000

<TABLE>
<CAPTION>
                                                                           2001               2000
                                                                       -------------------------------
<S>                                                                    <C>                 <C>
Interest and investment income                                          $        -         $   65,207
Equity in earnings of subsidiaries                                         635,852            577,154
Income tax credits                                                          79,623             64,344
Other expense                                                             (226,115)          (253,497)
                                                                       -------------------------------
        Net income                                                      $  489,360         $  453,208
                                                                      ================================

                              AF Bankshares, Inc.
                      Condensed Statements of Cash Flows
                      Years Ended June 30, 2001 and 2000

                                                                           2001               2000
                                                                       --------------------------------
Cash Flows from Operating Activities:
 Net income                                                             $  489,360         $  453,208
 Change in assets and liabilities:
  Gain on sale of securities                                                     -           (63,994)
  Equity in earnings of subsidiaries                                      (635,852)          (577,154)
  Increase (decrease) in accounts payable and other liabilities            (24,877)            39,883
  (Increase) decrease in other assets                                      182,358           (147,130)
        Net cash provided by (used in) operating activities            -------------------------------
                                                                            10,989           (295,187)
                                                                       -------------------------------
Cash Flows from Investing Activities:
 Proceeds from sales of securities available for sale                            -            269,335
 Capitalization of AF Brokerage, Inc.                                      (50,000)                 -
                                                                       -------------------------------
        Net cash provided by (used in) investing activities                (50,000)           269,335
                                                                       --------------------------------
Cash Flows from Financing Activities:
 Proceeds from note payable                                                250,000                  -
 Cash dividends paid                                                      (207,344)          (206,442)
                                                                       -------------------------------
        Net cash provided by (used in) financing activities                 42,656           (206,442)
                                                                       -------------------------------
Net increase (decrease) in cash                                              3,645           (232,294)
 Cash - beginning                                                              116            232,410
                                                                       -------------------------------
 Cash - ending                                                          $    3,761         $      116
                                                                       ===============================
</TABLE>

                                       54
<PAGE>

AF BANKSHARES, INC. AND SUSIDIARIES


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, 2001 and 2000:

                                AsheCo, M.H.C.
                           Condensed Balance Sheets
                            June 30, 2001 and 2000


<TABLE>
<CAPTION>
                                                                    2001             2000
                                                             ---------------------------------
<S>                                                          <C>                      <C>
Assets:
  Cash                                                         $     8,776        $   281,371
  Investment in AA&G, Inc. and Subsidiary                          135,337             99,090
  Investment in AF Bankshares, Inc. and Subsidiaries             6,681,798          6,431,897
  Other assets                                                     391,283             48,588
                                                             ---------------------------------
                                                               $ 7,217,194        $ 6,860,946
                                                             =================================
Liabilities and Equity:
  Liabilities:
    Accounts payable                                                     -        $     1,000
                                                             ---------------------------------
  Equity:
    Additional paid-in capital                                 $ 5,903,977          5,797,425
    Retained earnings                                            1,313,217          1,062,521
                                                             ---------------------------------
                                                                 7,217,194          6,859,946
                                                             ---------------------------------
                                                               $ 7,217,194        $ 6,860,946
                                                             =================================
</TABLE>


                               AsheCo, M.H.C.
                       Condensed Statements of Income
                     Years Ended June 30, 2001 and 2000


<TABLE>
<CAPTION>
                                                                     2001               2000
                                                             -----------------------------------
<S>                                                          <C>                       <C>
Interest income                                                $     7,862          $   7,367
Equity in earnings subsidiaries                                    287,240            264,713
Income tax credits (expense)                                          (451)            (9,661)
Other expense                                                      (43,956)           (23,981)
                                                             ----------------------------------
Net income                                                     $   250,695          $ 238,438
                                                             ==================================
</TABLE>


                                       55
<PAGE>

AF BANKSHARES, INC. AND SUSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

Note 17.  Mid-Tier Holding Company and Mutual Holding Company Data (Continued)

                                AsheCo, M.H.C.
                       Condensed Statement of Cash Flows
                      Years Ended June 30, 2001 and 2000

                                                 2001               2000
                                             -------------------------------
Cash Flows from Operating Activities:
 Net income                                   $ 250,695          $  238,438
 Change in assets and liabilities:
  Equity in earnings of subsidiaries           (287,240)           (264,713)
  Decrease in accounts payable                   (1,000)                  -
  Increase in other assets                     (342,697)            (22,502)
                                             -------------------------------
    Net cash used in operating activities      (380,242)            (48,777)
Cash Flows from Investing Activities:
 Dividends from AF Bankshares, Inc.             107,647             107,645
                                             -------------------------------
Net increase (decrease) in cash                (272,595)             58,868
 Cash - beginning                               281,371             222,503
                                             -------------------------------
 Cash - ending                                $   8,776          $  281,371
                                             ===============================


Note 18.  Recent Accounting Pronouncements Not Yet Adopted

In July, 2001, the Financial Accounting Standards Board issued two statements -
Statement 141, Business Combinations, and Statement 142, Goodwill and Other
Intangible Assets, which will potentially impact the Company's accounting for
its reported goodwill and other intangible assets.

Statement 141:

     .    Eliminates the pooling method for accounting for business
          combinations.
     .    Requires that intangible assets that meet certain criteria be reported
          separately from goodwill.
     .    Requires negative goodwill arising from a business combination to be
          recorded as an extraordinary gain.

Statement 142:

     .    Eliminates the amortization of goodwill and other intangibles that are
          determined to have an indefinite life.
     .    Requires, at a minimum, annual impairment tests for goodwill and other
          intangible assets that are determined to have an indefinite life.

                                       56
<PAGE>

AF BANKSHARES, INC. AND SUSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

Note 18.  Recent Accounting Pronouncements Not Yet Adopted (Continued)

Upon adoption of these Statements, the Company is required to:

     .    Re-evaluate goodwill and other intangible assets that arose from
          business combinations entered into before July 1, 2001. If the
          recorded other intangibles assets do not meet the criteria for
          recognition, they should be reclassified to goodwill. Similarly, if
          there are other intangible assets that meet the criteria for
          recognition but were not separately recorded from goodwill, they
          should be reclassified from goodwill.
     .    Reassess the useful lives of intangible assets and adjust the
          remaining amortization periods accordingly.
     .    Write-off any remaining negative goodwill.

The Company has not yet completed its full assessment of the effects of these
new pronouncements on its financial statements and so is uncertain as to the
impact. The standards will be required to be implemented by the Company by July
1, 2002.

Note 19.  Subsequent Event

The Company has participated in a pooled capital securities transaction to
securitize debt to be offered and sold to qualified buyers in a private
placement offering. The Company issued $5,000,000 of fixed rate middle market
capital securities in the offering, which closed in July 2001. The coupon for
the fixed rate securities is 10.25%, and the securities are non-callable for
five years. The debt will be recorded as a liability in the Company's
consolidated financial statements. The Company infused $3,000,000 of the
proceeds into the Bank, where it will be added to Tier 1 capital for regulatory
reporting purposes.

                                       57
<PAGE>

AF BANKSHARES, INC.
CORPORATE INFORMATION

                                   OFFICERS

<TABLE>
<S>                                          <C>
James A. Todd                                Melanie Paisley Miller
President and Chief Executive Officer        Executive Vice President, Secretary/Treasurer,
                                              Chief Financial Officer
</TABLE>



                                   DIRECTORS

Jan R. Caddell, Chairman                     Kenneth R. Greene, Vice Chairman

James A. Todd                                John D. Weaver

Jerry L. Roten                               Wayne R. Burgess

Jimmy D. Reeves                              Frank E. Roland

                                       58
<PAGE>

CORPORATE INFORMATION (Continued)

                                    OFFICES

<TABLE>
<S>                                                        <C>
Corporate Office                                           AF Brokerage Office
----------------                                           -------------------
21 East Ashe Street                                        206 S. Jefferson Avenue
West Jefferson, North Carolina 28694                       West Jefferson, North Carolina 28694

AF Bank Offices                                            AF Insurance Offices
---------------                                            --------------------
205 S. Jefferson Avenue                                    206 S. Jefferson Avenue
West Jefferson, North Carolina 28694                       West Jefferson, North Carolina 28694

840 E. Main Street                                         315 Main Street
Jefferson, North Carolina 28640                            North Wilkesboro, North Carolina 28659

4951 NC Hwy. 88 West                                       324 Morganton Blvd, SW
Warrensville, North Carolina 28693                         Lenoir, North Carolina 28645

403 South Main Street                                      403 South Main Street
Sparta, North Carolina 28675                               Sparta, North Carolina 28675

285 Highway 105                                            227A West Main Street
Boone, North Carolina 28607                                Elkin, North Carolina 28621

STOCK TRANSFER AGENT                                       400 Shadowline Drive, Suite 104
Mellon Investor Services, LLC                              Boone, North Carolina 28607
44 Wall Street, 6th Floor
New York, New York 10005                                   LEGAL COUNSEL
                                                           Vannoy & Reeves
AUDITORS                                                   306 East Main Street
McGladrey & Pullen, LLP                                    West Jefferson, North Carolina 28694
One Morrocroft Centre
6805 Morrison Boulevard, Suite 200                         Thacher Proffitt & Wood
Charlotte, North Carolina 28211                            1700 Pennsylvania Avenue
                                                           Washington, DC 20006
ANNUAL MEETING
The 2001 annual meeting of stockholders of                 FORM 10-KSB
AF Bankshares, Inc. will be held on                        A copy of Form 10-KSB as filed with the
November 5, 2001 at 6:00 p.m. at the Corporate             Office of Thrift Supervision will be
Office, 21 East Ashe Street, West Jefferson,               furnished without charge to shareholders upon
North Carolina 28694.                                      written request to James A. Todd, President,
                                                           AF Bankshares, Inc., 21 East Ashe Street, P.O.
                                                           Box 26, West Jefferson, North Carolina 28694.
</TABLE>

                                       59
<PAGE>

COMMON STOCK

The Company had 1,049,379 shares of common stock outstanding at August 31, 2001,
which are held by 419 shareholders of record. The majority of the outstanding
shares are held by the mutual holding company AsheCo, MHC. The remaining 511,158
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, 2001 and
2000. 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.

                                                            Stock Price
2001                                       Dividends      High         Low
--------------------------------------------------------------------------------
First Quarter                              $   0.05     $   8.75     $   7.50
Second Quarter                                 0.05         9.00         7.38
Third Quarter                                  0.05        11.00         8.25
Fourth Quarter                                 0.05        11.25        10.80

                                                            Stock Price
2000                                       Dividends      High         Low
--------------------------------------------------------------------------------
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

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

                                       60

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